Equity market valuation of human capital and stock returns

We investigate whether and how well firms’ stock market valuations reflect their employees’ collective skills and effectiveness relative to that of their industry peers and competitors. We devise a relative stock market valuation measure of human capital intangibles (EVHC) and find that portfolios of low EVHC firms systematically outperform portfolios of high EVHC firms by an average 1.34% per month. However, this is primarily a small firms effect, because for large firms the excess returns of the arbitrage portfolio that is long on the low EVHC stocks and short on the high EVHC stocks is zero. Our results suggest that reliance on human capital intangibles may proxy for risk not fully accounted for by conventional asset pricing models, or alternatively, that the market cannot correctly price human capital intangibles for small size firms.     

Do Socially Responsible Index Investors Incur an Opportunity Cost?

We construct index‐tracking portfolios using integer programming and then compare the tracking errors and performances of portfolios formed from an unrestricted and socially screened stock universe. We find that one can construct a portfolio of socially responsible stocks that deliver market performance. Thus, the exclusion of a set of stocks from consideration does not exhaust the existence of efficient index‐tracking portfolios, especially when the exclusionary screen is for nonfinancial reasons. Our results are robust to various specifications in constructing the portfolio, for example, number of stocks included in the portfolio and weighting schemes, and robust to alternative tracking error measurement; we show that the difference induced from conducting socially responsible screen is never statistically significant.     

Exchange‐Traded Fund Introductions and Closed‐End Fund Discounts and Volume

Exchange‐traded funds (ETFs), like closed‐end funds (CEFs), are managed portfolios traded like individual stocks. We hypothesize that the introduction of an ETF in an asset class similar to an existing CEF results in a substitution effect that reduces the value of the CEF's shares relative to that of its underlying assets. Our event studies show that upon the introduction of a similar ETF, CEF discounts widen significantly and relative volume declines significantly. Single‐equation and systems estimation models show that the widening in discounts and reduction in volume are related to returns‐based measures of the substitutability of ETFs for CEFs.     

Relation between time-series and cross-sectional effects of idiosyncratic variance on stock returns

Consistent with the post-1962 US evidence by Ang et al. [Ang, A., Hodrick, R., Xing Y., Zhang, X., 2006. The cross-section of volatility and expected returns. Journal of Finance 51, 259–299], we find that stocks with high idiosyncratic variance (IV) have low CAPM-adjusted expected returns in both pre-1962 US and modern G7 data. We also test in three ways the conjecture that IV is a proxy of systematic risk. First, the return difference between low and high IV stocks – that we dub as IVF – is a priced factor in the cross-section of stock returns. Second, loadings on lagged market variance and lagged average IV account for a significant portion of variation in average returns on portfolios sorted by IV. Third, the variance of IVF correlates closely with average IV, and the two variables have similar explanatory power for the time-series and cross-sectional stock returns.     

Investor Attention and Time‐varying Comovements

This paper analyses the effect of an increase in market‐wide uncertainty on information flow and asset price comovements. We use the daily realised volatility of the 30‐year treasury bond futures to assess macroeconomic shocks that affect market‐wide uncertainty. We use the ratio of a stock's idiosyncratic realised volatility with respect to the S&P500 futures relative to its total realised volatility to capture the asset price comovement with the market. We find that market volatility and the comovement of individual stocks with the market increase contemporaneously with the arrival of market‐wide macroeconomic shocks, but decrease significantly in the following five trading days. This pattern supports the hypothesis that investors shift their (limited) attention to processing market‐level information following an increase in market‐wide uncertainty and then subsequently divert their attention back to asset‐specific information.     

Volatility risk and the value premium: Evidence from the French stock market

This paper documents that systematic volatility risk is an important factor that drives the value premium observed in the French stock market. Using returns on at-the-money straddles written on the CAC 40 index as a proxy for systematic volatility risk, I document significant differences between volatility factor loadings of value and growth stocks. Furthermore, when markets are classified into expected booms and recessions, volatility factor loadings are also time-varying. When expected market risk premium is above its average, i.e. during expected recessions, value stocks are seen riskier than their growth counterparts. This implies in bad times, investors shift their preferences away from value firms. Instead they use growth stocks as hedges against deteriorations in their wealth during those times. The findings are in line with the predictions of rational asset pricing theory and support a “flight-to-quality” explanation.     

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.     

Canadian Investors and the Discount on Closed-End Funds

We explore the role of the discount on closed-end funds (CEFD) in asset pricing and test its validity as a proxy for investor sentiment in the Canadian stock market. Results show that CEFD is not a priced factor. Both cross-sectional and time-series tests confirm that stocks with different exposures to CEFD do not have significantly different average returns. CEFD does not even provide incremental explanatory power after controlling for firm characteristics and risk factors. Furthermore, CEFD fails to be a proxy for investor sentiment with no correlation to either the consumer confidence index or flows to open-ended funds.     

