The effect of uncertain inflation on firm value in a multiperiod economy

We model firm value in a multiperiod setting with uncertain inflation and show that real rates of return on the firm's securities are intertemporally dependent. The model also predicts an inverse intertemporal relationship between the real rate of return and the lagged value of Tobin'sq. We report empirical evidence in support of the hypothesized relationship. The model could explain the mean-reverting property of long-horizon stock returns reported in recent studies.     

THE CROSS-AUTOCORRELATION OF SIZE-BASED PORTFOLIO RETURNS IS NOT AN ARTIFACT OF PORTFOLIO AUTOCORRELATION

Prior studies find evidence of asymmetric size-based portfolio return cross-autocorrelations where lagged large firm returns lead current small firm returns. However, some studies question whether this economic relation is independent of the effect of portfolio return autocorrelation. We formally test for this independence using size-based portfolios of New York Stock Exchange and American Stock Exchange securities and, separately, portfolios of Nasdaq securities. Results from causality regressions indicate that, across all markets, lagged large firm returns predict current small firm returns, even after controlling for autocorrelation in small firm returns. These cross-autocorrelation patterns are stronger for Nasdaq securities.     

A MULTIVARIATE TEST OF THE GENERALISED MEAN-LOWER PARTIAL MOMENT ASSET PRICING MODEL: AUSTRALIAN EVIDENCE

This paper tests the Mean-Lower Partial Moment (MLPM) model of asset pricing, using the Gibbons (1982) multivariate methodology, as developed by Hariow and Rao (1989). The MLPM model specifies risk to be a measure of the downside deviations of return relative to a prespecified and exogenous target rate of return. The MLPM model of Hariow and Rao is a new model which has only been tested once, using US data. Therefore, further tests using independent data will help to assess whether the model deserves more serious consideration as a possible alternative to the Capital Asset Pricing Model (CAPM). In general, tests in this paper using Australian data confirm the results of Hariow and Rao (1989). The MLPM model cannot be rejected against an unspecified alternative, nor can it be rejected against the zero-beta CAPM. Conditional on the MLPM model's validity, the optimal target rate appears to be more closely related to mean market returns than either to a risk-free return or to a zero return. In addition, there is some evidence to support an intertemporally constant target rate of around 3 percent per month, over the 30 year period examined.     

Intermarket efficiency: An application of interbattery APT to mortgage-backed securities

Increasing popularity of investments in mortgage-backed securities has led to closer integration of the mortgage market into traditional capital markets. Using monthly returns during 1982–1988 for common stocks, Treasury bonds and GNMA and FHLMC mortgage-backed securities, the interbattery factor analytic Arbitrage Pricing Theory of (Cho, 1984) is used to test five hypotheses for intramarket and intermarket integration. Results indicate that three to five common factors are found within the same security market, while only one to three factors are found common between different markets.The APT could not be rejected within the same security market, but was rejected in most intermarket comparisons. While risk-free rates are found to differ between markets, the risk premium tests are conclusive indicators of integration. Our results support claims that the stock, bond, and the mortgage-backed securities markets are integrated.     

COMMON STOCK RETURNS,EXPECTED INFLATION,AND THE RATIONAL EXPECTATIONS HYPOTHESIS

This paper provides empirical evidence that expected inflation has a cross-sectional impact on common stock returns. The study differs from others in that (a) the relation between stock returns and expected inflation is investigated in a two-factor asset pricing model, where the factors are the return on an equally weighted stock portfolio and the expected rate of inflation; (b) the estimation of the expected rate of inflation is based on the rational expectations hypothesis of Muth; and (c) a non-linear seemingly unrelated regression technique is employed to determine consistent and asymptotically efficient estimates. The joint hypothesis of the two-factor asset pricing model and rational expectations is not rejected in this study. It is found that the return on common stocks is significantly affected by expected inflation. Also stocks whose returns are positively correlated with expected inflation have lower expected returns.     

A General Stationary Stochastic Regression Model for Estimating and Predicting Beta

A beta regression model is proposed where the coefficients follow a general class of stationary stochastic processes. The procedure identifies the process and estimates the parameters of the model simultaneously from the information contained in the return series. The returns of each of the Dow Jones 30 securities are examined. Betas of 5 of the securities are nonstationary and do not appear to follow a particular form of nonstationarity. Conclusions of many earlier studies may be suspect since they are based on procedures tailored to adoption of a specific form of beta nonstationarity and, thereby, based on an erroneous a priori assumption regarding such form. The ordinary least squares model is also found to be quite robust, providing reliable beta and intercept estimates not materially different from the more complex procedure with 25 of the return series.     

