IPO first-day returns,offer price revisions,volatility, and form S-1 language

Form S-1 is the first SEC filing in the initial public offering (IPO) process. The tone of the S-1, in terms of its definitiveness in characterizing the firm’s business strategy and operations, should affect investors’ ability to value the IPO. We find that IPOs with high levels of uncertain text have higher first-day returns, absolute offer price revisions, and subsequent volatility. Our findings provide empirical evidence for the theoretical models of uncertainty, bookbuilding, and prospect theory.     

Block ownership and firm-specific information

This study examines the impact of block ownership on the firm’s information environment. Previous research shows that stock price efficiency depends on the cost of acquiring private information, as well as on the precision of this information. Blockholders have a clear advantage over diffuse, atomistic shareholders in terms of the precision and acquisition cost of their private information. We hypothesize that this informational advantage will manifest itself primarily in the firm-specific component of stock returns. Our empirical findings confirm that blockholders increase the probability of informed trading and idiosyncratic volatility, and decrease the firm’s stock return synchronicity. These results hold for both inside and outside blockholders, but are insignificant for blocks controlled by employee stock ownership plans (ESOPs). Overall, our findings support the contention that ownership structure plays a significant role in shaping the firm’s information environment.     

Endogenizing exogenous default barrier models: The MM algorithm

In this paper, we propose a Maximization–Maximization (MM) algorithm for the assessment of hidden parameters in structural credit risk models. Step M1 updates the value, volatility, and expected return on the firm’s assets by maximizing the log-likelihood function for the time series of equity prices; Step M2 updates the default barrier by maximizing the equity holders’ participation in the firm’s asset value. The main contribution of the method lies in the M2 step, which allows for ‘endogenizing’ the default barrier in light of actual data on equity prices. Using a large international sample of companies, we demonstrate that theoretical credit spreads based on the MM algorithm offer the lowest CDS pricing errors when compared to other, traditional default barrier specifications: smooth-pasting condition value, maximum likelihood estimate, KMV’s default point, and nominal debt.     

The choice of ADRs

We study the determinants of a firm’s decision to issue one of the four available ADR programs (Level I, Level II, Level III, and Rule 144A). We find that the firm’s attributes (size, income, asset growth, leverage, privatization, ownership structure, and country-of-origin) and the firm’s home-country institutional variables (accounting rating and legal protection of minority shareholders) condition this choice. We also examine the issuing activity and the determinants of the ADR choice before and after the enactment of the Sarbanes–Oxley (SOX) Act. Following this structural change, we provide evidence of a reallocation between ADR programs. Compared to the pre-SOX period, firms from emerging markets, and those from countries with weak legal protection of minority shareholders, are more likely after SOX to choose Rule 144A and Level III, respectively.     

Generalized DEA model of fundamental analysis and its application to portfolio optimization

Fundamental analysis is used in asset selection for equity portfolio management. In this paper, a generalized data envelopment analysis (DEA) model is developed to analyze a firm’s financial statements over time in order to determine a relative financial strength indicator (RFSI) that is predictive of firm’s stock price returns. RFSI is based on maximizing the correlation between the DEA-based score of financial strength and the stock market performance. This maximization involves a difficult binary nonlinear program that requires iterative re-configuration of parameters of financial statements as inputs and outputs. We utilize a two-step heuristic algorithm that combines random sampling and local search optimization. The proposed approach is tested with 230 firms from various US technology-industries to determine optimized RFSI indicators for stock selection. Then, those selected stocks are used within portfolio optimization models to demonstrate the usefulness of the scheme for portfolio risk management.     

Explaining the idiosyncratic volatility puzzle using Stochastic Discount Factors

I use Stochastic Discount Factors to examine the sources of the idiosyncratic volatility premium. I find that non-zero risk aversion and firms’ non-systematic coskewness determine the premium on idiosyncratic volatility risk. The firm’s non-systematic coskewness measures the comovement of the asset’s volatility with the market return. When I control for the non-systematic coskewness factor, I find no significant relation between idiosyncratic volatility and stock expected returns. My results are robust across different sample periods and firm characteristics.     

Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles

We model consumption and dividend growth rates as containing (1) a small long‐run predictable component, and (2) fluctuating economic uncertainty (consumption volatility). These dynamics, for which we provide empirical support, in conjunction with Epstein and Zin's (1989) preferences, can explain key asset markets phenomena. In our economy, financial markets dislike economic uncertainty and better long‐run growth prospects raise equity prices. The model can justify the equity premium, the risk‐free rate, and the volatility of the market return, risk‐free rate, and the price–dividend ratio. As in the data, dividend yields predict returns and the volatility of returns is time‐varying.     

