Measuring economic uncertainty and its impact on the stock market

This paper proposes a novel measure of economic uncertainty based on the frequency of internet searches. The theoretical motivation is offered by findings in economic psychology that agents respond to increased uncertainty by intensifying their information search. The main advantages of using internet searches are broad reach, timeliness and the fact that they reflect actions, rather than words, which however are not directly related to the stock market. The search-based uncertainty measure compares well against a peer group of alternative indicators and is shown to have a significant relationship with aggregate stock returns and volatility.     

Employee stock option plans and stock market reaction: evidence from Finland

This paper examines whether the adoption of stock option plans results in changes in shareholders’ wealth, and whether the stock market reactions to ESOP announcements could be explained by the target group of ESOP and the dilution effect. Short-horizon test methods are applied for this purpose. The sample consists of ESOP announcements of Finnish publicly quoted companies on the Helsinki Stock Exchange during the time period 1988–1998. The event study results show a slightly positive market reaction to announcements of ESOPs targeted to management and a negative market reaction in the case of ESOPs targeted to all employees. The results of regression analysis show that the ESOPs with limited dilution convey positive information to the stock market and the dilution effect has a negative impact on stock returns, especially in the case of ESOPs targeted to all employees.     

Related-party transactions and corporate governance: The evidence from the Taiwan stock market

In this study we explore how corporate governance affects the level of related-party transactions (RPTs) and how it moderates the motives of using RPTs in Taiwan, an ownership-concentrated economy. The empirical results show that good corporate governance is effective in constraining RPTs with the negative relation being sustainable across different measures of RPTs (raw, residual and industry-adjusted RPTs) and across different types of RPTs (related sales, lending and guarantee, and related borrowings). The propping-up hypothesis indicates that the level of related sales is positively correlated with the condition that firms plan to issue seasoned equity next period and the condition of a decrease in the reported earnings. The internal capital market hypothesis indicates that the level of related lending and guarantee (related borrowing) is negatively (positively) correlated with the condition of an increase in capital expenditure and an increase in net working capital. The empirical results lend partial support to the two hypotheses. More importantly, we find that corporate governance moderates the relation between the motives and the level of RPTs.     

Overreaction to stock market news and misevaluation of stock prices by unsophisticated investors: Evidence from the option market

This paper examines investors' option activity on value and growth stocks before earnings announcements. The main finding is that unsophisticated investors enter option positions that load up on growth stocks relative to value stocks in the days leading up to earnings announcements. This occurs despite the fact that at earnings announcements value stocks outperform growth stocks by a wide margin. The paper's results provide evidence that unsophisticated option market investors (1) overreact to past news on underlying stocks and (2) mistakenly believe that mispriced stocks will move even further away from fundamentals at impending scheduled news releases.     

Individual and institutional herding and the impact on stock returns: Evidence from Taiwan stock market

Using high frequency intraday data, this paper investigates the herding behavior of institutional and individual investors in the Taiwan stock market. The study finds evidence of herding by both investors but a stronger herding tendency among institutional than among individual investors. Institutional investors herd more on firms with small capitalizations and lower turnovers and they follow positive feedback strategies. The portfolios that institutional investors herd buy outperform those they sell by an average of 1.009% during the 20 days after intense trading episodes. By contrast, individual investors herd more on firms with small sizes and higher turnovers, and they crowd to buy (sell) stocks with negative (positive) past returns. The portfolios that individual investors herd buy underperform those they sell by an average of − 0.829% during the following 20 days. Moreover, these return differences of both investors are more pronounced under a market with higher pressure and among small stocks. These findings suggest that the herding of institutional investors speeds up the price-adjustment process and is more likely to be driven by correlated private information, while individual herding is most likely to be driven by behavior and emotions.     

Cyber-attacks and stock market activity

I study how financial markets react to unexpected corporate security breaches in the short and the long-term. The main results show that daily excess returns drop, trading volume increases due to selling pressure, and liquidity improves upon the public disclosure of first-time corporate hacking events. The evidence from the search frequency in Google suggests that such short-lived market reaction is due to increasing investors' attention. Cyber-attacks affect firms' policies in the long run, up to five years after the security breach announcement. These results are consistent with the hypothesis that security breaches represent unexpected negative shocks to firms' reputations.     

Measuring the effects of geographical distance on stock market correlation

Recent studies suggest that the correlation of stock returns increases with decreasing geographical distance. However, there is some debate on the appropriate methodology for measuring the effects of distance on correlation. We modify a regression approach suggested in the literature and complement it with an approach from spatial statistics, the mark correlation function. For the stocks contained in the S&P 500 that we examine, both approaches lead to similar results. Contrary to previous studies we find that beyond 50 miles geographical proximity is irrelevant for stock return correlations. For distances below 50 miles, we can show that the magnitude of local correlations varies with investor sentiment.     

