Idiosyncratic Risk Matters!

This paper takes a new look at the predictability of stock market returns with risk measures. We find a significant positive relation between average stock variance (largely idiosyncratic) and the return on the market. In contrast, the variance of the market has no forecasting power for the market return. These relations persist after we control for macroeconomic variables known to forecast the stock market. The evidence is consistent with models of time‐varying risk premia based on background risk and investor heterogeneity. Alternatively, our findings can be justified by the option value of equity in the capital structure of the firms.     

The Impact of Structure and Openness on The Causal Ordering Of Interest,Inflation and Exchange Rates

Journal of Quantitative Economics - In a country with a very large population at low per capita income, the interaction between the price of food and wages is a major determinant of inflation. But,...     

Does the information content of payout initiations and omissions influence firm risks?

We study the influence on firm risks of NASDAQ and NYSE firm payout initiations and omissions. These payout events can be interpreted as managerial signals of firm financial life-cycle maturation resulting in concomitant changes in firm risks. We remove confounding payout types and we match on the propensity to initiate or omit informed by determinants of payout known to investors in advance. For payout event and matched firms, we apply the difference-in-differences method to estimate the effect of the information content of actual initiations and omissions on firm risks. We find consistent significant declines in total, aggregate systematic, and idiosyncratic firm risks after cash dividend initiations and increases after dividend omissions, but only incidentally after share repurchase initiations and omissions.     

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.     

Measuring the Accuracy of Federal Reserve Forecasts

Markets across the world pay enormous attention to every economic forecast made by Federal Reserve governors, particularly those from the chair. This article develops a new way that the academic literature can assess the accuracy of these Federal Reserve forecasts. In particular, our proposed method allows for both general and specific predictions to be assessed, while also accounting for the macroeconomic volatility that prevails at the time of the forecast. To develop this measure, we expand upon a methodology proposed by the Wall Street Journal to score the accuracy of forecasts made by the Fed. Our results show that Alan Greenspan was consistently the most accurate forecaster among Fed governors, while the most recent chair in our sample, Janet Yellen, has performed relatively poorly. More generally, we find that the chairs have become less accurate over time with their forecasts and have also tended to make fewer specific predictions.     

Co-ordination, Spillovers, and Cheap Talk

We analyze the role of cheap-talk in two player games with one-sided incomplete information. We identify conditions under which (1) players can fully communicate and coordinate on efficient Nash equilibria of the underlying complete information game; and (2) players cannot communicate so cheap-talk does not alter the equilibrium set of the Bayesian game. We present examples that illustrate several issues that arise when there is two-sided incomplete information. Journal of Economic Literature Classification Numbers: C72, D82.     

Who survives? A cross-country comparison

How capital structure, dividend policy, and corporate governance vary across countries has been the focus of recent studies, but how resources are reallocated in response to poor performance has not received as much attention. This paper argues that the market for corporate control and the formal bankruptcy/liquidation processes of a country are two key mechanisms through which corporate assets are reallocated. Ideally, an economy would only allow the best users of economic resources to retain the right to use those assets and any sub-optimal use would result in either a take-over by a more proficient owner or an asset sale. We present evidence that equity market delistings occur more frequently in countries with strong shareholder rights. Furthermore, both strong creditor and shareholder rights increase the use of bankruptcy, relative to acquisitions, as a mechanism to resolve financial distress. We also present some evidence that these mechanisms are not as effective in Japan.     

Board Characteristics,Firm Profitability and Earnings Management: Evidence from India

The present paper explores the association between earnings management and specific board characteristics and the firm's profitability in the Indian context. In India, the corporate ownership model is the promoter dominated shareholders model. This is the first study based on a panel data framework that employs a fixed effect model to control for time‐invariant endogeneity. It also contributes to the literature by exploring the role of the firm's profitability in transmitting the impact of audit committee independence on earnings management. The study finds that profitability is an important variable, as it moderates the association between audit committee independence and earnings management. Managers of a profit‐making company would have little need to modify their earnings. This signifies that independent audit committees are more effective monitors of earnings management in profitable firms than in non‐profitable firms. Independent directors with multiple directorships are also found to be ineffective monitors. The findings are of material significance to policymakers in analysing board effectiveness and earnings management and improving policymaking for corporate governance by using profitability and related variables.     

Cross-section of option returns and volatility

We study the cross-section of stock option returns by sorting stocks on the difference between historical realized volatility and at-the-money implied volatility. We find that a zero-cost trading strategy that is long (short) in the portfolio with a large positive (negative) difference between these two volatility measures produces an economically and statistically significant average monthly return. The results are robust to different market conditions, to stock risks-characteristics, to various industry groupings, to option liquidity characteristics, and are not explained by usual risk factor models.     

A comparison of voluntary and mandated climate change-related disclosure

This study draws on legitimacy theory to investigate the relationship between mandatory disclosure of greenhouse gas emissions by companies that are subject to specific environmental legislation (the Australian National Greenhouse Energy Reporting Act 2007) and the level of voluntary environmental disclosures. Using a sample of 535 observations, we find that i) Overall, legislation-affected companies increase their disclosures compared with non-affected companies, ii) As many companies reduce their disclosures as increase them, iii) there is an increase in the level of emissions volume disclosures in legislation-affected companies compared with the same company pre-implementation, iv) legislation-affected higher emitters have higher levels of voluntary disclosures. These findings are consistent with legitimacy theory, which predicts differential disclosures in circumstances to avoid scrutiny.