Investor sentiment and calendar anomaly effects: A case study of the impact of Ramadan on Islamic Middle Eastern markets

The holy month of Ramadan is usually a time of celebration and renewal in Muslim countries. This paper examines whether or not this is reflected in positive calendar anomalies effects in Islamic Middle Eastern stock markets during the period 1992-2007. Strong evidence is found of significant and positive calendar effects in respect to the whole period of Ramadan in most countries and it is argued that this can be attributed to the generally positive investor mood, or sentiment. Although Ramadan is a time of celebration for Muslims it also can be a time of uncertainty and this appears to result in the impact of the festival not being uniformly positive throughout Ramadan. It is found that market returns in the first and last days of Ramadan show high levels of statistically significant year-on-year variation. It is argued that this can possibly be attributed to synchronization-related herding effects amplifying the impact of the mood swings associated with this period. The paper also finds that although the overall Ramadan effect is both positive and statistically significant for most countries, the associated gains were only large enough to outweigh transactions costs and provide the basis of a profitable trading strategy in one market.     

Fast profits: Investor sentiment and stock returns during Ramadan

Observed by more than 1.5 billion Muslims, Ramadan is one of the most celebrated religious traditions in the world. We investigate stock returns during Ramadan for 14 predominantly Muslim countries over the years 1989-2007. The results show that stock returns during Ramadan are significantly higher and less volatile than during the rest of the year. No discernible declines in market liquidity are recorded. We find these results consistent with a notion that Ramadan positively affects investor psychology, as it promotes feelings of solidarity and social identity among Muslims world-wide, leading to optimistic beliefs that extend to investment decisions.     

Seasonality in stock returns and volatility: The Ramadan effect

Calendar anomalies in stock returns are well documented. Less obvious is the existence of seasonality in return volatility associated with moving calendar events such as the Muslim holy month of Ramadan. Using a GARCH specification and data for the Saudi Arabian stock market – now the largest stock market in the Muslim world – this paper documents a systematic pattern of decline in volatility during Ramadan, implying a predictable variation in the market price of risk. An examination of trading data shows that this anomaly appears to be consistent with a decline in trading activity during Ramadan. Evidence of systematic decline in volatility during Ramadan has significant implications for pricing of securities especially option-like products and asset allocation decisions by investors in the Islamic countries.     

The impact of religious practice on stock returns and volatility

With a psychological and behavioral perspective, this paper examines whether religious practice, through its influence on investors' moods and emotions, affect the behavior of the stock markets and investors in 15 Islamic countries over the period December 31, 2005 to December 31, 2015 and over four sub-periods (before and after both the global financial crisis and the Arab spring). The results indicate that volatility decreases during the month of Ramadan and is significantly different from the volatility observed in the other 11 months of the Islamic calendar year in most Muslim countries. We also identify that changes in stock returns and volatility during the month of Ramadan are related to religious practice and not due to the global financial crisis or the Arab spring. The findings significantly improve the understanding of the role of religious practice on stock market behavior and as such may be of great interest to investors and market regulators.     

East meets West: When the Islamic and Gregorian calendars coincide

Recent research has documented that at the time of religious celebrations in Muslim countries, such as Ramadan, there is a “festival” effect in share returns. In the Gregorian calendar, December is also a time of celebration and festivities which may be associated with patterns in the behaviour of security prices. Further, the first month of the year in the Islamic calendar, Muharram, is a time of sadness and mourning for some believers, and there may be an effect when the Islamic first month of the year overlaps with the first month of the Gregorian year - January. Over a 33-year cycle, each Islamic month falls in a Gregorian month for about 5–6 consecutive years; when this happens, an Islamic (Eastern) calendar effect may interact with a Gregorian (Western) calendar effect. The current paper addresses this issue by examining the behaviour of share returns and volatility for individual companies listed in Muslim countries’ stock exchanges when the two calendars coincide for: (i) religious festival effects; (ii) first-month-of-the-year effects; and (iii) the two most common effects reported in the Islamic and Gregorian calendars (Ramadan and January). The results show that the Western and Eastern effects interact more prominently in larger companies and in larger or more developed markets.     

