Nonlinear relationship between monetary policy and stock returns: Evidence from the U.S.

This paper studies the relationship between monetary policy and stock market return in the U.S. using nonlinear econometric models. It first employs a univariate Markov-switching model on each of the three stock indices and three monetary policy variables, displaying significant regime-switching patterns and common movements. This paper then uses a Markov-switching dynamic bi-factor model to simultaneously extract two latent common factors from stock indices and monetary policy variables to represent monetary policy changes and stock market movements separately. The smoothed probabilities of regimes demonstrate that expansionary monetary policy regimes follow economic recessions, but bear stock markets usually occur before economic recessions. The maximum likelihood estimation results show that expansionary monetary policy such as a decrease in the federal funds rate raises stock returns, but stock returns don't directly influence monetary policy decision.     

Economic and financial crises and the predictability of U.S. stock returns

We argue that the use of publicly available and easily accessible information on economic and financial crises to detect structural breaks in the link between stock returns and macroeconomic predictor variables improves the performance of simple trading rules in real time. In particular, our results suggest that accounting for structural breaks and regime shifts in forecasting regressions caused by economic and financial crises has the potential to increase the out-of-sample predictability of stock returns, the performance of simple trading rules, and the market-timing ability of an investor trading in the U.S. stock market.     

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.     

U.S. monetary policy indicators and international stock returns: 1970-2001

It is documented in the literature that U.S. and many international stock returns series are sensitive to U.S. monetary policy. Using monthly data, this empirical study examines the short-term sensitivity of six international stock indices (the Standard & Poor 500 [S&P] Stock Index, the Morgan Stanley Capital International [MSCI] European Stock Index, the MSCI Pacific Stock Index, and three MSCI country stock indices: Germany, Japan, and the United Kingdom) to two major groups of U.S. monetary policy indicators. These two groups, which have been suggested by recent research to influence stock returns, are based on the U.S. discount rate and the federal funds rate. The first group focuses on two binary variables designed to indicate the stance in monetary policy. The second group of monetary indicators involves the federal funds rate and includes the average federal funds rate, the change in the federal funds rate, and the spread of the federal funds rate to 10-year Treasury note yield. Dividing the sample period (1970-2001) into three monetary operating regimes, we find that not all policy indicators influence international stock returns during all U.S. monetary operating periods or regimes. Our results imply that the operating procedure and/or target vehicle used by the Federal Reserve Board (Fed) influences the efficacy of the policy indicator. We suggest caution in using any monetary policy variable to explain and possibly forecast U.S. and international stock returns in all monetary conditions.     

Extreme volumes and expected stock returns: Evidence from China's stock market

We examine the relation between extreme trading volumes and expected returns for individual stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange over the July 1994–December 2000 interval. Contrasted with the evidence obtained from the US data [J. Finance 56 (2001) 877], our results show that stocks experiencing extremely high (low) volumes are associated with low (high) subsequent returns. Moreover, this extreme volume–return relation significantly co-varies with security characteristics like past stock performance, firm size, and book-to-market values. In particular, stocks with extreme volumes are related to poorer performance if they are past winners, large firms, and glamour stocks than if they are past losers, small firms, and value stocks, respectively. These results are robust to both daily and weekly samples as well as stock exchange sub-samples. Although the liquidity premium hypothesis of Amihud and Mendelson [J. Financ. Econ. 17 (1986) 223] provides a partial explanation for the extreme volume–return relation, our results fit better the behavioral hypothesis of Baker and Stein [J. Financ. Mark. 7 (2004) 271].     

Economic policy uncertainty exposure and stock price bubbles: Evidence from China

We explore the impact of economic policy uncertainty exposure (hereafter, EPU exposure) on stock price bubbles. We find that there exists a significantly positive relationship between EPU exposure and stock price bubbles. This result is still significant after a series of robustness checks. Moreover, the relationship between EPU exposure and bubbles is due to retail investors' speculative trading behavior. In addition, optimistic aggregate states and firms with higher information uncertainty characteristics strengthen the EPU exposure effects. Overall, we provide unique evidence regarding the impact of uncertainty on stock prices.     

Foreign exchange exposure: Evidence from the U.S. insurance industry

We study the foreign exchange exposure of U.S. insurers. The evidence shows that no systematic difference exists in the currency risk profiles of life and non-life segments within the insurance industry. This suggests that life and non-life insurers have similar risk exposure management strategies arising from similar risk pooling and financial intermediary functions. The empirical results reveal that a sizable proportion of U.S. insurers are exposed to foreign exchange movements against the seven largest U.S. trade partners in insurance services (U.K., Japan, Switzerland, Netherlands, France, Germany and Canada). Significant operational and size effects are also documented and we find that the frequency of foreign exchange exposure increases with time horizon.     

