Age‐Dependent Increasing Risk Aversion and the Equity Premium Puzzle

We introduce a new preference structure—age‐dependent increasing risk aversion (IRA)—in a three‐period overlapping generations model with borrowing constraints, and examine the behavior of equity premium in this framework. We find that IRA preferences generate results that are more consistent with U.S. data for the equity premium, level of savings and portfolio shares, without assuming unreasonable levels of risk aversion. We find that the relative difference between the two risk aversions (how much more risk‐averse old agents are relative to the middle‐aged) matters more than the average risk aversion in the economy (how much more risk‐averse both cohorts are). Our findings are robust with respect to a number of model generalizations.     

European Momentum Strategies,Information Diffusion,and Investor Conservatism

In this paper we conduct an out‐of‐sample test of two behavioural theories that have been proposed to explain momentum in stock returns. We test the gradual‐information‐diffusion model of Hong and Stein (1999) and the investor conservatism bias model of Barberis et al. (1998) in a sample of 13 European stock markets during the period 1988 to 2001. These two models predict that momentum comes from the (i) gradual dissemination of firm‐specific information and (ii) investors’ failure to update their beliefs sufficiently when they observe new public information. The findings of this study are consistent with the predictions of the behavioural models of Hong and Stein's (1999) and Barberis et al. (1998) . The evidence shows that momentum is the result of the gradual diffusion of private information and investors’ psychological conservatism reflected on the systematic errors they make in forming earnings expectations by not updating them adequately relative to their prior beliefs and by undervaluing the statistical weight of new information.     

The impact of business group affiliation on stock price informativeness: Evidence from an emerging market

This paper examines the relationship between business group affiliation and stock price informativeness in an emerging market setting. We use stock price synchronicity as a measure, and study the impact of group affiliation ‐specifically the extent of affiliation, ownership structure and existence of group bank‐ on firm specific information content. Results reveal that the amount of firm‐specific information capitalized into stock prices tends to be lower (higher) when the firm is group‐affiliated (unaffiliated), indirectly (directly) owned, and affiliated group has (does not have) a group bank. Additionally, the extent of group affiliation maintains a non‐linear relationship with synchronicity, suggesting that the perception of higher versus lower levels of group ownership differs.     

Demographic Change and Pharmaceuticals' Stock Returns

We analyse how demographic change affected profits and returns across pharmaceutical industries over the last 20 years. Fluctuations in different age group sizes influence the estimated demand changes for age‐sensitive drugs, such as antibacterials for young, antidepressants for middle‐aged, and antithrombotics for old people. These demand changes are predictable as soon as a specific age group is born. We use consumption and demographic data to forecast future consumption demand growth for drugs caused by demographic changes in the age structure. We find that long‐term forecast demand changes predict abnormal annual pharmaceutical stock returns for more than 60 firms over the time period from 1986 to 2008. An increase by one percentage point of annual demand growth due to demographic changes predicts an increase in abnormal yearly stock returns in the size of 3–5 percentage points. Short‐term forecast demand changes does predict negative abnormal stock returns for a time horizon below 5 years. A trading strategy taking advantage of the demographic information earns a significant abnormal return between 6 and 8 percentage points per year. Our results are consistent with the model by DellaVigna and Pollet (2007) , where investors are inattentive with extrapolation in the distant future and overreact to information in the near future.     

Hedging with Two Futures Contracts: Simplicity Pays

We propose to use two futures contracts in hedging an agricultural commodity commitment to solve either the standard delta hedge or the roll‐over issue. Most current literature on dual‐hedge strategies is based on a structured model to reduce roll‐over risk and is somehow difficult to apply for agricultural futures contracts. Instead, we propose to apply a regression based model and a naive rules of thumb for dual‐hedges which are applicable for agricultural commodities. The naive dual strategy stems from the fact that in a large sample of agricultural commodities, De Ville, Dhaene and Sercu (2008) find that GARCH‐based hedges do not perform as well as OLS‐based ones and that we can avoid estimation error with such a simple rule. Our semi‐naive hedge ratios are driven from two conditions: omitting exposure to spot price and minimising the variance of the unexpected basis effects on the portfolio values. We find that, generally, (i) rebalancing helps; (ii) the two‐contract hedging rules do better than the one‐contract counterparts, even for standard delta hedges without rolling‐over; (iii) simplicity pays: the naive rules are the best one–for corn and wheat within the two‐contract group, the semi‐naive rule systematically beats the others and GARCH performs worse than OLS for either one‐contract or two‐contract hedges and for soybeans the traditional naive rule performs nearly as well as OLS. These conclusions are based on the tests on unconditional variance ( Diebold and Mariano, 1995 ) and those on conditional risk ( Giacomini and White, 2006 ).     

