Rare disaster risk and the expected equity risk premium

Consistent with the predictions of rare disaster models, we find that a proxy for the time‐varying probability of rare disasters helps to explain fluctuations in expectations of the equity risk premium. Our proxy for disaster risk is a recently developed measure of global political instability, and the expected market risk premium is from Value Line analysts' expected stock returns. Consistent with long‐run risk models, uncertainty about expected GDP growth and expected consumption growth is also significantly positively related to the expected market risk premium. We obtain similar results when we use the earnings–price ratio and the dividend–price ratio as proxies for the expected market risk premium.     

A new approach to measuring riskiness in the equity market: Implications for the risk premium

We introduce a new approach to measuring riskiness in the equity market. We propose option implied and physical measures of riskiness and investigate their performance in predicting future market returns. The predictive regressions indicate a positive and significant relation between time-varying riskiness and expected market returns. The significantly positive link between aggregate riskiness and market risk premium remains intact after controlling for the S&P 500 index option implied volatility (VIX), aggregate idiosyncratic volatility, and a large set of macroeconomic variables. We also provide alternative explanations for the positive relation by showing that aggregate riskiness is higher during economic downturns characterized by high aggregate risk aversion and high expected returns.     

Myopic loss aversion and the equity premium puzzle reconsidered

Benartzi and Thaler [The Quarterly Journal of Economics 110 (1995) 73–92] offer a quasi-rational explanation for the equity premium puzzle. We reconsider their methodology and, making a simple modification to it, find that their analysis is not robust.     

Testing for capital mobility: New evidence from a panel of G7 countries

In this paper, we test the savings-investment relationship for the G7 countries. Upon applying the Gregory and Hansen [Gregory, A.W., Hansen, B.E., 1996. Residual-based tests for cointegration in models with regime shifts, J. Econ. 70, 99-126] residual-based structural break test for cointegration for each of the G7 countries, we did not find any evidence of a cointegrating relationship between savings and investment. Extending the analysis to a panel framework, we could not establish any evidence of panel cointegration. Taken together, our findings suggest that capital in these G7 countries is highly mobile since no long-term relationship exists between savings and investment.     

Habit formation and the equity–premium puzzle: a skeptical view

We argue that, ceteris paribus, introducing a habit that resolves the equity–premium puzzle is equivalent to increasing the Arrow-Pratt coefficient of relative risk aversion, AP-RRA. If we constrain the AP-RRA to a constant ‘acceptable’ level, the effect on the equity premium is quantitatively insignificant. In a dynamic setting, the fluctuations of the habit increase the equity premium, slightly, though generates unrealistic fluctuations in the risk-free interest rate. We conclude a habit is observationally equivalent, up to a first-order approximation, to a higher AP-RRA and to a preference shock. These effects cannot resolve the equity–premium puzzle.      

Market incompleteness and the equity premium puzzle: Evidence from state-level data

This paper investigates the importance of market incompleteness by comparing the rates of risk aversion estimated from complete and incomplete markets environments. For the incomplete-markets case, we use consumption data for the 50 US states. We find that the rate of risk aversion under the incomplete-markets setup is much lower. Furthermore, including the second and third moments of the cross-sectional distribution of consumption growth in the pricing kernel lowers the estimate of risk aversion. These findings suggest that market incompleteness ought to be seen as an important component of solutions to the equity premium puzzle.     

Re-examination of the historical equity risk premium in Australia

In light of the ongoing debate over the value of the equity risk premium, its increasing use in the regulatory setting, and the impact of dividend imputation on the premium, this paper presents a timely new look at the historical equity risk premium in Australia, and provides an improved understanding of the historical record. We document concerns about data quality that become increasingly important the further back in time one looks. In particular, there are sufficient question marks over the quality of data prior to 1958 to warrant any estimates based thereon to be treated with caution. Accordingly, we present a new set of estimates of the historical equity risk premium corresponding to periods of increasing data quality but of decreasing sample size. Relative to bonds (bills), the equity premium has averaged 6.3 per cent (6.8 per cent) per annum over 1958–2005, which is a period of relatively good data quality. Together with other results in the paper, the findings reveal a historical estimate that is substantially less than widely cited historical studies would otherwise indicate. We reconcile prior evidence through documenting a dividend adjustment that has typically been overlooked. We also provide estimates that incorporate an adjustment for imputation credits.     

