School Of Business Administration: Financial Review

Is gold a hedge, defined as a security that is uncorrelated with stocks or bonds on average, or is it a safe haven, defined as a security that is uncorrelated with stocks and bonds in a market crash? We study constant and time-varying relations between U.S., U.K. and German stock and bond returns and gold returns to investigate gold as a hedge and a safe haven. We find that gold is a hedge against stocks on average and a safe haven in extreme stock market conditions. A portfolio analysis further shows that the safe haven property is short-lived.

Keywords:

safe haven • hedge • gold • stock-bond correlation • flight-to-quality

50+ Years of Diversification Announcements

Mehmet E. Akbulut, John G. Matsusaka

This paper studies announcement returns from 4,764 mergers over 57 years to shed light on several controversies concerning corporate diversification. One prominent view is that diversification destroys value because of agency problems or internal investment distortions, but we find that combined (acquirer plus target) announcement returns are significantly positive for diversifying mergers throughout the period, and no lower than the returns for related mergers. The returns from diversifying acquisitions fell after 1980, and investors rewarded mergers involving financially constrained firms before but not after 1980, consistent with the idea that the value of internal capital markets declined over time.

Keywords:

corporate diversification • mergers and acquisitions • event study

Terrorism and Stock Market Sentiment

Jussi Nikkinen, Sami Vahamaa

This paper examines the effects of terrorism on stock market sentiment by focusing on the behavior of expected probability density functions of the FTSE 100 index around terrorist attacks. We find that terrorism has a strong adverse impact on stock market sentiment. In particular, terrorist attacks are found to cause a pronounced downward shift in the expected value of the FTSE 100 index and a significant increase in stock market uncertainty. Furthermore, our results show that the expected FTSE 100 probability densities became significantly more negatively skewed and fat-tailed in the immediate aftermath of terrorist acts.

Keywords:

terrorism • stock market sentiment • implied probability densities • options

On Model Testing in Financial Economics

Robert A. Jarrow

This paper discusses the two different contradicting philosophies for testing models in financial economics (asset pricing, corporate finance, and market-microstructure) using linear regression. We synthesize these two contradicting approaches, document the errors that may occur in the existing estimation methodologies, and suggest a modified procedure that avoids these errors.

Keywords:

linear regression • omitted variables • control variables

Investment Irreversibility, Cash Flow Risk, and Value-Growth Stock Return Effects

Wikrom Prombutr, Larry Lockwood, J. David Diltz

We simulate results from a simple real options model to provide insight into the value-growth stock return anomaly. In our model, firms possess either single ("value" firm) or multiple ("growth" firm) investment opportunities. Our model predicts that growth firms: (1) invest sooner, (2) exhibit greater continuity in capital expenditure over time, (3) have lower book-to-market ratios, and (4) generate lower rates of return than value firms.

Keywords:

value stock anomaly • real options

Does Inclusion in a Smaller S&P Index Create Value?

John R. Becker-Blease, Donna L. Paul

This study finds overall increases in equity value surrounding addition to the S&P SmallCap and MidCap indexes from 1996 to 2003 and investigates sources of the value gains. Following addition, there are significant increases in proxy variables for stock liquidity and investor recognition, and changes in these variables are impounded into the permanent component of announcement share price revisions. We also find that changes in capital investment intensity are increasing in changes in stock liquidity, consistent with a reduction in the cost of capital following index addition.

Keywords:

index addition • event study • Standard & Poor's index • S&P 600 • S&P 400 • stock liquidity • capital expenditure

The Efficacy of Regulation Fair Disclosure

Praveen Sinha, Christopher Gadarowski

This paper examines the impact of Securities and Exchange Commission's Regulation Fair Disclosure (FD) on information leakage around voluntary management disclosures. We find a positive correlation between stock returns two days before and after the voluntary disclosure in the pre-Regulation FD period, but not in the post-Regulation FD period. After Regulation FD is implemented, pre-announcement abnormal return as a percentage of total return decreases by 26.1% (21.4%) for large firms with good (bad) news, suggesting that the amount of information leakage reduces for these firms. These findings provide support for the premise and the intended purpose of the regulation for large firms.

