Does Inflation Targeting Affect the Dispersion of Inflation Expectations?

In this paper, we examine the effect of having an inflation targeting framework on the dispersion of inflation forecasts from professional forecasters. We use a panel data set of 25 countries—including 14 inflation targeters—with 16 years of monthly information. We find that the dispersion of long-run inflation expectations is smaller in targeting regimes after controlling for country-specific effects, time-specific effects, the level and the variance of inflation, disinflation periods, and global inflation. On average, the full effect is not observed until the third year after implementation of inflation targeting. When we differentiate between developed and developing countries, the dispersion of inflation expectations after inflation targeting is smaller and statistically significant only in developing countries.     

Are Farmers’ Behaviors Rational When They Pay Less for Social Endowment Insurance? Evidence from Chinese Rural Survey Data

In recent years, farmers have had high participation rate in the rural social endowment insurance in China, for which personal contribution and government subsidy are the main funding source. There have been increasingly more farmers participating into the program. However, their enthusiasm for high premium payment was rather low as most of them selected the minimum premium for insurance. In this article, the discounted utility theory from behavioral economics was adopted to analyze insurance selection behaviors of farmers; in addition, a discounted incremental utility model with a hyperbolic discounting function was also further constructed to describe their insurance decision-making processes. Based on the investigation of time preferences of farmers, their insurance participation behaviors of diverse natures were simulated. The corresponding results indicated that active insurance participation and low insurance premium payment were rational choices for most farmers; in comparison, for the elders with higher income, different choices can be made. Therefore, policy makers could formulate differentiated subsidy policies directing at farmers from different groups, so as to stimulate their enthusiasm for premium payment.     

Are all management earnings forecasts created equal? Expectations management versus communication

Recent studies associate management earnings forecasts (MEFs) with expectations management. These studies, however, neither provide evidence on the extent and scope of expectations management through MEFs nor consider alternative incentives for issuing MEFs. Consequently, existing evidence does not help regulators assess whether MEFs effectively facilitate communication with investors. We investigate to what extent managers exploit their earnings forecasts as a tool of expectations management or as a communication device. By examining relations among MEFs, analysts?? forecasts, and actual earnings, we classify MEFs into three incentive categories: (1) expectations management, (2) communication, and (3) other incentives. We find that a significant proportion (approximately 45%) of MEFs is issued to convey accurate earnings information to the market (that is, communication incentive). We also find that the fraction of MEFs for the expectations-management incentive increases post-Regulation Fair Disclosure. The evidence from examination of the various managerial motives for each incentive category supports our classification. Additional analysis using alternative classifications based on bad/good news and pessimistic/optimistic forecasts reveals that our proposed classification of MEFs works better in defining expectations management than these other classifications. This implies that more caution is warranted in defining expectations management when investigating the association between managerial motives and incentives for issuing MEFs.     

When Does Extra Risk Strictly Increase an Option's Value?

It is well known that risk increases the value of options. Thisarticle makes that precise in a new way. The conventional theoremsays that the value of an option does not fall if the underlyingasset becomes riskier in the conventional sense of the mean-preservingspread. This article uses two new definitions of "riskier" toshow that the value of an option strictly increases (i) if theunderlying asset becomes "pointwise riskier," and (ii) onlyif the underlying asset becomes "extremum riskier."     

When Does Information Asymmetry Affect the Cost of Capital?

This paper examines when information asymmetry among investors affects the cost of capital in excess of standard risk factors. When equity markets are perfectly competitive, information asymmetry has no separate effect on the cost of capital. When markets are imperfect, information asymmetry can have a separate effect on firms’ cost of capital. Consistent with our prediction, we find that information asymmetry has a positive relation with firms’ cost of capital in excess of standard risk factors when markets are imperfect and no relation when markets approximate perfect competition. Overall, our results show that the degree of market competition is an important conditioning variable to consider when examining the relation between information asymmetry and cost of capital.     

Are There Rational Bubbles in REITs? New Evidence from a Complex Systems Approach

This study applies a complex systems approach to test for the presence of rational bubbles in the Equity REITs market. The applied model is based on theoretical implications of the evolution of prices under rational bubble regimes. The advantage of the approach is twofold. The model is able to detect rational bubbles while they rise and to predict the most likely time of their collapse. We apply the model to daily price data on U.S. Equity REITs from 1989 to 2011. Our findings suggest the existence of a bubble for the period of 2003 to 2007. Tests for sub-markets reveal that the bubble developed in the Residential REITs market, but not in the Office REITs market.     

