Non-linear dynamics of hot and cold cycles in Indian IPO markets: evidence from Markov regime-switching vector autoregressive model

The study aims to examine non-linear relationship between initial public offering (IPO) volume and average monthly initial returns for ‘hot’ and ‘cold’ issuing cycles in the Indian IPO markets using a two-state Markov regime-switching vector autoregressive model. The sample considers 557 IPOs during the period 2004–2014. The study establishes the presence of hot and cold states in Indian IPO markets. It finds bidirectional causality between IPO volume and initial returns for ‘hot’ issuing periods. The empirical findings suggest that the market possesses valuable information content in terms of the past issuing activity which has the potential to increase the predictability of future market behaviour.     

Predictability of stock markets with disequilibrium trading. A commentary paper

The paper focuses on the problem of predictability of stock market returns with disequilibrium trading. It is shown that the predictability of returns may be the consequence of quantity constraints appearing in the markets due to the imposition of administrative restrictions on trade. A relevant test of predictability for the Warsaw Stock Exchange (WSE) based on information referring to disequilibrium states occurrence is proposed. The empirical results of its application to the WSE on a sample containing session-to-session observations from the period January 1995 to December 1999 strongly support the hypothesis of predictability.     

The dividend–price ratio does predict dividend growth: International evidence

Unpredictable dividend growth by the dividend–price ratio is considered a ‘stylized fact’ in post war US data. Using long-term annual data from the US and three European countries, we revisit this stylized fact, and we also report results on return predictability. We make two main contributions. First, we document that for the US, results for long-horizon predictability are crucially dependent on whether returns and dividend growth are measured in nominal or real terms, and this difference is due to long-term inflation being strongly negatively predictable by the dividend–price ratio. The impact of inflation is to reinforce real return predictability and to reduce – or change direction of – real dividend growth predictability. This provides an explanation for the strong predictability of long-horizon real returns in the ‘right’ direction, and the strong predictability of long-horizon real dividend growth in the ‘wrong’ direction, that we see in US post war data. Second, we find that predictability patterns in three European stock markets are in many ways different from what characterize the US stock market. In particular, in Sweden and Denmark dividend growth is strongly predictable by the dividend–price ratio in the ‘right’ direction while returns are not predictable. The results for the UK are mixed. Our results are robust to a number of changes in the modeling framework. We discuss the results for dividend growth predictability in terms of the ‘dividend smoothing hypothesis’.     

Market Expectations in the Cross‐Section of Present Values

Returns and cash flow growth for the aggregate U.S. stock market are highly and robustly predictable. Using a single factor extracted from the cross‐section of book‐to‐market ratios, we find an out‐of‐sample return forecasting R² of 13% at the annual frequency (0.9% monthly). We document similar out‐of‐sample predictability for returns on value, size, momentum, and industry portfolios. We present a model linking aggregate market expectations to disaggregated valuation ratios in a latent factor system. Spreads in value portfolios’ exposures to economic shocks are key to identifying predictability and are consistent with duration‐based theories of the value premium.     

An Intertemporal International Asset Pricing Model: Theory and Empirical Evidence

We extend Campbell's (1993) model to develop an intertemporal international asset pricing model (IAPM). We show that the expected international asset return is determined by a weighted average of market risk, market hedging risk, exchange rate risk and exchange rate hedging risk. These weights sum up to one. Our model explicitly separates hedging against changes in the investment opportunity set from hedging against exchange rate changes as well as exchange rate risk from intertemporal hedging risk. A test of the conditional version of our intertemporal IAPM using a multivariate GARCH process supports the asset pricing model. We find that the exchange rate risk is important for pricing international equity returns and it is much more important than intertemporal hedging risk.     

Does an intertemporal tradeoff between risk and return explain mean reversion in stock prices?

When volatility feedback is taken into account, there is strong evidence of a positive tradeoff between stock market volatility and expected returns on a market portfolio. In this paper, we ask whether this intertemporal tradeoff between risk and return is responsible for the reported evidence of mean reversion in stock prices. There are two relevant findings. First, price movements not related to the effects of Markov-switching market volatility are largely unpredictable over long horizons. Second, time-varying parameter estimates of the long-horizon predictability of stock returns reject any systematic mean reversion in favour of behaviour implicit in the historical timing of the tradeoff between risk and return.     

