Priced risk and asymmetric volatility in the cross section of skewness

We investigate the sources of skewness in aggregate risk factors and the cross section of stock returns. In an ICAPM setting with conditional volatility, we find theoretical time series predictions on the relationships among volatility, returns, and skewness for priced risk factors. Market returns resemble these predictions; however, size, book-to-market, and momentum factor returns are not always consistent with our predictions. We find evidence that size and book-to-market may be priced post-crisis but not in the decade before. Momentum does not appear priced by our test. We link aggregate risk and skewness to individual stocks and find empirically that the risk aversion effect manifests in individual stock skewness. Additionally, we find several firm characteristics that explain stock skewness. Smaller firms, value firms, highly levered firms, and firms with poor credit ratings have more positive skewness.     

The stock performance of America's 100 Best Corporate Citizens

We consider the stock performance of America's 100 Best Corporate Citizens following the annual survey by Business Ethics. We examine both possible short-term announcement effects around the time of the survey's publication, and whether longer-term returns are higher for firms that are listed as good citizens. We find some evidence of a positive market reaction to a firm's presence in the Top 100 firms that are made public, and that holders of the stock of such firms earn small abnormal returns during an announcement window. Over the year following the announcement, companies in the Top 100 yield negative abnormal returns of around 3%. However, such companies tend to be large and with stocks exhibiting a growth style, which existing studies suggest will tend to perform poorly. Once we allow for these firm characteristics, the poor performance of the highly rated firms declines. We also find companies that are newly listed as good citizens and companies in the Top 100 but outside the S&P 500 can provide considerable positive abnormal returns to investors, even after allowing for their market capitalization, price-to-book ratios, and sectoral classification.     

Indicator selection and stock return predictability

We propose a momentum-determined indicator-switching (MDIS) strategy, simple and effective, to improve the predictability of stock returns, which can effectively select predictors. Empirical results indicate that the stock return forecasts generated by the MDIS strategy are statistically and economically significant. And we find that super long-term momentum of predictability (SMoP) exists in predictive factors. That is, in a long period of time in the past, the best predictor among a series of factors has best prediction ability in the future. We also design restricted momentum-determined indicator-switching (RMDIS) strategy when considering economic constrain. It is robust for the prediction performance of this strategy using a series of extension and robustness test. Success of the RMDIS strategy is also seen in using technical indicators to forecast stock returns.     

Forecasting abnormal stock returns and trading volume using investor sentiment: Evidence from online search

We examine the ability of online ticker searches (e.g. XOM for Exxon Mobil) to forecast abnormal stock returns and trading volumes. Specifically, we argue that online ticker searches serve as a valid proxy for investor sentiment — a set of beliefs about cash flows and investment risks that are not necessarily justified by the facts at hand — which is generally associated with less sophisticated, retail investors. Based on prior research on investor sentiment, we expect online search intensity to forecast stock returns and trading volume, and also expect that highly volatile stocks, which are more difficult to arbitrage, will be more sensitive to search intensity than less volatile stocks. In a sample of S&P 500 firms over the period 2005-2008, we find that, over a weekly horizon, online search intensity reliably predicts abnormal stock returns and trading volumes, and that the sensitivity of returns to search intensity is positively related to the difficulty of a stock being arbitraged. More broadly, our study highlights the potential of employing online search data for other forecasting applications.     

The Impact of Horizontal Mergers on Rivals: Gains to Being Left Outside a Merger

It is commonly perceived that firms do not want to be outsiders to a merger between competitor firms. We instead argue that it is beneficial to be a non-merging rival firm to a large horizontal merger. Using a sample of mergers with expert identification of relevant rivals and the event-study methodology, we find rivals generally experience positive abnormal returns at the merger announcement date. We also find that the stock reaction of rivals to merger events is not sensitive to merger waves; hence, 'future acquisition probability' does not drive the positive abnormal returns of rivals. Further, we find the positive (or non-negative) abnormal returns of rivals to be robust when considering heterogeneity in merger and rival characteristics.     

