> For the complete documentation index, see [llms.txt](https://laurence-wilse-samson.gitbook.io/textbooks/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://laurence-wilse-samson.gitbook.io/textbooks/financial-economics-claims-prices-holders/back-matter/glossary.md). # Glossary Every term the chapters mark as a key term, merged and alphabetised, with the chapter that defines it. Generated by `code/build_backmatter.py`; do not edit by hand. ## A **Abnormal return** $$AR\_{i,t}$$ (Ch 7). Realized return minus a benchmark, commonly the fitted market model $$\hat\alpha\_i + \hat\beta\_i R\_{M,t}$$ **Active share** (Ch 17). Degree to which a portfolio differs from its benchmark; the measure that separates genuine active management from closet indexing **Adverse selection component** (Ch 11). The part of the spread that compensates the liquidity supplier for systematically losing to traders who know more than she does; the part that survives zero costs and infinite capital **Adverse selection (in issuance)** (Ch 23). The transfer from existing to new shareholders when a firm with favorable private information issues equity, which makes such firms decline positive-net-present-value projects and makes the market mark down every issuer **Affine term structure model** (Ch 9). A model in which the short rate and the market prices of risk are affine in a low-dimensional state, so that yields are affine in that state and one kernel prices the whole curve **Agency cost** (Ch 24). In Jensen and Meckling's accounting, the sum of the principal's monitoring expenditures, the agent's bonding expenditures, and the residual loss that survives both; capitalized into the price at which an owner-manager can sell equity **Agency guarantee** (Ch 13). The undertaking by Ginnie Mae, Fannie Mae, or Freddie Mac to make MBS holders whole on defaulted loans, paid for by the guarantee fee, which removes credit risk from the claim and leaves prepayment timing **Amihud's ILLIQ** (Ch 11). The average ratio of absolute daily return to daily dollar volume; a price impact measure computable from free daily data **Announcement return** (Ch 22). The abnormal return around a deal's announcement, measured as in Chapter 7 §7.3; large and positive for targets, near zero to slightly negative for acquirers, small and positive for the combination **Arbitrage** (Ch 3). A portfolio with non-positive cost today and a payoff that is non-negative in every state and strictly positive in some **Arbitrage pricing theory (APT)** (Ch 6). Ross's (1976) result that a factor structure plus the absence of near-arbitrage forces expected returns to be approximately linear in factor loadings **Asset location** (Ch 14). The allocation of a given portfolio across taxable, tax-deferred, and Roth accounts so as to minimize the present value of taxes — heavily taxed income in tax-deferred accounts, equities in taxable — as distinct from asset *allocation* **Asset partitioning** (Ch 21). The separation of a firm's asset pool from its owners' personal estates in both directions; entity shielding is the direction contracts cannot cheaply replicate **Asset specificity** (Ch 21). The extent to which an investment supporting a transaction is worth more inside that relationship than in its next-best use; site, physical, human, and dedicated-asset forms **Attachment and detachment points** (Ch 10). The fractions of pool loss at which a tranche begins and finishes absorbing losses; a tranche is a call spread on the pool's loss distribution **Authorized participant (AP)** (Ch 17). A broker-dealer with a contractual right to transact creation units directly with an ETF; the arbitrageur in the ETF price mechanism ## B **Backtesting** (Ch 26). Counting realized losses that exceeded the model's own VaR and comparing the count with the model's prediction; low-powered at high confidence levels, and blind to clustering **Balance sheet** (Ch 2). A statement of what an agent owns and owes at an instant, with net worth as the residual that forces the two sides to balance **Balance-sheet capacity** (Ch 19). The quantity of claims an intermediary can hold given its equity and the capital, leverage, and margin constraints it faces; the scarce resource in every episode in this chapter **Bank-dependent firm** (Ch 25). A borrower with no access to the syndicated, bond, or private-credit doors, whose total borrowing therefore moves close to one for one with its lenders' capacity **Barnesian** (Ch 7). When use improves the model's fit **Basis risk** (Ch 26). The residual risk that the hedging instrument and the exposure do not move together — because of maturity, location, grade, or contract specification **Basis trade** (Ch 9). Long cash Treasuries against short futures, financed in repo at high leverage; the mechanism tying cash and futures prices together and the most fragile holder position in the market **Batch auction** (Ch 11). A mechanism in which orders arriving over an interval are pooled and cleared at a single price, so that the market maker sees only the aggregate **Berk-Green equilibrium** (Ch 17). The outcome in which performance-chasing flows expand skilled managers' funds until decreasing returns to scale drive net-of-fee alpha to zero, so managers capture skill rents through size and investors earn the passive return **Beta** $$\beta\_i$$ (Ch 4). $$\mathrm{Cov}(r\_i, r\_M)/\mathrm{Var}(r\_M)$$; the quantity of systematic risk, equal to the regression slope of the asset's return on the market's **Betting against beta (BAB)** (Ch 4). A market-neutral portfolio long the low-beta assets levered to unit beta and short the high-beta assets scaled to unit beta; its return is $$\hat\alpha(1/\beta\_L - 1/\beta\_H)$$ **Bid-ask spread** $$s$$ (Ch 11). The difference between the price at which a liquidity supplier will buy and the price at which she will sell; decomposes into order processing, inventory, and adverse-selection components **Black-Scholes formula** (Ch 8). $$C\_0 = S\_0N(d\_1) - Ke^{-rT}N(d\_2)$$, the continuous-time limit of the binomial model **Blockholder** (Ch 24). A shareholder whose stake is large enough to internalize a meaningful share of the gains from monitoring, and therefore to overcome part of the free-rider problem that afflicts diffuse ownership **Bookbuilding** (Ch 12). The dominant method of selling new equity, in which underwriters collect non-binding indications of interest from institutions during a roadshow, set a single price, and then allocate the shares at their own discretion **Book-to-market ratio** (Ch 6). Book equity divided by market equity; the value characteristic, and an increasingly imperfect one as intangible capital grows **Breakeven inflation** (Ch 9). Nominal yield minus TIPS yield; expected inflation plus an inflation risk premium minus a TIPS liquidity premium ## C **Call / put** (Ch 8). The right, not the obligation, to buy (respectively sell) the underlying at the strike $$K$$; payoffs $$\max(S\_T-K,0)$$ and $$\max(K-S\_T,0)$$ **Campbell-Shiller identity** (Ch 7). $$dp\_t \approx r\_{t+1} - \Delta d\_{t+1} + \rho dp\_{t+1}$$, which forces returns or dividend growth to be predictable if valuation ratios move **Cap rate** (Ch 13). Net operating income divided by price; a discount rate net of expected income growth, $$\mathrm{cap} = r - g$$ **CAPE** (Ch 7). Shiller's cyclically adjusted price-earnings ratio, price divided by a ten-year moving average of real earnings **Capital market line** (Ch 4). The line from $$r\_f$$ through the market portfolio in mean-standard-deviation space; the efficient frontier once a riskless asset exists **CARA-normal** (Ch 7). The tractability assumption pairing constant absolute risk aversion with normal payoffs, giving wealth-independent demands linear in the conditional mean **Carried interest (carry)** (Ch 18). The GP's share of fund profits, typically 20 percent, paid through the distribution waterfall and subject to clawback **Carry** (Ch 6). The return an asset earns if its price does not change — the interest differential in currencies, the futures basis in commodities, the yield in bonds **Cash-and-carry** (Ch 3). The arbitrage that enforces the forward price — borrow, buy the underlying, carry it to delivery **Catastrophe bond** (Ch 16). A security whose principal is forgiven on the occurrence of a defined catastrophe, transferring insurance risk to capital-market investors **CDS-bond basis** (Ch 10). The default swap spread minus the cash bond's spread; zero under a funding-free arbitrage, and therefore a direct measure of the shadow price of balance sheet when it is not **Characteristics-based demand** (Ch 20). The specification in which a holder's portfolio weight in an asset is a function of the asset's observable characteristics and its price, with holder-specific coefficients **Claim** (defined in 2 chapters, with different wording): * *Ch 1*: A contract entitling its holder to payments contingent on a state of the world. Every financial claim is simultaneously somebody's asset and somebody else's liability * *Ch 2*: A promise held by one party against another, defined by what is promised, how the promise is enforced, and where it ranks in seniority **Clientele** (Ch 23). A group of holders whose tax position, mandate, or horizon makes one form of payout or one type of claim strictly preferable, so that a change in firm policy imposes a cost on the holders who sorted in **Clientele effect (in liquidity)** (Ch 11). The equilibrium assignment of illiquid claims to long-horizon holders, which makes the liquidity premium concave in the spread **CLO (collateralized loan obligation)** (Ch 25). A vehicle holding a pool of leveraged loans and issuing rated tranches against it; the marginal holder of the leveraged-loan market, and the reason that market's terms take the form they do **Coefficient of relative risk aversion** $$\gamma$$ (Ch 5). The curvature of the utility function; under power utility it is also the price of consumption covariance and the reciprocal of the elasticity of intertemporal substitution **Coherent risk measure** (Ch 26). A measure satisfying monotonicity, translation invariance, positive homogeneity, and subadditivity (Artzner, Delbaen, Eber and Heath) **Collateral channel** (Ch 27). Transmission from asset prices to activity through the borrowing capacity of everyone who has pledged the repriced asset; mechanical, immediate, and independent of forecasts **Committed capital** (Ch 18). The amount an LP is contractually obliged to fund on demand, and the usual base for the management fee during the investment period — distinct from the capital actually invested **Common ownership** (Ch 17). The holding of significant stakes in competing firms by the same institutional investors, and the hypothesis that this softens product-market competition **Complete market** (Ch 3). A market in which every payoff over the state space can be replicated by traded assets; equivalently, one in which state prices are unique **Constraint** (Ch 1). Anything that makes a holder's demand for a claim depend on something other than the claim's risk and expected return — a mandate, a capital charge, a redemption term, a benchmark, an index rule, a tax status, or inertia **Consumption-based model** (Ch 5). The asset-pricing model that takes $$m = \delta u'(c\_{t+1})/u'(c\_t)$$ literally and measures $$c$$ from national accounts data **Contango / backwardation** (Ch 8). Futures above spot ($$y < r\_f$$) and futures below spot ($$y > r\_f$$) **Convenience yield** $$\mathrm{cy}\_t$$ (Ch 9). The price premium a claim commands for the money-like services it provides — settlement, collateral, regulatory eligibility — over and above the discounted value of its cash flows **★ convention** (Ch 1). A star in a section heading marks a PhD-track section, in a problem marks a harder problem, and in a data exercise marks an extension requiring licensed data. The body of every chapter is complete without any of them **Conversion / reversal** (Ch 8). The arbitrage packages that enforce parity — long stock, long put, short call against borrowing, and its mirror **Convexity** $$C$$ (Ch 9). The second derivative of price with respect to yield, scaled by price; positive convexity makes rallies worth more than selloffs cost **Convexity hedging** (Ch 13). Trading duration — selling Treasuries and paying fixed in swaps as rates rise, and the reverse as they fall — to restore a target exposure after a mortgage portfolio's duration has moved **Cost of carry** (Ch 8). Interest plus storage less the yield thrown off by holding the physical asset; the wedge between spot and forward **Cost-of-capital channel** (Ch 27). Transmission from asset prices to real activity through the discount rate applied to investment projects and through the terms on which claims can be issued **Counterperformative** (Ch 7). When use undermines the conditions the model requires **Covenant** (Ch 24). A term in a credit agreement or indenture that constrains the borrower and, on breach, transfers specified decision rights to the lender; the fine structure of Chapter 21 §21.4's state-contingent control allocation **Cov-lite** (Ch 24). A loan carrying incurrence covenants only, now the standard structure in the US institutional leveraged loan market; a repricing of the lender's control right, not a documentation detail **Creation/redemption** (Ch 17). The process by which ETF shares are issued and retired in blocks against a published basket of underlying securities, tethering the ETF price to net asset value **Credit spread** (Ch 10). The yield on a defaultable claim minus the yield on an otherwise identical riskless claim, $$s = y - r\_f$$; the compensation for everything that distinguishes the two **Credit spread puzzle** (Ch 10). The finding that observed investment-grade spreads greatly exceed both the expected default loss implied by historical default and recovery rates and the spreads that structural models calibrated to those rates can generate **Credit supply shock** (Ch 25). A change in the credit a lender is willing to extend that originates in the lender's own balance sheet rather than in the borrower's prospects; identified in practice by comparing differently shocked lenders to the same borrower **Credit triangle** (Ch 10). The identity $$s \approx \mathrm{PD}^{\ast} \times \mathrm{LGD}$$, in which any two of spread, risk-neutral default probability, and loss given default determine the third **Crowding** (Ch 6). Shared exposure to the same positions across levered holders; invisible in a return covariance matrix because it is a fact about holdings **Cumulative abnormal return** $$CAR\_i(t\_1,t\_2)$$ (Ch 7). The sum of abnormal returns across an event window ## D **Dealer** (Ch 19). An intermediary that quotes two-sided prices and absorbs the timing difference between buyers and sellers onto its own balance sheet, financing the resulting inventory in short-term secured markets **Decomposition problem** (Ch 9). The dependence of any expectations/term-premium split on an unobserved model of short-rate persistence, which samples of available length identify weakly **Default correlation** (Ch 10). The dependence between obligors' default events; it leaves a pool's expected loss unchanged while determining how that loss is distributed across tranches **Default effect** (Ch 14). The tendency of a household to remain in whatever allocation, contribution rate, or plan status it is placed in absent an active choice; the empirical basis for treating plan design as an asset-allocation decision made by the sponsor **Default rules** (Ch 21). The terms corporate law supplies when the parties' own contract is silent — board authority, fiduciary standards, voting and quorum rules — which allocate residual control unless and until the charter contracts around them **Default-adjusted short rate** (Ch 10). $$r\_t + \lambda^{\ast}\_t\mathrm{LGD}\_t$$, the rate at which a defaultable bond discounts under recovery of market value (Duffie-Singleton), which lets riskless term-structure machinery price credit **Delegated monitoring** (Ch 19). The Diamond (1984) rationale for intermediation — one agent monitors borrowers on behalf of many savers, and funds itself with debt against a diversified portfolio so that no one need monitor the monitor **Delta hedge** (Ch 26). Holding $$\Delta$$ units of the underlying against an option position so that the combination is locally insensitive to the underlying's price; requires rebalancing because $$\Delta$$ moves with the price and with time **Demand elasticity (**$$\zeta$$**)** (Ch 20). The percentage reduction in the quantity of a claim a holder wishes to hold in response to a one percent increase in its price, holding characteristics fixed **Demand system** (Ch 20). A set of estimated demand functions, one per holder, over the full set of claims, closed by market clearing; the asset-pricing analogue of a consumer demand system **Demand-based option pricing** (Ch 8). The framework in which an option's deviation from its frictionless price is proportional to end-user net demand times the unhedgeable risk of the dealer's inventory **Denominator effect** (Ch 18). The mechanical rise in a portfolio's