Automation, speed, and stock market quality: The NYSE's Hybrid

Automation and trading speed are increasingly important aspects of competition among financial markets. Yet we know little about how changing a market's automation and speed affects the cost of immediacy and price discovery, two key dimensions of market quality. At the end of 2006 the New York Stock Exchange introduced its Hybrid Market, increasing automation and reducing the execution time for market orders from 10 seconds to less than one second. We find that the change raises the cost of immediacy (bid-ask spreads) because of increased adverse selection and reduces the noise in prices, making prices more efficient.     

Investor type trading behavior and trade performance: Evidence from the Thai stock market

This paper examines the trading behavior and decomposes the trading performance of foreign, individual and institutional investors as well as proprietary traders in a dynamic emerging stock market, the Stock Exchange of Thailand. Foreign investors follow a positive feedback, momentum strategy and are good short term market timers but have poor security selection performance in poor markets, thus suggesting that they have a macro (market timing) but not a micro (security selection) informational advantage relative to local investors. Institutions and proprietary traders have poor security selection trading performance. Individuals display herding behavior and have fairly good security selection performance, but individual investors appear to compensate proprietary traders for the provision of short term liquidity by proprietary traders, so individuals' security selection gains are canceled out by market timing losses.     

Family control and investment–cash flow sensitivity: Empirical evidence from the Euro zone

This paper considers the ownership structure of family firms to determine whether family control alleviates or exacerbates investment–cash flow sensitivity in the Euro zone. We find that family-controlled corporations have lower investment–cash flow sensitivities. Further, our results show that this reduced sensitivity is mainly attributable to family firms with no deviations between cash flow and voting rights and to family firms in which family members hold managerial positions. We also find that second largest shareholders affect family firms' sensitivity and are associated with either monitoring (non-family second blockholders) or collusion (family second blockholders). Overall, family control seems to mitigate investment inefficiencies that derive from capital market imperfections.     

Perks and the informativeness of stock prices in the Chinese market

While the literature shows that perks can affect firm values positively or negatively, we argue that firms with higher perks are more likely to be associated with a lower quality of financial reporting, which, in turn, can affect the informativeness of stock prices. Based on hand-collected data on perks from Chinese listed firms, we find that firms with lower perks are associated with higher informativeness of stock prices (or lower R-square). Moreover, the positive association between perks and R-square is shown to be weaker for firms with higher financial reporting quality through audit and earnings quality measures.     

The effect of macroeconomic news on stock returns: New evidence from newspaper coverage

Previous literature has produced weak evidence to support the hypothesis that real economic news affects stock returns. This is, in part, attributed to the difficulty of measuring how investors interpret macroeconomic announcements in different economic environments. In this paper, we choose a different approach of measuring macroeconomic news to better estimate its effect on stock returns. Since newspaper stories provide an interpretation of the statistical releases, we choose newspaper stories as our measure of news. Our findings indicate that news about GDP and unemployment does affect stock returns.     

Macroeconomic risk and the cross-section of stock returns

We develop a conditional version of the consumption capital asset pricing model (CCAPM) using the conditioning variable from the cointegrating relation among macroeconomic variables (dividend yield, term spread, default spread, and short-term interest rate). Our conditioning variable has a strong power to predict market excess returns in the presence of competing predictive variables. In addition, our conditional CCAPM performs approximately as well as Fama and French’s (1993) three-factor model in explaining the cross-section of the Fama and French 25 size and book-to-market sorted portfolios. Our specification shows that value stocks are riskier than growth stocks in bad times, supporting the risk-based story.     