Mutual fund herding its impact on stock returns: Evidence from the Taiwan stock market

Using quarterly ownership data which identify identity codes of mutual funds in Taiwan, we investigate mutual fund herding and its impact on stock price. We show that mutual funds tend to follow their own steps in trading rather than follow trades made by other funds. More importantly, evidence of price continuation following mutual fund herd buying suggests that such herding is based on value-relevant information and is consistent with the investigative herding hypothesis. Alternatively, evidence of return reversal following mutual fund herd selling suggests that such herding is non-informational and is consistent with the characteristic herding hypothesis.     

Migration,spillovers, and trade diversion: The impact of internationalization on domestic stock market activity

This paper studies the relation between internationalization (firms cross-listing, issuing depositary receipts, or raising capital in international stock markets) and the trading activity of the remaining firms in domestic markets. Using a panel of 3000 firms from 55 emerging economies during 1989–2000, we find that internationalization is negatively related to the trading activity of domestic firms. We identify two channels. First, the trading of international firms migrates from domestic to international markets and this migration along with the reduction in domestic trading of international firms has negative spillover effects on domestic firm trading activity. Second, there is trade diversion within domestic markets as trading activity shifts out of domestic firms and into international firms.     

Neighborhood matters: The impact of location on broad based stock option plans

We find that fixed effects related to the location of firms’ headquarters explain variation in broad based option grants after controlling for industry effects and firm characteristics traditionally known to affect option granting. Location matters because of local labor market conditions and social interaction with neighboring firms. Broad based option grants are higher: (i) when a firm's stock prices co-move more with stock prices of other firms located in that Metropolitan Statistical Area (MSA); (ii) in states that are less likely to enforce non-compete agreements; and (iii) in MSAs where employees prefer options because stocks there experience abnormally high returns.     

Arbitrage-free market models for option prices: the multi-strike case

This paper studies modeling and existence issues for market models of option prices in a continuous-time framework with one stock, one bond and a family of European call options for one fixed maturity and all strikes. After arguing that (classical) implied volatilities are ill-suited for constructing such models, we introduce the new concepts of local implied volatilities and price level. We show that these new quantities provide a natural and simple parametrization of all option price models satisfying the natural static arbitrage bounds across strikes. We next characterize absence of dynamic arbitrage for such models in terms of drift restrictions on the model coefficients. For the resulting infinite system of SDEs for the price level and all local implied volatilities, we then study the question of solvability and provide sufficient conditions for existence and uniqueness of a solution. We give explicit examples of volatility coefficients satisfying the required assumptions, and hence of arbitrage-free multi-strike market models of option prices.      

The impact of industrial incidents on stock market volatility

We examine stock market volatility attributed to industrial incidents involving publicly traded US companies, with contributing factors identified as company violations and safety errors, equipment failure, human error and vandalism. Incidents identified as safety violations elicited the highest costs in terms of equity price reductions, but the volatility effects of these incidents tend to mitigate within two weeks. Incidents caused by vandalism experience the sharpest volatility increases, but reduce within two days. Volatility associated with incidents caused by equipment failure tends to persist for almost four weeks. Injuries cost publicly traded companies $14 million each while fatalities lead to equity market capitalisation reductions of between $465 and $720 million. These results shed light on the equity market's role as a driver for enhanced compliance with health and safety regulation and with industry good practice.     

Measuring the market impact of hedge funds

Hedge funds often employ opportunistic trading strategies on a leveraged basis. It is natural to find their footprints in most major market events. A “small bet” by large hedge funds can be a sizeable transaction that can impact a market. This study estimates hedge fund exposures during a number of major market events. In some episodes, hedge funds had significant exposures and were in a position to exert substantial market impact. In other episodes, hedge fund exposures were insignificant, either in absolute terms or relative to other market participants. In all cases, we found no evidence of hedge funds using positive feedback trading strategies. There was also little evidence that hedge funds systematically caused market prices to deviate from economic fundamentals.     

Price momentum in the New Zealand stock market: a proper accounting for transactions costs and risk*

We test for recently reported momentum profits in New Zealand using a practitioner technique that we have not yet seen in the academic literature. This technique simultaneously weighs returns, risk and transactions costs at each portfolio rebalance, rather than blindly chasing returns and then accounting for risk and transactions costs after the fact. We reverse the findings of the earlier literature because our gross profits are more than fully consumed once transactions costs are properly accounted for. Although we focus on momentum trading in New Zealand, our practitioner technique is broadly applicable to investigations of trading anomalies.     

