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A Generalized Econometric Model and Tests of a Signalling Hypothesis with Two Discrete Signals

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  • Acharya, Sankarshan
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    Abstract

    To test the major prediction of a signalling hypothesis-that the market price is m onotonic in the signal-the price response to the signal must be measu red. Since a signal is an outcome of a rational decision rule of the signaller, the market can infer the true type of the signaller from t he signal. This necessitates estimation of the price response to the signal, conditional on the rational decision rule. Thus, the empirica l models (e.g., event studies in corporate finance) that estimate the market price responses to signals without conditioning on the ration al decision rules are misspecified if viewed as tests of the predicti on of a signalling hypothesis. This paper builds a generalized econom etric model with two possible discrete signals, derives the rational decision rules, presents a simple estimator of the price response to a signal, and illustrates its use in testing a recently expounded hyp othesis that firms signal their true value by forcing or not forcing an outstanding convertible bond. Copyright 1988 by American Finance Association.

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    Bibliographic Info

    Article provided by American Finance Association in its journal Journal of Finance.

    Volume (Year): 43 (1988)
    Issue (Month): 2 (June)
    Pages: 413-29

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    Handle: RePEc:bla:jfinan:v:43:y:1988:i:2:p:413-29

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    Cited by:
    1. Berger, Allen N. & Herring, Richard J. & Szego, Giorgio P., 1995. "The role of capital in financial institutions," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 393-430, June.
    2. Sanjai Bhagat & Roberta Romano, 2001. "Event Studies and the Law - Part I: Technique and Corporate Litigation," Yale School of Management Working Papers amz2475, Yale School of Management, revised 01 Jan 2002.
    3. John G. Riley, 2001. "Silver Signals: Twenty-Five Years of Screening and Signaling," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 432-478, June.
    4. Datta, Sudip & E. Iskandar-Datta, Mai, 1995. "Corporate partial acquisitions, total firm valuation and the effect of financing method," Journal of Banking & Finance, Elsevier, vol. 19(1), pages 97-115, April.
    5. William H. Greene & David A. Hensher, 2008. "Modeling Ordered Choices: A Primer and Recent Developments," Working Papers 08-26, New York University, Leonard N. Stern School of Business, Department of Economics.
    6. repec:dgr:uvatin:2012060 is not listed on IDEAS
    7. Scruggs, John T., 2007. "Estimating the cross-sectional market response to an endogenous event: Naked vs. underwritten calls of convertible bonds," Journal of Empirical Finance, Elsevier, vol. 14(2), pages 220-247, March.
    8. Andres, Christian & Betzer, André & Doumet, Markus & Theissen, Erik, 2013. "Open market share repurchases in Germany: A conditional event study approach," CFR Working Papers 13-02, University of Cologne, Centre for Financial Research (CFR).
    9. Kjell Bjørn Nordal, 2006. "Banks’ optimal implementation strategies for a risk sensitive regulatory capital rule: a real options and signalling approach," Working Paper 2006/12, Norges Bank.

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