Takeover Prediction and Portfolio Performance: A Note

This paper empirically tests whether it is possible to generate abnormal returns from investing in a portfolio of predicted successful takeover targets. Portfolios are formed on the basis of predictions from models similar to those estimated by Palepu (1986). However, unlike Palepu (1986), the portfolios in this paper are formed using a decision rule that results in smaller portfolios with higher average takeover probabilities. This provides a stronger test of whether share prices reflect future takeover probabilities. The results show that while the models have significant explanatory power, the portfolios fail to beat the return on the market over a 12-month holding-period.     

Political Connection and Stock Returns: A Longitudinal Study

A stock market should display informational efficiency and, therefore, should appropriately reflect the value of political connections, if any value exists. Using a comprehensive data set that incorporates both obvious and less obvious political connections to firms in Thailand, we provide a longitudinal study which shows that higher realized stock returns are systematically associated with political connectedness. Consistent with the view that such a relationship provides economic rents, this finding is particularly prominent in more regulated industries. The politically connected premium is higher for higher level political connections and when the political bodies hold an equity stake in the firm.     

Returns to scale and asset prices

The q‐theory of investment is proposed to explain firm growth effects, where previous papers identify a negative effect of firm growth, including asset growth, real investment and net share issuance, on future stock returns. This paper uses returns to scale from the production function to test the dynamic q‐theory, which predicts that the firm growth effect is theoretically weaker for firms with decreasing returns to scale (DRS) than for non‐DRS firms. Our empirical results generally support the prediction of dynamic q‐theory. However, we find that the dynamic q‐theory explains little of the value, momentum and ROE effects from the standpoint of returns to scale.     

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.     

Investment decisions and internal capital markets: Evidence from acquisitions

In this paper, we examine the workings of internal capital markets in diversified firms that engage in related and unrelated corporate acquisitions. Our evidence indicates that bidders invest outside their core business (diversify) when the cash flows of their core business fall behind those of their non-core lines of business. However, bidders invest inside their core business (i.e., undertake non-diversifying investments) when their core business experiences superior cash flows. We also find that bidders whose core business are in industries with low growth prospects engage in diversifying acquisitions while bidders whose core business are in high growth industries undertake non-diversifying acquisitions. The pre-acquisition evidence, then, suggests that firms tend to diversify when the cash flows and the growth opportunities of their core business are considerably lower than those of their non-core business. Subsequent to acquisitions we find that diversifying bidders continue to allocate financial resources from less profitable business segments (i.e., core business) to more profitable business segments (i.e., non-core business). Given the low profitability of diversifying bidders’ core business, this capital resource allocation suggests that diversification increases do not result in capital allocation inefficiencies. The evidence for non-diversifying bidders, however, supports the existence of “corporate socialism” in the sense that there is transfer of funds from the profitable (core) to the less profitable (non-core) business segments in multi-segment bidders. We find that the capital expenditures of bidders’ non-core business segments rely on both core and non-core cash flows.     

Shiller's CAPE: Market Efficiency and Risk

Robert Shiller shows that Cyclically Adjusted Price to Earnings Ratio (CAPE) is strongly associated with future long‐term stock returns. This is often interpreted as evidence of market inefficiency. We present two findings contrary to such an interpretation. First, if markets are efficient, stock returns should be higher than the risk‐free rate. We find that even when CAPE is in its ninth decile, future 10‐year stock returns, on average, are higher than future returns on 10‐year U.S. Treasurys. Thus, the results are largely consistent with market efficiency. Second, consistent with a risk–return tradeoff, we find that CAPE is negatively associated with future stock market volatility.     

The Post‐Cost Profitability of Momentum Trading Strategies: Further Evidence from the UK

This paper examines the post‐cost profitability of momentum trading strategies in the UK over the period 1988–2003 and provides direct evidence on stock concentration, turnover and trading cost associated with the strategy. We find that after factoring out transaction costs the profitability of the momentum strategy disappears for shorter horizons but remains for longer horizons. Indeed, for ranking and holding periods up to 6‐months, profitable momentum returns would not be available to most average investors as the cost of implementation outweighs the possible returns. However, we find post‐cost profitability for ranking and/or holding periods beyond 6 months as portfolio turnover and its associated cost reduces. We find similar results for a sub‐sample of relatively large and liquid stocks.     

Heterogeneous Background Risks and Portfolio Choice: Evidence from Micro‐level Data

We construct a set of household‐level background risk variables to capture the covariance structure of three nonfinancial assets and two financial assets. These risks are in general statistically significant and economically important for a household's stock market participation and stockholdings. A one‐standard‐deviation increase in background risks reduces the participation probability by 11% and the stockholdings‐to‐wealth ratio by 4%. The volatilities of labor income, housing value, and business income reduce a household's participation and stockholdings. A household with labor income highly correlated with stock (bond) returns is less (more) likely to invest in stock.     

IPO first‐day returns: Skewness preference,investor sentiment and uncertainty underlying factors

In this paper, we investigate the initial public offering (IPO) first-day returns. Our focus is to examine the irrational component of the agent behavior towards IPO lotteries. Based on 234 French IPOs performed between 2002 and 2012, we find that IPOs with high initial returns have higher idiosyncratic skewness, turnover and momentum. This finding provides empirical evidence for investors' preference for stocks with lottery-like features and investor sentiment. In addition, we show that the skewness preference and the investor sentiment effect are stronger during periods of favorable market conditions. Our results are robust to the integration of uncertainty underlying factors.     

