Persistence and mean reversion in UK stock returns

This paper re-examines the issue of persistence and mean reversion in UK stock returns in the light of new developments published in Chow and Denning (1993) the random walk hypothesis is tested using multiple variance ratios for returns on the Financial Times All Share Index and 330 individual stocks for the period January 1965 to June 1994. There is no evidence of reversion in the UK stock market. Persistence only exists in high frequency data and is less strong in more recent times. Moreover, it is a portfolio phenomenon and is related to firm size. There is a possibility that persistence/reversion is also industry-related.     

Transition to the Euro and its impact on country portfolio diversification

By examining the impact of the introduction of the Euro on stock markets and on country diversification within the Eurozone, the evidence does not suggest a high risk to the stock market to justify a risk premium as a result of currency union. Although the Euro market integration has increased inter-country correlations, it does not preclude gains from international diversification, which partially rely on the non-Eurozone countries for an optimal portfolio in a mean-variance framework. Furthermore, the empirical evidence supports that there is a significant stationarity of average correlations over time between pre-Euro and post-Euro periods, and it has improved since the introduction of the Euro. Also, results show that the Euro produced a change in volatility with a different pace within the Eurozone vis-à-vis non-Eurozone countries, to support a direct and opposite relationship between volatility and correlation.     

Mean Reversion in the Short Horizon Returns of UK Portfolios

This paper will show that short horizon stock returns for UK portfolios are more predictable than suggested by sample autocorrelation co-efficients. Four capitalisation based portfolios are constructed for the period 1976–1991. It is shown that the first order autocorrelation coefficient of monthly returns can explain no more than 10% of the variation in monthly portfolio returns. Monthly autocorrelation coefficients assume that each weekly return of the previous month contains the same amount of information. However, this will not be the case if short horizon returns contain predictable components which dissipate rapidly. In this case, the return of the most recent week would say a lot more about the future monthly portfolio return than other weeks. This suggests that when predicting future monthly portfolio returns more weight should be given to the most recent weeks of the previous month, because, the most recent weekly returns provide the most information about the subsequent months' performance. We construct a model which exploits the mean reverting characteristics of monthly portfolio returns. Using this model we forecast future monthly portfolio returns. When compared to forecasts that utilise the autocorrelation statistic the model which exploits the mean reverting characteristics of monthlyportfolio returns can forecast future returns better than the autocorrelation statistic, both in and out of sample.     

The impact of the market portfolio on the valuation,incentives and optimality of executive stock options

This paper examines the effect on valuation and incentives of allowing executives receiving options to trade on the market portfolio. We propose a continuous time utility maximization model to value stock and option compensation from the executive's perspective. The executive may invest non-option wealth in the market and riskless asset but not in the company stock itself, leaving them subject to firm-specific risk for incentive?purposes. Since the executive is risk averse, this unhedgeable firm risk leads them to place less value on the options than their cost to the company.

By distinguishing between these two types of risks, we are able to examine the effect of stock volatility, firm-specific risk and market risk on the value to the executive. In particular, options do not give incentive to increase total risk, but rather to increase the proportion of market relative to firm-specific risk, so executives prefer high beta companies. The paper also examines the relationship between risk and incentives, and finds firm-specific risk decreases incentives whilst market risk may decrease incentives depending on other parameters. The model supports the use of stock rather than options if the company can adjust cash pay when granting stock-based compensation.     

The impact of geographic diversification on firm performance

This paper empirically examines the economic effects of both corporate industrial and geographic diversifications. Using a sample of 28,050 firm-year observations from 1990 to 1998, we find that industrial and geographic diversifications are associated with firm value decrease. Consistent with Denis et al. [Denis, D. J., Denis, D. K., and Yost, K. (2002). Global diversification, industrial diversification, and firm value. Journal of Finance, 57, 1951-1979], the costs of corporate diversification may outweigh the benefits of diversification. We find that geographically diversified firms have higher R&D expenditures, advertising expenses, operating income, ROE and ROA than industrially diversified firms. In addition, higher R&D expenditures create value for multi-segment global firms, but not for single-segment global firms. This result implies that there exists an interaction effect between industrial and geographic diversification. We also examine the effects of agency cost issues, as characterized by the diversification discount, on both industrial and geographic diversification. Consistent with the agency explanation, firms with high equity-based compensation are associated with higher firm value than firms with low equity-based compensation. Also, we find that firms with a higher insider ownership percentage are associated with higher excess value.     

The impact of international portfolio composition on consumption risk sharing

Recent empirical work has shown that ongoing international financial integration facilitates cross-country consumption risk sharing. These studies typically find that countries with high equity home bias exhibit relatively low international consumption risk sharing. We extend this line of research and demonstrate that it is not only a country's equity home bias that prevents consumption risk sharing. In addition, the composition of a country's foreign asset portfolio plays an important role. Using panel-data regression for a group of OECD countries over the period 1980–2007, we show that foreign investment bias has additional explanatory power for consumption risk sharing.     