private-asset percentage when public marks fall and private marks do not, which can force sales or halt new commitments at exactly the wrong time **Direct listing** (Ch 12). Registration of existing shares for trading with no new shares sold and no underwriter allocation, with supply set by existing holders in an opening auction **Disposition effect** (Ch 15). The tendency to realize gains at a higher rate than losses; predicted by reference dependence with diminishing sensitivity, measured in brokerage records by Odean, and costly because the winners sold outperform the losers kept **Distance to default** (Ch 10). The number of standard deviations of log asset value separating a firm from its default point; the KMV implementation's central statistic, mapped to a probability by an empirical frequency table **Distress costs** (Ch 23). The resources consumed by, and the decisions distorted in anticipation of, financial distress — direct fees, which are small, and indirect costs including customer and supplier flight, debt overhang, and risk-shifting, which are not **Distributional Financial Accounts (DFA)** (Ch 14). The Federal Reserve's quarterly distribution of the Z.1 household balance sheet across wealth groups, constructed by applying Survey of Consumer Finances shares to the aggregate; the source for Table 14.4 and for the concentration claim of §14.6 **Diversification** (Ch 4). The reduction in portfolio variance obtained by spreading holdings across imperfectly correlated assets; it removes own variance and leaves average covariance **Dollar factor** (Ch 6). The average excess return on foreign currencies against the dollar; the level factor in the currency cross-section **Dominance** (Ch 3). The relation between payoffs when one is at least as large in every state and larger in some; ruling it out requires the dominating payoff to cost more **Double sort** (Ch 6). A two-dimensional sort, independent or conditional, used to measure one characteristic's effect holding another fixed **Dry powder** (Ch 18). Capital committed to funds but not yet called; its accumulation raises entry valuations and depresses the returns of the vintage being deployed ## E **Early-exercise premium** (Ch 8). The excess of an American option's value over the otherwise identical European one, positive for puts and for calls on dividend-paying stocks **Effective spread** (Ch 11). Twice the distance from the prevailing midpoint to the execution price; splits into the realized spread and the price impact **Efficient frontier** (Ch 4). The set of portfolios with minimum variance for each attainable expected return, restricted to the upward-sloping branch **Efficiently inefficient markets** (Ch 7). The modern resolution — prices are inefficient enough to compensate those who bear the costs of information and arbitrage, and efficient enough that no one else profits **Elasticity of intertemporal substitution** $$\psi$$ (Ch 5). Willingness to move consumption across time in response to the interest rate; forced to equal $$1/\gamma$$ under power utility, free under Epstein-Zin **Epstein-Zin (recursive) preferences** (Ch 5). A utility recursion over current consumption and the certainty equivalent of continuation utility, separating $$\gamma$$ from $$\psi$$ **Equity premium puzzle** (Ch 5). The finding that the consumption-based model requires an implausibly large $$\gamma$$ to match the historical equity premium **Equivalent martingale measure** (Ch 8). The measure under which discounted prices are martingales; it exists if and only if there is no arbitrage, and is unique if and only if markets are complete **Errors-in-variables problem** (Ch 6). The attenuation of second-pass coefficients caused by using estimated betas as regressors; corrected by Shanken (1992) **Event study** (Ch 7). A test of semi-strong efficiency using a narrow window around a dated event, so that misspecification of expected returns cannot account for the finding **Excess volatility** (Ch 7). The finding that prices vary more than the bound $$\sigma(P) \le \sigma(P^{\ast})$$ permits, where $$P^{\ast}$$ is the perfect-foresight price **Expectations hypothesis** (Ch 9). The claim that long yields are averages of expected future short yields; equivalently, that $$m$$ and future short rates are uncorrelated **Expected shortfall (ES)** (Ch 26). The mean loss conditional on exceeding the VaR threshold; the coherent alternative, and far more sensitive to tail shape **External finance premium** (Ch 27). The wedge between the cost of funds raised externally and the opportunity cost of internal funds, arising from monitoring and enforcement costs and decreasing in borrower net worth **Extrapolative expectations** (Ch 15). Beliefs about future returns formed by projecting recent returns forward; documented across six independent survey series, procyclical, and negatively correlated with the countercyclical required returns implied by rational models of predictability ## F **Factor capacity** (Ch 6). The industry-wide capital at which a strategy's net alpha reaches zero; Berk-Green's $$A^{\ast} = (a-f)/b$$ applied to a trade rather than a fund **Factor structure** (Ch 6). The assumption that common variation in a large cross-section of returns is spanned by a small number of factors, leaving idiosyncratic residuals **Factor zoo** (Ch 6). The several hundred published characteristics claimed to predict the cross-section, most of which do not survive a multiple-testing-adjusted hurdle **Factor-mimicking portfolio** (Ch 6). A portfolio with unit loading on one factor and zero on the rest; its expected excess return is that factor's price of risk $$\lambda\_k$$ **Fallen angel** (Ch 10). A bond downgraded from investment grade to speculative grade, and therefore ineligible for the mandates and indices that governed a large share of its previous holders **Fama-MacBeth regression** (Ch 6). The two-pass estimator — time-series regressions for loadings, then period-by-period cross-sectional regressions for $$\hat\alpha\_t$$ and $$\hat\lambda\_{k,t}$$, with inference from the time series of the estimates **Financial accelerator** (Ch 27). The feedback by which a shock to net worth raises the external finance premium, lowers investment, and lowers net worth again, amplifying and propagating the original shock **Financial Accounts of the United States (Z.1)** (Ch 2). The Federal Reserve's quarterly statistical release reporting sector balance sheets and intersectoral claims for the US economy, published since the 1950s and known by its release code **Financial deepening** (Ch 27). Growth in the stock of financial claims relative to output, usually measured as private credit or liquid liabilities to GDP; a measure of holder demand as much as of capital allocation **Financing wall** (Ch 25). The discontinuity in a firm's menu created by the fixed costs of public-market access — rating, disclosure, underwriting, index-eligibility minimums — which are invariant to issue size and therefore exclude small firms from the doors that price most efficiently at scale **Fire sale** (Ch 16). Forced selling at depressed prices due to balance sheet constraints **Flight to liquidity** (Ch 11). The reallocation, in stress, from claims that can be exited to claims that can be exited faster, at a price **Float adjustment** (Ch 17). The construction of index weights using only shares available to public investors, excluding strategic and insider blocks **Flow** (Ch 20). A dollar of demand entering or leaving a market, financed by a transaction in another asset and unaccompanied by news about cash flows **Flow versus stock** (Ch 2). A flow is a quantity per unit of time (saving, issuance, fund inflows); a stock is a quantity at an instant (wealth, debt outstanding, assets under management). The Financial Accounts publish matched flow and stock tables, with revaluation reconciling the two **Flow-performance relationship** (Ch 16). Tendency of investors to move money toward recent winners **Forward contract** (Ch 8). An obligation to trade at a price $$F$$ fixed today, settled once at maturity; payoff $$S\_T - F$$ **Forward rate** $$f^{(n)}$$ (Ch 9). The rate for borrowing between $$n-1$$ and $$n$$ contracted today, pinned by no arbitrage at $$p^{(n-1)}/p^{(n)} - 1$$ **Fraud on the market** (Ch 24). The presumption, from *Basic v. Levinson*, that a purchaser in an efficient market relied on the integrity of the price rather than on the misstatement itself — the doctrine that makes the securities class action possible (Box 24.1) **Free cash flow** (Ch 24). Cash flow in excess of what is