Blog - External (Secondary) Research

Following are the introductory paragraphs of entries providing CXO Advisory Group LLC summaries of working papers and published articles written by others.

March 11, 2010 - Newsworthy Hedge Funds Underperform?

Do hedge funds covered by the news media underperform "hidden gems?" In their March 2010 paper entitled "Does Recognition Explain The Media-Coverage Discount? Contrary Evidence From Hedge Funds", Gideon Ozik and Ronnie Sadka examine the effects of media coverage on future hedge fund performance. Using results of 80,000 monthly searches of the Google News archive and monthly return data for 978 hedge funds spanning 1999-2008, they conclude that: More...

March 9, 2010 - Managing Investment Risk by Parsing Uncertainties

How scientific can economics and finance be? In the March 2010 draft of their paper entitled "WARNING: Physics Envy May Be Hazardous To Your Wealth!", Andrew Lo and Mark Mueller present a framework to help investors, portfolio managers, regulators and policymakers understand the potential effectiveness and inherent limitations of economics and finance. Focusing on levels of uncertainty (fully reducible, partially reducible, and irreducible) to explain some of the key differences between finance and physics and on the role of quantitative models in theory and practice, they conclude that: More...

March 8, 2010 - Perspectives on Global Equity Diversification

Given the sometimes high correlations in movements among local equity markets, how valuable is international diversification in a global era? In the February 2010 draft of their paper entitled "International Diversification Works (in the Long Run)", Clifford Asness, Roni Israelov and John Liew examine the argument that global markets are undiversified (correlated) when you need diversification and diversified (uncorrelated) when you don't. They use an equally weighted 22-country global portfolio for their investigation. Using monthly local currency-denominated total returns, exchange rates and inflation data for Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, UK and U.S. for 1950-2008, they conclude that: More...

March 5, 2010 - Amplifying Momentum Returns with Idiosyncratic Volatility

Does positive feedback trading, indicated by an adjusted measure of return autocorrelation, enhance momentum profitability? In the February 2010 version of their paper entitled "Positive Feedback Trading Activities and Momentum Profits", Thomas Chiang, Xiaoli Liang and Jian Shi examine the relationship between positive feedback trading and profitability of momentum strategies. The momentum parameters for their investigation are a six-month ranking interval followed by a six-month holding interval. Measurement of positive feedback trading is for a six-month window coinciding with the momentum ranking interval. Using daily stock return data for a broad sample of U.S. stocks spanning 1985-2005, they conclude that: More...

March 3, 2010 - Housing Price Reversion to Trend

Do real housing prices revert to some trend? If so, where do they stand now with respect to trend? In their February 2010 paper entitled "The Margin of Safety and House Price Turning Points: Observations from the US, the UK and Japan", Mitsuru Mizuno and Isaac Tabner investigate real housing price deviation from and reversion to trend in three developed markets. Using quarterly measures of housing price, inflation, disposable income, GDP and rent from 1960 (UK), 1963 (U.S.) and 1977 (Japan) through 2009, they conclude that: More...

March 2, 2010 - Unfooled by Randomness?

Can people reliably distinguish between actual financial markets time series and randomized data? In the February 2010 draft of their paper entitled "Is It Real, or Is It Randomized?: A Financial Turing Test", Jasmina Hasanhodzic, Andrew Lo and Emanuele Viola report the results of a web-based experiment designed to test the ability of people to distinguish between time series of returns for eight commonly traded financial assets (including stock indexes, a bond index, currencies and commodities, all given names of animals) and randomized data. Using a sample of 8015 guesses from 78 participants over eight contests conducted during 2009, they conclude that: More...

March 1, 2010 - The Performance of Individual Chinese Investors

Does the experience of individual investors in China confirm that trading tends to transfer wealth from individuals to institutions? Are there groups of individual investors who excel? In their February 2010 draft paper entitled "Do All Individual Investors Lose by Trading?", Wei Chen, Zhuwei Li and Yongdong Shi examine the trading performance of three categories of individual investors segmented by account size and several categories of institutional investors. Using the complete transaction history and account information of all traders on the Shenzhen Stock Exchange (68.4 million individual and institutional accounts) to construct portfolios that mimic the buys and sells of each investor group over the period 2002-2007, they conclude that: More...

February 26, 2010 - Combining E/P and B/P

Are stock earnings yield (E/P) and firm book-to-price ratio (B/P) complementary indicators of future stock returns? In their December 2009 paper entitled "Returns to Buying Earnings and Book Value: Accounting for Growth and Risk", Francesco Reggiani and Stephen Penman investigate the interplay of E/P and B/P in an accounting context, including joint implications for future stock returns. The authors hypothesize that B/P measures the degree to which firms defer recognition of risky earnings. Using monthly stock return and firm financial data for a broad sample of U.S. stocks spanning 1963-2006 (153,858 firm-years over 44 years), they find that: More...

February 25, 2010 - Why the Experts Don't Rule the World?

Why does the public resist the wisdom of scientific consensus on "questions only they [scientists] are equipped to answer?" In their February 2010 article entitled "Cultural Cognition of Scientific Consensus", Dan Kahan, Hank Jenkins-Smith and Donald Braman examine the tendency of individuals to perceive risk with biases congenial to their visions of how society should be organized. The authors focus on the examples of climate change, disposal of nuclear waste and the effect of permitting concealed possession of handguns. They measure individual cultural predisposition along two dimensions: hierarchy versus egalitarianism, and individualism versus communitarianism. Using results of an online survey of 1,500 U.S. adults during July 2009, they conclude that: More...

February 24, 2010 - Deconstructing Effects of Corporate News

What types of corporate news have the most impact on stock price? In their February 2010 paper entitled "Market Reaction to Corporate News and the Influence of the Financial Crisis", Andreas Neuhierl, Anna Scherbina and Bernd Schlusche analyze immediate stock return, volatility and liquidity reactions to various types of corporate news (focusing on one day before to five days after release date). They segment news releases into nine major categories and 52 subcategories. Using a comprehensive sample of 285,917 corporate press releases carried by all major news wire services between April 2006 and August 2009, they find that: More...

February 23, 2010 - Refined Short-term Reversal Strategies

Does short-term (one-month) stock return reversal persist? If so, is there a best way to refine and exploit it? In the February 2010 version of their paper entitled "Decomposing the Short-term Return Reversal", Zhi Da, Qianqiu Liu and Ernst Schaumburg investigate total market and intra-industry short-term price reversals and segment the intra-industry component according to expected return, cash flow news reaction and discount rate news reaction. Using monthly data for a broad sample of relatively large and liquid stocks accounting for about 75% of U.S. equity market capitalization over the period January 1982 through March 2008, they conclude that: More...

February 22, 2010 - The Return on Stamps

Do stamps provide a good return compared to equities? Can investors use stamps to hedge against inflation? In the February 2010 version of their paper entitled "Ex Post: The Investment Performance of Collectible Stamps", Elroy Dimson and Christophe Spaenjers investigate the returns on British collectible postage stamps over the long term. Using Stanley Gibbons stamp catalog prices to construct a value-weighted British stamp price index/returns and returns for other asset classes over the period 1900-2008, they conclude that: More...

