Do jumps contribute to the dynamics of the equity premium?

This paper investigates whether risks associated with time-varying arrival of jumps and their effect on the dynamics of higher moments of returns are priced in the conditional mean of daily market excess returns. We find that jumps and jump dynamics are significantly related to the market equity premium. The results from our time-series approach reinforce the importance of the skewness premium found in cross-sectional studies using lower-frequency data; and offer a potential resolution to sometimes conflicting results on the intertemporal risk-return relationship. We use a general utility specification, consistent with our pricing kernel, to evaluate the relative value of alternative risk premium models in an out-of-sample portfolio performance application.     

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.     

Can ambiguity aversion solve the equity premium puzzle? Survey evidence from international data

Ambiguity aversion has been suggested as a potential explanation for the equity premium puzzle in recent theoretical models. To test this hypothesis, we measure the amount of ambiguity aversion in a large-scale international survey. A comparison to the average equity premia in these countries demonstrates that ambiguity aversion does, indeed, have a significant influence on the amount of equity risk premium, even when controlling for macroeconomic parameters. Finally, we connect differences in ambiguity aversion to differences in uncertainty avoidance, one of Hofstede’s cultural dimensions.     

Can mispricing explain the value premium?

Empirical research finds that stocks with low market-to-book (MTB) ratios outperform stocks with high MTB ratios. Rhodes-Kropf, Robinson, and Viswanathan separate the MTB ratio into mispricing and growth options components. We report that the mispricing component, but not the growth options component, predicts abnormal returns for up to 5 years. We also find that the mispricing component, but not the growth options component, provides incremental information relative to existing asset pricing models. Moreover, after controlling for mispricing, value no longer beats growth. Overall, our evidence is consistent with a behavioral explanation of the value premium.     

Can investor-paid credit rating agencies improve the information quality of issuer-paid rating agencies?

This paper examines how the information quality of ratings from an issuer-paid rating agency (Standard and Poor's) responds to the entry of an investor-paid rating agency, the Egan-Jones Rating Company (EJR). By comparing S&P's ratings quality before and after EJR initiates coverage of each firm, I find a significant improvement in S&P's ratings quality following EJR's coverage initiation. S&P's ratings become more responsive to credit risk and its rating changes incorporate higher information content. These results differ from the existing literature documenting a deterioration in the incumbents' ratings quality following the entry of a third issuer-paid agency. I further show that the issuer-paid agency seems to improve the ratings quality because EJR's coverage has elevated its reputational concerns.     

How do share repurchases affect ownership concentration?

We study how share repurchases affect the ownership stake of outside blockholders in 950 publicly-traded US corporations from 1996 through 2001, using a control function approach to address the possible endogeneity of repurchases. We find that share repurchases tend to make outside ownership less concentrated: repurchasing 1% of outstanding common equity decreases the fraction owned by large shareholders by around one and a half percentage points. This may decrease outside shareholders' influence over firm decision-making. Our results are confirmed when we restrict the sample to institutional owners, but not to individual owners.     

Controlling shareholders’ opportunistic use of share repurchases

This study examines how share repurchase and dividend policies are influenced by controlling shareholders in an emerging market. We maintain that the controlling shareholders can utilize share repurchase opportunistically, particularly when they exercise voting rights in excess of cash-flow rights. The evidence of Korean firms suggests that the wedge between the voting rights and cash-flow rights positively affects share repurchases but negatively affects cash dividends. We also find that share repurchases are not always supported by operating performances. The results indicate that firms may utilize share repurchases as a means to pursue private benefits of the controlling shareholders. We also document that share repurchases do not substitute for cash dividends, suggesting that share repurchases are not genuine distributions. Furthermore, we find that the wedge of share repurchases reduces firm value. Overall, our results indicate that the controlling shareholders of Korean firms use share repurchases opportunistically rather than strategically.     

Why do firms issue private equity repeatedly? On the motives and information content of multiple PIPE offerings

This study examines why private equity issues tend to be a repeated source of financing for public firms. We test the recent operational needs theory of public equity issuance within the context of repeated private equity issues. We find that repeated PIPE issuers burn through cash quickly and do not reach the standards of information transparency or profitability needed for a successful public equity offering. This has implications for investor composition and the market response to a PIPE. Initial PIPE offerings are characterized by substantial diversity in investor type. In successive transactions firms increasingly rely upon hedge funds, who extract greater price discounts and more often require cash flow rights as opposed to control rights. As firms select a path of repeated PIPEs to raise funds, successive issues become uninformative to the market. We conclude that, for small public firms, the same motive underlies public equity offerings and repeated private equity offerings—an acute need for cash.     

