The Going-Public Decision and the Development of Financial Markets

This paper explores the linkages between stock price efficiency, the choice between private and public financing, and the development of capital markets in emerging economies. Generally, the advantage of public financing is high if costly information is diverse and cheap to acquire, and if investors receive valuable information without cost. The value of public firms generally depends on public market size, which implies that there can be a positive externality associated with going public, so that an inferior equilibrium can exist where too few firms go public. The model is consistent with empirical observations on financial market development.     

Corporate social responsibility and stock split

This study examines whether socially responsible companies are likely to conduct a stock split. We argue that these companies, compared to their counterparts, could use their strong corporate social responsibility (CSR) performance to reduce information asymmetry with shareholders, and therefore, are less likely to rely on stock splits to signal their future growth potentials. We find empirical evidence to support our hypothesis and investigate the reasons for the lower frequency of stock splits among CSR oriented firms. We find that more socially responsible firms experience a smaller increase in trading volume and a greater increase in bid-ask spread following a stock split than less socially responsible firms. Furthermore, our study finds that, when more socially responsible firms decide to conduct a stock split, they attract a greater proportion of institutional investors with long-term investment horizons.

     

Trading externalities and new equity issues in emerging markets

The volatility in emerging market finance over the last decade has highlighted the importance of developing equity exchanges to enhance risk sharing between international investors. Debt markets do not allow for as much risk sharing. Theoretically, stock market development involves trading externalities, as the decision by one firm to list provides a positive spillover for other firms considering an initial offering. This theory thus has a clear policy implication in terms of deliberate government action to promote stock market development. This paper tests empirically for the existence of trading externalities in developing countries, and finds evidence of such externalities for Latin American, but not Asian, stock markets.     

Idiosyncratic risk and the cross-section of stock returns: Merton (1987) meets Miller (1977)

Merton [1987. A simple model of capital market equilibrium with incomplete information. Journal of Finance 42, 483–510] predicts that idiosyncratic risk should be priced when investors hold sub-optimally diversified portfolios, and cross-sectional stock returns should be positively related to their idiosyncratic risk. However, the literature generally finds a negative relationship between returns and idiosyncratic risk, which is more consistent with Miller's [1977. Risk, uncertainty, and divergence of opinion. Journal of Finance 32, 1151–1168] analysis of asset pricing under short-sale constraints. We examine the cross-sectional effects of idiosyncratic risk while explicitly recognizing the confounding effects that dispersion of beliefs and short-sale constraints produce in the Merton framework. We find strong support for Merton's [1987. A simple model of capital market equilibrium with incomplete information. Journal of Finance 42, 483–510] model among stocks that have low levels of investor recognition and for which short selling is limited. For these stocks, the relation between idiosyncratic risk and expected returns is positive, as predicted by Merton [1987. A simple model of capital market equilibrium with incomplete information. Journal of Finance 42, 483–510].     

Profitability,Value, and Stock Returns in Production‐Based Asset Pricing without Frictions

In a production‐based asset pricing model without adjustment costs and with decreasing returns to scale following Brock (1982), stock returns at the firm level are determined by profitability, the book‐to‐market ratio, and the change in future profitability prospects. Although firms with low book‐to‐market ratios are normally more profitable and profitable firms are predicted to have higher returns, the stylized fact that book‐to‐market ratios positively forecast returns still holds theoretically, but with specific predicted exceptions. These implications are confirmed empirically.     

Real Stock Returns and Inflation

This paper develops the relation between the real rate of return on the stock market and changes in the price level using a multiperiod economy with production. The observed relation between real ex post stock returns and inflation is shown to be consistent with equilibrium in an economy with rational investors. The relation between expected real returns and expected inflation is shown to depend on the form of the economy's production function and on the form of investor preferences. When the production function exhibits stochastic constant returns to scale, the model explains the negative relation between expected real returns and expected inflation which has frequently been observed in empirical studies.     

Preference heterogeneity and asset prices: An exact solution

We introduce a general equilibrium model of a multi-agent, pure-exchange economy and find a set of conditions that enable us to obtain explicit closed-form solutions to the equilibrium interest rate, stock price, risk premium and stock market volatility when investors have heterogenous risk aversions. Because the market is dynamically complete, full risk sharing obtains and a representative agent can be constructed, though the risk aversion of this agent fluctuates over time with the state of the economy, as the relative wealth distribution of the individual investors changes. We show that preference heterogeneity can cause asset prices to be significantly more volatile than the underlying dividends and that it can lead to leverage-like effects in volatility, in the sense that volatility increases after stock-market declines.     

