Objective research and reviews to aid investing decisions
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Does combining two commodity futures trading signals shown to be effective in prior research, momentum and roll return (term structure), improve on both? In the May 2008 version of their paper entitled "Tactical Allocation in Commodity Futures Markets: Combining Momentum and Term Structure Signals", Ana-Maria Fuertes, Joëlle Miffre and Georgios Rallis measure the combined value of momentum and roll return signals in the design of commodity futures trading strategies. They test combinations that iteratively buy backwardated (positive roll return) winners and short contangoed (negative roll return) losers. Using daily closing prices on the nearby, second nearby and distant contracts for 37 commodities as available over the period January 1979 through January 2007, they find that: More...
Why does the conventional wisdom on the predictability of stock market returns morph (no, yes, maybe, probably not) over time? In their July 2008 paper entitled "Time-Varying Short-Horizon Return Predictability", Sam James Henkel, Spencer Martin and Federico Nardari apply a regime-switching vector autoregression (RSVAR) framework to explore and explain the degree to which the predictability of equity market returns at a one-month forecast horizon changes over time. They focus on the following four potential predictors: dividend yield, short-term interest rate, interest rate term spread and default spread between high-grade and low-grade corporate bonds. Using monthly stock market returns and contemporaneous economic data for the G7 countries (Canada, France, Germany, Italy, Japan, UK and U.S.) as available through 2007, they conclude that: More...
Does systematic use of stop-loss orders (automated position exits based on a cumulative loss threshold) improve net returns? Both the April 2008 paper entitled "Re-examining the Hidden Costs of the Stop-Loss" by Kira Detko, Wilson Ma and Guy Morita and the May 2008 draft paper entitled "When Do Stop-Loss Rules Stop Losses?" by Kathryn Kaminski and Andrew Lo address this question with theory and empirical tests. They conclude that: More...
Does technical analysis work in equity markets around the globe? In the July 2008 version of their paper entitled "Technical Analysis Around the World: Does it Ever Add Value?", Ben Marshall, Rochester Cahan and Jared Cahan apply bootstrapping techniques to investigate the profitability of 5,806 technical trading rules (filters, moving averages, support and resistance analyses, and channel break-outs) in the 23 developed and 26 emerging equity markets that comprise the Morgan Stanley Capital Index (MSCI). Using daily data for all 49 markets over the period 2001-2007, they conclude that: More...
Are momentum trading strategies reliable and economically significant after trading frictions for large-capitalization stocks? In his November 2006 paper entitled "Alpha Generating Momentum Strategies", Gregor Obrecht test 32 momentum trading strategies on large-capitalization U.S. stocks. The strategies encompass all combinations of: formation periods of three, six, nine and 12 months; wait periods of zero months and one month; and, holding periods of three, six, nine and 12 months. Using monthly returns for S&P 100 stocks over the period 12/85-8/06, he concludes that: More...
Does the degree to which out-of-the-money (OTM) put options are "overpriced" imply future returns for associated stocks? In other words, are options traders especially well-informed? In their March 2008 paper entitled "What Does Individual Option Volatility Smirk Tell Us about Future Equity Returns?", Xiaoyan Zhang, Rui Zhao and Yuhang Xing test whether option prices for individual stocks contain important information for the underlying equities. They focus on the predictive power of volatility smirks, the difference between the implied volatilities of OTM put options and at-the-money (ATM) call options. Using daily option and underlying stock price data for all firms with listed options during 1996-2005, they conclude that: More...
Is an adaptive marketplace extinguishing the January effect? In their June 2008 paper entitled "The Persistence of the Small Firm/January Effect: Is it Consistent with Investors’ Learning and Arbitrage Efforts?", Kathryn Easterday, Pradyot Sen and Jens Stephan investigate whether the stock market has adapted over time to diminish the small firm/January effect. Using returns and firm size data for a very large sample of stocks over three subperiods (1946-1962, 1963-1979, 1980-2007), they conclude that: More...
Can investors count on continued outperformance from hedge funds with exceptionally strong recent returns? In their July 2008 paper entitled "The Performance Persistence of Equity Long/Short Hedge Funds", Markus Schmid and Samuel Manser apply a flexible portfolio-based approach to investigate the persistence of raw and risk-adjusted returns for long/short equity hedge funds. Using return and holdings data for 1,150 long/short equity hedge funds over the period 1994-2005, they conclude that: More...
How should investors view corporate earnings estimates as determinants of stock valuations? Are analyst and management forecasts of any value? Is high growth inherently unsustainable? Is the source of growth important? In his June 2008 paper entitled "Growth and Value: Past Growth, Predicted Growth and Fundamental Growth", Aswath Damodaran examines the patterns and broad lessons of research on growth forecasts. Using results from past studies and new analyses of earnings data for 1997-2007, he concludes that: More...
How do the corporate experts most responsible for assessing the cost of equity currently feel about future stock returns? In their July 2008 paper entitled "The Equity Risk Premium in January 2008: Evidence from the Global CFO Outlook Survey", John Graham and Campbell Harvey provide an updated report on the views of U.S. Chief Financial Officers (CFOs) on the prospective equity risk premium relative to the yield on 10-year U.S. Treasury notes (T-notes), assuming a 10-year investment horizon. After analyzing 388 responses to the 32nd quarterly survey on this topic, they find that: More...
Just how much do investors in U.S. equities pay for the hope of beating the market? In his April 2008 paper entitled "The Cost of Active Investing", Kenneth French estimates the cost of active investing in the U.S. stock market as the difference between the total cost of investing and an estimate of the cost if everyone invested passively. He constructs the total cost of investing as the sum of four components: (1) fees/expenses investors pay for open-end, closed-end and exchange-traded funds; (2) investment management fees for institutional investors; (3) fees investors pay for hedge funds and funds of hedge funds; and, (4) costs all investors pay to trade. Using data for investing costs and market returns during 1980-2006 for NYSE, Amex and NASDAQ stocks, he concludes that: More...
Do any indicators systematically predict stock returns across global equity markets? In his June 2008 paper entitled "Predicting Global Stock Returns", Erik Hjalmarsson tests the power of four common indicators (dividend-price ratio, earnings-price ratio, short interest rate and term spread) to predict stock returns for markets in 24 developed and 16 emerging economies. Using a very large dataset encompassing 20,000 monthly observations of returns and indicators ranging as far back as 1836, he concludes that: More...
Do expense ratios for actively managed equity mutual funds represent pay for performance or pay for something else? In their July 2008 paper entitled "Performance and Characteristics of Actively Managed Retail Mutual Funds with Diverse Expense Ratios", John Haslem, Kent Baker and David Smith investigate factors determining the performance of actively managed retail equity mutual funds, with emphasis on expense ratios. Using characteristics and return data for 1,779 actively managed U.S. equity mutual funds segmented by Morningstar category and contemporaneous returns for category-matched Russell indexes, they conclude that: More...
Does the "overpricing" of out-of-the-money (OTM) stock index put options imply an investor estimate of the likelihood and size of economic disasters and stock market crashes? In his June 2008 paper entitled "How Bad Will the Potential Economic Disasters Be? Evidences From S&P 500 Index Options Data", Du Du estimates the the frequency and magnitude of U.S. economic disasters as implied by S&P 500 index option data within a model involving rare sharp drops in consumption and consumption habit formation. In his model, consumption drops induce stock market crashes via: (1) commensurate declines in dividends, and (2) elevated investor risk aversion. Using S&P 500 index option data for the period 4/4/88-6/30/05 and contemporaneous economic data, he concludes that: More...