THE EFFECT OF TRADING IN EIGHTHS ON SECURITY RETURN BEHAVIOR

Currently the equity securities of most British, Canadian and US firms trade in eighths. However, this pricing system may soon be abandoned in the US. Specifically, the US Securities and Exchange Commission (SEC) is currently studying the feasibility of changing the pricing of US securities to dollars and cents from dollars and eighths. 'SEC officials contend that moving to a system that quotes stock prices in dollars and cents would create efficiency in the stock market that eighths and sometimes sixteenths can't permit' (Torres and Salwen, 1991). This paper demonstrates the inefficiencies that result from constraining stocks to trade in eighths of a dollar. It describes the effects on returns and betas; then, it presents empirical evidence consistent with the effects. Systematic differences in the distributions of returns of low and high-priced stocks are documented. The covariance of returns with a market index is shown to vary systematically across stocks of different prices and to depend on the return interval used to estimate market model parameters. The variations are explainable by an observed lag between the returns of low-priced stocks relative to those of high-priced stocks. The lag is partially attributable to trading in eighths. A systematic relationship that varies with share price is observed between market model residual returns and unadjusted returns. This relationship is not eliminated by using longer return intervals alone. The extent of the relationship is reduced when longer return intervals are combined with the use of a market index composed of stocks that are priced similarly to those of the securities being tested. The implications of these results for capital market studies are discussed.     

The specification of conditional expectations

This paper explores different specifications of conditional expectations. The most common specification, linear least squares, is contrasted with nonparametric techniques that make no assumptions about the distribution of the data. Nonparametric regression is successful in capturing some nonlinearities in financial data, in particular, asymmetric responses of security returns to the direction and magnitude of market returns. The technique is ideally suited for empirically modeling returns of securities that have complicated embedded options. The conditional mean and variance of the NYSE market return are also examined. Forecasts of market returns are not improved with the nonparametric techniques which suggests that linear conditional expectations are a reasonable approximation in conditional asset pricing research. However, the linear model produces a disturbing number of negative expected excess returns. My results also indicate that the relation between the conditional mean and variance depends on the specification of the conditional variance. Furthermore, a linear model relating mean to variance is rejected and these tests are not sensitive to the expectation generating mechanism nor the conditioning information. Rejections are driven by the distinct countercyclical variation in the ratio of the conditional mean to variance.     

The Time-Variance Relationship of Security Returns: Implications for the Return-Generating Stochastic Process

Using a test statistic which specifically allows for parameter shifts over time, we investigate the time-variance relationship of security returns. The null hypothesis of stationary and independent increments is rejected, and the existence of a complex short-term reversal phenomenon is reported.     

Time-varying risk The case of the American computer industry

A bivariate GARCH-in-mean model for individual stock returns and the market portfolio is designed to model volatility and to test the conditional Capital Asset Pricing Model versus the conditional Residual Risk Model. We find that a univariate model of volatility for individual stock returns is misspecified. A joint modelling of the market return and the individual stock return shows that a major force driving the conditional variances of individual stocks is the history contained in the market return variance. We find that a conditional residual risk model, where the variance of the individual stock return is used to explain expected returns, is preferred to a conditional CAPM. We propose a partial ordering of securities according to their market risk using first and second order dominance criteria.     

Reversal of 3‐day losers and continuation of 3‐day winners on the NASDAQ

Using only the 200 large-cap securities that make up the NYSE 100 and NASDAQ 100, this study investigates 130 randomly selected formation periods from January 2000 through December 2012. During these formation periods, the three worst and three best performing stocks (based on excess return) are flagged. Once flagged, the subsequent 10-day holding period excess returns are calculated. Results indicate that NYSE securities demonstrate significant return reversal, but not return momentum. Conversely, the worst performing NASDAQ securities demonstrate return reversal, whereas the best performing NASDAQ securities demonstrate return momentum. Results are robust to the number of best and worst stocks that are flagged. Results are also robust to other combinations of formation and holding period lengths.     

Differences in Perstistence in Aggregated and Disaggregated UK Stock Returns: A Reconciliation

Studies of the persistence in the returns series of UK stocks, using inter alia variance ratios, have documented clear differences between the relatively low levels of persistence in individual security returns and the relatively high levels of persistence in the returns of portfolios composed of these same securities. In this paper, I reconcile this contrast by showing that portfolio return variance ratios should not be expected to reflect (own) persistence levels in the component security returns, but instead should reflect a 'cross-persistence' between the securities. I calculate synthetic portfolio variance ratios from measures of security return 'cross-persistence' and find that they replicate closely the observed portfolio return variance ratios, which provides empirical support for the theoretical results.     

