Unsophisticated Arbitrageurs and Market Efficiency: Overreacting to a History of Underreaction?

Prior research has documented that arbitrage activity significantly reduces or eliminates stock market anomalies. However, if anomalies arise due to unsophisticated investors’ behavioral biases, then these same biases can also apply to unsophisticated arbitrageurs and thereby disrupt the arbitrage process. Consistent with a disruption in the arbitrage process for the post‐earnings announcement drift anomaly, I document that the historically positive autocorrelation in firms’ earnings announcement news has become significantly negative for firms with active exchange‐traded options. For these easy‐to‐arbitrage firms, the firms in the highest decile of prior earnings announcement abnormal return (prior earnings surprise), on average, underperform the firms in the lowest decile by 1.59% (1.43%) at their next earnings announcement. Additional analyses are consistent with investors learning about the post‐earnings announcement drift anomaly and overcompensating. This study suggests that unsophisticated attempts to profit from a well‐known anomaly can significantly reverse a previously documented stock return pattern.     

中国A股市场存在品质溢价吗?

本文从价值投资的核心理念出发,基于盈利性、成长性、安全性、分红能力四个维度构建复合品质指标,并通过分析品质溢价在中国A股市场中的存在性来探讨价值投资的可行性和有效性。实证结果表明:(1)中国A股市场上存在显著为正的品质溢价,且品质溢价在控制其他相关变量后依然稳健存在;(2)高品质股票具有大市值、高成长特征,且品质溢价在大市值、高盈利的分组中更加显著;(3)品质溢价在不同时期下均能稳定存在;(4)中国A股市场上的品质溢价并非源于高风险承担,相反,由正向反馈偏好、博彩偏好、套利限制引起的错误定价有助于解释品质溢价。本文结论佐证了价值投资策略在中国A股市场的可行性和有效性,为培育良好投资理念、抑制过度投机、促进中国股市合理健康发展等提供了经验证据。     

上市公司综合盈利水平与股票收益

本文基于2000-2017年上市公司的财务及股票交易数据,研究了上市公司综合盈利水平与股票收益之间的关系。我们使用目前资产定价文献中较新的偏最小二乘法和组合预测法,从12个衡量公司盈利能力的指标中提取了一个测度上市公司综合盈利水平的指标。研究结果显示,上市公司综合盈利水平能够显著预测未来股票收益。使用单因子偏最小二乘法、取12个月斜率的平均值构造的综合盈利水平最有效,以其构建的多空对冲投资组合能产生15%的年平均收益,夏普比率达到0.75。与此对应,组合预测法提取的上市公司综合盈利水平的预测能力稍低,但依然显著。在控制了其他公司特征变量后,综合盈利水平对于股票收益的解释能力依然稳健。本文还从经济机制的角度出发,探讨了综合盈利水平对收益的预测来源。我们发现,上市公司综合盈利水平与股票预期回报的正向关系在投资摩擦更低的组中更高,而在错误定价程度更高的组通常更低。这些结果支持了基于投资摩擦的Q理论,而与行为金融的错误定价理论相悖。     

Information content of credit ratings in pricing of future earnings

This paper examines whether credit ratings convey information about the firm’s future earnings to the capital markets. Using the future earnings response coefficient methodology, we find that the current stock returns of rated firms reflect more future earnings than do the stock returns of non-rated firms. We also find that the market reflect more future earnings in current returns for higher-rated firms. In addition, we present evidence that returns impound future earnings to a greater extent after a ratings initiation or upgrade. We empirically eliminate the possibility that our findings are driven by earnings smoothing, market liquidity or omitted default risk factors associated with ratings. Our results are robust to controlling for potential omitted variables, endogeneity bias, loss versus profit firms, and serial correlation of error terms. Overall, the evidence suggests that credit ratings help disseminate private information to reduce information uncertainty about the firm’s future profitability among market participants.     

