Comments on "A reconsideration of tax shield valuation" by Enrique R. Arzac and Lawrence R. Glosten

While Arzac and Glosten (2005) affirm that "the value of tax shields depends upon the nature of the equity stochastic process, which, in turn, depends upon the free cash flow process," I prove that the value of tax shields depends only upon the nature of the stochastic process of the net increase of debt. Arzac and Glosten (2005) formulate the constant leverage ratio assumption as Dt = L•Et. The assumption of Fernández (2004) is E{Dt}= L•E{Et}, where E{•} is the expected value operator, D the value of debt, E the equity value, and L a constant. The Arzac and Glosten (2005) assumption requires continuous debt rebalancing, while mine does not. Under both financial policies, the expected leverage ratio is constant, but the Arzac and Glosten (2005) assumption is too extreme.Value of tax shields; required return to equity; cost of capital; net increase of debt;

Asymptotic Glosten Milgrom equilibrium

This paper studies the Glosten Milgrom model whose risky asset value admits an arbitrary discrete distribution. Contrast to existing results on insider's models, the insider's optimal strategy in this model, if exists, is not of feedback type. Therefore a weak formulation of equilibrium is proposed. In this weak formulation, the inconspicuous trade theorem still holds, but the optimality for the insider's strategy is not enforced. However, the insider can employ some feedback strategy whose associated expected profit is close to the optimal value, when the order size is small. Moreover this discrepancy converges to zero when the order size diminishes. The existence of such a weak equilibrium is established, in which the insider's strategy converges to the Kyle optimal strategy when the order size goes to zero

Point process bridges and weak convergence of insider trading models

We construct explicitly a bridge process whose distribution, in its own filtration, is the same as the difference of two independent Poisson processes with the same intensity and its time 1 value satisfies a specific constraint. This construction allows us to show the existence of Glosten-Milgrom equilibrium and its associated optimal trading strategy for the insider. In the equilibrium the insider employs a mixed strategy to randomly submit two types of orders: one type trades in the same direction as noise trades while the other cancels some of the noise trades by submitting opposite orders when noise trades arrive. The construction also allows us to prove that Glosten-Milgrom equilibria converge weakly to Kyle-Back equilibrium, without the additional assumptions imposed in \textit{K. Back and S. Baruch, Econometrica, 72 (2004), pp. 433-465}, when the common intensity of the Poisson processes tends to infinity

Limit order books and trade informativeness

In the microstructure literature, information asymmetry is an important determinant of market liquidity. The classic setting is that uninformed dedicated liquidity suppliers charge price concessions when incoming market orders are likely to be informationally motivated. In limit order book markets, however, this relationship is less clear, as market participants can switch roles, and freely choose to immediately demand or patiently supply liquidity by submitting either market or limit orders. We study the importance of information asymmetry in limit order books based on a recent sample of thirty German DAX stocks. We find that Hasbrouck’s (1991) measure of trade informativeness Granger-causes book liquidity, in particular that required to fill large market orders. Picking-off risk due to public news induced volatility is more important for top-of-the book liquidity supply. In our multivariate analysis we control for volatility, trading volume, trading intensity and order imbalance to isolate the effect of trade informativeness on book liquidity. JEL Classification: G14 Keywords: Price Impact of Trades , Trading Intensity , Dynamic Duration Models, Spread Decomposition Models , Adverse Selection Ris

No Trade, Informed Trading, and Accuracy of Information

We present a model in which there is uncertainty about realization of a risky asset value for an informed trader. We introduce two states such that in the "narrow" state the informed trader has better information than in the "wide" state. Then, we show that the informed trader in the wide state does not trade in equilibrium if the information that the informed trader with better information has is sufficiently accurate and the probability of the narrow state is sufficiently high. We use the framework presented by Glosten and Milgrom (1985) and extend the assumption that the informed trader knows the terminal value of the risky asset. Finally, we obtain the conditions under which the informed trader would not trade in equilibrium.Market microstructure; Glosten-Milgrom; Price formation; Asymmetric information; Bid-ask spreads.

Incentive Compatibility and Differentiability New Results and Classic Applications

We provide several generalizations of Mailath's (1987) result that in games of asymmetric information with a continuum of types incentive compatibility plus separation implies differentiability of the informed agent's strategy. The new results extend the theory to classic models in finance such as Leland and Pyle (1977), Glosten (1989), and DeMarzo and Duffie (1999), that were not previously covered

Assessing the relation between equity risk premium and macroeconomic volatilities in the UK

This paper uses the exponential GARCH-in-mean model to analyse the relationship between the equity risk premium and macroeconomic volatility. This premium depends upon conditional volatility, which is significantly affected by the long bond yield, acting as a proxy for the underlying rate of inflation

Incentive Compatibility and Differentiability: New Results and Classic Applications

This note provides several generalizations of Mailath's (1987) result that incentive compatibility plus separation implies differentiability. The new results extend the theory to classic models in finance such as Leland and Pyle (1977), Glosten (1989), and De Marzo and Duffie (1999), that were not previously covered.Adverse selection, separation, differentiable strategies, incentive-compatibility