The market price of risk and the equity premium: A legacy of the Great Depression?

By positing learning and a pessimistic initial prior, we build a model that disconnects a representative consumer's subjective attitudes toward risk from the high price of risk that a rational-expectations econometrician would deduce from financial market data. We follow Friedman and Schwartz [1963. A Monetary History of the United States, 1857-1960. Princeton University Press, Princeton, NJ] in hypothesizing that the Great Depression heightened fears of economic instability. We use a robustness calculation to elicit a pessimistic prior for a representative consumer and let him update beliefs via Bayes’ law. Learning eventually erases pessimism, but while it persists, pessimism contributes a volatile multiplicative component to the stochastic discount factor that a rational-expectation econometrician would detect. With sufficient initial pessimism, the model generates substantial values for the market price of risk and equity premium and predicts high Sharpe ratios and forecastable excess stock returns.     

Does the accruals quality premium arise from information risk?

In this study, we examine whether the accruals quality premium arises from information risk through the following: (i) an investigation of the accruals quality (AQ) premium conditioned by market competition levels; (ii) a test of the impact of an exogenous shock on tax‐loss‐selling incentives; and (iii) an examination of the quality of specific accruals. Consistent with an information risk explanation, we find that the pricing effect of AQ is concentrated in firms with low market competition; that tax‐loss selling is unlikely to explain the observed AQ premium; and that specific accruals quality measures which are more likely to reflect information risk are priced.     

Do firms follow GAAP when they record share repurchases?

This paper examines U.S. firms' accounting for share repurchases and the accounting choice provided to Delaware-incorporated firms between the treasury and retirement methods. This accounting choice does not affect income, cash flows, or net assets, but it nevertheless affects financial reporting transparency and the allocation of equity between retained earnings and contributed capital. According to Generally Accepted Accounting Principles (GAAP), the accounting choice to record share repurchases should reflect management's intended disposition of the repurchased shares. We compare characteristics of Delaware-incorporated treasury and retirement firms and find that the choice between the two accounting methods is not always consistent with GAAP, but neither is it random; rather, this choice is related to a number of firm characteristics including firm growth, industry membership, trading exchange, and price–earnings ratio. We also find that a firm's accounting method for share repurchases is associated with a firm's propensity to make future share repurchases.     

Can stochastic discount factor models explain the cross-section of equity returns?

We propose a multivariate test of the capital asset pricing model (C-CAPM) of the cross-sectional variation in equity returns in which we compare cross-sectional variation in equity returns to the cross-sectional variation in their conditional covariance with stochastic discount factors. We use a multivariate generalized heteroskedasticity in mean model to estimate 25 portfolios that are formed on size and the book-to-market ratio. Each portfolio is allowed to have its own no-arbitrage condition. We find that although the conditional covariances of returns with consumption exhibit negative variation across size, they do not vary across the book-to-market ratio. Thus, C-CAPM can capture the size effect, but not the value effect. The fit is, however, improved by allowing the coefficients on the consumption covariances to be different. The value effect appears to be associated with the book-to-market ratio as well as size. On its own the book-to-market ratio does not generate additional information about average returns to C-CAPM. A possible explanation for these findings is that both small and low book-to-market ratio firms are expected to have higher rates of growth.     

Double signals or single signal? An investigation of insider trading around share repurchases

We examine directors’ dealing activity around share repurchasing periods in Hong Kong. There are significant insider trading activities before the share repurchasing period. Consistent with the signaling hypothesis, the directors’ purchase activities during the share repurchase period are significantly higher than the expected level while the directors’ sale activities are significantly lower than the expected level. Double signals of share repurchase and directors’ purchases create a stronger signal in conveying undervaluation, while insider sales around share repurchase reduces the undervaluation signal. We find some evidence that is consistent with the free cash flow and signaling arguments for share repurchases.     

Is the market underreacting or overreacting to open market share repurchases? A UK perspective

Using UK open market repurchases, we reject the market underreaction hypothesis and the market overreaction hypothesis proposed by Ikenberry et al. (1995) and Peyer and Vermaelen (2009), respectively. The evidence suggests that the UK market reacts slowly to actual repurchases made by value firms. UK repurchases on average do not suffer from share undervaluation prior to the announcement. Value firms perform just as well as glamour firms during the authorisation period but outperform glamour firms significantly 2 years following the announcement. It turns out that value firms repurchase over 6% more shares than glamour firms during the authorisation period.     