BUSINESS CYCLES AND STOCK MARKET RETURNS: EVIDENCE USING INDUSTRY-BASED PORTFOLIOS

Much evidence has emerged recently that suggests stock returns are predictable. In representative agent consumption-based asset pricing models, asset returns are related to aggregate output and consumption through changes in the intertemporal marginal rate of substitution. An alternative view is that the amount of variation required in the intertemporal marginal rate of substitution is too large to be rationally explained. We shed further light on this debate by investigating whether the stock returns of certain sectors of the economy can predict future market returns even after controlling for the information contained in the aggregate market index. In the consumption-based models, aggregate output and consumption affect the discount rates of all assets synchronously; no particular sectoral return should have any more predictive ability than the others. We find evidence that the stock returns of five industry-based portfolios have significant information about future market returns that is not in the market index. This stylized empirical result is not consonant with existing models relating output to stock returns.     

Momentum returns in Australian equities: The influences of size,risk, liquidity and return computation

The apparent predictability of stock prices, and the related profitability of investment strategies based on this, has generated a great deal of research. Since the late 1980s, momentum strategies have attracted considerable attention and have been found to be profitable in numerous markets. This paper investigates the returns to short-term and intermediate-horizon momentum strategies in the Australian equity market. We focus on ‘practical’ or ‘realistic’ investment strategies, and find that momentum is prevalent in the Australian market and that the returns are of greater magnitude than previously found in overseas markets. These momentum strategy returns are robust to risk adjustment and prevail over time. We also examine the interaction of momentum on size and liquidity variables and conclude that the observed profits to these investment strategies are not explained by size or liquidity differences among the stocks.     

Global integration and emerging stock market excess returns

This article studies the effects of the global integration process on emerging stock market excess returns in a dynamic context. I improve the existing literature in four main directions. First, I show that the average excess returns rise as the level of financial and real integration rises. Second, I find overwhelming evidence that the financial liberalizations (i.e. de jure integration) of the late 1980s and early 1990s have not been simultaneously accompanied by a de facto integration. Third, I find that the percentage of variation in emerging excess returns explained by non-traded global risk factors rises as the level of market openness rises. Last, at the country level, I show that the correlation coefficient does not represent a robust measure of integration. Results also suggest that there are substantial cross-country differences in the dynamics of the degree of financial integration.     

SEC product-line reporting and market efficiency

This study tests the efficiency of the securities market with respect to non-public segment earnings data for 1967–1969 which was first made public by many firms in 1970 SEC 10-K reports. Trading rule strategies are proposed in which segment-based earnings forecasts are compared to consolidated-based forecasts to anticipate ‘unexpected’ changes in earnings. Using the ‘market model’ to eliminate market related movements in security prices, average monthly abnormal returns conditional on this segment-based strategy are estimated for 1968, 1969, and 1970 for two groups of firms: (1) ‘Non-disclosure’ firms that did not publicly report either segment revenue or profit data prior to 1970, and (2) ‘partial disclosure’ firms that publicly reported segment revenue information, but no segment profits, prior to 1970.The results suggest that the market was not efficient with respect to the non-public segment revenue and profit data of non-disclosure firms for 1968–1969. However, this finding could not be replicated for 1970. The average monthly abnormal returns conditional on the segment-based trading rule strategy were found to be relatively small for the partial disclosure firms. This suggests that segment revenue data can be used to successfully anticipate changes in total entity earnings which would otherwise be ‘unexpected’ if only consolidated data were available.     

VOLUME AND R2: A FIRST LOOK

Roll (1988) reports that when days on which public announcements occur are excluded from a regression of stock returns on market returns, the R²s are largely unaffected. To explain his findings, Roll suggests that much of the firm-specific movements in common stocks may be a result of private information or occasional trading frenzy. As a test of Roll's conjecture, volume is used in this study as a proxy to capture the impact of firm-specific information and irrational trading. If Roll's conjecture is correct, the R² should rise when high-volume days are excluded from a regression of stock returns on market returns. The results presented here are consistent with that prediction, but they are not strong.     

The systematic pricing of market sentiment shock

ABSTRACT

We show that market sentiment shocks create demand shocks for risky assets and a systematic risk for assets. We measure a market sentiment shock as the unexpected portion of the University of Michigan Consumer Sentiment Index’s growth. This shock prices stock returns in arbitrage pricing theory framework at 1% after controlling for market, size, value, momentum, and liquidity risk factors. Its premium lowered the implied risk aversion by 97.9% to 11.46 between 1978 and 2009 in our sentiment consumption-based capital-asset-pricing model. Merton’s [1973. “An Intertemporal Capital Asset Pricing Model.” Econometrica 41: 867–887]. intertemporal capital-asset-pricing model reconfirms our finding that this market sentiment shock is a systematic risk factor that provides investment opportunities.     

