Do Inventories Matter in Dealership Markets? Evidence from the London Stock Exchange

Using London Stock Exchange data, we test the central implication of the canonical model of Ho and Stoll (1983) that relative inventory differences determine dealer behavior. We find that relative inventories explain which dealers obtain large trades and show that movements between best ask, best bid, and straddle are highly correlated with both standardized and relative inventory changes. We show that the mean reversion in inventories is highly nonlinear and increasing in inventory levels. We show that a key determinant of variations in interdealer trading is inventories and that interdealer trading plays an important role in managing large inventory positions.     

Which Fundamentals Drive Exchange Rates? A Cross‐Sectional Perspective

Standard present‐value models suggest that exchange rates are driven by expected future fundamentals, implying that exchange rates contain information about future fundamentals. We test this key empirical prediction of present‐value models in a sample of 35 currency pairs ranging from 1900 to 2009. Employing a variety of tests, we find that exchange rates have strong and significant predictive power for nominal fundamentals (inflation, money balances, nominal GDP), whereas predictability of real fundamentals and risk premia is much weaker and largely confined to the post–Bretton Woods era. Overall, we uncover ample evidence that future macrofundamentals drive current exchange rates.     

Calendar effects in the London Stock Exchange FT–SE indices

This paper investigates the presence of various anomalies, or ‘calendar effects’, in the FT-SE 100, Mid 250 and 350 indices, and the accompanying industry baskets, for the period January 1986 to October 1992. Our results broadly support similar evidence found for many countries concerning stock market anomalies, for the ‘January’, ‘weekend’, ‘half of the month’ and ‘holiday’ effects all appear to be present in at least some of the indices.     

How Do Employees View Their Underwater Stock Options?: Evidence from the Stock Option Exchange Program

This paper examines the participation decisions of employees in a stock option exchange program aimed at restoring value to underwater options. The program invites employees to exchange their existing underwater options for new options, the value of which is determined by the company stock price in 6 months and 1 day. The participation turns out to vary cross-sectionally and, perhaps surprisingly, the employees do not surrender all their underwater options. We find that employees actively and rationally consider a variety of factors to make their participation decisions, rather than blindly surrendering their underwater options. The participation decisions of non-executive employees seem to be well anticipated by stock market investors, since no abnormal stock returns are related to the participation decisions.

Do Industry‐Level Analyses Improve Forecasts of Financial Performance?

Prior research documents mean reversion in firm profitability and growth under the implicit assumption that profitability and growth of all firms revert to a common benchmark at the same rate. However, a large body of academic research suggests that there are systematic interindustry differences (e.g., industry barriers to entry) that differentially affect firm performance based on industry membership. We evaluate the relative forecast accuracy of mean reverting models at the industry and economywide levels and find that industry-specific models are generally more accurate in predicting firm growth but not profitability.     

Do Analyst Stock Recommendations Piggyback on Recent Corporate News? An Analysis of Regular‐Hour and After‐Hours Revisions

Analysts often update their recommendations following corporate news. Questions have been raised regarding analysts’ ability to generate new information beyond recent corporate events. Employing a comprehensive database on corporate news, we show that only a small minority, or 27.9%, of all recommendation revisions directionally confirm the information in the preceding corporate events and even these “confirming revisions” facilitate the information discovery of corporate events and thus cannot simply be dismissed as “piggybacking.” Our analysis further shows that analysts not only facilitate price discovery to corporate news through issuing trending revisions but also help reverse prevailing market sentiments following corporate news by issuing contrarian revisions. Our study is the first to investigate short‐window intraday market reactions to revisions issued after hours, which account for 70% of all recommendation revisions in our sample period. Analysts’ incentives to issue revisions after hours appear to reflect demands from large institutional clients, who dominate after‐hours trading. More importantly, we show that the after‐hours revisions are associated with significantly greater price reactions and different price reaction patterns than revisions issued during regular trading hours. Collectively, our evidence indicates that analysts are a significant source of new information beyond recent corporate news and they also help shape the market's assessment of corporate disclosures.     

