Stock return reversal and continuance anomaly: new evidence from Hong Kong

Using weekly data, this article conducts a comprehensive analysis and presents new empirical evidences on the short-term stock return reversal and continuance anomaly in the Hong Kong stock market. We confirm that winner stocks behave differently from loser stocks in that the return reversal phenomenon is pervasive within past winner stocks only while past loser stocks tend to show weak return continuance. The arbitrage strategy can earn significantly positive contrarian profits, especially for small firms and illiquid stocks. The anomaly varies across different industries and is also sensitive to the market movement. Despite the existence of the anomaly, our results still in general suggest that the Hong Kong stock market is weak-form efficient because arbitrage trading costs would largely overwhelm the available profits in most cases.     

The expected real return to equity

The expected return to equity – typically measured as a historical average – is a key variable in the decision making of investors. A recent literature uses analysts' forecasts, investor surveys or present-value relationships and finds estimates of expected returns that are sometimes much lower than historical averages. This study extends the present-value approach to a dynamic optimizing framework. Given a model that captures this relationship, one can use data on dividends, earnings and valuations to infer the model-implied expected return. Using this method, the estimated expected real return to equity ranges from 4.9% to 5.6% . Furthermore, the analysis indicates that expected returns have declined by about 3 percentage points over the past 40 years. These results indicate that future returns to equity may be lower than past realized returns.     

Cross‐sectional Tests of Conditional Asset Pricing Models: Evidence from the German Stock Market

We study the performance of conditional asset pricing models and multifactor models in explaining the German cross‐section of stock returns. We focus on several variables, which (according to previous research) are associated with market expectations on future market excess returns or business cycle conditions. Our results suggest that the empirical performance of the Capital Asset Pricing Model (CAPM) can be improved when allowing for time‐varying parameters of the stochastic discount factor. A conditional CAPM using the term spread explains the returns on our size and book‐to‐market sorted portfolios about as well as the Fama‐French three‐factor model and performs best in terms of the Hansen‐Jagannathan distance. Structural break tests do not necessarily indicate parameter instability of conditional model specifications. Another major finding of the paper is that the Fama‐French model – despite its generally good cross‐sectional performance – is subject to model instability. Unconditional models, however, do a better job than conditional ones at capturing time‐series predictability of the test portfolio returns.     

On the predictive power of the surplus consumption ratio

This paper shows that the surplus consumption ratio, specified by Campbell and Cochrane [1999. Journal of Political Economy 107, 205–251], is a good predictor of excess returns at long horizons. We also provide empirical evidence that this variable captures a component of expected returns, not explained by the proxies for the consumption to wealth ratio, cay and cdy, proposed by Lettau and Ludvigson [2001a. Journal of Finance 56, 815–849; 2001b. Journal of Political Economy 109, 1238–1286; 2005. Journal of Financial Economics 76, 583–626]. Moreover, used as a conditioning information for the Consumption based Asset Pricing Model (C)CAPM, the resulting linear model helps to explain for the variation in average returns across the Fama–French (25) portfolios sorted by size and book-to-market characteristics.     

Security Choice, Information Effects and Firm Characteristics: A Factor Analytic Approach

Abstract:   We examine the marginal choice between debt and equity securities using a factor analytic approach. This data reduction property eliminates the need to select the one best variable to proxy for a particular theoretical construct. Our results reinforce numerous existing findings using traditional methods and suggest both static tradeoff and asymmetric information based considerations are relevant in determining security choice. Two new results are presented related to the accounting liquidity of the firm. First, the preference for equity is increasing with liquidity as suggested by the window of opportunity hypothesis. Secondly, the market response to equity issuance announcements is inversely related to the liquidity of the firm. Profitability and growth measures support Jensen's (1986) agency cost of free cash flow as a potential explanation for the second finding.     

Stock market booms and real economic activity: Is this time different?

Since World War II, the United States has experienced two large booms on the stock market. During the first boom, which lasted from the late 1940s to the mid-1960s, stock returns were clearly leading real activity. Moreover, the evidence also suggests the existence of predictable return variations in the discount rate through time as a response to changing business conditions. Therefore, the first boom does not stand out as unusual because previous studies, such as Fama (1990) or Chen (1991), confirm these results for the whole period from the 1950s to the 1980s. But during the current boom, which started in the early 1980s, these results do not hold up any more. Stock returns do not seem to lead real activity and predictable return variations as a response to business conditions cannot be detected.     

Failures to Deliver,Short Sale Constraints,and Stock Overvaluation

Studying a large sample of publicly available data on failures to deliver, we find that stocks reaching threshold levels of failures become significantly overvalued. Where short sale constraints are especially binding, we report extreme overpricing and subsequent reversals. These findings support the overvaluation hypothesis, although the mispricing is likely to be difficult to arbitrage because of extreme shorting costs. In addition, threshold stocks with low short interest become more overvalued than threshold stocks with high short interest. This suggests that the level of short interest reflects supply‐side effects when the examination conditions on the difficulty of borrowing shares.     

Financial density selection

We propose and study simple but flexible methods for density selection of skewed versions of the two most popular density classes in finance, the exponential power distribution and the t distribution. For the first type of method, which simply consists of selecting a density by means of an information criterion, the Schwarz criterion stands out since it performs well across density categories, and in particular when the DGP is normal. For the second type of method, general-to-specific density selection, the simulations suggest that it can improve the recovery rate in predictable ways by changing the significance level. This is useful because it enables us to increase (reduce) the recovery rate of non-normal densities by increasing (reducing) the significance level, if one wishes to do so. The third type of method is a generalisation of the second type, such that it can be applied across an arbitrary number of density classes, nested or non-nested. Finally, the methods are illustrated in an empirical application.