Findings

Risky Returns

Kevin Lewis

November 17, 2010

The Halloween Effect: Trick or Treat?

Stephen Haggard & Douglas Witte
International Review of Financial Analysis, forthcoming

Abstract:
Research documents higher stock returns in November through April than for the rest of the year. This anomaly is known as the "Halloween effect" and results in the following trading rule: Sell stocks in early May, invest in T-bills, and re-invest in stocks on Halloween. In contrast to recent studies, we show that the Halloween effect is robust to consideration of outliers and the "January effect." Additionally, we show that investing in a "Halloween portfolio" provides risk-adjusted returns in excess of buy and hold equity returns even after consideration of transaction costs.

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Patriotism in your portfolio

Adair Morse & Sophie Shive
Journal of Financial Markets, forthcoming

Abstract:
More patriotic countries have greater home bias in their equity selection. In a panel of World Values Surveys covering 53 countries, measures of patriotism are positively related to home bias measures after controlling for transaction barriers, diversification benefits, information, and familiarity. Within-country changes in patriotism vary with changes in the home bias. The results are robust to using ISSP measures of patriotism covering 24 countries and within-U.S. data from the Survey of Consumer Finances. Instrumenting patriotism with social variables uncorrelated with economic and political factors confirms that patriotism affects investment. The average country invests 18 to 30 billion more abroad (a 3% to 5% increase) with a one standard deviation drop in patriotism.

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Country-specific sentiment and security prices

Byoung-Hyoun Hwang
Journal of Financial Economics, forthcoming

Abstract:
I study the effect of country-specific sentiment on security prices. I provide evidence that a country's popularity among Americans affects US investors' demand for securities from that country and causes security prices to deviate from their fundamental values. Moreover, I find that country popularity is positively associated with the intensity of US cross-border mergers and acquisitions activity, suggesting that country popularity also affects firms' investment decisions.

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This Time Is Different: An Example of a Giant, Wildly Speculative, and Successful Investment Mania

Andrew Odlyzko
B.E. Journal of Economic Analysis & Policy, 2010

Abstract:
The literature on manias and bubbles is dominated by spectacular collapses and the question of whether they could have been foreseen. What is not widely known, though, is that there was at least one giant and wildly speculative investment episode that was successful in that it produced above-market profits for original investors. The British railway mania of the 1830s involved real capital investment comparable, as a fraction of GDP, to about $2 trillion for the U.S. today. It faced withering skepticism and criticism, much of it very reasonable, as its supposedly rosy prospects were based on extrapolation from the brief experience of just a couple of successful early railways. Yet by the mid-1840s, it was seen as a success. The example of the railway mania of the 1830s serves as a useful antidote to claims that bubbles are easy to detect or that all large and quick jumps in asset valuations are irrational. This episode also suggests the need to reexamine much of the work on business cycles and the diffusion of technologies. The standard literature in this area, starting from Juglar and continuing through Schumpeter to more recent authors, almost uniformly ignores large investment mania, whose nature does not fit the stereotypical pattern.

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How good was the profitability of British railways, 1870-1912?

Brian Mitchell, David Chambers & Nick Crafts
Economic History Review, forthcoming

Abstract:
This article provides new estimates of the return on capital employed (ROCE) for major British railway companies. It shows that ROCE was generally below the cost of capital after the mid-1870s and fell until the turn of the century. Addressing cost inefficiency issues could have restored ROCE to an adequate level in the late 1890s but not in 1910. Declines in ROCE hit share prices and investors made little or no money in real terms after 1897. Optimal portfolio analysis shows that, while railway securities were attractive to investors before this date, they would have been justified in rushing to the exits thereafter.

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Do hedge funds trade on private information? Evidence from syndicated lending and short-selling

Nadia Massoud, Debarshi Nandy, Anthony Saunders & Keke Song
Journal of Financial Economics, forthcoming

Abstract:
This paper investigates an important contemporary issue relating to the involvement of hedge funds in the syndicated loan market. In particular, we investigate the potential conflicts of interest that arise when hedge funds make syndicated loans and take short positions in the equity of borrowing firms. We find evidence consistent with the short-selling of the equity of the hedge fund borrowers prior to public announcements of both loan originations and loan amendments. We also find that hedge funds are more likely to lend to highly leveraged, lower credit quality firms, where access to private information is potentially the most valuable and where trading on such information could lead to enhanced profits. Overall, our results have important implications for the current debate regarding regulating the hedge fund industry.

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Charitable donations are more responsive to stock market booms than busts

John List & Yana Peysakhovich
Economics Letters, forthcoming

Abstract:
This paper examines aggregate time series data on individual charitable donations from 1968-2007. We find that changes in individual giving show an asymmetric response to changes in the S&P 500: individuals are more responsive to stock market upturns than downturns.

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Stock market aversion? Political preferences and stock market participation

Markku Kaustia & Sami Torstila
Journal of Financial Economics, forthcoming

Abstract:
We find that left-wing voters and politicians are less likely to invest in stocks, controlling for income, wealth, education, and other relevant factors. This finding from unique data sets in Finland is robust both at the zip code and at the individual level. A moderate left voter is 17-20% less likely to own stocks than a moderate right voter. The results are consistent with the idea that personal values are a factor in important investment decisions, in this case leading to "stock market aversion." The results are inconsistent with alternative explanations such as wealth effects, risk aversion, reverse causality, return expectations, or social capital.

