Do fire sales create externalities?

We develop three novel measures of the incentives of equity mutual funds to internalize the price impact of their trading. We show that mutual funds with stronger incentives to internalize their price impact accommodate inflows and outflows by adjusting their cash buffers instead of trading in portfolio securities. As a result, stocks held by these funds have lower volatility, and flows out of these funds have smaller spillover effects on other funds holding the same securities. Our results provide evidence of meaningful fire sale externalities in the equity mutual fund industry.     

Trading volume: definitions, data analysis, and implications of portfolio theory

We examine the implications of portfolio theory for the cross-sectionalbehavior of equity trading volume. Two-fund separation theoremssuggest a natural definition for trading activity: share turnover.If two-fund separation holds, share turnover must be identicalfor all securities. If (K + 1)-fund separation holds, we showthat turnover satisfies an approximately linear K-factor structure.These implications are examined empirically using individualweekly turnover data for NYSE and AMEX securities from 1962to 1996. We find strong evidence against two-fund separation,and a principal-components decomposition suggests that turnoveris well approximated by a two-factor linear model.     

基于期权平价原理的内幕交易管制设计

根据期权平价原理,股票、零息国债、欧式股票的买权与卖权等四类资产之间存在一种等价关系,因此每种资产都可由其他三个变量的投资组合来进行等价的表达。某些高管人员利用政府对分属于不同领域的投资组合的管制差异,以等价的期权投资组合替代股票交易从而进行变相内幕交易。中国证券监管部门有必要对管制制度安排进行优化,将衍生证券交易也纳入到内幕交易管制系统中来。     

Capital Gains Taxes and Equity Trading: Empirical Evidence

Individual investors have an incentive to defer selling appreciated stock until it qualifies for tax‐favored, long‐term capital gains treatment. Shackelford and Verrecchia [2002] show that these incentives can affect equity trading around public disclosures. This article provides some empirical support for their theory with evidence of price increases and equity constrictions around announcements of quarterly earnings and additions to the S&P 500 index. We find share returns rise and trading volume falls with the incremental taxes saved by deferring the sale of appreciated property. The price increases, however, are temporary, reversing in subsequent trading days. The results are consistent with buyers believing the compensation to sell before long‐term qualification (through higher prices) is less costly than holding an inappropriately weighted portfolio. This finding—that personal capital gains taxes affect equity trading—adds to a growing literature that challenges longstanding assumptions that firm value is independent of shareholders and their taxes.     

Constructing Asset Pricing Models With Specific Factor Loadings

We demonstrate how one can build pricing formulae in which factors other than beta may be viewed as determinants of asset returns. This is important conceptually as it demonstrates how the additional factors can compensate for a market portfolio proxy that is mis‐specified, and also shows how such a pricing model can be specified ex ante. The procedure is implemented by first selecting an ‘orthogonal’ portfolio which falls on the mean‐variance efficient frontier computed from the empirical average returns, variances and covariances on the equity securities of a large sample of firms. One then determines the inefficient index portfolio which leads to a vector of betas that when multiplied by the average return on the orthogonal portfolio, and which when subtracted from the vector of average returns for the firms comprising the sample, yields an error vector that is equal to the vector of numerical values for the variables that are to form the basis of the asset pricing formula. There will then be a perfect linear relationship between the vector of average returns for the firms comprising the sample, the vector of betas based on the inefficient index portfolio and such other factors that are deemed to be important in the asset pricing process. We illustrate computational procedures using a numerical example based on the quality of information contained in published corporate financial statements.     

Trading volume and short-horizon contrarian profits: Evidence from the Malaysian market

We provide evidence on short-term predictability of stock returns on the Malaysian stock market. We examine the relation between return predictability and the level of trading activity. This is particularly relevant in emerging stock markets, where thin trading is more pervasive. We find that the returns from a contrarian portfolio strategy are positively related to the level of trading activity in the securities. Specifically, the contrarian profits on actively and frequently traded securities are significantly higher than that generated from the low trading activity securities. We find that the differential behavior of high- and low-volume securities is not subsumed by the size effect, although for the small firms, the volume–predictability relation is most pronounced. We also suggest that the price patterns may be related to the institutional arrangement in the Malaysian stock market.     