required to fund all projects with positive net present value at the relevant cost of capital; Jensen's diagnosis of where the agency conflict is most severe, and the reason payout and leverage are governance instruments **Full-insurance efficiency** (Ch 27). Tobin's third sense — the availability of claims contingent on every state, so that every risk borne is a risk chosen **Functional efficiency** (Ch 27). Tobin's fourth sense — whether the financial system performs its economic functions (pooling saving, allocating capital, spreading risk, clearing payments) at a reasonable cost in real resources. A property of the system, not of prices **Fundamental pricing equation** (Ch 3). $$p = E\[mx]$$, equivalently $$1 = E\[mR]$$ — the statement that every asset-pricing model is a specification of $$m$$ **Fundamental transformation** (Ch 21). The conversion of a large-numbers bidding situation into a small-numbers bargaining situation by the act of specific investment itself **Fundamental-valuation efficiency** (Ch 27). Tobin's second sense — price equal to the rationally discounted value of the payments a claim will actually make **Futures contract** (Ch 8). A forward marked to market daily through a clearing house, so gains and losses are settled in cash as they accrue ## G **Gap-filling** (Ch 23). The finding that firms adjust the maturity and type of the claims they issue to fill the gaps that government issuance and holder demand leave, concentrated in the large, unconstrained issuers able to act on the spread **General partner (GP) / limited partner (LP)** (Ch 18). The manager of a private fund and its investors; the GP controls calls, distributions, valuations, and exits, and the LP has no redemption right **Global minimum-variance portfolio** (Ch 4). The lowest-variance portfolio available; distinct from, and generally worse than, the tangency portfolio **Governance structure** (Ch 21). The institutional arrangement within which a transaction is organized — market, hybrid (long-term contract, franchise, alliance), or unified ownership — assessed by its adaptive capacity and its bureaucratic cost **Greenium** (Ch 6). The lower expected return on green assets implied by nonpecuniary demand or transition-risk pricing; distinct from their realized return during a repricing **Greenshoe (over-allotment option)** (Ch 12). The syndicate's right to sell up to 15 percent more shares than the base offering and to cover the resulting short either by exercising the option or by buying in the aftermarket, which is the legal form of price stabilization **Grossman-Stiglitz paradox** (Ch 7). A fully revealing price destroys the incentive to acquire the information it reveals, so informationally efficient prices cannot be an equilibrium when information is costly ## H **Habit formation** (Ch 5). Preferences defined over consumption relative to a slow-moving benchmark $$X\_t$$; makes effective risk aversion $$\gamma/S\_t$$ countercyclical **Hansen-Jagannathan bound** (Ch 5). $$\sigma(m)/E\[m] \ge \mathrm{SR}$$; the volatility of any admissible discount factor is at least the maximum Sharpe ratio in the market **Hedge** (Ch 26). A position taken to offset an existing exposure. An *economic* hedge offsets in present value; a *survivable* hedge also has intermediate cash flows the firm can finance, and the two differ whenever the offsetting gain cannot be borrowed against **Hedge ratio (delta)** (Ch 3). The number of shares in the replicating portfolio, equal to the ratio of the spread in the derivative's payoffs to the spread in the underlying's **Held to maturity (HTM)** (Ch 13). An accounting classification permitting debt securities to be carried at amortized cost rather than fair value, which suppresses mark-to-market volatility and defers loss recognition until a sale **Hierarchy of money and credit** (Ch 16). The ordering of financial instruments by their proximity to central bank money, and by the reliability of the promise each embodies **Holder** (Ch 1). The party that owns a claim. In this book an analytical category rather than a descriptive one, because a holder's identity, size, and constraints are inputs to the price **Holder section** (Ch 1). The section required in every chapter of Parts II, III and V asking who holds this claim and what their constraints do to its price. The structural device that makes the subtitle a method rather than a slogan **Hold-up** (Ch 21). The ex-post renegotiation of terms made possible by bilateral monopoly after specific investment is sunk; its characteristic cost is the underinvestment it induces ex ante **Home bias** (defined in 2 chapters, with different wording): * *Ch 4*: The tendency of investors to hold far more of their domestic market than world market weights imply * *Ch 14*: The tendency of investors to overweight domestic securities relative to world market capitalization, and, at shorter radius, to overweight local, familiar, and employer-linked firms **Homemade leverage** (Ch 23). An investor's manufacture of a levered (or unlevered) payoff by borrowing (or lending) on personal account, which is the trade that enforces irrelevance and the operation constrained holders cannot always perform **Hubris hypothesis** (Ch 22). Roll's account of acquirer losses as the winner's curse applied to bidding managers — the winning bidder is the one whose valuation error was largest — predicting that acquirer losses roughly offset target gains **Human capital** (Ch 14). The present value of a household's expected future labor income ($$H\_t$$); an untraded implicit asset whose safety and size determine the optimal risky share of the *financial* portfolio, and whose run-down over a working life is the derivation of the age glide path **Hurdle (preferred return)** (Ch 18). A return, commonly 8 percent compounded, paid to LPs before the GP receives carry. With a full catch-up it changes the timing of carry, not its amount; as a hard hurdle it reduces carry substantially **Hurdle rate** (Ch 22). The return a firm actually requires of a project, which surveys find exceeds its estimated weighted average cost of capital by a substantial margin and moves little as interest rates move ## I **Idiosyncratic (diversifiable) risk** (Ch 4). The component of an asset's variance that vanishes from a large portfolio, and therefore earns no premium in equilibrium **Immediacy** (Ch 11). The service of trading now rather than waiting for a natural counterparty; what the bid-ask spread is the price of **Implied volatility** $$\sigma\_{\text{imp}}$$ (Ch 8). The volatility input that makes the Black-Scholes price equal the observed price; the option's price restated in the model's units **Inclusion effect** (defined in 2 chapters, with different wording): * *Ch 12*: The abnormal return around a stock's addition to an index, interpreted as a measurement of the slope of the demand curve for that stock because the index provider's decision carries no cash-flow information * *Ch 17*: The abnormal return around a security's addition to (or deletion from) an index, used as evidence on the slope of the demand curve for individual stocks **Incomplete contract** (Ch 21). A contract that does not specify an action for every state of the world, because contingencies are unforeseeable, indescribable, or unverifiable by a court **Incurrence covenant** (Ch 24). A test applied only when the borrower takes a specified action — new debt, an acquisition, a dividend — and evaluated pro forma for it; silent when the business simply worsens **Inelastic markets hypothesis** (Ch 20). The proposition that the aggregate demand curve for equities is steep, so that flows unaccompanied by information move the level of the market substantially **Information set** $$\Omega\_t$$ (Ch 7). The conditioning set relative to which efficiency is defined; efficiency claims are meaningless without one **Information-arbitrage efficiency** (Ch 27). Tobin's first sense — the absence of systematic profit from public information; the weak and semi-strong forms of Chapter 7 §7.1 **Initial public offering (IPO)** (Ch 12). The first sale of a company's shares to public investors, combining primary shares sold by the company with secondary shares sold by existing holders, and conferring a listing with its recurring disclosure and governance obligations **Institutional investor** (Ch 16). An entity that holds and manages financial claims on behalf of others, subject to regulatory, contractual, and liability-driven constraints **Instrument** (Ch 2). A standardized class of claim (Treasury security, corporate bond, deposit, equity