Price Behavior of Qualified Companies around the Audit Report and Report Announcement Days: The Case of Taiwan

This study investigates the stock price behavior of companies with qualified opinions around (1) the audit report day and (2) the report announcement day. Using a sample of 106 Taiwanese public companies during 1999–2007, we find negative abnormal returns 5 days following the audit report day. Returns that are more negative are associated with a decrease in insider ownership during several months before the audit report day. These results imply that investors can infer qualified opinions or that there is information leakage of qualified opinions. We also find that the average cumulative abnormal return over the 20 days following the announcement day of qualified reports is about ?25%, which is much more pronounced than that in Anglo‐Saxon countries. We ascribe this finding to a rule unique to Taiwan: qualified companies are likely to be subject to mandatory delisting if they cannot restate reports with unqualified opinions.     

The impact of inventory dynamics on long-term stock returns – An empirical investigation of U.S. manufacturing companies

This paper investigates the relationship between the inventory dynamics and long-term stock returns of a large panel of U.S. manufacturing firms over the time period from 1991 to 2010. We propose two measures of inventory dynamics: one metric to assess the fluctuations of quarterly inventories within the year and a second metric to quantify relative year-over-year inventory growth. Our results indicate that within-year inventory volatility (IV) and abnormal year-over-year inventory growth (ABI) are associated with abnormal stock returns. Both metrics cannot be entirely explained by common risk factors. We find that firms with high IV and low ABI have the best long-term stock returns, and that stock performance decreases monotonically with higher ABI values. Our results are robust to various control variables including size, book-to-market value, industry and prior performance. We therefore conclude that changes in inventory levels provide valuable insights into the risks and opportunities faced by a company.     

Supply chain integration and shareholder value: Evidence from consortium based industry exchanges

Recent trade and academic literature point to the importance of supply chain integration among partners as a key determinant of value creation. This paper analyzes the shareholder value effects of setting up industry exchanges, a prominent mechanism used to achieve supply chain integration. Shareholder value effects are estimated by measuring the stock market reaction (abnormal returns) associated with announcements to form or join industry exchanges. We find that abnormal returns from participation in industry exchanges are positive but only marginally significant in the whole sample of 144 firms in 18 exchanges formed during 2000–2001. In the sub-sample of 88 exchange founders who were part of the original announcements to form the exchange, the abnormal market reaction is about 1% and significant. We also find that firms with greater bargaining power and higher process efficiency benefit more from participation in industry exchanges.     

Stock prices and the location of trade: Evidence from China-backed ADRs

This study examines whether the trading location affects equity returns of China-backed American Depository Receipts (ADRs) traded in the US. If International Financial Markets are integrated, stock prices should be affected only by their fundamentals; otherwise, stock prices may also be affected by their trading locations/investor sentiment. We find that China ADRs’ returns are affected more by the US market fluctuations than by Chinese market returns. We interpret the results as suggesting that International Financial Markets are at least partially segmented and country-specific investor sentiment affects stock prices.     

Bayesian forecasting and portfolio decisions using dynamic dependent sparse factor models

We extend the recently introduced latent threshold dynamic models to include dependencies among the dynamic latent factors which underlie multivariate volatility. With an ability to induce time-varying sparsity in factor loadings, these models now also allow time-varying correlations among factors, which may be exploited in order to improve volatility forecasts. We couple multi-period, out-of-sample forecasting with portfolio analysis using standard and novel benchmark neutral portfolios. Detailed studies of stock index and FX time series include: multi-period, out-of-sample forecasting, statistical model comparisons, and portfolio performance testing using raw returns, risk-adjusted returns and portfolio volatility. We find uniform improvements on all measures relative to standard dynamic factor models. This is due to the parsimony of latent threshold models and their ability to exploit between-factor correlations so as to improve the characterization and prediction of volatility. These advances will be of interest to financial analysts, investors and practitioners, as well as to modeling researchers.     

