Income hedging and portfolio decisions

We examine whether the decision to participate in the stock market and other related portfolio decisions are influenced by income hedging motives. Economic theory predicts that the market participation propensity should increase as the correlation between income growth and stock market returns decreases. Surprisingly, empirical studies find limited support for the income hedging motive. Using a rich, unique Dutch data set and the National Longitudinal Survey of the Youth (NLSY) from the United States, we show that when the income-return correlation is low, individuals exhibit a greater propensity to participate in the market and allocate a larger proportion of their wealth to risky assets. Even when the income risk is high, individuals exhibit a higher propensity to participate in the market when the hedging potential is high. These findings suggest that income hedging is an important determinant of stock market participation and asset allocation decisions.     

Is there price discovery in equity options?

We use tick-by-tick quote data for 39 liquid US stocks and options on them, and we focus on events when the two markets disagree about the stock price in the sense that the option-implied stock price obtained from the put-call parity relation is inconsistent with the actual stock price. Option market quotes adjust to eliminate the disagreement, while the stock market quotes behave normally, as if there were no disagreement. The disagreement events are typically precipitated by stock price movements and display signed option volume in the direction that tends to eliminate the disagreements. These results show that option price quotes do not contain economically significant information about future stock prices beyond what is already reflected in current stock prices, i.e., no economically significant price discovery occurs in the option market. We also find no option market price discovery using a much larger sample of disagreement events based on a weaker definition of a disagreement, which verifies that the findings for the primary sample are not due to unusual or unrepresentative market behavior during the put-call parity violations.     

DO INSIDERS PRACTICE WHAT THEY PREACH? INFORMED OPTION EXERCISES AROUND MERGERS AND ACQUISITIONS

We examine executive stock option exercises around a sample of merger and acquisition announcements between 1996 and 2006, focusing on a subset we identify as potentially informed. For stock‐financed acquisitions, we find a surge in informed exercises by acquirer insiders in the year leading up to the acquisition announcement, but target insiders display no similar increase. We find the market reaction upon the announcement for acquirers is negatively related to extreme early exercises and find some evidence of long‐run underperformance. Overall, our evidence indicates that insiders knowingly bid for firms when they personally believe their own firm is overvalued.     

Why Do Traders Split Orders?

We examine factors that influence decisions by U.S. equity traders to execute a string of orders, in the same stock, in the same direction, around the same time. Order splitting is more likely to occur when traders submit larger‐size orders and when market depth and trading activity are lower. Order splitters demand liquidity more and pay higher trading costs, but their overall performance is better. When controlling for execution time, split orders are more informative than single orders. Our results suggest that order splitting arises from a variety of factors, including informational differences, order and trader characteristics, and market conditions.     

Do Corporate Managers Know When Their Shares Are Undervalued? New Evidence Based on Actual (and Not Just Announced) Stock Buybacks

This article summarizes the findings of the authors' recent study, published in the Journal of Financial Economics, of whether public companies are able to repurchase their own shares at a discount to the market, thereby earning more than a market return on such “investments.” To the extent the answer is yes, it would suggest that management has an advantage in assessing the intrinsic value of the companies they manage. Using as their sample all 2,237 publicly traded U.S. companies that repurchased their own stock between 2004 and 2011, the authors compared the average price paid during the month to the average price at which the firm's shares traded during that month as well as three and six months after the repurchase. (All earlier studies had measured stock performance from the date of the repurchase announcements rather than from the date of the actual repurchases.) The authors' conclusion, which may come as more of a surprise to financial economists than practicing corporate executives, was that the majority of companies repurchasing their shares have in fact earned a positive return on their investment in their own stock. Perhaps the most important finding of the study, however, was that infrequent repurchasers—defined as companies that bought back their own stock four or fewer times a year—have been much more successful in buying undervalued shares than regular repurchasers. For example, when evaluated over a six‐month holding period, the annual “alpha” of infrequent repurchasers was 2.4% greater than that of frequent repurchasers—those that bought back their shares at least nine times a year. And this advantage was even more significant for companies that repurchased just once during the year—a group that recorded an alpha of 5.9%, as compared to 1.5% for monthly repurchasers. Moreover, the results were essentially the same when extended over considerably longer holding periods. For the entire sample of companies that repurchased their shares, the authors reported finding positive and significant alphas of 0.3% per month over windows ranging from three months to three years after the repurchase. But, as reported above, the infrequent repurchasers significantly outperformed frequent repurchasers over all time horizons, with differences in alpha that ranged from a low of 0.3% and to as high as 0.6% per month.     

Share Issuance and Factor Timing

We show that characteristics of stock issuers can be used to forecast important common factors in stocks' returns such as those associated with book‐to‐market, size, and industry. Specifically, we use differences between the attributes of stock issuers and repurchasers to forecast characteristic‐related factor returns. For example, we show that large firms underperform after years when issuing firms are large relative to repurchasing firms. While our strongest results are for portfolios based on book‐to‐market (i.e., HML), size (i.e., SMB), and industry, our approach is also useful for forecasting factor returns associated with distress, payout policy, and profitability.     

