Disagreement, Tastes, and Asset Prices

Confused about the differing assumptions of pricing models? More than likely you know that the assumptions don’t hold very well and you probably know much research has looked at how the assumptions matter. Fama and French now provide a framework to hopefully make sense of some of this confusion. In a working paper they show that investor tastes and expectations matter. For … [ Read more ]

IPO Pricing in “Hot” Market Conditions: Who Leaves Money on the Table?

Two concerns IPO researchers have are the apparent short-run underpricing (the stock trades up in the secondary market) and the longer run underperformance (stock falls during long event window). Previous research has been only partially successful in explaining the continued existence of these two conflicting and seemingly contradictory anomalies. Some of these previous attempts include Chowdry and Nanda 1996 who show that … [ Read more ]

Confidence in the Familiar: An International Perspective

Investors have long exhibited a “home country bias” whereby they hold more shares of firms from their own country than would seem warranted based off of typical diversification theory. This seeming anomaly has been partially explained in many ways (my favorite is Butler’s view that when markets fall, the correlation is actually greater than the long run correlation, hence overstating the value of diversification). … [ Read more ]

Analyzing the Analysts: When do Recommendations Add Value? (.pdf)

This one is a must for any investment class! Jegadeesh, Kim, Krische, and Lee provide a fascinating look at investment analysts. They study stock analyst recommendations. Some of their findings are that analysts tend to prefer glamour stocks (higher growth and with momentum), and firms with whom the analyst’s firm has an investment banking relationship. Additionally, changes in analyst recommendations tend … [ Read more ]

Modeling the bid/ask spread: Measuring the inventory-holding premium (.pdf)

This article models (and tests!) the bid/ask spread of stock trades and models it as a function of “minimum tick size, order-processing costs, inventory holding costs, adverse selection costs, and competition.” VERY cool. And the model even seems to work empirically! [FinanceProfessor.com Annotation]

Stock Prices and IPO Waves (.pdf)

Pastor and Veronsi explain IPO waves by creating a model of “optimal IPO timing.” Their model predicts that firms will be more willing to issue shares when the required returns are lower, when the firm’s expected cash flows are higher (which could be interpreted at there being more positive investment opportunities-and therefore likely a greater need for cash), and “when the uncertainty surrounding … [ Read more ]

The Impact of Market Design and Institutional Features on World Equity Market Performance: The Relation Between Market Design

Westerholm, Swan, and Liu look at how market design impacts how the market operates. That is, there is a tradeoff between transaction costs and volatility. Having dealers available to trade continually increases expenses, which in turn lead to larger spreads (transaction costs) for these so-called continuous dealer markets. On the other hand in return for these larger spreads, the dealers do help … [ Read more ]

The Impact of Clientele Changes: Evidence from Stock Splits

A stock split occurs when a company changes the number of shares it has outstanding. For example, suppose the firm had 1 million shares outstanding and then announced a 2:1 split. The firm would now have 2 million shares outstanding. It is not surprising that the stock price drops after the split, but what continues to leave researchers puzzled is why there … [ Read more ]

The Greening of American Capitalism

Could Wall Street become the vanguard of environmental activism?

Can the Market Add and Subtract? Mispriced Stocks Break the Rules of Efficient Markets

According to the law of one price, identical assets should have identical prices. Driving this law is arbitrage, in which an investor buys and sells the same security for two different prices to make a profit. In a well functioning capital market, arbitrage prevents the law of one price from being broken, and in fact, violations of the law are rarely seen.

Risks For the Long Run: A Potential Resolution of Asset Pricing Puzzles

That the volatility of the equity risk premium and the risk-free rate are larger than most models predict has long been known and discussed (for example the seminal Mehra and Prescott 1985 paper). Bansal and Yahon try their hands at explaining why this puzzle exists (their paper will appear in an upcoming Journal of Finance (JF)). They model the “consumption and dividend … [ Read more ]

The Price Response to S&P 500 Index Additions and Deletions: Evidence of Asymmetry and a New Explanation (.pdf)

Chen, Noronha, and Singal report in a forthcoming JF article that when stocks are dropped from the S&P 500, there is a temporary price decline. However when firms are added, the increase is seemingly permanent. This asymmetry is seemingly counter to most widely held views that demand curves for individual stocks are elastic. The authors suggest that this asymmetry is due to … [ Read more ]

Governance Mechanisms and Equity Prices (.pdf)

Internal and external monitoring have a strong complementary (synergistic) effect. That is the finding of Cremers and Nair who show that firms with both strong internal as well as external controls tend to outperform firms without the strong controls. To test this, the authors construct various portfolios and find that those firms who measure high on both categories outperform others in the sample. … [ Read more ]

The Foundations of Freezeout Laws in Takeovers (.pdf)

Why include a freeze-out provision in takeover contracts? Because if not, investors would not tender shares. How is that? Consider the Grossman-Hart (1980) view that if the takeover is in fact value maximizing, then shareholders would have an incentive to not tender their shares but to wait for the stock price to increase. Of course if shareholders knew this, then they … [ Read more ]

Adding an Ethical Dimension to Portfolio Management

Socially Responsible Investing (SRI) means different things to different people, but essentially is investing in firms that treat their employees well, care for the environment, and make products or perform services that are aligned with the goals and desires of the investors (for example, many investors may refuse to buy tobacco stocks). For as long as I can remember there has been a debate … [ Read more ]

The Pack Mentality: A Behavioral Finance View of Stock Price Comovement

By looking carefully at data on individual stock prices, it is easy to find many examples of “comovement” – groups of stocks whose prices tend to move together. For instance, prices of stocks in the same industry tend to move together, as do the prices of small-cap stocks, value stocks, and closed-end funds.

Dissecting the Decline

A “share-weighting” analysis gives a better read on the market’s vital signs than major market indices.

The Value of Control

U.S. corporate scandals such as Enron and Tyco have highlighted the fact that insiders enjoy benefits above and beyond those of the average shareholder-the so-called “private benefits of control.” How widespread are these benefits? What effects do they have on the development of a country’s securities market? Furthermore, how can such benefits be curbed? New research indicates that in spite of the recent corporate scandals … [ Read more ]

Are Unmanaged Earnings Always Better for Shareholders?

Is earnings management always bad? No, if you believe the new paper by Arya, Glover, and Sunder. They point out that Earnings management can reduce the noise inherent in earnings and thereby reduce investor uncertainty. To quote the paper “a smooth car ride is not only comfortable, it also assures the driver of the driver’s expertise.” Moreover, too much transparency may reduce incentives of managers. … [ Read more ]

One Simple Test of Samuelson’s Dictum for the Stock Market

Jung and Shiller have an interesting paper that looks at Samuelson’s dictum: that is that the market is more efficient pricing individual stocks than getting the overall price level (i.e. the market) correct. In English it means that while we can price stocks relative to one another reasonably well, we can not price the overall market as well. [FinanceProfessor Annotation]