February 12, 2010 - Individual Risk Tolerance Under the Hood

How can an advisor accurately gauge and effectively respond to the risk tolerance(s) of an advisee? In their January 2010 paper entitled "Beyond Risk Tolerance: Regret, Overconfidence, and Other Investor Propensities", Carrie Pan and Meir Statman: (1) argue that the typical questionnaire used to assess advisee risk tolerance is deficient for five reasons; and, (2) offer remedies for these deficiencies. Using historical asset class return data and results of multiple investor surveys, they conclude that: More...

February 10, 2010 - Long-term Trends and Short-term Variations in Valuation Ratios

Does decomposition of widely used valuation ratios into components that reflect long-term trend and shorter-term variation from trend reveal predictability? In their November 2009 paper entitled "Do Decomposed Financial Ratios Predict Stock Returns and Fundamentals Better?", Xiaoquan Jiang and Bong-Soo Lee explore decomposition of the dividend-price, earnings-price and book-to-market ratios into stochastic trend and cyclical components. The stochastic trend component measures variations in longer-term trend (fundamental structural changes), while the cyclical component measures shorter-term deviations from this trend. The study employs rolling four-quarter sums of dividends and earnings, with the latter smoothed via a ten-year moving average, and accounting data to model older book values. Using quarterly S&P 500 Index returns and valuation metrics for the S&P 500 over the period 1926-2008, they find that: More...

February 9, 2010 - ETF Pair Trading Based on Relative Returns/Volatilities (Updated 3/6/10 based on a revision to the paper)

Does pairs trading work for exchange-traded funds (ETF)? In their February 2010 paper entitled "Pairwise Asset Rotation Trading and Market Timing: An Anatomy to a New Trading Strategy", Panagiotis Schizas and Dimitrios Thomakos present a market timing strategy based on transforming the predictability of relative returns/volatilities between pairs of ETFs into weekly trading signals via simple rules. They choose S&P Depository Receipts (SPY), the Financial Sector Select SPDR (XLF), PowerShares QQQ (QQQQ) and Oil Services HOLDRs (OIH) to investigate three pairs: SPY-XLF, SPY-QQQQ and SPY-OIH. For robustness, they consider weeks ending on Monday, Wednesday and Friday (for a total of nine pair-endpoint combinations). They devise five trading models based on relative pair returns, relative pair (realized) volatilities and more complex characterizations of relative pair performance. Relative return/volatility predictions derive from a rolling historical window of 104 weeks. Using daily open-high-low-close prices for SPY, XLF, QQQQ and OIH to construct weekly metrics from earliest availability through April 4, 2008, they conclude that: More...

February 4, 2010 - Important News Releases for Short Sellers

How do short sellers gain an informational advantage over other traders? On what news do they focus? Do they anticipate or react to news? In their January 2010 paper entitled "How are Shorts Informed? Short Sellers, News, and Information Processing", Joseph Engelberg, Adam Reed and Matthew Ringgenberg combine detailed data on short selling with data on news releases to investigate how short sellers use news. Using detailed information on short sales (daily short volume divided by total volume) for a broad sample of stocks and relevant news releases spanning January 3, 2005 through July 6, 2007, they conclude that: More...

February 2, 2010 - Variation in Long-run Stock Market Predictability

Is there a steady, zero or varying supply of stock market return predictability? In their January 2010 paper entitled "Stock Return Predictability and the Adaptive Markets Hypothesis: Evidence from Century Long U.S. Data", Jae Kim, Kian-Ping Lim and Abul Shamsuddin employ a battery of tests to evaluate the evolution of U.S. stock market return predictability over the last century and determine whether this evolution is consistent with the Adaptive Markets Hypothesis. Using monthly Dow Jones Industrial Average (DJIA) return data, along with various indicators of market conditions and economic fundamentals, for 1900 through 2009, they conclude that: More...

February 1, 2010 - A Market Volatility Factor Model

How much of the variation in stock returns flows from actual (realized or backward-looking) and implied (forward-looking) market volatilities? In the January 2010 version of his paper entitled "Option Implied Volatility Factors and the Cross-Section of Market Risk Premia", Junye Li investigates the effectiveness of a three-factor model of stock returns based on market return (beta), diffusion volatility (moderate and persistent component) and jump volatility (large and mean-reverting component). The author also examines how the value premium and size effect relate to the two volatility factors and how relying only on realized market volatility affects results. Using weekly (Wednesday) data for the S&P 500 Index, S&P 500 Index options (filtering out options with extremely long/short durations, extreme moneyness and low activity) and the S&P 500 Volatility Index (VIX) spanning January 1997 through September 2008 (608 weeks), he concludes that: More...

January 29, 2010 - The Return on Art

Do works of art provide a good return compared to equities, or do they carry an aesthetic discount? Can investors use art to hedge equities? In their July 2009 paper entitled "Art as an Investment: the Top 500 Artists", Roman Kraeussl and Jonathan Lee employ public auction prices from Artnet.com to construct and analyze a Top 500 Art Market index based on historical prices of artworks by the top 500 artists in the world (as ranked by Artprice.com). They relate art returns to those for commodities, corporate bonds, 10-year U.S. Treasury notes, hedge funds, private equity, real estate, global stocks and U.S. Treasury bills. Using prices for nearly 100,000 art transactions and contemporaneous quarterly levels of indexes for other asset classes over the period January 1985 through March 2009 (as available), they conclude that: More...

January 28, 2010 - Earnings Surprises and Future Stock Market Returns

As espoused by many market commentators, do positive (negative) earnings surprises in fact predict upward (downward) stock market movement? In their January 2010 paper entitled "Aggregate Market Reaction to Earnings Announcements", William Cready and Umit Gurun investigate the relationship between earnings announcement surprises and market returns, focusing on the days surrounding earnings news. Using quarterly earnings announcements for a broad sample of firms spanning January 3, 1973 through June 21, 2006 (413,687 announcements) and contemporaneous values of a combined NYSE/AMEX index, they find that: More...

January 27, 2010 - Unadmired Stocks Beat Admired Ones?

Are the most admired companies the best investments? Or, is current state of admiration a contrarian indicator for future returns? In their January 2010 paper entitled "Stocks of Admired Companies and Spurned Ones", Deniz Anginer and Meir Statman use Fortune magazine's yearly survey-based lists of "America's Most Admired Companies" to answer these questions by measuring the returns (April 1 through March 31) of two portfolios reformed annually: admired companies (upper half of survey scores), and unadmired companies (lower half of survey scores). Survey respondents are senior executives, directors and securities analysts, and the questions asked seemingly relate indirectly or directly to the investment value of the companies named. Using these lists for April 1983 (survey inception) through March 2007 and associated stock return data, they conclude that: More...