Pandemic-induced fear and stock market returns: Evidence from China

We construct a pandemic-induced fear (PIF) index to measure fear of the COVID-19 pandemic using Internet search volumes of the Chinese local search engine and empirically investigate the impact of fear of the pandemic on Chinese stock market returns. A reduced-bias estimation approach for multivariate regression is employed to address the issue of small-sample bias. We find that the PIF index has a negative and significant impact on cumulative stock market returns. The impact of PIF is persistent, which can be explained by mispricing from investors' excessive pessimism. We further reveal that the PIF index directly predicts stock market returns through noise trading. Investors' Internet search behaviors enhance the fear of the pandemic, and pandemic-induced fear determines future stock market returns, rather than the number of cases and deaths caused by the COVID-19 pandemic.     

Equity financing capacity and stock returns: Evidence from China

We examine the relation between the capacity for financing through rights and seasoned public offers of equity and subsequent stock returns in China. The results show that the capacity for rights and public offers is reliably negatively related with future returns for firms that met regulatory criteria. Further, the capacity for rights offers is strongly negatively related with returns for firms that met the criteria and applied for approval, and for firms that issued equity after meeting the criteria and obtaining approval. Thus, there is clear evidence of a negative relation between equity financing capacity and stock returns in China.     

Short selling and stock returns: Evidence from the UK

The practice of shorting stocks was put forward as one of the causes of the recent financial crisis whereas Shiller (2003), for example, considers shorting an essential element of an efficient market. Shorting involves selling borrowed stocks and subsequently closing the position by purchasing and returning the stock to the lender. A profit will be realised if the stock's price decreases. Shorting enables investors who do not own a perceived overvalued stock to sell. Using a high-frequency UK dataset for the period between September 2003 and April 2010, our findings suggest shorting indicates evidence of overvalued stocks as significantly negative abnormal stock returns appear to follow an increase in shorting. These results do not hold, however, for shorting which occurs around the ex-dividend date. We further find that these results hold during the recent financial crisis.     

The effects of oil price shocks on U.S. stock order flow imbalances and stock returns

This paper investigates for the first time the effects of oil demand shocks and oil supply shocks on stock order flow imbalances leading to changes in stock returns. Through the estimation of a structural VAR model, positive oil demand shocks are able to explain almost 36% of the observed variation in the daily average stock order flow imbalances measured by the buy/sell trades ratio; which consequently lead to a negative rather than positive stock returns reaction. In contrast, oil supply shocks exhibit a negative and marginally significant effect on stock order flow imbalances. Our aggregate analysis suggests that positive shocks on stock order flow imbalances are negatively related to stock returns. These effects are stronger for oil-related sectors when compared with the rest of the equities sectors.     

Accruals quality,stock returns and asset pricing: Evidence from the UK

The extent to which accruals quality (AQ) is relevant for asset pricing has been debated widely. Prior research in this area has focused almost exclusively on the US. Using UK data, we investigate whether AQ portfolios exhibit evidence of significant mispricing, and whether an AQ factor is useful in explaining the portfolios' returns. We also investigate whether AQ is a priced risk factor. Using a two stage cross-sectional regression, we show that an AQ measure explains the cross-section of stock returns. AQ also explains the time-series variation in returns for two sets of portfolios: 16 size-BM portfolios, and 20 industry portfolios. Consistent with some recent US evidence, however, we find no evidence that AQ is a priced risk factor for UK stocks.     

Asymmetric foreign exchange risk exposure: Evidence from U.S. multinational firms

This paper examines how U.S. multinational firms are affected by foreign currency movements. In light of detailed exchange rate data, we find that 29% of our sample of 935 U.S. firms with real operations in foreign countries is significantly affected by currency movements between 1990 and 2001. Results show moreover that U.S. stock returns react asymmetrically to currency movements. By introducing nonlinearity in foreign currency risk exposure, we noticeably increase the precision and the significance of exposure estimates. We demonstrate moreover that asymmetries are more pronounced towards large versus small currency fluctuations than over depreciation and appreciation cycles.     

Asset growth and stock returns: Evidence from Asian financial markets

This study examines the effect of corporate asset growth on stock returns using data on nine equity markets in Asia. For the period from 1981 to 2007, we find a pervasive negative relation between asset growth and subsequent stock returns. Such relation is weaker in markets where firms' asset growth rates are more homogeneous and persistent and in markets where firms rely more on bank financing for growth. On the other hand, corporate governance, investor protection, and legal origin do not influence the magnitude of the asset growth effect in Asian markets.     