Oil price shocks,investor sentiment,and asset pricing anomalies in the oil and gas industry

This paper documents that stocks are not efficiently priced in the oil and gas industry. We find significant cross-sectional effects on stock returns from various firm characteristics in the oil and gas industry. Specifically, 13 out of 15 prominent capital market anomalies are robust in the oil and gas industry. Investor sentiment has significantly positive impact on 4 anomalies: composite equity issues, investment to assets, net stock issues, and value effect. Among the three oil shocks, we find that aggregate demand shocks have significantly impact on 6 anomalies: composite equity issues, financial distress, net stock issues, O-SCORE, return on assets, and idiosyncratic volatility. Our results are consistent with the view that high arbitrage costs and risks have significant deterring effects on arbitrage in the oil and gas industry. Our findings also have practical investment and policy implications for investors, firm managers, and policy makers alike.     

The IPO corporate social responsibility information disclosure: Does the stock market care?

We create textual information indices using corporate social responsibility (CSR) information extracted from IPO prospectuses in China. We use the indices to measure the issuers’ corporate social performance (CSP) and corporate environmental performance (CEP) and assess how the stock market reacts. We find that CSP disclosure is significantly related to the post‐market performance of the firm. Specifically, better CSP disclosure is correlated with higher post‐IPO listing holding period returns among firms that do not disclose donations or environmental expenditures, although the association does not hold for firms that make donations and environmental expenditures. In addition, institutional investors seem to care more about the CEP information for a firm than the CSP information.     

The profitability effect: Insight from a dynamic perspective

This study dynamically captures the trend changes in a firm's profitability over a period and explores the impact of the firm's profitability growth and acceleration on the cross-section of stock returns. The empirical evidence reveals a significantly positive dynamic profitability growth and an acceleration premium in the Chinese stock market, which are still robust in the out-of-sample test. The significantly positive predictive information contained in the dynamic profitability (DP) is not subsumed under the profitability level at a certain point in time. Moreover, the first-order DP growth has the strongest pricing power among the profitability strategies. We can obtain a higher excess return while simultaneously combining the dynamic and static profitability factors. In addition, this study provides ample evidence for the source of profitability anomalies, based on the behavioral finance framework. The findings under this framework indicate the substantial contribution of irrational mispricing, rather than rational pricing based on risk compensation or Q-theory, to the premium. This paper comprehensively explores the DP anomalies (fundamental characteristics of a firm), thus providing a novel perspective to better understand the pricing mechanisms of the emerging stock market and cultivate investors' philosophy on rational trading.     

Share pledges,tone of earnings communication conferences,and market reaction: evidence from China

We investigate how share pledging affects firms’ disclosures and influences investors in Chinese stock market. The tone of firm disclosures when there are shares pledged by controlling shareholders is more positive than that of firms without them. Considering tone inflation motivation and ability simultaneously, we find share pledge risk has an inverted U‐shaped relation with tone. Investors react positively to tone in short‐run windows, and firms with controlling shareholders’ pledges have higher stock returns for earnings communication conferences. We identify an inverted U‐shaped link between margin distance of controlling shareholders and stock returns for earnings communication conferences.     

Firm efficiency and stock returns: Australian evidence

We employ a stochastic frontier approach to estimate firm efficiency - the efficiency with which a firm converts its inputs into output. We find a negative relation between firm efficiency and the cross-section of stock returns (‘firm efficiency effect’) in the Australian stock market. The firm efficiency effect is robust after controlling for other firm characteristics and is more pronounced in stocks with high limits-to-arbitrage. However, we find no evidence that firm efficiency is a priced factor in the cross-section. Our findings suggest that investors misprice firm efficiency and arbitrage costs perpetuate its return predictability.     

