Findings

Econ Gone Wild

Kevin Lewis

September 06, 2009

Individualism and Momentum around the World

Andy Chui, Sheridan Titman & John Wei
Journal of Finance, forthcoming

Abstract: This paper examines the extent to which cultural differences influence the returns of momentum strategies. We measure cultural differences using an index of individualism developed by Hofstede (2001), which we argue is related to overconfidence and self-attribution bias. Our cross-country evidence indicates that individualism is positively associated with trading volume and volatility, and is strongly related to the magnitude of momentum profits. The evidence also indicates that momentum profits are positively related to the dispersion of analyst forecasts, transaction costs, and the familiarity of a market to foreign investors, and negatively related to firm size and stock volatility. However, the addition of these and other variables does not dampen the relation between individualism and momentum profits. These results are robust to whether or not East Asian countries, which exhibit less momentum, are included in our sample. Finally, consistent with the prediction of behavioral models, momentum profits reverse one year after portfolio formation in most countries, and the magnitude of the reversals tends to be higher in countries with higher individualism.

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When Everyone Runs for the Exit

Lasse Pedersen
NBER Working Paper, August 2009

"I focus on the 'quant' event of August 2007 as it illustrates well the nature of liquidity crises. While this event was almost invisible to the public, it can be seen very clearly through the lens of a diversified long-short strategy. Quantitative traders running for the exit had a significant impact on some of the most liquid markets in the world, and I show how prices dropped and rebounded in early August 2007. Using high-frequency data, I document an amazing short-term predictability and volatility driven by the run to the exit. In hindsight, the quant crisis was an early warning signal of how the levered system would face trouble as the liquidity spirals caused havoc in the global markets."

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More hedging instruments may destabilize markets

W.A. Brock, C.H. Hommes & F.O.O. Wagener
Journal of Economic Dynamics and Control, November 2009, Pages 1912-1928

Abstract: This paper formalizes the idea that more hedging instruments may destabilize markets when traders have heterogeneous expectations and adapt their behavior according to performance-based reinforcement learning. In a simple asset pricing model with heterogeneous beliefs the introduction of additional Arrow securities may destabilize markets, and thus increase price volatility, and at the same time decrease average welfare. We also investigate whether a fully rational agent can employ additional hedging instruments to stabilize markets. It turns out that the answer depends on the composition of the population of non-rational traders and the information gathering costs for rationality.

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Implications of Keeping up with the Joneses Behavior for the Equilibrium Cross Section of Stock Returns: International Evidence

Juan-Pedro Gomez, Richard Priestley & Fernando Zapatero
Journal of Finance, forthcoming

Abstract: This paper tests the cross-sectional implications of "keeping up with the Joneses" (KUJ) preferences in an international setting. When agents have KUJ preferences, in the presence of undiversifiable nonfinancial wealth, both world and domestic risk (the idiosyncratic component of domestic wealth) are priced, and the equilibrium price of risk of the domestic factor is NEGATIVE. We use labor income as a proxy for domestic wealth and find empirical support for these predictions. In terms of explaining the cross-section of stock returns and the size of the pricing errors, the model performs better than alternative international asset pricing models.

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Explosive Behavior in the 1990s Nasdaq: When did Exuberance Escalate Asset Values?

Peter Phillips, Yangru Wu & Jun Yu
Yale Working Paper, June 2009

Abstract: A recursive test procedure is suggested that provides a mechanism for testing explosive behavior, date-stamping the origination and collapse of economic exuberance, and providing valid confidence intervals for explosive growth rates. The method involves the recursive implementation of a right-side unit root test and a sup test, both of which are easy to use in practical applications, and some new limit theory for mildly explosive processes. The test procedure is shown to have discriminatory power in detecting periodically collapsing bubbles, thereby overcoming a weakness in earlier applications of unit root tests for economic bubbles. An empirical application to Nasdaq stock price index in the 1990s provides confirmation of explosiveness and date-stamps the origination of financial exuberance to mid-1995, prior to the famous remark in December 1996 by Alan Greenspan about irrational exuberance in financial markets, thereby giving the remark empirical content.

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Experimental Analysis on the Role of a Large Speculator in Currency Crises

Kenshi Taketa, Kumi Suzuki-Löffelholz & Yasuhiro Arikawa
Journal of Economic Behavior & Organization, forthcoming

Abstract: Corsetti, Dasgupta, Morris, and Shin (2004) demonstrate that the presence of a large speculator in the foreign exchange market makes the remaining traders more aggressive in their speculative attacks. We conduct an experiment designed to test their theoretical predictions and also use the experiment to analyze an additional aspect that has not been previously covered in the literature: namely, whether the entry of a large speculator and the exit of the same speculator have the same effect in magnitude on the probability of a successful speculative attack. We obtain two main findings. First, the results support the main conclusion of (Corsetti, Dasgupta, Morris, Shin, 2004. Does one Soros make a difference? A theory of currency crises with large and small traders. Review of Economic Studies 71, 87-113) that the presence of a large speculator makes other small speculators more aggressive. Second, the results suggest that the effect of the entry of a large speculator on the probability of successful speculative attacks is larger than that of the exit of the same speculator.

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Profitability of technical stock trading: Has it moved from daily to intraday data?

Stephan Schulmeister
Review of Financial Economics, October 2009, Pages 190-201

Abstract: This paper investigates how technical trading systems exploit the momentum and reversal effects in the S&P 500 spot and futures market. When based on daily data, the profitability of 2580 technical models has steadily declined since 1960, and has been unprofitable since the early 1990s. However, when based on 30-minutes-data the same models produce an average gross return of 7.2% per year between 1983 and 2007. These results do not change substantially when trading is tested over eight subperiods. In particular, there is no clear trend of a declining profitability of technical stock trading based on 30-minutes-data. Those 25 models which performed best over the most recent subperiod produce a significantly higher gross return over the 1980s and 1990s. This result could be due to stock markets becoming recently more efficient or to stock price trends shifting from 30-minutes-prices to prices of higher frequencies.

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The Evolution of the US Financial Industry from 1860 to 2007: Theory and Evidence

Thomas Philippon
NYU Working Paper, November 2008

Abstract: The share of finance in U.S. GDP displays large historical variations. I argue, using evidence and theory, that corporate finance is a key factor behind these evolutions. Corporate demand for intermediation depends crucially on the relative investment opportunities of firms with low cash flows (young firms) and firms with high cash flows (incumbents). A simple general equilibrium model is developed in order to separate demand and supply factors in the market for financial intermediation. The demand parameters accord well with historical evidence on the importance of entrants during technological revolutions. The supply parameters suggest financial regress in the 1930s and progress in the 1990s. The model accounts for much of the variation in the income share of the financial sector from 1860 to 2001. Only the period 2002-2007 appears puzzling.


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