Top management incentives and financial flexibility: The case of make‐whole call provisions

Consistent with the premise that make‐whole call provisions enhance value‐creating financial flexibility, we find that higher sensitivity of managerial wealth to stock price (delta) increases the likelihood that corporate bonds contain make‐whole provisions. Building on the results of related research, post‐issue financial performance of make‐whole callable bond issuers increases in delta. In line with prior findings that demonstrate financial flexibility can be costly to bondholders, we find that managerial equity incentives impact the incremental effect of make‐whole provisions on the pricing of corporate debt securities. Consistent with the flexibility explanation, we also find that the market response as measured by abnormal trading volume to the issuance of make‐whole callable debt varies in equity incentives. Overall, our results suggest that managerial incentives play a role in the choice, pricing, and market response to make‐whole options in corporate debt securities.     

Piecing together the extent of retail fractional trading

We examine the introduction of fractional trading and its impact on retail security ownership. Fractional trading aims to increase investor access to securities with high prices. Over the initial months of Robinhood’s fractional trading program, the number of unique owners increases approximately 53 percentage points more for stocks priced above $100 versus those priced below $50. Intraday, high-price stocks exhibit incremental ownership growth specifically during periods when fractional trading is permitted. Our results show that Robinhood investors make ample use of fractional trading to acquire previously inaccessible securities, indicating a substantial reduction in price-based investing frictions and carrying implications for retail portfolio management. In addition, we show that potential market impacts of fractional trading appear negligible based on share volume data from multiple brokers with fractional trading programs.     

Trading Volume: Implications of an Intertemporal Capital Asset Pricing Model

We derive an intertemporal asset pricing model and explore its implications for trading volume and asset returns. We show that investors trade in only two portfolios: the market portfolio, and a hedging portfolio that is used to hedge the risk of changing market conditions. We empirically identify the hedging portfolio using weekly volume and returns data for U.S. stocks, and then test two of its properties implied by the theory: Its return should be an additional risk factor in explaining the cross section of asset returns, and should also be the best predictor of future market returns.     

The Impact of Portfolio Diversification on Trading Rules Profits: Some Evidence for UK Share Portfolios

This paper demonstrates how the autocorrelation structure of UK portfolio returns is linked to dynamic interrelationships among the component securities of that portfolio. Moreover, portfolio return autocorrelation is shown to be an increasing function of the number of securities in the portfolio. Since the security interrelationships seemed to be more a product of their history of non-synchronous trading than of systematic industry-related phenomena, it should not be possible to exploit the high levels of return persistence using trading rules. We show that rules designed to exploit this portfolio autocorrelation structure do not produce economic profits.     

Confidence and Investors' Reliance on Disciplined Trading Strategies

Researchers and practitioners in accounting and finance often investigate or advocate particular disciplined trading strategies, but little work investigates the determinants of individual investors' trading‐strategy reliance. We report two experiments, which provide evidence that the dual‐source model of overconfidence (Sniezek and Buckley [1991]) predicts the circumstances in which investors are more likely to rely on disciplined trading strategies. Our results indicate that reliance is more likely when investors trade portfolios of securities rather than trading on a case‐by‐case basis, particularly when investors have received feedback that their previous (unaided) trading decisions have been unprofitable. These results are driven by the number of shares that investors transact rather than by investors' directional agreement with the recommendations of the trading strategy, suggesting that the effects of a portfolio approach and trading experience occur by mitigating investors' overconfidence. The effects violate an aspect of economic rationality because our experiments ensure that investors in all conditions trade the same set of securities based on the same set of information.     

Funding conditions and insurance stock returns: Do insurance stocks really benefit from rising interest rate regimes?

We examine funding conditions and U.S. insurance company stock returns. Although constrained funding conditions, signaled by restrictive Federal Reserve monetary policy, correspond with increases in the future payouts of fixed‐income securities held by insurance firms and potentially provide value through the liability side of insurer balance sheets, they also decrease the values of securities currently held in insurer portfolios. Prior research finds that restrictive policy has a negative effect on equity returns in general. Our results suggest the negative impacts of constrained funding environments outweigh the potential positives, as insurance company stock returns are significantly lower during periods of constrained funding. This effect varies within a given funding state and also across insurer type. The effect is strongest during the first 3 months of a constrained funding environment and for life and health insurers—insurer types with longer portfolio durations. For property and liability (P&L) insurers, lower stock return performance only exists in the first 3 months of a constrained funding environment. In the subsequent months, P&L insurers actually have higher stock returns during constrained periods, consistent with their typically shorter duration asset portfolios, which are more quickly rolled over into new higher‐yielding securities.     

