JOSHUA D. COVAL, Harvard Business School, National Bureau of Economic Research (NBER)
Email: jcoval@hbs.edu
JAKUB W. JUREK, Princeton University - Bendheim Center for Finance
Email: jjurek@princeton.edu
ERIK STAFFORD, Harvard Business School
Email: estafford@hbs.edu

The essence of structured finance activities is the pooling of economic assets (e.g. loans, bonds, mortgages) and subsequent issuance of a prioritized capital structure of claims, known as tranches, against these collateral pools. As a result of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. We examine how the process of securitization allowed trillions of dollars of risky assets to be transformed into securities that were widely considered to be safe, and argue that two key features of the structured finance machinery fueled its spectacular growth. At the core of the recent financial market crisis has been the discovery that these securities are actually far riskier than originally advertised.

STEVEN L. SCHWARCZ, Duke University - School of Law
Email: schwarcz@law.duke.edu

This short and accessible paper, based on a keynote speech for a law review symposium, addresses how and why the financial crisis occurred and what should be done to avoid future crises. Among other things, the paper explains why neither the making of subprime mortgages nor the originate-and-distribute model pursuant to which these mortgages were monetized was per se evil; why the governmental regulatory structure failed to deter the crisis; and why the governmental bailout plan under the Emergency Economic Stabilization Act is critically needed and where it may be deficient. The paper also explains the difficulties in valuing mortgage-backed securities and in locating the ultimate holders of risk under credit default swaps and the relationship between financial market breakdown and counterparty risk.

OGUZHAN KARAKAS, London Business School - Department of Finance
Email: okarakas.phd2005@london.edu

This paper proposes a new approach of inferring the value of voting rights attached to a stock by using options. This method might help solve the problems present in previous studies on the value of control such as endogeneity and data availability. The paper also has implications for option pricing literature. It provides a rational explanation for some of the widely documented violations of put-call parity. Using a sample of 80 US public companies intervened by activist hedge funds from 2002 to the first half of 2006 and their industry- and size-matched firms, I find that the average percentage and probability of lower-bound put-call parity violations are higher for the companies after they are attacked by hedge funds, which is consistent with the predictions of the model.

JOHN A. HASLEM, University of Maryland - Robert H. Smith School of Business
Email: jhaslem@rhsmith.umd.edu

The Investment Company Act of 1940 states that the interests of shareholders are compromised when mutual funds are operated in the interest of fund advisers. In this regard, one of the Act's major objectives is to ensure investors receive adequate and accurate information.

This study focuses on achievement of normative transparency of disclosure. Normative transparency is the degree of mutual fund voluntary, proactive disclosure and legal and regulatory disclosure required for shareholders to be able to make normative fund investment decisions.

Normative transparency of disclosure requires changes in the current practices of individual mutual funds across the fund industry, and also in current laws and regulation. Implicit in shareholder ability to make normative investment decisions is prohibition with disclosure of those fund behaviors that impede shareholder ability to make normative investment decisions.

If Congress and the SEC were to enact and require, respectively, laws and regulations requiring normative transparency of disclosure, these mandates would be all that should be required. While additional laws and regulatory disclosure are likely to be forthcoming, it is most unlikely that the political process will achieve normative transparency. However, the political obstacles are much more likely to be overcome if individual mutual funds and funds collectively work vigorously and proactively in cooperation with Congress and the SEC.

Thus, the achievement of normative transparency of disclosure requires mutual fund advisors, managers and independent directors to work voluntarily, proactively and collectively to achieve normative transparency. However, it is also highly unlikely that these efforts will be collectively optimized as normatively transparent. Further, what is normative transparency of disclosure today will evolve over time as fund, fund industry, shareholder, and legal and regulatory conditions change. Thus, there is need for this study to benchmark normative transparency as a stimulus to achievement of actual normative transparency of fund disclosure.

Normative transparency includes prohibition with disclosure of mutual fund actions that are inappropriate, but also changes in those laws, regulations, and practices that provide incorrect, incomplete, missing, misleading and perfunctory disclosure. The prohibitions should include 12b-1 fees, soft-dollar arrangements, revenue sharing agreements, market timing, and late trading, among others. Normative transparency also requires standardized disclosure of fair-value pricing.

To attain normative transparency in mutual fund disclosure, Congress, the SEC, and mutual fund advisers, managers and independent directors must voluntarily and collectively become more proactive in serving and protecting shareholders. Basically, achievement of fund normative transparency rests with independent directors who are proactively motivated and further empowered to vigorously pursue their fiduciary mandate of shareholder "watchdogs."

GEETESH BHARDWAJ, AIG Financial Products
Email: geetesh.bhardwaj@gmail.com
GARY B. GORTON, Yale School of Management, National Bureau of Economic Research (NBER)
Email: gary.gorton@yale.edu
K. GEERT ROUWENHORST, Yale School of Management, International Center for Finance
Email: k.rouwenhorst@yale.edu

Investors face significant barriers in evaluating the performance of hedge funds and commodity trading advisors (CTAs). The only available performance data comes from voluntary reporting to private companies. Funds have incentives to strategically report to these companies, causing these data sets to be severely biased. And, because hedge funds use nonlinear, state-dependent, leveraged strategies, it has proven difficult to determine whether they add value relative to benchmarks. We focus on commodity trading advisors, a subset of hedge funds, and show that during the period 1994-2007 CTA excess returns to investors (i.e., net of fees) averaged 85 basis points per annum over US T-bills, which is insignificantly different from zero. We estimate that CTAs on average earned gross excess returns (i.e., before fees) of 5.4%, which implies that funds captured most of their performance through charging fees. Yet, even before fees we find that CTAs display no alpha relative to simple futures strategies that are in the public domain. We argue that CTAs appear to persist as an asset class despite their poor performance, because they face no market discipline based on credible information. Our evidence suggests that investors' experience of poor performance is not common knowledge.