The relationship between implied and realized volatility: evidence from the Australian stock index option market

This paper examines the relationship between the volatility implied in option prices and the subsequently realized volatility by using the S&P/ASX 200 index options (XJO) traded on the Australian Stock Exchange (ASX) during a period of 5 years. Unlike stock index options such as the S&P 100 index options in the US market, the S&P/ASX 200 index options are traded infrequently and in low volumes, and have a long maturity cycle. Thus an errors-in-variables problem for measurement of implied volatility is more likely to exist. After accounting for this problem by instrumental variable method, it is found that both call and put implied volatilities are superior to historical volatility in forecasting future realized volatility. Moreover, implied call volatility is nearly an unbiased forecast of future volatility.

The impact of short-selling and margin-buying on liquidity: Evidence from the Chinese stock market

We propose a framework based on limit order book to analyze the impact of short-selling and margin-buying on liquidity. We show that when short-sellers are perceived as informed, adverse selection may lead to uninformed traders withdrawing their limit orders. Given that the Chinese stock market has strong information asymmetry and a high proportion of uninformed traders, we predict that the pilot program launched in March 2010, which lifts restrictions on short-selling and margin-buying for a designated list of stocks, may have a negative impact on liquidity. We perform difference-in-differences tests and show evidence that allowing for short-selling and margin-buying indeed has a significantly negative impact on liquidity for stocks on the designated list. In particular, the negative impact on liquidity is more pronounced for stocks with high information asymmetry. Nevertheless, when short-selling volume dries up due to regulation changes in August 2015, i.e., the “T+1” trading rule on short-selling, we show that consistent with model predictions, lifting restrictions on short-selling and margin-buying has a positive effect on liquidity.     

Evaluating asset pricing models in the Korean stock market

This paper evaluates and compares asset pricing models in the Korean stock market. The asset pricing models considered are the CAPM, APT-motivated models, the Consumption-based CAPM, Intertemporal CAPM-motivated models, and the Jagannathan and Wang conditional CAPM model. By using various test portfolios as well as individual stocks, we conduct time-series tests and cross-sectional regression tests based on individual t-tests, the joint F-tests, the Hansen and Jagannathan (1997) distance, and R-squares. Overall, the Fama and French (1993) five-factor model performs most satisfactorily among the asset pricing models considered in explaining the intertemporal and cross-sectional behavior of stock returns in Korea. The Fama and French (1993) three-factor model, the Chen et al. (2010) three-factor model, and the Campbell (1996) model are the next. The results indicate that the two bond portfolios, term spread and default spread, play an important role in explaining stock returns in Korea.     

The impact of regulation FD on the information environment: evidence from the stock market response to stock split announcements

This paper examines the information environment effects of regulation fair disclosure (Reg FD). We investigate the stock market response to stock splits in the pre- and post-regulation periods. We find that abnormal returns around split announcement are positive in both periods, but the magnitude of the returns is smaller in the post-FD period relative to the pre-FD period. The difference between the pre- and post-FD period abnormal returns persists even after we control for factors that may affect split announcement returns. We also find that the magnitude of the association between announcement returns and the unexpected portion of the split factor has increased post-regulation. Our analysis of performance trends for split firms reveals that patterns of profitability and changes in profitability in the years around stock splits are similar in the pre- and post-FD periods. However, we find that announcement returns are associated with lagged profitability changes in the pre-FD period, but with future profitability changes in the post-FD period. Collectively, our results imply that Reg FD has reduced information asymmetry and improved price efficiency.     

The impact of the Japanese market on the intraday Hong Kong stock returns

This paper examines the impact of the price movement of the Japanese market on the Hong Kong market. We find that the Hong Kong stock prices react rapidly to the return information of the Japanese market. The evidence also indicates that the large price movement of the Japanese market can be used as an indicator for the Hong Kong market. The price reaction of the Hong Kong market is instantaneous and takes place in the opening minutes of the afternoon session. However, there is no excess profits when the transactions costs are included. Finally, the Hong Kong market has a significantly higher turnover when the Japanese market is open.     

Evaluating density forecasts from models of stock market returns

Density forecasts have become important in finance and play a key role in modern risk management. Using a flexible density forecast evaluation framework that extends the Berkowitz likelihood ratio test this paper evaluates in- and out-of-sample density forecasts of daily returns on the DAX, ATX and S&P 500 stock market indices from models of financial returns that are currently widely used in the financial industry. The results indicate that GARCH-t models produce good in-sample forecasts. No model considered in this study delivers fully acceptable out-of-sample forecasts. The empirical findings emphasize that proper distributional assumptions combined with an adequate specification of relevant conditional higher moments are necessary to obtain good density forecasts.