Do financial variables help predict the state of the business cycle in small open economies? Evidence from Switzerland

We analyze the forecasting ability of financial variables to predict the state of the Swiss business cycle up to eight quarters ahead. Overall, our results suggest that financial variables convey leading information for the prediction of business cycles, even when applied to a small open economy. However, we clearly find that model specifications need to be extended to include variables accounting for external shocks, such as exchange rates or international commodity prices. It also appears that the forecasting contribution of individual variables changes over time. Specifically, in the last two decades, stock market liquidity has replaced the term spread as the best single predictor.     

Do financial reforms help stabilize inequality?

We explore the relationship between financial reforms and income inequality using a panel of 29 countries in 1975–2005. We extend panel unit root tests to allow for the presence of some financial-reform covariates and further suggest an associated but novel, semi-parametric approach. Results demonstrate that although both gross and net Gini indices follow a unit root process, this picture can change when financial reform indices are accounted for. In particular, while gross Gini coefficients are generally not stabilized by financial reforms, net measures are (more likely to be). Thus financial reforms enacted in the presence of a strong safety net would seem preferable.     

Do fear indices help predict stock returns?

This study investigates the forecasting power of implied volatility indices on forward looking returns. Prior studies document that negative innovations to returns are associated with increasing implied volatility of the underlying indices; thus, suggesting a possible relationship between extremely high levels of implied volatility and positive short term returns. We investigate this issue by examining the predictive power of three implied volatility indices, VIX, VXN and VDAX, on the underlying index returns. We extend previous research by also focusing on characterised selected stocks and examine the relationship between implied volatility indices and future returns across different sectors and classified portfolios. Our findings suggest that implied volatility indices are good predictors of 20-days and 60-days forward looking returns and illustrate insignificant predictive power for very short term (1-day and 5-days) returns.     

Nudging the financial market? A review of the nudge theory

A systematic review of the nudge literature and an examination of its applications across different domains reveals that: (i) a nudge, in the sense of using choice architecture to push people to choose desired results, works well; and (ii) a nudge, in the sense of pushing people to choose desired results so that people will be better off, remains questionable. In financial markets, regulators and financial intermediaries currently use nudge theory to: (i) adjust how investment choices are presented to investors; and (ii) provide information in a selective way. Besides nudging investors, it is also possible for regulators to nudge financial intermediaries towards making more ethical decisions.     

Do jumps mislead the FX market?

This paper investigates the link between jumps in the exchange rate process and rumours of central bank interventions. Using the case of Japan, we analyse specifically whether jumps trigger false reports of intervention (i.e. an intervention is reported when it did not occur). Intraday jumps are extracted using a non-parametric technique recently proposed by Lee and Mykland in 2008 and by Andersen et al. in 2007, and later modified by Boudt et al. in 2011. Rumours are identified by using a unique database of Reuters and Dow Jones newswires. Our results suggest that a significant number of jumps on the YEN/USD have been falsely interpreted by the market as being the result of a central bank intervention. The paper has policy implications in terms of central bank interventions. We show that in times where the central bank is known to intervene, some investors may attach a lot of weight to central bank interventions as a source of exchange rate movement, leading to a false ‘intervention explanation’ for observed jumps.     

Do managers listen to the market?

There are competing theories as to whether managers learn from stock prices. Dye and Sridhar (2002), for example, argue that capital markets can be better informed than the firm itself, while Roll [Roll, R., 1986, “The hubris hypothesis of corporate takeovers,” Journal of Business 59, 97–216.] argues managers may ignore market signals due to hubris. In this paper, we examine whether managers listen to the market in making major corporate investments, and whether agency costs and corporate governance mechanisms help explain managers' propensity to listen. We find that, on average, managers listen to the market: they are more likely to cancel investments when the market reacts unfavorably to the related announcement. Further, we find mixed evidence consistent with the notion that managers' propensity to listen is related to agency costs. We find that firms tend to listen to the market more when more of their shares are held by large blockholders, and when their CEOs have higher pay-performance sensitivities.     

Do dividend changes predict the future profitability of firms?

Many previous studies have been conducted to test whether corporate dividend changes predict the future profitability of firms. While the debate continues, we assess the information content of dividends (ICD) hypothesis in the Korean market as it provides an interesting experimental setting for testing the hypothesis in the context of corporate governance. We find that it is difficult to support the ICD hypothesis if one accepts nonlinear patterns in earnings. However, when we divide the sample in terms of Chaebol vs. non‐Chaebol and high‐growth vs. low‐growth firms, we find that the ICD hypothesis becomes valid, especially for non‐Chaebol firms and for low‐growth firms. Therefore, we suggest that the validity of the ICD hypothesis may be dependent on firm characteristics such as the corporate governance structure and growth stage.     

A comparison of the stock market reactions of convertible bond offerings between financial and non-financial institutions: Do they differ?

