The price impact of the disposition effect on the ex-dividend day of NYSE and AMEX common stocks

We empirically test whether the disposition effect has an asymmetrical impact on the price adjustment on the ex-dividend day of common stocks listed in NYSE and AMEX during the 2001–2008 period. We find that stocks with accrued gains have a greater ex-day price drop ratio (PDR) than stocks with accrued losses. We also find a positive relationship between the PDR and the capital gains overhang that has significant explanatory power over the cross-sectional variability of the PDR. Moreover, the capital gains overhang seems to explain part of the time variation of the PDR for a particular stock that can be a winner or loser at different times. We attribute our results to the disposition effect because active (limited) selling by holders of winning (losing) stocks will most likely accelerate (restrain) the downward price adjustment on the ex-dividend day.     

The tax-loss selling hypothesis,market liquidity,and price pressure around the turn-of-the-year

In this paper, we use intra-day data for all stocks listed on the ISSM and provide new and direct evidence consistent with the tax-loss selling hypothesis. We find that (a) there is abnormal selling pressure prior to the year-end for stocks that have experienced large capital losses in the current and prior years (b) investors delay realizing capital gain by postponing the sale of capital gain stocks until after the new year (c) there is a significant decrease in the average trade size for stocks with large capital losses before the year-end and for stocks with capital gains in the new year, which suggests that individuals, rather than institutional investors, are the major sellers around the year-end (d) the tax-loss selling hypothesis, and not firm size or share price, is the fundamental explanation for abnormal January returns. Further, small or low share priced firms with capital gains do not experience abnormal returns in January. However, conditional on capital losses, small or low share priced firms magnify the turn-of-the-year effect (e) On average, the increase in selling activity adversely affects market liquidity by increasing bid-ask spreads and reducing depths. (f) The tax-loss selling pressure not only causes the price to be at the bid at the year-end, it also temporarily depresses the equilibrium price indicating the short run demand curve is not perfectly elastic (g) the year-end buying activity suggests that large investors buy capital loss stocks prior to the year-end to take advantage of the temporarily depressed price and capital gain stocks after the new year to reinvest the proceeds of the tax-loss selling.     

High Idiosyncratic Volatility and Low Returns: A Prospect Theory Explanation

The well‐documented negative relationship between idiosyncratic volatility and stock returns is puzzling if investors are risk‐averse. However, under prospect theory, while investors are risk‐averse in the domain of gains, they exhibit risk‐seeking behavior in the domain of losses. Consistent with risk‐seeking investors’ preference for high‐volatility stocks in the loss domain, we find that the negative relationship between idiosyncratic volatility and stock returns is concentrated in stocks with unrealized capital losses, but is nonexistent in stocks with unrealized capital gains. This finding is robust to control for short‐term return reversals and maximum daily return, among other variables.     

Capital Gains Tax Rules, Tax-loss Trading, and Turn-of-the-year Returns

Changes in the capital gains tax rules facing individual investors do not affect the incentives for "window dressing" by institutional investors, but they can affect the incentives for year-end tax-induced trading by individual investors. Empirical evidence for the 1963 to 1996 period suggests that when the tax law encouraged taxable investors who accrued losses early in the year to realize their losses before year-end, the correlation between early year losses and turn-of-the-year returns was weaker than when the law did not provide such an early realization incentive. These findings suggest that tax-loss trading contributes to turn-of-the-year return patterns.     

Investor type trading behavior and trade performance: Evidence from the Thai stock market

This paper examines the trading behavior and decomposes the trading performance of foreign, individual and institutional investors as well as proprietary traders in a dynamic emerging stock market, the Stock Exchange of Thailand. Foreign investors follow a positive feedback, momentum strategy and are good short term market timers but have poor security selection performance in poor markets, thus suggesting that they have a macro (market timing) but not a micro (security selection) informational advantage relative to local investors. Institutions and proprietary traders have poor security selection trading performance. Individuals display herding behavior and have fairly good security selection performance, but individual investors appear to compensate proprietary traders for the provision of short term liquidity by proprietary traders, so individuals' security selection gains are canceled out by market timing losses.     