January 22, 2010 - Performance of Buy-Write Strategies for Australian Stocks

Do buy-write strategies, wherein investors buy stocks and simultaneously sell matched out-of-money call options, generally outperform their underlying stocks? In other words, do option premiums more than compensate for any sacrifice of capital gains? In their January 2010 paper entitled "The Efficiency of the Buy-Write Strategy: Evidence from Australia", Tafadzwa Mugwagwa, Vikash Ramiah and Tony Naughton examine the performances of buy-write strategies on the Australian Stock Exchange for portfolios formed monthly, quarterly and yearly at different levels of call option out-of-the-moneyness. They test the profitability of buy-write strategies during weak and strong markets. They measure the effects on buy-write returns of underlying stock liquidity (turnover ratio), dividend yield, firm size, book-to-market ratio, earnings per share and price-earnings ratio. Using prices, firm fundamentals and out-of-the-money call option prices (actual and modeled) for 179 stocks over the period January 1995 through October 2006, they conclude that: More...

January 21, 2010 - Stock Returns and Changes in Implied Volatility

Are there reliable and exploitable predictive relationships between stock returns and changes in implied volatility? In the January 2010 version of their paper entitled "The Joint Cross Section of Stocks and Options", Andrew Ang, Turan Bali and Nusret Cakici investigate the relationship between changes in implied volatility and stock returns for individual stocks. Using monthly implied volatilities and associated stock prices and firm fundamentals for a broad sample of U.S. stocks over the period January 1996 through September 2008 (153 months), they conclude that: More...

January 20, 2010 - Success Factors for Futures Traders

Does the profitability of futures traders depend on risk-taking, private information or luck? In the January 2010 revision of their paper entitled "Determinants of Trading Profits of Individual Traders: Risk Premia or Information", Michaël Dewally, Louis Ederington and Chitru Fernando investigate success factors for traders in the crude oil, gasoline and heating oil futures markets. They exploit detailed daily open interest data for specific large and mid-size traders (from the Commodity Futures Trading Commission, as augmented by the Department of Energy) accounting for about 70% to 80% of these three futures markets. This detailed data enables analytical segmentation of traders into eleven types, consolidated into four categories: (1) hedgers, (2) speculators, (3) market makers and (4) others. Using detailed data for a final sample of 382 traders over the period June 1993 through March 1997 (46 months), they conclude that: More...

January 15, 2010 - Quantitative Versus Qualitative Hedge Funds

Do quants outperform quals? In his January 2010 preliminary draft paper entitled "A Comparison of Quantitative and Qualitative Hedge Funds", Ludwig Chincarini compares the performance characteristics of quantitative and qualitative hedge funds. Using return data and strategy descriptions spanning a total of 6,352 hedge funds over the period January 1970 through June 2009 and risk factor adjustment data for a January 1994 through March 2009 subperiod, he concludes that: More...

January 11, 2010 - Update: Using Commitments of Traders Reports to Time Asset Allocations

Is the aggregate sentiment of futures traders predictive for asset returns? In the June 2008 update of their 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 timing of U.S. equities and commodities markets. These reports aggregate 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 reporting threshold. The study seeks to exploit "hedging pressure" (the fraction of positions that are long) for each of six liquid commodities (crude oil, gold, silver, copper, soybeans and sugar) and for the S&P 500 Index. Each Friday, the six trading strategies studied: (1) take a long position in a commodity if hedging pressure for both the commodity and the S&P 500 Index are below their 52-week averages; or, (2) take a long position in the S&P 500 Index if hedging pressure for both the commodity and the S&P 500 Index are above their 52-week averages; or, (3) hold 3-month U.S. Treasury bills. Using COT reports and associated weekly futures prices for October 1992 through December 2006, they conclude that: More...

January 4, 2010 - Analyzing the Economic Value of Predictive Variable Trading Strategies

Do the methods and assumptions used in studies of the power of variables to predict differences in future returns across stocks accurately represent implementable trading strategies? In his December 2009 paper entitled "Economic and Statistical Properties of Implementable Trading Strategies", Andrew Christie assesses the realism of widely used portfolio-level tests for anomalous cross-sectional stock returns. Using analysis and (as an example) the results from some past portfolio studies on the predictive power of standardized unexpected earnings, he concludes that: More...

December 29, 2009 - Is Voluntarily Reported Performance Data Misleading?

Are hedge fund industry performance metrics, which are based on voluntarily reported data, materially unrepresentative? In their November 2009 draft paper entitled "Out of the Dark: Hedge Fund Reporting Biases and Commercial Databases", Adam Aiken, Christopher Clifford and Jesse Ellis compare directly the performances of funds that choose to report and funds that do not. They calculate return data for non-reporting funds by examining the holdings described in SEC filings of 117 publicly listed (registered) funds of hedge funds. Using quarterly return data for reporting and non-reporting hedge funds spanning 2000-2008, they conclude that: More...

December 17, 2009 - Do TIPS Work?

Are Treasury Inflation Protected Securities (TIPS), for which the Treasury adjusts the principal based on the Consumer Price Index for all urban consumers (CPI-U), effective as an inflation hedge? In their September 2009 paper entitled "A TIPS Scorecard: Are TIPS Accomplishing What They Were Supposed to Accomplish? Can They Be Improved?", Michelle Barnes, Zvi Bodie, Robert Triest and Christina Wang evaluate the progress of the TIPS market toward providing: (1) consumers with a hedge against real interest rate risk; (2) holders of nominal bonds with a hedge against inflation risk; and, (3) everyone with a reliable indicator of expected inflation. Using inflation rate and bond yield data available since the introduction of TIPS in September 1997, they conclude that: More...

December 15, 2009 - Update: Gold as Hedge and Safe Haven

Is gold a prototypical hedge (based on average uncorrelated or negatively correlated behavior) and safe haven (based on uncorrelated or negatively correlated behavior during a market crash)? Two recent papers address this question. In the February 2009 update of their paper entitled "Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold", Dirk Baur and Brian Lucey examine the hedging/haven behavior of gold for stocks and bonds during normal market conditions and during extreme market events. In their September 2009 paper entitled "Is Gold a Safe Haven? International Evidence", Dirk Baur and Thomas McDermott investigate whether gold represents a safe haven with respect to stocks of major emerging and developing countries. These studies conclude that: More...

December 8, 2009 - Volatility and Valuation Ratios

Conventional wisdom holds that a low market valuation ratio and a high market volatility both relate positively to future market return. Do valuation ratio and volatility therefore relate negatively to each other with some consistency? If not, why not? In their November 2009 paper entitled "What Ties Return Volatilities to Price Valuations and Fundamentals?", Alexander David and Pietro Veronesi investigate the relationships between stock and bond valuations and their volatilities in the context of varying investor beliefs about future economic growth and inflation. Using S&P 500 operating earnings from Standard & Poor's, daily closes of the S&P 500 Index, daily bond yield/return data and monthly values of the Consumer Price Index over the period 1958 through 2008 (51 years), they conclude that: More...

December 7, 2009 - Hedging Against Inflation

How can long-term investors best hedge against inflation's erosion of purchasing power? In their April 2009 paper entitled "Inflation Hedging for Long-Term Investors", Alexander Attié and Shaun Roache assess the inflation hedging properties of traditional asset classes over different investment horizons. Using total return indexes for several asset classes from initial data availability (January 1927 at the earliest) through November 2008, they conclude that: More...