A Tale of Two Anomalies: Higher Returns of Low‐Risk Stocks and Return Seasonality

Prior studies have shown that low beta and low volatility stocks earn higher average returns than high beta and high volatility stocks, contradicting the prediction of the capital asset pricing model and the fundamental relationship between risk and return. In this paper, we demonstrate that this phenomenon is driven by the seasonality of stock returns. We show that the risk‐return tradeoff does hold in the nonsummer months, and that switching to a portfolio of low‐risk stocks in summer outperforms—both in terms of absolute and in risk‐adjusted returns—buy and hold strategies as well as the Sell in May strategy of switching to treasury bills in summer.     

Behavioural Finance: A Review and Synthesis

I provide a synthesis of the Behavioural finance literature over the past two decades. I review the literature in three parts, namely, (i) empirical and theoretical analyses of patterns in the cross‐section of average stock returns, (ii) studies on trading activity, and (iii) research in corporate finance. Behavioural finance is an exciting new field because it presents a number of normative implications for both individual investors and CEOs. The papers reviewed here allow us to learn more about these specific implications.     

Asymmetric Trading Costs Prior to Earnings Announcements: Implications for Price Discovery and Returns

We show that the cost of trading on negative news, relative to positive news, increases before earnings announcements. Our evidence suggests that this asymmetry is due to financial intermediaries reducing their exposure to announcement risks by providing liquidity asymmetrically. This asymmetry creates a predictable upward bias in prices that increases preannouncement, and subsequently reverses, confounding short‐window announcement returns as measures of earnings news and risk premia. These findings provide an alternative explanation for asymmetric return reactions to firms' earnings news, and help explain puzzling prior evidence that announcement risk premia precede the actual announcements. Our study informs methods for research centering on earnings announcements and offers a possible explanation for patterns in returns around anticipated periods of heightened inventory risks, including alternative firm‐level, industry‐level, and macroeconomic information events.     

In Defence of Capitalisation Weights: Evidence from the FTSE 100 and S&P 500 Indices

A simple method for decomposing the variance covariance matrix of portfolio returns at the level of individual stocks is applied to the FTSE 100 Index. During extreme negative shocks, the largest index constituents exhibit lower than average covariance, thereby reducing the volatility of the capitalisation‐weighted index. The risk‐adjusted returns of the capitalisation‐weighted FTSE 100 Index exceed those of an equally‐weighted version of the same index and the outperformance is robust to the method of risk adjustment applied. The equally‐weighted index also exhibits greater systematic (market) risk than the capitalisation‐weighted version.     

Corporate Real Estate Sale and Leaseback Effect: Empirical Evidence from Europe

Corporate real estate disposals have increased in Europe during the past few years. In this research paper, we study market reactions of publicly traded European companies' real estate sale and leaseback announcements during 1998–2004. This study is one of the first ones to study the sale and leaseback impact on corporate value with a pan‐European data. We find that the sale and leaseback announcements have on average positive impact to firm's value which is in line with the previous studies. However, we also find that the positive effect is mainly caused by the deals with high transaction value to company market value ratio. Smaller transactions do not create on average any abnormal returns. Our results support the hypothesis that the positive sale and leaseback announcement effect is a consequence of revealed hidden value of the company's assets. Thus, sale and leaseback can also be seen as a mechanism for revealing the hidden value of company's assets to the market.     

Wolf in Sheep's Clothing: The Active Investment Strategies behind Index Performance

This paper argues that the commonly used market indices imply forms of active investment management in disguise. The selection and rebalancing rules make these indices highly exclusive and dynamic regarding their underlying components and significantly bias their performance. Any passive investment tracking these indices turns into an active strategy characterised by market timing and state‐dependent performance. Evidence is provided that exclusive indices outperform (underperform) more inclusive peer indices in upward (downward) markets. The constitution and maintenance rules of exclusive indices correspond to a set of active trading and investment rules similar to momentum strategies.     

Governance and Performance Implications of Diversification Strategies: Evidence from Large U.S. Firms

Recent research focuses on explaining the diversification discount. However, there is little direct evidence regarding the relation among ownership structure, corporate governance, and corporate diversification. The results in this paper suggest that agency issues do not account for firms adopting a particular diversification strategy. Also, the performance consequences of the shift in the diversification strategy and the subsequent changes in institutional and block ownership structures are not related to agency issues. In fact, investors seem not to avoid diversified firms per se. We suggest that observed board and ownership differences between diversified and focused firms are due to their being at different stages of corporate evolution.     

The Return of the Size Anomaly: Evidence from the German Stock Market

This paper examines the size effect in the German stock market and intends to address several unanswered issues on this widely known anomaly. Unlike recent evidence of a reversal of the size anomaly this study documents a conditional relation between size and returns. I also detect strong momentum across size portfolios. The results indicate that the marginal effect of firm size on stock returns is conditional on the firm's past performance. I use an instrumental variable estimation to address Berk's critique of a simultaneity bias in prior studies on the small firm effect and to investigate the economic rationale behind firm size as an explanatory variable for the variation in stock returns. The analysis in this paper indicates that firm size captures firm characteristic components in stock returns and that this regularity cannot be explained by differences in systematic risk.     

Investor behaviour and reaching for yield: Evidence from the sterling corporate bond market

We provide evidence on how corporate bond investors react to a change in yields, and how this behaviour differs in times of market‐wide stress. We also investigate ‘reaching for yield’ across investor types, as well as providing insights into the structure of the corporate bond market. Using proprietary sterling corporate bond transaction data, we show that insurance companies, hedge funds and asset managers are typically net buyers when corporate bond yields rise. Dealer banks clear the market by being net sellers. However, we find evidence for this behaviour reversing in times of stress for some investors. During the 2013 ‘taper tantrum’, asset managers were net sellers of corporate bonds in response to a sharp rise in yields, potentially amplifying price changes. At the same time, dealer banks were net buyers. Finally, we provide evidence that insurers, hedge funds and asset managers tilt their portfolios towards higher risk bonds, consistent with ‘reaching for yield’ behaviour.