The holiday and Yom Kippur War sentiment effects: the Tel Aviv Stock Exchange (TASE)

Several empirical studies reveal that holidays generally create positive sentiment in the stock market, whereas negative events, such as wars or disasters, are accompanied by negative sentiment. However, what happens if a negative event occurs on a holiday? In such a case, we expect two conflicting sentiment effects, which may cancel one another out or, alternatively, one effect may dominate the other. The stock market in Israel provides a unique laboratory in which to test these two conflicting effects, as Israel faced a horrible war on the Yom Kippur holiday in 1973—a war whose influence is still strongly felt today. Indeed, we find two robust effects: A strong and significant positive holiday sentiment effect; and a negative war sentiment effect, which dominates the positive holiday effect. These results, which show how sentiment effects are created, are general and can easily be applied to other events and other markets when conflicting sentiment effects occur.     

Market uncertainty and disclosure of internal control deficiencies under the Sarbanes–Oxley Act

This study examines cross-sectional differences in stock market reactions to the disclosure of internal control deficiencies under Section 302 of the Sarbanes–Oxley Act. We hypothesize that the market punishment for internal control problems will be less severe for internal control disclosure that helps reduce market uncertainty around the disclosure. We also predict that such a relation is dependent on the types of disclosure and the market’s prior knowledge of the credibility of firms’ financial reporting. Consistent with our hypothesis, we find that when firms disclose their internal control deficiencies, their abnormal stock returns are negatively associated with changes in market uncertainty (e.g., changes in the standard deviations of daily stock returns) around the disclosure. We also find that the impact of the uncertainty reduction is greater for voluntary disclosures of non-material weakness, especially those made in the context of previous suspicious events. The negative impact of changes in market uncertainty on the abnormal stock returns remains intact even after controlling for possible simultaneity. An analysis using financial analysts’ earnings forecasts dispersion as an alternative proxy for uncertainty confirms the results.     

The long-term performance of acquiring firms: A re-examination of an anomaly

In this paper, we investigate the long-term stock return performance of Canadian acquiring firms in the post-event period by using 1300 M&A events in the 1993–2002 period. We use both event-time and calendar-time approaches and conduct robustness tests for benchmarks, methodological choices, statistical techniques and other related factors such as payment methods. We also assess the role of governance variables. Contrary to stylized facts reported in US studies, neither do we find negative abnormal long-term abnormal stock market returns once we account for methodological discrepancies nor do we find negative long-term operating performance in the post-acquisition periods for the acquirer following an acquisition event. We also find that the Canadian market reacts positively to acquisition announcements but corrects for this reaction within a short period of time. Overall we find that Canadian acquisitions do not show value destruction or overpayment.     

THE IMPORTANCE OF LIQUIDITY AS A FACTOR IN ASSET PRICING

We employ the Fama‐French time‐series regression approach to examine liquidity as a risk factor affecting stock returns. Prior studies establish liquidity as an important consideration in investment decisions. Here, liquidity is found to be an important factor affecting portfolio returns, even after the effects of market, size, book‐to‐market equity, and momentum are considered. Nonzero intercepts remain, however, indicating continued missing risk factors.     

Sudden crash or long torture: The timing of market reactions to operational loss events

An emerging literature investigating market responses to operational loss announcements concludes that financial markets tend usually to overreact to loss events. This overreaction is commonly interpreted as reputational damage. We revisit this issue by focusing on the timing of markets’ reactions and highlight two variables: the start and the speed of stock markets’ responses. It appears that when operational losses are caused by internal fraud the negative market reaction materializes earlier and faster. Industry sectors and prevailing market conditions influence the timing of market reactions as well. Our empirical findings reveal moreover that a higher initial grading of the company is associated with a later stock market reaction to the announcement. While the relative magnitude and the length of markets’ overreactions is positively correlated to the concomitant downgrading our study shows that overreaction magnitudes are also strongly correlated to our estimate of the total duration of the reaction.     

LIQUIDITY AND ASSET PRICING UNDER THE THREE‐MOMENT CAPM PARADIGM

We examine whether the use of the three‐moment capital asset pricing model can account for liquidity risk. We also make a comparative analysis of a four‐factor model based on Fama–French and Pástor–Stambaugh factors versus a model based solely on stock characteristics. Our findings suggest that neither of the models captures the liquidity premium nor do stock characteristics serve as proxies for liquidity. We also find that sensitivities of stock return to fluctuations in market liquidity do not subsume the effect of characteristic liquidity. Furthermore, our empirical findings are robust to differences in market microstructure or trading protocols between NYSE/AMEX and NASDAQ.     

Go long or short in pyramids? News from the Egyptian stock market

Similar to other emerging economies, the Egyptian stock market has recently experienced a remarkable run-up but also a major downturn. This paper analyzes the stock market from two angles. First, it compares the performance of the major stock price index with its underlying fundamentals. Second, it explores the relationship between the Egyptian and other stock markets. The paper finds that (i) there is some evidence against a stable relationship between the Egyptian index and its fundamental value; and (ii) short-term correlations and long-term cointegrating relations provide conflicting signals on the value of Egyptian stocks as a means of diversification.     

