Predictive regression with order-p autoregressive predictors

Studies of predictive regressions analyze the case where y_t is predicted by x_t ? 1 with x_t being first-order autoregressive, AR(1). Under some conditions, the OLS-estimated predictive coefficient is known to be biased. We analyze a predictive model where y_t is predicted by x_t ? 1, x_t ? 2,… x_t ? p with x_t being autoregressive of order p, AR(p) with p > 1. We develop a generalized augmented regression method that produces a reduced-bias point estimate of the predictive coefficients and derive an appropriate hypothesis testing procedure. We apply our method to the prediction of quarterly stock returns by dividend yield, which is apparently AR(2). Using our method results in the AR(2) predictor series having insignificant effect, although under OLS, or the commonly assumed AR(1) structure, the predictive model is significant. We also generalize our method to the case of multiple AR(p) predictors.     

Market microstructure: A survey

Market microstructure studies the process by which investors’ latent demands are ultimately translated into prices and volumes. This paper reviews the theoretical, empirical and experimental literature on market microstructure relating to: (1) price formation, including the dynamic process by which prices come to impound information, (2) market structure and design, including the relation between price formation and trading protocols, (3) Transparency, the ability of market participants to observe information about the trading process, and (4) Applications to other areas of finance including asset pricing, international finance, and corporate finance.     

Under-or-overreaction: Market responses to announcements of earnings surprises

We test whether the well-documented market reaction to the announcements of earnings surprises is a manifestation of an investor underreaction or overreaction to extremely good or bad earnings news. Using the market reaction in the three-day period surrounding the announcements of extreme earnings surprises (i.e., SUE) in quarter Q_t as a reference point, we show that firms reporting a high (low) SUE in subsequent quarter Q_t + 1 that confirms their initial quarter Q_t SUE ranking in the same highest or lowest SUE quintiles generate an incremental price run that moves in the same direction as that of the initial SUE. However, the price impact of the confirming SUE signal is weaker than that of its initial SUE. Our findings are robust to the Fama-French three-factor daily regression extended by the momentum factor and a number of other robustness tests. Our result is not consistent with the prevalent view that investors underreact to earnings news. To the contrary, the evidence suggests an initial investor overreaction to extreme SUE signals.     

Foreign investment with inflation-linked securities: A natural hedge under Fisher theory?

All foreign holders of U.S. dollars currencies face significant risk of unfavorable currency exchange movements, proportional to the amounts they hold. Some of these risks can be hedged to an extent, but the costs of doing so can be significant, and errors in execution or maintenance of the hedges can cause serious capital losses. Today the vast holdings of China and others creates currency risk on an unprecedented scale. China alone now has a total in excess of a trillion (1 × 10¹²) U.S. dollars, which makes traditional approaches to hedging problematic at best.¹ This paper analyzes the potential hedging effectiveness of investing foreign dollar holdings in U.S. inflation-indexed securities under Fisher's Identity. To the extent that Fisher's Identity and its derivative theories hold, foreign investors can effectively protect the purchasing power of their dollar balances, and earn an assured rate of return. Investment in inflation-indexed securities does not incur the additional expenses that swaps and currency hedges do.     

Exact inference and optimal invariant estimation for the stability parameter of symmetric α-stable distributions

Hill estimation (Hill, 1975), the most widespread method for estimating tail thickness of heavy-tailed financial data, suffers from two drawbacks. One is that the optimal number of tail observations to use in the estimation is a function of the unknown tail index being estimated, which diminishes the empirical relevance of the Hill estimation. The other is that the hypothesis test of the underlying data lying in the domain of attraction of an α-stable law (α < 2) or of a normal law (α ≥ 2) for finite samples, is performed on the basis of the asymptotic distribution, which can be different from those for finite samples. In this paper, using the Monte Carlo technique, we propose an exact test method for the stability parameter of α-stable distributions which is based on the Hill estimator, yet is able to provide exact confidence intervals for finite samples. Our exact test method automatically includes an estimation procedure which does not need the assumption of a known number of observations on the distributional tail. Empirical applications demonstrate the advantages of our new method in comparison with the Hill estimation.     

Gaining a competitive edge through acquisitions: Evidence from the telecommunications industry

I study the announcement effects of all acquisitions in the recent telecom wave on both the acquirers and their industry competitors. I find evidence of negative rival returns (? 0.55%, t-stat = 2.47) by focusing on non-horizontal acquisitions where rivals are less susceptible to experience positive returns due to increased market power or expectation that some will become future targets themselves. I find that this effect is worse for closer rivals defined as having similar size and being in the same primary service area as the acquirer. Competitor returns are positively correlated with those of the acquirers suggesting that the negative impact experienced by competitors is driven by acquisitions in which the acquirer itself is earning negative abnormal returns. Results are broadly consistent with the Competitive Advantage Hypothesis that posits acquisitions are a means of corporate restructuring in a changing environment, awarding the acquirer a competitive edge and thereby making these acquisitions costly for their non-merging competitors.     

