Value stocks and market efficiency

We form portfolios based on firm book-to-market equity ratios and apply stochastic dominance tests. Value (high book-to-market) portfolios dominate low book-to-market portfolios. Thus, value stocks are not rationally priced by the market and the book-to-market ratio is not an efficiently priced proxy for equity risk. We also find that the superior performance of value stocks is not due to the January effect.     

The long-run performance of initial public offerings: Stochastic dominance criteria

We examine the long-run performance of initial public offerings (IPOs) using the idea of stochastic dominance. The analysis is a first attempt using a non-event study methodology to evaluate long-horizon performance. We find that there is no first-order stochastic dominance relation between the IPO portfolio and the benchmark of a broad index or a portfolio including either small size or low book-to-market stocks. However, those benchmarks second-order stochastically dominate the IPO portfolio. When using a portfolio including both small size and low book-to-market stocks as benchmark, there is a clear dominance of the IPO portfolio over the benchmark for both orders. Our findings generally imply that the question of assessing portfolio performance between IPO firms and benchmark portfolios depends critically on the specific construction or the cumulative distribution function of the benchmark portfolios. The empirical results also potentially explain the extent of sample dependent results in the literature.     

Lessons from naïve diversification about the risk-reward trade-off

Studies of naïve diversification show that average total portfolio risk declines asymptotically as number of stocks increases. Recent work shows that a significant amount of idiosyncratic risk remains, even for portfolios with large numbers of stocks. The corresponding shocks are non-trivial. For example, more than half of all equal-weighted portfolios with 100 stocks have better than a 16 percent chance of an annual shock at least as large as about half of the annualized mean excess return on the U.S. total stock market index over July 1963–June 2018. I perform a simulation analysis of portfolio reward-to-risk as well as the components of total portfolio risk. On average, investors do not appear to be rewarded for exposure to non-systematic risk. The cross-sectional distribution of the true Sharpe ratio rises and its dispersion shrinks significantly as the number of stocks in the portfolio increases, whereas the cross-sectional distribution of the true non-systematic risk falls and its dispersion shrinks significantly as the number of stocks in the portfolio increases. This pattern appears regardless of the true asset pricing model for generating security returns, the portfolio weighting method, or specification of security alphas.     

Seasonality in firm-size portfolio returns: A nonparametric analysis

In this study the author uses stochastic dominance, a nonparametric method of portfolio performance analysis, to test for seasonality in firm-size portfolio return behavior. Stochastic dominance confirms the January effect, found in previous parametric studies, only for the smallest firm-size portfolio. It statistically eliminates the size effect for the larger firm-size portfolios in January and for all firm-size portfolios in the other months of the year. It is demonstrated that a market proxy problem and normality assumption violation may bias the parametric results. Nonparametric analysis, therefore, suggests that markets may be more efficient than parametric methods imply when model violations exist.     

How can investors build a better portfolio in small open economies? Evidence from Asia’s Four Little Dragons

This study investigates the role of hedging and portfolio design among stocks, exchange rates, and gold in small open economies (SOEs) from 4 January 2000 to 31 March 2020. We adopt the trivariate dynamic conditional correlation-fractionally integrated asymmetric power ARCH model and unconditional quantile regression model, and our findings show that the hedging role of the U.S. dollar (USD) and gold against stocks differs under regular and extreme market conditions. The USD can act as a powerful hedge asset for stocks in regular market periods. Moreover, during the global financial crisis and COVID-19 outbreak, the safe-haven effect of gold becomes stronger for almost all stocks, whereas the USD can serve as a strong safe haven against stock markets of Korea, Taiwan, and Singapore when stock returns are extremely low. In terms of portfolio designing, we find that adding the USD and gold to portfolios improves their hedging effectiveness, and the optimally weighted stock-USD-gold portfolio is the best portfolio strategy, irrespective of referring to return or risk.     