December 2, 2009 - Better to Meet or Beat Analyst Earnings Forecasts?

Should investors look for consistent predictability, or upside surprises, in quarterly earnings announcements? In his November 2009 paper entitled "Meeting Analyst Forecasts and Stock Returns", Ioan Mirciov investigates relationships between announced earnings (relative to analyst forecasts) and long-run future stock performance. Using earnings forecasts, actual earnings, stock returns and firm characteristics data for a broad sample of U.S. stocks over the period 1993-2007, he concludes that: More...

November 27, 2009 - Varying Leverage for Optimal Long-Term Performance

Is there a way to optimize dynamically the degree of leverage for an investment? In his November 2009 paper entitled "On the Performance of Leveraged and Optimally Leveraged Investment Funds", Guido Giese derives a general model for leveraged multi-asset investment strategies with daily re-balancing applicable to leveraged long and short Exchange-Traded Funds (ETF) and leveraged carry trades. Using daily data for the Dow Jones EURO STOXX 50 Index, the Dow Jones EURO STOXX 50 Volatility Index (VSTOXX) and the Euro OverNight Index Average (EONIA) rate from end of 1991 through May 2009, he concludes that: More...

November 25, 2009 - Parsing Impacts of SEOs on Future Stock Returns

Can investors tell which secondary equity offerings (SEO) are most likely to indicate future stock underperformance? In their November 2009 paper entitled "Managers' Private Information, Investor Underreaction and Long-Run SEO Underperformance", Pawel Bilinski and Norman Strong investigate whether the level of surprise in an SEO announcement (indicating the magnitude of management's private information) systematically relates to future returns for the stock. They define and measure this level of surprise based on market and firm accounting variables available before the SEO announcement and related to: firm overvaluation and firm value uncertainty; costs of issuing stock; options for firm growth; firm leverage and financial constraints; and, stock liquidity. Using firm accounting, characteristic and stock price data associated with 4,422 SEOs and matched non-issuing firms over the period January 1970 through December 2007 (with the last SEO in December 2004 to allow a three-year holding period), they conclude that: More...

November 24, 2009 - Abnormal Returns after Extreme Quarterly Earnings

Do investors efficiently process the information in extreme quarterly earnings? In their November 2009 paper entitled "Post Loss/Profit Announcement Drift", Karthik Balakrishnan, Eli Bartov and Lucile Faurel examine whether investors fully price the implications of current quarterly losses/profits for future losses/profits. They consider three alternative definitions for profit/loss, all scaled by beginning-of-quarter total assets: (1) earnings before extraordinary items and discontinued operations; (2) earnings before extraordinary items, discontinued operations and special items; and, (3) net income. Using stock return, financial and risk adjustment data for a broad sample of 15,143 distinct firms (458,693 firm-quarters) over the period 1976-2005 (120 quarters), they conclude that: More...

November 23, 2009 - Quantifying the Penalty of Hedge Fund Withdrawal Restrictions

Should hedge fund investors worry about withdrawal restrictions (lockup period, redemption notice period and redemption frequency constraint)? In the November 2009 update of their paper entitled "Being Locked Up Hurts", Frans de Roon, Jinqiang Guo, and Jenke ter Horst apply Modern Portfolio Theory to model optimal asset allocations for an investor choosing among the risk-free asset (1-month Treasury bill), stocks (value-weighted NYSE equity index), bonds (Fama Bond Portfolio) and a fund of hedge funds (HFRI Fund of Funds composite index) with and without a withdrawal restriction (lockup) period. The essential assumption is that the portfolio efficiency goal requires rebalancing at an interval shorter than the lockup period (in the study, one month versus three months). Using data spanning January 1990 through December 2007 (18 years), limited by hedge fund data availability, they conclude that: More...

November 20, 2009 - Fly-off of Eight GARP, Value and Size Strategies

Is the value premium readily accessible for individual investors? Which value strategy works best? In his May 2009 article entitled "Can Individual Investors Capture The Value Premium?", Patrick Larkin uses a ranking methodology to compare the performances of Joel Greenblatt's magic formula and seven other one and two-factor growth at a reasonable price (GARP) and value strategies. The portfolios for the eight strategies derive from rankings on: (1) the magic formula, a combination of return on capital (ROC) and the ratio of earnings before interest and taxes to Enterprise Value ((EBIT/EV); (2) a combination of return on assets (ROA) and earnings yield (E/P); (3) a combination of return on equity (ROE) and E/P; (4) EBIT/EV alone; (5) E/P alone; (6) a combination of book-to-market ratio (B/M) and market capitalization (Size); (7) B/M alone; and, (8) Size alone. Each month, the author forms equally weighted portfolios of the 30 highest-ranking stocks for each of these eight strategies. Using monthly stock return and GARP-value metric data for a broad sample of firms with market capitalizations over $50 million during December 1998-2006 (97 months), he finds that: More...

November 19, 2009 - Passive and Active Collar Strategies for ETFs and Mutual Funds (Updated to append reader comments)

An investor can collar (bound) a long position in an asset by simultaneously purchasing a put option at one strike price (lower bound) and selling a call option at a higher strike price (upper bound) on the asset. How does this strategy perform? In the September 2009 version of their paper entitled "Loosening Your Collar: Alternative Implementations of QQQ Collars", Edward Szado and Thomas Schneeweis evaluate the performances of passive and active collar strategies for the PowerShares QQQ (QQQQ) Exchange-Traded Fund (ETF) and for a small cap equity mutual fund. While a standard collar employs put and call options with the same expiration date, the study also considers puts with longer durations. The passive collar strategy follows a fixed set of rules regardless of market conditions. The active strategy varies collar specifications according to three market/economic conditions: (1) momentum of the underlying; (2) broad market volatility; and, (3) a macroeconomic measure combining unemployment and the business cycle. Using data covering the period from the introduction of QQQQ options on March 19, 1999 through May 31, 2009 (122 months), they conclude that: More...

November 13, 2009 - Art and Stocks

How do prices for art relate to prices for equities? Does art underperform or outperform stocks over the long run? In their November 2009 paper entitled "Art and Money", William Goetzmann, Luc Renneboog and Christophe Spaenjers investigate relationships between equity prices and art prices and between incomes and art prices. To enable their analysis, they construct an art price index spanning 1765-2007. Since art price data draws heavily on sales in Great Britain, they focus on the British equity market and incomes. Using their art price index, a British equity market index and GDP data for 1830-2007 and British income data for 1908-2007, they conclude that: More...

November 12, 2009 - Extracting the Irrational Part of VIX (Updated to append comments)

Does the Chicago Board Options Exchange Volatility Index (VIX) have separable components of rational and irrational risk? If so, is the irrational risk component of use to investors? In their October 2009 paper entitled "Risk Sentiment Index (RSI) and Market Anomalies", Guy Kaplanski and Haim Levy introduce the Risk Sentiment Index (RSI) as a measure of the residual risk contained in VIX after accounting for the statistical and economic variables most predictive of future stock market volatility (such as previous month actual volatility and VIX). They also analyze factors which affect RSI and its relationships with day-of-the-week and month-of-the-year stock market anomalies. Using daily closes for VIX and the S&P 500 Index during 1990-2007 (4,538 days) and for the Volatility Index Japan (VXJ) and the Nikkei 225 Index during 1995-2007 (3,200 days), they conclude that: More...

