The open society assesses its enemies: shocks, disasters and terrorist attacks

This paper conducts a systematic investigation of the incidence and economic costs of terrorist attacks at the country level. We use newly assembled datasets on terrorist attacks, natural disasters and currency crises to answer three different questions: what are the determinants of terrorism; is there an output cost following a terrorist attack; and is that cost larger or smaller in the case of democracies. We find that rich countries are the most prone to suffer attacks while democracies are, if anything, less vulnerable than other countries. The cost to output of a terrorist attack is quantitatively small and closely associated with the occurrence of an event rather than the number of casualties. Finally, we find robust evidence that a terrorist attack imposes a lower output cost the more democratic a country is.     

Intra-Industry Reactions to Stock Split Announcements

We examine whether favorable information conveyed by stock split announcements transfers to nonsplitting firms within the same industry. On average, nonsplitting firms' shareholders experience positive and significant abnormal returns at the stock split announcements of their industry counterparts. In addition, industrywide and firm-specific characteristics are important determinants in explaining nonsplitting firms' stock returns. These firms' earnings increase significantly, and the earnings changes are positively related to the stock price reactions. Finally, we find no evidence that investors revise the value of nonsplitting firms because they anticipate a decline in earnings volatility.     

Terrorist attacks and corporate investment: The beneficial value of CEO overconfidence

This study examines whether terrorist attacks influence corporate investments and firm value. We expect that overconfident CEOs can mitigate the underinvestment problem caused by terrorist attacks because they overestimate the returns on investment. Using measures of terrorist attack proximity in the U.S., we find that firms with non-overconfident CEOs significantly decrease their investment growth when terrorist attacks affect them, while firms with overconfident CEOs do not. Consequently, the impact of terrorist attacks on firm value varies between firms with overconfident and non-overconfident CEOs. Overall, this study suggests that CEO overconfidence can benefit shareholder value under certain conditions, such as terrorist attacks.     

Changes in equity returns and volatility across different Australian industries following the recent terrorist attacks

We investigate the impact of five recent terrorist attacks on equities listed on the Australian Stock Exchange. Following the Global Industry Classification Standard, we analyse how these events affect the different sectors in Australia. Using parametric and non-parametric tests, we investigate the relationship between stock returns for equities listed in these sectors and terrorist attacks. We report significant short term negative abnormal returns around the September 11 attacks and to a lesser extent, the Madrid and London bombings. Our evidence shows a weak positive equity response to the Bali bombing, and no response from the Mumbai attack in the Australian market. We also document negative industry abnormal returns as high as 37.30% on the day in the Utilities sector. Our findings show that systematic risk of certain sectors increased after the events of September 11 but remained unchanged for the other attacks.     

Terrorism and Stock Market Sentiment

This paper examines the effects of terrorism on stock market sentiment by focusing on the behavior of expected probability density functions of the FTSE 100 index around terrorist attacks. We find that terrorism has a strong adverse impact on stock market sentiment. In particular, terrorist attacks are found to cause a pronounced downward shift in the expected value of the FTSE 100 index and a significant increase in stock market uncertainty. Furthermore, our results show that the expected FTSE 100 probability densities became significantly more negatively skewed and fat‐tailed in the immediate aftermath of terrorist acts.     

The impact of the introduction of the Euro on foreign exchange rate risk exposures

This paper tests whether significant changes in stock return volatility, market risk, and foreign exchange rate risk exposures took place around the launch of the Euro in 1999. The experiment analyzes weekly returns for 3220 nonfinancial firms from 18 European countries, the United States, and Japan. We find that though the Euro's launch was associated with an increase in total stock return volatility, significant reductions in market risk exposures arose for nonfinancial firms both in and outside of Europe. We show that the reductions in market risk were concentrated in firms domiciled in the Euro area and in non-Euro firms with a high fraction of foreign sales or assets in Europe. The Euro's introduction led to a net absolute decrease in the foreign exchange rate exposure of nonfinancial firms, but these changes are statistically and economically small. We interpret our findings in the context of existing theories of exchange rate risk management.     

Resilience of Environmental and Social Stocks under Stress: Lessons from the COVID-19 Pandemic

This paper examines whether environmental and social (ES) activities affect the resiliency of firms during the COVID-19 crisis. We study a sample of 330 firms operating in five developed countries: Canada, France, Japan, the UK and the US. Our analysis shows that US firms with a high ES ranking experienced a significantly lower stock price range volatility during the Covid stock market rundown of February-March 2020. Such findings also hold for Japanese firms but only later on after the introduction of government support. In terms of returns, compared to their peers with a low ES ranking, Japanese and UK stock prices with a high ES ranking suffered more during and after the market rundown. For other countries, we do not find significant differences in stock price behavior based on ES ratings. Our findings suggest that engaging with ES activities is not associated with a better or worse performance during crisis times, which has important implications for investors and managers.     

