Global private information in international equity markets

This paper studies international equity markets when some investors have private information that is valuable for trading in many countries simultaneously. We use a dynamic model of equity trading to show that global private information helps explain US investors’ trading behavior and performance. In particular, the model predicts global return chasing (positive co-movement of US investors’ net purchases with returns in many countries) which we show to be present in the data. Return chasing in our model can be due to superior performance of US investors, not inferior knowledge or naive trend-following. We also show that trades due to private information are strongly correlated across countries. A common (global) factor accounts for about half their variation.     

Lessons from the evolution of foreign exchange trading strategies

The adaptive markets hypothesis posits that trading strategies evolve as traders adapt their behavior to changing circumstances. This paper studies the evolution of trading strategies for a hypothetical trader who chooses portfolios from foreign exchange (forex) technical rules in major and emerging markets, the carry trade, and US equities. The results show that a backtesting procedure to choose optimal portfolios improves upon the performance of nonadaptive rules. We also find that forex trading alone dramatically outperforms the S&P 500, with much larger Sharpe ratios over the whole sample, but there is little gain to coordinating forex and equity strategies, which explains why practitioners consider these tools separately. Forex trading returns dip significantly in the 1990s but recover by the end of the decade and have been markedly superior to an equity position since 1998. Overall, trading rule returns still exist in forex markets—with substantial stability in the types of rules—though they have migrated to emerging markets to a considerable degree.     

Trading behavior in S&P 500 index futures

This article examines the determinants of trading decisions and the performance of trader types, in the context of the E-Mini S&;P 500 futures and S&;P 500 futures markets. Speculators and small traders tend to follow positive feedback strategies while hedgers dynamically adjust positions in response to market returns. Such strategies apparently reverse during the 2008–09 financial crisis. Investor sentiment and market volatility play an important role in determining the net trading position of traders across the sample period. While all trader types are better at foreseeing market upturns, an out-of-sample test suggests that speculators and small traders have some predictive ability for short-term market returns.     

Price momentum in the New Zealand stock market: a proper accounting for transactions costs and risk*

We test for recently reported momentum profits in New Zealand using a practitioner technique that we have not yet seen in the academic literature. This technique simultaneously weighs returns, risk and transactions costs at each portfolio rebalance, rather than blindly chasing returns and then accounting for risk and transactions costs after the fact. We reverse the findings of the earlier literature because our gross profits are more than fully consumed once transactions costs are properly accounted for. Although we focus on momentum trading in New Zealand, our practitioner technique is broadly applicable to investigations of trading anomalies.     

Varying risk premia in international bond markets

Cochrane and Piazzesi [Cochrane, J.H., Piazzesi, M., 2005. Bond risk premia. American Economic Review 95, 138–160] use forward rates to forecast future bond returns. We extend their approach by applying their model to international bond markets. Our results indicate that the unrestricted Cochrane and Piazzesi (2005) model has a reasonable forecasting power for future bond returns. The restricted model, however, does not perform as well on an international level. Furthermore, we cannot confirm the systematic tent shape of the estimated parameters found by Cochrane and Piazzesi (2005). The forecasting models are used to implement various trading strategies. These strategies exhibit high information ratios when implemented in individual countries or on an international level and outperform alternative approaches. We introduce an alternative specification to forecast future bond returns and achieve superior risk-adjusted returns in our trading strategy. Bayesian model averaging is used to enhance the performance of the proposed trading strategy.     

Currency momentum strategies

We provide a broad empirical investigation of momentum strategies in the foreign exchange market. We find a significant cross-sectional spread in excess returns of up to 10% per annum (p.a.) between past winner and loser currencies. This spread in excess returns is not explained by traditional risk factors, it is partially explained by transaction costs and shows behavior consistent with investor under- and overreaction. Moreover, cross-sectional currency momentum has very different properties from the widely studied carry trade and is not highly correlated with returns of benchmark technical trading rules. However, there seem to be very effective limits to arbitrage that prevent momentum returns from being easily exploitable in currency markets.     

Market Efficiency and the Returns to Simple Technical Trading Rules: New Evidence from U.S. Equity Market and Chinese Equity Markets

Numerous studies in the finance literature have investigated technical analysis to determine its validity as an investment tool. This study is an attempt to explore whether some forms of technical analysis can predict stock price movement and make excess profits based on certain trading rules in markets with different efficiency level. To avoid using arbitrarily selected 26 trading rules as did by Brock, Lakonishok and LeBaron (1992) and later by Bessembinder and Chan (1998), this paper examines predictive power and profitability of simple trading rules by expanding their universe of 26 rules to 412 rules. In order to find out the relationship between market efficiency and excess return by applying trading rules, we examine excess return over periods in U.S. markets and also compare the excess returns between U.S. market and Chinese markets. Our results found that there is no evidence at all supporting technical forecast power by these trading rules in U.S. equity index after 1975. During the 1990s break-even costs turned to be negative, –0.06%, even failing to beat a buy-holding strategyin U.S. equity market. In comparison, our results provide support for the technical strategies even in the presence of trading cost in Chinese stock markets.     