share) reported as a row in the accounts and identified by its issuer, promise, and seniority **Intermediary capital ratio** (Ch 19). Aggregate equity over aggregate assets of the intermediary sector; the state variable in He-Krishnamurthy and, measured on primary dealers' holding companies, the pricing factor in He-Kelly-Manela **Intermediary SDF** (Ch 19). The stochastic discount factor $$m\_{t+1} = \delta\Lambda\_{t+1}/\Lambda\_t$$, in which $$\Lambda\_t$$ is the marginal value of a dollar of intermediary equity capital rather than a household's marginal utility **Intermediation** (Ch 2). The insertion of one or more balance sheets between an ultimate saver and an ultimate borrower, each layer transforming maturity, liquidity, credit risk, or denomination **Internal funds** (Ch 25). Undistributed profits plus the consumption of fixed capital — the firm's own retained cash flow, and the source of most corporate investment in aggregate **Internal rate of return (IRR)** (defined in 2 chapters, with different wording): * *Ch 18*: The discount rate setting the net present value of a fund's cash flows to zero; sensitive to timing, not aggregable across funds, and inflatable by subscription credit lines * *Ch 22*: The discount rate setting net present value to zero; unreliable for ranking projects of different scale or timing, and non-unique when cash flows change sign more than once **Investment CAPM** (Ch 22). The reading of the profitability and investment factors as consequences of firms' optimal investment against investor-set discount rates, rather than as compensation for investor-side risk **Investment universe** (Ch 20). The set of assets a holder has actually held in the recent past; the restricted menu whose variation supplies the instrument for price **IPCA** (Ch 6). Instrumented principal components; latent factors whose loadings are functions of observable characteristics, testing whether characteristics are covariances ## J **Jensen's alpha** $$\alpha\_i$$ (Ch 4). The intercept in a regression of an asset's excess return on the market's; zero for every asset under the CAPM, and the standard measure of delegated-manager performance **Joint-hypothesis problem** (Ch 7). The impossibility of testing efficiency separately from a model of equilibrium expected returns, since "abnormal return" presupposes a benchmark ## K **Kyle's lambda** $$\Lambda\_K$$ (Ch 11). The price impact coefficient, $$\Lambda\_K = \sigma\_x/(2\sigma\_z)$$ in the one-period model — the price change per unit of net order flow. Never written as a bare lambda in this book, which reserves that letter for the price of risk ## L **Latent demand** (Ch 20). The holder-specific residual in a fitted demand system — the part of a portfolio weight the observed characteristics do not explain; the channel through which idiosyncratic reallocation moves prices **Law of one price (LOOP)** (Ch 3). The condition that portfolios with identical payoffs in every state have identical prices; equivalently, that the pricing function is linear **Leverage cycle** (Ch 16). Procyclical expansion and contraction of institutional balance sheets **Leverage factor** (Ch 19). The growth rate of aggregate broker-dealer leverage, used by Adrian, Etula and Muir (2014) as a single priced factor on the argument that dealer leverage is high precisely when the marginal value of dealer wealth is low **Leveraged loan** (Ch 25). A syndicated loan to a below-investment-grade borrower, floating-rate and senior secured, whose institutional tranche is bought principally by collateralized loan obligations and loan funds **Liability-driven investment (LDI)** (Ch 16). Investment strategy focused on matching assets to liabilities **Limited participation** (Ch 5). The fact that many households hold no equity, so aggregate consumption is not the consumption of the marginal equity holder **Limits to arbitrage** (Ch 15). The set of reasons — delegated and performance-sensitive capital, short-sale constraints, career risk, fundamental risk, and horizon — why a known mispricing is not traded away; the reason behavioral finance is a claim about institutions and not only about psychology **Liquidity beta** (Ch 11). A claim's loading on innovations in aggregate market liquidity; priced, per Pástor and Stambaugh **Liquidity premium** (Ch 11). The higher expected return required on a claim that is costly to trade, scaled by the holder's expected holding period **Liquidity spiral** (Ch 11). The feedback between market liquidity and funding liquidity, in which falling prices raise haircuts, force liquidity suppliers to shed inventory, and reduce depth further **Liquidity transformation** (Ch 19). Issuing a claim that is redeemable on demand against assets that lose value if liquidated early; the bank's second function and the source of its fragility **Listing gap** (Ch 12). Doidge, Karolyi and Stulz's measure of the shortfall between the number of US listed firms and the number predicted by the country's size, wealth, and institutional quality **Lockup** (Ch 12). The contractual restriction, typically 180 days, on insider sales after an offering; its expiry is a predictable supply shock **Long-run risk** (Ch 5). A small, highly persistent component $$\eta\_t$$ in expected consumption growth, priced under recursive preferences because it moves the value of long-horizon claims **Loss aversion** (Ch 15). The property that the value function is steeper below the reference point than above it, with a coefficient estimated at roughly two; the source of non-participation, of myopic loss aversion, and of the equity premium in behavioral accounts **Loss given default (LGD)** (Ch 10). One minus the recovery rate; the fraction of face value lost when default occurs. Recovery conventions differ — trading price shortly after default versus ultimate resolution value — and the two are not interchangeable ## M **Macaulay duration** $$D\_{\mathrm{Mac}}$$ (Ch 9). The present-value-weighted average time to a claim's payments, in years **Maintenance covenant** (Ch 24). A financial test applied every period regardless of the borrower's actions, so that deterioration in the business alone transfers control to the lender **Make-or-buy** (Ch 21). The decision whether to produce an input internally or procure it on the market; the applied form of the boundary-of-the-firm question **Margin spiral** (Ch 16). Feedback loop between margin requirements, forced selling, and price declines **Marginal holder** (Ch 5). The investor whose Euler equation actually binds in a given claim, and whose marginal utility therefore appears in its price **Marginal investor** (Ch 3). The holder who is unconstrained at the margin in a given claim, and whose $$m$$ therefore appears in its price; an empirical object, not a modeling convenience **Market clearing** (Ch 20). The condition that the total dollar demand of all holders for a claim equals its total dollar supply; the equation that turns estimated demand curves into prices **Market depth** $$1/\Lambda\_K$$ (Ch 11). The net order imbalance the market absorbs per unit of price movement **Market maker** (Ch 11). A dealer who posts two-sided quotes and stands ready to trade at them, holding inventory in the interval between a seller's arrival and a buyer's **Market portfolio** $$w^M$$ (Ch 4). The value-weighted portfolio of all risky assets; in CAPM equilibrium, identical to the tangency portfolio **Market timing** (Ch 23). The account in which capital structure is the cumulative residue of past attempts to issue claims when they were expensive, with no target to revert to **Mental accounting** (Ch 15). The practice of assigning money to separate notional accounts governed by different rules, so that fungible dollars are treated as non-fungible; the source of inverted asset location and of layered "safety-then-aspiration" portfolios **Merger wave** (Ch 22). The clustering of acquisition activity in time and within industries, attributed to industry shocks combined with available capital and to episodes of high equity valuation **Model risk** (Ch 26). Loss arising from using a model outside what it can support — wrong model, parameters estimated on data lacking the relevant states, or use outside the fitted range **Model validation** (Ch 26). Independent review of a model's conceptual soundness, implementation, and approved input range, staffed and reporting separately from the desk that uses it **Modified duration** $$D\_{\mathrm{mod}}$$ (Ch 9). $$D\_{\mathrm{Mac}}/(1+y)$$; the percentage price change per unit change in yield, and the unit in which institutions measure rate