November 10, 2009 - Traditional Beta and Capitalization Weighting Under Attack

Are there alternatives to traditional beta and capitalization weighting strategies for asset allocation that improve investing outcomes? In the October 2009 version of their paper entitled "Beyond Cap-Weight: The Empirical Evidence for a Diversified Beta", Rob Arnott, Vitali Kalesnik, Paul Moghtader and Craig Scholl explore diversification of beta risk by comparing the merits of four basic major strategies for portfolio weighting from a global perspective: Cap Weight; Equal Weight; Minimum Variance weighting; and, Economic Scale weighting. They also examine two combination strategies: Efficient Beta, an equal weighting of Cap Weight, Economic Scale and Minimum Variance; and, an equal weighting of all four basic strategies. Using dollarized returns and other data necessary for construction of indexes comprised of the 1,000 largest (by market capitalization) companies across 23 developed countries over the period January 1993 through June 2009, they conclude that: More...

November 2, 2009 - Haugen's Closed Case

What fundamental and technical factors are optimum for stock selection, and how well do they work? In the October 2008 draft of their paper entitled "Case Closed", flagged by a reader, Robert Haugen and Nardin Baker present a model of future stock returns based on multiple regressions of 12 factors they find most significant in predicting monthly returns. Using monthly data for a sample of U.S. stocks over the 45-year period 1963-2007, they conclude that: More...

October 26, 2009 - Update: The "Best" Equity Risk Premium

What are the different ways of estimating the equity risk premium, and which one is the best? In the October 2009 update of his paper entitled "Equity Risk Premiums (ERP): Determinants, Estimation and Implications - A Post-crisis Update", Aswath Damodaran offers a comprehensive overview of equity risk premium estimation and application. Using data from multiple countries (but focusing on the U.S.) over long periods, he concludes that: More...

October 22, 2009 - Clarifications of The Black Swan

Is The Black Swan: The Impact of the Highly Improbable gimmicky or profound? In his October 2009 paper entitled "Common Errors in Interpreting the Ideas of The Black Swan and Associated Papers", Nassim Taleb seeks to clarify the import of this book and related publications, with some key points as follows: More...

October 15, 2009 - Combining Value and Earnings Surprise

Do earnings surprises work differently for value and growth stocks? If so, can investors exploit the difference? In the September 2009 draft of their paper entitled "When Two Anomalies meet: Post-Earnings Announcement Drift and Value-Glamour Anomaly", Zhipeng Yan and Yan Zhao investigate the combined effects of the value premium and the post-earnings announcement drift anomaly. They first sort stocks into quintiles according to some measure of value (book-to-market ratio, earnings-to-price ratio, cash-flow-to-price ratio or three-year average sales growth) and then allocate firms within these quintiles to six categories according to sign of the most recent quarterly earnings surprise (+/-/0) and the direction of the most recent earnings announcement abnormal return (+/-). Using stock price, earnings estimate and accounting data for a broad sample of firms over the period June 1984 through December 2008, they find that: More...

October 14, 2009 - The Timing Ability of Bond Mutual Fund Managers

Do managers of bond mutual funds generate value for fund holders by successfully timing the market? In the September 2009 update of their paper entitled "Measuring the Timing Ability and Performance of Bond Mutual Funds", Yong Chen, Wayne Ferson and Helen Peters evaluate the ability of U.S. bond fund managers to time nine common factors related to bond returns. The nine factors reflect the term structure of interest rates, credit and liquidity spreads, currency exchange rates, mortgage spread and equity market returns. The authors also define seven benchmarks matching different bond fund styles. Using monthly returns for more than 1,400 U.S. bond mutual funds and contemporaneous bond market factor and benchmark data during January 1962 through March 2007, they conclude that: More...

October 13, 2009 - Abnormal Returns After Switches to/from Daylight Saving Time?

Do sleep disruptions from switches between standard time and daylight saving time reliably affect the return on the next trading day? In their September 2009 paper entitled "The Daylight Saving Time Anomaly in Stock Returns: Fact or Fiction?", Russell Gregory-Allen, Ben Jacobsen and Wessel Marquering revisit this question based on a much larger sample than used in prior studies. Using daily returns of stock market indexes around switches to/from daylight saving time for 22 countries around the world spanning 1966-2005 (1,150 switches, tilted toward later decades), they conclude that: More...

October 9, 2009 - Allocating Assets for Retirement

What is the best way to deploy assets for retirement? In his September 2009 paper entitled "Life is Non-linear: Structuring Retirement Portfolios for the Long Haul", Joachim Klement analyzes six common retirement portfolio strategies in terms of their longevity and income generation over a retiree's expected lifetime. The study emphasizes that income requirements vary during retirement, first declining with age and then accelerating near the end of life. The study applies Monte Carlo simulation based on the following assumptions: annual rebalancing of assets to strategic portfolio weights; total annual fees of 1% of portfolio value; inflation rate of 3%; 15% tax rate on portfolio cash flow; normal distributions of annual returns with means (standard deviations) of 9.4% (15%) for stocks and 5.3% (5.4%) for bonds; and, correlation between stock and bond returns of 0.20. Using this model, he concludes that: More...

October 8, 2009 - A Better Way to Define Value?

Is the book-to-market ratio (B/M) the most efficient way to identify value stocks? In their October 2009 paper entitled "The Enterprise Multiple Factor and the Value Premium", Tim Loughran and Jay Wellman investigate the Enterprise Multiple (EM), calculated as (equity value + debt value + preferred stock – cash)/ EBITDA, as a replacement for B/M in defining value. Using common stock prices and accounting data for a broad sample of non-financial firms (with outliers suppressed) over the period 1963 through 2008, they conclude that: More...

September 29, 2009 - Outperformance Based on Three Macroeconomic Indicators

Can the right macroeconomic indicators help investors beat the market? In their August 2009 paper entitled "Predictive Signals and Asset Allocation", Hui Ou-Yang, Zhen Wei and Haochuan Zhang identify three predictive indicators for returns on the S&P 500 Index (SPX) and 2-year U.S. Treasury notes (T-note) and derive signals from these indicators to specify an outperforming dynamic allocation to SPX futures and T-note futures. The three indicators are: (1) the credit standard from the quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices; (2) the percentage change in the daily Baltic Dry Index (BDI); and, (3) the change in the 2-year constant maturity swap (CMS) rate. They generate weights for the two futures (up to 200% each) at the end of each month from rolling 36-month regressions of indicators and past monthly asset returns. Using data for July 1990 through June 1993 to determine initial weights and data for July 1993 through June 2009 for testing (a total of 228 months), they conclude that: More...

September 24, 2009 - Upside Down Beta Distributions for Value and Momentum?