We focus on the stock price reaction to convertible bond offering made by financial institutions and find that the cumulative abnormal return over the three day interval around convertible bond issuance is 1.41 percentage higher than that for non-financial institutions. This result supports our hypothesis that since financials are heavily regulated, the market is less likely to assume that the issuance of convertible bond by financials signals information that are overvalued. Our results remain robust after controlling for a number of firm-, issue-, and market-specific characteristics as well as the level of short selling pressure induced by convertible bond arbitrageurs.     

Do defaulting CEOs and directors increase the likelihood of financial distress of the firm?

We hypothesize that the information on a CEO’s and directors’ (board members) past personal payment default entries in public credit data files significantly increases the predictive power of Altman’s (in J Fin 23(4):589–609, 1968) and Ohlson’s (In J Acc Res 18(1):109–131, 1980) distress prediction models. We base our hypothesis on the literature showing that (1) managerial traits such as overconfidence, over-optimism, and the illusion of control affect corporate decisions and that (2) these same personal traits explain personal over-indebtedness and credit defaults. Our results of analyzing the credit data files of more than 100,000 CEOs and directors of the Finnish private limited liability companies support this hypothesis. Our results remain materially unchanged when using the bootstrapping method to assess their significance and when excluding small firms (firm size below the sample median). Collectively, our results imply that creditors should recognize the increased distress risk of firms appointing defaulting CEOs and directors.     

Does financial connectedness predict crises?

The global financial crisis has reignited interest in models of crisis prediction. It has also raised the question whether financial interconnectedness—a possible source of systemic risk—can serve as an early warning indicator of crises. In this paper, we examine the ability of connectedness in the global network of financial linkages to predict systemic banking crises during the 1978–2010 period. Our results indicate that increases in a country’s own connectedness and decreases in its neighbours’ connectedness are associated with a higher probability of banking crises after controlling for macroeconomic fundamentals. Our findings suggest that financial interconnectedness has early warning potential, especially for the 2007–2010 wave of systemic banking crises.     

Is the market valuation of banks’ loan loss provision conditional on auditor reputation?

We examine how auditor reputation conditions the market valuation of banks’ loan loss provision (LLP). The inherent uncertainty associated with and discretion permitted in estimating the LLP contributes to information asymmetry. The auditor’s certification and monitoring roles influence firm value by mitigating this information asymmetry. We examine two aspects of auditor reputation, auditor type (Big 5 vs. non-Big 5) and auditor expertise, in the banking industry. We find a significant, positive association between the discretionary component of LLP and stock return for banks audited by the Big 5 auditors. Further analysis indicates that auditor expertise within banking and not auditor type drives this significant, positive association. Overall, our results are consistent with auditor expertise in the banking industry mitigating information asymmetry between bank managers and investors and enhancing the information conveyed by discretionary loan loss provision.     

Do powerful chief executives influence the financial performance of UK firms?

Drawing on a framework from agency theory, we examine the relation between the decision-making power of Chief Executive Officers (CEOs) and the financial performance of 468 United Kingdom (UK) publicly listed companies (plcs) using a dynamic panel data estimation method for the six years 2003–2008. We measure CEO power using a ‘power index’ which captures the extent to which the autonomy of the CEO to make unilateral decisions could influence firms' financial performance. To test for robustness, our analysis is conducted using different measures of financial performance. Our results reveal that, consistent with previous UK research, CEO power, as defined by CEO-Chair duality, CEO-tenure and CEO share ownership, is negatively related to financial performance. We also find that concentrated ownership is inversely related to the performance of UK plcs. CEO's compensation and board structure, however, do not appear to be related to the financial performance of the UK plcs.     

Do differences in financial reporting attributes impair the predictive ability of financial ratios for bankruptcy?

This study explores the effect of cross-sectional and time-series differences in financial reporting attributes on the predictive ability of financial ratios for bankruptcy. We identify proxies for discretion over financial reporting, the importance of intangible assets, the comprehensiveness of the accounting model and recognition of losses. Each of our proxies for financial reporting attributes is associated with financial ratios that are less informative in predicting bankruptcy. Furthermore, our time-series tests reveal a decline in the predictive ability of financial ratios for bankruptcy and document that this decline is associated with our measures of financial reporting attributes.     

The output gap and stock returns: Do cyclical fluctuations predict portfolio returns?

This study examines whether the output gap leads portfolio stock returns. The paper conducts in-sample and out-of-sample forecasting of US stock portfolios formed on the basis of size and value. First, the paper finds cross-sectional portfolios are predictable in-sample by the output gap. Out-of-sample evidence is weaker but still generally supports the finding that the historical average benchmark can be beaten. Secondly and most importantly, we find mixed evidence that the Fama–French factor mimicking portfolios can be forecasted by the output gap. In particular, there is some out-of-sample predictability of the size effect (SMB) suggesting this lags the output gap. However, the output gap, a key business cycle indicator, cannot predict the value effect (HML) either in-sample or out-of-sample. Our results add to the prior literature which finds that the factor mimicking returns are related contemporaneously (Petkova and Zhang, 2005) or lead (Liew and Vassalou, 2000) economic indicators.     