Finding diamonds in the rough: Analysts’ selective following of loss‐reporting firms

Investors face greater difficulty valuing loss‐reporting than profit‐reporting firms: losses may be due to very different reasons (e.g., poor operating performance or investments in intangibles, and financial accounting information is of more limited use for valuing loss‐making firms than profit‐making firms. Because of increased uncertainty about loss firms’ future financial and business viability, we hypothesize that financial analysts will be more selective when choosing to follow loss firms than profit firms, with the result that “abnormal” analyst following will be more informative to investors regarding the future performance of loss firms than profit firms. Consistent with this prediction, we find that abnormal analyst coverage is useful for predicting firms’ future prospects, and is more strongly associated with future performance (stock returns and ROA) for loss firms than for profit firms. The market, however, does not seem to use this useful information when pricing loss firms: for loss firms a portfolio investment strategy based upon abnormal analyst following can generate positive excess returns over 1‐ to 3‐year holding periods. These results are stronger for persistent‐loss firms than for occasional‐loss firms. We conclude that abnormal analyst following contains useful information about firms’ future prospects, and even more so for loss firms than for profit firms.     

The roles of past returns and firm fundamentals in driving US stock price movements

This paper provides new empirical evidence that incorporating past stock returns from different time horizons can enhance the ability of firm fundamentals to better explain stock price movements but this benefit dissipates under uncertainty. We apply both OLS and state-space modeling to US firms' stock price movements over the period from 1999 to 2012 to compare the roles of the two main types of information typically used by equity investors. Empirical results reveal the importance of firm fundamentals over longer term horizons for particularly, small-cap stocks with greater information uncertainty. Furthermore, when market uncertainty is high, fundamentals unambiguously dominate in driving stock price movements of smaller sized firms indicating that uncertainty at the firm and market level both create attention bias on firm fundamentals.     

Big is brilliant: Understanding the Chinese size effect through profitability shocks

Taking a dynamic view, this paper assesses the extent to which profitability shocks affect the size premium in the Chinese market. In the short run, there is a significant U-shaped relationship between size and profitability shocks; i.e., both small and large firms experience large and (in most cases) positive profitability shocks, while firms with medium market capitalizations display small profitability shocks. In the long run, profitability shocks in large firms remain large and stable, while profitability shocks in small firms decrease sharply. Adjusting for profitability shocks increases the returns of small firms but decreases the returns of large firms, indicating that large and positive profitability shocks in small firms cannot bring investors sizable returns even though the correlation between profitability shocks and returns is positive. Mismatches between profitability shocks and the per-unit return impact of such shocks (e.g., when firms experience positive shocks but the market reacts to these shocks irrationally) can help explain this phenomenon. Our work reveals that in terms of fundamentals, large firms are very worthy of investment owing to their superb fundamental performance, i.e., large and persistent profitability shocks.     

A note on foreigners’ trading and price effects across firms

We study the investment behavior of foreign investors in association with an equity market liberalization, and find a strong link between foreigners’ trading and local market returns. In the period following the liberalization, net purchases by foreign investors induced a permanent increase in stock prices, suggesting that local firms reduced their cost of equity capital. We also find a strong link between a firm’s fraction of foreign ownership and the magnitude of the cost reduction. Foreign investors seem to prefer large and well-known firms, and these firms realize the largest reduction in capital cost. Furthermore, our analysis suggests that foreigners increase their net holding in firms that have recently performed well. Analyzing foreigners’ performance, we find very little evidence of informed trading, suggesting that risk sharing is the most plausible explanation for the reduction of the cost of equity capital.     

WHAT'S IN A NAME? A CAUTIONARY TALE OF PROFITABILITY ANOMALIES AND LIMITS TO ARBITRAGE

The recent literature investigating profitability anomalies defines profitability in various ways (i.e., gross, operating, and cash based). We show that limits to arbitrage are associated with returns of gross and cash-based operating profitability anomalies, suggesting mispricing. In contrast, returns from the operating profitability strategy have no relation with barriers to arbitrage and exhibit no evidence of mispricing. Additionally, we show that the differential effects of limited arbitrage-related mispricing of gross and cash-based operating profitability anomalies are attributable to their respective correlations with selling, general, and administrative (SG&A) expense and accruals anomalies. We find that SG&A return predictability, like that of accruals, is related to limits to arbitrage. These findings suggest that investors and researchers should proceed with caution when searching for return predictability by redefining profitability measures.     