Tests of the multiperiod two-parameter model

Although investors face multiperiod decision problems, there are conditions under which the results of the one-period two-parameter model apply period by period. In addition to the assumptions made in the development of the two-parameter model itself (a perfect capital market, investor risk aversion, and normal distributions of one-period portfolio returns), the critical assumption in a multiperiod context is that, for any t, returns on portfolio assets from t?1 to t are independent of stochastic elements of the state-of-the-world at time t that affect investor tastes for given levels of wealth to be obtained at t.One such element of the state-of-the-world is the nature of investment opportunities to be available at t. For example, if the level of expected returns on investment portfolios to be available at time t is uncertain at time t?1, and if the returns from t?1 to t on some investment assets are more strongly related to the level of expected returns at t than returns on other assets, then the former assets are better vehicles for hedging against the level of expected returns at t. This can affect the demands for assets and their prices in such a way that the simple results of the one-period two-parameter model do not hold.The empirical tests of this paper reveal no evidence of measurable relationships between the returns on portfolio assets from t?1 to t and the level of expected returns to be available at t. Indeed, in our opinion there is no reliable evidence that the level of expected returns changed during the 1953–1972 period.     

The wandering weekday effect in major stock markets

This paper reports a wandering weekday effect: the pattern of day seasonality in stock market returns is not fixed, as assumed in the Monday or weekend effects, but changes over time. Analysing daily closing prices in eleven major stock markets during 1993–2007, our results show that the wandering weekday is not conditional on average returns in the previous week (the “twist” in the Monday effect). Nor does it diminish through the period of analysis. The results have important implications for market efficiency, and help to reconcile mixed findings in previous studies, including the reported disappearance of the weekday effect in recent years.     

When does the dividend–price ratio predict stock returns?

If the dividend–price ratio becomes I(1) while stock returns are I(0), the unbalanced predictive regression makes the predictability test more likely to indicate that the dividend–price ratio has no predictive power. This might explain why the dividend–price ratio evidences strong predictive power during one period, while it exhibits weak or no predictive power at other times. Using international data, this paper demonstrates that the dividend–price ratio generally has predictive power for stock returns when both are I(0). However, this paper also shows that the dividend–price ratio loses its predictive power when it becomes I(1). The results are shown to be robust across countries.     

Is VIX an investor fear gauge in BRIC equity markets?

This study examines the intertemporal relationships between CBOE market volatility index (VIX) and stock market returns in Brazil, Russia, India, and China (BRIC), and between VIX and U.S. stock market returns, to uncover if VIX serves as an investor fear gauge in BRIC and U.S. markets. We conduct the VIX-returns analysis for the 1993–2007 period.Our results suggest a strong negative contemporaneous relation between daily changes (innovations) in VIX and U.S. stock market returns. This relation is stronger when VIX is higher and more volatile. A significant negative contemporaneous relation between VIX and equity returns also exists for China and Brazil during 1993–2007 and for India during 1993–1997. Similar to the U.S. market, the immediate negative relation between the Brazilian stock returns and VIX changes is much stronger when VIX is both high and more volatile. Our results also indicate a strong asymmetric relation between innovations in VIX and daily stock market returns in U.S., Brazil, and China, suggesting that VIX is more of a gauge of investor fear than investor positive sentiment. However, the asymmetric relationship between stock market returns and VIX is much weaker when VIX is large and more volatile. These results have potential implications for portfolio diversification and for stock market and option trading timing in the equity markets of Brazil, India, and China. Overall, our results indicate that VIX is not only an investor fear gauge for the U.S. stock market but also for the equity markets of China, Brazil, and India.     

Portfolio Returns,Market Volatility,and Seasonality

This paper examines three important issues related to the relationship between stock returns and volatility. First, are Duffee's (1995) findings of the relationship between individual stock returns and volatility valid at the portfolio level? Second, is there a seasonality of the market return volatility? Lastly, do size portfolio returns react symmetrically to the market volatility during business cycles? We find that the market volatility exhibits strong autocorrelation and small size portfolio returns exhibit seasonality. However, this phenomenon is not present in large size portfolios. For the entire sample period of 1962–1995, the highest average monthly volatility occurred in October, followed by November, and then January. Examining the two sub-sample periods, we find that the average market volatility increases by 15.4% in the second sample period of 1980–1995 compared to the first sample period of 1962–1979. During the contraction period, the average market volatility is 60.9% higher than that during the expansion period. Using a binary regression model, we find that size portfolio returns react asymmetrically with the market volatility during business cycles. This paper documents a strongly negative contemporaneous relationship between the size portfolio returns and the market volatility that is consistent with the previous findings at the aggregate level, but is inconsistent with the findings at the individual firm level. In contrast with the previous findings, however, we find an ambiguous relationship between the percentage change in the market volatility and the contemporaneous stock portfolio returns. This ambiguity is attributed to strongly negative contemporaneous and one-month ahead relationships between the market volatility and portfolio returns.