For what types of stocks is sentiment trading most likely to work? In the June 2008 update of their paper entitled "How Does Investor Sentiment Affect the Cross-Section of Stock Returns?", Malcolm Baker, Johnathan Wang and Jeffrey Wurgler investigate returns for different types of stocks in the context of broad investor sentiment index derived from six indicators: trading volume as measured by NYSE turnover; the dividend premium; the closed-end fund discount; the number of, and first-day returns on, Initial Public Offerings; and the equity share in new issues. Using this sentiment index and monthly stock return and characteristics data for 1962-2005, they conclude that: More...
What do leading textbooks have to say about the excess return you got, should expect, should require or should infer from the market for taking the risk of owning stocks? In his June 2008 paper entitled "The Equity Premium in 100 Textbooks", Pablo Fernández reviews definitions and values of the equity risk premium offered in 100 finance and valuation textbooks published from 1979 to 2008. Based on this review, he finds that: More...
Industries arguably follow multi-month cycles of outperformance and underperformance. Can investors use industry/sector Exchange Traded Funds (ETF) to capture abnormal returns from industry momentum? In their June 2008 paper entitled "Can Exchange Traded Funds Be Used to Exploit Industry Momentum?", Laurens Swinkels and Liam Tjong-A-Tjoe analyze the profitability of industry momentum strategies based on two sets of industry/sector ETFs. Using monthly ETF return data for the period July 2000 through November 2007, they conclude that: More...
Do commodity futures prices react systematically to news about the overall U.S. economy? If so, how might investors/traders exploit the reactions? In their March 2008 working paper entitled "How Do Commodity Futures Respond to Macroeconomic News?", Dieter Hess, He Huang and Alexandra Niessen investigate the impact of surprises in 17 U.S. macroeconomic indicators on two broad commodity futures indexes: (1) the equally-weighted CRB Index, and (2) the production-weighted S&P GSCI Commodity Index. Using macroeconomic news reports (surprise components), contemporaneous daily commodity index prices and various measures of the economic cycle over the period 1989 to 2005, they conclude that: More...
How do the typical portfolio and performance of self-directed investors differ from those of investors who employ financial advisors? Do financial advisors systematically add value by providing information to, and tempering the irrationalities of, individual investors? In his March 2008 paper entitled "The Influence of Financial Advice on Individual Investor Portfolio Performance", Marc Kramer compares the investment portfolio content and performance of advised and self directed investors in the Netherlands. Using portfolio data for a diverse mix of 15,675 individual Dutch investors over the 52-month period from April 2003 to August 2007, he concludes that: More...
Does interaction with peers significantly affect the choices of individual investors? Are some individuals more susceptible to such pressure than others? In their April 2008 paper entitled "Susceptibility to Interpersonal Influence in an Investment Context", A. Hoffmann and Thijs Broekhuizen investigate how interpersonal influences affect the investment decisions of individuals and which individuals are most susceptible to such influences. Combining the results of a laboratory experiment involving 154 university students and a survey of 287 investors, they conclude that: More...
Should long-term investors view their retirement portfolios more like houses than savings plans? In other words, should they start out with considerable leverage and draw the leverage down over time? In their May 2008 paper entitled "Life-Cycle Investing and Leverage: Buying Stock on Margin Can Reduce Retirement Risk", Ian Ayres and Barry Nalebuff investigate the effects of gradually phased-out leverage on long-term (for retirement) equity investment. Using annual return data for U.S. stocks and bonds and margin interest rate estimates for the period 1871-2007, they conclude that: More...
How can investors and speculators tell foolish, theoretical and practical investing/trading schemes apart? In his August 2002 paper entitled "Cranks, Academics and Practitioners", former head of quantitative strategies at Goldman Sachs Emanuel Derman briefly circumscribes this question. He notes that: More...
Why do equal-weighted portfolios tend to outperform capitalization-weighted portfolios? Is this tendency related to the size effect? In the May 2008 update of their paper entitled "The Effect of Value Estimation Errors On Portfolio Growth Rates", Robert Ferguson, Dean Leistikow, Joel Rentzler and Susana Yu examine how value estimation (stock valuation) errors affect long-term returns for several portfolio weighting methods. Based on simple assumptions and general statistical analysis, they conclude that: More...
Does the U.S. stock market reliably decline in response to a positive crude oil price shock? In their March 2007 paper entitled "The Impact of Oil Price Shocks on the U.S. Stock Market", Lutz Kilian and Cheolbeom Park investigate complexities in the relationship between U.S. stock returns and crude oil prices according to the causes of oil price shocks. Using data for crude oil prices, aggregate (value-weighted) stock returns and inflation over the period January 1975 through September 2005, they conclude that: More...
Have Regulation FD (Fair Disclosure) of 2000 and the Global Analyst Research Settlements of 2002 effectively removed incentives for sell-side analysts to curry favor with their own and covered company management teams by issuing inflated earnings forecasts? In their May 2008 paper entitled "Conflicts of Interest and Analyst Behavior: Evidence from Recent Changes in Regulation", Armen Hovakimian and Ekkachai Saenyasiri investigate whether these two regulatory actions reduced the average analyst earnings forecast bias found in prior studies. Based on the annual earnings forecasts of sell-side analysts and associated actual annual earnings over the period 1984-2006, they conclude that: More...
Should investors shift from traditional long-only mutual funds to newer and more flexible 130/30 (130% long/30% short) equity funds? In other words, does the flexibility of 130/30 funds to short stocks and expand portfolios enhance returns? In the May 2008 version of his paper entitled "130/30 Investing: Just Another Hype or Here to Stay?", David Blitz enumerates theoretical advantages and disadvantages of 130/30 investing and discusses ways in which 130/30 fund managers are implementing their flexibility, concluding that: More...
How strong and persistent are the effects of inflation rate and interest rate shocks on the stock market? In the May 2008 draft of their paper entitled "Inflation, Monetary Policy and Stock Market Conditions", Michael Bordo, Michael Dueker and David Wheelock quantify the extent to which various macroeconomic and policy shocks (industrial production, inflation, money supply growth, 10-year Treasury note yield and 3-month Treasury bill yield) explain the behavior of U.S. real stock prices and stock market conditions (trend) during the second half of the 20th century. Using monthly data for these variables and the S&P 500 index (as a proxy for stock prices) over the period August 1952 through December 2005, they conclude that: More...
Do the attention-grabbing past returns of high-flying stocks produce pre-earnings announcement buying frenzies? In the April 2008 version of their paper entitled "Limited Attention and the Earnings Announcement Returns of Past Stock Market Winners", David Aboody, Reuven Lehavy and Brett Trueman examine whether the limited time and resources of small investors explains a striking return pattern around the earnings releases of firms with extremely strong prior year price momentum. Using daily stock return data and earnings release/forecast news from the beginning of 1971 through the third quarter of 2005 for a broad sample of companies, they conclude that: More...
Does any broad measure of the state of the economy meaningfully predict financial market returns? In their May 2008 paper entitled "Time-Varying Risk Premia and the Output Gap", Ilan Cooper and Richard Priestley investigate the output gap as a direct link between future stock returns and economic fundamentals. They define output gap as the deviation of the log of industrial production from a trend constructed from both linear and quadratic components. Using unrevised industrial production data, aggregate U.S. stock market returns and Treasury bill yields (to calculate excess returns) for the period 1948-2005, they conclude that: More...
