Do sentiment trades explain investor overconfidence around analyst recommendation revisions?

This study examines irrational stock market reactions to analyst recommendation revisions depending on investor sentiment levels prior to analyst report announcements. We construct a firm-specific sentiment indicator by extending Huang et al. (2015, Review of Financial Studies, 28, pp.791–837). Analyst recommendation revisions have more pronounced effects for downgrades, which is attributable to sentiment effects. Domestic investors tend to react less to upgrades (downgrades) news when their prior beliefs are pessimistic (optimistic), implying that they are overconfident. The domestic investors drive sentiment trades, whereas foreign investors are not biased.     

Do liquidity measures measure liquidity?

Given the key role of liquidity in finance research, identifying high quality proxies based on daily (as opposed to intraday) data would permit liquidity to be studied over relatively long timeframes and across many countries. Using new measures and widely employed measures in the literature, we run horseraces of annual and monthly estimates of each measure against liquidity benchmarks. Our benchmarks are effective spread, realized spread, and price impact based on both Trade and Quote (TAQ) and Rule 605 data. We find that the new effective/realized spread measures win the majority of horseraces, while the Amihud [2002. Illiquidity and stock returns: cross-section and time-series effects. Journal of Financial Markets 5, 31–56] measure does well measuring price impact.     

Do retail stockbrokers understand clients' investment preferences?

Recent research has suggested that individual share investors fall into a number of groups with distinct preferences for particular share characteristics. The majority are relatively risk-averse and seek stable investments. An important source of advice for these investors is their stockbroker. But, how well do stockbrokers understand their clients' attitudes and preferences? The present paper suggests that retail stockbrokers overestimate their clients' willingness to take risk and to invest in more speculative stocks. As on-line stockbroking is providing significant competition to the traditional full-service broker, stockbrokers must understand their clients' needs. If this is not the case, it may be difficult for retail stockbrokers to give appropriate advice or for a fruitful adviser–client relationship to be established.     

Do option open-interest changes foreshadow future equity returns?

Recent work considers whether information is simultaneously reflected in both option and equity markets. We provide new evidence supporting Black’s (Financ. Anal. J. 31:36–72, 1975) conjecture that information is first revealed in option markets. Specifically, changes in call and put open-interest levels have predictive power for future equity returns. Large increases in call open interest are followed by significantly increased equity returns. Put open-interest increases precede weaker future returns, but the relationship is considerably less pronounced in the presence of certain controls. The recent change in the call-to-put open-interest ratio has predictive power as to equity returns over the following week, even after controlling for numerous factors.     

Do investor expectations affect sell-side analysts’ forecast bias and forecast accuracy?

We examine the association between investor expectations and its components and sell-side analysts’ short-run quarterly earnings forecast bias and forecast accuracy. To measure investor expectations, we use the Index of Consumer Expectations survey and decompose it into the “fundamental” component related to underlying economic factors (FUND) and the “sentiment” component unrelated to underlying economic factors (SENT). We find that analysts are the most optimistic and the least accurate when SENT is higher. Management long-horizon earnings forecasts attenuate the effects of SENT on forecast optimism and forecast accuracy. Analysts are also the most accurate when FUND is higher. Last, the market places more weight on unexpected earnings when SENT is high. These findings suggest that analysts are affected by investor sentiment and the market reacts more strongly to unexpected earnings when analyst forecasts are the least accurate. The last result potentially explains why prior research (for example, Baker and Wurgler, The Journal of Finance 61:1645–1680, 2006) finds an association between investor sentiment and cross-sectional stock returns.     

Do dividend changes predict the future profitability of firms?

Many previous studies have been conducted to test whether corporate dividend changes predict the future profitability of firms. While the debate continues, we assess the information content of dividends (ICD) hypothesis in the Korean market as it provides an interesting experimental setting for testing the hypothesis in the context of corporate governance. We find that it is difficult to support the ICD hypothesis if one accepts nonlinear patterns in earnings. However, when we divide the sample in terms of Chaebol vs. non‐Chaebol and high‐growth vs. low‐growth firms, we find that the ICD hypothesis becomes valid, especially for non‐Chaebol firms and for low‐growth firms. Therefore, we suggest that the validity of the ICD hypothesis may be dependent on firm characteristics such as the corporate governance structure and growth stage.     