Abnormal research and development investments and stock returns

We investigate the relation between abnormal research and development (R&D) investments change and expected stock returns. We provide evidence that firms that abnormally increase their R&D investments (RDI) earn higher returns in comparison to the market portfolio. Specifically, our findings document an economically significant annual positive abnormal RDI returns that ranges from 3.2% to 11.5%. These findings are robust to well-established risk factors in the literature and suggest that the abnormal increases in RDI impacts stock returns.     

Over-investment in corporate R&D,risk, and stock returns

Large-size firms which significantly increase their R&D expenditures experience subsequently three-year-long negative abnormal stock returns on the magnitude of 56 basis-points per month. We find no robust evidence of significant event-induced abnormal returns for small-size sample firms or any systematic risk changes for the small- and large- size firms. We also find that the large-size sample firms generate relatively much larger cash flows (i.e., have significantly greater over-investment discretion) and have significantly larger (over-) valuation multiples than the small-size firms. Moreover, some of their operating performance measures show signs of deterioration instead of improvement following these R&D programs. These findings are consistent with the view that investors initially underestimate the over-investment in R&D by some large-size firms that appear to be overvalued and have high cash flows at the time of the investment, only to be disappointed later.     

Co-determination of capital structure and stock returns—A LISREL approach: An empirical test of Taiwan stock markets

Titman and Wessels (1988) utilize a structural-equations model (LISREL) to find out the latent determinants of capital structure. Maddala and Nimalendran (1996) indicate that the problematic model specification causes the poor results in Titman and Wessels’ research. Chang, Lee, & Lee (2009) apply a Multiple Indicators and Multiple Causes (MIMIC) model to re-examine the same issue as Titman and Wessels did but found more convincing results. We extend Titman and Wessels’ research from using a single-equation approach to a multi-equations approach. In addition to the determinants of firms’ capital structure, those of stock returns are determined simultaneously. Literature indicates that a firm's capital structure may affect its stock returns (Bhandari, 1988), and the reverse is true too (Baker and Wurgler, 2002, Lucas and McDonald, 1990, Welch, 2004). Hence, a firm's determinants of its capital structure and those of its stock returns should be decided simultaneously, rather than independently. By solving the simultaneous equations, we examine the empirical relationship between the two endogenous variables: capital structure and stock returns and find out their common determinants as well. Our results show that stock returns, expected growth, uniqueness, asset structure, profitability, and industry classification are the main factors of capital structure, while the primary determinants of stock returns are leverage, expected growth, profitability, value and liquidity. The level of debt ratios and stock returns are mutually determined by the aforementioned factors and themselves.     

Cross-sectional variation in the stock market reaction to bond rating changes

Previous research has found that the stock market reacts negatively to bond rating downgrades and that downgrades tend to follow periods of negative returns, indicating that at least some downgrades are partially predictable. Hypothesizing that the reaction to a downgrade depends on both the implications for cash flows and the degree of surprise, we explore how the reaction to downgrade announcements varies across bond issues. We find that the equity market reacts much more negatively to bond rating downgrades to and within the speculative bond category than to downgrades within the investment grade category. Within the speculative category, the reaction is stronger, the lower the old and new ratings are. The reaction to multiple-level downgrades is not very different from that to single-level downgrades. The market reaction is also stronger if the firm has experienced negative pre-downgrade abnormal returns. Our evidence indicates that downgrades are viewed by the market as providing information on likely future earnings before interest charges, not just likely future interest charges. It is also consistent with Billett's (1996) hypothesis that low rated debt makes a firm less attractive as a takeover target.     

Insider trading around open-market share repurchases

We examine insider trading around open-market share repurchases and find that insiders trade passively in 3 months prior to repurchase announcements and in up to 12 months following the announcements. Furthermore, both pre-announcement and post-announcement abnormal insider trading is unrelated to short-term announcement returns but correlated with long-term post-announcement returns. Our results indicate that corporate insiders trade passively around repurchase announcements in accordance with their perceived undervaluation to exploit the long-run abnormal stock returns related to the events.     