     

Liquidity and expected returns—Evidence from 1926–2008

This paper re-examines the liquidity effect on stock expected returns in the NYSE over the period 1926–2008, the pre-1963 period, for which there is a lack of research, and the post-1963 period. The results from the entire sample of 1926–2008 show that expected returns increase with the stock level illiquidity. However, illiquidity level has explanatory power in the cross-sectional variation of stock expected returns only over the post-1963 period, and is, both economically and statistically, insignificant for the whole sample and the pre-1963 period. These findings are robust after taking into account various characteristics such as size and risk controls. On the other hand, evidence from the entire sample and the pre-1963 sample suggests that the systematic liquidity risk plays a significant role in the cross-sectional variation of stock expected returns. The different result for the pre- and post-1963 is explained by the portfolio shifts occurred during the economic downturns.     

Using industry momentum to improve portfolio performance

Minimum-variance portfolios, which ignore the mean and focus on the (co)variances of asset returns, outperform mean–variance approaches in out-of-sample tests. Despite these promising results, minimum-variance policies fail to deliver a superior performance compared with the simple 1/N rule. In this paper, we propose a parametric portfolio policy that uses industry return momentum to improve portfolio performance. Our portfolio policies outperform a broad selection of established portfolio strategies in terms of Sharpe ratio and certainty equivalent returns. The proposed policies are particularly suitable for investors because portfolio turnover is only moderately increased compared to standard minimum-variance portfolios.     

IPO or SBO?: The Increasing Importance of Operational Performance for Private Equity Exits Following the Global Financial Crisis of 2007–08

The authors report the findings of their recent study of the role of portfolio company operating performance in determining the choice of exit options by private equity firms between initial public offerings (IPOs) and secondary buyouts (SBOs), and how that role may have changed since the Global Financial Crisis of 2007–2008. Virtually all studies of PE exits in all countries have found that portfolio companies that exit through IPOs tend to be larger and have higher operating returns than companies that exit through SBOs or sales to other companies. After examining the exits of PE portfolio companies based in Denmark and Sweden during the period 2003–2013, the authors report that, although general market conditions continue to be a major factor, operating performance and size have become even more important requirements for IPO exits since the crisis. And thus PE firms that fail to make operating improvements in their portfolio companies are likely to find their exit options limited.     

On the distribution and conditional heteroscedasticity in Taiwan stock prices

This paper studies the distribution and conditional heteroscedasticity in stock returns on the Taiwan stock market. Apart from the normal distribution, in order to explain the leptokurtosis and skewness observed in the stock return distribution, we also examine the Student-t, the Poisson–normal, and the mixed-normal distributions, which are essentially a mixture of normal distributions, as conditional distributions in the stock return process. We also use the ARMA (1,1) model to adjust the serial correlation, and adopt the GJR–generalized autoregressive conditional heteroscedasticity (GARCH (1,1)) model to account for the conditional heterscedasticity in the return process. The empirical results show that the mixed–normal–GARCH model is the most probable specification for Taiwan stock returns. The results also show that skewness seems to be diversifiable through portfolio. Thus the normal–GARCH or the Student-t–GARCH model which involves symmetric conditional distribution may be a reasonable model to describe the stock portfolio return process¹.     

Dynamic correlations and volatility linkages between stocks and sukuk: Evidence from international markets

An understanding of volatility and co-movements in financial markets is important for portfolio allocation and risk management practices. The current financial crisis caused a shrinkage in values of most assets, an increased volatility and a threat to the survival of several institutional investors. Managing risks and returns within the classic portfolio theory, when correlations across securities soar, is increasingly challenging. In this paper, we investigate the volatility behavior and the co-movements between sukuk and international stock indexes. Symmetric multivariate GARCH models with dynamic conditional correlations (DCC) were estimated under Student-t distribution. We provide evidence of high correlations between sukuk and US and EU stock markets, without finding the well-known flight to quality behavior affecting Islamic bonds. We also show that volatility linkages between sukuk and regional market indexes are higher during financial crisis. We argue that investors could obtain diversification benefits including sukuk in a well-diversified equity portfolio, given their lower volatility compared to equity. But higher volatility linkages and dynamic correlations during financial crises show that they are hybrid instruments between bonds and equity. Our findings are relevant for institutional investors and asset managers that include Islamic bonds in a diversified portfolio.     

Hedge fund allocation: Evaluating parametric and nonparametric forecasts using alternative portfolio construction techniques

