Accruals,cash flows,and aggregate stock returns

This paper examines whether the firm-level accrual and cash flow effects extend to the aggregate stock market. In sharp contrast to previous firm-level findings, aggregate accruals is a strong positive time series predictor of aggregate stock returns, and cash flows is a negative predictor. In addition, innovations in accruals are negatively contemporaneously correlated with aggregate returns, and innovations in cash flows are positively correlated with returns. These findings suggest that innovations in accruals and cash flows contain information about changes in discount rates, or that firms manage earnings in response to marketwide undervaluation.     

Stock market crashes,firm characteristics,and stock returns

A number of studies have investigated the causes and effects of stock market crashes. These studies mainly focus on the factors leading to a crash and on the volatility and co-movements of stock market indexes during and after the crash. However, how a stock market crash affects individual stocks and if stocks with different financial characteristics are affected differently in a stock market crash is an issue that has not received sufficient attention. In this paper, we study this issue by using data for eight major stock market crashes that have taken place during the December 31, 1962–December 31, 2007 period with a large sample of US firms. We use the event-study methodology and multivariate regression analysis to study the determinants of stock returns in stock market crashes.     

Short-sale inflow and stock returns: Evidence from Japan

Using a 10-year panel of flow-based information on stock borrowings and constructing a flow-based measure for shorting demand, I examine the relation between shorting demand and subsequent stock price movements. I find that the least heavily shorted stocks tend to outperform the most heavily shorted stocks and that this outperformance persists up to three months. In addition, using proxies for information asymmetry derived from the market microstructure literature, I find that this outperformance is not confined to stocks with high information asymmetry. These empirical findings indicate that short sellers act not only as informed investors who gain negative news but also as skillful investors who detect stock price deviations from fundamental values.     

Sentiment and stock returns: The SAD anomaly revisited

Widely-cited research by Kamstra et al. (2003) argues that changes in mood resulting from Seasonal Affective Disorder (SAD) drive changes in investor risk aversion and cause seasonal patterns in aggregate stock returns around the world. In this paper we reexamine the so-called SAD effect by replicating and extending Kamstra et al. (2003). We study the psychological underpinnings of the SAD hypothesis and show that the time-series predictions of the SAD model do not correspond to the seasonal patterns in depression found in the general population. We also investigate the cross-sectional prediction that SAD has a greater effect on stock markets in countries where SAD is more prevalent and find no relation between the prevalence of SAD and stock returns. Finally, we document that the SAD effect is mechanically driven by an overlapping dummy-variable specification and higher returns around the turn of the year.     

Accounting for investments and the relevance of losses to firm value

Recent research has documented investment in research and development as a key driver of the market value of currently unprofitable firms (hereafter loss firms) in a knowledge-based economy. We broaden this argument to consider the influence of accounting for investments in general on the relation between current profitability and firm value for loss firms. Specifically, in the context of a resource-based economy, we find that exploration costs, cash flow measures of investment, and research and development costs help to explain the value of loss firms and reduce the negative relation between current profitability and firm value.     

Fast profits: Investor sentiment and stock returns during Ramadan

Observed by more than 1.5 billion Muslims, Ramadan is one of the most celebrated religious traditions in the world. We investigate stock returns during Ramadan for 14 predominantly Muslim countries over the years 1989-2007. The results show that stock returns during Ramadan are significantly higher and less volatile than during the rest of the year. No discernible declines in market liquidity are recorded. We find these results consistent with a notion that Ramadan positively affects investor psychology, as it promotes feelings of solidarity and social identity among Muslims world-wide, leading to optimistic beliefs that extend to investment decisions.     

Corporate tax avoidance and stock price crash risk: Firm-level analysis

Using a large sample of U.S. firms for the period 1995–2008, we provide strong and robust evidence that corporate tax avoidance is positively associated with firm-specific stock price crash risk. This finding is consistent with the following view: Tax avoidance facilitates managerial rent extraction and bad news hoarding activities for extended periods by providing tools, masks, and justifications for these opportunistic behaviors. The hoarding and accumulation of bad news for extended periods lead to stock price crashes when the accumulated hidden bad news crosses a tipping point, and thus comes out all at once. Moreover, we show that the positive relation between tax avoidance and crash risk is attenuated when firms have strong external monitoring mechanisms such as high institutional ownership, high analyst coverage, and greater takeover threat from corporate control markets.     

