Who is the more overconfident trader? Individual vs. institutional investors

Guided by the Gervais and Odean (2001) overconfident trading hypothesis, we comprehensively investigate the trading behavior of individual vs. institutional investors in Taiwan in an attempt to identify who is the more overconfident trader. Conditional on the various states of the market, on market volatility, and on the risk level of the securities they trade, we find that both individual and institutional investors trade more aggressively following market gains in bull markets, in up-market states, in up-momentum market states, and in low-volatility market states and that only individual investors trade more in riskier securities following market gains. More importantly, we find that individual investors trade more aggressively following market gains in the three conditional states of the market and in high-volatility market states than institutional investors. Also, individual investors trade more in relatively riskier securities following gains than institutional investors. These findings provide evidence that individual investors are more overconfident traders than institutional investors.     

Who makes on-the-run Treasuries special?

The most recently issued, on-the-run, Treasuries are extremely liquid and frequently trade at a premium in both the cash and repo, or financing, markets. Previous research suggests that both the cash and repo premiums reflect demand from buy-and-hold investors who value the superior liquidity of these securities and are reluctant to lend them in the repo market. We find evidence that premiums in the repo market are also closely related to market participants’ demand to hedge interest rate risk associated with their holdings of fixed income securities.     

Who benefits more from international diversification?

This paper investigates the relative magnitude of the international diversification benefits for the domestic investors in various countries. The constraints of short-sales, over-weighting investments, and investing region are considered. The empirical results suggest that local investors in the less developed countries, particularly in East Asia and Latin America, comparatively benefit more from both regional and global diversification. This finding holds even though the international market has become more integrated so that the diversification benefits have decreased over the past two decades. The results are useful for asset management professionals to determine target markets to promote the business of national/international funds.     

Foreign exchange customers and dealers: Who’s driving whom?

This paper tests the theoretical assumption of the foreign exchange market microstructure that dealers and non-dealer customers interact over discrete trading rounds. An exhaustive frequency-domain analysis reveals that the interaction is limited and mainly due to the instability of financial markets. The principal finding is that the trading activity of dealers is able to predict the customer order flow at low frequencies with wavelengths longer than roughly a week. In all, the evidence shows that non-financial customers are not as passive as some other research has suggested.     

Who makes acquisitions? CEO overconfidence and the market's reaction

Does CEO overconfidence help to explain merger decisions? Overconfident CEOs over-estimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs’ personal over-investment in their company and their press portrayal. We find that the odds of making an acquisition are 65% higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (-90$-90$ basis points) is significantly more negative than for non-overconfident CEOs (-12$-12$ basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.     

Who really makes the big decisions in your company?

In many companies, the top management team is officially responsible for helping the CEO make a company's big decisions. But another, unofficial group usually does that job de facto. That's the way it should be, argues Frisch, of the Strategic Offsites Group, provided that the CEO is deliberate in devising the role of this informal and unnamed "kitchen cabinet." Problems can nevertheless arise when senior executives learn about important decisions after the fact, mistakenly assume that they have real power to protect their departments, and find themselves in a system where the way decisions are actually made goes unacknowledged. The key, according to Frisch, is to make better use of senior executives' time and talents by giving them specific responsibilities that complement--but do not overlap--the advisory duties of the kitchen cabinet. A CEO who explicitly acknowledges the role of her cabinet and strikes the right balance between it and her official advisory group of executives can get the best from both.     

Should more local governments purchase a bond rating?

We investigate whether issuers that choose to forgo a bond rating suffer an interest cost penalty greater than the cost of the rating. We use estimated ratings provided by Moody’s Investor Service to proxy for what the rating would have been if it had been purchased. We find that the primary factors associated with an issuer’s decision to purchase a rating are the rating expected by the issuer and the extent to which an issue is marketed locally. After controlling for self-selection bias, we find that the issuers that forgo a rating do not suffer an interest cost penalty.

Global financial shocks and foreign asset repatriation: Do local investors play a stabilizing role?

We study the dynamic response of gross capital flows in emerging market economies to different global financial shocks, using a panel vector-autoregressive (PVAR) approach. Our focus lies primarily on the potentially stabilizing role played by domestic investors in offsetting the response of foreign investors to adverse global shocks. We find that, while foreign investors tend to retrench from emerging markets in response to global risk aversion and monetary policy shocks, foreign asset repatriation by resident investors does not always follow suit. Local investors play a meaningful stabilizing role in the face of global risk aversion shocks, with sizeable asset repatriation largely offsetting the retrenchment of non-residents. In contrast, foreign investor retrenchment in response to global monetary policy shocks is not mirrored by asset repatriation. Finally, we find robust evidence that positive global real shocks tend to have a positive impact on net capital inflows to emerging markets. Our results shed light on the likely impact of the Fed's QE tapering on capital flows to emerging market economies.     

Information interpretation or information discovery: which role of analysts do investors value more?

This study provides evidence that a significant percentage of analyst forecast revisions are issued promptly after a broad set of corporate public disclosures and that investors perceive these prompt revisions as more valuable than nonprompt revisions. These results hold for all revisions, revisions outside of the earnings announcement window, or revisions in weeks preceding the earnings announcements and are also robust to various sensitivity tests. Investors particularly value analysts?? prompt interpretation of earnings announcements, Form 8-K filings, or certain qualitative news. To the extent that prompt revisions are more likely to reflect analysts?? information interpretation role, our results suggest that investors value more highly analysts?? ability to interpret public disclosures, especially less structured or non-financial disclosures, than their ability for information discovery.     

