Capitalized
Company name fluency, investor recognition, and firm value
Clifton Green & Russell Jame
Journal of Financial Economics, forthcoming
Abstract:
Research from psychology suggests that people evaluate fluent stimuli more favorably than similar information that is harder to process. Consistent with fluency affecting investment decisions, we find that companies with short, easy to pronounce names have higher breadth of ownership, greater share turnover, lower transaction price impacts, and higher valuation ratios. Corporate name changes increase fluency on average, and fluency-improving name changes are associated with increases in breadth of ownership, liquidity, and firm value. Name fluency also affects other investment decisions, with fluently named closed-end funds trading at smaller discounts and fluent mutual funds attracting greater fund flows.
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Informed Trading through the Accounts of Children
Henk Berkman, Paul Koch & Joakim Westerholm
Journal of Finance, forthcoming
Abstract:
This study shows that the guardians behind underaged accounts are successful at picking stocks. Moreover, they tend to channel their best trades through the accounts of children, especially when they trade just before major earnings announcements, large price changes, and takeover announcements. Building on these results, we argue that the proportion of total trading activity through underaged accounts (labeled BABYPIN) should serve as an effective proxy for the probability of information trading in a stock. Consistent with this claim, we show that investors demand a higher return for holding stocks with a greater likelihood of private information, proxied by BABYPIN.
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Can Financial Engineering Cure Cancer?
David Fagnan et al.
American Economic Review, May 2013, Pages 406-411
Abstract:
Traditional financing sources such as private and public equity may not be ideal for investment projects with low probabilities of success, long time horizons, and large capital requirements. Nevertheless, such projects, if not too highly correlated, may yield attractive risk-adjusted returns when combined into a single portfolio. Such "megafund" portfolios may be too large to finance through private or public equity alone. But with sufficient diversification and risk analytics, debt financing via securitization may be feasible. Credit enhancements (i.e., derivatives and government guarantees) can also improve megafund economics. We present an analytical framework and illustrative empirical examples involving cancer research.
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How Safe are Money Market Funds?
Marcin Kacperczyk & Philipp Schnabl
Quarterly Journal of Economics, forthcoming
Abstract:
We examine the risk-taking behavior of money market funds during the financial crisis of 2007-2010. We find that: (1) money market funds experienced an unprecedented expansion in their risk-taking opportunities; (2) funds had strong incentives to take on risk because fund inflows were highly responsive to fund yields; (3) funds sponsored by financial intermediaries with more money fund business took on more risk; (4) funds suffered runs as a result of their risk taking. This evidence suggests that money market funds lack safety because they have strong incentives to take on risk when the opportunity arises and are vulnerable to runs.
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Playing Favorites: How Firms Prevent the Revelation of Bad News
Lauren Cohen, Dong Lou & Christopher Malloy
Harvard Working Paper, March 2013
Abstract:
We explore a subtle but important mechanism through which firms manipulate their information environments. We show that firms control information flow to the market through their specific organization and choreographing of earnings conference calls. Firms that "cast" their conference calls by disproportionately calling on bullish analysts tend to underperform in the future. A long-short portfolio that exploits this differential firm behavior earns abnormal returns of up to 95 basis points per month. Firms that call on more favorable analysts experience more negative future earnings surprises and more future earnings restatements. Further, firms that cast their calls have higher accruals, barely exceed/meet earnings forecasts, and subsequently issue equity.
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Before and After: The Impact of a Real Bubble Crash on Investors' Trading Behavior in the Lab
Binglin Gong, Vivian Lei & Pan Deng
Journal of Economic Behavior & Organization, forthcoming
Abstract:
We report the results of an experiment designed to study whether or not having experienced booms and crashes in naturally occurring asset markets affects subjects' trading behavior in the lab. Active investors in the Shanghai Stock Exchange were recruited to participate in either the Boom treatment, conducted in June 2007 after the Shanghai Stock Exchange had had a bull market for almost two years, or the Crash treatment, conducted in August 2008 after the SSE Composite Index had plummeted almost 60 percent from its high reached in October 2007. We find that, compared to those in the Crash treatment, subjects in the Boom treatment were much more active when participating in our experimental asset markets in that they tended to made bigger trades and preferred to hold more shares than cash. These behavioral differences cannot be explained by the overconfidence hypothesis.
