Recent trends in trading activity and market quality

We explore the sharp uptrend in recent trading activity and accompanying changes in market efficiency. Higher turnover has been associated with more frequent smaller trades, which have progressively formed a larger fraction of trading volume over time. Evidence indicates that secular decreases in trading costs have influenced the turnover trend. Turnover has increased the most for stocks with the greatest level of institutional holdings, suggesting professional investing as a key contributor to the turnover trend. Variance ratio tests suggest that more institutional trading has increased information-based trading. Intraday volatility has decreased and prices conform more closely to random walk in recent years. The sensitivity of turnover to past returns has increased and cross-sectional predictability of returns has decreased significantly, revealing a more widespread use of quantitative trading strategies that allow for more efficient securities prices.     

Insiders’ incentives for asymmetric disclosure and firm-specific information flows

Recent research suggests that insiders’ incentives for capturing cash flows affect price formation process in which insiders are inclined to withhold good news and to accelerate the release of bad news (Jin and Myers, 2006). We investigate whether insiders’ incentives for private control benefit, proxied by control-ownership wedge, affect firm-specific return characteristics. We find that control-ownership wedge is negatively related to the likelihood of positive return jumps and positively related to the extent of asymmetric market reaction to good news rather than to bad news. Overall, our results support the notion that corporate insiders increase opaqueness and withhold good news in order to capture unexpected cash flow.     

CEO risk incentives and firm performance following R&D increases

In this study we analyze how CEO risk incentives affect the efficiency of research and development (R&D) investments. We examine a sample of 843 cases in which firms increase their R&D investments by an economically significant amount over the period of 1995–2006. We find that firms with higher sensitivity of CEO compensation portfolio value to stock volatility (vega) are more likely to have large increases in R&D investments. More importantly, we find that high-vega firms experience lower abnormal stock returns and lower operating performance compared to their low-vega counterparts following the R&D increases. Our main results hold in a variety of robustness tests. The results are consistent with the conjecture that high-vega compensation portfolios may induce managers to overinvest in inefficient R&D projects and therefore hurt firm performance.     

The long-run stock performance of preferred stock issuers

We examine the long-run common stock performance of preferred stock issuers. We find that significant abnormal underperformance is present only for 1 year after the issue. For the longer term we do not find consistently significant abnormal performance. This result contrasts with substantial underperformance of common equity and debt issuers during the 3 or 5 years post-issue. The better long-run performance of preferred issuers relative to common equity and debt issuers is driven primarily by financial firms' motivation to issue preferred stock to satisfy regulatory requirements of capital adequacy.     

The volatility effect of futures trading: Evidence from LSE traded stocks listed as individual equity futures contracts on LIFFE

This study investigates the impact of LIFFE's introduction of individual equity futures contracts on the risk characteristics of the underlying stocks trading on the LSE. We employ the Fama and French three-factor model (TFM) to measure the change in the systematic risk of the underlying stocks which arises subsequent to the introduction of futures contracts. A GJR-GARCH(1,1) specification is used to test whether the futures contract listing affects the permanent and/or the transitory component of the residual variance of returns, and a control sample methodology isolates changes in the risk components that may be caused by factors other than futures contract innovation. The observed increase (decrease) in the impact of current (old) news on the residual variance implies that futures contract listing enhances stock market efficiency. There is no evidence that futures innovation impacts on either the systematic risk or the permanent component of the residual variance of returns.     

Are survey forecasts of individual and institutional investor sentiments rational?

We examine the effects of rational risk factors on investor sentiments. We find that institutional investor sentiments are more rational than individual investor sentiments. There are significant positive effects of, market return and dividend yield and negative effect of inflation on both types of sentiments. These risk factors have stronger effects on institutional than individual investor sentiments. Also, there are significant effects of term spread and HML on the institutional investor sentiments. The evidence suggests that linkages between sentiments and stock return stems from a combination of rational outlook and noise i.e. expectations that are not fully justified by information.     