Do the big commodity futures speculators make money? If so, how? In their April 2008 draft paper entitled "Returns to Speculators in Commodity Futures Markets: A Comprehensive Revisit", Christof Sigl-Grüb and Dirk Schiereck investigate the performance and performance drivers for large speculators in 22 commodity markets over the last 15 years. Using aggregate position data for non-commercial traders (large speculators) from the weekly Commodity Futures Trading Commission Commitments of Traders (COT) reports and contemporaneous daily futures price data over the period 10/1/92 to 3/6/07, they conclude that: More...
Is the Fed Model an artifact of bad investor behavior (money illusion) or rational response? In the April 2008 draft of their paper entitled "Inflation and the Stock Market: Understanding the "Fed Model", Geert Bekaert and Eric Engstrom carefully re-examine mechanisms that might explain why the Fed Model "works." Using quarterly inputs for bond yield, S&P 500 index level and dividend yield, the economic forecast and a consumption-based measure of risk aversion spanning the fourth quarter of 1968 through 2007, they conclude that: More...
We occasionally select for retrospective review an all-time "best selling" research paper from the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the June 2007 paper entitled "The Fundamentals of Commodity Futures Returns" (download count over 2,500) by Gary Gorton, Fumio Hayashi and Geert Rouwenhorst. Commodity futures are derivative, short-maturity claims on real assets. In this paper, the authors apply the theory of storage to investigate relationships between the physical inventories of these assets and the returns to traders in the associated commodity futures. Using monthly data for over 30 commodity futures and associated physical inventories as available between 1969 and 2006 and data from the weekly Commodity Futures Trading Commission Commitments of Traders (COT) reports, they conclude that: More...
Are expected cash flows (earnings) or expected discount rates (risk tolerance) more important in determining stock valuations? In the April 2008 version of their paper entitled "What Drives Stock Price Movement?", Long Chen and Xinlei Zhao investigate the relative importance of cash flows and discount rates in equity valuation by studying the relationships among proportional stock price change, cash flow news and discount rate news at firm and aggregate levels. They make a critical assumption that analyst earnings forecasts are accurate and timely measures of investor beliefs regarding future cash flows. Using quarterly stock price data and contemporaneous prevailing earnings forecasts over the period 1985 through 2006, they conclude that: More...
Should investors avoid mutual funds that charge redemption fees, or is there a good reason to accept this explicit hit to liquidity? In other words, do these fees protect underperforming fund managers or long-term investors? In their recent paper entitled "Redemption Fees: Reward for Punishment", David Nanigian, Michael Finke and William Waller study the impact of short-term redemption fees on long-term fund performance based on fee size and duration (effective time interval of the redemption fee after purchase). Using monthly after-tax returns for a very large sample of open-end US equity mutual funds over the period July 2003 to May 2007, they conclude that: More...
Do northern hemisphere seasonal variations impact stock market volatility and return by affecting aggregate investor/trader mood? In their April 2008 paper entitled "Seasonal Affective Disorder (SAD) and Perceived Market Risk", Guy Kaplanski and Haim Levy test the effect of seasonal environmental factors (daylight hours, temperature and fall season) on perceived market risk as indicated by the Chicago Board Options Exchange Volatility Index (VIX). VIX, also known as the Fear Index, is a measure of the risk perceived by traders of S&P 500 index options. Using VIX and actual volatility data and environmental measurements (for latitude 41 degrees north, Chicago and New York) over the period 1990-2007, they conclude that: More...
Does sharing ideas and actions with a community help make individual active traders successful? In the March 2008 version of their paper entitled "Experts Online: An Analysis of Trading Activity in a Public Internet Chat Room", Bruce Mizrach and Susan Weerts study a group of active traders who voluntarily posted their trades in real time in a free public Internet chat room called Activetrader. Using data on 8,967 trades by 676 traders from four snapshots (64 total trading days) during 2000-2003, along with survey responses from 67 of these traders, they conclude that: More...
Is there a predictable market reaction to stocks reaching round-number n-day highs and lows? In their November 2007 paper entitled "Highs and Lows: A Behavioral and Technical Analysis", Bruce Mizrach and Susan Weerts investigate whether there are systematic trading behaviors for stocks posting 10-day, 25-day, 50-day, 100-day, 150-day, 200-day and 52-week highs and lows. Using daily price data for 488 Nasdaq stocks and 361 NYSE stocks over the period January 1993 through October 2003, they conclude that: More...
Is the aggregate sentiment of commodity traders predictive for associated asset returns? In their June 2006 paper entitled "How to Time the Commodity Market", Devraj Basu, Roel Oomen and Alexander Stremme investigate whether information in the weekly Commodity Futures Trading Commission's Commitments of Traders (COT) reports enable successful market timing. These reports tabulate the size and direction of the positions taken by different categories of futures traders in different assets. "Commercial" traders use futures contracts for hedging, "non-commercial" traders use them for other types of speculation and "non-reportable" traders operate below the individual reporting threshold. The study utilizes "hedging pressure" (the fraction of positions that are long) for the S&P 500 index (focusing on commercial and non-reportable hedging pressure) and for copper and oil (focusing on non-commercial hedging pressure) to adjust portfolio allocations among the S&P 500 index, copper and oil futures and a one-month certificate of deposit. Using COT reports and associated asset price data for the period January 1993 to May 2006, they conclude that: More...
Do commodity futures exhibit short-term momentum and long-term reversion, as do stocks? In the August 2006 version of their paper entitled "Momentum Strategies in Commodity Futures Markets", Joëlle Miffre and Georgios Rallis examine the profitability of 32 momentum (short-term continuation) and 24 contrarian (long-term reversal) strategies in commodity futures markets. The momentum strategies buy (sell) recently outperforming (underperforming) commodity futures and hold resulting long-short portfolios up to 12 months. The contrarian strategies buy (sell) the commodity futures that underperformed (outperformed) in the distant past and hold resulting long-short portfolios for periods of two to five years. All strategies trade liquid futures contracts with nearby maturities involving 31 commodities, unimpeded by short-selling restrictions often encountered in equity markets. Using futures contract price data spanning 1/31/79-9/30/04, they conclude that: More...
We occasionally select for retrospective review an all-time "best selling" research paper from the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the January 2006 paper entitled "The Tactical and Strategic Value of Commodity Futures" (download count over 2,400) by Claude Erb and Campbell Harvey. Commodity futures are derivative, short-maturity claims on real assets. In this paper, the authors explore the strategic and tactical opportunities that these derivatives present to investors. Using long-run commodity futures return data as available mostly through mid-2004, they conclude that: More...
Does a high dividend yield translate on average to high total return? In the February 2008 version of their paper entitled "Dividend Yield Strategy in the British Stock Market: 1994-2007", Janusz Brzeszczynski, Kathryn Archibald, Jerzy Gajdka and Joanna Brzeszczynska examine the recent performance of an equally-weighted portfolio of UK stocks with the highest dividend yields. Using total dividend-reinvested return data for portfolios of the Top Ten highest dividend yield stocks in the FTSE 100, reformed annually on the first trading day in March, and for the index itself over the period 1994-2007 (13 years), they conclude that: More...