The impact of delivery terms on stock return volatility

The application of generalized ARCH models to daily stock returns shows changes in delivery and payment terms to be an important factor in determining measured volatility. In contrast, the holding period between trading days when markets are closed is relatively unimportant. This new approach allows fresh insights into stock return volatility and indicates that subsequent research on stock return volatility should incorporate the effects of payment delays.     

The dynamics of the Monday effect in international stock indices

This examination of the temporal dynamics of the international Monday effect is based on 50 countries. Observed between-country differences are characterised by an economic factor based on four indices. The prior day effect captures the tendency for price changes to follow those on the prior day. A bad (good) day occurs when the price change on the prior day is negative (positive). A panel regression with panel corrected standard errors, is used to characterise the way that the Monday effect and the cognate prior day effect systematically vary between countries over the period 1994 to 2006. At the start of the data in 1994, there is a considerable prior day effect which is larger for poor countries. This between-country difference declines over time and has essentially disappeared by 2006. The bad non-Monday effect and the bad-Monday effect also decline over time. Further analysis with six leading economies provides evidence that the prior day influence on Mondays and non-Mondays dates back to at least 1973.     

The impact of nominal stock price on ex-dividend price responses

In this paper, we examine whether nominal stock price can help to explain the ex-dividend day anomaly where stock prices drop by less than the dividend amount on the ex-dividend date. We find that stocks with lower nominal prices have ex-dividend day price drops that are more consistent with theoretical predictions based on an efficient market. After controlling for factors that have been previously documented to influence ex-dividend day stock price behavior, price-drop-to-dividend ratios are closer to one for lower priced stocks. To further explore this phenomenon, we examine the change in the price-drop-to-dividend ratio around stock splits. Firms that split their shares have a larger price-drop-to-dividend ratio after the split, and companies that reverse split their shares have a smaller price-drop-to-dividend ratio after the split. Our evidence indicates that ex-dividend day stock price behavior is influenced by the nominal price of a share and that this relation could also influence the decision to split a firm’s shares.     

Bank capital buffer and portfolio risk: The influence of business cycle and revenue diversification

The relationship between macroeconomic developments and bank capital buffer and portfolio risk adjustments is relevant to assess the efficacy of newly created countercyclical buffer requirements. Using the U.S. bank holding company data over the period 1992:Q1–2011:Q3, we find a negative relationship between the business cycle and capital buffer. Our results offer some support for the Basel III agreements that countercyclical capital buffer in the banking sector is necessary to help the performance of the real economy during recessions. We find a robust evidence of inverse relationship between business cycle and bank default risk. Our analysis provides evidence of diversification benefits. The probability of insolvency risk decreases for diversified banks and banks with high revenue diversity achieve capital savings.     

The impact of diverse measures of default risk on UK stock returns

A number of recent papers examine the relationship between default risk and equity returns, and the results are mixed. These studies employ different measures of default risk and we find that correlations between eight diverse measures of default risk tend to be less than 50%. Nonetheless, we find that the relationship between stock returns and diverse measures of default risk tends to be consistent; default risk is a significant determinant of stock returns and this relationship is “hump backed”, as predicted by Garlappi and Yan (2011).     

Neighborhood matters: The impact of location on broad based stock option plans

We find that fixed effects related to the location of firms’ headquarters explain variation in broad based option grants after controlling for industry effects and firm characteristics traditionally known to affect option granting. Location matters because of local labor market conditions and social interaction with neighboring firms. Broad based option grants are higher: (i) when a firm's stock prices co-move more with stock prices of other firms located in that Metropolitan Statistical Area (MSA); (ii) in states that are less likely to enforce non-compete agreements; and (iii) in MSAs where employees prefer options because stocks there experience abnormally high returns.     

The impact of keeping up with the Joneses behavior on asset prices and portfolio choice

This paper studies the asset pricing and portfolio choice implications of keeping up with the Joneses preferences. In terms of portfolio choice, we provide sufficient conditions on the utility function under which no portfolio bias can arise across agents in equilibrium. Regarding asset prices, we find that under Joneses behavior asset prices are a function of the economy's aggregate consumption, the agents preference parameters, the wealth endowment distribution and the weighting across agents in the Joneses definition. We present necessary and sufficient conditions such that equilibrium prices are only a function of aggregate wealth. Non-financial, non-diversifiable income is introduced in the model. In the presence of Joneses behavior, an under-diversified equilibrium emerges where investors will bias their portfolios towards the financial assets that better hedge their exposure to the non-financial income risk.     