Typically, value means unexciting low-beta stocks, and momentum means exciting high-beta stocks. Does "typically" mean always? In their September 2009 paper entitled "The Changing Beta of Value and Momentum Stocks", Andrea Au and Robert Shapiro investigate the relationships between beta and value and between beta and momentum under varying stock market conditions. Using monthly beta distributions for value (based on book-to-market ratio) and momentum (based on prior 12-month return) sorts of the Russell 3000 stocks over the period December 1978 through March 2009, they conclude that: More...

September 21, 2009 - Update: Equity Risk Premium Book Learning

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 September 2009 paper entitled "The Equity Premium in 150 Textbooks", Pablo Fernandez reviews definitions and values of the equity risk premium offered in 150 finance and valuation textbooks published from 1979 to 2009. Based on this review, he finds that: More...

September 17, 2009 - Abnormal Returns from Providing Liquidity After Hours?

Can traders reliably turn a profit by providing liquidity to anxious after-hours counterparts and then closing the trade at the open? In his September 2009 paper entitled "The Cost of Illiquidity: Evidence from After-Hours Trading", Brian Walkup quantifies price reversal/momentum when the market opens for stocks experiencing price movements during preceding after-hours trading. Using a large sample of after-hours trades from the three major U.S. stock exchanges during 2006, he concludes that: More...

September 4, 2009 - The Genetics of Investing (Not the Algorithms)

Two recent papers investigate the genetics of individual investing. The September 2009 paper "Nature or Nurture: What Determines Investor Behavior?" by Amir Barnea, Henrik Cronqvist and Stephan Siegel examines the degree to which genetic makeup influences individual investing behavior. The July 2009 paper "IQ and Stock Market Participation" by Mark Grinblatt, Matti Keloharju and Juhani Linnainmaa explores the relationship between intelligence and individual investing. These studies conclude that: More...

September 2, 2009 - Employment Growth and Stock Returns

Is there a reliable relationship between U.S. employment and the U.S. stock market? In their August 2009 paper entitled "The Stock Market and Aggregate Employment", Long Chen and Lu Zhang study the interactions between the stock market and the labor market. Using quarterly returns for the S&P 500 Index and quarterly data for employment and other economic indicators over the period 1952-2007, they find that: More...

September 1, 2009 - Mutual Fund Momentum Measure Fly-off

Which measure of mutual fund momentum best predicts future fund returns? In his August 2009 paper entitled "The 52-Week High, Momentum, and Predicting Mutual Fund Returns", Travis Sapp examines the intermediate-term future performance of mutual funds ranked by: (1) nearness to the one-year high of the fund share net asset value; (2) prior six-month fund return; and, (3) fund sensitivity to stock return momentum. Using mutual fund returns for a broad sample of U.S. common stock funds and risk-adjustment data over the period 1970-2004, he concludes that: More...

August 31, 2009 - A Rather Unsatisfying Morass of Variables

Has the last generation of academic research clarified which factors/characteristics/indicators predict which stocks will outperform and which stocks will not? How can academia do better? In his August 2009 paper entitled "The Cross-Section of Expected Stock Returns: What Have We Learnt from the Past Twenty-Five Years of Research?", Avanidhar Subrahmanyam reviews recent research on cross-sectional predictors of stock returns at monthly or longer horizons and offers observations on how to improve this research. Citing a large number of relevant studies, he concludes that: More...

August 27, 2009 - Interplay of Beta with Momentum and Contrarian Investing

Does momentum trading (and its contrarian counterpart) work better for certain kinds of stocks? In their August 2009 paper entitled "Systematic Risk and the Performance of Mutual Funds Pursuing Momentum and Contrarian Trades", Grant Cullen, Dominic Gasbarro, Gary Monroe and Kenton Zumwalt examine mutual fund trading activity and performance to measure the prevalence of and results for momentum and contrarian equity investing strategies. Using the quarterly stock holdings of 2,829 U.S. equity mutual funds and associated stock price data for the period 1991-2006, they conclude that: More...

August 19, 2009 - Due Diligence on Hedge Funds

What does due diligence discover about hedge funds? If outperformance attracts due diligence investigations, does this outperformance persist after the investigations? In the June 2009 draft of their paper entitled "Trust and Delegation", Stephen Brown, William Goetzmann, Bing Liang and Christopher Schwarz characterize the findings of formal hedge fund due diligence investigations and measure their timing with respect to fund performance. Using a sample of 444 hedge fund due diligence reports (typically 100-200 pages each) from a major hedge fund due diligence firm spanning 2003-2008, along with associated fund performance data, they conclude that: More...

August 17, 2009 - The Predictive Power of Aggregate Versus Firm-specific Earnings

Do aggregate earnings (for example, for the S&P 500) predict stock market behavior? In their 2008 paper entitled "Aggregate Earnings, Firm-Level Earnings and Expected Stock Returns", Turan Bali, Ozgur Demirtas and Hassan Tehranian analyze the predictability of stock returns using market, industry and firm-level earnings. Using monthly stock return data and quarterly fundamentals data for a broad range of U.S. stocks focused mostly on the period from mid-1972 through 2002, they conclude that: More...

August 11, 2009 - Are Some Covered Calls More Profitable Than Others?

On what kind of stocks can covered call writers obtain the best returns? In their July 2009 paper entitled "Cross-Section of Stock Option Returns and Individual Stock Volatility Risk", Jie Cao and Bing Han investigate how delta-hedged stock option returns vary with volatility risk. They measure this return as the change in value of a self-financing portfolio that is long the call and short the underlying stock, rebalanced daily so that it is not sensitive to stock price movement. They assume trade execution at the mid-point of closing bid and ask quotes. Using returns for about 160,000 at-the-money delta-hedged option positions initially about one and half months from maturity (and held to maturity) for over 5,000 underlying stocks during 1996-2006, they conclude that: More...

August 4, 2009 - Overreaction Persistence: Sources and Consequences

Is overreaction pervasive? Is it resistant to learning, or does experience temper it? Is overconfidence a driver of overreaction? How does overreaction affect portfolio performance? Two related July 2009 papers entitled "Overreaction in Stock Forecasts and Prices" by Alen Nosic and Martin Weber and "Overreaction and Investment Choices: An Experimental Analysis" by Bruno Biais, Alen Nosic and Martin Weber tackle these questions experimentally. Using somewhat informed university students as subjects, they conclude that: More...

July 30, 2009 - The Value of Fundamental Investment Research?

Is it possible to measure the value of fundamental investment research? How does the degree of measurability affect the behaviors of investors and financial markets? In the June 2009 version of his paper entitled "Investment Research: How Much is Enough?", Bradford Cornell speculates on answers to these questions. Citing a range of research on mutual fund research practices and performance, he concludes that: More...