Macroeconomic risks and characteristic-based factor models

We show that book-to-market, size, and momentum capture cross-sectional variation in exposures to a broad set of macroeconomic factors identified in the prior literature as potentially important for pricing equities. The factors considered include innovations in economic growth expectations, inflation, the aggregate survival probability, the term structure of interest rates, and the exchange rate. Factor mimicking portfolios constructed on the basis of book-to-market, size, and momentum therefore, serve as proxy composite macroeconomic risk factors. Conditional and unconditional cross-sectional asset pricing tests indicate that most of the macroeconomic factors considered are priced. The performance of an asset pricing model based on the macroeconomic factors is comparable to the performance of the Fama and French (1993) model. However, the momentum factor is found to contain incremental information for asset pricing.     

Information based trade,the PIN variable,and portfolio style differences: Evidence from Tokyo stock exchange firms

We investigate whether the variables related to information based trade proposed by Easley et al. [Easley, D., Kiefer, N.M., O'Hara, M., Paperman, J.B., 1996. Liquidity, information, and infrequently traded stocks. Journal of Finance 51, 1405–1436.] help explain the daily price discovery process in an electronically order-driven market of the Tokyo Stock Exchange using the microstructure tick data. We find strong evidence that the value firms show higher probability of bad news occurrences than the growth firms. We also find that the PIN is higher for smaller firms as is the case in the U.S. With the portfolio ranking tests and the Fama and MacBeth test we find that the alpha variable, which represents the information event occurrence rate, is systematically related to required returns, while the evidence related to the PIN is weaker. In the final Fama and MacBeth test, in which the PIN or alpha variable is used as an additional explanatory variable to the benchmark Fama and French three factor model, we find that the sign of the alpha variable supports our hypothesis that the arrival of new information reduces the risk of the stock, though not significantly. We also find that the higher PIN value increases the risk of the stock, at the same time it can marginally improve the explanatory power of the multifactor model. We conclude that the PIN variable cannot be a substitutable proxy variable for the book-to-market factor unlike in the U.S., and that it is strongly related to the size variable.     

A Comparison of the Efficacy of Liquidity,Momentum, Size and Book‐to‐Market Value Factors in Equity Pricing on a Heterogeneous Sample: Evidence from Asia

This paper compares the size and book‐to‐market value factors of Fama and French (1993) alongside Momentum of Jagadeesh and Titman ( 1993 ) with two Liu ( 2006 ) liquidity factors formed from 1 year rebalancing and 1 month rebalancing respectively. A heterogeneous and comprehensive sample of the top blue chip stocks of all national Asian equity markets with further differentiation undertaken between sub samples formed for Japan only and Asia excluding Japan for period January 2000 to August 2014. Our empirical results suggest that multifactor time invariant pricing models based on augmented capital asset pricing model (CAPM) framework are ineffective in explaining the cross section of stock returns in the presence of significant inter and intra‐market segmentation. However an alternative model specification based on a time varying parameter specification and using same sets of factors yields significant enhancements in explaining cross section of stock returns across universe. We find that momentum factor largely lacks significance while a time varying two factor model, based on CAPM plus liquidity factor, is optimal. The liquidity factor being that of Liu (2006) and annually rebalanced. Our findings are important for investment managers seeking appropriate factors and modelling techniques to hedge against risks as well as firm's financial managers seeking to reduce costs of equity capital.     

The coskewness puzzle

We propose a novel approach to testing non-linear stochastic discount factor (SDF) specifications that arise in rational representative investor models. Our approach does not require overly-restrictive assumptions about the shape of investors’ preferences, typically imposed by the extant literature, and is based instead on restrictions that rule out “good deals”, i.e., arbitrage opportunities as well as unduly large Sharpe ratios. We apply this framework to test the empirical admissibility of 3 and 4-moment versions of the CAPM. We find that, while coskewness and cokurtosis risk help price a number of stock strategies and portfolios, including static strategies based on a fine industry-level diversification, momentum strategies and portfolios managed on the basis of available information, the CAPM and its 3 and 4-moment versions cannot provide an exhaustive account of observed asset returns.     

Do zero-cost portfolios have the ability to predict economic growth? Evidence from Hong Kong, South Korea and Taiwan

In this paper we investigate the relationship between growth in future Gross Domestic Product (GDP) and Industrial Production (IDP) and the performance of SMB (small stocks minus big stocks) and HML (High book-to-market stocks minus low book-to-market stocks) portfolios for equities listed in Hong Kong, South Korea and Taiwan.We find evidence to suggest that: (a) the excess market return is positively related to future GDP or IDP growth in South Korea and Taiwan; (b) contrary to most European markets, Australia, Japan and the US, future economic growth is in general significantly negatively related to SMB in Hong Kong and South Korea; and, (c) a negative relationship between future economic growth and HML for Hong Kong. Our results cast doubt if SMB and HML portfolios are positive risk factors in the Fama and French (Fama, E. F., and French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33, 3-56) three-factor asset pricing model for Hong Kong, South Korea and Taiwan.     