Stock return volatility,operating performance and stock returns: International evidence on drivers of the ‘low volatility’ anomaly

This study highlights the link between stock return volatility, operating performance, and stock returns. Prior studies suggest that there is a ‘low volatility’ anomaly, where firms with a low stock return volatility out-perform firms with a high stock return volatility. This paper confirms that low volatility stocks earn higher returns than high volatility stocks in emerging markets and developed markets outside of North America. We also show that low volatility stocks have higher operating returns and this might explain why low volatility stocks earn higher stock returns. These results provide a partial explanation for the ‘low volatility effect’ that is independent from the existence of market anomalies or per se inefficiencies that might otherwise drive a low volatility effect. We emphasize the importance of controlling for stock return volatility when analyzing operating performance and stock performance.     

Earnings volatility,ambiguity, and crisis-period stock returns

Financial crises are marked by substantial increases in ambiguity where prices appear to decouple from fundamentals. Consistent with ambiguity-based asset pricing theories, we find that ambiguity concerns are more severe for firms with higher earnings volatility, causing investors to demand a higher ambiguity premium for such firms. While there is no relation between earnings volatility and stock returns under normal conditions, there is a significant negative relation between crisis-period stock returns and prior earnings volatility. The effect is stronger in firms with low institutional ownership and low analyst following, consistent with ambiguity concerns being greatest amongst firms with unsophisticated investors.     

The pricing of currency risk in Japan

Previous work on the pricing of exchange-rate risk has primarily focused on US firms and, surprisingly, found stock returns were not significantly affected by exchange-rate fluctuations. In this paper we conduct an in-depth investigation that examines whether exchange-rate risk is priced in the equity market of Japan using an intertemporal asset pricing testing procedure that allows risk premia to change through time in response to changes in macroeconomic conditions. Our multiperiod asset pricing tests show that the foreign exchange-rate risk premium is a significant component of Japanese stock returns. Specifically, the results suggest that currency-risk exposure commands a significant risk premium for multinationals and high-exporting Japanese firms. The currency-risk factor is found to be less influential in explaining the behavior of average returns for low-exporting and domestic firms. However, it is shown to exhibit large return volatility that is likely to be perceived by investors, who wish to control portfolio risk, as an important underlying source of risk. Furthermore, Japanese stock returns are found to be related to the relative distress and size factors above and beyond the covariation explained by the currency-risk factor.     

What are the risks when investing in thin emerging equity markets: Evidence from the Arab world

This study attempts to identify the risks involved when investing in five emerging Arab capital markets. We first find that a constant beta is not a good proxy for risk in these thinly traded emerging markets. However, firms’ fundamentals and country risk rating factors prove significant in explaining the cross-sections of stock returns. The paper provides three important contributions to the literature on asset pricing in emerging capital markets: (i) we show how country risk ratings can be aggregated into a country risk factor; (ii) we add to a growing literature suggesting that, in markets other than the US, it is possible to find large and growth stocks to be riskier than small and value stocks; (iii) we determine that despite economic, financial and political reforms, issues related to financial transparency and political instability are still powerful obstacles to investments in these nascent emerging markets.     

Volatility,the Macroeconomy,and Asset Prices

How important are volatility fluctuations for asset prices and the macroeconomy? We find that an increase in macroeconomic volatility is associated with an increase in discount rates and a decline in consumption. We develop a framework in which cash flow, discount rate, and volatility risks determine risk premia and show that volatility plays a significant role in explaining the joint dynamics of returns to human capital and equity. Volatility risk carries a sizable positive risk premium and helps account for the cross section of expected returns. Our evidence demonstrates that volatility is important for understanding expected returns and macroeconomic fluctuations.     

The Determinants of Conditional Autocorrelation in Stock Returns

We investigate whether return volatility, trading volume, return asymmetry, business cycles, and day‐of‐the‐week are potential determinants of conditional autocorrelation in stock returns. Our primary focus is on the role of feedback trading and the interplay of return volatility. We present empirical evidence using conditional autocorrelation estimates generated from multivariate generalized autoregressive conditional heteroskedasticity (M‐GARCH) models for individual U.S. stock and index data. In addition to return volatility, we find that trading volume and market returns are important in explaining the time‐varying patterns of return autocorrelation.     