STOCK MARKET REACTION TO ETHICAL INITIATIVES OF DEFENSE CONTRACTORS: THEORY AND EVIDENCE

This paper offers an Investor Decision Framework (IDF) to describe and measure investor behavior toward social responsibility information. This framework seeks to explain how investors perceive the effects of social responsibility information on firm value. The formation in 1986 by 32 major defense contractors of the Defense Industries Initiative (DII) provides an ideal example to assess stock market reaction to an ethical initiative. The performance of the DII firms was compared with that of a control group of non-DII defense firms, which did not sign the agreement, in order to measure and determine the extent to which the market placed substance on the DII as a public commitment to ethics. We initially posited that the DII firms stock price would move in a significantly positive direction. However, when our analysis revealed a significant negative impact not only on DII, but also on non-DII defense stock prices, we were forced to reject thisa priorihypothesis. The market interpreted this ethical initiative as (i) a precursor of future sanctions towards firms engaged in defense contracting or (ii) as a penalty for social irresponsibility imposed by socially conscious investors. Either way, it would have a negative impact upon future cash flows.     

A Strategic Asset Pricing Model for Relative Performance Concern

We propose a strategic asset pricing model for the relative performance concern with heterogeneous beliefs in the framework of Nash equilibrium. In our model, the presence of heterogeneous beliefs generates the upward pressure on the stock market volatility and gives rise to the separation of agents’ perceived Sharpe ratios. We show that if one of the agents temporarily wins the market, the presence of relative performance concern will reduce the impacts of the winner and make the investors who have been edged out of the market more inclined to return. Besides, the sufficiently strong concern of relative performance will bring investors the extreme aversion to losing and get them to trade similarly.     

Does investor recognition predict returns?

Merton [1987. A simple model of capital market equilibrium with incomplete information. Journal of Finance 42, 483–510] shows that stocks about which not all investors are informed should yield a return premium. This premium depends on the shadow cost of incomplete information which in turn depends on the shareholder base, relative market size, and idiosyncratic risk. Utilizing a comprehensive database of Swedish shareholdings, we demonstrate that stock returns are positively related to the shadow cost. We also find that the shareholder base is negatively related to returns when controlling for size and idiosyncratic risk. Zero-cost portfolios based on the shadow cost/shareholder base yield substantial trading profits that are never positively correlated with the market and are only modestly explained by the four-factor model.     

Income Redistribution,Consumer Credit,and Keeping Up with the Riches

In this study, we set up a dynamic stochastic general equilibrium (DSGE) model with upward looking consumption comparison and show that consumption externalities are an important driver of consumer credit dynamics. Our model economy is populated by two different household types. Investors, who hold the economy's capital stock, own the firms and supply credit, and workers, who supply labor and demand credit to finance consumption. Furthermore, workers condition their consumption choice on the investors' level of consumption. We estimate the model and find a significant keeping up mechanism by matching business cycle statistics. In reproducing credit moments, our proposed model significantly outperforms a model version in which we abstract from consumption externalities.     

信息不对称、过度自信与股价变动

信息传导的非同步和投资者情绪变化是股票市场的两个典型特征,前者会引发投资者之间出现信息不对称问题,后者主要体现为投资者过度自信,两者共同作用影响股票价格变动。本文将信息不对称和投资者过度自信情绪置于同一个分析框架,建立两阶段动态序贯定价理论模型研究现实市场上信息传导过程中股价变动的内在机制。结果表明:(1)面临新信息的进入,投资者对股票收益预期的调整与均衡价格之间具有正相关关系;(2)面临有利消息时,过度自信投资者比例越大,股票的均衡价格越高,投资收益将越低;面临不利消息时则相反;(3)随着过度自信投资者比例以及过度自信程度升高,市场风险溢价将下降;(4)投资者群体在信息传导过程中出现分化,对股价变动形成异质信念,未获取信息和获取信息但未出现过度自信的投资者认为股价被高估,获取信息且出现过度自信的投资者认为价格被低估,促使更多的交易,引发市场成交量和股价变动;(5)过度自信投资者比例与过度自信程度提高均会对市场效率产生正向影响,而对市场深度具有负向效应。最后,基于理论结果对非对称性和持续性等典型的市场波动性特征进行解释。     

Credit derivatives and stock return synchronicity

The role of credit default swaps (CDS) in the 2008 financial crisis has been widely debated among regulators, investors, and researchers. While CDS were blamed for destabilizing the financial system, they remain effective tools for hedging credit risk, especially for major banks, and produce positive informational externalities to market participants. This paper examines whether the introduction of CDS enhances the amount of firm-specific information impounded in stock prices. We use stock return synchronicity to measure the amount of firm-specific information reflected in stock prices, with more firm-specific information being associated with a lower level of synchronicity. We find that a firm’s stock return synchronicity decreases after the commencement of CDS trading. This finding is robust to different model specifications, synchronicity measures, and endogeneity controlling methodologies. Furthermore, the decrease in stock return synchronicity is more pronounced for CDS firms with higher credit risk. Overall, our evidence supports the positive role of CDS in improving informativeness of stock prices.     

