Asymmetric Trading Costs Prior to Earnings Announcements: Implications for Price Discovery and Returns

We show that the cost of trading on negative news, relative to positive news, increases before earnings announcements. Our evidence suggests that this asymmetry is due to financial intermediaries reducing their exposure to announcement risks by providing liquidity asymmetrically. This asymmetry creates a predictable upward bias in prices that increases preannouncement, and subsequently reverses, confounding short‐window announcement returns as measures of earnings news and risk premia. These findings provide an alternative explanation for asymmetric return reactions to firms' earnings news, and help explain puzzling prior evidence that announcement risk premia precede the actual announcements. Our study informs methods for research centering on earnings announcements and offers a possible explanation for patterns in returns around anticipated periods of heightened inventory risks, including alternative firm‐level, industry‐level, and macroeconomic information events.     

Returns to Speculators and the Theory of Normal Backwardation

A nonparametric statistical procedure is employed to examine the returns to speculators in wheat, corn, and soybeans futures markets. We find that the theory of normal backwardation is supported. Moreover, the presence of the risk premiums to speculators tends to be more prominent in recent years than in earlier years. We also find that large wheat speculators as a whole possessed some superior forecasting ability. The evidence is inconsistent with the hypothesis that commodity futures prices are unbiased estimates of the corresponding future spot prices.     

THE WAIVER PORK BARREL: COMMITTEE MEMBERSHIP AND THE APPROVAL TIME OF MEDICAID WAIVERS

Recent growth in Medicaid spending has forced states to look for ways to slow the program's rate of growth. Under the Medicaid program's rules, state governments must submit a waiver to the federal government in order to implement a cost-saving program. The time required to process a waiver varies from 14 days to over three years. This study examines the determinants of the time it takes to process a waiver and the number of revisions required before final approval. The results indicate that an increase in the tenure of the state's delegation to the House oversight committee reduces the time to approval for Freedom of Choice waivers. However, more liberal committee members appear to delay waivers. The results complement the existing literature on the pork barrel by showing that seniority on a committee is an important determinant-not only of monetary benefits but also of nonmonetary benefits. ( JEL H51, 118)     

How Wise Are Crowds? Insights from Retail Orders and Stock Returns

We analyze the role of retail investors in stock pricing using a database uniquely suited for this purpose. The data allow us to address selection bias concerns and to separately examine aggressive (market) and passive (limit) orders. Both aggressive and passive net buying positively predict firms’ monthly stock returns with no evidence of return reversal. Only aggressive orders correctly predict firm news, including earnings surprises, suggesting they convey novel cash flow information. Only passive net buying follows negative returns, consistent with traders providing liquidity and benefiting from the reversal of transitory price movements. These actions contribute to market efficiency.     

Underreaction to Industry‐Wide Earnings and the Post‐Forecast Revision Drift

We test whether the post‐forecast revision drift is mainly attributable to investors’ underreaction to industry‐wide earnings news conveyed by analysts’ forecast revisions. We find a large drift associated with industry‐wide earnings news but no drift associated with firm‐specific earnings news. Consistent with the functional fixation hypothesis, we provide evidence that the post‐forecast revision drift is driven by investors’ underreaction to the higher persistence of industry‐wide earnings. Although prior research has focused on differential persistence of earnings components stemming from managerial reporting discretion, we provide evidence suggesting that investors do not fully understand the differential earnings persistence attributable to industry fundamentals.     

The Long-Lasting Momentum in Weekly Returns

Reversal is the current stylized fact of weekly returns. However, we find that an opposing and long‐lasting continuation in returns follows the well‐documented brief reversal. These subsequent momentum profits are strong enough to offset the initial reversal and to produce a significant momentum effect over the full year following portfolio formation. Thus, ex post, extreme weekly returns are not too extreme. Our findings extend to weekly price movements with and without public news. In addition, there is no relation between news uncertainty and the momentum in 1‐week returns.     

A Political Agency Theory of Central Bank Independence

We propose a simple theory to explain why, and under what circumstances, a politician delegates policy tasks to a technocrat in an independent institution and then analyze under what conditions delegation is optimal for society. Our theory builds on Holmström's (1982, 1999) “hidden effort” principal–agent model. The election pressures that politicians face, and the absence of such pressures for technocrats, give rise to a dynamic incentive structure that formalizes two rationales for delegation, one highlighted by Hamilton (1788) and the other by Blinder (1998) . Delegation trades off the cost of having a possibly incompetent technocrat with a long‐term job contract against the benefit of having a technocrat who (i) invests more effort into the specialized policy task and (ii) is better insulated from the whims of public opinion. A natural application of our framework suggests a new theory of central bank independence.     

Partial Identification in Monotone Binary Models: Discrete Regressors and Interval Data

We investigate identification in semi-parametric binary regression models, y = 1( x β +υ+ε > 0) when υ is either discrete or measured within intervals. The error term ε is assumed to be uncorrelated with a set of instruments z , ε is independent of υ conditionally on x and z , and the support of − ( x β +ε) is finite. We provide a sharp characterization of the set of observationally equivalent parameters β . When there are as many instruments z as variables x , the bounds of the identified intervals of the different scalar components β _k of parameter β can be expressed as simple moments of the data. Also, in the case of interval data, we show that additional information on the distribution of υ within intervals shrinks the identified set. Specifically, the closer the conditional distribution of υ given z is to uniformity, the smaller is the identified set. Point identified is achieved if and only if υ is uniform within intervals.     

Incremental Information Content of the Change in the Percent of Production Added to Inventory*

Abstract. Manufacturing firms can manipulate income by producing in excess of the quantity needed to meet current period demand, thereby allocating part of current period fixed manufacturing overhead costs from cost of goods sold to inventory. Because it is subject to manipulation, the component of earnings due to producing in excess of sales may be of lower quality than the remaining component of earnings. We investigate this possibility using a regression of security returns on unexpected income and an estimate of the change in percent of production added to inventory (CPAI). An analytical model indicates that CPAI determines the “earnings surprise” subject to manipulation by overproducing. Assuming the market recognizes this, the coefficient on CPAI should be negative because this low quality component must be deducted from the total “good news” conveyed by the change in reported earnings. Alternatively, CPAI may convey good or bad news to the market that is unrelated to the manipulation of current period earnings. Firms may increase the percent of production added to inventory in anticipation of high levels of future sales. In this case, the estimated coefficient on CPAI should be positive. Or, if the increase in the percent of production added to inventory reflects anticipation of a strike or an unexpected downturn in current sales, the estimated coefficient should be negative. Cross-sectional tests using a large sample of manufacturing firms indicate a significant positive relation between security returns and CPAI. This finding is consistent with market participants viewing CPAI as a leading indicator of firm performance. Although the results are most supportive of CPAI conveying good news, there is some evidence that CPAI is used by managers to smooth earnings and, for firms classified as smoothing earnings, there is weak evidence that the component of earnings related to CPAI is viewed by market participants to be of lower quality.