Do strong incentives for new hedge fund managers and small-fund nimbleness translate to outperformance for new funds? In the January 2008 draft of their paper entitled "The Performance of Emerging Hedge Fund Managers", Rajesh Aggarwal and Philippe Jorion analyze the performance of new hedge funds, emphasizing avoidance of backfill bias. New fund managers may at their discretion "back fill" past performance when they decide to start reporting fund performance. The authors account for the potential bias of favorable backfilling by assembling a sample of funds with inception dates within 180 days of first report dates. Using return data for the resulting sample of 923 (both live and dead) hedge funds that are new over the period 1996-2006, they conclude that: More...
Are there exploitable differences in returns for stocks with heavy versus light institutional trading activity? In his March 2008 paper entitled "Trader Composition and the Cross-Section of Stock Returns", Tao Shu analyzes the impact of institutional trading activity on the returns of individual stocks and on the strength of the momentum effect, post earnings-announcement drift (PEAD), the value premium and the investment effect. He calculates institutional trading activity at a quarterly frequency by dividing the aggregate absolute change in reported institutional holdings of a stock by the contemporaneous total quarterly trading volume for the stock. Using holdings data as reported via SEC Form 13F and associated stock trading volume and return data for the period 1980-2005, he concludes that: More...
Do traders with solid information about firm prospects use equity options to get leverage and avoid short selling constraints? Two recent papers address this question by testing the predictive power of distortions in out-of-the money option prices for individual stocks. In their December 2007 paper entitled "Deviations from Put-Call Parity and Stock Return Predictability", Martijn Cremers and David Weinbaum examine the power of relatively expensive options to predict returns for individual stocks. In a similar March 2008 paper entitled "What Does Individual Option Volatility Smirk Tell Us about Future Equity Returns?", Xiaoyan Zhang, Rui Zhao and Yuhang Xing focus on relatively expensive put options as indicators of bad news and poor future returns for individual stocks. Using options pricing and associated stock return data over the period 1996-2005, these two studies conclude that: More...
Are there patterns to intraday stock returns and, if so, are they exploitable? In their March 2008 paper entitled "Intraday Patterns in the Cross-Section of Stock Returns", Steven Heston, Robert Korajczyk and Ronnie Sadka examine the intraday behavior of stock prices. Using return data for 13 half-hour intervals during the trading day for all NYSE-listed stocks over the decimalized period of 2001-2005, they conclude that: More...
Do certain market industries outperform when Democrats or Republicans hold the U.S. presidency, or during certain years of the presidential term? In their recent paper entitled "Political Cycles in US Industry Returns", Jeffrey Stangl and Ben Jacobsen investigate whether specific industries tend to perform better: (1) under Democratic or Republican presidents; and (2) during the last two years of a presidency. Using return data for 48 industries representing all stocks listed on the major U.S. exchanges during 1926-2006, they conclude that: More...
Do Commodity Trading Advisors (CTAs), generally associated with the "managed futures" hedge fund style, successfully time their chosen markets? These traders take long or short positions in investment vehicles with low transaction cost (such as futures contracts) to exploit trends in commodity prices, exchanges rates, interest rates and equity prices. In the February 2008 version of their paper entitled "Market Timing of CTAs: An Examination of Systematic CTAs vs. Discretionary CTAs", Hossein Kazemi and Ying Li investigate the return and volatility timing ability of CTAs and examine whether there is a difference in market timing abilities between systematic and discretionary traders. To this end, they develop a set of risk factors based on returns from the most heavily traded futures contracts. Using monthly, net-of-fees return data for 1994-2004 (encompassing 278 live and 622 defunct CTA funds), they conclude that: More...
What is the nature and value of stock recommendations made by bloggers? Do investors/traders act on them? In his recent paper entitled "The Impact of Blog Recommendations on Security Prices and Trading Volumes", Veljko Fotak measures the performance and influence of blogger stock recommendations based on a sample of 340 buy and 160 sell recommendations from 122 distinct bloggers (with posted biographies) via Seeking Alpha during 2006. Using this sample, along with daily price and volume data for the recommended stocks, he concludes that: More...
Should speculators expect a profit from assuming the risk of volatility (for example, by selling options)? In their October 2007 paper entitled "The Price of Market Volatility Risk", Jefferson Duarte and Christopher Jones employ a combination of simulations and analyses of empirical data to investigate the volatility risk premium. This premium ostensibly provides compensation for those assuming risks stemming from both option contract characteristics and the price variability of the underlying equity. The study addresses biases, induced by large bid-ask spreads, in typical approaches to calculating mean returns for options. Using daily data for options on U.S. equities spanning 1996-2005, they conclude that: More...
Is it possible to predict bear markets for stocks using macroeconomic indicators? In his March 2008 paper entitled "Predicting the Bear Stock Market: Macroeconomic Variables as Leading Indicators",Shiu-Sheng Chen investigates whether macroeconomic variables such as interest rate term spread, inflation rate, money supply, aggregate output and unemployment rate can individually predict equity bear markets both in-sample and out-of-sample. Using monthly S&P 500 index data and macroeconomic data for the period February 1957 through December 2007, he concludes that: More...
Does the power of short interest to predict future returns derive from superior information of short sellers or from overvaluation driven by short-selling constraints? In their January 2008 paper entitled "Why Do Short Interest Levels Predict Stock Returns?", Ferhat Akbas, Ekkehart Boehmer, Bilal Erturk and Sorin Sorescu examine evidence that discriminates between the competing information and overvaluation explanations. Their key discriminators are: (1) the effects of levels of and changes in institutional ownership (availability of shares for shorting) on the predictive power of short interest; and, (2) the relationship between short interest and subsequent news. Using daily stock returns, monthly short interest, quarterly institutional holdings, firm fundamentals and news/earnings reports spanning 1988-2005, they conclude that: More...
Can investors beat the market by iteratively finding and exploiting the current hot anomaly? In his February 2008 paper entitled "Real-Time Profitability of Published Anomalies: An Out-of-Sample Test", Zhijian Huang investigates whether a trader can realize excess returns by repeatedly picking the anomaly with the best return during a rolling historical window from an expanding universe of anomalies as published. The universe includes anomalies that: (1) have been published in at least one of three top-ranked finance journals; (2) relate to the calendar or to cross-sectional predictability; and, (3) can be re-evaluated annually. Using monthly return data associated with nine anomalies published during 1977-1991 (Monday effect, January effect and cross-sectional effects related to size, book-to-market ratio, momentum, earnings/price ratio, cash flow/price ratio, dividend yield and and debt/equity ratio) as available through 2006, he concludes that: More...
What proportion of mutual funds truly, after accounting for luck, generate positive alpha? Is there a reliable way to find such funds? In the March 2008 version of their paper entitled "False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas", Laurent Barras, Olivier Scaillet and Russ Wermers apply a new technique to measure the role of luck across a large sample of mutual funds. Using monthly returns for 2,076 U.S. actively managed domestic equity mutual funds (1,304 growth, 388 aggressive growth and 384 growth and income) existing for at least 60 months during 1975-2006, they conclude that: More...
Does technical analysis work after accounting for luck and trading frictions? More specifically, can traders reliably identify technical rules that generate future net outperformance? In the January 2008 version of their paper entitled "Technical Trading Revisited: Persistence Tests, Transaction Costs, and False Discoveries", Pierre Bajgrowicz and Olivier Scaillet investigate the economic value of technical trading rules applied to long-run daily Dow Jones Industrial Average (DJIA) data. Their approach includes: (1) a new measure of data snooping bias to distinguish between luck and true forecasting power in backtesting; (2) out-of-sample persistence testing of recently successful trading rules; (3) determination of whether certain trading rules work consistently under specific economic conditions; and, (4) incorporation of trading costs. Using daily DJIA price and volume data for January 1897 through July 2007 to test 7,846 rules (filters, moving averages, support and resistance, channel breakouts and on-balance volume averages), they conclude that: More...
