An Analytic Solution for Interest Rate Swap Spreads
Mark Grinblatt (Anderson School at UCLA)

This paper argues that liquidity differences between government securities and short-term Eurodollar borrowings account for interest rate swap spreads. It then models the convenience of liquidity as a linear function of two mean-reverting state variables and values it. The interest rate swap spread for a swap of particular maturity is the annuitized equivalent of this value. It has a closed form solution: a simple integral. Special cases examined include the Vasicek and Cox-Ingersoll-Ross one-factor term structure models. Numerical values for the parameters in both special cases illustrate that many realistic ‘swap spread term structures’ can be replicated. Model parameters are estimated using weekly data on the term structure of swap spreads from several countries. The model fits the data well.
*The author is grateful to the UCLA Academic Senate for financial support and to Francis Longstaff, Walter Torous, Wolfgang Buehler, Suresh Sundaresan, William Perraudin, Adam Olive, Yacine Ait-Sahalia, Arthur Warga, the editor Sheridan Titman, an anonymous referee and seminar participants at the UCLA Fixed Income Conference, the NBER and the CEPR Summer Symposium in Financial Markets for helpful comments and discussions. He also wishesto acknowledge the special contribution of Bing Han, whose assistance was invaluable in completing this paper.

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On the Demand Elasticity of Initial Public Offerings: An Analysis of Discriminatory Auctions
Yu-Jane Liu (Department of Finance, National Chengchi University, Taipei)
K. C. John Wei (Department of Finance, Hong Kong University of Science and Technology)
Gwohorng Liaw (Department of Economics, Tunghai University, Taiwan)

We analyze 52 Taiwanese IPOs that were introduced through discriminatory auctions (you pay what you bid) between December 1995 and October 1998. The evidence suggests that the elasticity of demand for IPOs in Taiwan through discriminatory auctions is relatively flat. The elasticity is significantly negatively correlated with bidders’ heterogeneity, which is consistent with the investor heterogeneity hypothesis. We also find that the average winning bidders earn a significant average abnormal return of 7.83% in the post-IPO market. The post-IPO market abnormal return is positively correlated with the demand elasticity, the idiosyncratic risk of stock returns and the institutional participation rate, and is negatively correlated with the auction clearing price, which is consistent with theory. Finally there is evidence that informed investors have an incentive to shade their demand for IPOs to avoid the winner’s curse. The most aggressive bidders (the top 5% of the winning bidders) on average incur a small loss of 1.64% (not significant) in the market-adjusted initial returns.
*The authors thank the Chinese Securities Association for providing the auction data, and Jay Ritter, Ann Sherman, Sheridan Titman (the editor), Avi Wohl, two anonymous referees and seminar participants at the 2001 American Finance Association meetings in New Orleans, the 2000 NTU International Conference on Finance in Taipei, the Chinese Finance Association meetings in Taipei, the Seventh Conference on the Theories and Practices of Security and Financial Markets in National Sun Yat-sen University, Kaoshiung, Taiwan(1998) and the Hong Kong University of Science and Technology for their comments and suggestions and Dr Virginia Unkefer for editorial assistance. The paper won the best paper award in the 2000 NTU International Conference on Finance. John Wei acknowledges the financial support from the RGC Research Infrastructure Grant of Hong Kong Special Administration Region, China(RI/93/94.BM02) and the Wei Lun Fellowship.

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Investing Public Pensions in the Stock Market: Implications for Risk Sharing, Capital Formation and Public Policy in the Developed and Developing World
Deborah Lucas (Northwestern University, Kellogg School of Management)

Concerns that existing public pension systems will be unable to pay benefits to a rapidly ageing population without sharp tax increases, and the prospect of higher average returns on stocks than on government securities, are drawing the attention of policy-makers worldwide to the option of investing public pension assets in stocks. Including stock market investments in public pension plans could improve risk sharing within and between generations, and could perhaps lead to faster market development in some countries. It could also result in excessive risk-taking, higher transactions costs and a false sense of increased financial security. This paper assesses these issues, with an emphasis on the considerations that are of special importance to developing markets. A contrast is drawn between the demographic outlook in East Asia and the major industrialized counties. Some lessons are drawn from the reform experience in Chile and elsewhere in Latin America.
*Prepared for the APFA 2001 Conference, July 2001, Bangkok, Thailand. The views expressed in this paper are those of the author, and should not be interpreted as those of the Congressional Budget Office. Parts of this paper are drawn from work with John Heaton, ‘Investing Public Pensions in the my colleagues at the Congressional Budget Office, and members of the 1999 Social Security Technical Advisory Panel, for helping to shape my views on these issues.

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