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Diego Garcia
Journal of Finance, June 2013, Pages 1267-1300
Abstract:
This paper studies the effect of sentiment on asset prices during the 20th century (1905 to 2005). As a proxy for sentiment, we use the fraction of positive and negative words in two columns of financial news from the New York Times. The main contribution of the paper is to show that, controlling for other well-known time-series patterns, the predictability of stock returns using news' content is concentrated in recessions. A one standard deviation shock to our news measure during recessions predicts a change in the conditional average return on the DJIA of 12 basis points over one day.
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Externalities of Public Firm Presence: Evidence from Private Firms' Investment Decisions
Brad Badertscher, Nemit Shroff & Hal White
Journal of Financial Economics, forthcoming
Abstract:
Public firms provide a large amount of information through their disclosures. In addition, information intermediaries publicly analyze, discuss, and disseminate these disclosures. Thus, greater public firm presence in an industry should reduce uncertainty in that industry. Following the theoretical prediction of investment under uncertainty, we hypothesize and find that private firms are more responsive to their investment opportunities when they operate in industries with greater public firm presence. Further, we find that the effect of public firm presence is greater in industries with better information quality and in industries characterized by a greater degree of investment irreversibility. Our results suggest that public firms generate positive externalities by reducing industry uncertainty and facilitating more efficient private firm investment.
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Is Gold the Best Hedge and a Safe Haven under changing Stock Market Volatility?
Matthew Hood & Farooq Malik
Review of Financial Economics, April 2013, Pages 47-52
Abstract:
We evaluate the role of gold and other precious metals relative to volatility (VIX) as a hedge (negatively correlated with stocks) and safe haven (negatively correlated with stocks in extreme stock market declines) using data from the US stock market. Using daily data from November 1995 to November 2010, we find that gold, unlike other precious metals, serves as a hedge and a weak safe haven for US stock market. However, we find that VIX serves as a very strong hedge and a strong safe haven during our sample period. We also find that in periods of extremely low or high volatility, gold does not have a negative correlation with the US stock market. Our results show that VIX is a superior hedging tool and serves as a better safe haven than gold during our sample period. We highlight the practical significance of our results for financial market participants by conducting a portfolio analysis.
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Do Hedge Funds Manipulate Stock Prices?
Itzhak Ben-David et al.
Journal of Finance, forthcoming
Abstract:
We provide evidence suggesting that some hedge funds manipulate stock prices on critical reporting dates. Stocks in the top quartile of hedge fund holdings exhibit abnormal returns of 0.30% on the last day of the quarter and a reversal of 0.25% on the following day. A significant part of the return is earned during the last minutes of trading. Analysis of intraday volume and order imbalance provides further evidence consistent with manipulation. These patterns are stronger for funds that have higher incentives to improve their ranking relative to their peers.
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Greed and Fear in Financial Markets: The Case of Stock Spam E-Mails
Bill Hu & Thomas McInish
Journal of Behavioral Finance, Spring 2013, Pages 83-93
Abstract:
Using a rich dataset of stock spam e-mails as a laboratory, we test and find support for three behavioral finance theories related to investor attention, ambiguity, and overweighting of low probability outcomes. First, we find that both the dollar volume and return on the peak day of the spam campaigns (SCs) are significantly higher compared to those on randomly selected non-spam dates. In addition, SCs reduce the number of zero trading days while the campaign is underway. Second, e-mails with a target price have significantly higher abnormal dollar volume and abnormal return on the peak day of the SC than e-mails without a target price. Thus, individual investors favor bets with unambiguous payoffs, which supports the ambiguity hypothesis. Finally, when the target price indicated in spam e-mails is about 53 times the current price, the abnormal return of the SC peaked at 31%. We document a nonlinear relationship between abnormal return on the peak day of the SCs and the premium implied in the spam e-mails. Although investors overweight low probability events, the overweighting decreases when the probability becomes out of reach. Our findings concerning target price are consistent with cumulative prospect theory.