Trading frequency and asset pricing on the London Stock Exchange: Evidence from a new price impact ratio

This study proposes a new price impact ratio as an alternative to the widely used Amihud’s (2002) Return-to-Volume ratio. We demonstrate that the new price impact ratio, which is deemed Return-to-Turnover ratio, has a number of appealing features. Using daily data from all stocks listed on the London Stock Exchange over the period 1991–2008, we provide overwhelming evidence that this ratio, while being unequivocal to construct and interpret, is also free of a size bias. More importantly, it encapsulates the stocks’ cross-sectional variability in trading frequency, a relatively neglected but possibly important determinant of stock returns given the recently observed trends in financial markets. Overall, our findings argue against the conventional wisdom that there is a simple direct link between trading costs and stock returns by strongly suggesting that it is the compound effect of trading frequency and transaction costs that matters for asset pricing, not each aspect in isolation.     

New evidence on oil price and firm returns

In this paper, we examine the relationship between oil price and firm returns for 560 US firms listed on the NYSE. First, we find that oil price affects returns of firms differently depending on their sectoral location. Second, we find strong evidence of lagged effect of oil price on firm returns. Third, we test whether oil price affects firm returns based on different regimes and find that in five out of the 14 sectors this is indeed the case. Finally, we unravel that oil price affects firm returns differently based on firm size, implying strong evidence of size effects.     

A multi-country test of the Fisher model for stock returns

This article provides a test of the Fisher model, linking expected stock returns and inflation, based on international data. Since the Fisher model is ‘universal’ and calls for a slope of 1 in any country, we improve the testing power by conducting a joint test over eight countries. The pooling of data for several countries seems to reduce the small-sample bias. We test the Fisher model, using an instrumental variable approach, for holding-period horizons ranging from 1–12 months. The Fisher model is not rejected at any horizon: however, the magnitude of the slope coefficient lends stronger support at long horizons. This study using multi-country panel data provides evidence corroborating the finding of Boudoukh and Richardson (1993) that the Fisher model holds at long horizons (5 years), using 180 years of US data.     

Stock price fragility

We study the relation between the ownership structure of financial assets and non-fundamental risk. We define an asset to be fragile if it is susceptible to non-fundamental shifts in demand. An asset can be fragile because of concentrated ownership, or because its owners face correlated or volatile liquidity shocks, i.e., they must buy or sell at the same time. We formalize this idea and apply it to mutual fund ownership of US stocks. Consistent with our predictions, fragility strongly predicts price volatility. We then extend the logic of fragility to investigate two natural extensions: (1) the forecast of stock return comovement and (2) the potentially destabilizing impact of arbitrageurs on stock prices.     

Price discovery in currency markets

This paper examines the price discovery process in currency markets, basing its analysis on the pivotal distinction between the customer (end-user) market and the interdealer market. It first provides evidence that this price discovery process cannot be based on adverse selection between dealers and their customers, as postulated in standard models, because the spreads dealers quote to their customers are not positively related to a trade’s likely information content. The paper then highlights three factors familiar in the literature – fixed operating costs, market power, and strategic dealing – that may explain the cross-sectional variation in customers’ spreads. The paper finishes by proposing a price discovery process relevant to liquid two-tier markets and providing preliminary evidence that this process applies to currencies.     

What UIP tests on extreme samples reveal about the missing variable

In their UIP regressions, Huisman et al. (1998. Extreme support for uncovered interest parity, Journal for International Money and Finance 17, 211–228.) focus on extreme forward premia and find much higher coefficients. We show that, for such results, the expectation signal needs to be thicker-tailed than the missing variable. Transaction costs may produce the right sort of bias. It is (i) bounded (i.e. it has no tails at all), (ii) wide (i.e. it may generate betas below 1/2) and (iii) U-distributed, which makes an “extreme” sample quite effective. We derive theoretical and numerical results in the direction of what Huisman et al. observe. We also tighten Fama's moment conditions.     

Strategic trading by index funds and liquidity provision around S&P 500 index additions

We examine the trades of index funds and other institutions around S&P 500 index additions. We find index funds begin rebalancing their portfolios with the announcement of composition changes and do not fully establish their positions until weeks after the effective date. Trading away from the effective date is more prevalent for stocks with lower levels of liquidity and among large index funds, which is consistent with index funds accepting higher tracking error in order to reduce the price impact of their trades. Small and mid-cap funds provide liquidity to index funds around additions, and added stocks with a greater proportion of these natural liquidity providers experience lower inclusion returns.     