exposure **Modigliani-Miller irrelevance** (Ch 23). The proposition that a firm's total market value is independent of how its payoff is divided into securities, proved by replication from the linearity of prices rather than assumed **Multiple** (Ch 22). A ratio of price or enterprise value to an accounting flow or stock, used to price a firm by reference to comparables; algebraically a discounted-cash-flow model with its assumptions compressed into one number **Multiple-testing hurdle** (Ch 6). The raised $$t$$-statistic threshold appropriate when many hypotheses are tested against one dataset; about 3.0 on Harvey, Liu and Zhu's recommendation ## N **NAV smoothing** (Ch 18). The partial adjustment of reported fund values toward true values, which halves reported volatility and cuts reported contemporaneous beta at plausible smoothing weights; the practitioner term for the effect is *volatility laundering* **Negative convexity** (defined in 2 chapters, with different wording): * *Ch 9*: The property of callable bonds and mortgage securities whose duration shortens as rates fall, turning holders into procyclical buyers and sellers of duration * *Ch 13*: $$C\_{\mathrm{vx}} < 0$$; the property of a claim whose duration shortens as rates fall and extends as they rise, so that a rally is worth less than an equal selloff costs and the holder is a procyclical trader of duration **Net convenience yield** $$y$$ (Ch 8). The flow of benefit from holding the physical asset rather than a claim to it, net of storage; a dividend yield, a foreign interest rate, or the shadow value of inventory **Net equity issuance** (Ch 12). Gross equity issued less equity retired through repurchases and cash-financed mergers; persistently negative for US nonfinancial corporations since the mid-1980s **Net order flow** $$\mathrm{OF}$$ (Ch 11). Signed buy volume minus sell volume over an interval; the informed trader's order plus the liquidity traders' **Net present value (NPV)** (Ch 22). The present value of a project's incremental free cash flows less its outlay, discounted at a rate matching the flows' risk and denomination; positive net present value is the decision rule that value additivity licenses **Nexus of contracts** (Ch 21). Jensen and Meckling's view of the firm as a legal fiction serving as the connecting point for contracting relationships among individuals, with no objectives of its own **Noise (supply) shock** $$z$$ (Ch 7). Random asset supply unrelated to fundamentals; the ingredient that lets an equilibrium with costly information exist at all **Noise-trader risk** (Ch 15). The risk, borne by an arbitrageur trading against sentiment, that the mispricing widens before it converges; created by the noise traders themselves, unhedgeable, and sufficient to bound arbitrage positions and allow mispricing in equilibrium **Nonpecuniary demand** (Ch 16). Demand for a claim arising from the utility of holding it rather than from its payoff; the source of the greenium and of divestment effects ## O **Option-adjusted spread** ($$\mathrm{OAS}$$) (Ch 13). The constant increment to path short rates that equates a simulated average present value to the observed price; the holder's compensation after paying for the option she wrote, and a joint statement about the price and the prepayment model **Out-of-sample** $$R^2$$ (Ch 6). Forecast accuracy on data never used in estimation or tuning; the discipline that distinguishes the machine-learning literature from what preceded it ## P **Par curve** (Ch 9). The coupon rate at each maturity that prices a bond at face value; the curve usually plotted as "the yield curve" **Participation puzzle** (Ch 14). The finding that a large share of households hold no equity at all despite a substantial and persistent equity premium; explained by some combination of fixed participation costs, background risk and borrowing constraints, and information, trust, and familiarity **Passive investing** (Ch 17). Investment strategy that tracks a market index rather than attempting to beat it; a claim about mandate, not about trading frequency **Payout smoothing** (Ch 23). The Lintner pattern in which dividends adjust only partially toward a target payout ratio each year, producing a dividend series far less volatile than earnings **Pay-performance sensitivity** (Ch 24). The change in a manager's wealth per one thousand dollars of change in shareholder wealth; about three dollars and twenty-five cents for the median large-firm chief executive in Jensen and Murphy's 1990 estimate, and roughly an order of magnitude higher after the options era **Pecking order** (Ch 23). The financing hierarchy — internal funds, then debt, then equity — that follows from Myers and Majluf's adverse-selection problem rather than being assumed **Performativity** (Ch 7). The use of a model changing the market it describes **Poison pill (shareholder rights plan)** (Ch 22). A charter or board-adopted device issuing cheap shares to all holders except a bidder crossing an ownership threshold, making an unnegotiated acquisition prohibitively dilutive; decisive as a defense when combined with a staggered board **Portfolio sort** (Ch 6). Ranking assets on a characteristic, forming portfolios from the ranking, and reporting the top-minus-bottom average return **Portfolio weight** $$w\_i$$ (Ch 4). The share of a portfolio's value held in asset $$i$$; weights sum to one and may be negative (a short position) **Post-earnings-announcement drift** (Ch 7). Continued price movement in the direction of an earnings surprise for weeks after the announcement; the most durable violation of semi-strong efficiency **Post-publication decay** (Ch 6). The fall in a predictor's return after its publication, attributable to arbitrage capital rather than to statistics **Power law** (Ch 18). The extreme right-skewed distribution of venture investment outcomes, in which essentially all of a fund's return comes from a very small number of positions **Power utility (CRRA)** (Ch 5). $$u(c) = (c^{1-\gamma}-1)/(1-\gamma)$$; risk aversion independent of wealth, with a single parameter $$\gamma$$ **Preferred habitat** (Ch 9). A maturity segment an investor occupies for reasons exogenous to bond returns, leaving it only for compensation **Prepayment** (Ch 13). Repayment of mortgage principal ahead of schedule — from refinancing, moving, curtailment, or (in an agency pool) default, which is bought out at par; measured by the conditional prepayment rate $$\mathrm{CPR}$$ and its monthly equivalent $$\mathrm{SMM}$$ **Present value** (Ch 3). The price today of a stream of future payments, computed by discounting each at the rate appropriate to its date and risk **Price informativeness** (Ch 7). The fraction of the variance of the learnable payoff component revealed by the price, $$\Psi/(1+\Psi)$$ in the model of §7.2 **Price multiplier (**$$\mathcal{M}$$**)** (Ch 20). The dollars of aggregate market value created per dollar of flow, $$\mathcal{M} = dV/dF$$; the reciprocal of the aggregate demand elasticity **Private credit** (Ch 25). Direct lending by a fund — closed-end partnership, business development company, or evergreen vehicle — to a middle-market borrower, held rather than syndicated, funded by committed capital that cannot be redeemed **Procyclicality** (Ch 26). The property of a constraint calibrated to current measured risk that it loosens in booms and tightens in busts, expanding risk-bearing capacity when risk is building and contracting it when risk materializes **Prospect theory** (Ch 15). Kahneman and Tversky's descriptive theory of choice under risk, in which outcomes are evaluated as gains and losses relative to a reference point, through a value function that is concave over gains, convex and steeper over losses, and in which probabilities enter through a weighting function that overweights small probabilities **Proxy contest** (Ch 24). A campaign to elect directors nominated by someone other than the incumbent board, decided by a vote of shareholders; the instrument a staggered board is designed to blunt **Public market equivalent (PME)** (Ch 18). The ratio of fund distributions to contributions, each discounted at the realized return on a public index; a value above one means the LP ended with more wealth than indexing the same flows **Put-call parity** (Ch 8). $$C + K/R\_f = P + S\_0$$; the law of one price applied to two portfolios with identical payoffs ## Q **Qualified default investment alternative (QDIA)** (Ch 14). A category of investment, defined by Department of Labor rules under the Pension Protection Act of 2006, into which a plan