Do uninformed crossed and internalized trades tap into unexpressed liquidity? The case of Nokia

Crossed and internalized upstairs trades are analysed in a dataset in which institutional investors can be identified. Earlier findings that upstairs trading is uninformed, taps into unexpressed liquidity, and does not affect market quality are revisited. The permanent price effect of crossings and internalized upstairs trades is significantly lower than that of limit order book trades due to the fact that the least informed institutional trades are routed upstairs. Crossed and internalized trades affect the depth and transaction costs in the limit order book and a greater reliance is placed on the upstairs market when liquidity is low and volatility is high.     

Do emerging markets with consistent returns have better future performance?

Using monthly data for 25 emerging markets around the world, it is found that emerging markets with recently consistent stock returns tend to have future returns that continue in the same direction. The effects are long-lived for negative consistency, and imply that capital flows are much more sensitive to market downturns than market upturns. Additionally, the longer a market has had consistently negative (positive) stock returns, the more negative (positive) are future returns. These results serve as confirmation that the consistency effects of Grinblatt and Moskowitz [J. Finan. Econ., 2004 Grinblatt, M and Moskowitz, T. 2004. Predicting stock price movements from the pattern of past returns. J. Finan. Econ., 71: 541–579. [Crossref], [Web of Science ®] , [Google Scholar], forthcoming] and Watkins [J. Behav. Finan., 2003 Watkins, B. 2003. Riding the wave of investor sentiment: an analysis of consistency as a predictor of future stock returns. J. Behav. Finan., 4: 1–32.  [Google Scholar], 4, 1–32] exist in emerging markets around the world.     

Do boards pay attention when institutional investor activists “just vote no”?

We examine “just vote no” campaigns, a recent innovation in low-cost shareholder activist tools whereby activists encourage their fellow shareholders to withhold votes toward a director's election to express dissatisfaction with management performance or the firm's corporate governance structure. Grundfest [1993. Just vote no: a minimalist strategy for dealing with barbarians inside the gates. Stanford Law Review 45, 857–937] argues that a substantial withheld vote motivates directors to take immediate action to avoid further embarrassment. We find a variety of supportive evidence, including operating performance improvements and abnormal disciplinary chief executive officer (CEO) turnover, indicating that such campaigns induce boards to take actions in shareholders’ interests. Furthermore, abnormal turnover is robust to controlling for concurrent events and firm- and CEO-specific controls.     

Do retail gasoline prices respond asymmetrically to cost shocks? The influence of Edgeworth Cycles

Asymmetric price cycles similar to Edgeworth Cycles are appearing in increasingly many retail gasoline markets in the United States and worldwide. The asymmetry in the cycles can give rise to a finding of asymmetric price responses to cost shocks (asymmetric passthrough). This article estimates asymmetric passthrough for the market of Toronto, which exhibits cycles, and decomposes it into two components—that part explainable by the cycles and that part driven by other unknown sources. Significant asymmetric passthrough is found, with increases passed through more quickly than decreases. A significant cause of the finding is the presence of the cycles themselves.     

Do individual investors’ stock recommendations in online communities contain investment value?

This paper investigates the investment value of individual investors’ stock recommendations within online communities. We find that aggregated recommendations contain no explicit investment value and that following these recommendations may have a negative impact on investment performance. Our results suggest that recommendations are mostly based on simple heuristics and concentrate on a small number of stocks. When restricting the set of recommendations to those made by the most experienced or successful recommenders, results marginally improve but still preclude profitable investment strategies. Experienced and successful recommenders seem more likely to avoid the most expensive pitfalls rather than actually exhibit superior investment performance.     