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Sebastian Lotz & Andrea Fix
Journal of Economic Psychology, forthcoming
Abstract:
Since the recent financial crisis, regulators and the general public have focused on financial speculation as one of its potential causes. In addition to the roles played by rating agencies and complicated financial engineering, speculative short sales have been put into question. However, laypeople's moral judgments about this type of financial speculation have rarely been investigated in economic psychology. The present study aims to fill this gap. Across four studies, we find that laypeople's moral judgments of short selling are significantly harsher than their judgments of long positions. Both successful (Study 1) and unsuccessful (Study 2) short selling receives harsher moral judgments. In addition, studies which manipulate the moral character of the shorted asset (Study 3) or the time horizon of the investment strategy (Study 4) support the conclusion that short selling is considered less moral than taking a similar long position. The results present consistent support for a judgment bias of economic laypeople in the domain of financial economics.
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Structural Shifts in Credit Rating Standards
Aysun Alp
Journal of Finance, forthcoming
Abstract:
I examine the time-series variation in corporate credit rating standards from 1985 to 2007. A divergent pattern exists between investment-grade and speculative-grade rating standards from 1985 to 2002 as investment-grade standards tighten and speculative-grade loosen. In 2002, a structural shift occurs towards more stringent ratings. Holding characteristics constant, firms experience a drop of 1.5 notches in ratings due to tightened standards from 2002 to 2007. Credit spread tests suggest that the variation in standards is not completely due to changes in the economic climate. Rating standards affect credit spreads. Loose ratings are associated with higher default rates.
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Rick Quax, Drona Kandhai & Peter Sloot
Scientific Reports, May 2013
Abstract:
In financial markets, participants locally optimize their profit which can result in a globally unstable state leading to a catastrophic change. The largest crash in the past decades is the bankruptcy of Lehman Brothers which was followed by a trust-based crisis between banks due to high-risk trading in complex products. We introduce information dissipation length (IDL) as a leading indicator of global instability of dynamical systems based on the transmission of Shannon information, and apply it to the time series of USD and EUR interest rate swaps (IRS). We find in both markets that the IDL steadily increases toward the bankruptcy, then peaks at the time of bankruptcy, and decreases afterwards. Previously introduced indicators such as ‘critical slowing down' do not provide a clear leading indicator. Our results suggest that the IDL may be used as an early-warning signal for critical transitions even in the absence of a predictive model.
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No conflict, no interest: On the economics of conflicts of interest faced by analysts
William Forbes
European Journal of Law and Economics, June 2013, Pages 327-348
Abstract:
This paper outlines evolution of the policy response to conflicts of interest analysts face in offering investment advice to investors when the company they follow may also buy merchant banking services from their employer. Both in the US and the UK on a both statutory and common law basis the response has been one of to disclose and let market participants price the implied conflict or simply rebut the advice given. An efficient market can price conflicts and by implication unravel any potential damage to shareholder wealth induced by analysts' conflicts of interests in this view. I consider the impact the presence of "noise traders" in financial markets may have on the welfare implications of this sort of policy stance. The presence of noise traders casts doubt on the benign impact of conflicts of interest in financial markets. In particular the presence of noise induced variance in analyst's forecasts implies disclosure based remedies may be ineffective in mitigating the harm of analyst's conflicts of interest.
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The Real Effects of Financial Shocks: Evidence from Exogenous Changes in Analyst Coverage
François Derrien & Ambrus Kecskés
Journal of Finance, forthcoming
Abstract:
We study the causal effects of analyst coverage on corporate investment and financing policies. We hypothesize that a decrease in analyst coverage increases information asymmetry and thus increases the cost of capital; as a result, firms decrease their investment and financing. We use broker closures and broker mergers to identify changes in analyst coverage that are exogenous to corporate policies. Using a difference-in-differences approach, we find that firms that lose an analyst decrease their investment and financing by 1.9% and 2.0% of total assets, respectively, compared to similar firms that do not lose an analyst.
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Shaping Liquidity: On the Causal Effects of Voluntary Disclosure
Karthik Balakrishnan et al.