Firm profitability and expected stock returns: Evidence from Latin America

Despite their higher valuation ratios, larger size, and higher investment needs, profitable firms outperform, in both raw and risk-adjusted returns, unprofitable firms in Latin America. The positive effect of firm profitability on stock returns is pervasive in univariate and bivariate sorts, panel regressions, across sub-regional markets, and among small and large stocks. A five-factor model that includes market, size, distress, profitability, and investment factors prices profitability portfolios better than other popular factor models. Five-factor alphas of profitability portfolios tend to be lower and less statistically significant, both individually and collectively, than alphas from other three widely-used pricing models.     

Idiosyncratic skewness and cross-section of stock returns: Evidence from Taiwan

In this study, we examine whether idiosyncratic skewness (IS) affects the returns of the Taiwan stock market. We find that speculative retail investors prefer positive skewness in stocks that leads them to overprice these stocks. As a result, the IS, that reflects gambling, has a negative relation with future returns. Gambling preferences vary with time, mainly occur during recessions and down markets. Moreover, the negative IS-return relation exists only among firms with prior capital gains. We use a difference-in-difference (DID) framework to mitigate the endogeneity concern and find that this IS effect is more significant among stocks with lower arbitrage limits. The IS effect remains significant even after controlling for the IS risk factor. Overall, the IS effect cannot be explained by either arbitrage limits or risk exposure.     

Accounting-based downside risk and expected stock returns: Evidence from China

We document that earnings downside risk contains information on firms' future operating performance and is positively associated with expected stock returns in Chinese stock markets, and the return predictability of earning downside risk mainly comes from its accrual downside risk component. The pricing of earnings downside risk is especially evident among firms with more transparent information environment and stronger governance efficacy, such as large firms, non-high-tech firms, old firms, and firms with high analyst coverage. Lastly, we show that aggregated earnings downside risk and its components at the market level are all significantly and positively associated with subsequent stock market returns, which is consistent with the notion that the accounting-based downside risk measures contain information about future macroeconomic conditions.     

Economic policy uncertainty,agency problem,and funding structure: Evidence from U.S. banking industry

We empirically examine the impact of economic policy uncertainty (EPU) on banks’ funding structure (FUD). Using an extensive dataset of U.S. bank holding companies, we find that high policy uncertainty strengthens banks’ FUD. For banks with a pre-existing low FUD, an increase in EPU raises FUD. However, for banks with a pre-existing high FUD, the relationship between EPU and FUD becomes negative and economically significant. Considering the lack of relevant studies, our paper contributes to the literature and provides implications for policymakers and practitioners in the banking industry.     

Fundamentals and bubbles in asset prices: Evidence from U.S. and Japanese asset prices

This paper investigates the existence and extent of non-fundamental bubbles in both U.S. and Japanese asset prices by employing a flexible empirical method which allows us to decompose asset prices into fundamental and non-fundamental bubble components. This study finds that a substantial fraction of U.S. and Japanese asset prices is accounted for by non-fundamental bubble components and that these asset prices overreact to non-fundamental bubble shocks. In addition, allowing for time-varying interest rates as another fundamental factor does not change any qualitative results about the role of non-fundamental bubble components. This suggests that the present value model fails to explain volatile asset price behavior even with time-varying interest rates. This paper was initially written when I was visiting Keio University in Japan. I benefited from several discussions with Mike Dothan, Pat Hess, and Steve LeRoy in my department, Takashi Kaneko, Yukitami Tsuji and Naoyuki Yoshino at Keio University, and Yong-Seok Park at the International University of Japan. Special thanks are due to the anonymous referee and the editor of this journal, who provided many useful and insightful comments that helped to improve the paper. This research was in part supported by a grant from the International Program Development.     

Unemployment beta and the cross-section of stock returns: Evidence from Australia

This study provides evidence of the significant impacts of unemployment indicators, including the projected unemployment rate and actual unemployment gap, on the cross-sectional stock returns in the Australian market. Utilising the extensive dataset of all listed stocks and unemployment data from 1992 to 2021, we construct an unemployment beta to measure the monthly-varying sensitivity of returns to the actual and forecasted unemployment levels. The findings confirm that stocks in the lowest unemployment beta decile can generate higher excess and risk-adjusted returns compared to the higher unemployment beta deciles. The predictive powers of unemployment remain significant within the horizon of 36 months for the aggregate returns and 24 months for cross-sectional returns. Further, the unemployment premiums are positively correlated with firms' operating leverage and economic, financial, and political uncertainties. After considering a battery of sensitivity analyses accounting for alternative approaches, risk, and macroeconomic indicators, our results remain robust.