Is market fragmentation harming market quality?

We examine how fragmentation is affecting market quality in US equity markets. We use newly available trade reporting facilities (TRFs) data to measure fragmentation, and we use a variety of empirical approaches to compare execution quality and efficiency of stocks with more and less fragmented trading. We find that fragmentation affects all stocks; more fragmented stocks have lower transactions costs and faster execution speeds; and fragmentation is associated with higher short-term volatility but greater market efficiency, in that prices are closer to being a random walk. Our results that fragmentation does not appear to harm market quality are consistent with US markets being a single virtual market with multiple points of entry.     

Tests of technical trading strategies in the emerging equity markets of Latin America and Asia

This study examines the potential profit of ten Variable Length Moving Average (VMA) technical trading rules in ten emerging equity markets in Latin America and Asia from January 1982 through April 1995. The average difference in buy − sell returns after trading costs for each rule and country are compared to a buy and hold strategy. Taiwan, Thailand and Mexico emerge as markets where technical trading strategies may be profitable. We find no strong evidence of profitability for the other markets. However, we find that 82 out of the 100 country–trading rule combinations tested in ten emerging markets, disregarding their statistical significance, correctly predict the direction of changes in the return series. These findings may provide investors with important asset allocation information.     

An analysis of trading strategies in eleven European stock markets

Abstract

In recent years, the validity of the weak form efficient market hypothesis (EMH) has been called into question as several studies have uncovered evidence that technical trading rules have predictive ability with respect to both developed and emerging stock market indices. This study analyses the forecasting power of 2 of the most popular trading rules using index data for a selection of 11 European stock markets over the January 1991 to December 2000 period. The findings indicate that the emerging markets included in this paper are informationally inefficient; these markets displayed some degree of predictability in their share returns, although the developed markets did not. Furthermore, the results point to large differences in the performance of the rules examined; while small size filters consistently outperformed the buy-and-hold strategy in the emerging markets examined even after the consideration of transaction costs, the performance of the moving average rules was erratic and varied dramatically from market to market.     

Emerging markets: Is the trend still your friend?

Using an extensive sample consisting of 30 emerging countries and 38 years of data, we examine the profitability of two momentum and two trend following strategies. Over the entire sample, we find excess returns that are economically and statistically significant for all four strategies. Furthermore, we show that the significance of the excess returns remains after adjusting for macroeconomic risk factors. In addition, we find that in spite of their relative neglect, trend strategies frequently demonstrate superior performance, compared to momentum strategies. However, contrary to previous research, we do not find that time series momentum strategies outperform cross-sectional momentum strategies. Finally, we show that the effectiveness of the alternative strategies is largely diminished once transactions costs and liberalizations in emerging markets are considered.     

Another look at trading costs and short-term reversal profits

Several studies report that abnormal returns associated with short-term reversal investment strategies diminish once trading costs are taken into account. We show that the impact of trading costs on the strategies’ profitability can largely be attributed to excessively trading in small cap stocks. Limiting the stock universe to large cap stocks significantly reduces trading costs. Applying a more sophisticated portfolio construction algorithm to lower turnover reduces trading costs even further. Our finding that reversal strategies generate 30-50 basis points per week net of trading costs poses a serious challenge to standard rational asset pricing models. Our findings also have important implications for the understanding and practical implementation of reversal strategies.     

Technical trading rules for nonlinear dynamics of stock returns: evidence from the G-7 stock markets

This paper explores a possible link between an asymmetric dynamic process of stock returns and profitable technical trading rules. Using the G-7 stock market indexes, we show that the dynamic process of daily index returns is better characterized by nonlinearity arising from an asymmetric reverting property. The asymmetric reverting property of stock returns is exploitable in generating profitable buy and sells signals for technical trading strategies. The bootstrap analysis shows that not all nonlinearities generate profitable buy and sell signals, but rather only the nonlinearities generating a consistent asymmetrical pattern of return dynamics can be exploitable for the profitability of the trading rules. The significant positive (negative) returns from buy (sell) signals are a consequence of trading rules that exploit the asymmetric nonlinear dynamics of the stock returns that revolve around positive (negative) unconditional mean returns under prior positive (negative) return patterns. Our results corroborate the arguments for the usefulness of technical trading strategies in stock market investments.     