Explaining the idiosyncratic volatility puzzle using Stochastic Discount Factors

I use Stochastic Discount Factors to examine the sources of the idiosyncratic volatility premium. I find that non-zero risk aversion and firms’ non-systematic coskewness determine the premium on idiosyncratic volatility risk. The firm’s non-systematic coskewness measures the comovement of the asset’s volatility with the market return. When I control for the non-systematic coskewness factor, I find no significant relation between idiosyncratic volatility and stock expected returns. My results are robust across different sample periods and firm characteristics.     

Operating and stock market performance of state-owned enterprise privatizations: The Spanish experience

We investigate the operating and stock market performance of Spanish state-owned enterprises (SOEs) privatized through public share issue offerings (SIPs) from 1990 to 2001, when the last SIP was conducted. We compare the performance of SOEs and privately-owned firms. We find significant operating improvements in Spanish SOEs after the privatization. Specifically, they show significant increases in income efficiency, real sales and employment. Spanish governments tried to minimize the foregone proceeds when selling SOE shares and underpriced them lower than private firms. We relate these results with the pressure of the Maastricht Treaty fiscal criteria, as well as lower information asymmetries between firms and investors. Finally, we do not find long-term abnormal stock market performance after SIPs.     

Exchange trading rules and stock market liquidity

We examine stock exchange trading rules for market manipulation, insider trading, and broker–agency conflict, across countries and over time, in 42 stock exchanges around the world. Some stock exchanges have extremely detailed rules that explicitly prohibit specific manipulative practices, but others use less precise and broadly framed rules. We create new indices for market manipulation, insider trading, and broker–agency conflict based on the specific provisions in the trading rules of each stock exchange. We show that differences in exchange trading rules, over time and across markets, significantly affect liquidity.     

Volume- and size-related lead-lag effects in stock returns and volatility: An empirical investigation of the Warsaw Stock Exchange

We analyze the autocorrelation structure of returns and volatility of stocks listed in the single auction system on the Warsaw Stock Exchange during the period January 1996 - October 2000. First, we find that size- and volume-related cross-autocorrelation in portfolio returns exists even after accounting for the portfolio's own-autocorrelation. Second, we find that size and volume leadership are independent from each other. Third, our results indicate slower adjustment of the small (low volume) portfolios to market-wide information that differs for up and down markets. We also find evidence for volatility spillovers between portfolio returns.     

THE EFFECTS OF INSIDER TRADING RESTRICTIONS: EVIDENCE FROM HISTORICAL DIVIDEND INITIATIONS AND OMISSIONS

We investigate whether insider trading restrictions had their intended effects during the 1960s and 1970s. We examine insider trading and stock market behavior before dividend initiations and omissions announced between 1935 and 1974. Contrary to existing research and commentary, we show that restrictions had meaningful effects. During the 1960s and 1970s, insiders sold less frequently before dividend omissions, and the average profitability of insider trades declined. In addition, the positive (negative) stock price runup before dividend initiations (omissions) decreased after 1961. The results provide some vindication for the Securities and Exchange Commission's adjudicative approach toward insider trading regulation.     

Cross-sectional performance and investor sentiment in a multiple risk factor model

Economists have long recognized the importance of information veracity in valuing risky securities. Market participants concerned about the credibility of information measures may require additional compensation to entice them to hold stocks with less transparent information. These same securities are expected to display greater sensitivities to measures of market sentiment. We find that investor sentiment sensitivities increase directly with multiple measures of opacity in the cross-section. Next we examine the extent to which sentiment sensitivities are priced in an asset pricing context. Using the Jha et al. (2009) model of conditional performance evaluation, we find an inverse relation between ex ante known investor sentiment and the marginal performance of opaque stocks. In contrast, translucent stocks exhibit relatively little variability in performance across levels of sentiment.     

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.     

Option trading and individual investor performance

This paper examines the impact of option trading on individual investor performance. The results show that most investors incur substantial losses on their option investments, which are much larger than the losses from equity trading. We attribute the detrimental impact of option trading on investor performance to poor market timing that results from overreaction to past stock market returns. High trading costs further contribute to the poor returns on option investments. Gambling and entertainment appear to be the most important motivations for trading options while hedging motives only play a minor role. We also provide strong evidence of performance persistence among option traders.     