Keywords:

regulation • public securities • management forecasts • private information

Yes, The Value Line Enigma Is Still Alive: Evidence from Online Timeliness Rank Changes

Ying Zhang, Giao X. Nguyen, Steven V. Le

Beginning June 9, 2005, Value Line started announcing its Timeliness changes online at 10:00 a.m. on Thursday, one day earlier than Friday noon's post-delivery. We confirm that the Value Line effect still exists but shifts to Thursday in the Internet era. Unlike previous findings, the next-day abnormal return after the announcement has disappeared, suggesting that the market efficiently priced the change. We find that a portfolio upgraded from rank 5 to 4 gains the highest cumulative abnormal return of 9.07% over a 50-day window. Finally, we find that the post-earnings announcement drift does not explain the Value Line enigma.

Keywords:

analyst recommendations • market efficiency • value line • post-earnings announcement drift

Stock Splits and Bond Yields: Isolating the Signaling Hypothesis

David Michayluk, Ruoyun Zhao

One explanation offered for stock splits is that the split signals positive information by reducing the stock price range in expectation of improved future prospects. Price declines also lead to changes in stock price dynamics, but related securities are not subject to these other changes and therefore can be used to provide a separate assessment of the markets' interpretation of the split. We examine corporate bond issues around stock splits and find a significant decline in the bond yield spread following stock splits, supporting the signaling hypothesis. We also confirm improvements in forecasted and realized earnings subsequent to stock splits.

Keywords:

stock splits • signaling hypothesis • corporate bonds

Does the Quality of Financial Advice Affect Prices?

Arthur Allen, Donna Dudney

Using a large data sample of 58,562 new municipal issues covering the period from 1984 to 2002, we examine whether the quality of advice provided by a financial advisor affects new issue interest costs. We find that higher-quality financial advisors are associated with statistically significant decreases in new issue yields. The effect of advisor quality on yields is more pronounced for revenue, negotiated, and opaque bond issues than for general obligation and competitively sold issues. However, issuers of revenue or negotiated bonds are more likely to choose a low-quality advisor.

Keywords:

financial advisor • municipal bonds • bond yields • reputation

The Moving Average Ratio and Momentum

Seung-Chan Park

I show the ratio of the short-term moving average to the long-term moving average (moving average ratio, MAR) has significant predictive power for future returns. The MAR combined with nearness to the 52-week high explains most of the intermediate-term momentum profits. This suggests that an anchoring bias, in which investors use moving averages or the 52-week high as reference points for estimating fundamental values, is the primary source of momentum effects. Momentum caused by the anchoring bias do not disappear in the long-run even when there are return reversals, confirming that intermediate-term momentum and long-term reversals are separate phenomena.

Keywords:

momentum • moving average • 52-week high • anchoring bias • behavioral theory • efficient market hypothesis

Arbitrage and the Evaluation of Linear Factor Models in UK Stock Returns

Jonathan Fletcher

I examine the impact of the no arbitrage restriction on the estimation and evaluation of linear factor models in UK stock returns. The no arbitrage restriction reduces volatility and eliminates most of the negative values of the fitted stochastic discount factor models. All of the factor models are rejected and there are significant differences in the pricing performance between models under the no arbitrage restriction. The no arbitrage restriction can have a significant impact on both the parameter estimates and pricing errors for some models.

Keywords:

stochastic discount factor • no arbitrage • distance measures

Short-Horizon Return Predictability in International Equity Markets

Abul Shamsuddin, Jae H. Kim

This study measures the degree of short-horizon return predictability of 50 international equity markets and examines how its variation is related to the indicators of equity market development. Two multiple-horizon variance ratio tests are employed to measure the degree of return predictability. We find evidence that return predictability is negatively correlated with publicly available indicators of equity market development. Our cross-sectional regression analysis shows that the per capita gross domestic product, market turnover, investor protection, and absence of short-selling restrictions are correlated with cross-market variations in return predictability.

Keywords:

return predictability • variance ratio test • international equity markets

Asset Pricing and Welfare Analysis with Bounded Rational Investors

Lei Lu

Motivated by the fact that investors have limited ability to process information, I model investors' bounded rational behavior in processing information and investigate its implications for asset pricing. Investors can make mistakes in processing information and thus have inaccurate estimates of fundamentals. This process generates "bounded rational risk." I find that the volatility of stock and bond return increases in the presence of bounded rational investors, which can help explain the excessive volatility puzzle. The stock-bond return correlation becomes time varying and even negative and rational investors benefit from the trading with bounded rational investors.

Keywords:

asset pricing • bounded rationality • general equilibrium

The University of Mississippi: School of Business Administration