Will Any q Do?

We find that the relative levels of computationally costly q estimators and simple q estimators, when used as continuous variables, are affected by variations in many firm financial characteristics. In contrast, when the estimators are used as dichotomous variables, they classify the vast majority of firms identically with respect to the unit q breakpoint. Finally, we find that the computationally costly approach may induce sample‐selection bias as a result of data unavailability. Our results suggest that the simple approach is preferable except when extreme precision of the q estimate is of paramount importance and sample‐selection bias is not likely to be an issue.     

European Corporate Governance: a Thematic Analysis of National Codes of Governance

Using Latent Semantic Analysis techniques to analyse the corporate governance codes of 23 EU nations, we obtain a number of new findings regarding their thematic content, variability, and convergence. We determine that these codes can be decomposed into five common themes, with substantial cross‐sectional variability in their relative importance. We also find that the themes contained in these codes cluster in ways that are not fully consistent with the legal regime classifications of La Porta et al. (1997) , leading us to construct two new country clusters. We further discover that the identity of the code issuer (e.g., government versus stock exchange) is important in explaining a code's primary theme as well as changes in theme prominence over time. Finally, we fail to find evidence of an unchecked thematic convergence towards an Anglo‐Saxon model of corporate governance, with some code themes converging to UK practices while others diverge.     

The Return to Direct Investment in Private Firms: New Evidence on the Private Equity Premium Puzzle*

This paper uses a novel dataset to analyze the return to direct investments in private firms by pension funds. We have two key findings. First, direct investments in private firms have underperformed public equity by 392 basis points per annum under conservative risk adjustments. Second, initial mispricing, due to over‐optimism or misperceived risk, and subsequent low capital gains seem to explain the gap in returns to private firms. Overall, these findings complement the finding of Moskowitz and Vissing‐Jørgensen (2002) of low returns on entrepreneurial investments and provide new insight into the existence of what they call the private equity premium puzzle: Even professional investors with well‐diversified portfolios like pension funds seem to get a poor risk‐return tradeoff from investing directly in private firms.     

Equity‐Based Compensation for Employees: Firm Performance and Determinants

I examine the effect of employee equity‐based compensation (EBC) on firm performance and the determinants of EBC. Using two samples, I find that firms have come to rely more heavily on EBC than in the past. For both samples, I document a significant, positive relation between Tobin's q and the percentage of employee compensation that is equity based. For accounting returns, I find a positive relation with the earlier sample. However, for the later sample I find that greater use of EBC leads to lower levels of future accounting returns. I also find that the determinants of the proportion of EBC are different between the two samples.     

Risk‐based explanation for the book‐to‐market effect

This paper proposes a risk‐based explanation for the book‐to‐market (B/M) effect. I decompose B/M into net operating asset‐to‐market (NOA/M) and net financing asset‐to‐market (NFA/M) components. Portfolio analysis shows that (i) positive B/M, NOA/M and NFA/M are positively related to future returns and (ii) negative B/M, NOA/M and NFA/M are negatively related to future returns. To the extent that positive B/M, NOA/M and NFA/M act as measures of asset risk and negative B/M, NOA/M and NFA/M act as inverse measures of borrowing risk, the nonlinear relations between B/M, NOA/M and NFA/M and future returns provide some evidence to support the risk‐based explanation for the book‐to‐market effect in stock returns.     