Does the Wall Street Journal's SmartMoney Fund Screen help its readers beat the market? In the February 2008 version of their paper entitled "Do Mutual Fund Media Recommendations Hold Value? An Empirical Analysis of the Wall Street Journal’s SmartMoney Fund Screen", George Comer, Norris Larrymore and Javier Rodriguez employ two methods to test the performance of mutual funds listed at the ends of the Wall Street Journal's SmartMoney Fund Screen columns during the year before and the year after publication. These weekly columns flag top performing mutual funds based on criteria such as fund objective, historical returns and expense ratios. The authors collect and assign the funds in these lists to one of five fund categories: domestic equity, international equity, sector, hybrid (asset allocation and balanced funds) and fixed income. Using daily returns for 399 mutual funds (263 unique) listed during 2005, they conclude that: More...
Does bias on the part of U.S. investors in favor of companies headquartered within their home states create opportunities for geographical abnormal returns? In the February 2008 draft of their paper entitled "Long Georgia, Short Colorado? The Geography of Return Predictability", George Korniotis and Alok Kumar investigate whether the behavior of local investors in response to local economic conditions produces predictable patterns in the returns of local stocks. They define local as individual U.S. states. They define local economic conditions as the combination of: (1) growth rate of state labor income; (2) state unemployment rate relative to a moving average; and, (3) state-level housing collateral ratio (as a measure of borrowing constraints). Using quarterly state-level economic data, company headquarters locations and quarterly stock return data for 1980-2004 (covering a total of 39 states as limited by sample size), they conclude that: More...
What is the state of research on the forecasting methods and outputs of equity analysts? In their 2008 paper entitled "The Financial Analyst Forecasting Literature: A Taxonomy with Suggestions for Further Research", Sundaresh Ramnath, Steve Rock and Philip Shane catalog and organize past research on the forecasting of equity analysts with focus on the period since 1992. Using results from approximately 250 post-1992 papers related to equity analysts from eleven major research journals, they summarize findings related to the following questions: More...
Is the momentum effect pervasive across different equity markets and persistent through different time periods? The overview of Chapter 3 in "Global Investment Returns Yearbook 2008: Synopsis", which summarizes annual work performed by by Elroy Dimson, Paul Marsh and Mike Staunton for ABN AMRO, provides "findings from the longest momentum study ever undertaken." Applying a 12-1-1 strategy (rank returns over the past 12 months, wait one month and then hold for one month until rebalancing) to very long-run UK data and more recent data for each of 17 country stock markets, they conclude that: More...
Do investors price stocks based mostly on rational analysis or feelings? In their February 2008 paper entitled "Affect in a Behavioral Asset Pricing Model", Meir Statman, Kenneth Fisher and Deniz Anginer use survey results to investigate both the objective and subjective (perceived) connections between risk and return. Using results of: (1) the 1982-2006 annual Fortune surveys of senior executives, directors and security analysts regarding the long-term investment value of companies; and (2) May and July 2007 surveys of high-net worth clients of a large investment firm, they conclude that: More...
Do investors love their losers more than their winners? In their January 2007 paper entitled "The Effect of Prior Beliefs and Preferences on Information Processing in an Investment Experiment", Jeremy Ko and Oliver Hansch use a stock picking simulation to measure the bias investors exhibit when processing new information about stocks they have selected. Each iteration of the simulation involves picking one of two similar stocks that will outperform during the coming week. Using results from simulations involving 99 total participants in 2003 and 2004, they conclude that: More...
Do hedge funds have a predictable life cycle? If so, can investors exploit it? In his January 2008 draft paper entitled "The Life Cycle of Hedge Funds", Dieter Kaiser investigates whether excess returns diminish as a hedge fund ages perhaps because: (1) successful hedge funds outgrow their target markets; (2) good returns attract other investment managers who compete for similar inefficiencies; and/or (3) successful hedge funds outgrow their founding entrepreneurial spirits. Using return data for an initial sample of 1,433 hedge funds over the period January 1996 through May 2006, he finds that: More...
Are asset prices still in a behavioral bubble, sustained at least in part by wrongly using nominal rather than real interest rates in valuation calculations? In his October 2007 paper entitled "Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Economic Models", Robert Shiller examines the Fed model-like belief that that long-term asset prices are generally high because monetary authorities are keeping long-term interest rates low. Using interest rate and inflation data for 1871-2007 and more recent behavioral evidence, he argues that: More...
Does past performance predict future results for bond funds? In their April 2007 paper entitled "'Hot Hands' in Bond Funds", Joop Huij and Jeroen Derwall measure persistence in the relative performance of bond mutual funds. Using return data for 3,549 bond funds spanning 1990-2003, they find that: More...
Are presumably sophisticated (or at least wealthy) hedge fund investors on the whole past return chasers or future return finders? In their November 2007 paper entitled "Aggregate Hedge Fund Flows and Asset Returns", Ashley Wang and Lu Zheng answer these questions in aggregate by analyzing the overall flow of money into and out of hedge funds. They also examine separately flow patterns for ten hedge fund categories: convertible arbitrage, dedicated short bias, emerging markets, equity market neutral, event driven, fixed income arbitrage, global macro, long/short equity, managed futures and multi strategies. Using quarterly hedge fund flow and return data across the ten fund categories from first quarter 1994 to first quarter 2007, they find that: More...
What is the latest reading on the future equity risk premium from the academic community? In his January 2008 paper entitled "The Consensus Estimate For The Equity Premium by Academic Financial Economists in December 2007", Ivo Welch answers this question. Based on 369 "core" responses to a survey of finance professors conducted during late December 2007, he finds that: More...
As goes January, so goes the rest of the year? In their November 2007 paper entitled "How Accurate is the January Barometer?", Ben Marshall and Nuttawat Visaltanachoti examine the ability of January returns to predict February-December returns in the U.S. and other equity markets. They apply multiple robustness tests to determine the statistical and economic significance of results. Using U.S. stock return data spanning 1940-2006 and stock return data for 22 other countries and the world spanning 1970-2006, they conclude that: More...
Do hedge funds systematically exploit the major stock return anomalies? Or, do they earn their keep (if they do) via more arcane strategies? In their January 2008 paper entitled "Do Hedge Funds Arbitrage Market Anomalies?", Dan Lawson and David Peterson apply a seven-factor model (market, size, value, momentum, earnings momentum, equity financing and asset growth) to investigate whether hedge funds successfully exploit market anomalies. They also examine whether hedge funds generate abnormal returns separately from these "famous" factors. Using detailed data on 1,460 individual hedge funds involving 21 types of strategies and stock return anomaly data for the period 1990-2005, they find that: More...