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The lunar moon festival and the dark side of the moon

Jing-Ming Kuo, Jerry Coakley & Andrew Wood
Applied Financial Economics, October 2010, Pages 1565-1575

Abstract:
We propose and adduce evidence for a new seasonal anomaly associated with the Lunar Moon Festival (LMF) in East Asian economies. While the LMF effect bears some resemblance to the festivity and vacation anomalies, it is mainly driven by nostalgia, historically negative associations, the full moon and uncertainty about future harvest prospects. This negative sentiment and associated increase in risk and loss aversion are responsible for reducing share turnover, return volatility and stock returns over a 2-week period. The LMF effect is the strongest for China, Taiwan and South Korea where it is not only celebrated as a public or cultural holiday but it also impacts on neighbouring stock markets where overseas Chinese investors possess significant resources. Robustness checks demonstrate that it has a distinctive and more pronounced impact than competing seasonal effects associated with lunar phases and the summer vacations.

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Research for sale: Determinants and consequences of paid-for analyst research

Marcus Kirk
Journal of Financial Economics, forthcoming

Abstract:
I examine the determinants and market impact of paid-for coverage using a hand-collected sample of paid-for reports over 1999-2006. More than five hundred publicly listed US companies paid for analyst coverage since 1999. Yet little is known about the informational consequences of this analyst research. Firms with greater uncertainty, weaker information environments, and low turnover are more likely to buy coverage as they have the most to gain from analyst coverage but are unlikely to attract sell-side analysts. Despite the inherent conflicts of interest, I find paid-for reports have information content for investors based on two-day abnormal returns. After the initiation of coverage, companies experience an increase in institutional ownership, sell-side analyst following, and liquidity. In addition, the results are strongest for the fee-based research firm with ex ante policies that reduce potential conflicts of interest.

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Option Traders Use (Very) Sophisticated Heuristics, Never the Black-Scholes-Merton Formula

Espen Gaarder Haug & Nassim Nicholas Taleb
Journal of Economic Behavior & Organization, forthcoming

Abstract:
Options traders use a pricing formula which they adapt by fudging and changing the tails and skewness by varying one parameter, the standard deviation of a Gaussian. Such formula is popularly called "Black-Scholes-Merton" owing to an attributed eponymous discovery (though changing the standard deviation parameter is in contradiction with it). However we have historical evidence that 1) the said Black, Scholes and Merton did not invent any formula, just found an argument to make a well known (and used) formula compatible with the economics establishment, by removing the "risk" parameter through "dynamic hedging", 2) Option traders use (and evidently have used since 1902) sophisticated heuristics and tricks more compatible with the previous versions of the formula of Louis Bachelier and Edward O. Thorp (that allow a broad choice of probability distributions) and removed the risk parameter by using put-call parity. 3) Option traders did not use the Black-Scholes-Merton formula or similar formulas after 1973 but continued their bottom-up heuristics more robust to the high impact rare event. The paper draws on historical trading methods and 19th and early 20th century references ignored by the finance literature. It is time to stop using the wrong designation for option pricing.

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Naïve Herding in Rich-Information Settings

Erik Eyster & Matthew Rabin
American Economic Journal: Microeconomics, November 2010, Pages 221-243

Abstract:
In social-learning environments, we investigate implications of the assumption that people naïvely believe that each previous person's action reflects solely that person's private information. Naïve herders inadvertently over-weight early movers' private signals by neglecting that interim herders' actions also embed these signals. Such "social confirmation bias" leads them to herd with positive probability on incorrect actions even in extremely rich-information settings where rational players never do. Moreover, because they become fully confident even when wrong, naïve herders can be harmed, on average, by observing others.

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Investor sentiment and the mean-variance relation

Jianfeng Yu & Yu Yuan
Journal of Financial Economics, forthcoming

Abstract:
This study shows the influence of investor sentiment on the market's mean-variance tradeoff. We find that the stock market's expected excess return is positively related to the market's conditional variance in low-sentiment periods but unrelated to variance in high-sentiment periods. These findings are consistent with sentiment traders who, during the high-sentiment periods, undermine an otherwise positive mean-variance tradeoff. We also find that the negative correlation between returns and contemporaneous volatility innovations is much stronger in the low-sentiment periods. The latter result is consistent with the stronger positive ex ante relation during such periods.

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The determinants of increasing equity market comovement: Economic or financial integration?

Lieven Baele & Pilar Soriano
Review of World Economics, September 2010, Pages 573-589

Abstract:
This paper investigates to what extent the substantial increase in exposures of local European equity market returns to global shocks is mainly due to a convergence in cash flows ("economic integration"), to a convergence in discount rates ("financial integration"), or to both. We find that this increased exposure is nearly entirely due to increasing discount-rate betas. This finding is robust to alternative ways of calculating discount-rate and cash-flow shocks.


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