Risk Measures for Hedge Funds: a Cross‐sectional Approach

This paper analyses the risk‐return trade‐off in the hedge fund industry. We compare semi‐deviation, value‐at‐risk (VaR), Expected Shortfall (ES) and Tail Risk (TR) with standard deviation at the individual fund level as well as the portfolio level. Using the Fama and French (1992) methodology and the combined live and defunct hedge fund data from TASS, we find that the left‐tail risk captured by Expected Shortfall (ES) and Tail Risk (TR) explains the cross‐sectional variation in hedge fund returns very well, while the other risk measures provide statistically insignificant or marginally significant results. During the period between January 1995 and December 2004, hedge funds with high ES outperform those with low ES by an annual return difference of 7%. We provide empirical evidence on the theoretical argument by Artzner et al. (1999) that ES is superior to VaR as a downside risk measure. We also find the Cornish‐Fisher (1937) expansion is superior to the nonparametric method in estimating ES and TR.     

The Long‐Term Effect of the Sarbanes‐Oxley Act on Cross‐Listing Premia

This paper uses a triple difference approach to assess whether the adoption of the Sarbanes‐Oxley Act predicts long‐term changes in cross‐listing premia of affected foreign firms. I measure cross‐listing premia as the difference between the Tobin's q of a cross‐listed company and a non‐cross‐listed company from the same country matched on propensity to cross‐list (first difference). I find that average premia for firms cross‐listed on levels 2 or 3 (subject to SOX) declined in the year of SOX adoption (2002) and remained significantly below their pre‐SOX level through year‐end 2005 (second difference). Firms listed on levels 2 or 3, which are subject to SOX, experienced larger declines in premia than firms listed on levels 1 or 4, which are not subject to SOX (third difference). The estimated decline is 0.15–0.20 depending on specification. Riskier firms and firms from high‐disclosing and high‐GDP countries suffered larger post‐SOX declines. Firm size predicts smaller declines in premia in well‐governed countries. Faster‐growing firms in poorly‐governed countries experienced smaller declines in premia. The results are robust to the use of different before‐and‐after periods; the use of annual, quarterly, or monthly data; the use of individual companies' Tobin's q's instead of matched pairs, and different regression specifications. The overall evidence is consistent with the view that SOX negatively affected cross‐listed premia, and particularly hurt riskier firms and firms from well‐governed countries, while perhaps helping high‐growth firms from poorly‐governed countries. At the same time, after‐SOX, level‐23 firms continue to enjoy a substantial premium, estimated at about 0.32.     

Delayed Expected Loss Recognition and the Risk Profile of Banks

This paper investigates the extent to which delayed expected loan loss recognition (DELR) is associated with greater vulnerability of banks to three distinct dimensions of risk: (1) stock market liquidity risk, (2) downside tail risk of individual banks, and (3) codependence of downside tail risk among banks. We hypothesize that DELR increases vulnerability to downside risk by creating expected loss overhangs that threaten future capital adequacy and by degrading bank transparency, which increases financing frictions and opportunities for risk‐shifting. We find that DELR is associated with higher correlations between bank‐level illiquidity and both aggregate banking sector illiquidity and market returns (i.e., higher liquidity risks) during recessions, suggesting that high DELR banks as a group may simultaneously face elevated financing frictions and enhanced opportunities for risk‐shifting behavior in crisis periods. With respect to downside risk, we find that during recessions DELR is associated with significantly higher risk of individual banks suffering severe drops in their equity values, where this association is magnified for banks with low capital levels. Consistent with increased systemic risk, we find that DELR is associated with significantly higher codependence between downside risk of individual banks and downside risk of the banking sector. We theorize that downside risk vulnerability at the individual bank level can translate into systemic risk by virtue of DELR creating a common source of risk vulnerability across high DELR banks simultaneously, which leads to risk codependence among banks and systemic effects from banks acting as part of a herd.     

Behavioural Finance: A Review and Synthesis

I provide a synthesis of the Behavioural finance literature over the past two decades. I review the literature in three parts, namely, (i) empirical and theoretical analyses of patterns in the cross‐section of average stock returns, (ii) studies on trading activity, and (iii) research in corporate finance. Behavioural finance is an exciting new field because it presents a number of normative implications for both individual investors and CEOs. The papers reviewed here allow us to learn more about these specific implications.     