Does volume help in predicting stock returns? An analysis of the Australian market

This paper presents an analysis of the relationship between trading volume and stock returns in the Australian market. We test this hypothesis by using data from a sample of firms listed on the Australian stock market for a period of 5 years from January 2001 to December 2005. We explore this relationship by focusing on the level of trading volume and thin trading in the market. Our results suggest that trading volume does seem to have some predictive power for high volume firms and in certain industries of the Australian market. However, for smaller firms, trading volume does not seem to have the same predictive power to explain stock returns in Australia.     

Euro money market spreads during the 2007–? financial crisis

In the paper we investigate the empirical features of euro area money market turbulence during the recent financial crisis. By means of a novel Fractionally Integrated Heteroskedastic Factor Vector Autoregressive model, we find evidence of a deterministic level factor in the EURIBOR-OIS (OIS) spreads term structure, associated with the two waves of stress in the interbank market, following the BNP Paribas (9 August 2007) and Lehman Brothers (16 September 2008) “shocks”, and two additional factors, of the long memory type, bearing the interpretation of curvature and slope factors, respectively. The unfolding of the crisis yields a significant increase in their persistence and volatility. We also find evidence of a declining trend in the level and volatility of OIS spreads since December 2008, associated with ECB liquidity policies.     

Do accruals exacerbate information asymmetry in the market?

A considerable body of evidence, both archival and experimental, suggests that accounting accruals are heterogeneously interpreted by investors. We examine whether the information asymmetry among investors arising from this heterogeneous interpretation, implied in these empirical results, affects transactions costs in the form of the adverse selection component of the bid-ask spread. We examine this impact both, in a yearly setting and around the first release of quarterly accrual information. The results of the study provide empirical evidence of a positive association between the adverse selection component and accruals in the yearly analysis. Since wider bid-ask spreads are both theoretically and empirically linked to higher stock returns (Brennan & Subrahmanyam, 1996), our results provide a transaction cost basis for understanding one possible factor underlying the linkage between accruals and cost of equity capital, and accruals and information risk pricing as documented in Francis et al. (2005) and Ecker et al. (2006).     

Did the financial crisis affect the market valuation of large systemic U.S. banks?

We examine the impact of the financial crisis on the stock market valuation of large and systemic U.S. bank holding companies (BHCs). Using the Bertsatos and Sakellaris (2016) model of fundamental valuation of bank equity, we provide evidence that the financial crisis has not altered investors’ attitudes towards bank characteristics. In particular, before, during, and after the crisis, investors in large and systemic U.S. BHCs seemed to penalize leverage, albeit temporarily. Both before and after the crisis, they reward size in the short run. This pattern is appearing only briefly during the crisis. We also show that bank opacity plays no role in market valuation either in the short run or in the long run. Last but not least, we find evidence that stress testing has been informative to the market and that those BHCs that failed at the post-crisis stress tests were not subsequently valued differently by the market.     

Does the equity premium puzzle persist during financial crisis? The case of the French equity market

This paper examines the effects of the financial crisis that began in 2008 on the equity premium of 6 French sector indices. Since the systematic risk coefficient beta remains the most common explanatory element of risk premium in most asset pricing models, we investigate the impact of the crisis on the time-varying beta of the six sector indices cited. We selected daily data from January 2003 to December 2012 and we applied the bivariate MA-GARCH model (BEKK) to estimate time-varying betas for the sector indices. The crisis was marked by increased volatility of the sector indices and the market. This rise in volatility led to an increase in the systematic risk coefficient during the crisis and first post-crisis period for all the major indices. The results are intuitive and corroborate findings in the empirical literature. The increase of the time-varying beta is considered by investors as an additional risk. Therefore, as expected, investors tend to increase their equity premiums to b ear the impact of financial crisis.     

Is financial advice a cure-all or the icing on the cake for financial literacy? Evidence from financial market participation in China

We examine how financial advice interacts with financial literacy to shape household decisions on stock market participation in China. Particularly, we investigate how the effect of financial advice varies with economic expectations, preferences for asset diversification and the level of financial literacy. Feeding the data of 5274 households into a Probit model that predicts the probability of holding stocks, we find that, while an increase in financial literacy significantly raises the stock market participation of all households, seeking financial advice only increases the participation for those households which have a preference for asset diversification or which have an optimistic expectation about the economy. Moreover, the effect of financial advice is concentrated on households with high financial literacy, implying that an insufficient level of financial literacy is the reason for the poor performance of financial advice in China. We also examine if there are influential trust or quality concerns which would reduce the effectiveness of financial advice but we find no significant evidence for it.