Does the Conditional CAPM Work? Evidence from the Istanbul Stock Exchange

Using a sample of common stocks traded on the Istanbul Stock Exchange from February 1997 to April 2008, we test whether the conditional capital asset pricing model (CAPM) accurately prices assets. In our empirical analysis, we closely follow the methodology introduced in Lewellen and Nagel (2006). Our results show that the conditional CAPM fares no better than the static counterpart in pricing assets. Although market betas do vary significantly over time, the intertemporal variation is not large enough to drive average conditional alphas to zero.     

Don't They Care? Or,Are They Just Unaware? Risk Perception and the Demand for Long‐Term Care Insurance

The potential need for long‐term care (LTC) is one of the greatest financial risks faced not only by the elderly but also by their adult children, who often provide care or financial assistance. We investigate adult children's role in the demand for LTC insurance. Similar to flood insurance, we find that demand for LTC insurance is low due to low risk perception. The more aware adult children are of the risk, the more likely LTC insurance is to be purchased, either by the children themselves on behalf of their parents or by the parents under the influence of their children.     

Do Publicly Traded Property–Casualty Insurers Cater to the Stock Market?

This article examines the catering theory in the insurance industry. We investigate whether managers of publicly traded insurers pursue a growth strategy catering to the stock market's preference. Two hypotheses are tested in this study: (1) an insurer will devote more efforts to increasing premium growth when the stock market places greater values on growth, and (2) this catering effect will be more pronounced at firms where managers have greater incentives to maximize short‐term stock prices. We find evidence supporting both hypotheses. Our study discovers a new channel through which the stock market and executive compensation affect insurance companies’ business strategies and the insurance market. The implication of the interplay between insurers and the stock market is significant and deserves future research.     

Why Do Price Limits Exist in Stock Markets? A Manipulation‐Based Explanation

Numerous stock market regulators around the world impose daily price limits on individual stock price movements. We derive a simple model that shows that price limits may deter stock market manipulators. Based on our model's implications, we predict that regulators impose price limit rules for markets where the likelihood of manipulation is high. We present empirical evidence consistent with this hypothesis. Our study is the first to formally propose a manipulation‐based rationale for the existence of price limits in stock markets.     

What Drives the Disposition Effect? An Analysis of a Long‐Standing Preference‐Based Explanation

We investigate whether prospect theory preferences can predict a disposition effect. We consider two implementations of prospect theory: in one case, preferences are defined over annual gains and losses; in the other, they are defined over realized gains and losses. Surprisingly, the annual gain/loss model often fails to predict a disposition effect. The realized gain/loss model, however, predicts a disposition effect more reliably. Utility from realized gains and losses may therefore be a useful way of thinking about certain aspects of individual investor trading.     

Do the Investment and Return‐on‐Equity Factors Proxy for Economic Risks?

We study the information content of two new return factors, the investment factor (IA) and the return‐on‐equity factor (ROE), as proposed by Chen, Novy‐Marx, and Zhang in 2011. First, IA is a strong predictor for future gross domestic product (GDP) growth despite the presence of other financial and economic variables. IA subsumes the pricing power of the GDP factor for the cross section of asset returns. Second, ROE is closely related to innovations in dividend yield and term spread. When modeled together with innovations in state variables that forecast future investment opportunities, IA and ROE lose their explanatory power.     

Tracking Stock or Spin‐Off? Determinants of Choice

I examine the roles of valuable internal capital markets, cross-subsidization, and insider ownership as determinants of choice between tracking stock and spin-offs in corporate equity restructuring. I show that conglomerates are more likely to choose tracking stock if they want to obtain some of the benefits offered by a spin-off, without loosing the potential for valuable internal capital markets. My results suggest that the market rewards firms with valuable internal capital markets that opt for tracking stocks, and penalizes the possibility of consolidated tax treatments. The market also reacts more favorably to unanticipated tracking-stock announcements.     

Do Fund Flow‐Return Relations Depend on the Type of Investor? A Research Note

This study investigates whether the relation between aggregate fund flow and market returns differs between retail and institutional funds. For the retail fund sample, we document a contemporaneous relation between flow and market returns and also find evidence of feedback trading. In contrast, there is little evidence of a relation between flow and market returns for the institutional fund sample. Consequently, it appears that retail and institutional fund investors use different investment strategies, with retail investors following a more naive strategy. We find no evidence of flow inducing price pressure for either type of fund.     