SENSITIVITY OF INVESTOR REACTION TO MARKET DIRECTION AND VOLATILITY: DIVIDEND CHANGE ANNOUNCEMENTS

We examine whether investor reactions are sensitive to the recent direction or volatility of underlying market movements. We find that dividend change announcements elicit a greater change in stock price when the nature of the news (good or bad) goes against the grain of the recent market direction during volatile times. For example, announcements to lower dividends elicit a significantly greater decrease in stock price when market returns have been up and more volatile. Similarly, announcements to raise dividends tends to elicit a greater increase in stock price when market returns have been normal or down and more volatile, although this latter tendency lacks statistical significance. We suggest an explanation for these results that combines the implications of a dynamic rational expectations equilibrium model with behavioral considerations that link the responsiveness of investors to market direction and volatility.     

The Valuation Impact of SEC Enforcement Actions on Nontarget Foreign Firms

This study shows that the Securities and Exchange Commission's (SEC) enforcement intensity toward the foreign firms under its jurisdiction has increased dramatically over the past two decades. Because enforcement events signify an increased threat of future enforcement, I examine the stock returns of foreign firms not targeted by the SEC during windows around enforcement actions that target foreign firms. This design captures the net effects of public enforcement and helps to rule out omitted variables as alternative explanations, because other factors would have to align with enforcement events that do not occur in an obvious pattern (and are therefore unlikely to map onto other news). Nontarget firms experience positive stock returns during the event windows, which is consistent with enforcement constraining the risks of expropriation. The cross‐sectional pattern in returns reveals greater returns for firms from weak home legal environments. Finally, consistent with the market adjusting to a new enforcement regime, the magnitude of event returns declines over time. Overall, SEC enforcement is associated with increases in the value of foreign firms, supporting the premise of the legal bonding hypothesis.     

The disposition effect and investor experience

We examine whether investing experience can dampen the disposition effect, that is, the fact that investors seem to hold on to their losing stocks to a greater extent than they hold on to their winning stocks. To do so, we devise a computer program that simulates the stock market. We use the program in an experiment with two groups of subjects, namely experienced investors and undergraduate students (the inexperienced investors). As a control procedure, we consider random trade decisions made by robot subjects. We find that though both human subjects show the disposition effect, the more experienced investors are less affected.     

DAYLIGHT AND INVESTOR SENTIMENT: A SECOND LOOK AT TWO STOCK MARKET BEHAVIORAL ANOMALIES

Kamstra, Kramer, and Levi (2000, 2003) describe two stock market behavioral anomalies associated with changes in investor sentiment caused by daylight saving time (DST) changes and seasonal affective disorder (SAD). According to the hypothesized effects, DST changes and SAD affect asset prices by changing investors’ risk aversion. Although changes in the timing or amount of daylight are correlated with unusual stock market returns, I present evidence they do not cause those unusual returns. Instead, seasonal patterns in market‐related information during the sample period are the likely cause of the correlation between stock market returns and DST changes or SAD.     

Stock Returns and Operating Performance of Securities Issuers

We examine long‐run stock returns and operating performance around firms’ offerings of common stock, convertible debt, and straight debt from 1985 to 1990. We find that pre‐issue abnormal returns are positive and significant for stock issuers, but not for convertible and straight debt issuers. The post‐issue mean returns show that common stock and convertible debt issuers experience underperformance during the post‐issue periods, but straight debt issuers do not. Consistent with these results, common stock issuers experience the best pre‐issue operating performance among all three types of issuers, and operating performance declines during the post‐issue periods for common stock and convertible debt issuers. Using a new approach in linear model estimations to correct heteroskedasticity and to adjust for finite sample, we find a positive relation between post‐issue operating performance and issue‐period stock price reactions. The results suggest that future operating performance is anticipated at the issue and that securities issues provide information on issuers’ future performance.     

Firm-specific information and the efficiency of investment

In the three-year period following stock market liberalizations, the growth rate of the typical firm's capital stock exceeds its pre-liberalization mean by an average of 4.1 percentage points. Cross-sectional changes in investment are significantly correlated with the signals about fundamentals embedded in the stock price changes that occur upon liberalization. Panel-data estimations show that a 10-percentage point increase in a firm's expected future sales growth predicts a 2.9- to 3.5-percentage point increase in the growth rate of its capital stock. Country-specific changes in the cost of capital drive changes in investment but firm-specific changes in the cost of capital do not.     

Do CRA‐Related Events Affect Shareholder Wealth? The Case of Bank Mergers

This study explores how Community Reinvestment Act (CRA) protests and their resolution affect the market value of merging banks. We find, in contrast to earlier research, that CRA‐related events are not associated with significant negative market reactions for either bidder or target institutions. Rather, the market does not seem to respond strongly to CRA‐related events at all. The results appear to stem from the choice of an estimation period for establishing an institution's baseline stock‐market price dynamics that does not include abnormal security price movements induced by the merger announcement.