Divergence of Opinion Surrounding Extreme Events

This paper examines the stock market performance of a large sample of new issues (IPOs and SEOs) following an extreme price movement during the first three years after the offering. Strong underperformance follows either a positive or negative (at least +/?15%) one‐day return event. This poor performance cannot be explained by the Fama‐French four‐factor methodology, or by the generally low stock returns of growth firms. Unlike recent issuers, non‐issuers report no poor performance following a similar extreme event using the four‐factor methodology. The extreme event date shows very high levels of turnover, a measure of divergence of opinion. Finally, there is a strong negative linkage between higher levels of divergence of opinion and subsequent stock performance.     

Valuation Effects of Short Sale Constraints: the Case of Corporate Takeovers

We examine the relation between the degree of short sale constraints for acquiring firms' equity and post takeover stock performance. We find that negative long‐run abnormal returns appear to decline (in economic and statistical terms) as the extent and persistence of institutional block‐holder ownership increase, after accounting for the size, book‐to‐market and method of payment effects. In the spirit of Miller (1977) , such evidence implies that the degree of short sale constraints serves as an important determinant of acquiring firms' short‐run overpricing. It appears that the presence of concentrated institutional presence mitigates and in most cases eliminates, through effective arbitrage, any short‐run overpricing that may be responsible for the long‐run underperformance of acquirers, preserving in this way efficiency in the takeover markets.     

The Performance of Hedge Fund Strategies and the Asymmetry of Return Distributions

We present hedge fund performance estimates that adjust for stale prices, Fama‐French risk factors and skewness. We contrast these new performance estimates with traditional performance measures. Using three‐factor models to adjust for staleness in prices and to incorporate Fama‐French factors along with the Harvey‐Siddique (2000) two‐factor model that incorporates skewness, we find that for the period 1990–2003, all hedge fund categories achieve above average performance when measured against an aggregate market index. More significantly, however, when we estimate performance at the individual hedge fund level, we discover that only 40 to 47% of the funds are shown to achieve an above average performance over that time period depending on the model used. These results have important implications for investors, endowments and pensions when they choose hedge fund managers.     

Regulations and Productivity Growth in Banking: Evidence from Transition Economies

This paper examines the relationship between the regulatory and supervision framework, and the productivity of banks in 22 countries over the period 1999–2009. We follow a semiparametric two‐step approach that combines Malmquist index estimates with bootstrap regressions. The results indicate that regulations and incentives that promote private monitoring (PMON) have a positive impact on productivity. Restrictions on banks’ activities relating to their involvement in securities, insurance, real estate, and ownership of nonfinancial firms also have a positive impact. Regulations relating to the first and second pillars of Basel II, namely, capital requirements (CAPR) and official supervisory power (SPR) do not have, in general, a statistically significant impact on productivity over the study period although they appear to gain in importance following the onset of the financial crisis in 2007. The latter finding indicates that stringent capital and supervisory standards have positive productivity effects when financial pressures peak. Our results are robust when controlling for various country‐specific features and alternative estimation approaches.     

UK Evidence on the Characteristics versus Covariance Debate

We evaluate the Fama–French three‐factor model in the UK using the approach of Daniel and Titman (1997) to determine whether characteristics or covariance risk better explains the size and value premiums. Across all three factors, we find that return premiums bear little relationship to the corresponding loadings. We show that small and value stocks earn higher returns irrespective of their return covariance. Our study contributes to the existing literature by reporting original findings on the Fama–French three‐factor model in the UK and by reporting results that complement existing evidence from similar studies in the USA and Japan.     

Performance of Foreign and Global Mutual Funds: The Role of Security Selection,Region‐Shifting,and Style‐Shifting Abilities

We examine the performance of U.S.‐based foreign and global funds after controlling for their regional and style exposure. We show that, on average, the total performance (TP) and security selection abilities of both foreign and global funds are significantly negative and exhibit short‐term predictability. Additionally, R² reflects funds’ security selection abilities, consistent with previous findings for domestic mutual funds. Investors can earn higher abnormal returns and TP in the short run by purchasing past winners with low R² than by purchasing past losers with high R². However, there is no evidence of predictability in the funds' region‐shifting and style‐shifting abilities.