What is the impact of wealth shocks on asset allocation?

I test the assumption of constant relative risk aversion using U.S. macroeconomic data and analyse the role of wealth shocks in generating transitory changes in asset portfolio composition. I show that the risky asset share exhibits cyclical behavior and it is significantly (and positively) affected by unexpected variation in wealth. Therefore, the empirical evidence suggests that risk aversion is counter-cyclical. I also find that the portfolio share of housing wealth falls when the agent is faced with a positive wealth shock, i.e. housing is a hedge against unfavorable wealth fluctuations. Finally, considering a variety of wealth definitions, the results show that: (i) wealth effects are stronger for direct holdings of risky assets than for indirect holdings, which highlights that investors do not typically trade some assets such as pension or mutual funds; (ii) although significant, wealth effects on asset allocation are mainly temporary as agents quickly rebalance the asset portfolio composition (i.e. there is weak evidence of inertia or slow adjustment in asset allocation); and (iii) changes in expected returns partially explain the variation in risky asset allocation.     

How do banks respond to shocks? A dynamic model of deposit-taking institutions

This paper proposes a dynamic model of the optimal choices of a bank that benefits from market power and takes into account the impact of the deposit generation process. Interbank lending/borrowing emerges as a buffer that assists the bank in smoothing intertemporal adjustments in interdependent loan and deposit choices. The bank smooths the impact of interest-rates shocks on its customers to minimize the adjustments over time of the stocks of deposits and loans. It does not, however, provide insurance against negative shocks of real origin that increase its expected default costs. The predictions of the model help to shed light on the available empirical evidence and to analyze some recent developments of the banking industry.     

How does the stock market react to the announcement of green policies?

We investigate the impact of 19 announcements of environmental regulation on the equities listed on the Australian Stock Exchange over the period 2005–2011. Using a well-established event study methodology, we assess whether these announcements are value constructive or destructive for equity investors. Additionally, we estimate the change in systematic risk following the announcements. Our results show that the Australian market was particularly sensitive to the carbon pollution reduction scheme (CPRS) announcement. A cumulative abnormal return of −31% was recorded in the alternative energy sector after Australia submitted its target range to the Copenhagen Accord. We observe that a move towards a greener nation has a mixed effect on abnormal returns with apparent sector-by-sector differences. Green policies appear to affect the long-term systematic risk of industries, leading to the diamond risk phenomenon.     

The impact of derivatives hedging on the stock market: Evidence from Taiwan’s covered warrants market

We examine the impact of derivatives hedging on the spot market using accurate hedge ratios of covered warrants traded in the Taiwan Stock Exchange (TWSE). Results present significant positive abnormal returns and trading volumes before the announcement of a warrant’s issuance, and the effect is stronger when the hedging demand is larger. Moreover, a significantly positive relationship exists between stock return volatility and the price elasticity of hedging demand. Finally, we observe a significantly negative price effect upon the underlying stock after a call warrant has expired in-the-money due to the liquidation of hedging portfolios.     

The impact of FIFA’s official announcements on the stock market of Qatar: The case of the 2022 World Cup

This study examines the impact of the FIFA’s official announcements on Doha Stock Exchange (DSE) of Qatar with respect to the 2022 World Cup. Using the abnormal unsystematic volatility method of Hilliard and Savickas (2002), our empirical findings reveal that the DSE market is sensitive to FIFA’s announcements about the 2022 World Cup. We find that four out of six FIFA announcements act as primary drivers to the DSE market volatility. The significant reactions of the DSE market to these announcements unveil the investors’ sentiments about the fate of the governmental and private expenditures on medium- and long-term projects undertaken in anticipation of hosting the 2022 World Cup. The results have some implications to investors in this newly emerging market related to this global sporting event. Any future announcements, good or bad, are likely to impact share prices in DSE market and trigger portfolio reallocation by local and international investors, leading to increased volatility.     

How do oil supply and demand shocks affect Asian stock markets?

This paper examines how oil market shocks affect Asian stock prices using the structural vector autoregression (VAR) approach. Global oil supply and demand shocks are disentangled using sign restrictions and elasticity bounds. Oil price increases are bad news only if the source is from oil-market-specific demand shifts. Northeast Asian stock markets are more resilient as investors’ expectation of continued economic growth outweighs the adverse effect of higher oil prices. Increased global economic activity also stimulates stock prices. Global oil shocks are more important in explaining variability in Asian stock returns compared with the United States, suggesting different dynamics in Asia.     