中国公募基金挖掘了股票市场异象吗？

公募基金是我国重要的机构投资者之一,分析其投资逻辑对理解机构投资者行为和公募基金的选择至关重要。基于2005年至2019年主动管理偏股型开放式基金数据,本文检验了公募基金对A股市场87个异象因子的挖掘。为解决因子维度过大问题,本文采用非参方法从87个异象因子中提取有效信息的综合指标A-Score,并根据基金持仓构建基金的异象投资指标AIM(Anomalies Investing Measure)。结果显示:(1)中国公募基金挖掘了市场异象;(2)利用AIM可以选择表现更好的基金,并能获得0.45%的月度多空组合收益;(3)基金经理的选股能力、风格选择能力和风控能力是其挖掘异象收益的主要来源;(4)异象挖掘可以为基金带来长期资金流,同时也缓和了市场的错误定价。     

How are political connections valued in China? Evidence from market reaction to CEO succession

Using a sample of listed Chinese firms between 2000 and 2010, the paper analyzes the stock market reaction to CEO succession. We document significantly positive cumulative abnormal returns when CEO succession is accompanied with increased political connections. We also show that the market reaction to political connections is significantly stronger for external successors and for poorly performing firms, while it is significantly weaker for firms in high-tech industries and firms located in more developed regions. Finally we find that political connections are valued significantly less in state owned enterprises than in privately controlled firms. Our findings suggest that Chinese investors do value political connections, and such valuation is conditioned by successor origin, prior firm performance, industry, region, and ownership structure.     

Internal Governance Does Matter to Equity Returns but Much More So During “Flights to Quality”

Although few doubt that good internal governance helps firms perform better, the statistical evidence is actually mixed because the positive effects of good corporate governance matters much more so at some times than others. The statistical link is strongest during “flights to quality,” when market sentiment turns bearish and pessimistic but weakens for long periods of time during bull markets and low market volatility. Using more than ten years' evidence from Australian firms, the authors show that internal governance is related to both firm value and performance and that firms with stronger governance are less risky, generate higher equity returns and perform significantly better during market downturns. When risk aversion is high, demand for well‐governed firms increases and investors discount the value of firms with potential agency conflicts. This time‐varying relationship between internal governance and returns may explain both the limited explanatory power of governance on firm value and the mixed empirical evidence reported in previous studies. Firms with strong internal governance do earn significantly higher stock returns compared with firms with weak governance; but that also means that the value of governance is not fully incorporated into prices, thereby explaining the limited explanatory power of governance on firm value.     

Short term persistence in mutual fund market timing and stock selection abilities

Using daily return data from 448 actively managed mutual funds over a recent 9-year period, we look for persistence, over two consecutive quarters, in the ability of funds to select individual stocks and time the market. That is, we decompose overall fund performance into excess returns resulting from stock selection and timing abilities and we separately test for persistence in each ability. We find persistence in the ability to time the market only among well performing funds and in the ability to select stocks only among the very best and worst performers. The existing literature patterns appear only when funds are ranked by their overall performance, which includes stock selection, market timing and fees. With respect to overall performance, there is persistence among most poorly performing and only the top well performing funds. Furthermore, the profitability of a winner-picking strategy depends on the rebalancing frequency and potentially the size of the investment. Small investors cannot profit, whereas large investors can take advantage of the class-A share fee structure and realize positive abnormal returns by annually rebalancing their portfolios.     

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.     

Mispricing firm-level productivity

This paper provides a mispricing-based explanation for the negative relation between firm-level productivity and stock returns. Investors appear to underprice unproductive firms and overprice productive firms. We find evidence consistent with the speculative overpricing of productive firms driven by investor sentiment and short sale constraints. Investors erroneously extrapolate past productivity growth and its associated operating performance and stock returns, despite their subsequent reversals. Such mispricing is perpetuated because of limits to arbitrage and is partially corrected around earnings announcements when investors are surprised by unexpected earnings news. Decomposition analysis indicates that extrapolative mispricing and limits to arbitrage explain most of the return predictability of firm-level productivity.