Which stock return anomalies are trustworthy, and which are not? In the June 2007 draft of their paper entitled "Dissecting Anomalies", Eugene Fama and Kenneth French apply both sorts and regressions to examine the robustness of the momentum, net stock issuance, accruals, profitability and asset growth anomalies. They note that sorts on an anomaly variable offer a simple picture of how average returns vary, but microcaps (a few big stocks) can dominate the performance of a sort-based equal-weighted (value-weighted) hedge portfolio. In addition, sorts are ill-suited to determinations of: (1) the exact relationship between an anomaly variable and returns, and (2) relationships among anomalies. They note also that extreme behavior by microcaps and outliers generally can distort inference from regressions. Using a robust set of firm data for a broad set of U.S. stocks allocated to three size groups (microcap, small and big) over the period 1963-2005, they conclude that: More...
Do companies systematically manage earnings in attempts to smooth out the bumps? If so, can investors detect and exploit such gaming? In their January 2008 paper entitled "Reconciling the Market’s Underreaction to Earnings Changes and Overreaction to (Abnormal) Accruals: An Earnings Management Explanation", Henock Louis and Amy Sun investigate whether earnings management accounts for anomalous market reactions to earnings and accruals surprises. Specifically, they test whether firms with accelerating (deteriorating) earnings systematically manage earnings downward to create reserves (upward to avoid reporting losses). Using firm financial data and associated stock prices over the period 1988-2005, they conclude that: More...
Are value and momentum anomalies reliably present across international asset classes? If so, can investors exploit them to generate abnormal returns? In the December 2007 version of their paper entitled "Global Tactical Cross-Asset Allocation: Applying Value and Momentum Across Asset Classes", David Blitz and Pim van Vliet examine global tactical asset allocation strategies across a broad range of asset classes based on both value (asset yield or earnings yield) and momentum (both short-term and long-term). These strategies weight asset classes according to volatility, with higher (lower) weights assigned to classes with lower (higher) volatilities. Using price and yield data for 12 international asset classes spanning January 1985 through September 2007, they conclude that: More...
In considering the stock ratings of expert analysts, should investors focus more on the level of the ratings or changes in ratings? In their December 2007 paper entitled "Ratings Changes, Ratings Levels, and the Predictive Value of Analysts’ Recommendations", Brad Barber, Reuven Lehavy and Brett Trueman investigate the potential value to investors of both levels of (strong buy, buy, hold, sell, strong sell) and changes in analyst stock ratings. Using real-time analyst stock ratings from two databases spanning 1986-2006 (more than 1,000,000 ratings) and contemporaneous daily stock returns, they conclude that: More...
Should investors who suspect asset pricing bubbles go with it or against? Or, should they just step aside and await a "Return to Normalcy?" In their November 2007 preliminary paper entitled "Riding Bubbles", Nadja Guenster, Erik Kole and Ben Jacobsen investigate empirically the best approach for investors to take regarding active asset bubbles, practically indicated by: (1) a price advance faster than the growth rate of fundamental value; and, (2) a sudden acceleration in price advance. Using monthly returns and contemporaneous fundamentals for 48 value-weighted industry indexes spanning July 1926 to December 2006, they conclude that: More...
Do Treasury instruments exhibit a seasonal return pattern? If so, is the pattern related to that of stock returns? In their September 2007 paper entitled "Opposing Seasonalities in Treasury versus Equity Returns", Mark Kamstra, Lisa Kramer and Maurice Levi investigate the calendar month dependence of returns for U.S. Treasuries and its relationship to that of U.S. stock returns. Using monthly returns for mid-term to long-term Treasury indexes and for a broad equal-weighted stock index over the period 1952-2004, along with contemporaneous economic data, they find that: More...
Does increasingly powerful and more automated trading technology create the need for more sophisticated equity return benchmarks? In the December 2007 version of their paper entitled "130/30: The New Long-Only", Andrew Lo and Pankaj Patel present a passive but dynamic "plain-vanilla" 130% long/30% short (130/30) benchmark index based on: (1) simple factors (encompassing value, growth, profitability, momentum and technical) to rank stocks; and, (2) standard methods for constructing a portfolio based on these rankings. Applying a standard portfolio optimizer to 10 well-known and commercially available valuation factors for S&P 500 stocks, with monthly rebalancing during 1/96-9/07, they find that: More...
Mutual fund investors have two ways to beat the market: (1) pick the right funds, and (2) time their purchases and sales. How effectively does the average fund investor execute the latter goal? In their December 2007 paper entitled "Investor Timing and Fund Distribution Channels", Mercer Bullard, Geoff Friesen and Travis Sapp examine the investment timing performance of equity mutual fund investors and the relationship of this performance to the fund distribution channel. Using data on returns and funds flows for 6,164 U.S. equity mutual funds during 1991-2004, they conclude that: More...
Which path, stock picking (company analysis) or industry picking (economic trend analysis) is the more direct to investing outperformance? In their December 2007 paper entitled "Mutual Fund Industry Selection and Persistence", Jeffrey Busse and Qing Tong examine the relative importance of industry selection and stock selection in the performance of actively managed mutual funds. Using quarterly stockholdings during 1980-2006 for a large sample of actively managed U.S. equity mutual funds, along with associated stock return data, they find that: More...
Does momentum investing have cycles, or at least better/worse times? In their December 2007 paper entitled "Winner-minus-Loser Return Spreads, Return Dispersion, and Changes in the Market State", Chris Stivers and Licheng Sun investigate the profitability of momentum investing in stocks and industries over symmetric ranking-holding periods of 6, 18 and 36 months relative to the state of the stock market as indicated by recent dispersion of returns. Using monthly return data for individual NYSE/AMEX stocks and for 48 value-weighted industries during 1962-2005, they conclude that: More...
Is risk premium variation principally a consequence of changes in objective business conditions, or is some human dynamic important? In their November 2007 paper entitled "Diverse Beliefs and Time Variability of Risk Premia", Mordecai Kurz and Maurizio Motolese examine the effect of diverse but individually rational market beliefs on risk premiums. They define belief as a variable independent of all observed fundamentals, with its own dynamic that reflects changes in the distribution of investor risk perceptions. Using monthly interest rate forecasts compiled by Blue Chip Financial Forecasts since 1983 to measure market beliefs and associated actual interest rate data, they conclude that: More...
Do the most skilled stock pickers among fund managers gravitate toward funds that focus on a few good ideas, thereby outperforming diversified peers? In their recent paper entitled "Security Concentration and Active Fund Management: Do Focused Funds Offer Superior Performance?", forthcoming in The Financial Review, Travis Sapp and Xuemin Yan examine whether funds concentrated in relatively few securities outperform. Using price and holdings data for a broad sample of U.S. equity mutual funds operating at any time during 1984-2002 (2,278 funds encompassing 16,399 fund-years), they conclude that: More...
How do investors respond to the state of the U.S. federal fiscal deficit? In their August 2007 paper entitled "Fiscal Policy and Asset Markets: A Semiparametric Analysis", Dennis Jansen, Qi Li, Zijun Wang and Jian Yang examine the relationships between U.S. fiscal policy and U.S. asset markets (stocks and bonds). Using monthly data for the S&P 500 index, U.S. corporate bond yield, 10-year Treasury note (T-note) yield, the Federal Funds Rate (FFR), industrial production, the Consumer Price Index and the U.S. government budget deficit over the period July 1954 through December 2005 (618 months), they conclude that: More...
Can investors/traders outperform by exploiting (or avoiding) the black swans that populate daily equity market returns? In his November 2007 paper entitled "Black Swans and Market Timing: How Not To Generate Alpha", Javier Estrada investigates the influence of the best and worst days on long-term equity returns and the likelihood that investors can predict when these outliers will occur. Using evidence from 15 international equity markets and over 160,000 daily returns, he concludes that: More...