may default a non-electing participant while retaining fiduciary safe-harbor protection; balanced, managed-account, and life-cycle funds qualify, money market funds do not as a long-term default ## R **Rare disasters** (Ch 5). A small annual probability $$\pi\_D$$ of a large consumption contraction $$\kappa$$; generates a premium at modest $$\gamma$$ because marginal utility in the disaster state is enormous **Rational expectations equilibrium** (Ch 7). An equilibrium in which uninformed traders correctly invert the mapping from fundamentals and noise to prices, and are limited by inseparability rather than by error **Reach for yield** (Ch 16). The tendency of return-targeting institutions to buy the highest-yielding asset permitted within a regulatory or mandate category **Real option** (Ch 22). The value of managerial flexibility — to wait, expand, or abandon — priced with the machinery of Chapter 8 §8.3, material when investment is irreversible, uncertain, and postponable **Realized spread** (Ch 11). The effective spread net of the post-trade revision in the midpoint; what the liquidity supplier actually keeps **Reduced-form (intensity) model** (Ch 10). A model in which default arrives as the first jump of a point process with intensity $$\lambda$$, and the intensity is fitted to observed prices rather than derived from the firm **REIT** (Ch 13). A tax-transparent corporate form for holding income-producing real estate, conditional on asset and income tests and on distributing at least ninety percent of taxable income **Relationship lending** (Ch 25). Credit extended on the basis of private information the lender produced over a continuing relationship, rather than on publicly verifiable data; raises credit availability more than it lowers price, and generates informational holdup as a by-product **Replicating portfolio** $$(\Delta, B)$$ (defined in 2 chapters, with different wording): * *Ch 3*: A combination of traded assets that reproduces a target claim's payoff state by state; its cost is the claim's no-arbitrage price * *Ch 8*: The position in the underlying and riskless borrowing that reproduces a derivative's payoff at every node **Repo (repurchase agreement)** (Ch 19). A sale of a security combined with an agreement to repurchase it, economically a collateralized loan with a haircut; the dealer sector's principal funding instrument **Residual control rights** (Ch 21). The rights to make decisions that no contract covers; under Grossman-Hart-Moore, ownership of an asset *is* the possession of these rights **Residual sector** (Ch 2). A sector whose holdings are computed as the difference between known totals and all other measured sectors — in Z.1, households and nonprofits, which therefore absorbs hedge funds, personal trusts, and measurement error **Rights issue** (Ch 12). An offering of new shares to existing shareholders pro rata, usually at a discount; the theoretical ex-rights price and the value of a right follow arithmetically, and a subscribing holder's wealth is unaffected by the size of the discount **Risk-based capital (RBC)** (Ch 16). The US insurance capital regime that assigns a capital charge to each asset class and rating bucket, making required capital a function of portfolio composition **Risk-free rate puzzle** (Ch 5). Weil's complement — the large $$\gamma$$ that fixes the premium implies a counterfactually high riskless rate, or a discount factor above one **Risk-neutral default probability** (Ch 10). The physical default probability re-weighted by state prices; larger than the physical probability whenever default occurs in high-marginal-utility states, and the source of the risk-premium component of the spread **Risk-neutral probability** $$\pi^{\ast}\_s$$ (defined in 2 chapters, with different wording): * *Ch 3*: A state price normalized by the price of a riskless dollar, $$\pi^{\ast}\_s = q\_s R\_f$$; the distribution under which every asset earns the riskless rate * *Ch 8*: In the binomial model, $$(R\_f - d)/(u - d)$$; the measure under which every asset earns the riskless rate. Not a belief **Rolling stack** (Ch 26). Hedging a long-dated obligation with near-dated contracts and rolling the whole position forward at each expiry; introduces exposure to the slope of the forward curve and concentrates margin flows in the most liquid, most volatile contract **Roll's critique** (Ch 4). The argument that the market portfolio is unobservable and that the SML is equivalent to the efficiency of the proxy, so every CAPM test is a joint test **Roll's estimator** (Ch 11). $$\hat s = 2\sqrt{-\mathrm{Cov}(\Delta p\_t, \Delta p\_{t-1})}$$; recovers the spread from bid-ask bounce in daily closing prices alone **Run equilibrium** (Ch 19). In Diamond-Dybvig, the second equilibrium of the demand deposit game, in which each depositor withdraws because she expects others to. It requires no news about asset values and no irrationality ## S **Safe asset** (Ch 9). A claim whose value is expected to be preserved precisely when other values are not, and which is therefore usable as collateral and as a store of value in stress; a joint product of the issuer and of the intermediaries who make it tradable **S-curve** (Ch 13). The empirical relation between refinancing incentive and prepayment speed — flat at a turnover floor, steep through the money, flattening below one hundred percent because some borrowers never act **Seasoned equity offering (SEO)** (Ch 12). A sale of additional shares by an already-listed company, announced at an average share-price reaction of roughly minus two to minus three percent **Secondaries** (Ch 18). The market in which LPs sell fund interests, including unfunded commitments, to other investors; LP-led transactions have typically priced at discounts to reported NAV, and GP-led continuation vehicles move assets between funds run by the same manager **Sector** (Ch 2). A grouping of economic agents with similar function used in the national and financial accounts — households and nonprofits, nonfinancial business, government, depository institutions, funds, insurers and pensions, and the rest of the world **Security market line (SML)** (Ch 4). The equilibrium relation $$\mu\_i - r\_f = \beta\_i(\mu\_M - r\_f)$$, linear in beta with a common price of risk **Self-financing** (Ch 8). The property that rebalancing the replicating portfolio requires no injection or withdrawal of cash **Seniority** (Ch 2). The order in which claims are satisfied when assets are insufficient; the content of the term "capital structure" **Sentiment** (Ch 15). A common, time-varying component of investor demand not justified by fundamentals; measured by Baker and Wurgler as a factor extracted from market-based proxies, and predictive of the cross-sectional spread between hard-to-arbitrage and easy-to-arbitrage stocks **Separating equilibrium** (Ch 24). In a screening market, a menu of contracts under which each privately informed type selects a different one; achieved by rationing the low-risk type's coverage until the high-risk type prefers her own contract (Box 24.2) **Sequential service constraint** (Ch 19). The rule that depositors are paid in the order they arrive, which is what makes a run individually rational for those near the front of the queue **Share repurchase (buyback)** (Ch 12). A firm's purchase of its own shares, most often through an announced open-market authorization; a discretionary substitute for dividends that pays only the holders who sell **Sharpe ratio** $$\mathrm{SR}$$ (Ch 4). $$(\mu\_p - r\_f)/\sigma\_p$$; the slope of the line from the riskless asset through a portfolio **SMB, HML, UMD, RMW, CMA** (Ch 6). The traded factor returns for size, value, momentum, profitability and investment — small minus big, high minus low book-to-market, up minus down, robust minus weak, conservative minus aggressive **Special purpose acquisition company (SPAC)** (Ch 12). A shell that raises money in a conventional offering, holds it in trust, and merges with a private company; the sponsor's promote is founder equity of roughly a fifth of the post-offering shares, acquired for a nominal sum **Stambaugh bias** (Ch 7). Upward bias in a predictive-regression slope when the predictor is persistent and its innovations correlate with returns **State price (Arrow-Debreu price)** $$q\_s$$ (Ch 3). The price today of one dollar delivered in state $$s$$ and nothing otherwise; the primitive object from which all other prices are built **Stewardship** (Ch 17). The voting, engagement, and monitoring activity of asset managers on behalf of the funds they run; the governance obligation