Investing Research Articles

Is the value premium consistent across equity markets worldwide? In their May 2013 paper entitled “Value around the World”, Nilufer Caliskan and Thorsten Hensyz measure returns for stock portfolios sorted on value in 41 countries and investigate how cultural differences affect the magnitude of the value premium. Each month in each country, they sort stocks based on prior-year price-to-book value ratio into equally weighted fifths (quintiles), designating the bottom quintile as the value portfolio and the top quintile as the growth portfolio. The value premium is the difference in average monthly gross returns between the value and growth portfolios. They use survey responses from economics students (for the 2006-2010 International Test on Risk Attitudes) to derive two measures of cultural differences, patience and risk aversion. Patience is the percentage of respondents willing to wait for a higher return, and risk aversion is the average reward-to-potential loss ratio required by respondents. Using monthly stock prices and annual book values for firms in 41 country markets as available during December 1979 (various series begin in the 1980s, 1990s and 2000s) through December 2011, along with the specified survey responses, they find that: More…

The Inflation Forecast now incorporates actual total and core Consumer Price Index (CPI) data for May 2013. The actual total (core) inflation rate for May is about the same as (about the same as) than forecasted.

The new actual and forecasted inflation rates will flow into Real Earnings Yield Model projections about the end of June.

Are there worldwide anomalies with regard to equity market returns by calendar month? In his June 2013 paper entitled “Stock Market Performance: High and Low Months”, Vichet Sum examines stock market performance in 70 countries to determine which months generate relatively high and low returns. He weights country stock markets equally in calculating worldwide statistics. Using monthly returns as available (with many series beginning in the 1980s and 1990s) mostly through May 2012, he finds that: More…

Is faster-than-exponential asset price growth (acceleration of price increase) inherently unsustainable and therefore predictive of an eventual crash? In his June 2013 paper entitled, “Stock Crashes Led by Accelerated Price Growth”, James Xiong applies both regressions and rankings to test whether faster-than-exponential growth over the last two or three years predicts stock price crashes. Each month, he measures past price returns in non-overlapping six-month intervals to determine whether a stock’s price is accelerating. He consider three crash risk indicators: (1) skewness, with negative skewness indicating a tendency for large negative returns; (2) excess conditional value-at-risk, a normalized version of value-at-risk that controls for volatility; and, (3) maximum drawdown, cumulative loss from the peak to the trough over a specified interval. He computes these indicators monthly based on six months of daily returns. He then relates each crash indicator to stock price acceleration over the last two six-month intervals. In a separate test, he calculates returns from equally weighted portfolios reformed monthly by sorting stocks into fifths (quintiles) based on stock price acceleration over that last two six-month intervals. Using daily returns in excess of the contemporaneous U.S. Treasury bill yield for a broad sample of U.S. common stocks (those in the top 80% of market capitalizations if priced above $2) during January 1960 through December 2011, and for the S&P 500 Index during January 1950 to December 2012, he finds that: More…

In the prologue of their 2013 book entitled Happy Money: The Science of Smarter Spending, authors Elizabeth Dunn and Michael Norton state: “When it comes to increasing the amount of money they have, most people recognize that relying on their own intuition is insufficient, spawning an entire industry of financial advisors. But when it comes to spending that money, people are often content to rely on their hunches about what will make them happy. And yet, if human happiness is even half as complicated as the stock market, there is little reason to assume that intuition provides a sufficient guide. …trying to uncover the causes of your own happiness through introspection is like trying to perform your own heart transplant. You have some idea of what needs to be done, but a surgical expert would come in handy. Consider us your surgical experts.” Making liberal use of anecdotes to illustrate findings from an array of happiness research projects, they conclude that: More…

Does the market pay a premium to equity funds with relatively high “bad” (left tail) volatility? In their May 2013 paper entitled “Volatility vs. Tail Risk: Which One is Compensated in Equity Funds?”, James Xiong, Thomas Idzorek and Roger Ibbotson compare return premiums for conventional volatility (standard deviation of total returns) and tail risk (value-at-risk) across U.S. and non-U.S. equity mutual funds. Each month, they use the previous five years of monthly net total returns to sort funds into fifths (quintiles) based on volatility and on excess (relative to a normal distribution) value-at-risk for the worst 5% of returns. They estimate premiums for these two risk measures as the difference in average (arithmetic mean) returns between the riskiest and least risky quintiles in excess of the Treasury bill (T-bill) yield. Using monthly returns for the oldest share class for a broad sample of alive and dead open-end equity mutual funds (3,389 U.S. and 1,055 non-U.S.), and the contemporaneous T-bill yield, during January 1980 through September 2011, they find that: More…

The Federal Reserve states that open market operations regulate “the aggregate level of balances available in the banking system,” thereby keeping the effective Federal Funds Rate close to a target level. The operations are predominantly repurchases, whereby the Federal Reserve provides liquidity. Do Permanent Open Market Operations (POMO) systematically affect the nominal or real yields on 10-year Treasury notes (T-notes)? Using monthly amounts of Treasuries repurchases via POMO during August 2005 through May 2013 (94 months) and contemporaneous monthly T-note yields and 12-month trailing inflation rates, we find that: More…

A reader hypothesized that the Federal Reserve uses Open Market Operations repurchases to stimulate, or prop up, the stock market. The hypothesis supposes that private parties, such as prime brokers, use the funds released by these repurchases to buy (highly leveraged) stock futures contracts, immediately attracting arbitrageurs who simultaneously short futures and purchase stock indexes. Trend followers then pile on. The Federal Reserve states that open market operations regulate “the aggregate level of balances available in the banking system,” thereby keeping the effective Federal Funds Rate close to a target level. The operations are predominantly repurchases, whereby the Federal Reserve provides liquidity. Do these Permanent Open Market Operations (POMO) and Temporary Open Market Operations (TOMO) affect the U.S. stock market? In other words, do the managers of POMO and TOMO transactions act as a “Plunge Protection Team?” Using accepted Treasuries repurchase transaction data for POMO during August 2005 through May 2013 (over 600 transactions) and TOMO during July 2000 through May 2013 (over 2,600 transactions) and contemporaneous daily and monthly closes of the S&P 500 Index, we find that: More…

Why does the widely cited and intuitive Capital Asset Pricing Model (CAPM) prediction that extra risk (beta) earns extra reward (rate of return) not work for stocks? In their May 2013 paper entitled “Explanations for the Volatility Effect: An Overview Based on the CAPM Assumptions”, David Blitz, Eric Falkenstein and Pim van Vliet organize research on potential explanations according to the following CAPM assumptions:

1. Investors are unconstrained regarding leverage, short selling and solvency (regulatory capital requirements).
2. Investors are risk-averse, focus on absolute return and care only about return mean and variance (such that returns are normally distributed).
3. There is only one return measurement interval and therefore no compounding effect (ignoring the difference between arithmetic and geometric means).
4. Investors have complete information and process it rationally.
5. Investors have no liquidity constraints, transaction costs or taxes.

Based on a review of research on potential explanation for the empirical failure of CAPM, they find that: More…

Does commercial and industrial (C&I) credit fuel business growth and thereby drive the stock market? To investigate, we relate changes in credit standards from the Federal Reserve Board’s quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices to future U.S. stock market returns. The Federal Reserve publishes survey results about the end of the first month of each quarter (January, April, July and October). Using the “Net Percentage of Domestic Respondents Tightening Standards for C&I Loans” from the Senior Loan Officer Opinion Survey on Bank Lending Practices Chart Data for the second quarter of 1990 through the second quarter of 2013 (93 surveys), and contemporaneous S&P 500 Index quarterly returns, we find that: More…