July 22, 2009 - Optimally Exploiting the January Barometer

The January Barometer (as goes January, so goes the rest of the year) seems persistent for U.S. stocks. Is there a best way to exploit it? In their July 2009 paper entitled "What’s the Best Way to Trade Using the January Barometer?", Michael Cooper, John McConnell and Alexei Ovtchinnikov update their prior analysis of the January Barometer through 2008 and explore how an investor can best exploit its signal. Specifically, they consider five alternative strategies (all ignoring trading costs and taxes): (1) long stocks all the time; (2) long stocks in all Januaries and long (short) stocks during February-December when the return for January is positive (negative); (3) long stocks in all Januaries and long stocks (Treasury bills) during February-December when the return for January is positive (negative); (4) long Treasury bills all the time; and, (5) long stocks in all Januarys and long Treasury bills the rest of all years. Using monthly U.S. stock returns and one-month Treasury bill (or equivalent) yields over the period 1857-2008 (152 years), they conclude that: More...

July 8, 2009 - Long-run Stock Market Volatility Based on Reasonable Expectations

The conventional wisdom is that annualized stock market volatility declines with investment horizon because of the moderating effect of mean reversion in returns. In the May 2009 version of their paper entitled "Are Stocks Really Less Volatile in the Long Run?" Lubos Pastor and Robert Stambaugh challenge this view by focusing on the reasonable expectations of investors dealing with uncertainty rather than data in hindsight. Using annual real (inflation-adjusted) returns and return predictors for the period 1802-2007 (206 years), they conclude that: More...

July 7, 2009 - Momentum a Big Mistake?

Is chasing returns a bet on rational analysis or investor overreaction? In the June 2009 version of their paper entitled "Myopic Extrapolation, Price Momentum, and Price Reversal", Long Chen, Claudia Moise and Xinlei Zhao compare expected and actual momentum returns and explore the detailed relationship between momentum/reversal returns and firm fundamentals. Using monthly stock return data and associated fundamentals for a broad sample of firms spanning 1985-2006, they conclude that: More...

July 3, 2009 - An Overview of Confirmation Bias

How real and substantial is confirmation bias as an inhibitor of individual investor and market belief adjustments? What factors affect its impact? In their July 2009 paper entitled "Feeling Validated Versus Being Correct: A Meta-Analysis of Selective Exposure to Information", William Hart, Dolores Albarracin, Alice Eagly, Inge Brechan, Matthew Lindberg and Lisa Merrill survey a broad selection of past research measuring the degree to which people favor information that supports pre-existing attitudes, beliefs and behaviors over information that challenges pre-existing attitudes, beliefs and behaviors. Using results from 67 reports encompassing 91 separate studies of 300 statistically independent groups comprised of nearly 8,000 participants, they conclude that: More...

June 25, 2009 - An Annual Worldwide Optimism Cycle (Sell in May)?

Does the conventional wisdom to "sell in May," with the average stock return during November-April far exceeding that for May-October, work for the world equity market? If so, why? In the November 2005 version of his paper entitled "The Optimism Cycle: Sell in May", flagged by a reader, Ronald Doeswijk examines the hypothesis that this seasonal pattern derives from an annual optimism cycle. Using monthly return data for markets, sectors and Initial Public Offerings (IPO) over the period 1970 through 2003 (34 years), he concludes that: More...

June 12, 2009 - A Better Three-Factor Model?

The widely used Fama-French three-factor model explains stock returns based on aggregate market return, firm size (small versus large) and firm valuation (value versus growth). Since the Fama-French model does not explain the stock price momentum effect, researchers and investors often add momentum as a fourth factor to predict future stock returns. Might some other small set of factors (three) outperform the Fama-French model in explaining stock returns, obviating the need for a momentum factor and accounting for other stock return anomalies as well? In their June 2009 paper entitled "A Better Three-Factor Model That Explains More Anomalies", Long Chen and Lu Zhang argue that a three-factor model based on aggregate market return, level of firm investment relative to assets (low versus high) and return on assets (high versus low) substantially outperforms the Fama-French model in explaining stock returns. Using a wide range of firm and stock data for a broad sample of stocks over the period 1972-2006 to test this model, they conclude that: More...

May 29, 2009 - Modifiers of the Stock Buyback Indicator

Stock buybacks are often, but not always, an indication that stock price is at a relative low. Are there ways to filter out "not always" cases? In their May 2009 paper entitled "Insider Ownership, Institutional Ownership, and the Timing of Open Market Stock Repurchases", Amedeo De Cesari, Susanne Espenlaub, Arif Khurshed and Michael Simkovic test whether open market repurchases occur at relatively low prices and whether a firm’s ability to time repurchases relates to levels of insider and institutional ownership. This study exploits a recent SEC requirement, effective at the end of 2003, that publicly held firms disclose monthly stock buyback volumes and prices in quarterly filings. Using this monthly buyback volume and price data for the period February 2004 through July 2006, they conclude that: More...

May 28, 2009 - Characteristics of Exchange-Traded Notes

An exchange-traded note (ETN) "is a senior, unsecured, unsubordinated debt security issued by an underwriting bank. Similar to other debt securities, ETNs have a maturity date and are backed only by the credit of the issuer... Similar to equities, they are traded on an exchange and can be shorted. Similar to index funds, they are linked to the return of a benchmark index. But as debt securities, ETNs don't actually own anything they are tracking." Should investors consider ETNs as diversifying investments? In their May 2009 paper entitled "Exchange Traded Notes: An Introduction", Dean Diavatopoulos, James Felton and Colbrin Wright: (1) describe what ETNs are and why they might appeal to investors; (2) analyze the daily tracking error between the ETN market prices and the indicative (redemption) value; (3) investigate why tracking error varies; and, (4) test whether ETN tracking error predicts future price changes for assets associated with the ETN. Using data for various ETNs from inception (with the earliest in June 2006) through June 2008, they conclude that: More...

May 27, 2009 - The Unreliability of Beta

Is beta a useful risk management or leveraging tool for investors? Two May 2009 articles, "ß = 1 Does a Better Job than Calculated Betas" by Pablo Fernandez and Vicente Bermejo and "Betas Used by Professors: A Survey with 2,500 Answers" by Pablo Fernandez, address this question by testing the reliability of beta measurements over time, across calculation methods and across data sources. Focusing on betas for the Dow Jones industrial stocks relative to the S&P 500 index, these articles conclude that: More...

May 26, 2009 - A Long Play When Shorts Are Away?

The conventional wisdom is that short sellers are on average more informed than other traders, and high levels of short interest in a stock indicate poor future returns. Is the converse true? Do short sellers stay away from good stocks? In the May 2009 version of their paper entitled "The Good News in Short Interest", Ekkehart Boehmer, Zsuzsa Huszar and Bradford Jordan investigate whether the absence of short selling is informative about future returns. They base their investigation on three lightly (heavily) shorted portfolios that include stocks from the 1st, 5th and 10th (90th, 95th and 99th) percentiles of monthly short interest ratios (SIR), along with three related long-short portfolios. Using monthly short interest, returns and firm characteristics for NYSE, AMEX, and NASDAQ stocks from 1988 to 2005 (930,109 stock-month observations), they conclude that: More...