Dependence and mean reversion in stock prices: The case of the MENA region

This paper provides empirical evidence on the long memory behavior of the stock markets of Egypt, Jordan, Morocco, and Turkey. To test for long memory in the returns and volatility, we employ the modified rescaled range statistic R/S proposed by Lo [Lo, A.W., 1991. Long-term memory in stock market prices. Econometrica 59, 1279–1313] and the recently proposed rescaled variance V/S statistic developed by Giraitis et al. [Giraitis, L., Kokoszka, P.S. Leipus, R., Teyssiere, G., 2003. Rescaled variance and related tests for long memory in volatility and levels. J. Econ. 112, 265–294]. Further analysis is conducted by employing the ARFIMA (p, d, q) model to estimate the long memory parameters. Egypt and Morocco show evidence of long memory in the return series, while Jordan and Turkey display negative persistence. For the volatility series, long memory is conclusively demonstrated for all markets. Then, we compare the forecasting performance of ARMA and ARFIMA models and find that the ARFIMA model outperforms in out-of-sample forecasting of the markets. Our results should be useful to regulators, practitioners and derivative market participants, whose success depends on the ability to forecast stock price movements in these markets.     

The impact of regulation FD on the information environment: evidence from the stock market response to stock split announcements

This paper examines the information environment effects of regulation fair disclosure (Reg FD). We investigate the stock market response to stock splits in the pre- and post-regulation periods. We find that abnormal returns around split announcement are positive in both periods, but the magnitude of the returns is smaller in the post-FD period relative to the pre-FD period. The difference between the pre- and post-FD period abnormal returns persists even after we control for factors that may affect split announcement returns. We also find that the magnitude of the association between announcement returns and the unexpected portion of the split factor has increased post-regulation. Our analysis of performance trends for split firms reveals that patterns of profitability and changes in profitability in the years around stock splits are similar in the pre- and post-FD periods. However, we find that announcement returns are associated with lagged profitability changes in the pre-FD period, but with future profitability changes in the post-FD period. Collectively, our results imply that Reg FD has reduced information asymmetry and improved price efficiency.     

The impact of Saturday trading on stock returns: Evidence from the Tokyo stock exchange January 1976 to January 1989

This paper examines the impact of TSE Saturday trading on daily TOPIX returns and TSE trading volume over the January 1976 to January 1989 period. Saturday trading is shown to have no significant impact on mean stock returns for the other days of the week. However, a significant shift in the pattern of Monday and Tuesday TOPIX returns is documented in the post-August 1986 period. This shift does not appear to be related to Saturday trading. TSE Saturday trading is found to have a significant impact on the variance of stock returns on surrounding days. In addition, trading volume is significantly lower on trading days surrounding Saturday trading. These findings are relevant to the timing of portfolio adjustment decisions.     

The impact of revenue diversification on bank profitability and risk: evidence from MENA banking industry

The aim of this paper is to investigate the effects of revenue diversification on bank performance while shedding light on the impact of the shift towards non-interest income sources. To this end, we use a sample of 275 banks from fourteen MENA countries over 1990–2011. The model estimation using the GMM system reveals that diversification, when taken as a whole, improves bank profitability. We also split the non-interest income and we find that trading-generating business lines contribute the most to boosting profitability and stability. Engaging in non-interest-related activities worsens the benefit-cost trade-off of diversification, induced by the increased insolvency risk.     

The impact of assets-in-place on corporate financing and investment decisions

In a dynamic setting with asymmetric information we consider firms’ debt-equity choice and investment timing. We extend recent research by adding an abandonment option and assets-in-place and we show that these extensions make debt more attractive. This implies, e.g., that mature firms (with larger assets-in-place) mainly use debt financing, whereas young high-growth firms (without assets-in-place) frequently use equity financing and signal their type by early investment. Simulation analyses confirm this and our model is thus able to explain empirical patterns which contradict the static pecking order theory.     

A tale of two time zones: The impact of substitutes on cross-listed stock liquidity

This article examines how the market quality of European cross-listed stocks is affected by the partial-day availability of close substitutes, i.e., shares of the same companies that are traded in their home markets but are not fully fungible with the cross-listed shares. Our findings suggest that narrower spreads and more competitive liquidity provision during overlapping trading hours reflect a significant impact from the availability of more substitutes in addition to the enhanced information environment and liquidity externalities when home markets are open. Our results also provide a richer picture of specialists’ intraday activities and offer new evidence of market integration.     

The impact of tax on foreign direct investment: Empirical evidence and the implications for tax integration schemes

We estimate the impact of taxation on foreign direct investment (FDI) flows, using data on flows between seven countries for 1984 through 1989, and a sophisticated measure of the cost of capital. We find that the choice between domestic investment and total outward FDI is not significantly affected by taxation but that taxation does affect the location of outward FDI. These results are used to examine the impact of tax integration systems. Giving a tax credit to foreign shareholders may induce a large increase in inward FDI from exemption countries but not from partial-credit countries. For the United States, the total effect would be small.