Robustness of size and value effects in emerging equity markets, 1985–2000

We examine the robustness of size and book-to-market effects in 35 emerging equity markets during 1985–2000. Mean returns for high book-to-market firms significantly exceed mean returns for low book-to-market firms. These findings are robust to tests that control for size effects and that remove extreme returns. Similarly, mean returns for small firms exceed mean returns for large firms. But, the firm size results lack robustness to the removal of extreme returns. Moreover, significant size effects are found in tests that define firm size relative to the local market average, but generally are not found in tests that use absolute firm size. Our findings are confirmed by cross-sectional regressions that control for systematic risk at the global and local levels.     

Arbitrage risk and the cross-section of stock returns: Evidence from China

We demonstrate that arbitrage risk, constructed using three measures — noise trader risk, trading cost and information uncertainty — can predict the return of stocks cross-sectionally in China. The findings are broadly consistent even when out-of-sample tests are conducted using the Fama-MacBeth cross-sectional regression approach. We also construct hypothetical portfolios using the information arising from arbitrage risk and find the existence of abnormal returns which is robust to the use of various portfolios constructed by re-sampling the observations through multiple approaches (e.g., by market capitalization and by book-to-market ratio). Lastly, we reconstruct our portfolios by considering the unique nature of the Chinese stock market (e.g., the dominance of individual investors). Our trading strategies again successfully obtain abnormal returns, suggesting that arbitrage risk can be useful to construct effective investment portfolios in China.     

Unintended investor sentiment on bank financial products: Evidence from China

Investor sentiment on bank financial products (BFPs) is commonly overlooked. However, given the implementation of regulatory policies and the development of Internet financial market, investor sentiment on BFPs has become increasingly important in China since 2013. This paper constructs investor sentiment on BFPs, based on six proxies that reflect market liquidity, transaction status, market activity, and industry development. We contribute to the literature by finding the comovement of the investor sentiment on BFPs and the returns, and by demonstrating the spillover effects from bank financial markets to related markets from the perspective of the investor sentiment on BFPs.     

Internet Search Intensity and Its Relation with Trading Activity and Stock Returns*

Using Google search volume as a proxy for investor attention, this paper provides evidence on the role attention plays in financial markets. We first show that abnormal Google search volume (ASVI) helps explain cross‐sectional variations in trading activity, even after controlling for its important determinants. Specifically, ASVI is positively related to trading volume, order imbalance and liquidity. When the relation between stock returns and ASVI is examined, we find a strong positive relation in the month after attention shocks and a reversal over a longer holding period. We further conjecture that the attention effect is more pronounced in stocks with higher limits to arbitrage. For this purpose, we construct a limits‐to‐arbitrage index and show that limits to arbitrage play an important role in explaining the attention effect.     

Integration and arbitrage in the Spanish financial markets: An empirical approach*

Several authors have introduced different ways to measure integration between financial markets. Most of them are derived from the basic assumptions about asset prices, like the Law of One Price or the absence of arbitrage opportunities. Two perfectly integrated markets must give identical prices to identical final payoffs, and a vector of positive discount factors, common to both markets, must exist. If these properties do not hold, the degree to which they are violated can be defined and considered as a measure of integration. The present paper empirically tests integration measures in the Spanish financial markets. Furthermore, the integration measures are operationalized to analyze the presence of cross‐market arbitrage without previously specifying the exact nature of the arbitrage strategy to be used. When the absence of arbitrage holds, several interesting variables are obtained, for instance, state prices or risk‐neutral probabilities. When this absence fails, explicit cross‐market arbitrage portfolios are provided. The results of the test yield some evidence about market efficiency and integration outside the United States, and they are surprising for several reasons. First of all, arbitrage opportunities do sometimes appear, and the bid–ask spread and transaction costs seem to be unable to prevent arbitrage profits. Furthermore, the criticisms that are usually raised when empirical papers show the existence of arbitrage opportunities do not apply here because we work with perfectly synchronized high frequency data. On the other hand, different integration measures show a similar evolution along the tested period, although these measures give different information about the markets’ efficiency and integration, and they do not necessarily have to be related. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20: 321–344, 2000     