Value investing versus other investment strategies: A volatility spillover approach and portfolio hedging strategies for investors

Motivated by the incessant demand for portfolio diversification, this study examines the connectedness between value and diverse types of stocks (growth, momentum, ESG, high beta, classic S&P 500, volatility). The applied methodology encompasses the time-varying parameter vector autoregressive (TVP-VAR) extension of the Diebold and Yilmaz (2012) framework for the period from 03/31/2011 to 03/31/2021. Results show moderate volatility transmissions among the sampled assets, which tend to escalate during periods of turmoil, such as the European Sovereign Debt Crisis, the plunge in oil prices and the COVID-19 outbreak. Growth and ESG stocks play an indispensable part in the transmission mechanism. Moreover, we investigate the hedging ability of value stocks within a portfolio containing other stocks, by estimating hedge ratios and optimal weights with the usage of conditional variance estimates (DCC-GARCH). The empirical findings reveal that value stocks can adequately hedge against the risk deriving from the volatility of the remaining investment instruments, especially in the case of high beta and volatility stocks. Thus, this analysis provides portfolio managers and investors with valuable insights in order for them to hedge their stock portfolios effectively.     

A demonstration of the non-necessity of marginal conditional stochastic dominance for portfolio inefficiency

This paper demonstrates that a finding of marginal conditional stochastic dominance between two sub-portfolios of a portfolio, while sufficient for showing inefficiency of the portfolio and hence sub-optimality of the portfolio for all risk-averse investors, is not necessary. It is shown by an example that a portfolio can be inefficient even if, for all pairs of sub-portfolios, there is no marginal conditional stochastic dominance. In such a situation, a universally preferred portfolio can be constructed on the margin only by adjusting the shares of more than two sub-portfolios.     

Alternative estimation method of earnings growth rate for PEGR strategy

The ambiguous return pattern for the PEGR (the ratio of the stock’s price/earnings to its estimated earnings growth rate) strategy has been documented in literature for the US stock markets. As stock prices and earnings per share (EPS) are objective data, earnings growth rate, however, is estimated by analyst whose method partial explains the PEGR vague return pattern. The purpose of this study is not to deny or substitute analysts’ estimation, but rather, to provide a simple and popular method, log-linear regression model, to forecast the earnings growth rate (G), and examine whether the typical PEGR effect, such as PER (price/earnings ratio) or PBR (price/book ratio) effect, exists by using our alternative estimation method. Our evidence indeed shows that returns on the lowest PEGR portfolio not only dominate over all higher PEGR portfolios, but also beat the market with stochastic dominance (SD) analysis, which is consistent with our prediction. Our results, at least, imply that using the log-linear regression model to construct the PEGR-sorted portfolios can benefit investors and the model is also a good choice for analysts in their forecasting.     

IPO and Aftermarket Performance of Single‐Listed Chinese ADRs

This paper analyzes the post‐IPO and long‐run aftermarket performances of single‐listed Chinese ADRs during the 2004–2010 period. Single‐listed ADRs are traded daily in major exchanges in the United States, but their underlying shares are not traded in the issuer's home market. Our results show that over the short‐run, buy‐and‐hold abnormal returns of single‐listed Chinese ADRs following their IPO are not significantly different from the typical post‐IPO performance of stocks in U.S. exchanges, including that of traditional dual‐listed Chinese ADRs. Nevertheless, over the longer horizon, the excess returns of a portfolio composed solely of single‐listed Chinese ADRs outperform a portfolio of dual‐listed Chinese ADRs, but underperform a benchmark portfolio composed of U.S. firms matched on the basis of their IPO date. We also find that the portfolio formed solely of single‐listed Chinese ADRs exhibits significantly distinct loadings on the common portfolio factors from the portfolio formed of dual‐listed Chinese ADRs and from the benchmark portfolio of U.S. stocks.     