Do hedge funds' exposures to risk factors predict their future returns?

This paper investigates hedge funds' exposures to various financial and macroeconomic risk factors through alternative measures of factor betas and examines their performance in predicting the cross-sectional variation in hedge fund returns. Both parametric and non-parametric tests indicate a significantly positive (negative) link between default premium beta (inflation beta) and future hedge fund returns. The results are robust across different subsample periods and states of the economy, and after controlling for market, size, book-to-market, and momentum factors as well as the trend-following factors in stocks, short-term interest rates, currencies, bonds, and commodities. The paper also provides macro-level and micro-level explanations of our findings.     

Is market impact a measure of the information value of trades? Market response to liquidity vs. informed metaorders

We examine a data-set of institutional trades where approximately one-fourth of the trades were labelled as having been created for cash flow purposes. We aggregate near-overlapping trades into metaorders and consider information, market impact and metaorder size. We find that during the execution, the functional form and scale of market impact are similar for cash flows and other metaorders. Differences arise in the price reversion following the end of a metaorder. For cash flows, presumed to have no true information content, the impact reverts almost completely on average in two to five days. For other metaorders, we find that reversion erases about one-third of the peak impact: for each size, price reverts to the average execution price, leaving no immediate profits after accounting for trading costs. Observed mark-to-market profits on metaorders that aggregate multiple portfolio manager orders, new metaorders and Nasdaq-listed stocks suggest that these metaorders are more informed than the average. Vice-versa, we find mark-to-market losses are more likely to occur on cash flows, metaorders in large-cap stocks, metaorders that follow momentum and additions to a prior position seeking to take advantage of an improved price. The complete price reversion for cash flows suggests that the mechanical permanent impact that is considered in no-quasi-arbitrage arguments would be much smaller than the information in typical institutional metaorders.     

Institutional investor horizon and stock price synchronicity: Do product market competition and analyst coverage matter?

This paper provides new insights into the relation between institutional investment horizon and stock price synchronicity and investigates whether this relationship depends on the intensity of product market competition and analyst coverage. Based on a sample of French listed companies, we find that long-term (short-term) institutional investors are associated with lower (higher) stock price synchronicity. The results also show that the negative effect of long-term institutional investors is more accentuated for firms in less competitive markets and with high analyst coverage. An additional analysis shows that the synchronicity reduction effect does not vary during the financial crisis. Overall, these findings suggest that unlike their short-term counterparts, long term investors reduce asymmetric information and help disseminate firm-specific information into stock prices.     

Do earnings reported under IFRS tell us more about future earnings and cash flows?

We contribute to the debate about the relative benefits and costs of International Financial Reporting Standards (IFRS) adoption by examining whether earnings persistence and the association between current accounting earnings and future cash flows differ for firms reporting under IFRS versus firms reporting under United States Generally Accepted Accounting Principles (U.S. GAAP) and firms reporting under non-U.S. domestic accounting standards (DAS). Using samples comprised of 58,832 firm-year observations drawn from 33 countries from 2002 through 2008, we find that positive earnings reported under IFRS are no more or less persistent than earnings reported under U.S. GAAP but losses reported under IFRS are less persistent than losses reported under U.S. GAAP. Moreover, we find that earnings reported under IFRS are no more or less persistent and are no more or less associated with future cash flows than earnings reported under non-U.S. DAS. However, we find that earnings reported under U.S. GAAP are more closely associated with future cash flows than earnings reported under IFRS. This is important if a key role of reported earnings is to help investors form expectations about future cash flows. These results should be of interest to academics and standard-setters as they debate the merits of transitioning to IFRS, and to parties who use reported earnings to form expectations about future earnings and cash flows.     

Do core and non-core cash flows from operations persist differentially in predicting future cash flows?