Terror attacks and stock-market fluctuations: evidence based on a nonparametric causality-in-quantiles test for the G7 countries

We use a novel nonparametric causality-in-quantiles test to study the effects of terror attacks on stock-market returns and volatility in G7 countries. We also use the novel test to study the international repercussions of terror attacks. Test results show that terror attacks often have significant effects on returns, whereas the effect on volatility is significant only for Japan and the UK for several quantiles above the median. The effects on returns in many cases become stronger in terms of significance for the upper and lower quantiles of the conditional distribution of stock-market returns. As for international repercussions, we find that terror attacks mainly affect the tails of the conditional distribution of stock-market returns. We find no evidence of a significant cross-border effects of terror attacks on stock-market volatility, where again Japan and the UK are exceptions as far as terror attacks on the US are concerned. Finally, our results continue to hold following various robustness checks involving model structure, lag-lengths and possible omitted variable bias.     

Disappointment aversion and the equity premium puzzle: new international evidence

Drawing upon the seminal study of Ang, Bekaert, and Liu [2005. “Why Stock May Disappoint?” Journal of Financial Economics 76 (3): 471–508], we incorporate disappointment aversion (DA, that is, aversion to outcomes that are worse than prior expectations) within a simple theoretical portfolio-choice model. Based on the results of this model, we then empirically address the portfolio allocation problem of an investor who chooses between a risky and a risk-free asset using international data from 19 countries. Our findings strongly support the view that DA leads investors to reduce their exposure to the stock market (i.e. DA significantly depresses the portfolio weights on equities in all cases considered). Overall, our study shows that in addition to risk aversion, DA plays an important role in explaining the equity premium puzzle around the world.     

Finance and consumption volatility: Evidence from India

The main objective of this paper is to explore the determinants of private consumption growth volatility in India, focusing on the role of financial sector policies. Using data for India over the period 1950-2005, the results show that the implementation of financial repressionist policies is strongly associated with lower consumption volatility. The results remain robust after controlling for a wide range of macroeconomic shocks and variables. The presence of a threshold effect implies that the benefits of financial reforms in reducing consumption volatility can only be reaped when the financial system becomes sufficiently liberalized. The results also indicate that the presence of a more open financial system may serve to dampen fluctuations in private consumption.     

Price informativeness and stock return synchronicity: Evidence from the pricing of seasoned equity offerings

We investigate what stock return synchronicity reflects in terms of price informativeness by examining its effect on the pricing of seasoned equity offerings (SEOs). Based on 5,087 SEOs from 1984 to 2007, we find a significantly negative relation between stock return synchronicity (estimated as the logit transformation of the R-squared statistic from a two-factor regression) and SEO discounts (the percentage differences between pre-offer day closing prices and offer prices). The negative relation is strongest when there is no analyst coverage, and it declines as analyst coverage increases. This shows that stock price is more informative when stock return synchronicity is higher and also that information asymmetry can be mitigated by analyst coverage. We further decompose stock return synchronicity into the market comovement and industry comovement components and find that both components are equally important in affecting SEO discounts.     

Stock returns and volatility following the September 11 attacks: Evidence from 53 equity markets

September 11 attacks matter, and why not? Given that globalization has integrated financial markets, the magnitudes of the effect of the September 11 attacks on global markets are expected to be pervasive. We used data from 53 equity markets to investigate the short term impact of the September 11 attacks on markets' returns and volatility. Our empirical findings indicate that the impact of the attacks resulted in significant increases in volatility across regions and over the study period. However, stock returns experienced significant negative returns in the short-run but recovered quickly afterwards. Nevertheless, we find that the impact of the attacks on financial markets varied across regions. The implication here is that the less integrated regions (e.g., Middle East and North Africa) are with the international economy, the less exposed they are to shocks.     

Funding liquidity and equity liquidity in the subprime crisis period: Evidence from the ETF market

Using index and financial exchange-traded funds (ETFs), this study explores the relation between funding liquidity and equity liquidity during the subprime crisis period. Our empirical results show that a higher degree of funding illiquidity leads to an increase in bid–ask spread and a reduction in both market depth and net buying imbalance. Such findings indicate that an increase in funding liquidity can improve equity liquidity, with a stronger effect for the financial ETFs than for the index ETFs. Our study provides a better overall understanding of the effect of the liquidity–supplier funding constraint during the subprime crisis period.     

