The Paradoxical Stock Buyback

The Paradoxical Stock Buyback

From 2004 through 2011 the S&P 500 companies spent $2.7 trillion buying back their own stock. A recent article in the WSJ discussed how companies tend to buy back their stocks when they are flush with cash, which usually happens during market boom periods. But when markets are booming, it is likely that companies’ stock prices are also high. In other words, companies buy back their stock when it is likely to be overvalued. In fact, according to this Thomson Reuters report, share repurchases have a 76% correlation with the value of the S&P 500.  This is an interesting problem. Management should know the most about its stock (in theory, at least) and be the most rational about it. So in an informationally-inefficient market, management is the most informationally-efficient. Then why does it behave so irrationally? There are three possible reasons right off the top of my head: Just because it knows the…

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The TED Spread and Europe: Another Risk Premium

The TED Spread and Europe: Another Risk Premium

The TED spread is the difference between the three-month commercial interbank lending rate (LIBOR) and the three-month US Treasury bill yield. LIBOR is a rate that is used to measure the cost of bank-to-bank lending and borrowing.  The US Treasury bill yield is generally interpreted as the de facto risk free rate. So the difference between the two indicates whether a bank would prefer to lend to another bank (a risky entity), or to invest in a risk free security, which depends on how risk averse the banks are feeling…

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GMAN 507 Bonus Assignment: The Market Risk Premium

Today, on the economics blog Marginal Revolution, economist Tyler Cowen wrote the following (the bold-face was added by me): It is often claimed that the governments of the United States, the UK, and Germany should spend more money because they can borrow at low rates, thus raising the present expected return on the investment considered as a whole. Maybe, but keep in mind that the interest rates on quality government debt are down, in part, because the risk premium is up. Non-governmental investments are perceived as riskier.It is also possible…

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Last Post on Facebook (I Promise)

(Written for a local newspaper op-ed, but rejected) More than seven thousand IPOs in the last thirty years have returned, on average, just under 18% on the first day itself. In the case of Facebook, this return was less than 1% (using the pre-IPO price of $38).  It has also been shown that underwriters generally price IPOs conservatively, that is, below what they think will be the actual fair market value. They do this for two reasons: firstly, they are not completely sure how the market will react to the…

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The Most Important News Event of All Time

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