A Labor Capital Asset Pricing Model

We show that labor search frictions are an important determinant of the cross‐section of equity returns. Empirically, we find that firms with low loadings on labor market tightness outperform firms with high loadings by 6% annually. We propose a partial equilibrium labor market model in which heterogeneous firms make dynamic employment decisions under labor search frictions. In the model, loadings on labor market tightness proxy for priced time‐variation in the efficiency of the aggregate matching technology. Firms with low loadings are more exposed to adverse matching efficiency shocks and require higher expected stock returns.     

Model Uncertainty, Limited Market Participation, and Asset Prices

We demonstrate that limited participation can arise endogenouslyin the presence of model uncertainty and heterogeneous uncertainty-averseinvestors. When uncertainty dispersion among investors is small,full participation prevails in equilibrium. Equity premium isrelated to the average uncertainty among investors and a conglomeratetrades at a price equal to the sum of its single-segment components.When uncertainty dispersion is large, investors with high uncertaintychoose not to participate in the stock market, resulting inlimited market participation. When limited participation occurs,participation rate and equity premium can decrease in uncertaintydispersion and a conglomerate trades at a discount.     

Valuation implications of socially responsible tax avoidance: Evidence from the electricity industry

Prior literature suggests that firms may bear reputational costs associated with corporate tax avoidance, which could in turn reduce the net present value of firms’ tax planning strategies. However, these studies do not consider the fact that firms may have opportunities to avoid tax in socially responsible ways. We investigate the equity valuation implications of one form of socially responsible tax avoidance: claiming the renewable electricity production tax credit (PTC). We predict and find that investors more positively value tax savings generated from PTCs compared to other forms of corporate tax avoidance, consistent with the notion that socially responsible tax avoidance should not subject firms to reputational costs. Additionally, consistent with the role that CSR can play in enhancing a firm’s reputational capital, we find evidence of a spillover effect in which investors more positively value other sources of tax avoidance to the extent the firm also reduces its taxes in a socially responsible way. Our results demonstrate the importance for managers to consider socially responsible tax avoidance as a component of a firm’s tax planning portfolio and for policymakers to recognize the appeal of socially responsible tax strategies as the reputational consequences of tax avoidance become more prominent.     

Political institutions,stock market liquidity and firm dividend policy: Some international evidence

In this cross-country study, we draw on the dividend liquidity hypothesis and the political economy literature to examine whether political institutions affect the relationship between stock market liquidity and a firm’s dividend policy. In countries with weak political institutions, we expect that investors are less able to demand higher dividends for stocks with low liquidity. Using a sample of 52 countries, we show that the negative association between stock market liquidity and dividends is more pronounced in countries with sound political institutions, consistent with the “outcome” model of dividends. These results are stronger in countries with better legal institutions and weaker for firms with financial constraints.     

The Effect of Socially Responsible Investing on Portfolio Performance

More and more investors apply socially responsible screens when building their stock portfolios. This raises the question whether these investors can increase their performance by incorporating such screens into their investment process. To answer this question we implement a simple trading strategy based on socially responsible ratings from the KLD Research & Analytics: Buy stocks with high socially responsible ratings and sell stocks with low socially responsible ratings. We find that this strategy leads to high abnormal returns of up to 8.7% per year. The maximum abnormal returns are reached when investors employ the best‐in‐class screening approach, use a combination of several socially responsible screens at the same time, and restrict themselves to stocks with extreme socially responsible ratings. The abnormal returns remain significant even after taking into account reasonable transaction costs.     

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.     

The Timing and Stock Selection Abilities of Bank Funds: Evidence Based on Meta-Analysis

This study investigates the risk-adjusted investment performance of the equity portfolios of bank trust departments, over the 1975–1992 period, attributable to their micro stock selection and macro market timing abilities. This paper first employs a widely known parametric statistical procedure developed by Henriksson and Merton to test jointly for the presence of either superior stock selection or market timing abilities. The paper then utilizes an alternative technique, called meta-analysis, to further examine the regression results obtained under the Henriksson–Merton model. The meta-analysis essentially eliminates such study artifacts as sampling and measurement errors through cumulation of results across studies. The findings of the joint test, based on the Henriksson–Merton model, do not support either superior stock selection abilities or market timing skills on the part of bank equity fund managers: selectivity measures are positive and timing measures are generally negative, but both measures are statistically insignificant. In contrast, the evidence based on the meta-analysis suggest that the managers of bank equity investment funds possess superior stock selection abilities and somewhat negative timing skills. Therefore, the results of this study suggest that, even though bank trust departments, like other categories of institutional investors, are unable to outperform a passive buy and hold investment strategy through timing the equity market, they are able to improve their investment performance through superior stock selection abilities.