Managerial responses to incentives: Control of firm risk, derivative pricing implications, and outside wealth management

We model a firm’s value process controlled by a manager maximizing expected utility from restricted shares and employee stock options. The manager also controls allocation of his outside wealth, which allows partially hedging of his exposure to firm risk. Managerial control increases the expected time to exercise for his employee stock options. It also reduces the gap between his certainty equivalent and the firm’s Fair Value for his compensation, but that gap remains substantial. Managerial control also causes traded options to exhibit an implied volatility smile. With costly control the same basic patterns remain, but the manager’s risk-taking is dampened.     

A cultural explanation of the foreign bias in international asset allocation

This paper examines the foreign bias in international asset allocation. Following extant literature in behavioral finance, we argue that a society’s culture and the cultural distance between two markets play an important role in explaining the foreign bias. In particular, we hypothesize that the degree of a nation’s uncertainty avoidance affects the foreign bias (more uncertainty-avoiding countries allocate less to foreign markets), as does the degree of a country’s individualism (in individualistic countries performance is more directly attributed to a person and less to teams, causing these individuals to be more aggressive in their foreign asset allocations). We further expect that the degree of cultural distance between two countries affects the amount of money allocated to that market. Based on extensive robustness analyses, we find support for our hypotheses on the role of culture in international asset allocation.     

Accruals quality and analyst coverage

We provide evidence that analyst coverage increases as accruals quality decreases. This finding is consistent with the services of financial analysts becoming more valuable and in greater demand as accruals provide weaker signals about future cash flows. Further, it is accruals quality associated with innate uncertainty in the firm’s operating environment that attracts analysts even after controlling for operating uncertainty associated with cash flow and stock return volatility. This suggests that low quality accruals provide an opportunity for analysts to benefit from generating private information. Consistent with analysts providing compensating information, we find that forecasts for firms with lower accruals quality contain more private information.     

Investor Attention and Time‐varying Comovements

This paper analyses the effect of an increase in market‐wide uncertainty on information flow and asset price comovements. We use the daily realised volatility of the 30‐year treasury bond futures to assess macroeconomic shocks that affect market‐wide uncertainty. We use the ratio of a stock's idiosyncratic realised volatility with respect to the S&P500 futures relative to its total realised volatility to capture the asset price comovement with the market. We find that market volatility and the comovement of individual stocks with the market increase contemporaneously with the arrival of market‐wide macroeconomic shocks, but decrease significantly in the following five trading days. This pattern supports the hypothesis that investors shift their (limited) attention to processing market‐level information following an increase in market‐wide uncertainty and then subsequently divert their attention back to asset‐specific information.     

Asymmetric stock market volatility and the cyclical behavior of expected returns

Recent explanations of aggregate stock market fluctuations suggest that countercyclical stock market volatility is consistent with rational asset evaluations. In this paper, I develop a framework to study the causes of countercyclical stock market volatility. I find that countercyclical risk premia do not imply countercyclical return volatility. Instead, countercyclical stock volatility occurs if risk premia increase more in bad times than they decrease in good times, thereby inducing price–dividend ratios to fluctuate more in bad times than in good. The business cycle asymmetry in the investors’ attitude toward discounting future cash flows plays a novel and critical role in many rational explanations of asset price fluctuations.     

Price volatility,welfare, and trading hours in asset markets

This paper studies the consequences of opening asset markets more often for the properties of asset prices and social welfare. For all reasonable parameter values, increasing trading hours lowers average asset prices, increases unconditional asset price volatility at a given point in time, and decreases unconditional asset price volatility when averaged over the period of time that includes the additional hours that markets are open. Unconditional social welfare is increased by opening markets more often, although the welfare gains are small – well below 1% of lifetime consumption. In contrast, because expanding hours of trading affects agents' information sets, the welfare effect of more trading hours conditional on information available to agents can be large and the effect can be negative.     

Comparative analysis on the effects of the Asian and global financial crises on precious metal markets

The global financial crisis has vigorously struck major financial markets around the world, in particular in the developed economies since they have suffered the most. However, some commodity markets, and in particular the precious metal markets, seem to be unscathed by this financial downturn. This paper investigates therefore the nature of volatility spillovers between precious metal returns over fifteen years (1995-2010 period) with the attention being focused on these markets’ behavior during the Asian and the global financial crises. Daily closing values for precious metals are analyzed. In particular, the variables under study are the US$/Troy ounce for gold, the London Free Market Platinum price in US$/Troy ounce, the London Free Market Palladium price in US$/Troy once, and the Zurich silver price in US$/kg. The main sample is divided into a number of sub periods, prior to, during and after the Asian crisis. The aim of this division is to provide a wide and deep analysis of the behavior of precious metal markets during this financial event and of how these markets have reacted during times of market instability. In addition, this paper also looks at the effects of the global financial crisis from August 2007 to November 2010 using GARCH and EGARCH modeling. The main results show that there is clear evidence of volatility persistence between precious metal returns, a characteristic that is shared with financial market behavior as it has been demonstrated extensively by the existing literature in the area. In terms of volatility spillover effects, the main findings evidence volatility spillovers running in a bidirectional way during the periods; markets are not affected by the crises, with the exception of gold, that tends to generate effects in all other metal markets. However, there is little evidence in the case of the other precious metals generating any kind of influence on the gold market. On the other hand, there is little evidence of spillover effects during the two crisis episodes. Finally, the results from asymmetric spillover effects show that negative news/information have a stronger impact in these markets than positive news, again a characteristic that has been also exhibited by financial markets.     