Is there a diversification “cost” of Shari’ah compliance? Empirical evidence from Malaysian equities

Islamic equity portfolios work with a smaller investment universe given the filtering of non-Shari’ah compliant stocks. It has been theoretically argued that this culminates in suboptimal portfolio diversification, which in turn adversely affects risk-adjusted returns. We offer empirical evidence that such a conceived portfolio diversification “penalty” is far from a foregone conclusion, at least empirically. Our results tend to indicate that Islamic portfolios are not invariably handicapped in terms of portfolio diversification. We also explored dimensions that may account for differences in the relative investment performance between Islamic and conventional portfolios, such as portfolio constraints, short selling and market conditions. We believe this paper is among the first to apply substantial empirical analysis specifically with respect to the portfolio diversification perspective on Islamic equity investments.     

How Do Alphas and Betas Move? Uncertainty,Learning and Time Variation in Risk Loadings*

I employ a parsimonious model with learning, but without conditioning information, to extract time‐varying measures of market‐risk sensitivities, pricing errors and pricing uncertainty. The evolution of these quantities has interesting implications for macroeconomic dynamics. Parameters estimated for US equity portfolios display significant low‐frequency fluctuations, along patterns that change across size and book‐to‐market stocks. Time‐varying betas display superior predictive accuracy for returns against constant and rolling‐window OLS estimates. As to the relationship of betas with business‐cycle variables, value stocks’ betas move pro‐cyclically, unlike those of growth stocks. Investment growth, rather than consumption, predicts the betas of value and small‐firm portfolios.     

Finance and Growth: Evidence from Some Arab Countries

Abstract

Some analysts contend that the ‘size effect’ -the higher returns associated with small-capitalization companies over those with large-capitalization, are a myth. Most empirical studies to date relate to U.S. stock exchanges. Since the Tel-Aviv Stock Exchange is considered an ‘emerging market,’ it is valuable to explore this phenomenon in this market.

This empirical study considers the performance of individual stocks and two alternative portfolios. The results show that the ‘size effect’ does not exist on the TASE, and that the large-capitalization stocks and portfolios generated higher returns versus their small-capitalization counterparts. Thus, the ‘size effect’ may only be a myth.     

Does investor sentiment impact the returns and volatility of Islamic equities?

In this paper, we estimate generalized autoregressive conditional heteroskedasticity (GARCH) and vector autoregressive (VAR) models to examine whether investor sentiment impacts the returns and volatility of various U.S. Dow Jones Islamic equity indices. The results from GARCH estimations show that changes in investor sentiment are positively correlated with the returns of the Shari’ah-compliant market portfolio. In addition, we find similar results for the three Shari’ah-compliant firm-size portfolios (i.e., large-, medium-, and small-cap). However, this relationship is stronger for harder to arbitrage Shari’ah-compliant stocks; that is, investor sentiment has a greater influence on small-cap equities. Additionally, estimations from the vector autoregressive model confirm the aforementioned results. In terms of volatility, GARCH estimations suggest that bullish shifts in investor sentiment in the current period are accompanied by lower conditional volatility in the ensuing period. In general, our findings suggest that as noise traders create more risk the market seems to reward them with higher expected returns.     

Flow Signals: Evidence from Patent and Alliance Portfolios in the US Biopharmaceutical Industry

Integrating signalling theory and the portfolio diversity literature, we theorize that diversity in a firm's patent and alliance portfolios sends contrasting flow signals impacting its market value in a nuanced way. Diversity in an alliance portfolio mediates the patent portfolio diversity – market value relationship by suppressing the negative effect of patent portfolio diversity creating an overall positive effect. We test our mediation model on a longitudinal set of 225 US biopharmaceutical firms that were awarded 17,078 patents and participated in 37,744 alliances between 1990 and 2006. Our theory and findings contribute three novel insights. First, we demonstrate the value of a temporal lens in explaining why diversity in a firm's patent and alliance portfolios send flow signals that establish expectations among market observers and have performance implications. Second, establishing that patent and alliance portfolio diversity are temporally sequenced provides compelling evidence for the value of studying multiple types of portfolios, their temporal relationships and effects on firm outcomes. Third, since diversity in a firm's portfolios can send contrasting flow signals conditioned on the cognitive demands and proximity involved in interpreting the signals, firms that do not maintain a ‘signalling fit’ with market observers increase the probability of unintentional negative signalling effects.     