THE CHOICE OF TRADING VENUE AND RELATIVE PRICE IMPACT OF INSTITUTIONAL TRADING: ADRs VERSUS THE UNDERLYING SECURITIES IN THEIR LOCAL MARKETS

We address two important themes associated with institutions’ trading in foreign markets: (1) the choice of trading venues (between a company's listing in its home market and that in the United States as an American Depositary Receipt [ADR]) and (2) the comparison of trading costs across the two venues. We identify institutional trading in both venues using proprietary institutional trading data. Overall, our research underscores the intuition that the choice of institutional trading in a stock's local market or as an ADR is a complex process that embodies variables that measure the relative adverse selection and liquidity at order, stock, and country levels. Institutions route a higher percentage of trades to more liquid markets, and these trades are associated with higher cumulative abnormal returns. We also find that institutional trading costs are generally lower for trading cross‐listed stocks on home exchanges even after controlling for selection bias.     

Global industry portfolios and short-term predictability of returns: Is it there?

This paper explores the degree of success of a large set of active trading rules that have been popularized in the literature on the short-term predictability of returns in equity and foreign exchange markets by extending the scope of research in three dimensions: global portfolios, industry portfolios, and exclusive versus inclusive portfolios. Our results show that after adjusting for (1) the impact of nonsynchronous prices in the reported closing index levels which causes spurious autocorrelations in returns, (2) data snooping bias caused by searching through a large number of possible trading strategies in order to find a few that yield superior in-sample performance, and (3) transaction costs that reduce any profits from active trading, the risk-adjusted profits generated by short-term trend chasing trading rules are generally not statistically significant and the hypothesis of no outperformance of trading rules over either buy-and-hold or risk-free benchmark return cannot be rejected in most industries. Such findings favor short-term market efficiency and are hardly comforting for active traders.     

Combining mean reversion and momentum trading strategies in foreign exchange markets

The literature on equity markets documents the existence of mean reversion and momentum phenomena. Researchers in foreign exchange markets find that foreign exchange rates also display behaviors akin to momentum and mean reversion. This paper implements a trading strategy combining mean reversion and momentum in foreign exchange markets. The strategy was originally designed for equity markets, but it also generates abnormal returns when applied to uncovered interest parity deviations for five countries. I find that the pattern for the positions thus created in the foreign exchange markets is qualitatively similar to that found in the equity markets. Quantitatively, this strategy performs better in foreign exchange markets than in equity markets. Also, it outperforms traditional foreign exchange trading strategies, such as carry trades and moving average rules.     

Financial market integration and the value of global diversification: Evidence for US acquirers in cross-border mergers and acquisitions

In contrast to the previously documented cross-border discount, we find that there is positive cross-border effect for US acquirers during late 1990s and early 2000s. This is especially particular the case for those that acquire/merge with targets from segmented financial markets where acquirers experience significantly higher positive abnormal returns than those that acquire targets from integrated financial markets. Furthermore, firms acquiring segmented-market targets are also characterized by significantly higher post-merger operating performance improvement. The results indicate that the observed positive cross-border effect is mainly due to the increase in the number of transactions involving targets from segmented markets, in which the average firm experience significant financial constraints. We contend that value is created by a combination of firms with different financial market integration status, in which funds are provided to high cost firms. The finding that the value creation is even higher within the group of acquirers with a lower cost of capital provides additional support for our conjecture.     

Do optimal diversification strategies outperform the 1/N strategy in U.K. stock returns?

This paper examines whether optimal diversification strategies outperform the 1/N strategy in U.K. stock returns. The study focuses on the performance of recent strategies developed by Tu and Zhou (2011) and Kirby and Ostdiek (2010). I find that a number of optimal asset allocation strategies can significantly outperform the 1/N strategy even after adjusting for trading costs. The strategies developed by Kirby and Ostdiek outperform the 1/N strategy, even at higher trading costs, due to the low turnover of these strategies. The strategies of Tu and Zhou have mixed performance after adjusting for trading costs due to the high turnover of these strategies. The results of the paper provide support for the use of optimal diversification strategies.     

Option trading and individual investor performance

This paper examines the impact of option trading on individual investor performance. The results show that most investors incur substantial losses on their option investments, which are much larger than the losses from equity trading. We attribute the detrimental impact of option trading on investor performance to poor market timing that results from overreaction to past stock market returns. High trading costs further contribute to the poor returns on option investments. Gambling and entertainment appear to be the most important motivations for trading options while hedging motives only play a minor role. We also provide strong evidence of performance persistence among option traders.     

Leverage Is a Double-Edged Sword

We use proprietary data on intraday transactions at a futures brokerage to analyze how implied leverage influences trading performance. Across all investors, leverage is negatively related to performance, due partly to increased trading costs and partly to forced liquidations resulting from margin calls. Defining skill out-of-sample, we find that relative performance differentials across unskilled and skilled investors persist. Unskilled investors' leverage amplifies losses from lottery preferences and the disposition effect. Leverage stimulates liquidity provision by skilled investors, and enhances returns. Although regulatory increases in required margins decrease skilled investors' returns, they enhance overall returns, and attenuate return volatility.