Specialists as risk managers: The competition between intermediated and non-intermediated markets

We develop a model that analyzes competition between a non-intermediated market (such as an electronic communications network) and an intermediated market (such as via the market specialist’s structure within the NYSE) when both markets are allowed to trade the same securities. Specialists are viewed as providers of a “volatility dampening” service, a mechanism for reducing round-trip trading costs, as well as an “order execution risk management” service. The economic value of these three specialist services is determined by five key factors (the difference in spreads between the two financial market types, investors’ holding periods, the specialist’s quoted spread in relation to the asset’s price, the relative probability of executing an order in the intermediated market, and the short-term risk-free rate).     

Investigating the nature of interaction between crypto-currency and commodity markets

This paper investigates the dynamic relationship and volatility spillovers between cryptocurrency and commodity markets using different multivariate GARCH models. We take into account the nature of interaction between these markets and their transmission mechanisms when analyzing the conditional cross effects and volatility spillovers. Our results confirm the presence of significant returns and volatility spillovers, and we identify the GO-GARCH (2,2) as the best-fit model for modeling the joint dynamics of various financial assets. Our findings show significant dynamic linkages and volatility spillovers between gold, natural gas, crude oil, Bitcoin, and Ethereum prices. We find that gold can serve as a safe haven in times of economic uncertainty, as it is a good hedge against natural gas and crude oil price fluctuations. We also find evidence of bidirectional causality between crude oil and natural gas prices, suggesting that changes in one commodity's price can affect the other. Furthermore, we observe that Bitcoin and Ethereum are positively correlated with each other, but negatively correlated with gold and crude oil, indicating that these cryptocurrencies may serve as useful diversification tools for investors seeking to reduce their exposure to traditional assets. Our study provides valuable insights for investors and policymakers regarding asset allocation and risk management, and sheds light on the dynamics of financial markets.     

Commodity betas with mean reverting output prices

This paper provides a theoretical derivation of commodity beta (stock price sensitivity to commodity price) using a contingent-claim model. The model incorporates operating leverage, financial leverage, costly financial distress, and mean reverting commodity prices; and highlights the important role played by the speed of reversion of the commodity price. It is used to identify theoretically the main determinants of commodity beta. Commodity beta is predicted to be an increasing function of the operating and financial leverage of the firm, and a decreasing function of the company’s tax rate and the level, volatility and speed of reversion of the commodity price. Empirical tests with a sample of gold mining firms provide support for these predictions, particularly the new implications of the model (the effect of the commodity price’s speed of reversion and the company’s tax rate).     

Price adjustment to news with uncertain precision

We analyze how markets adjust to new information when the reliability of news is uncertain and has to be estimated itself. We propose a Bayesian learning model where market participants receive fundamental information along with noisy estimates of news’ precision. It is shown that the efficiency of a precision estimate drives the slope and the shape of price response functions to news. Increasing estimation errors induce stronger nonlinearities in price responses. Analyzing high-frequency reactions of Treasury bond futures prices to employment releases, we find strong empirical support for the model’s predictions and show that the consideration of precision uncertainty is statistically and economically important.     

Firm specific and macro herding by professional and amateur investors and their effects on market volatility

We find a herding tendency among both amateur and professional investors and conclude that the propensity to herd is lower in the professionals. These results are obtained both when we consider herding into individual stocks and herding into stocks in general. Herding depends on the firm’s systematic risk and size, and the professionals are less sensitive to these variables. The differences between the amateurs and the professionals may be attributable to the latter’s superior financial training. Most of the results are consistent with the theory that herding is information-based. We also find that the herding behavior of the two groups is a persistent phenomenon, and that it is positively and significantly correlated with stock market returns’ volatility. Finally, herding, mainly by amateurs, causes market volatility in the Granger causality sense.     

Foreign exchange risk pricing and equity market segmentation in Africa

This work is the first to investigate simultaneously the occurrence of unconditional currency risk pricing and equity market segmentation in Africa’s major stock markets. The multi-factor asset pricing theory provides the theoretical framework for our model. We find strong evidence suggesting that Africa’s equity markets are partially segmented. However, we find insufficient evidence to reject the hypothesis that foreign exchange risk is not unconditionally priced in Africa’s stock markets. This result is robust to alternative foreign exchange rate-adjusted return measures. These findings suggest that international investors can diversify into Africa’s equity markets without worrying about unconditional risks associated with foreign exchange rate fluctuations.