Dividend privileges and the value of voting rights: Evidence from Italy

The present paper proposes a new measure of the voting right, the Relative Vote Segment, which incorporates dividend privileges into the inferior class of shares. We test and compare it against the standard Relative Price Difference and the Nenova (2003) measure using 1998–2008 data from Italy, a country where dividend privileges are relevant. Results show that when dividend privileges are considered, the average voting right equals + 35.63%, while its estimated value corresponds to a significantly lower + 20.35% and + 1.29% with the Relative Price Difference and the Nenova (2003) measure, respectively. Negative values of voting rights drop significantly with our methodology. Results become even more clear-cut when we clean the sample of possible measurement errors. As far as the determinants of the voting premium are concerned, the choice of the measure does not appear to have a significant impact, as long as the dividend differences are controlled for.     

Towards an orientation of higher education in the post Rio + 20 process: How is the game changing?

The purpose of this paper is to identify and assess the implications of sustainable development for the future orientation of higher education, especially after the 2012 United Nations Conference on Sustainable Development (Rio + 20). A qualitative trend analysis is being used for this purpose, in the context of which three macro trends are combined: (1) higher education that has been developed via five periods; (2) sustainable development that has evolved through three stages; and (3) the nexus between sustainable development and higher education which has strengthened through three phases. The simultaneous analysis of the macro trends regarding their possible interactive effects (through an expert panel discussion) demonstrates that higher education and universities under the influence of sustainable development elements are entering into a new era in which the function of “higher education for sustainable development” could be interpreted as the seeds of a newly emerging mission for universities. In this regard, it is expected that the concept of “sustainable university” is likely to become more common to meet the emerging mission. Consistent with the Rio + 20 outcomes, the authors analyzed the concept of “sustainable university” and identified the fact that it is practically divided into three interrelated and complementary categories, namely social-, environmental-, and economic-oriented university in pursuit of actualizing sustainable development.     

The home bias is here to stay

Over the last 15 years, dramatically decreasing foreign investment costs have not reduced the home bias. We show that the home bias induced by a given cost is proportional to the factor ρ/(1 − ρ), where ρ is the average correlation between markets. This factor is very sensitive to the correlation, especially when the correlation is high. Empirically, correlations have been steadily increasing from 0.4 in the 90’s to about 0.9 today. Thus, the decreasing extra costs are increasingly magnified, explaining the persistence of the home bias, and predicting its continuation.     

Command-and-control: Alternative futures of geoengineering in an age of global weirding

In July 2012, Russ George, the founder of Planktos Inc., organized efforts to dump 100 tons of iron sulfate off the coast of Canada to engineer a plankton bloom that would, ostensibly, absorb carbon dioxide and store it in the depths of the Pacific Ocean. As George's geoengineering experiment is one of the largest and first of its kind, many were quick to denounce his rogue action while others were delighted to see that he succeeded as a large algae bloom was reported to have emerged. Using the George event as a point of entry for exploring alternative futures of geoengineering in an age of global weirding, this project fuses the 2 × 2 scenario modeling technique with the “Mānoa School” four-futures method by situating command and control, along X (control) and Y (command) axes as two critical uncertainties and key drivers of change that will impact the design, development, and diffusion of climate mitigation engineering initiatives, which some see as holding the only solution to avert global catastrophe and others condemn as a postnormal remedy.     

The nexus between financial integration and real economy: Solow-growth model concept

This paper aims to investigate the nexus between financial integration and the real economy in ASEAN + 3 economies based on the concept of Solow-Growth Model. The equity indices as a proxy for financial markets are collected from each ASEAN + 3 members and are segmented between two periods; before and after the financial cooperation agreement period. The finding presents several outcomes; 1) no cointegration nexus is found in the system during the pre-agreement periods; 2) the markets are found cointegrated during the post-agreement period, 3) financial integration is found to influence the real sectors of ASEAN + 3 economies. Finally, this study offers policy implications to improve financial integration for stabilizing the real economy.     

How costly is the Sarbanes Oxley Act? Evidence on the effects of the Act on corporate profitability

The Sarbanes-Oxley Act (SOX) was intended to protect investors by improving the accuracy and reliability of corporate disclosures. However, critics have argued that the costs of SOX far outweigh its intended benefits. Prior studies based on stock-price reactions to SOX-related events document mixed evidence on the expected impact of SOX. In contrast, we provide evidence on the net realized costs of SOX by examining its impact on operating profitability. We find that average cash flows decline by 1.3% of total assets after SOX. These costs are more significant for smaller firms, for more complex firms, and for firms with lower-growth opportunities. Annually, these costs range from $6 million for smaller firms to $39 million for larger firms. Further, we document that net SOX-related costs are not limited to one-time expenses associated with internal-control design and implementation. In aggregate, for the 1428 firms in our sample, these costs amount to about $19 billion per year. Profitability is lower for up to four years post-SOX. To our knowledge, ours are the first estimates of the realized net costs imposed by SOX.     

Hedging in a HJM model

This note shows how to hedge in a HJM model when the term structure evolution is Markov in the entire forward rate curve.     