Do Corporate Managers Know When Their Shares Are Undervalued? New Evidence Based on Actual (and Not Just Announced) Stock Buybacks

This article summarizes the findings of the authors' recent study, published in the Journal of Financial Economics, of whether public companies are able to repurchase their own shares at a discount to the market, thereby earning more than a market return on such “investments.” To the extent the answer is yes, it would suggest that management has an advantage in assessing the intrinsic value of the companies they manage. Using as their sample all 2,237 publicly traded U.S. companies that repurchased their own stock between 2004 and 2011, the authors compared the average price paid during the month to the average price at which the firm's shares traded during that month as well as three and six months after the repurchase. (All earlier studies had measured stock performance from the date of the repurchase announcements rather than from the date of the actual repurchases.) The authors' conclusion, which may come as more of a surprise to financial economists than practicing corporate executives, was that the majority of companies repurchasing their shares have in fact earned a positive return on their investment in their own stock. Perhaps the most important finding of the study, however, was that infrequent repurchasers—defined as companies that bought back their own stock four or fewer times a year—have been much more successful in buying undervalued shares than regular repurchasers. For example, when evaluated over a six‐month holding period, the annual “alpha” of infrequent repurchasers was 2.4% greater than that of frequent repurchasers—those that bought back their shares at least nine times a year. And this advantage was even more significant for companies that repurchased just once during the year—a group that recorded an alpha of 5.9%, as compared to 1.5% for monthly repurchasers. Moreover, the results were essentially the same when extended over considerably longer holding periods. For the entire sample of companies that repurchased their shares, the authors reported finding positive and significant alphas of 0.3% per month over windows ranging from three months to three years after the repurchase. But, as reported above, the infrequent repurchasers significantly outperformed frequent repurchasers over all time horizons, with differences in alpha that ranged from a low of 0.3% and to as high as 0.6% per month.     

Risk Management Failures: What Are They and When Do They Happen?

The difficulties of the past year have convinced many observers that current risk management practices are deeply flawed, and that such flaws have contributed greatly to the current financial crisis. In this paper, the author challenges this view by showing the need to distinguish between flawed assessments by risk managers and corporate risk‐taking decisions that, although resulting in losses, were reasonable at the time they were made. In making this distinction, the paper also identifies a number of different ways that risk management can fail. In addition to choosing the wrong risk metrics and misidentifying or mismeasuring risks, risk managers can fail to communicate their risk assessments and provide effective guidance to top management and boards. And once top management has used that information to help determine the firm's risk appetite and strategy, the risk management function can also fail to monitor risks appropriately and maintain the firm's targeted risk positions. But if risk management has been mistakenly identified as the culprit in many cases, current risk management practice can be improved by taking into account the lessons from financial crises past and present. In particular, such crises have occurred with enough frequency that crisis conditions can be modeled, at least to some extent. And when models reach their limits of usefulness, companies should consider using scenario planning that aims to reveal the implications of crises for their financial health and survival. Instead of relying on past data, scenario planning must use forward‐looking economic analysis to evaluate the expected impact of sudden illiquidity and the associated feedback effects that are common in financial crises.     

Are Banks Still Special When There Is a Secondary Market for Loans?

Secondary market trading in loans elicits a significant positive stock price response by a borrowing firm's equity investors. We find the major reason for this response is the alleviation of borrowing firms’ financial constraints. We also find that new loan announcements are associated with a positive stock price effect even when prior loans made to the same borrower already trade on the secondary market. We conclude that the special role of banks has changed due to their ability to create an active secondary loan market while simultaneously maintaining their traditional role as information producers.     

When Does a Merger Create Value? Using Option Prices to Elicit Market Beliefs

I introduce and test a method to identify market expectations about value creation in mergers. Post‐announcement market prices reflect beliefs about both merged and standalone firm values, and the likelihood of either outcome. Stock prices alone do not contain sufficient information to identify these latent beliefs. By adding exchange‐traded stock option data, I deliver a clear decomposition of observed value change into two parts: 1) value creation and 2) new information about standalone value. Previous research has struggled to disentangle the two. This decomposition provides a strong and practical measure of the market's expectations about value creation in a merger.     

Insurance and Endogenous Bankruptcy Risk: When is it Rational to Choose Gambling,Insurance, and Potential Bankruptcy?

We examine the coexistence of insurance and gambling in the context of limited liability. We develop a model where actuarially fair insurance is available to a risk-averse decision maker for a liability risk with non-bankrupting severity. The remaining wealth may be invested in a zero expected value risky project (i.e., gambled). The risk of bankruptcy is endogenous since either fully insuring or forgoing the project will guarantee solvency. We show that, for a range of parameters, it is optimal to both insure and gamble. The amounts insured and invested are chosen to create the potential for bankruptcy. Our results are robust to the cases where the risky project can cause bankruptcy without a liability loss and where the risky project’s expected return is nonzero.     