Can monthly-return rank order reveal a hidden dimension of momentum? The post-cost evidence from the U.S. stock markets

We introduce a new return-momentum indicator that is based on monotonicity of monthly-return rank order within a lookback period (henceforth abbreviated as MRRO). Based on an extensive post-cost performance comparison of long-only momentum portfolios formed on six stand-alone and 36 double-sort criteria across three holding period lengths in the non-microcap universe of U.S. stocks over the 55-year sample period, MRRO is particularly useful for annual holding periods, towards the end of whom the conventional return-momentum indicators tend to lose their prediction power. Based on the return-based style analysis, MRRO adds some favorable style-diversification characteristics into long-only momentum portfolio selection.     

A Conditional Single Index model with Local Covariates for detecting and evaluating active portfolio management

The intercept of standard Single Index and Conditional Single Index models, the so-called alpha, is often used to evaluate the long-run performance of managed portfolios. However, this measure is not always appropriate for detecting the presence and impact of active management strategies. Based on the conditional factor models literature, we introduce a Conditional Single Index model where the time-varying alpha and beta parameters depend only on the past history of the underlying portfolio returns and of the benchmark returns. The dynamics of the parameters have two components: the first describes the long-term behaviour of the alpha and beta, whereas the second is associated with the short-term performance of the underlying portfolio. The interpretation of parameters allows the identification of portfolio managers who implement active management strategies. An application on a set of 1300 U.S. mutual funds shows how widespread active management is on the U.S. market.     

The Market Performance of Socially Responsible Investment during Periods of the Economic Cycle – Illustrated Using the Case of FTSE

The debate about socially responsible investment (SRI) portfolio performance compared with its non‐SRI counterparts remains inconclusive. This paper contributes to the debate by adding a new approach, examining the issue of a full economic circle through economic boom, recession and recovery. We compare stock performance of two value‐weighted investment portfolios: FTSE4Good (SRI portfolios) and FTSE 350 (conventional portfolios) from 2004 to 2011 including 2007 to 2009 financial crash. The results indicate the SRI portfolio performed better and recovered its value quicker in post‐crisis than the non‐SRI portfolio, indicating that SRI portfolios are more resilient to economic turmoil and market shocks. Copyright © 2015 John Wiley & Sons, Ltd.     

Individual stock sentiment beta and stock returns

Using the data in Chinese stock market, we measure the individual stock sentiment beta, which is defined as the sensitivity of individual stock returns to the individual stock sentiment changes. We demonstrate that stocks in the highest individual stock sentiment beta portfolio have significantly higher excess returns, CAPM alpha, Fama-French three-factor alpha and Fama-French five-factor alpha. Besides, we find that the high individual stock sentiment beta stocks are smaller, younger, more volatile stocks with higher price and higher market beta. After controlling for firm characteristic, the returns of High-Low individual stock sentiment beta portfolios are still significantly positive. Moreover, we show the effect of the individual stock sentiment beta on stock returns is positive and significant in different stock markets, in different sample periods, and in bull and bear market. Besides, the results of the Bayes-Stein individual stock sentiment beta are still stable.     

Leisure and long-run risks: An empirical evaluation on value premium puzzle

I study the ability of a long-run risk model, with nonseparable leisure and consumption, to price the cross-section of U.S. equity returns over the 1948–2015 period. The stochastic discount factor features innovations to future leisure and consumption growth as factors. The model performs well, in terms of a variety of criteria, relative to competing models in explaining the cross-section of the spread in size and value portfolios.