Capital Gains Tax Overhang and Price Pressure

I study whether the capital gains tax is an impediment to selling by some investors and if so, to what degree associated delayed selling affects stock prices. I find that selling decisions by institutions serving tax‐sensitive clients are sensitive to cumulative capital gains, a pattern not observed for institutions with predominantly tax‐exempt clients. Moreover, tax‐related underselling impacts stock prices during large earnings surprises for stocks held primarily by tax‐sensitive investors. The corresponding price reactions are less negative (more positive) with higher cumulative capital gains. This price pressure pattern is more severe when arbitrage is more costly.     

Optimal tax-timing and asset allocation when tax rebates on capital losses are limited

This article studies the portfolio problem with realization-based capital gain taxation when limited amounts of losses qualify for tax rebate payments, as is the case under current US tax law. When the tax rate applicable to realized losses exceeds that on realized capital gains, it can be optimal to realize capital gains immediately and pay capital gain taxes to regain the option to use potential future losses against a higher tax rate. This incentive adds an entirely new and as yet unstudied dimension to the portfolio problem. It causes risk averse investors to hold more equity and attain higher welfare levels than is the case when trading under a tax system that seeks to collect the same amount of taxes, but does not allow for tax rebate payments. This is because the benefit to these investors from having their losses subsidized is greater than the suffering from having profits taxed at a higher rate.     

Capital gains lock-in and governance choices

Differences in accrued gains and investors’ tax-sensitivity induce variation in a capital gains lock-in effect across mutual funds even for the same stock at the same time. Exploiting this variation, we show this effect influences funds’ governance decisions: higher capital gains decrease the likelihood a fund exits prior to contentious votes and increase the likelihood a fund votes against management. Consistent with tax motivation, these findings are concentrated among funds with tax-sensitive investors. Further, high aggregate capital gains across funds holding a stock predict a higher likelihood management loses a vote and a lower likelihood a contentious vote is proposed.     

Stock performance and the mispricing of accruals

I investigate the relationship between contemporaneous stock-price performance and the persistence of accrued earnings, and its impact on the accrual anomaly. I find that, in a fiscal year, accrued earnings for stocks that have performed poorly are less persistent in predicting future earnings than accrued earnings for stocks that have performed moderately. I further find that a hedge-strategy based on accruals earns greater abnormal returns following bad-news years. The results are consistent with conservative accounting causing accrued earnings to be even less persistent in bad-news years and investors failing to efficiently price this differential in persistence.     

Do institutional investors have superior stock selection ability in China?

This paper uses unique data on the shareholdings of both institutional and individual investors to directly investigate whether institutional investors have better stock selection ability than individual investors in China. Controlling for other factors, we find that institutional investors increase (decrease) their shareholdings in stocks that subsequently exhibit positive (negative) short- and long-term cumulative abnormal returns. In contrast, individual investors decrease (increase) their shareholdings in stocks that subsequently exhibit positive (negative) short- and long-term cumulative abnormal returns. These findings indicate that institutional investors have superior stock selection ability in China.     

Optimal stock trading with personal taxes: Implications for prices and the abnormal January returns

The tax law confers upon the investor a timing option - to realize capital losses and defer capital gains. With the tax rate on long term gains and losses being about half the short term rate, the law provides a second timing option - to realize losses short term and gains long term, if at all. Our theory and simulation over the 1962–1977 period establish that taxable investors should realize long term gains in high variance stocks and repurchase stock in order to realize potential future losses short term. Tax trading does not explain the small-firm anomaly but predicts a seasonal pattern in trading volume which maps into a seasonal pattern in stock prices, the January anomaly, only if investors are irrational or ignorant of the price seasonality.     

On the relationship between concentration of prospect theory/mental accounting investors,cointegration, and momentum

We examine the role of cointegration between stock prices and their estimated fundamental values in return momentum. We find that the positive relationship between capital gains overhang and future stock returns in Grinblatt and Han (2005) is significantly stronger among the “non-cointegrated” group of stocks as compared with the “cointegrated” group of stocks. Further, for the cointegrated stocks, the slower the speed of adjustment to the cointegrating equilibrium, the greater (smaller) is the future return of stocks with unrealized capital gains (losses). These findings are robust to various firm characteristics including firm size, book-to-market ratio, past returns, idiosyncratic volatility, dispersion in analysts’ earnings forecasts, turnover, individual investor ownership, and industry returns.     