Dispersion in Analysts’ Earnings Forecasts and Market Efficiency

Recent studies show that firms with higher analysts’ earnings forecasts dispersion subsequently have lower returns than firms with lower forecasts dispersion. This paper evaluates alternative explanations for the dispersion–return relation using a stochastic dominance approach. We aim to discriminate between the hypothesis that some asset pricing models can explain the puzzling negative relation between dispersion and stock returns, and the alternative hypothesis that the dispersion effect is mainly driven by investor irrationality and thus is an evidence of a failure of efficient markets. We find that low dispersion stocks dominate high dispersion stocks by second‐ and third‐order stochastic dominance over the period from 1976 to 2012. Our results imply that any investor who is risk‐averse and prefers positive skewness would unambiguously prefer low dispersion stocks to high dispersion stocks. We conclude that the dispersion effect is more likely evidence of market inefficiency, rather than a result of omitted risk factors.     

Semi‐efficient valuations and put‐call parity

We propose an approach to the valuation of payoffs in general semimartingale models of financial markets where prices are nonnegative. Each asset price can hit 0; we only exclude that this ever happens simultaneously for all assets. We start from two simple, economically motivated axioms, namely, absence of arbitrage (in the sense of NUPBR) and absence of relative arbitrage among all buy‐and‐hold strategies (called static efficiency). A valuation process for a payoff is then called semi‐efficient consistent if the financial market enlarged by that process still satisfies this combination of properties. It turns out that this approach lies in the middle between the extremes of valuing by risk‐neutral expectation and valuing by absence of arbitrage alone. We show that this always yields put‐call parity, although put and call values themselves can be nonunique, even for complete markets. We provide general formulas for put and call values in complete markets and show that these are symmetric and that both contain three terms in general. We also show that our approach recovers all the put‐call parity respecting valuation formulas in the classic theory as special cases, and we explain when and how the different terms in the put and call valuation formulas disappear or simplify. Along the way, we also define and characterize completeness for general semimartingale financial markets and connect this to the classic theory.     

New product preannouncements,advertising investments,and stock returns

This study examines the synergistic effects of advertising spending and new product preannouncements (NPPAs) on stock market responses. The empirical results indicate that returns of preannouncing firms over both the short- and long-term could be improved by an increase in advertising expenditure. Additionally, the results also show that the positive impacts of earnings and revenues can be enhanced, while the negative influence of trading costs can be reduced, for preannouncing firms with higher advertising expenditures. The holding returns of institutional investors can also increase with greater spending on advertising. Therefore, marketing communication strategies that aim to reduce information asymmetry within NPPAs, coupled with greater advertising expenditures, would yield more favorable investor responses.     

The anatomy of financial crises: Evidence from the emerging ADR market

We study the anatomy of recent financial crises in Mexico, East Asia, Russia, Brazil, Turkey, and Argentina by investigating the efficiency and pricing of the emerging American depositary receipt (ADR) market. We use a non-parametric technique to test for persistent regime shifts in two basic structural relationships for ADR returns in 20 emerging countries — identified via arbitrage and capital mobility considerations — that should always hold in efficient and integrated capital markets. We find that those “normal” market conditions were instead often violated in proximity of financial crises: The law of one price often weakened (by 54% on average) and domestic sources of risk became more important (often by more than 100%) for many emerging ADRs. We also find the likelihood of these regime shifts to be related to proxies for uncertainty among investors, exchange rate volatility, trade linkages, and liquidity (but not stock market trends, currency devaluations, capital flight, or capital controls).     

THE TWO FUNDAMENTAL THEOREMS OF ASSET PRICING FOR A CLASS OF CONTINUOUS‐TIME FINANCIAL MARKETS

The paper is concerned with the first and the second fundamental theorems of asset pricing in the case of nonexploding financial markets, in which the excess‐returns from risky securities represent continuous semimartingales with absolutely continuous predictable characteristics. For such markets, the notions of “arbitrage” and “completeness” are characterized as properties of the distribution law of the excess‐returns. It is shown that any form of arbitrage is tantamount to guaranteed arbitrage, which leads to a somewhat stronger version of the first fundamental theorem. New proofs of the first and the second fundamental theorems, which rely exclusively on methods from stochastic analysis, are established.     