The importance of size in private equity: Evidence from a survey of limited partners

Using a comprehensive survey, we show that investors with a larger capital allocation to private equity are more specialized − measured by the degree to which the investor focuses on private equity rather than other classes of investments − and have a wider scope of due diligence and investment activities. Other investor characteristics (experience, type, location, compensation structure, number of funds under management) play no role. In particular, endowments are not special according to the survey measures. These results are consistent with the changing LP–GP relationship in private equity as capital is increasingly concentrated in the hands of large investors.     

Design and evaluation of an advanced continuous data level auditing system: A three-layer structure

Audit efficiency and effectiveness can be significantly affected by data aggregation during audit procedures. Previous studies highlight that an appropriate level of data aggregation is needed because a continuous auditing (CA) system often generates numerous alarms. To respond to this issue, this study proposes a CA system with a three-layer structure. In the first layer of the proposed system, all journal entry level transactions are classified and aggregated using defined rules; any transactions that deviate from these rules are identified as unusual transactions. The second layer detects the observations that violate controls. Analytical monitoring models are developed in the final layer to identify observations that statistically deviate from an organization’s typical business behaviors. To examine whether the proposed three-layer CA system enhances the effectiveness of a CA system in identifying financial irregularities, this study empirically tests the proposed models using real-world journal entry data from a construction company. The results indicate that the proposed framework enhances audit effectiveness and efficiency.     

Frequency of observation and the estimation of integrated volatility in deep and liquid financial markets

Using two newly available ultrahigh-frequency datasets, we investigate empirically how frequently one can sample certain foreign exchange and U.S. Treasury security returns without contaminating estimates of their integrated volatility with market microstructure noise. Using the standard realized volatility estimator, we find that one can sample dollar/euro returns as frequently as once every 15 to 20 s without contaminating estimates of integrated volatility; 10-year Treasury note returns may be sampled as frequently as once every 2 to 3 min on days without U.S. macroeconomic announcements, and as frequently as once every 40 s on announcement days. Using a simple realized kernel estimator, this sampling frequency can be increased to once every 2 to 5 s for dollar/euro returns and to about once every 30 to 40 s for T-note returns. These sampling frequencies, especially in the case of dollar/euro returns, are much higher than those that are generally recommended in the empirical literature on realized volatility in equity markets. The higher sampling frequencies for dollar/euro and T-note returns likely reflect the superior depth and liquidity of these markets.     

The effect of Sarbanes-Oxley on the timely disclosure of restricted stock trading

Our paper investigates the effect of the Sarbanes-Oxley Act (SOX) on the disclosure timeliness of restricted stock trading. Insiders selling restricted stock are required to file a Form 144 because the stock is restricted and also a Form 4 because they are an insider. We confirm that mandatory filing requirements under Section 403 of SOX reduced the Form 4 disclosure delay for restricted stock transactions from 24 days in the pre-SOX period to the mandated 2 days in the post-SOX period. Although SOX did not mandate changes to Form 144 filings, we expect that disclosure timeliness of Form 144 filings is likely impacted by SOX. We find that Form 144 filings of restricted stock sales have become less timely. In the post-SOX period, Form 144, the intent to sell restricted stock, is almost always reported after the Form 4 disclosure of the executed trade. Thus, an unintended consequence of SOX is that by making the Form 4 filing more timely than the Form 144, market participants will know about a trade sooner, but have less information about the type of equity traded. An implication of this finding is that Section 403 of SOX may not have unambiguously improved investor protection as intended.     

The risk level discriminatory power of mutual fund investment objectives: Additional evidence

We reexamine the information content of mutual fund investment objectives to learn whether investors can use them to infer risk. For investment objectives to properly convey risk, risk must be heterogeneous between investment objective groups and homogeneous within them. The present study differs from earlier work in two important ways: (1) it reaches a generally different conclusion about within-objective class fund risk, and (2) it is being done against a backdrop of industry-wide incentive compensation structures that rely on these classifications as proxies for fund volatility. Empirical testing suggests that risk is heterogeneous within groups.     

Google Internet search activity and volatility prediction in the market for foreign currency

I study whether evolution in the number of Google Internet searches for particular keywords can predict volatility in the market for foreign currency. I find that data on Google searches for the keywords economic crisis + financial crisis and recession has incremental predictive power beyond the GARCH(1,1). These results support the mixture of distributions hypothesis in that volatility is linked to the stochastic rate at which information flows into the marketplace. These results also demonstrate the potential for Google to become a storehouse of information for financial markets.     

Time to equilibrium in exchange rates: G-10 and Eastern European economies

This paper reports different times-to-equilibrium for G-10 developed economies and the Eastern European emerging economies. By applying a novel method of value-weighted index to highly-trade-linked economies, we test the purchasing power parity to the full length of time-to-equilibrium. The times-to-equilibrium obtained are: 6 years for developed and 2 years for emerging economies. These results are consistent with the sticky price hypothesis: economies trading in highly aggregated capital goods take longer time to reach price equilibrium in the face of overshooting exchange rates: the opposite is true for primary exporters. This finding is new for these two groups, and could be compared usefully with the earlier reports of long half-life for developed countries. Also, our method of measurement establishes the actual time of the theory prediction on price-to-currency relationship. It is possible to apply this methodology to study more groups of countries.