Value relevance of proportionate consolidation versus the equity method: Evidence from Hong Kong

Whether proportionate consolidation (PC) or the equity method (EM) provides more informative financial statements is a controversial issue. This study uses data from listed companies in Hong Kong to investigate the value relevance of the EM compared with PC during 2005–2008 when the local word-for-word equivalent HKAS 31 offered the same options. The results of this study provide evidence that PC does not offer higher value relevance than the EM. PC’s horizontal aggregation of a portion of the operations, assets and liabilities of the jointly controlled entities with those of the venturer is less informative to investors than the EM’s vertical aggregation.     

An empirical study of equity agency costs and internationalization: Evidence from Taiwanese firms

Under methodologies of the event study procedure and the multiple regression analysis, this study investigates equity agency costs and internationalization, using a Taiwanese sample from 2000 to 2004. The evidence shows that the shareholder wealth effects of security offering announcements are unfavorable for higher equity agency costs, especially unfavorable for higher equity agency costs of foreign-exposed multinational corporations (MNCs) because internationalization renders monitoring more difficult in comparison to domestic corporations (DCs).This study suggests MNCs to increase their information transparency in order to achieve lowered equity agency costs, and help to reduce information asymmetry, thereby enable firms to raise capital on the best available terms.     

The role of co-managers in reducing flotation costs: Evidence from seasoned equity offerings

We examine the effect on expected flotation costs of including co-managers in the underwriting syndicate. We consider five components of SEO flotation costs: announcement returns, underpricing, the probability of withdrawals, offering delays, and underwriting spreads. The results show that the characteristics of co-managers participating in syndicates have significant effects on flotation costs, while the effect of the number of co-managers is largely insignificant. Our results are consistent with the notion that highly reputable underwriters and commercial banks serving as co-managers serve a certification role, reducing information asymmetries and, as a result, lowering SEO flotation costs.     

The bright and dark side of staging: Investment performance and the varying motivations of private equity firms

Previous papers that examined investment decisions by private equity funds are divided on whether staging has a positive or negative effect on returns. We believe these opposing views can be reconciled by studying when staging is used during the life of the investment relationship: We find that staging has a positive effect on investment returns in the beginning of the investment relationship, consistent with the notion that staging helps mitigate information asymmetry. However, staging appears to be negatively associated with returns when used prior to the exit decision. Our unique dataset allows us to measure these intertemporal effects precisely.     

On the implications of market power in banking: Evidence from developing countries

This paper investigates how different degrees of market power affect bank efficiency and stability in the context of developing economies. It sheds light on the competition-stability nexus by documenting and analyzing the complex interactions between a tripod of variables that are central for regulators: the degree of market power, bank cost and profit efficiency, and overall firm stability. The results show that an increase in the degree of market power leads to greater bank stability and enhanced profit efficiency, despite significant cost efficiency losses. The findings lend empirical justification to the traditional view that increased competition may undermine bank stability, and may bear significant implications for stressed banking systems in developing economies.     

Size and momentum in European equity markets: empirical findings from varying beta Capital Asset Pricing Model

We use securities listed on 13 European equity markets to form size and momentum portfolios. We find limited evidence of a size premium but significant momentum returns in eight sample markets. We find that these premia may not constitute an anomaly because they are consistent with a varying‐beta Capital Asset Pricing Model. We also show that systematic risk is related to the business cycle. Furthermore, the results suggest that although size and especially momentum returns are significant, it would be difficult to exploit them in the short to medium run, because they are positive and sizeable in very few years in our sample.     

Dual foreign currency markets and the role of expectations: Evidence from the Pacific Basin countries

This paper analyzes the role of expectations about the government policy in the official foreign currency market in determining the black market premium. We use data for the recent float from six emerging markets of the Pacific Basin where active black markets for foreign currency exist, namely, Indonesia, Korea, Malaysia, the Philippines, Singapore and Thailand. To test the impact of anticipated and unanticipated shocks to the official exchange rate on the black market premium, we employ the two-step procedure of Hoffman et al. [Hoffman, D.L., Low, S.A., Schlagenhauf, D.E., 1984. Tests of rationality, neutrality and market efficiency: a Monte Carlo analysis of alternative test statistics. J. Monet. Econ. 14, 339–363] which provides corrected F-statistics and allows us to draw valid inference in the presence of generated regressors. The main finding of our analysis is that anticipated and unanticipated shocks to the official exchange rate have an impact on the black market premium in all six Pacific Basin countries. These results suggest that portfolio balance models provide the suitable theoretical framework for analyzing the behaviour of the black market premium in the markets for foreign currency in the Pacific Basin countries. Furthermore, this implies that economic agents in these countries are sensitive to expected returns in foreign exchange.