Foreign Acquisitions in the United States and the Effect on Shareholder Wealth

The research presented here indicates that foreign acquisitions in the United States in the form of mergers, have resulted in abnormal returns to targets of nearly 22 percent, a figure not much higher than in domestic mergers. Sell-off abnormal returns have averaged nearly three percent, substantially higher than the average 0.7 to 1.66 percent in the domestic case. We find that merger abnormal returns have been substantially higher in our first subperiod (1982–84) than in the second (1985–87). For selloffs, our results are reversed-abnormal returns have been higher in the second subperiod. In cross-sample tests, we find the Japanese paying the highest merger premiums/abnormal returns, while the sell-off abnormal returns are highest when Germans are the buyers. We also find significant differences across industry samples but not across combination type samples. We do not find a significant relationship of these abnormal returns to the firm's accounting and financial variables.     

Asymmetric volatility spillover in the Tokyo stock exchange

This paper examines volatility transfers between size-based stock indexes from the Tokyo Stock Exchange. We use a bivariate EGARCH model to test for volatility spillover effects between large- and small-cap stock indexes. We find an asymmetric volatility spillover from large-cap stock returns to small-cap returns, but not vice versa. We also find a small-firm January effect, but not a June seasonality, in either large-and small-cap stock returns. Instead, we find that the conditional correlation between large- and small-cap indexes is time-varying, showing a tendency to increase during the month of June.(JEL G12, G15)     

Trading cost expectations: Evidence from S&P 500 index replacement stock announcements

This paper tests the effect on stock value of an expected change in future trading costs. The capitalized value of a reduction in trading costs is hypothesized to increase the stock value, a trading cost effect. Improved liquidity reduces trading costs. Inclusion as an S&P 500 Index replacement stock is an event hypothesized to increase liquidity. We use 114 observations between January 1, 1983 and October 12, 1989 of stocks added to the Index as replacements for stocks removed. The abnormal return of each stock is regressed against the ratio of the bidask spread to the price of the stock, the change in trading volume of the stock, and the open interest in the Index futures contracts at the close of the month prior to the replacement announcement. We find that the positive abnormal returns for replacement stocks are related to increased daily trading volume after inclusion in the Index. Further, the trading cost effect is proportional to percentage bid-ask spreads prior to inclusion. The trading cost effect increases as trading in derivatives of the Index increases. The volume and stock price changes after replacement are not transitory, indicating an improvement in liquidity. Three alternate hypotheses suggested in prior research to explain the abnormal returns for replacement stocks are tested. Testing each of the three models previously considered: price pressure, inelastic demand curves, and information, we find that none can be accepted with statistical confidence. The abnormal returns of Index replacement stocks are consistent with rational pricing of an anticipated reduction in future transaction costs. This anticipated reduction is capitalized in the value of the stock at the time of the replacement announcement. These results are consistent with a trading cost effect.     

Economic policy and the presidential election cycle in stock returns

Many papers in the academic literature have documented a “Presidential Election” cycle in stock returns. Prior literature also documents that stock returns appear to be influenced by economic policy. The goal of this study is to examine the tools of fiscal and monetary policy to test for the presence of a presidential election cycle. The findings strongly suggest that the presidential election cycle in stock returns and the government’s economic policy influence on stock returns are two separate phenomena. Moreover, it is much more likely that stock returns are influencing economic policy rather than the other way around. However, the findings also suggest that tax legislation may drive the Presidential Election Cycle.     

Higher moment exchange rate exposure of S&P500 firms

We examine the impact of higher order moments of changes in the exchange rate on stock returns of U.S. large-cap companies in the S&P500. We find a robust negative effect of exchange rate volatility on S&P500 company returns. The consumer discretionary and the consumer staples sectors have significant negative exposure to exchange rate volatility suggesting that exchange rate volatility affects stock returns through the channel of international operations. In terms of industries, the household products and personal products industries have significant negative exposure as well. The impact in the financial sector suggests that derivatives and hedging activity can mitigate exposure to exchange rate volatility. We find weak evidence that exchange rate skewness has an effect on S&P500 stock returns, but, find evidence that exchange rate kurtosis affects returns of companies that are more exposed to exchange rate volatility.