an index fund cannot discharge by selling **Stochastic discount factor (**$$m$$**)** (Ch 1). The random variable that prices every claim through $$p = E\[mx]$$. Introduced in Chapter 3 §3.5; the object every asset pricing model in Part II specifies and every holder in Part IV owns a version of **Stochastic discount factor (SDF)** $$m$$ (Ch 3). The ratio of a state price to its physical probability, $$m\_s = q\_s/\pi\_s$$; equal at a household's optimum to marginal utility growth **Stress test** (Ch 26). Revaluation of a portfolio under a specified scenario rather than a specified probability; *reverse* stress testing instead solves for the scenario that would exhaust the firm's capital **Strike price** $$K$$ (Ch 8). The fixed exchange price written into an option contract **Structural model** (Ch 10). A model in which default is derived from the firm's asset value crossing a boundary, so that credit risk is an option position on the firm (Merton 1974) **Stub quote** (Ch 11). A placeholder bid or offer posted far from the market to satisfy a nominal obligation to quote, with no intention of trading on it **Stub value** (Ch 3). The implied value of a parent company net of its holdings in a listed subsidiary; negative stubs are the sharpest observable violations of the law of one price **Subadditivity** (Ch 26). The requirement that the risk of a combined portfolio never exceed the sum of its parts' risks, so that diversification never appears harmful and desk limits can be aggregated. Expected shortfall satisfies it; VaR does not **Surplus consumption ratio** $$S\_t$$ (Ch 5). $$(c\_t - X\_t)/c\_t$$; the state variable governing effective risk aversion in the habit model **Syndicated loan** (Ch 25). A large loan arranged by one or more banks and distributed to a syndicate of participants; above a certain size the ultimate holders are institutions rather than banks **Systematic risk** (Ch 4). The component that does not vanish; the only kind for which any investor is compensated ## T **Tangency portfolio** $$w^T$$ (Ch 4). The risky portfolio with the highest Sharpe ratio, $$w^T \propto \Sigma^{-1}(\mu - r\_f\mathbf{1})$$ **Target-date fund** (Ch 14). A diversified fund whose equity share declines along a published glide path toward a dated retirement year; the dominant QDIA and the modal entire portfolio of recently hired plan participants **Tax shield** (Ch 23). The present value of the tax saved by deducting interest, equal to $$\tau\_c D$$ for permanent debt discounted at the cost of debt, and materially smaller under rebalancing, limited taxable income, or an offsetting personal-tax wedge **Tax-equivalent yield** (Ch 10). $$y\_m/(1-\theta)$$, the taxable yield equivalent to a tax-exempt yield $$y\_m$$ for an investor at marginal rate $$\theta$$; its inverse gives the implied marginal tax rate embedded in a muni-Treasury ratio **TBA** (Ch 13). The to-be-announced forward market in agency pass-throughs, in which specific pools are identified only at delivery; the source of the market's liquidity and the mechanism behind the rate lock **Term premium** $$\mathrm{tp}^{(n)}\_t$$ (Ch 9). The gap between a long yield and the average expected short rate over its life; compensation for bearing duration risk **Terminal value** (Ch 22). The value assigned to all cash flows beyond an explicit forecast horizon, usually as a growing perpetuity or an exit multiple; typically three quarters or more of a discounted-cash-flow valuation **The Greeks** (Ch 8). Delta, gamma, vega and theta — the sensitivities of the option price to the spot, to delta itself, to volatility, and to time **Theory of storage** (Ch 8). The account of convenience yield as an option on unexpected demand, decreasing in the level of inventory **Tightness, depth, resiliency** (Ch 11). The three dimensions of liquidity — the cost of a small round trip, the quantity absorbable per unit of price movement, and the speed of recovery from an uninformed shock **Tobin's Q** (Ch 22). The market value of the claims on a firm divided by the replacement cost of its capital; the theory says firms invest until marginal Q equals one, and Hayashi (1982) gives the conditions under which average and marginal Q coincide **Trade credit** (Ch 25). Financing extended by a supplier that ships before being paid; comparable in scale to bank lending for small firms, and carrying a very high implicit rate when an early-payment discount is forgone **Trade-off theory** (Ch 23). The account in which an interior optimal leverage ratio equates the marginal tax shield to the marginal expected cost of distress, predicting targets, mean reversion, and a positive profitability-leverage relation that the data reverse **Transaction cost** (Ch 21). The cost of using the price mechanism — discovering prices, negotiating and writing contracts, and enforcing and adapting them. Positive transaction costs are the reason some transactions are organized inside firms **Transaction lending** (Ch 25). Credit extended on publicly verifiable information — a credit score, an audited statement, a rating — and therefore contestable by any lender with access to the same data **Two-fund separation** (Ch 4). The result that every mean-variance investor holds only the riskless asset and the tangency portfolio, differing solely in the proportions ## U **Underlying** (Ch 8). The asset whose price determines a derivative's payoff, written $$S\_t$$ **Underpricing** (Ch 12). The gap between the offer price and the first trading price, measured as the first-day return; the deal-level dollar measure is the money left on the table, $$(p\_1 - p\_0)$$ times shares sold **Universal owner** (Ch 24). A holder diversified across essentially the whole market, whose stake in any one firm is small but whose aggregate control rights are large, and who therefore governs by general policy rather than by company-specific judgment ## V **Value at risk (VaR)** (Ch 26). The loss threshold not exceeded with a stated probability over a stated horizon; a quantile of the loss distribution, not a worst case, and silent about the tail beyond it **Voice and exit** (Ch 24). The two channels through which a blockholder disciplines management — direct engagement and the vote, versus the credible threat to sell and depress the price on which the manager's wealth depends **Volatility smile / skew** (Ch 8). The dependence of implied volatility on the strike; flat under Black-Scholes, downward-sloping in equity indices since October 1987 **Volatility targeting** (Ch 26). A mandate that sizes positions inversely to recent realized volatility so that forecast portfolio volatility stays fixed; produces the same buy-high, sell-low trading rule as a leverage constraint, without leverage ## W **Weak, semi-strong, strong form efficiency** (Ch 7). The nested cases in which $$\Omega\_t$$ is past prices, all public information, and all information including private **Wealth channel** (Ch 27). Transmission from asset prices to consumption through household net worth; its magnitude depends on how the repriced assets are distributed across households **Weighted average cost of capital (WACC)** (Ch 22). The market-value-weighted average of the cost of equity and the after-tax cost of debt, and the discount rate for free cash flow to the firm **Well-diversified portfolio** (Ch 6). A portfolio in which every weight is small, so residual variance vanishes as the number of holdings grows **Willingness to pay** (Ch 10). The sovereign-credit concept that repayment is a choice weighed against the costs of default, rather than a constraint imposed by resources; the object Eaton-Gersovitz models and Merton's boundary cannot represent **Winner's curse** (Ch 12). Rock's mechanism, in which uninformed investors receive full allocations of the deals informed investors avoid and rationed allocations of the deals they want, so the offer price must be set low enough for the uninformed to break even after rationing ## Y **Yield to maturity** $$y$$ (Ch 9). The single discount rate that reproduces a bond's observed price; a price quoted in units of a rate, not a forecast and not an expected return ## Z **Zero curve** (Ch 9). The schedule of yields $$y^{(n)}$$ on zero-coupon claims by horizon; the primitive from which coupon bonds are portfolios **Zero-beta portfolio** $$R\_Z$$ (Ch 4). The minimum-variance portfolio uncorrelated with the market; it replaces the riskless rate in Black's (1972) restricted-borrowing CAPM *** 339 terms from 27 chapters; 7 are defined in more than one chapter and are shown with each definition, because a silent merge would hide drift.