How the Internet affects output and performance at community banks

Internet web sites have become an important alternative distribution channel for most banking institutions. However, we still know little about the impact of this delivery channel on bank performance. We observe 424 community banks among the first wave of US banks to adopt transactional banking web sites in the late-1990s, and compare the change in their 1999–2001 financial performance to that of 5175 branching-only community banks. Whereas today virtually all viable community banking franchises offer the Internet banking channel, studying this earlier time period allows us to make clean comparisons between subsamples of “brick-and-mortar” and “click-and-mortar” community banks. We find that Internet adoption improved community bank profitability, chiefly through increased revenues from deposit service charges. Internet adoption was also associated with movements of deposits from checking accounts to money market deposit accounts, increased use of brokered deposits, and higher average wage rates for bank employees. We find little evidence of changes in loan portfolio mix. Our findings suggest that these initial click-and-mortar banks (and their customers) used the Internet channel as a complement to, rather than a substitute for, physical branches.     

Improving performance of corporate rating prediction models by reducing financial ratio heterogeneity

We introduce a new approach to improve the performance of rating prediction models for multinational corporations. In this segment, the low number of defaults poses a challenge, as it prevents rating models to be constructed for individual industry sectors or regions. We show that reducing group-level heterogeneity in financial ratios results in a rating prediction model with better performance than both unadjusted models and models adjusted by including industry dummies or other simpler procedures. Our approach fills a gap in cases where a limited dataset does not permit the construction of separate models for individual industries or regions.     

Long-run performance of Spanish seasoned equity issues with rights

This paper analyzes the long-run effect on shareholders' wealth and firms' operating performance of the right offering decision in Spain. The evidence shows that the stock price of firms' issuing rights substantially underperform the different benchmarks employed. It has also been observed that these companies experience a decrease in accounting profitability for some pre- to postissue periods. An excessive optimism about the long-term prospects of equity issuers could explain these results.     

The leverage effect puzzle: Disentangling sources of bias at high frequency

The leverage effect refers to the generally negative correlation between an asset return and its changes of volatility. A natural estimate consists in using the empirical correlation between the daily returns and the changes of daily volatility estimated from high frequency data. The puzzle lies in the fact that such an intuitively natural estimate yields nearly zero correlation for most assets tested, despite the many economic reasons for expecting the estimated correlation to be negative. To better understand the sources of the puzzle, we analyze the different asymptotic biases that are involved in high frequency estimation of the leverage effect, including biases due to discretization errors, to smoothing errors in estimating spot volatilities, to estimation error, and to market microstructure noise. This decomposition enables us to propose novel bias correction methods for estimating the leverage effect.     

The jump component of S&P 500 volatility and the VIX index

Much research has investigated the differences between option implied volatilities and econometric model-based forecasts. Implied volatility is a market determined forecast, in contrast to model-based forecasts that employ some degree of smoothing of past volatility to generate forecasts. Implied volatility has the potential to reflect information that a model-based forecast could not. This paper considers two issues relating to the informational content of the S&P 500 VIX implied volatility index. First, whether it subsumes information on how historical jump activity contributed to the price volatility, followed by whether the VIX reflects any incremental information pertaining to future jump activity relative to model-based forecasts. It is found that the VIX index both subsumes information relating to past jump contributions to total volatility and reflects incremental information pertaining to future jump activity. This issue has not been examined previously and expands our understanding of how option markets form their volatility forecasts.     

Regulatory pressure and fire sales in the corporate bond market

This paper investigates fire sales of downgraded corporate bonds induced by regulatory constraints imposed on insurance companies. As insurance companies hold over one-third of investment-grade corporate bonds, the collective need to divest downgraded issues may be limited by a scarcity of counterparties. Using insurance company transaction data, we find that insurance companies that are relatively more constrained by regulation are more likely to sell downgraded bonds. Bonds subject to a high probability of regulatory-induced selling exhibit price declines and subsequent reversals. These price effects appear larger during periods when the insurance industry is relatively distressed and other potential buyers' carpital is scarce.