We propose a model for constructing Asian funds of hedge funds. We compare the accuracy of forecasts of hedge fund returns using an ordinary least squares (OLS) regression model, a nonparametric regression model, and a nonlinear nonparametric model. We backtest to assess these forecasts using three different portfolio construction processes: an “optimized” portfolio, an equally-weighted portfolio, and the Kelly criterion-based portfolio. We find that the Kelly criterion is a reasonable method for constructing a fund of hedge funds, producing better results than a basic optimization or an equally-weighted portfolio construction method. Our backtests also indicate that the nonparametric forecasts and the OLS forecasts produce similar performance at the hedge fund index level. At the individual fund level, our analysis indicates that the OLS forecasts produce higher directional accuracy than the nonparametric methods but the nonparametric methods produce more accurate forecasts than OLS. In backtests, the highest information ratio to predict hedge fund returns is obtained from a combination of the OLS regression with the Fung–Hsieh eight-factor variables as predictors using the Kelly criterion portfolio construction method. Similarly, the highest information ratio using forecasts generated from a combination of the nonparametric regression using the Fung–Hsieh eight-factor model variables is achieved using the Kelly criterion portfolio construction method. Simulations using risk-adjusted total returns indicate that the nonparametric regression model generates superior information ratios than the analogous backtest results using the OLS. However, the benefits of diversification plateau with portfolios of more than 20 hedge funds. These results generally hold with portfolio implementation lags up to 12 months.     

Tukey’s transformational ladder for portfolio management

Over the past half-century, the empirical finance community has produced vast literature on the advantages of the equally weighted Standard and Poor (S&P 500) portfolio as well as the often overlooked disadvantages of the market capitalization weighted S&P 500’s portfolio (see Bloomfield et al. in J Financ Econ 5:201–218, 1977; DeMiguel et al. in Rev Financ Stud 22(5):1915–1953, 2009; Jacobs et al. in J Financ Mark 19:62–85, 2014; Treynor in Financ Anal J 61(5):65–69, 2005). However, portfolio allocation based on Tukey’s transformational ladder has, rather surprisingly, remained absent from the literature. In this work, we consider the S&P 500 portfolio over the 1958–2015 time horizon weighted by Tukey’s transformational ladder (Tukey in Exploratory data analysis, Addison-Wesley, Boston, 1977): \(1/x^2,\,\, 1/x,\,\, 1/\sqrt{x},\,\, \text {log}(x),\,\, \sqrt{x},\,\, x,\,\, \text {and} \,\, x^2\), where x is defined as the market capitalization weighted S&P 500 portfolio. Accounting for dividends and transaction fees, we find that the 1/\(x^2\) weighting strategy produces cumulative returns that significantly dominate all other portfolio returns, achieving a compound annual growth rate of 18% over the 1958–2015 horizon. Our story is furthered by a startling phenomenon: both the cumulative and annual returns of the \(1/x^2\) weighting strategy are superior to those of the 1 / x weighting strategy, which are in turn superior to those of the \(1/\sqrt{x}\) weighted portfolio, and so forth, ending with the \(x^2\) transformation, whose cumulative returns are the lowest of the seven transformations of Tukey’s transformational ladder. The order of cumulative returns precisely follows that of Tukey’s transformational ladder. To the best of our knowledge, we are the first to discover this phenomenon.     

International diversification and risk of multinational banks: Evidence from the pre-crisis period

The recent financial crisis has clearly shown that the relationship between bank internationalization and risk is complex. Multinational banks can benefit from portfolio diversification, reducing their overall riskiness, but this effect can be offset by incentives going in the opposite direction, leading them to take on excessive risks. Since both effects are grounded on solid theoretical arguments, the answer of what is the actual relationship between bank internationalization and risk is left to the empirical analysis. In this paper, we study such relationship in the period leading to the financial crisis of 2007–2008. For a sample of 384 listed banks from 56 countries, we calculate two measures of risk for the period from 2001 to 2007 – the expected default frequency (EDF), a market-based and forward-looking indicator, and the Z-score, a balance-sheet-based and backward-looking measure – and relate them to the degree of banks’ internationalization. We find robust evidence that international diversification increases bank risk.     

Portfolio Selection and Optimization with Higher Moments: Evidence from the Indian Stock Market

The Markowitz portfolio optimization model, popularly known as the Mean-Variance model, assumes that stockreturns follow normal distribution. But when stock returns do not follow normal distribution, this model wouldbe inadequate as it would prescribe sub-optimal portfolios. Stock market literature often deliberates that stock returns are non-normal. In such context the Markowitz model would not be sufficient to estimate the portfolio risks. The purpose of this paper is to expand the original Markowitz portfolio theory (mean-variance) via adding the higher order moments like skewness (third moment about the mean) and kurtosis (fourth moment about the mean) in the return characteristics. The research paper investigates the impact of including higher moments using multi-objective programming model for portfolio stock selection and optimization. The empirical results indicate that the inclusion of higher moments had a considerable impact in estimating the returns behavior of portfolios. The portfolios optimized using all the four moments, generated higher returns for the given level of risk in comparison to the returns of the Markowitz model during the study period 2000–2011. The results of this study would be immensely useful to fund managers, portfolio managers and investors as it would help them in understanding the Indian stock market behavior better and also in selecting alternative portfolio selection models.