Taxes,dividend yields and returns in the UK equity market

The higher rate of taxation on dividend income relative to capital gains has been offered as an explanation for the positive relation between stock returns and dividend yields among US firms. In the UK the relative tax rates are the reverse of those in the US. Thus, UK data provides an independent test of the tax-based approach to explaining the relation between stock returns and dividend yields. We find that high yielding stocks earn positive risk adjusted returns, whereas low yielding stocks earn negative risk adjusted returns. We also detect evidence of non-linearity in the performance of zero-dividend stocks. Controlling for firm size, seasonality and market risk we find a significant positive relation between dividend yields and returns. We conclude that the evidence is inconsistent with a tax-based explanation.     

Empirical relationship between macroeconomic volatility and stock returns: Evidence from Latin American markets

Emerging market stock returns have been characterized as having higher volatility than returns in the more developed markets. But previous studies give little attention to the fundamentals driving the reported levels of volatility. This paper investigates whether dynamics in key macroeconomic indicators like exchange rates, interest rates, industrial production and money supply in four Latin American countries significantly explain market returns. The MSCI world index and the U.S. 3-month T-bill yield are also included to proxy the effects of global variables. Using a six-variable vector autoregressive (VAR) model, the study finds that the global factors are consistently significant in explaining returns in all the markets. The country variables are found to impact the markets at varying significance and magnitudes. These findings may have important implications for decision-making by investors and national policymakers.     

The Comovement of US and UK Stock Markets

US and UK stock returns are highly positively correlated over the period 1918–99. Using VAR‐based variance decompositions, we investigate the nature of this comovement. Excess return innovations are decomposed into news about future dividends, real interest rates, and excess returns. We find that the latter news component is the most important in explaining stock return volatility in both the USA and the UK and that stock return news is highly correlated across countries. This is evidence against Beltratti and Shiller's (1993) finding that the comovement of US and UK stock markets can be explained in terms of a simple present value model. We interpret the comovement as indicating that equity premia in the two countries are hit by common real shocks.     

Striking the implied volatility of US drone companies

This study analyzes the impact of drone strikes on the implied volatility of US drone companies. We find evidence of an overall increase in the implied volatility the day after the strike. We subset drone strikes according to countries targeted and US president in office, finding a more significant impact for strikes in Afghanistan and Pakistan, and under the Bush or Obama’s administration. We find that drone strikes are also associated with next day decreasing stock returns of the drone companies. A possible increasing geopolitical risk concern and resiliency rationale may explain our findings.     

CEO risk incentives and firm performance following R&D increases

In this study we analyze how CEO risk incentives affect the efficiency of research and development (R&D) investments. We examine a sample of 843 cases in which firms increase their R&D investments by an economically significant amount over the period of 1995–2006. We find that firms with higher sensitivity of CEO compensation portfolio value to stock volatility (vega) are more likely to have large increases in R&D investments. More importantly, we find that high-vega firms experience lower abnormal stock returns and lower operating performance compared to their low-vega counterparts following the R&D increases. Our main results hold in a variety of robustness tests. The results are consistent with the conjecture that high-vega compensation portfolios may induce managers to overinvest in inefficient R&D projects and therefore hurt firm performance.     

Modeling Time-Varying Volatility and Expected Returns: Evidence from the GCC and MENA Regions

The aim of this study is to investigate empirically the underlying nexus of stock market returns and volatility in the Gulf Cooperation Council (GCC) countries and Middle East and North Africa (MENA) region by using the GARCH-M model. We find that volatility is time-varying in all countries, which indicates substantial variation in the degree of risk across time. However, we do not find empirical support that this time-varying volatility significantly explains expected returns, except in the case of Kuwait, United Arab Emirates, and the MENA region portfolio. Our findings show that stock return volatility is negatively correlated with stock returns in these three markets under the assumption of investor risk aversion. This lends some support to the hypothesis of a volatility-driven negative relationship in the literature. The policy implications of our results are discussed.     

New ESG rating drivers in the cross-section of European stock returns

We assess the performance of two quantitative signals based on ESG scores across a large, multi-national cross-section of European stock returns. We test whether the cost of equity capital is more influenced by the upward momentum (measured over time) of the ESG scores of the firms issuing stocks or by their stability (identified as the volatility of the scores over time), measured around a changing mean level. We find that short-term ESG momentum over 1 month has a significant impact on the cross-section of stock returns, lowering the anticipated cost of capital and leading to positive average abnormal returns. This suggests that short-term ESG momentum may represent a novel, priced systematic risk factor. Furthermore, we find strong evidence that an ESG volatility spread strategy which buys low ESG score volatility stocks and sells high volatility ones, generates a substantial alpha and affects the ex-ante cost of capital. Both quantitative ESG signals result in portfolio sorting and long-short strategies that enhance the overall sustainability profile of the issuing firms without compromising the raw average of their ESG scores.