Stock returns,aggregate earnings surprises,and behavioral finance

We study the stock market's reaction to aggregate earnings news. Prior research shows that, for individual firms, stock prices react positively to earnings news but require several quarters to fully reflect the information in earnings. We find a substantially different pattern in aggregate data. First, returns are unrelated to past earnings, suggesting that prices neither underreact nor overreact to aggregate earnings news. Second, aggregate returns correlate negatively with concurrent earnings; over the last 30 years, for example, stock prices increased 5.7% in quarters with negative earnings growth and only 2.1% otherwise. This finding suggests that earnings and discount rates move together over time and provides new evidence that discount-rate shocks explain a significant fraction of aggregate stock returns.     

Seasonality in the cross-section of stock returns

This paper presents a new pattern in the cross-section of expected stock returns. Stocks tend to have relatively high (or low) returns every year in the same calendar month. We recognize the annual cross-sectional autocorrelation pattern documented in Jegadeesh [1990. Evidence of predictable behavior of security returns. Journal of Finance 45, 881–898] at lags of 12, 24, and 36 months as part of a general pattern that lasts up to 20 annual lags, superimposed on the general momentum/reversal patterns. This pattern explains an economically and statistically significant magnitude of the cross-sectional variation in average stock returns. Volume and volatility exhibit similar seasonal patterns but they do not explain the seasonality in returns. The pattern is independent of size, industry, earnings announcements, dividends, and fiscal year. The results are consistent with the existence of a persistent seasonal effect in stock returns.     

Distress risk premia in expected stock and bond returns

Prior studies find that shareholders’ strategic actions over debtholders are significant for stock prices but not for bond prices. I find that for firms with private and public debt, strategic default has no significant effect on distress risk premia in expected stock or bond returns, suggesting that the dispersion of bondholders greatly weakens the shareholder advantage effect. The shareholder advantage effect on stock prices is only significant for firms with only private debt and to some degree affected by the dispersion of stockholders and complexity in capital structure. Overall, renegotiation friction helps explain the cross-sectional implications of strategic default for stock and bond prices.     

Sell-order liquidity and the cross-section of expected stock returns

We estimate buy- and sell-order illiquidity measures (lambdas) for a comprehensive sample of NYSE stocks. We show that sell-order liquidity is priced more strongly than buy-order liquidity in the cross-section of equity returns. Indeed, our analysis indicates that the liquidity premium in equities emanates predominantly from the sell-order side. We also find that the average difference between sell and buy lambdas is generally positive throughout our sample period. Both buy and sell lambdas are significantly positively correlated with measures of funding liquidity such as the TED spread as well option implied volatility.     

Caught on tape: Institutional trading,stock returns,and earnings announcements

Many questions about institutional trading can only be answered if one tracks high-frequency changes in institutional ownership. In the United States, however, institutions are only required to report their ownership quarterly in 13-F filings. We infer daily institutional trading behavior from the “tape”, the Transactions and Quotes database of the New York Stock Exchange, using a sophisticated method that best predicts quarterly 13-F data from trades of different sizes. We find that daily institutional trades are highly persistent and respond positively to recent daily returns but negatively to longer-term past daily returns. Institutional trades, particularly sells, appear to generate short-term losses—possibly reflecting institutional demand for liquidity—but longer-term profits. One source of these profits is that institutions anticipate both earnings surprises and post-earnings announcement drift. These results are different from those obtained using a standard size cutoff rule for institutional trades.     

Weather and intraday patterns in stock returns and trading activity

We examine the relation between weather in New York City and intraday returns and trading patterns of NYSE stocks. While stock returns are found to be generally lower on cloudier days, cloud cover has a significant influence on stock returns only at the market open. There are significantly more seller-initiated trades when there is more cloud cover at the market open, which is consistent with the return results. Cloudy skies are associated with higher volatility and less market depth over the entire trading day. Finally, cloud cover is not significantly correlated with spread measures and turnover ratios. The findings overall suggest that weather has a significant influence on investors’ intraday trading behavior.     