The Disposition Effect and Underreaction to News

This paper tests whether the “disposition effect,” that is the tendency of investors to ride losses and realize gains, induces “underreaction” to news, leading to return predictability. I use data on mutual fund holdings to construct a new measure of reference purchasing prices for individual stocks, and I show that post‐announcement price drift is most severe whenever capital gains and the news event have the same sign. The magnitude of the drift depends on the capital gains (losses) experienced by the stock holders on the event date. An event‐driven strategy based on this effect yields monthly alphas of over 200 basis points.     

Lottery stocks and stop-loss rules

We show that stop-loss rules increase the returns to investment in stocks with lottery features. These stocks typically have sporadic big gains and frequent small losses. However, stop-loss rules can reduce losses and allow investors to receive the gains from large price increases. We also highlight that sell signals of popular technical rules resemble stop-loss rules and are effective at increasing risk-adjusted returns for lottery stock. These rules could have helped investors avoid losses from major historical drawdowns, are particularly beneficial in declining markets, and are robust to the inclusion of transaction costs.     

Monitoring via staging: Evidence from Private investments in public equity

I study the causes and consequences of staging in the setting of private investments in public equities (PIPEs). I find that, in PIPE investments, as in venture capital staging, the staging strategy is used by investors as a monitoring mechanism to mitigate information asymmetry and agency problems. Moreover, strategic investors and investors investing alone are more likely to utilize staging. I show also that staging reduces the cost of financing and has positive implications for PIPE issuers’ long-run stock performance.     

How loss averse are investors in financial markets?

We investigate loss aversion in financial markets using a typical asset allocation problem. Our theoretical and empirical results show that investors in financial markets are more loss averse than assumed in the literature. Moreover, loss aversion changes depending on market conditions; investors become far more loss averse during bull markets than during bear markets, indicating their more profound disutility for losses when others enjoy gains. Contrary to most previous results, we find that investors are more sensitive to changes in losses than changes in gains.     

The turn-of-the-year effect and tax-loss-selling by institutional investors

Prior studies attribute the turn-of-the-year effect whereby small capitalization stocks earn unusually high returns in early January to tax-loss-selling by individual investors and window-dressing by institutional investors. My results suggest that a significant portion of the effect on turn-of-the-year returns that prior studies attribute to window-dressing is actually attributable to tax-loss-selling by institutional investors. Among small capitalization stocks, I find that institutional investors with strong tax incentives and weak window-dressing incentives realize significantly more losses in the fourth quarter than in the first three quarters of the calendar year, and that their fourth quarter realized losses have a significant impact on turn-of-the-year returns. A one percentage point change in these institutional investors' fourth quarter realized losses scaled by a firm's market capitalization results in an increase of 47 basis points in the firm's average daily return over the first three trading days of January, which represents a 46 percent change for the mean firm.     

Direct evidence of dividend tax clienteles

The paper is the first to evaluate the dividend tax clientele hypothesis using a data set of all domestic stock portfolios in the market. We find that investment funds that face a higher effective tax rate on dividend income than on capital gains tilt their portfolios away from dividend-paying stocks. These investors consequently earn a dividend yield that is about 35 basis points lower than that of investors who are tax neutral between dividends and capital gains (pension funds, unit-linked insurance, life insurance). Consistent with tax rules and charter provisions, we also find that private corporations prefer growth stocks, that foundations exhibit strong dividend preferences, and that partnerships rarely hold stocks portfolios.     

Saving and investing for early retirement: A theoretical analysis

We study optimal consumption and portfolio choice in a framework where investors adjust their labor supply through an irreversible choice of their retirement time. We show that investing for early retirement tends to increase savings and reduce an agent's effective relative risk aversion, thus increasing her stock market exposure. Contrary to common intuition, an investor might find it optimal to increase the proportion of financial wealth held in stocks as she ages and accumulates assets, even when her income and the investment opportunity set are constant. The model predicts a decrease in risk aversion following strong market gains like those observed in the nineties.     

Left-tail momentum: Underreaction to bad news,costly arbitrage and equity returns

This paper documents a significantly negative cross-sectional relation between left-tail risk and future returns on individual stocks trading in the US and international countries. We provide a behavioral explanation to this anomaly based on the idea that investors underestimate the persistence in left-tail risk and overprice stocks with large recent losses. Thus, low returns in the left-tail of the distribution persist into the future causing left-tail return momentum. We find that the left-tail risk anomaly is stronger for stocks that are more likely to be held by retail investors, that receive less investor attention, and that are costlier to arbitrage.