Can traders reliably exploit the reaction of stocks to scheduled Federal Funds Rate (FFR) decisions? In their October 2007 paper entitled "The Effects of Federal Funds Target Rate Changes on S&P100 Stock Returns, Volatilities, and Correlations", Helena Chulia-Soler, Martin Martens and Dick van Dijk study the impact of Federal Open Market Committee scheduled announcements of FFR decisions on individual stocks at the intraday level. Using high-frequency price data for components of the S&P 100 index around scheduled FFR decision announcements between between May 1997 and November 2006 (77 announcements), they find that: More...
Some eminent economists and political scientists believe that prediction-information-decision markets offer significant benefits to society through efficient extraction and consolidation of the knowledge of individuals. They may also offer some insights into the workings of traditional financial markets that have evolved from trading. They could represent a natural progression from increasingly abstract financial derivatives. The summaries below outline potential benefits and shortcomings of prediction markets. Key points are that prediction markets: More...
How do fund managers behave when they have recently outperformed or underperformed? Do winners hunker down and protect their gains, while losers ratchet up risk to recover. In two recent papers, Manuel Ammann and Michael Verhofen use a variety of risk measures to analyze the impact of prior performance on the risk-taking behavior of mutual fund managers. Their October 2006 paper entitled "Prior Performance and Risk-Taking of Mutual Fund Managers: A Dynamic Bayesian Network Approach" examines year-to-year changes in fund risk levels based on a large sample of U.S. mutual funds and contemporaneous risk premium data (market, size, value, momentum) over the period 1985-2003. Their subsequent November 2007 paper entitled "The Impact of Prior Performance on the Risk-Taking of Mutual Fund Managers" examines changes in fund risk levels from the first half of the year to the second half based on daily return data for a large sample of U.S. mutual funds and contemporaneous risk premium data over the period 2001-2005. In both papers, they conclude that: More...
Do firms that manage accruals conservatively (liberally) tend to be good (bad) investments? In their June 2007 paper entitled "Repairing the Accruals Anomaly", Nader Hafzalla, Russell Lundholm and Matt Van Winkle test adjustments to prior studies of the accrual anomaly to determine whether accruals can reliably predict future stock returns without look-ahead bias. One improvement is the use of Joseph Piotroski's financial health score to refine accrual signals. The other improvement is to define accruals as a fraction of earnings rather than as a fraction of total assets. Using a sample of 72,668 firm-years spanning 1988-2004, they find that: More...
Is there a key indicator that investors can use as a signal to overweight stocks of cyclical (non-cyclical) industry sectors that should outperform during economic expansions (contractions)? In their July 2007 paper entitled "Sector Rotation and Monetary Conditions", flagged by a reader, Mitchell Conover, Gerald Jensen, Robert Johnson and Jeffrey Mercer evaluate a sector rotation strategy that emphasizes cyclical (defensive) stocks when the Federal Reserve shifts to easing (tightening) the discount rate. Using daily returns for a value-weighted U.S. equity market index, four noncyclical sectors (Resources, Noncyclical Consumer Goods, Noncyclical Services, Utilities) and six cyclical sectors (Cyclical Consumer Goods, Cyclical Services, General Industrials, Information Technology, Financials, and Basic Industries) during 1973-2005, they find that: More...
Are "intuitive statistics" good enough for investing? In their brief March 2007 paper entitled "We Don’t Quite Know What We Are Talking About When We Talk About Volatility", Daniel Goldstein and Nassim Taleb report the results of a simple test of the ability of portfolio managers, traders, quantitative analysts and financial engineering graduate students to distinguish between two widely used measures of volatility: mean absolute deviation and standard deviation. Based on responses from 87 individuals to a survey question giving the mean absolute deviation for a normal distribution of stock returns and asking for the standard deviation, they find that:
More...Past research finds that stocks with low (high) short-term historical volatility tend to outperform (underperform). What causes this relationship? In the November 2007 update of their paper entitled "Volatility Spreads and Expected Stock Returns", Turan Bali and Armen Hovakimian examine the similarities and differences between realized (historical) volatility and implied volatility in the context of power to predict stock returns. Using stock price/fundamentals data for a broad range of stocks and volatilities implied by associated options with near-term expiration dates over the period January 1996-January 2005, they find that: More...
Does strong (weak) past growth in a company's total assets predict high (low) future stock returns? Or, does investor overreaction to past data predict the opposite? In the July 2007 update of their paper entitled "Asset Growth and the Cross-Section of Stock Returns", flagged by a reader, Michael Cooper, Huseyin Gulen and Michael Schill examine the relationship between firm asset growth (year-on-year percentage change in total assets) and subsequent stock returns. Using firm fundamentals and stock return data for all non-financial U.S. public companies over the period 1968-2003, they conclude that: More...
Just why do those Ivy League endowments do so well? In their October 2007 paper entitled "Secrets of the Academy: The Drivers of University Endowment Success", Josh Lerner, Antoinette Schoar and Jialan Wang investigate the performance of university endowments overall during the past decade and the factors contributing to outperformance of the most successful ones. Using voluntarily provided holdings and return data for over 1,300 university endowments mostly over the period 1992-2005, they conclude that: More...
What is the best approach for measuring the stock picking, industry concentration and factor risk aspects of active fund management? In the October 2007 update of their paper entitled "How Active Is Your Fund Manager? A New Measure That Predicts Performance", Martijn Cremers and Antti Petajisto introduce "Active Share" to quantify active portfolio management in terms of the share of portfolio holdings that differ from the makeup of an appropriate benchmark index. They then apply Active Share (measuring stock/industry selection) in combination with index tracking error (measuring factor bets) to evaluate equity mutual funds. Using data on holdings and returns for 2,647 equity mutual funds and 19 associated benchmark indexes spanning 1980-2003, they conclude that: More...
The SEC originally adopted Rule 10a-1 (the tick test) for listed securities in 1938 to restrict short selling in a declining market. After a test commencing 5/2/05 involving about 1,000 "pilot stocks," the SEC removed the tick-test rule for all listed securities effective 7/3/07. Does this rescission change the equity valuation landscape for U.S. equity investors/traders? In an October 2007 paper entitled "The Tick-Test Rule, Investors’ Opinions Dispersion, and Stock Returns: The Daily Evidence", Min Zhao investigates how the removal of the tick test changes the effect of short selling on stock prices. Using SEC Regulation SHO daily short selling data, along with associated daily return and firm fundamentals data, for the period May 2005 through December 2005, the study concludes that: More...
Picking the right benchmark is critical when assessing the performance of a fund manager. Benchmark selection is especially difficult for hedge fund managers because of: (1) the number of style options available to them, and (2) the difficulty of assigning specific funds to styles. Should evaluators simply accept the style claims of fund managers for benchmarking purposes? In their recent paper entitled "Hedge Funds: Ability Persistence and Style Bias", Matteo Belleri and Marco Navone do not. Instead, they calculate a benchmark for each hedge fund by fitting its actual performance over the past three years to a weighted portfolio of ten hedge fund indexes (Convertible Arbitrage, Dedicated Short Bias, Emerging Markets, Market Neutral, Event Driven, Fixed Income Arbitrage, Global Macro, Long/Short Equity, Managed Futures and Multi-Strategy). This approach essentially makes each manager accountable for modifications of fund strategy to benefit from current market conditions. Using the benchmark index data and return data for 3,627 hedge funds over the period 1994-2004, they conclude that: More...