This study investigates the persistence of cash flow components (core and non-core cash flows) using a cash flow prediction model. By extending the Barth, Cram, and Nelson (Account Rev 76(January):27–58, 2001) model, we examine the role of cash flow components in predicting future cash flows beyond that of accrual components. We propose a cash flow prediction model that decomposes cash flows from operations into core and non-core cash flow components that parallel the presentation and format of operating income from the income statement. Consistent with the AICPA and financial analysts’ recommendations, and as predicted, we find that core and non-core cash flows defined in our paper are differentially persistent in predicting future cash flows; and these cash flow components enhance the in-sample predictive ability of cash flow prediction models. We also analyze the association of in-sample prediction errors with earnings, cash flow and accruals variability. We find that disaggregating cash flows improve in-sample prediction, especially for large firms with high cash flows and earnings variability.

Do sovereign credit default swaps represent a clean measure of sovereign default risk? A factor model approach

In this study, we use a factor model in order to decompose sovereign Credit Default Swaps (CDS) spreads into default, liquidity, systematic liquidity and correlation components. By calibrating the model to sovereign CDSs and bonds we are able to present a better decomposition and a more accurate measure of spread components. Our analysis reveals that sovereign CDS spreads are highly driven by liquidity (55.6% of default risk and 44.32% of liquidity) and that sovereign bond spreads are less subject to liquidity frictions and therefore could represent a better proxy for sovereign default risk (73% of default risk and 26.86% of liquidity). Furthermore, our model enables us to directly study the effect of systematic liquidity and flight-to-liquidity risks on bond and CDS spreads through the factor sensitivity matrix. We find that these risks do have an influence on the default intensity and they contribute significantly to spread movements. Finally, our empirical results advance the idea that the increase in the CDS spreads observed during the crisis period was mainly due to a surge in liquidity rather than to an increase in the default intensity.     

Do investors hold that they know? Impact of familiarity bias on investor’s reluctance to realize losses: Experimental approach

In this article we investigate the impact of familiarity bias on the individual investor’s reluctance to realize losses. Our experimental approach reveals a strong correlation between familiarity and disposition effect. We conducted 714 tests in which different respondents could sell stocks of two types – winners and losers. One group of respondents “owned” familiar assets and another group operated anonymous portfolios. The results of the experiment show that an individual investor’s tendency to ride losers too long is more than twice as high in the case of unfamiliar stocks as it is when assets are familiar to the holder.     

Do asset impairments and the associated disclosures resolve uncertainty about future returns and reduce information asymmetry?

The objective of this study is to provide insights into how Australian listed firms are implementing AASB 136 Impairments of Assets. Our first concern is whether uncertainty about future returns and information asymmetry motivates the recognition of asset impairments. We find no evidence that the recognition of asset impairments is associated with higher uncertainty about future returns. Furthermore, we find no evidence that the recognition of asset impairments is associated with higher information asymmetry. Our second concern is whether asset impairments and the associated disclosures provide information that reduces uncertainty about future returns and information asymmetry. While we find some evidence that asset impairments are associated with decreases in information asymmetry before the financial crisis, during the financial crisis, asset impairments are associated with increases in both measurement uncertainty and information asymmetry.     

Do management EPS forecasts allow returns to reflect future earnings? Implications for the continuation of management’s quarterly earnings guidance

Using 18,253 firm-year observations from 1998 through 2003, we build on literature suggesting that more informative disclosures allow returns to better reflect future earnings and test whether management earnings per share forecasts and their characteristics influence the future earnings response coefficient (FERC). We find that FERCs are greater for forecasting firms and when forecasts are more frequent or precise. We suggest that more frequent and more precise forecasts assist investors in better predicting future earnings. Importantly, we find that quarterly and short-term forecasts incrementally increase the association between returns and future earnings beyond annual and long-term forecasts; thus, even short-term, quarterly forecasts allow investors to form better expectations about future earnings. This suggests a benefit of quarterly earnings forecasts possibly overlooked in recommendations from the United States Chamber of Commerce, CFA Institute, Business Roundtable Institute for Corporate Ethics, and The Conference Board to eliminate quarterly earnings guidance.