An Investigation on Incentive Strategies in Community Building in Business-to-Business Electronic Markets

ABSTRACT

Purpose: Community building is recognized as an important governance mechanism in business-to-business (B-to-B) electronic markets by enhancing firms’ participation in these platform markets. However, little research has been done regarding the role of incentive strategies in community building. The main purpose of this paper is to understand how to motivate merchants to participate in a merchant community with incentive strategies.

Methodology: Data were collected in a community of a large B-to-B electronic platform market in China. We randomly chose a sample of 605 participants from among all merchant firms registered in this community, and track their behaviors for 2 weeks. Their behaviors are recorded based on our research design.

Findings: With the empirical analysis from a community of a large B-to-B electronic platform market in China, our results show that (1) both platform and peer incentive strategies can significantly enhance community participation, while platform incentives is more effective in general; (2) platform incentive strategy is a more effective strategy as seller firm uncertainty increases; (3) peer incentive strategy is a more effective strategy as buyer firm uncertainty increases.

Originality: This paper is among the first to investigate two types of incentive strategies in community building, platform level and peer level. We also investigate the moderating role of market uncertainties due to market participants from seller and buyer when examining the effectiveness of these two incentive strategies.     

The anatomy of financial crises: Evidence from the emerging ADR market

We study the anatomy of recent financial crises in Mexico, East Asia, Russia, Brazil, Turkey, and Argentina by investigating the efficiency and pricing of the emerging American depositary receipt (ADR) market. We use a non-parametric technique to test for persistent regime shifts in two basic structural relationships for ADR returns in 20 emerging countries — identified via arbitrage and capital mobility considerations — that should always hold in efficient and integrated capital markets. We find that those “normal” market conditions were instead often violated in proximity of financial crises: The law of one price often weakened (by 54% on average) and domestic sources of risk became more important (often by more than 100%) for many emerging ADRs. We also find the likelihood of these regime shifts to be related to proxies for uncertainty among investors, exchange rate volatility, trade linkages, and liquidity (but not stock market trends, currency devaluations, capital flight, or capital controls).     

Pricing dynamics of index options and index futures in Hong Kong before and during the Asian financial crisis

This article studies the impact of the Asian financial crisis on index options and index futures markets in Hong Kong. We employed a time‐stamped transaction data set of the Hang Seng Index options and futures contracts that were traded on the Hong Kong Futures Exchange. The results show that during the crisis period, the arbitrage profits, and the standard deviations of these profits increased in both ex‐post and ex‐ante analyses. In a market turbulent time, market volatility brings a higher arbitrage profit level. However, despite the increased market volatility, the profitability of the arbitrage trades declined substantially with longer execution time lags in the ex‐ante analysis. This suggests that the HSI futures and options markets are mature and resilient. A multiple regression analysis on the ex‐post arbitrage profit also suggests that there were structural changes during the Asian financial crisis and the Hong Kong government intervention periods. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20: 145–166, 2000     

Determinants of the round-to-round returns to pre-IPO venture capital investments in U.S. biotechnology companies

I propose that pre-IPO venture-backed biotech companies offer a useful new setting through which to evaluate the relative merits of theories for why firm size and book-to-market explain variation in stock returns. This is because pre-IPO biotech firms have large and rapidly evolving growth options relative to assets-in-place. Such attributes align closely with the key features of the model by Berk et al. [Berk, J.B., Green, R.C., Naik, V., 1999. Optimal investment, growth options, and security returns. Journal of Finance 54 (5), 1553–1607] of the endogenous relations between growth options, optimal investment actions and expected equity returns, where firm size and book-to-market emerge as sufficient statistics for the aggregate risk of a firm's assets-in-place. Using venture capital investments in pre-IPO U.S. biotech companies during 1992–2001, I find that equity returns between financing rounds (‘round-to-round’ returns) are reliably negatively related to firm size and positively related to book-to-market ratios. I interpret these results as being most consistent with the theory of Berk et al., and less consistent with alternative explanations such as financial distress, behaviorally biased investors or data snooping.     