Do the business media serve as reliable sources of good stock picks? In his 2003 working paper entitled "Fifty-Fifty. Stock Recommendations and Stock Prices. Effects and Benefits of Investment Advice in the Business Media", Thomas Schuster surveys and summarizes past research on this question. Using the results of 32 studies of relationships between business media stock recommendations and stock prices, he concludes that: More...
Do round numbers have a special meaning for stock traders? If so, is there a way to exploit any associated trading tendencies? In their 2007 paper entitled "Round Numbers and Security Returns", Edward Johnson, Nicole Johnson and Devin Shanthikumar examine returns (calculated based on midpoints of subsequent closing bid and ask prices) after closing prices that are just above or just below round numbers. Using closing price and closing bid-ask data and firm characteristics for a broad sample of U.S. stocks during the post-decimalization period of 5/01-12/06, they conclude that: More...
Are the stocks recommended by columnists in major business magazines good short-term and/or long-term picks? Can one trade these stocks around the publication event? In their 2006 working paper entitled "The Value of Columnists' Stock Recommendations", Dan Palmon, Ephraim Sudit and Ari Yezegel assess the short-term and long-term performance of buy recommendations made by columnists in Business Week (BW), Forbes and Fortune. Sensitive to the fact that magazine availability dates differ from nominal publication dates, they use a range of benchmarks and risk adjustments to measure the abnormal returns of these picks. Using 2,503 buy recommendations from the three magazines made during 2000-2003 along with associated price, fundamentals and benchmarking data, they conclude that: More...
Are some types of equity options consistently overpriced compared to others? If so, are there ways to exploit the pricing differences? In the December 2006 update of their paper entitled "Systematic Variance Risk and Firm Characteristics in the Equity Options Market", Vadim di Pietro and Gregory Vainberg investigate differences in options pricing between individual stocks and indexes and between different types of stocks (small versus large capitalization and value versus growth). Specifically, they examine mismatches between implied and realized (actual) asset volatilities as measured by returns from synthetic variance swaps, which are constructed from combinations of options and futures on underlying assets. Using stock and option prices and associated firm fundamental data for 1,402 firms over the period 1/96-12/04, they conclude that: More...
Why does high short interest indicate future underperformance of stocks? Does the reason suggest a way to refine the short interest signal? In their October 2007 paper entitled "Why Do Short Interest Levels Predict Stock Returns?", Ekkehart Boehmer, Bilal Erturk and Sorin Sorescu employ two distinct methods to determine which of two hypotheses drives the underperformance of heavily shorted stocks: (1) constraints on short selling, or (2) superior private information of short sellers. These methods combine the level of short interest with the level of institutional holdings (supply of shares available for lending) and with earnings surprises. Using return, short interest, institutional ownership, earnings and related fundamental data for a broad sample of stocks over the period 1988-2005, they find that: More...
Are factor models universal, or does each group of related stocks have a unique set of factors for predicting differences in future returns? In their September 2007 paper entitled "How Common Are Common Return Factors Across NYSE/AMEX and Nasdaq?", Amit Goyal, Christophe Perignon and Christophe Villa propose a general procedure to identify pervasive risk factors and apply the methodology to identify similarities and differences between the return structures of the specialist-controlled NYSE/AMEX and the computer-driven Nasdaq. Using monthly return data for large samples of NYSE/AMEX and Nasdaq stocks over the period 1978-2002 (25 years), divided into five 60-month subperiods, they find that: More...
Are there ways that individual investors can systematically use options for individual stocks to enhance portfolio returns? In their September 2007 paper entitled "Firm Specific Option Risk and Implications for Asset Pricing", James Doran and Andy Fodor examine the benefits and costs of 12 basic strategies for augmenting an initial investment in a group of stocks with systematic investments in the associated options. Options positions are initially 75-90 days to expiration and held to maturity. For each strategy, the authors test sensitivity to the size and moneyness (at the money, in of the money and out of the money) of options investments. Using stock and option prices and associated firm fundamental data for the 213 companies over the period 1/96-7/06, they conclude that: More...
Are Jim Cramer's stock recommendations on CNBC's Mad Money most meaningful for small-capitalization stocks, for which prices are most susceptible to influence by the concerted behavior of a group of individual investors? In their September 2007 working paper entitled "The Performance and Impact of Stock Picks Mentioned on Mad Money", Bryan Lim and Joao Rosario evaluate the show's ability to move markets over the short term and to forecast winners and losers over the long term. Using a sample of 10,589 Mad Money buy and sell recommendations representing 2,074 distinct firms, either initiated by Jim Cramer or provided by him in response to callers, from shows aired between June 28, 2005 and December 22, 2006, they conclude that: More...
Which factors are most predictive of differences in future returns among individual stocks? In their September 2007 paper entitled "Efficient Estimation of a Semiparametric Characteristic- Based Factor Model of Security Returns", Gregory Connor, Matthias Hagmann and Oliver Linton develop a new method for analyzing the influence of simple fundamental and technical factors on the returns of individual stocks. The method accommodates consideration of additional factors more readily than widely used alternative approaches. Using monthly return data and associated fundamentals for a broad sample of stocks over the period 1962-2005, they find that: More...
Have hedge funds proliferated, grown and leveraged to the point that groups of them with similar quantitative strategies can crash as they try to exit common positions in response to some external trigger? In their September 2007 paper entitled "What Happened To The Quants In August 2007?", Amir Khandaniy and Andrew Lo investigate the hypothesis that similar market-neutral and long/short equity hedge funds suffered a cascading fire sale liquidation (one-month losses of 5%-30%) during early August 2007. Using daily return data for a broad set of stocks to model hedge fund performance over the period 1/95-8/07, they tentatively conclude that: More...
In his recent PhD thesis entitled "An Analysis of Hedge Fund Strategies", Daniel Capocci offers an epic study of hedge fund properties, results and potential benefits. Specifically, he: (1) applies a multi-factor performance analysis model to determine the degree to which hedge funds persistently produce alpha; (2) measures the extent to which market-neutral hedge funds are really neutral; and, (3) examines the mean, volatility, skewness and kurtosis of hedge fund returns to evaluate their potential benefits to investors. Using hedge fund performance data from several sources spanning 1993-2003, he finds that: More...
Do strong emotions generally help or hinder trading? How do outperforming traders handle their emotions? In the 2007 paper entitled "Being Emotional during Decision making - Good or Bad? An Empirical Investigation", flagged by reader Dennis Page, Myeong-Gu Seo and Lisa Feldman Barrett investigate the role of emotions in stock trading via a simulation involving 101 traders recruited from investment clubs and paid $100 to $1,000 based on performance during the simulation. Using the self-reported emotional states of these traders during simulated buy-sell decisions on 12 available stocks each day for 20 consecutive trading days, they conclude that: More...
In seeking to control interest rates, has the Federal Reserve become less relevant to equity investors? In his September 2007 paper entitled "The Unusual Behavior of the Federal Funds and 10-Year Treasury Rates: A Conundrum or Goodhart’s Law?", Daniel Thornton examines the loss of correlation between the Federal Funds Rate (FFR) and long-term interest rates in the context of Goodhart's Law, which states that "any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes." Using monthly data for the FFR and the yields for Treasury instruments of various durations over the period 1/83-3/07, he concludes that... More...