Return Volatility,Trading Imbalance and the Information Content of Volume

In this paper, we examine the relationship between volume and return volatility using the transaction data. We introduce transaction and volume imbalance measures to capture the information content of trades. These two information measures are shown to have a strong explanatory power for return volatility and contain incremental information about the asset values over and above that conveyed by the size and frequency of trades. Also, return volatility is significantly correlated with the percentage of trading volume taking place at NYSE. This result suggests that NYSE trades are more informative and contribute more to price discovery. There is evidence that price discovery concentrates in more heavily traded stocks, particularly the Dow Jones Stocks. Finally, return volatility is found to be persistent at the intraday level. The persistence level is higher for less frequently traded stocks. Return volatility also exhibits temporal variations. In particular, return volatility is significantly higher in the opening half-hour for less frequently traded stocks. Thus, stocks with different frequencies of trades may follow different volatility processes.     

Cross‐sectional Tests of Conditional Asset Pricing Models: Evidence from the German Stock Market

We study the performance of conditional asset pricing models and multifactor models in explaining the German cross‐section of stock returns. We focus on several variables, which (according to previous research) are associated with market expectations on future market excess returns or business cycle conditions. Our results suggest that the empirical performance of the Capital Asset Pricing Model (CAPM) can be improved when allowing for time‐varying parameters of the stochastic discount factor. A conditional CAPM using the term spread explains the returns on our size and book‐to‐market sorted portfolios about as well as the Fama‐French three‐factor model and performs best in terms of the Hansen‐Jagannathan distance. Structural break tests do not necessarily indicate parameter instability of conditional model specifications. Another major finding of the paper is that the Fama‐French model – despite its generally good cross‐sectional performance – is subject to model instability. Unconditional models, however, do a better job than conditional ones at capturing time‐series predictability of the test portfolio returns.     

New strategies and a new paradigm for Shariah-compliant portfolio optimization

In this paper we analyze the effects of different strategies to construct Shariah compatible financial portfolios. The difference between conventional and current Shariah portfolio management is the application of sector screens and financial screens by which the asset universe is reduced. Yet, here different schools of scholars define different screening rules leading to significant differences with respect to compliance, but also with respect to performance. After analyzing this discrepancy we propose several new strategies to apply the inconsistent rule systems and a new paradigm for defining Shariah-compliance. Under this new paradigm compliance is attributed to the portfolio and not to the individual assets of the universe. We report results of an empirical study analyzing the potentials of these strategies and of the paradigm. We can show that under the proposed concepts Shariah-compliant portfolios can be realized which have return and risk profiles comparable to the conventional non-constrained portfolios.     

Style investing,comovement and return predictability

Barberis and Shleifer (2003) argue that style investing generates momentum and reversals in style and individual asset returns, as well as comovement between individual assets and their styles. Consistent with these predictions, in some specifications, past style returns help explain future stock returns after controlling for size, book-to-market and past stock returns. We also use comovement to identify style investing and assess its impact on momentum. High comovement momentum portfolios have significantly higher future returns than low comovement momentum portfolios. Overall, our results suggest that style investing plays a role in the predictability of asset returns.     

The Variation of Economic Risk Premiums in Real Estate Returns

We examine the predictable components of returns on stocks, bonds, and real estate investment trusts (REITs). We employ a multiple-beta asset pricing model and find that there are varying degrees of predictability among stocks, bonds, and REITs. Furthermore, we find that most of the predictability of returns is associated with the economic variables employed in the asset pricing model. The stock market risk premium is highly important in capturing the predictable variation in stock portfolios, and the bond market risk premiums (term and risk structure of interest rates) are important in capturing the predictable variation in bond portfolios. For REITs, however, both the stock and bond market risk premiums capture the predictable variation in returns. REITs have comparable return predictability to stock portfolios. We conclude that there is an important economic risk premium for REITs that are not captured by traditional multiple-beta asset pricing models.     

Availability,recency, and sophistication in the repurchasing behavior of retail investors

When determining a stock to buy, Strahilevitz et al. (2011) demonstrate that individual investors often repurchase a stock previously traded for a profit as a learning process. When evaluating a decision, people use the most available information that comes to mind. We posit that the most recently sold stocks are the most salient. Our analysis reveals that the presence of another more recently sold stock decreases a household’s propensity to repurchase a different stock by 23%. This recency effect dominates the impact of prior profitability on the repurchasing decision. The repurchase activity of investors appears to be sub-optimal, partially due to commission costs and under-diversification of portfolios, which is magnified for households repurchasing at higher frequencies. More sophisticated investors demonstrate less of this behavior.