TRACTABLE ROBUST EXPECTED UTILITY AND RISK MODELS FOR PORTFOLIO OPTIMIZATION

Expected utility models in portfolio optimization are based on the assumption of complete knowledge of the distribution of random returns. In this paper, we relax this assumption to the knowledge of only the mean, covariance, and support information. No additional restrictions on the type of distribution such as normality is made. The investor’s utility is modeled as a piecewise‐linear concave function. We derive exact and approximate optimal trading strategies for a robust (maximin) expected utility model, where the investor maximizes his worst‐case expected utility over a set of ambiguous distributions. The optimal portfolios are identified using a tractable conic programming approach. Extensions of the model to capture asymmetry using partitioned statistics information and box‐type uncertainty in the mean and covariance matrix are provided. Using the optimized certainty equivalent framework, we provide connections of our results with robust or ambiguous convex risk measures, in which the investor minimizes his worst‐case risk under distributional ambiguity. New closed‐form results for the worst‐case optimized certainty equivalent risk measures and optimal portfolios are provided for two‐ and three‐piece utility functions. For more complicated utility functions, computational experiments indicate that such robust approaches can provide good trading strategies in financial markets.     

Hedging and Portfolio Optimization in Financial Markets with a Large Trader

We introduce a general continuous-time model for an illiquid financial market where the trades of a single large investor can move market prices. The model is specified in terms of parameter-dependent semimartingales, and its mathematical analysis relies on the nonlinear integration theory of such semimartingale families. The Itô–Wentzell formula is used to prove absence of arbitrage for the large investor, and, using approximation results for stochastic integrals, we characterize the set of approximately attainable claims. We furthermore show how to compute superreplication prices and discuss the large investor's utility maximization problem.     

The capital market spillover effect of product market advertising: Evidence from stock price synchronicity

We analyze whether product market advertising has a spillover effect on stock price synchronicity by transmitting firm-specific information to the capital market and attracting more investor attention. Using a sample of Chinese listed firms from 2009 to 2017, we find that firms with greater advertising expenditures have lower stock price synchronicity. The results are robust after we address endogeneity concerns. In accord with our hypothesis that product market advertising increases the amount of firm-level information capitalized into stock prices through the information channel, we find that the impact of advertising on synchronicity is more pronounced for firms with a higher degree of information asymmetry and firms in the consumer-product industry. Further tests show that product market advertising enhances the ability of current period returns to reflect future earnings, and thus rules out that the negative relationship between advertising and synchronicity is driven by noise trading. Our results imply that product market advertising plays an informative role and improves information efficiency in a capital market.     

A model for unpacking big data analytics in high-frequency trading

This study develops a conceptual model of the 7 V′s of big data analytics to gain a deeper understanding of the strategies and practices of high-frequency trading (HFT) in financial markets. HFT is computerized trading using proprietary algorithms. Empirical data collected from HFT firms and regulators in the US and UK reveals competitive asymmetries between HFTs and low-frequency traders (LFTs) operating more traditional forms of market trading. These findings show that HFT gains extensive market advantages over LFT due to significant investment in advanced technological architecture. Regulators are challenged to keep pace with HFT as different priorities to the 7 V′s are given in pursuit of a short term market strategy. This research has implications for regulators, financial practitioners and investors as the technological arms race is fundamentally changing the nature of global financial markets.     

Institutional determinants of emerging market returns and flows

Investors commonly rely on macroeconomic variables to drive capital allocation decisions. But other institutional factors may alter investor returns as well, particularly in emerging market countries. Given these concerns, this paper examines the effects of institutional factors—specifically democracy, transparency and corruption—on emerging market equity returns and flows. We find that institutional quality impacts stock market returns and flows in emerging markets where corruption, transparency, and democracy levels are below average. We also find that government-owned or controlled industries are positively impacted by a deterioration in the corruption and democracy indexes, while highly concentrated sectors, like the financial industry, are negatively impacted by improving transparency.     

Pricing by Arbitrage Under Arbitrary Information

A substantial applications literature on pricing by arbitrage has effectively restricted information to that arising solely from securities markets; return distributions are then governed solely by past prices. We reconsider pricing by arbitrage in markets rendered incomplete by arbitrary information, which, moreover, may influence required returns. We show that contingent claims depending solely on securities' normalized price histories are priced by arbitrage if and only if all risk-adjusted probabilities agree upon the law of primitive securities' normalized prices. We show how existing diffusion-based results can be preserved, and resolve an issue relating to Merton's (1973) stochastic interest rate model.