The more the better? Foreign ownership and corporate performance in China

We examine the relationship between the degree of foreign ownership and performance of recipient firms, using a panel of 21,582 Chinese firms over the period 2000–2005. We find that joint-ventures perform better than wholly foreign-owned and purely domestic firms. Although productivity and profitability initially rise with foreign ownership, they start declining once it reaches a certain point. This suggests that some domestic ownership is necessary to ensure optimal performance. We referred these findings to a model of a joint-venture, where strategic interactions between a foreign and a domestic owner's inputs may lead to an inverted U-shaped ownership–performance relationship.     

Measuring investors’ assessment of earnings persistence: do investors see through smoothed earnings?

Prior studies document that investors value persistent earnings more than transitory earnings. This argument offers incentives to managers to smooth their reported earnings and make them look more persistent. This study examines whether investors are misled by management’s income-smoothing behavior and whether they can correctly assess the persistence of smoothed earnings. Using a simple theoretical model, this paper shows that investors’ assessment of earnings persistence can be derived from their reactions to reported earnings, which is the ratio of the coefficient on earnings change relative to the coefficient on earnings level in the return–earnings relation. Empirical results show that investors’ assessment of earnings persistence is negatively associated with the level of income smoothing after controlling for time-series persistence of earnings and hence suggest that investors understand that the high persistence of smoothed earnings is not real and they discount the persistence of smoothed earnings when they react to such earnings news.     

Who moves the stock market in an emerging country – Institutional or retail investors?

By analyzing the dynamic behavior of institutional and retail investors in the Indonesia Stock Exchange using their completed transactions (comprising over 250 million observations), this study highlights that their trading strategies and behavior, in which institutions play a more important role than individuals in the market, are indeed different. Specifically, past trading activities by individual (institutional) investors have significantly affected the current trading behaviors and strategies of individual investors (both investor types). Furthermore, retail (institutional) investors are most likely to perform contrarian (momentum) strategies and trade frequently (infrequently) with small (large) amounts of money and short (long) holding periods.     

How do US investors perceive the risk of local political corruption? Evidence from acquisition announcement

This study examines the impact of local political corruption on investors’ evaluation of firms’ mergers and acquisitions (M&As) in the US. Using the number of corruption convictions of government officials reported by the US Department of Justice, we find that acquirers in more corrupt court districts experience lower acquirer announcement returns, lower combined acquirer and target announcement returns, and are less likely to complete acquisitions. We further find that the relation between local political corruption and acquirer announcement returns is worsened when acquirers operate primarily in the headquarters state. Overall, the results suggest that local political corruption has an adverse impact on investors’ evaluation of a firm’s M&A profitability.     

Do local analysts know more? A cross-country study of the performance of local analysts and foreign analysts

This paper examines whether analysts resident in a country make more precise earnings forecasts for firms in that country than non-resident analysts. Using a sample of 32 countries, we find an economically and statistically significant local analyst advantage even after controlling for firm and analyst characteristics. The local advantage is high in countries where earnings are smoothed more, less information is disclosed by firms, and firm idiosyncratic information explains a smaller fraction of stock returns. It is negatively related to whether a firm has foreign assets and to market participation by foreign investors and by institutions, and positively related to holdings by insiders. The extent to which U.S. investors underweight a country's stocks is positively related to that country's local analyst advantage.     

How do global investors differentiate between sovereign risks? The new normal versus the old

When global investors go into emerging markets or get out of them, how do they differentiate between economies? Has this behavior changed since the crisis of 2008 to reflect a “new normal”? We consider these questions by focusing on sovereign risk as reflected in monthly returns on credit default swaps (CDS) for 18 emerging markets and 10 developed countries. Tests for breaks in the time series of such returns suggest a new normal that ensued around October 2008 or soon afterwards. Dividing the sample into two periods and extracting risk factors from CDS returns, we find an old normal in which a single global risk factor drives half of the variation in returns and a new normal in which that risk factor becomes even more dominant. Surprisingly, in both the old and new normal, the way countries load on this factor depends not so much on economic fundamentals as on whether they are designated an emerging market.     

Who gets to the top? Generalists versus specialists in managerial organizations

We study organizations with individuals whose expertise differ in content and breadth. For example, specialists have deeper expertise than generalists, but in fewer areas. Difficulties in communication depend on who communicates with whom. Our analysis, which is consistent with several empirical findings, shows that: (i) an organization is more valuable and its leader has broader expertise if it is more complex, faces more unpredictability, or communication technologies improve; (ii) those higher in multilayered hierarchies have broader expertise; and (iii) any one‐dimensional concept (e.g., talent) cannot explain the assignment of different individuals to different levels in hierarchies.     

Do locals know better? A comparison of the performance of local and foreign institutional investors

We compare the performance of local versus foreign institutional investors using a comprehensive data set of equity holdings in 32 countries during the 2000–2010 period. We find that foreign institutions perform as well as local institutions on average, but only domestic institutions show a trading pattern consistent with an information advantage. Our results suggest a smart-money effect of local institutions in countries subject to higher information asymmetry, non-English speaking countries, countries with less efficient stock markets, with poor investor protection, or high levels of corruption. The local advantage is more pronounced in periods of market turmoil and in illiquid stocks.     

Does non-interest income make banks more risky? Retail- versus investment-oriented banks

In this paper, we show that the impact of non-interest income on bank risk differs between retail- and investment-oriented banks. More specifically, while retail-oriented banks such as savings, cooperative and other banks that focus on lending and deposit-taking services become significantly more stable (in the sense of having a higher Z-score) if they increase their share of non-interest income, investment-oriented banks become significantly more risky. They do not only generate a higher share of their income from non-traditional activities, but also engage in significantly different activities from retail-oriented banks. This might limit the potential benefits to investment-oriented banks of diversifying into non-interest income. Overall, therefore, our paper implies that it is important to distinguish between retail- and investment-oriented banks when drawing general conclusions regarding the impact of non-interest income on bank risk.