NBER Working Paper, April 2013
Abstract:
Can managers influence the liquidity of their firms' shares? We use plausibly exogenous variation in the supply of public information to show that firms seek to actively shape their information environments by voluntarily disclosing more information than is mandated by market regulations and that such efforts have a sizeable and beneficial effect on liquidity. Firms respond to an exogenous loss of public information by providing more timely and informative earnings guidance. Responses appear motivated by a desire to reduce information asymmetries between retail and institutional investors. Liquidity improves as a result of voluntary disclosure and in turn increases firm value. This suggests that managers can causally influence their cost of capital via voluntary disclosure.
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Libertarian Paternalism, Information Production, and Financial Decision Making
Bruce Ian Carlin, Simon Gervais & Gustavo Manso
Review of Financial Studies, forthcoming
Abstract:
We develop a theoretical model to analyze the effects of libertarian paternalism on information production and financial decision making. Individuals in our model appreciate the information content of the recommendations made by a social planner. This affects their incentive to gather information, and in turn the speed at which information spreads across market participants, via social learning or formal advice channels. We characterize situations in which libertarian paternalism improves welfare and contrast them with scenarios in which this policy is suboptimal because of its negative impact on the production and propagation of information.
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The Effects of Stock Lending on Security Prices: An Experiment
Steven Kaplan, Tobias Moskowitz & Berk Sensoy
Journal of Finance, forthcoming
Abstract:
We examine the impact of short selling by conducting a randomized stock lending experiment. Working with a large, anonymous money manager, we create an exogenous and sizeable shock to the supply of lendable shares by taking high-loan fee stocks in the manager's portfolio and randomly making available and withholding stocks from the lending market. The experiment ran in two independent phases: the first, from September 5 to 18, 2008, with over $580 million of securities lent; and the second, from June 5 to September 30, 2009, with over $250 million of securities lent. While the supply shocks significantly reduce market lending fees and raise quantities, we find no evidence that returns, volatility, skewness, or bid-ask spreads are affected. The results provide novel evidence on the impact of shorting supply and do not indicate any adverse effects on stock prices from securities lending.
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Evolutionary Thinking in Microeconomic Models: Prestige Bias and Market Bubbles
Adrian Viliami Bell
PLoS ONE, March 2013
Abstract:
Evolutionary models broadly support a number of social learning strategies likely important in economic behavior. Using a simple model of price dynamics, I show how prestige bias, or copying of famed (and likely successful) individuals, influences price equilibria and investor disposition in a way that exacerbates or creates market bubbles. I discuss how integrating the social learning and demographic forces important in cultural evolution with economic models provides a fruitful line of inquiry into real-world behavior.
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Diamonds - A precious new asset?
Benjamin Auer & Frank Schuhmacher
International Review of Financial Analysis, June 2013, Pages 182-189
Abstract:
During the recent turbulences in the world's financial markets, diamond companies have started advertising diamonds as a new asset that can hedge against market volatility and be a valuable portfolio component. To put this claim to the test, this article investigates (i) the performance of investments in diamonds of different quality grades, (ii) time-varying correlations between the returns on diamonds and traditional asset classes and (iii) the role of diamonds as a potential diversifier in a world market portfolio. Our results, based on monthly PolishedPrices diamond index data for the years 2002 to 2012, show that in this crisis-ridden period, an investment in a diversified diamond portfolio has outperformed a diversified stock market investment. Additionally, evidence on low time-varying correlations to traditional asset classes highlights that diamonds offer some diversification potential. However, further analysis shows that diamonds can only generate economically significant value in a world market portfolio (by either reducing risk or increasing mean return) when rather high diamond proportions are included in the portfolio.
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Kevin Krieger & Andy Fodor
Journal of Economics and Business, July-August 2013, Pages 70-82
Abstract:
Recent research has hypothesized that a higher concentration of informed traders in a market implies that prices are more efficient. A reasonable next question is whether large price movements in markets with a relatively more informed clientele are more indicative of information realization. We find line movements in college basketball games of relatively low profile, denoted by the lack of a "power conference" team in the contest, are significantly more likely to be the result of information realization. This confirms that substantial price changes in markets with fewer ordinary traders are more (less) likely indicative of information flow (noise).