A comment on: “The solution to the forward-bias puzzle”

Pippenger (2011) recently proposed a solution to the longstanding forward-bias puzzle. He argues that the puzzling estimates obtained using the standard equation for the efficient markets hypothesis are due to omitted variable bias. He identifies the missing variables as the future change in the forward exchange rate and the future interest differential. When these are added to the standard equation, he finds a one-to-one relationship between the future change in the spot rate and the forward premium. However, we argue that his equation can only test covered interest parity and offers no insight into the forward-bias puzzle.     

Measuring price discovery: The variance ratio, the R, and the weighted price contribution

We analyze the statistical properties of three price discovery measures: The variance ratio, the weighted price contribution (WPC), and the R² of unbiasedness regressions. We find that, if the price process is a driftless martingale, only the WPC is an unbiased estimator for the return variance explained during a time interval. For autocorrelated processes with a drift, only the R² of the unbiasedness regression is consistent, but it is biased for small samples.     

Accruals and the performance of stock returns following external financing activities

This paper investigates the relation of the external financing anomaly with the accrual anomaly, by focusing separately on working capital accruals and long-term accruals. We find that external financing and accrual hedge portfolios not only generate superior returns, but they also constitute statistical arbitrage opportunities. Portfolio-level analysis and firm-level cross-sectional regressions show that the ability of external financing measures in predicting future returns remains strong, after controlling for working capital accruals. However, this ability is substantially reduced after controlling for long-term accruals. Our results appear to be consistent with investors’ failure to recognise agency-related overinvestment and/or opportunistic earnings management.     

Cross hedging single stock with American Depositary Receipt and stock index futures

This paper investigates the cross hedging effectiveness of individual stock in a market that does not have single stock futures traded using American Depositary Receipt (ADR) and stock index futures. We apply Caporin and Billio’s Multivariate regime switching GARCH to capture the state-dependent covariance structure of underlying stock, ADR and stock index futures. Empirical results indicate that in general simultaneous hedging with both ADR and index futures creates hedging gains and incorporating regime switching effects further increases the hedging performances.     

The persistent effects of a false news shock

In September 2008, a six-year-old article about the 2002 bankruptcy of United Airlines' parent company resurfaced on the Internet and was mistakenly believed to be reporting a new bankruptcy filing by the company. This episode caused the company's stock price to drop by as much as 76% in just a few minutes, before NASDAQ halted trading. After the “news” had been identified as false, the stock price rebounded, but still ended the day 11.2% below the previous close. We explore this natural experiment by using a simple asset-pricing model to study the aftermath of this false news shock. We find that, after three trading sessions, the company's stock was still trading below the two-standard-deviation band implied by the model and that it returned to within one standard deviation only during the sixth trading session. On the seventh day after the episode, the stock was trading at the level predicted by the asset-pricing model. We investigate several potential explanations for this finding, but fail to find empirical evidence supporting any of them. We also document that the false news shock had a persistent negative effect on the stock prices of other major airline companies. This is consistent with the view that contagion effects would have dominated competitive effects had the bankruptcy actually taken place.     

Do institutional investors have superior stock selection ability in China?

This paper uses unique data on the shareholdings of both institutional and individual investors to directly investigate whether institutional investors have better stock selection ability than individual investors in China. Controlling for other factors, we find that institutional investors increase (decrease) their shareholdings in stocks that subsequently exhibit positive (negative) short- and long-term cumulative abnormal returns. In contrast, individual investors decrease (increase) their shareholdings in stocks that subsequently exhibit positive (negative) short- and long-term cumulative abnormal returns. These findings indicate that institutional investors have superior stock selection ability in China.