An Examination of ERR and Asset Allocation in Public Pension Plans

In this paper, we examine the usefulness of expected rates of return (ERR) for public pension plans. Specifically, we test the correlation between the expected rate of return on plan assets and asset allocation. We also examine the predictive power of ERR on the actual returns of the pension assets. We find that the correlation between expected return and the percentage of assets that are equity securities is relatively weak. Further, we find that the percentage of assets that are equity securities is a much better predictor of actual returns than the disclosed expected return in public pension plans. These results provide evidence to support SFAS No. 87 , which requires the disclosure of plan assets and against recently promulgated SFAS No. 132 , which eliminates this disclosure requirement. The evidence also supports GASB 25'sStatement of Net Plan Assets .     

Trading volume and short-horizon contrarian profits: Evidence from the Malaysian market

We provide evidence on short-term predictability of stock returns on the Malaysian stock market. We examine the relation between return predictability and the level of trading activity. This is particularly relevant in emerging stock markets, where thin trading is more pervasive. We find that the returns from a contrarian portfolio strategy are positively related to the level of trading activity in the securities. Specifically, the contrarian profits on actively and frequently traded securities are significantly higher than that generated from the low trading activity securities. We find that the differential behavior of high- and low-volume securities is not subsumed by the size effect, although for the small firms, the volume–predictability relation is most pronounced. We also suggest that the price patterns may be related to the institutional arrangement in the Malaysian stock market.     

Sensitivity of Multivariate Tests of the Capital Asset-Pricing Model to the Return Measurement Interval

The capital asset-pricing model's (CAPM) primary empirical implication is a positively sloped linear relation between a security's expected rate of return and its relative risk (beta). Recent research indicates that inferences about the risk-return relation are sensitive to the choice of the return measurement interval. We perform multivariate tests of the Sharpe-Lintner CAPM using monthly and annual returns on market-value-ranked portfolios. The CAPM is rejected using monthly returns, a result consistent with previous research. In contrast, we fail to reject the CAPM when annual holding period returns are used.     

Anomalies in Security Returns and the Specification of the Market Model

We examine the hypothesis originally advanced by Roll 12 that observed anomalies in excess returns can be explained by misspecification of the market model used to estimate systematic risk. We find substantial misspecifications in the model systematically related to size and period of listing of the securities in question. There is some evidence that these misspecifications are associated with systemic biases in measured betas used to construct excess returns.     

The effects of dividend yield and dividend policy on common stock prices and returns

This paper suggests that it is not possible to demonstrate, using the best available empirical methods, that the expected returns on high yield common stocks differ from the expected returns on low yield common stocks either before or after taxes. A taxable investor who concentrates his portfolio in low yield securities cannot tell from the data whether he is increasing or decreasing his expected after-tax return by so doing. A tax exempt investor who concentrates his portfolio in high yield securities cannot tell from the data whether he is increasing or decreasing his expected return. We argue that the best method for testing the effects of dividend policy on stock prices is to test the effects of dividend yield on stock returns. Thus the fact that we cannot tell, using the best available methods, what effects dividend yield has on stock returns implies that we cannot tell what effect, if any, a change in dividend policy will have on a corporation's stock price.     

The Dynamics of Institutional and Individual Trading

We study the daily and intradaily cross‐sectional relation between stock returns and the trading of institutional and individual investors in Nasdaq 100 securities. Based on the previous day's stock return, the top performing decile of securities is 23.9% more likely to be bought in net by institutions (and sold by individuals) than those in the bottom performance decile. Strong contemporaneous daily patterns can largely be explained by net institutional (individual) trading positively (negatively) following past intradaily excess stock returns (or the news associated therein). In comparison, evidence of return predictability and price pressure are economically small.     

International exchange risk and asset substitutability

This paper estimates subsitutability/complementarity relations among financial assets denominated in foreign currencies. Utilizing a representative investor and a flexible functional form methodology, a mean-variance utility function was estimated and used to determine expected return and variance elasticities between assets in the world portfolio. The hypothesis that international assets are perfect substitutes was rejected. It was also found that relative changes in variance tended to have a bigger impact on asset demand than did relative changes in expected returns. Substituability/complementarity relationships were not strong except in specific cases where strong relationships were expected a priori.     

The pricing of real estate investment trust initial public offerings

This paper examines the pricing of Initial Public Offerings (IPOs) of Real Estate Investment Trusts (REITs). Unlike standard corporations, evidence suggests that REIT IPOs are correctly priced in the initial market. Significant negative initial-day return for mortgage REITs is found to be a function of using the bid price to calculate returns for those securities, which trade initially over the counter (OTC). If the bid-ask average or the ask price is used in calculating returns, any apparent overpricing disappears. Additionally, we find that once transactions costs are considered, an investor is better off purchasing a REIT on the offering.