Do Focused Funds Offer Superior Performance in an Emerging Market? Evidence from Taiwan's Stock Market

We examine the effects of the number of stock holdings and industry concentration on Taiwan's equity fund performance. The quadratic regression model is applied to explore the optimal number of stock holdings for mutual funds. The empirical results suggest that funds with a smaller number of stock holdings and with a higher level of industry concentration achieve better performance. We also find that mutual fund performance and the number of stock holdings have an inverted U-shaped relationship, and funds that hold twenty-four to twenty-eight stocks can generate superior performance.     

Is the Mean Return of Hotel Real Estate Stocks Apt to Overreact to Past Performance?

This study examines the return patterns of hotel real estate stocks in the U.S. during the period from 1990 to 2007.We find that the magnitude and persistence of future mean returns of hotel real estate stocks can be predicted based on past returns, past earnings surprise, trading volume, firm size, and holding period. The empirical evidence found from this paper confirms that short-horizon contrarian profits can be partially explained by the lead-lag effects, while in the intermediate-term price momentum profits and long-term contrarian profits can be partially attributed to the firms’ overreaction to past price changes. Our results support the contrarian/overreaction hypothesis, and they are inconsistent with the Fama-French risk-based hypothesis or the underreaction hypothesis. The study also confirms the earning underreaction hypothesis and finds the high volume stocks tend to earn high momentum profits in the intermediate-term. The study finds that the earning momentum effect for hotel stocks is more short-lived and smaller in magnitude than the market average. Price momentum portfolios (or contrarian portfolios) of big hotel firms underperform small hotel firms and the hotel price momentum portfolio (or contrarian portfolios) significantly underperform the overall market over the intermediate-term (or the long-term). These findings imply that the U.S. hotel industry, particularly the big hotel firms, have experienced relatively conservative growth in the sample period. It suggests that a conservative hotel growth strategy accompanied by an internal-oriented financing policy is proper in a period of prosperity.     

Do Weather‐Induced Moods Affect the Processing of Earnings News?

We investigate whether unpleasant environmental conditions affect stock market participants’ responses to information events. We draw from psychology research to develop a new prediction that weather‐induced negative moods reduce market participants’ activity levels. Exploiting geographic variation in equity analysts’ locations, we find compelling evidence that analysts experiencing unpleasant weather are slower or less likely to respond to an earnings announcement relative to analysts responding to the same announcement but experiencing pleasant weather. Price association tests find evidence consistent with reduced activity due to weather‐induced moods delaying equilibrium price adjustments following earnings announcements. We also use our analyst‐based research design to re‐examine an existing prediction that unpleasant weather induces investor pessimism, and find evidence of both analyst pessimism and reduced activity in the presence of unpleasant weather. Together, our study provides new evidence that both extends and reaffirms findings of a relation between unpleasant weather and market activities, and contributes to the broader psychology and economics literature on the impact of weather‐induced mood on labor productivity.     

When Do International Operations Lead to Improved Performance? An Analysis of Property‐Liability Insurers

In recent decades, insurers have been increasing their exposure to international markets. This article seeks to investigate the relationship between property-liability insurers' international operations and their risk-adjusted returns using cross-section and time-series data for the years 1992 through 2000. Our findings indicate that the relationship between international operations and performance is contingent upon the degree of product diversification. Insurance companies with focused operations in terms of product lines achieve higher risk-adjusted performance as they increase their exposures to international markets. However, insurers who are highly diversified across product lines face declining returns with greater exposure to international markets.     

How Do Stock Markets in the US and Europe Price Efficiency Gains from Bank M&As?

This paper examines whether the stock markets price changes in operating efficiency as a result of bank mergers and if the premiums paid by the acquiring banks also reflect these changes. The sample covers mergers and acquisitions consummated in the US and Europe during the period of 1997 to 2003. Changes in cost and profit efficiency are calculated using the non-parametric Data Envelopment Analysis (DEA) method 1 year prior and 3 years following the merger announcement. Evidence suggests a significant relation between the announcement-period abnormal returns and the post-merger profit efficiency changes. Results also indicate that bank managers are likely to pay a higher premium for those M&A transactions that can bring about greater efficiency gains, particularly on the profit side. Further, although acquirer shareholders in the US and Europe appear to react differently to the announcement of a bank merger, our results for target shareholders suggest that regional differences might be less important than the degree of capital market development in explaining wealth effects.