Does the stock market reward innovation? European stock index reaction to negative news during the global financial crisis

This study uses data on 27 European stock indices over the period from January 2007 to December 2012 to investigate the relationship between innovations and the market reaction to negative news during the financial crisis. We use the bivariate BEKK-GARCH approach to estimate time-varying betas and abnormal returns. We show that index prices of countries in the high (low) innovation groups experience significantly positive (negative) abnormal returns on and following the negative news announcement dates. We also find that index beta changes following the arrival of bad news is negatively associated with a country's innovativeness. This finding suggests that innovations promote economic stability and enhance investors' confidence in a country's ability to cope during difficult times. Thus, policy makers who are concerned with sustainable growth should encourage R&D investments by adopting effective policies and avoid unnecessary cuts in R&D expenditures even during times of crisis. A study of the pre-crisis period from January 2001 to December 2006, using the same methods, indicates that investors value innovation more during difficult times.     

How do commodity futures respond to macroeconomic news?

This paper investigates the impact of seventeen US macroeconomic announcements on two broad and representative commodity futures indices. Based on a large sample from 1989 to 2005, we show that the daily price response of the CRB and GSCI commodity futures indices to macroeconomic news is state-dependent. During recessions, news about higher (lower) inflation and real activity lead to positive (negative) adjustments of commodity futures prices. In contrast, we find no significant reactions during economic expansions. We attribute this asymmetric response to the state-dependent interpretation of macroeconomic news. Our findings are robust to several alternative business cycle definitions.

Why do companies delist voluntarily from the stock market?

We analyse the motives and market valuation of voluntarily delisting from the London Stock Exchange. We show that firms that delist voluntarily are likely to have come to the market to rebalance their leverage rather than to finance their growth opportunities. During their quotation life, their leverage and insider ownership remained very high, they did not raise equity capital, and their profitability, growth opportunities, and trading volume declined substantially. They also generate negative pre-event and announcement date excess returns. These results hold even after controlling for agency, asymmetric information, and liquidity effects, and suggest that firms delist voluntarily when they fail to benefit from listing. Overall, these firms destroyed shareholder value and they should not have come to the market.     

State uncertainty in stock markets: How big is the impact on the cost of equity?

We propose a novel Bayesian framework to incorporate uncertainty about the state of the market. Among others, one advantage of the framework is the ability to model a large collection of time-varying parameters simultaneously. When we apply the framework to estimate the cost of equity we find economically significant effects of state uncertainty. A state-independent pricing model overestimates the cost of equity by about 4% per annum for a utility firm and by as much as 3% for industries. We also observe that the expected return, volatility, risk loading, and pricing error all display state-dependent dynamics that coincide with the business cycle. More interestingly, the forecasted market and Fama–French factor risk premiums can predict the future real GDP growth rate even though the model does not use any macroeconomic variables, which suggests that the proposed Bayesian framework captures the state-dependent dynamics well.     

How do auditors respond to low annual report readability?

We show that increased audit effort is associated with lower annual report readability to compensate for a perceived increase in the risk of financial misstatement for United States (US) firms. In particular, we find that lower annual report readability is associated with longer audit delays and higher audit fees for Form 10-K for US auditors, suggesting that auditors spend more effort auditing clients when annual reports have lower readability. We also find that low readability increases the likelihood of auditors using more explanatory language in unqualified audit reports.     

Does futures trading increase stock market volatility? The case of the Nikkei stock index futures markets

We propose new tests to examine whether stock index futures affect stock market volatility. These tests decompose spot portfolio volatility into the cross-sectional dispersion and the average volatility of returns on the portfolio's constituent securities. Our tests show that for Nikkei stocks spot portfolio volatility increased and cross-sectional dispersion decreased compared with average volatility when Nikkei futures began trading on the Osaka Securities Exchange, but not on the Singapore International Monetary Exchange. For non-Nikkei stocks, no shift occurred when futures trading began on either exchange. These findings are consistent with the hypotheses that futures trading increases spot portfolio volatility but that there is no volatility “spillover” to stocks against which futures are not traded. However, the increase in volatility attributable to futures trading is small compared with volatility shifts induced by changes in broad economic factors.     

Are stock market crises contagious? The role of crisis definitions

Financial contagion studies generally examine whether co-movement between markets increases during a crisis. We use a flexible co-movement measure to examine how conclusions of such analyses depend on the sample chosen as the ‘crisis’. To this end, we analyse stock market co-movement during the 1997 Asian crisis and the 2007 global financial crisis for all possible source countries and for all possible time periods or extreme return quantiles. This way we account for the main crisis dating approaches adopted in the literature. Our results suggest there is no clear relationship between excess co-movement and commonly used crisis samples.     