Earnings acceleration and stock returns

We document that earnings acceleration, defined as the quarter-over-quarter change in earnings growth, has significant explanatory power for future excess returns. These excess returns are robust to a wide range of previously documented anomalies and a battery of risk controls. The future return predictability appears to be consistent with investors assuming a seasonal random walk model for quarterly earnings and missing predictable implications of earnings acceleration for future earnings growth. Finally, the excess returns from the basic earnings acceleration strategy can be enhanced further by focusing on profit firms, low earnings volatility firms and on specific patterns of earnings acceleration.     

The relationship between asset growth and the cross-section of stock returns

There is a large body of literature examining the association between stock characteristics and the cross-section of stock returns in international markets. Recently, Cooper et al. (2008) reported a strong association between total asset growth and stock returns in the US. In this paper, we show that an asset-growth effect also exists in the Australian equity market. Of particular interest, it is present amongst the largest Australian stocks. Over the 1983-2007 period, an equally-weighted portfolio of low-growth Big stocks outperforms a portfolio of high-growth Big stocks by an average 1% per month, equating to nearly 13% per annum. At an individual stock level of analysis, the asset-growth effect remains even after controlling for other variables whose association with the cross-section of returns is well known. Finally, we explicitly test whether asset growth is a priced risk factor using the common two-stage cross-sectional regression methodology. We find no evidence to support a risk-based explanation, thereby lending credence to Cooper et al.’s (2008) suggestion that the asset-growth effect is attributable to mispricing.     

The second moment matters! Cross-sectional dispersion of firm valuations and expected returns

Behavioral theories predict that firm valuation dispersion in the cross-section (“dispersion”) measures aggregate overpricing caused by investor overconfidence and should be negatively related to expected aggregate returns. This paper develops and tests these hypotheses. Consistent with the model predictions, I find that measures of dispersion are positively related to aggregate valuations, trading volume, idiosyncratic volatility, past market returns, and current and future investor sentiment indexes. Dispersion is a strong negative predictor of subsequent short- and long-term market excess returns. Market beta is positively related to stock returns when the beginning-of-period dispersion is low and this relationship reverses when initial dispersion is high. A simple forecast model based on dispersion significantly outperforms a naive model based on historical equity premium in out-of-sample tests and the predictability is stronger in economic downturns.     

Composition of wealth,conditioning information,and the cross-section of stock returns

Value stocks covary with aggregate consumption more than growth stocks during periods when financial wealth is low relative to consumption. However, the conditional value premium does not exhibit such countercyclical behavior. Consequently, a one-factor conditional consumption-based asset pricing model can be rejected without making any arbitrary assumptions on the dynamics of the price of risk or the conditional moments. Empirical evidence is somewhat more consistent with a consumption-based model augmented with an aggregate wealth growth factor, which can be motivated by either recursive preferences or relative wealth concerns.     

Country versus sector factors in equity returns: The roles of non-unit exposures

In this paper we disentangle, analytically and empirically, the roles of the unit-exposure restriction in Heston and Rouwenhorst (1994). We show that if the purpose is to construct factors, the unit-exposure variance-analysis model can be viewed as just an algorithm that does not really assume a return-generating process; and in practice the effect of relaxing the restriction is immaterial. The restriction is more important if one wants to estimate whether, for a typical stock, the country factor generates more variance than the sector factor: exposure estimation becomes more important (i) the further the average exposures are from unity; or (ii) the higher the dispersion of the exposures. With respect to (i), the more important the corrections for sector (or geographical) structure in country (or sector) factors are, the more the average exposure falls below unity. Thus, the average exposure provides an alternative indicator of the importance of country versus sector effects. We empirically find that the average sector exposure is low (0.3) compared to the average country exposure (0.9). With respect to (ii) we correct the dispersion of exposures for estimation error in the exposures. We find that in our sample these estimation error corrections are more important for sector factors than for country factors, and that country factors are generating far more variance, in a typical stock's return, than do sector factors.     

Do managers intentionally use repurchase tender offers to signal private information? Evidence from firm financial reporting behavior

Signaling is the most commonly cited explanation for stock repurchases in the academic literature. Yet, there is little evidence on whether managers intentionally use repurchases as signaling devices. Using a firm's financial reporting behavior to infer managerial intent, we find evidence suggesting that managers intentionally use fixed-price repurchase tender offers to signal undervaluation. In contrast, we find no evidence that managers use Dutch-auction tender offers to signal undervaluation. Instead, firms engaging in Dutch-auction repurchases act as if they are trying to deflate their earnings prior to the repurchases to further reduce the repurchasing price.     

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.