Does accounting conservatism improve the corporate information environment?

This study investigates whether and how accounting conservatism improves the corporate information environment. We argue that conservatism facilitates the flow of firm-specific information from corporate insiders to outsiders and leads to a high-quality information environment. Using the Basu (1997) model to capture the extent of accounting conservatism and firm-specific return variation to proxy for the quality of information environment, we find that conservatism is positively associated with the improvement of the corporate information environment in our sample of 43 countries. We also find that the information role of conservatism is more pronounced in countries with weaker protection of private property rights, suggesting that conservatism substitutes for legal institutions in ensuring the quality of information environment.     

Can exchange rate volatility explain persistence in the forward premium?

The persistence of the forward premium has been cited both as evidence of the failure of the unbiasedness hypothesis and as rationale for the forward premium anomaly. This paper examines the recent proposition that forward premium persistence can be explained solely by the conditional variance of the spot rate. We provide theoretical and empirical evidence to challenge this proposition. Our empirical results are shown to be robust to the presence of structural breaks. A corollary of the results is that the ‘true’ risk premium contains a long memory component. This is non-standard and has implications for the construction of rational expectations models of the foreign exchange market.     

Insider trading and share repurchases: Do insiders and firms trade in the same direction?

Signaling undervaluation is often considered a primary motive for repurchasing stock, but insider trading activity by repurchasing firms is not always consistent with undervaluation. Net insider buying and selling are both more frequent in quarters when firms are repurchasing non-trivial amounts of stock, with the odds of observing a repurchase the highest in quarters with net insider selling. In multinomial logit models, share repurchases associated with net insider selling are positively related to illiquidity, option exercises by insiders, and pre-repurchase returns and negatively correlated with industry-adjusted book to market ratios when compared to other repurchases. Hence, repurchases when insiders are selling stock are more likely done to support share prices or avoid dilution and are less likely undervaluation signals. We find that insider trades either validate or mitigate the undervaluation signal of the repurchase. Abnormal returns of repurchasing firms with net insider buying versus net insider selling in a given quarter are significantly higher for the quarter immediately after the repurchase and the three subsequent years. For repurchases accompanied by net insider selling, abnormal returns are negligible after only one year.     

What’s in the news? The ambiguity of the information content of index reconstitutions in Germany

We analyze stock price behavior around reconstitutions of the German DAX index family from 1990 to 2013. The strong price run-up of added stocks in the 2 months preceding the announcement date remains robust until 2 months after the effective date (ED), and is fully reversed 5 months later. Conversely, stock prices of deleted firms are under pressure until 10 months after the ED. Unlike most previous studies, we find that outright entries and exits have temporary price effects, as do additions to and deletions from better-known indices; however, promotions and demotions related to lesser-known indices command permanent stock price responses. Rather surprisingly, deleted stocks consistently earn higher abnormal returns than added stocks in the 5-year post-event period. Specifically, the return differential levels out at 77.3%. We establish that this differential in permanent stock prices is attributable to differences in operating performance and media coverage. In practice, index reconstitutions do not appear to give unambiguous signals about the long-run investment appeal of affected firms. However, index fund managers not constrained by tracking error minimization would be better off holding deleted stocks for 5 years after the ED.     

Does model complexity improve pricing accuracy? The case of CoCos

Review of Derivatives Research - In this study, we analyze whether model complexity improves accuracy of CoCo pricing models. We compare the out-of-sample pricing ability of four models using a...     

Does insider trading have information content for the bond market?

This study documents that there is significant information content in stock trading by registered corporate insiders for the bond market. We report significant positive price reactions for convertible and straight bonds in response to the Wall Street Journal's Insider Trading Spotlight publication of insider buy transactions and significant negative reactions for insider sell transactions. The stock market response to the publication of the insider transactions, although weaker than the bond market reaction, is also found to be significant. Cross-sectional results suggest that bond market participants extract the quality of the insider-trading signal by observing factors such as the dollar volume of the trade, the percentage change in the holding of the insider, and the insider's position in the firm. Lower-rated (riskier) bonds are found to be more sensitive to the information than higher-rated issues. The empirical evidence presented in this paper suggests that the absence of any reporting requirement for insider bond transactions may create aan enhanced opportunity for the insiders to exploit private information to expropriate wealth from uninformed bond traders.