Trading frequency and the efficiency of price discovery in a non-dealer market

The increasing popularity of non-dealer security markets that offer automated, computer-based, continuous trading reflects a presumption that institutionally-set trading sessions are economically obsolete. This theoretical paper investigates the effect of the trading frequency, a key feature of the trading mechanism, on the efficiency of price discovery in a non-dealer market. By tracing the market pricing error to the correlation structures of arriving information and pricing errors of individual traders, the effect of diverging expectations on error-based and overall return volatility is isolated. The analysis reveals that, due to a portfolio effect, an increase in the trading time interval has contradictory effects on the portion of return volatility stemming from pricing errors. The greater accumulation of information increases error-based return volatility, but the greater volume and number of traders per session have the opposite effect. The net effect on overall return volatility can go either way. It is found that the return volatility of heavily traded securities is likely to be minimized under continuous trading, but that of thinly traded securities may be minimized under discrete trading at moderate time intervals. The latter is more likely to occur the greater is the divergence of expectations among traders. These findings challenge the presumption that automated continuous trading in a non-dealer market is more efficient than discrete trading for all securities, regardless of trading volume. The findings are applicable to all economies, but have special importance for developing countries where typically a single market is dominated by small issues and a low volume of trade. As a by-product of the analysis, it is shown how to correct the biased estimate of inter-session price volatility when observations are less frequent than the trading sessions themselves.     

Capital Requirements for Securities Firms

Regulatory authorities set capital requirements to cover the position risk of securities firms and to protect against losses arising from fluctuations in the value of their holdings. The requirements may be set using the comprehensive approach required by the U.S. Securities and Exchange Commission, the building-block approach required by the European Community, or the portfolio approach required by the United Kingdom. We compare these three alternatives using a large sample of U.K. equity trading books. The portfolio approach systematically specifies larger requirements for riskier books, and vice versa. It is more efficient than the building-block approach, and far more efficient than the comprehensive approach.     

Sizing Up Repo

To understand which short‐term debt markets experienced “runs” during the financial crisis, we analyze a novel data set of repurchase agreements (repo), that is, loans between nonbank cash lenders and dealer banks collateralized with securities. Consistent with a run, repo volume backed by private asset‐backed securities falls to near zero in the crisis. However, the reduction is only $182 billion, which is small relative to the stock of private asset‐backed securities as well as the contraction in asset‐backed commercial paper. While the repo contraction is small in aggregate, it disproportionately affected a few dealer banks.     

The Irrelevance of Margin: Evidence from the Crash of '87

Following the crash of 1987, one contentious regulatory issue has been whether margin activity exacerbated the decline in equity values. We contrast the crash behavior of NASDAQ securities eligible for margin trading with the behavior of ineligible ones. Consistent with the hypothesis that margin-eligible securities were more frequently subjected to margin calls and forced sales, we find that abnormal volumes were uniformly larger for eligible securities. However, there is no evidence that this activity provoked additional price depreciation. Margin-eligible securities actually fell by one percent less than the ineligible securities over the period.     

Trading activity and price reversals in futures markets

We use the standard contrarian portfolio approach to examine short-horizon return predictability in 24 US futures markets. We find strong evidence of weekly return reversals, similar to the findings from equity market studies. When interacting between past returns and lagged changes in trading activity (volume and/or open interest), we find that the profits to contrarian portfolio strategies are, on average, positively associated with lagged changes in trading volume, but negatively related to lagged changes in open interest. We also show that futures return predictability is more pronounced if interacting between past returns and lagged changes in both volume and open interest. Our results suggest that futures market overreaction exists, and both past prices and trading activity contain useful information about future market movements. These findings have implications for futures market efficiency and are useful for futures market participants, particularly commodity pool operators.     

Price Discovery and Liquidity in Basket Securities

Basket securities enable investors to purchase a broad portfolio of securities in a single transaction. We examine the link between HOLDRS, a basket security comprising stocks from an industry or sector, and the underlying stocks. We find that the price of the portfolio of underlying securities leads and is more informative than the basket price. Our results are contrary to the findings of empirical studies that use futures, which are basket securities with features less like those of the underlying equities. Our findings suggest uninformed investors can minimize adverse selection costs by trading basket securities rather than the underlying stocks.     

Heterogeneous preferences and equilibrium trading volume

The representative-agent Lucas model stresses aggregate risk and hence does not allow us to study the impact of agents’ heterogeneity on the dynamics of equilibrium trading volume. In this paper, we investigate under what conditions non-informational heterogeneity, i.e., differences in preferences and endowments, leads to nontrivial trading volume in equilibrium. We present a non-informational no-trade theorem that provides necessary and sufficient conditions for zero equilibrium trading volume in a continuous-time Lucas market model with heterogeneous agents, multiple goods, and multiple securities. We explain in detail how no-trade equilibria are related to autarky equilibria, portfolio autarky equilibria, and peculiar financial market equilibria, which play an important role in the literature on international risk sharing.