An analysis of trading strategies in eleven European stock markets

Abstract

In recent years, the validity of the weak form efficient market hypothesis (EMH) has been called into question as several studies have uncovered evidence that technical trading rules have predictive ability with respect to both developed and emerging stock market indices. This study analyses the forecasting power of 2 of the most popular trading rules using index data for a selection of 11 European stock markets over the January 1991 to December 2000 period. The findings indicate that the emerging markets included in this paper are informationally inefficient; these markets displayed some degree of predictability in their share returns, although the developed markets did not. Furthermore, the results point to large differences in the performance of the rules examined; while small size filters consistently outperformed the buy-and-hold strategy in the emerging markets examined even after the consideration of transaction costs, the performance of the moving average rules was erratic and varied dramatically from market to market.     

On the theory of market information efficiency

This paper discusses the concept of market information efficiency and demonstrates the following: As the number of traders who participate in the market becomes large, the variations in the price of a security caused by the variations in traders' beliefs make the market price vary as if traders all knew the ‘true’ distribution of returns on the security. The empirical implications of the analysis are also explored.     

Predictability of Emerging Market Local Currency Bond Risk Premia

This article investigates the source of predictability of emerging market (EM) local currency bond risk premia by using a dynamic factor approach based on a large panel of economic and financial time series. We find strong predictable variation in EM local currency excess bond returns that is associated with macroeconomic activity. We provide evidence that the main predictor variables are the factors based on real economic activity that are highly correlated with measures of industrial and manufacturing production; however, factors based on global financial factors also contain information about the future local currency bond returns. The predictive power of the extracted factors is both statistically significant and economically important. Our research has important implications for policymakers and pension fund managers.     

Welfare effects of information and rationality in portfolio decisions under parameter uncertainty

We analyse and quantify, in a financial market with parameter uncertainty and for a Constant Relative Risk Aversion investor, the utility effects of two different boundedly rational (i.e. sub-optimal) investment strategies (namely, myopic and unconditional strategies) and compare them with each other and with the utility effect of full information. We show that effects are mainly caused by full information and predictability, being the effect of learning marginal. We also investigate the saver's decision regarding whether to manage her/his portfolio personally (DIY investor) or hire, against the payment of a management fee, a professional investor and find that delegation is mainly motivated by the belief that professional advisors are, depending on investment horizon and risk aversion, either better informed (‘insiders’) or more capable of gathering and processing information, rather than possessing the ability to learn from financial data. In particular, for very short investment horizons, delegation is primarily, if not exclusively, motivated by the beliefs that professional investors are better informed.     

Personal taxes and the time variation of stock returns – evidence from the UK

A potential explanation for the time-series predictability of market returns with dividend yields is the differential tax treatment of capital gains and dividends. This article investigates to what extent the predictability of long-horizon returns can be explained by this tax effect. Assuming that after-tax expected returns are constant, we test the derived relationships between pretax returns and lagged dividend yields with UK data. We also compare the predictability of before-tax long-horizon returns with that of after-tax returns. The results indicate that the tax treatment of dividends does not significantly contribute towards the predictability of stock returns.     

Bond risk premia and realized jump risk

We find that augmenting a regression of excess bond returns on the term structure of forward rates with an estimate of the mean realized jump size almost doubles the R² of the forecasting regression. The return predictability from augmenting with the jump mean easily dominates that offered by augmenting with options-implied volatility and realized volatility from high-frequency data. In out-of-sample forecasting exercises, inclusion of the jump mean can reduce the root mean square prediction error by up to 40%. The incremental return predictability captured by the realized jump mean largely accounts for the countercyclical movements in bond risk premia. This result is consistent with the setting of an incomplete market in which the conditional distribution of excess bond returns is affected by a jump risk factor that does not lie in the span of the term structure of yields.     

Volatility transmission in the UK equity market

In this study, the three-factor model of Fama and French and the ‘characteristic model’ of Daniel and Titman are tested using the French Stock Market. Stocks are ranked by size and book to market ratio and then by ex-ante β, HML or SMB loadings. Based on average returns, results reject the factor model with ‘characteristic balanced’ portfolios. In contrast, in time-series regressions, results are consistent with the factor pricing model and inconsistent with the characteristic-based pricing model. Because the value premium is small, conclusions must be interpreted carefully. However, size and market premiums allow more powerful tests of the two models.     

Partial adjustment to public information in the pricing of IPOs

Extant literature shows that IPO first-day returns are correlated with market returns preceding the issue. We propose a rational explanation for this puzzling predictability by adding a public signal to Benveniste and Spindt (1989)’s information-based framework. A novel result of our model is that the compensation required by investors to truthfully reveal their information decreases with the public signal. This “incentive effect” receives strong empirical support in a sample of 6300 IPOs in 1983–2012. Controlling for the incentive effect, the positive relation between initial returns and pre-issue market returns disappears for top-tier underwriters, where the order book is held to be most informative, effectively resolving the predictability puzzle.