Where,When, and by How Much Does Abnormal Weather Affect Housing Construction?

This article investigates whether departures from normal in precipitation or temperature have a significant contemporaneous effect on housing starts in each month of the year, for the nation as a whole and in each of the four Census regions. It also evaluates the extent to which these immediate effects are reversed in later months. The results indicate that atypical weather has statistically significant effects on the change in housing starts that are concentrated in the months of the first quarter and that the magnitude of these effects is quite substantial. However, such effects also are found in some other months as well. Significant lagged effects are found that tend to offset the contemporaneous effects of weather deviations.     

Rational Risk Perception: Utopia or Dystopia?

Societal conflicts with regard to risk management are common. The public has different beliefs than many experts and administrators with regard to such issues as the citing of a repository for spent nuclear fuel or whether genetically modified organisms should be allowed to enter the human food chain. As a result, political tensions arise and there may be a skew allocation of resources for risk mitigation. The question raised in the article is if a consensus society is possible and desirable. If views converge on high risk beliefs, the cost would be very high as well. If views converge on low risks, some hazards could be neglected and environmental damage considerable, as used to be the case in the Former Soviet Union and other socialist countries which lacked a free press. A consensus society is neither possible nor desirable. No party has access to the final truth with regard to risks and hazards; diversity is an asset.     

Does the Market Incorporate Previous IPO Withdrawals When Pricing Second‐Time IPOs?

This paper examines the initial public offering (IPO) valuations of issuers that return to the IPO market successfully after withdrawing their first IPO attempt. We find that these second-time IPOs sell at a significant discount relative to similar contemporaneous IPOs that succeed in their first attempt. We also demonstrate that switching underwriters on the second IPO attempt reduces, but does not eliminate, the discount for second-time IPOs. When compared to their matched first-time IPOs, second-time IPOs have similar price revisions and post-IPO long-run stock and operating performances. Overall, these results suggest that the negative information conveyed by the withdrawal event is incorporated into the lower offer valuations for second-time IPOs. Switching investment banks can mitigate, but not eliminate, the perceived higher risk of the second-time offerings.     

When Is a Liability Not a Liability? Textual Analysis,Dictionaries, and 10‐Ks

Previous research uses negative word counts to measure the tone of a text. We show that word lists developed for other disciplines misclassify common words in financial text. In a large sample of 10‐Ks during 1994 to 2008, almost three‐fourths of the words identified as negative by the widely used Harvard Dictionary are words typically not considered negative in financial contexts. We develop an alternative negative word list, along with five other word lists, that better reflect tone in financial text. We link the word lists to 10‐K filing returns, trading volume, return volatility, fraud, material weakness, and unexpected earnings.     

Are cryptocurrencies homogeneous?

This article investigates if cryptocurrencies returns' are similarly affected by a selection of demand- and supply-side determinants. Homogeneity among cryptocurrencies is tested via a least absolute shrinkage and selection operator (LASSO) model where determinants of Bitcoin returns are applied to a sample of 12 cryptocurrencies. The analysis goes beyond existing research by simultaneously covering different periods and design choices of cryptocurrencies. The results show that cryptocurrencies are heterogeneous, apart from some similarities in the impact of technical determinants and cybercrime. The cryptocurrency market displays evidence of substitution effects, and design choices related explain the impact of the determinants of return.     

When Is Sticky Information More Information?

This paper uses sectoral data to study survey‐based balance indices designed to capture changes in the business cycle in real time. The empirical framework recognizes that when answering survey questions regarding their firm's output, respondents potentially rely on infrequently updated information. The analysis then suggests that their answers reflect notable information lags, on the order of 7^1/2 months on average. Moreover, information stickiness implies that noisy output fluctuations will be attenuated in survey answers and, consequently, helps explain why balance indices successfully track business cycles. Conversely, in an environment populated by fully informed identical firms, as in the standard RBC framework, for example, balance indices instead become degenerate. Finally, information regarding changes in aggregate output tends to be sectorally concentrated. The paper, therefore, illustrates how this feature of the data may be relevant for the construction of balance indices.     

Which Shorts Are Informed?

We construct a long daily panel of short sales using proprietary NYSE order data. From 2000 to 2004, shorting accounts for more than 12.9% of NYSE volume, suggesting that shorting constraints are not widespread. As a group, these short sellers are well informed. Heavily shorted stocks underperform lightly shorted stocks by a risk‐adjusted average of 1.16% over the following 20 trading days (15.6% annualized). Institutional nonprogram short sales are the most informative; stocks heavily shorted by institutions underperform by 1.43% the next month (19.6% annualized). The results indicate that, on average, short sellers are important contributors to efficient stock prices.