How resilient is the German banking system to macroeconomic shocks?

Macroeconomic stress testing studies often rely on rather short sample periods due to the limited availability of banking data. They may fail to appropriately account for the cyclicality in the interaction between the banking system and macroeconomic developments. In this paper, we use a newly constructed data set on German banks’ income and loss statements over the past 39 years to model the interaction between the banking sector and the macroeconomy. Our VAR analysis indicates that the level of stress in the banking sector is strongly affected by monetary policy shocks. The results rationalize the active behavior of central banks observed during periods of financial market crises.     

Should individual investors avoid the stock market outside of January?

Recent studies suggest that there is no reward for bearing risk outside of January, implying that individuals should invest in common stocks only in January. The purpose of this study is to demonstrate that this conclusion is far too strong given existing empirical evidence. Our results suggest that inferences drawn from the evidence can be altered greatly through small changes in the way the empirical question is addressed. There is sufficient evidence to doubt the conclusion that individuals are not compensated for the risk of participating in the stock market outside of January.     

How do stocks react to extreme market events? Evidence from Brazil

This paper studies the short-term (21 trading days) behavior of Brazilian stocks in the event of extreme movements in the Brazilian market index. Using cumulative abnormal returns, we find that stocks tend to overreact after both positive and negative events, as well as global and domestic shocks. Interestingly, this behavior is particularly intense when the events are not clustered. This counterintuitive finding can be explained by the Contrast Hypothesis, since shocks during calm circumstances can be viewed by investors as more surprising. In fact, when we split events according to market volatility, we document a stronger overreaction when volatility is low.     

The market reaction to cross-listings: Does the destination market matter?

This paper examines (i) whether market reactions to cross-listings differ across destination markets and (ii) to what extent the following explanations for value creation around cross-listings can account for differences in market reactions across cross-listings on various destination markets: overcoming market segmentation, increased market liquidity, improved information disclosure, and better investor protection (“bonding”). We analyze 526 cross-listings from 44 different countries on eight major stock exchanges and document significant announcement returns of 1.3% on average for cross-listings on US exchanges, 1.1% on London Stock Exchange, 0.6% on exchanges in continental Europe, and 0.5% (not significant) on Tokyo Stock Exchange. We find evidence consistent with improved disclosure and bonding creating value for cross-listings on US exchanges, while overcoming segmentation and bonding are associated with higher announcement returns on the London Stock Exchange. The evidence is mixed for continental European exchanges and for Tokyo. Our results highlight the role of the destination market in value creation around cross-listings.     

Inflation responses to commodity price shocks – How and why do countries differ?

This paper relates the inflationary impact of commodity price shocks across countries to a broad range of structural characteristics and policy frameworks over the period 2001–2010, using several approaches. The analysis suggests that economies with higher food shares in CPI baskets, fuel intensities, and pre-existing inflation levels were more prone to experience sustained inflationary effects from commodity price shocks. Countries with more independent central banks and higher governance scores seem to have contained the impact of these shocks better. The effect of the presence of inflation targeting regimes, however, appears modest and not evident during the 2008 food price shock. The evidence suggests that trade openness, financial development, dollarization, and labor market flexibility do not significantly influence the way in which domestic inflation responds to international commodity price shocks.     

Discussion of “The impact of product market competition on the quantity and quality of voluntary disclosures”

Li (2010, this issue) examines how product market competition affects voluntary disclosure by firms. Using several competition proxies, she finds that both the competitive threat from potential entrants into an industry and from existing rivals affect the quantity and accuracy of voluntary profit and investment forecasts by firms in that industry. However, the study’s findings are inconclusive mainly because each competition proxy used can reflect both types of competitive threat. The focus of my discussion is to provide some comments and suggestions for future researchers to consider in examining how the nature of product market competition affects voluntary firm disclosure.     

Where are the sources of stock market mispricing and excess volatility?

Using a simple dividend model, we illustrate and synthesize the sources of stock market mispricing and excess volatility based upon two hypotheses—inflation illusion and heterogeneous beliefs. Our theoretical framework posits that equity mispricing arises when investors have subjective expectations about discount rates or dividend growth rates. We then analyze the sources of equity mispricing and market excess volatility under a VAR framework. Empirically, we find that both inflation illusion and heterogeneous beliefs explain equity mispricing. However, heterogeneous beliefs play a more important role in explaining stock mispricing in the long run. We also find that heterogeneous beliefs cause excess volatility, but inflation illusion does not. Therefore, dispersion in investors’ beliefs is a better explanation of stock market mispricing than the investors’ inability to properly discount future cash flows.