May 22, 2009 - Purifying Stock Market Sentiment Indicators

It is arguable that sentiment indicators derive substantially from what just happened in the stock market and that they therefore add little or no value to price action itself in predicting future returns. In their May 2009 paper entitled "Purified Sentiment Indicators for the Stock Market", David Aronson and John Wolberg investigate this thesis by removing the influence of recent stock market price dynamics (defined by 18 variations of price velocity, acceleration and volatility) to produce multiple "purified" versions of each of five sentiment indicators: (1) the CBOE Implied Volatility Index (VIX); (2), the CBOE Equity Put-to-Call Ratio (PCR); (3) the American Association of Individual Investors Bulls minus Bears (AAII); (4) the Investors Intelligence Bulls minus and Bears (INV); and, (5) Hulbert’s Stock Newsletter Sentiment Index (HUL). They then measure the power of the purified sentiment indicators to generate profitable trading signals by testing 100 signaling rules for each indicator. Using data for the five sentiment indicators from initial availability (ranging from January 1963 to July 1987) through October 2008, along with contemporaneous daily closes of the S&P 500 index, they conclude that: More...

May 21, 2009 - The Required Yield Theory of Asset Valuation

What aggregate return thresholds are critical to investors in deciding whether to accept or reject equity and bonds for investment portfolios? In their December 2008 paper entitled "A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination", Christophe Faugère and Julian Van Erlach argue that investors first require that U.S. stocks and bonds in aggregate prospectively provide a real after-tax earnings yield directly related to real long-term GDP per capita growth. Investors then decide between stocks and bonds based on the better after-tax real return. Applying this Required Yield Theory (RYT) to quarterly data over the period 1953-2006, they find that: More...

May 20, 2009 - Update: CFOs Project the Equity Risk Premium

How do the corporate experts most responsible for assessing the cost of equity currently feel about future stock returns? In their May 2009 paper entitled "The Equity Risk Premium amid a Global Financial Crisis", John Graham and Campbell Harvey provide an updated report on the views of U.S. Chief Financial Officers (CFOs) on the prospective U.S. equity risk premium relative to the 10-year U.S. Treasury note (T-note) yield, assuming a 10-year investment horizon. Based on 36 quarterly surveys on this topic over the period June 2000 through March 2009, they find that: More...

May 18, 2009 - The Implied-Realized Volatility Gap as Return Predictor

Does the gap between the (sentiment-driven?) options-implied volatility and the (data-driven) expected volatility of the broad equity market predict future stock returns? In the May 2009 version of his paper entitled "Variance Risk Premia, Asset Predictability Puzzles, and Macroeconomic Uncertainty", Hao Zhou examines the predictive power of this gap based on several ways to derive expected volatility from realized volatility. Using monthly values of the Chicago Board of Options Exchange Volatility Index (VIX) to calculate implied volatility and high-frequency intraday S&P 500 index levels to calculate realized volatility over the period 1990-2008, along with contemporaneous data for traditional market predictors, he concludes that: More...

May 15, 2009 - Measuring Money Madness

Do the stock recommendations of guru Jim Cramer on CNBC's Mad Money move the market? Do they beat the market? In their May 2009 paper entitled "Investing in Mad Money: Price and Style Effects", flagged by a reader, Paul Bolster and Emery Trahan examine the market impacts and performances of buy and sell recommendations made by Jim Cramer on Mad Money. Using daily closing prices for a sample of 1,387 clear buy recommendations and 534 clear sell recommendations from YourMoneyWatch.com spanning July 28, 2005 through December 31, 2007, they conclude that: More...

April 30, 2009 - Predicting Crashes for Individual Stocks

Can investors tell when management is unsustainably propping up the stock price of a company? In their June 2008 paper entitled "Identifying Overvalued Equity", Craig Nichols and M. D. Beneish devise and test a method for predicting stock price declines that integrates observable accounting, operating, investing and financing data indicative of management efforts to sustain overvaluation. Specifically, they relate future stock returns to an overvaluation score (O-Score, ranging from zero to five points) calculated by assigning one point each for the following indications: (1) likely earnings overstatement; (2) high sales growth; (3) low operating cash flow to total assets; (4) an acquisition in the last five years; and, (5) unusual amounts of equity issuance in the past two years. Using 27,427 firm-year observations over the period 1993-2004 (with financial services and very small companies excluded), they conclude that: More...

April 29, 2009 - The Best Ideas of Mutual Fund Managers

How many stocks within an equity fund manager's portfolio represent truly "passionate" (high-conviction) picks? Do passionate picks outperform the diversifying "fillers" in the portfolio, and the market in general? In the March 2009 version of their paper entitled "Best Ideas", Randy Cohen, Christopher Polk, and Bernhard Silli attempt to identify which holdings in equity mutual fund portfolios represent the high-conviction "Best Ideas" of the fund managers and then measure the performance those stocks after the conviction becomes apparent. They identify high-conviction holdings via several measures that indicate unusually high commitment (tilt) of funds to specific stocks, with the "Best Idea" in a portfolio being the stock with the highest tilt. Using monthly stock returns and quarterly fund holdings data for U.S. equity mutual funds over the period 1991-2005, they conclude that: More...

April 28, 2009 - Valuation Forecasting Fly-off: Discounted Cash Flow vs. Comparables

Is the discounted cash flow (DCF) method or the comparables method more accurate in forecasting equity valuations? In their April 2009 preliminary paper entitled "Exploring the Accuracy of DCF and Comparables Valuation Methods by Using Ex-Post Market Data as Forecasts ", Friedrich Sommer, Arnt Woehrmann and Andreas Wömpener use both truly historical data and "best" forecasts of basic firm fundamentals (such as earnings) to compare the forecasting power of the DCF and comparables methods. They define "best" forecasts of input data as actual results inserted retroactively (see the chart below). They consider multiple variations of both the DCF and comparables methods. Using fundamentals and stock price data for the period 1998 through 2006 to support truly historical and retroactive valuation calculations as of 12/31/2001 for 89 U.S. public companies via DCF and over 200 U.S. public companies via comparables, they conclude that: More...

April 27, 2009 - The Unintended Characteristics of Leveraged and Inverse ETFs

The intended characteristics of leveraged and inverse exchange-traded funds (ETF) are obvious. Do they have unintended characteristics that may make them unsuitable for some investors? In their April 2009 paper entitled "The Dynamics of Leveraged and Inverse-Exchange Traded Funds", Minder Cheng and Ananth Madhavan investigate the dynamics, market impacts, unusual features and investor suitability of leveraged (2x and 3x long exposure) and inverse (-1x, -2x and -3x short exposure) ETFs. Using daily returns for many leveraged and inverse ETFs, they conclude that: More...

April 24, 2009 - Options Detrimental to Individual Investor Health?

Do individual investors who trade equity options do better or worse than those who do not? In their October 2008 paper entitled "Option Trading and Individual Investor Performance", Rob Bauer, Mathijs Cosemans and Piet Eichholtz examine the impact of option trading on individual investor performance. Using all daily trades and end-of-month portfolio positions for 68,146 individual Dutch investors (41,880 who trade equities only and 26,266 who trade options at least once) over the period January 2000 to March 2006, they conclude that: More...

April 23, 2009 - Actual Index Options Trading Results

What kinds of returns do options traders actually achieve? In their January 2009 paper entitled "Investor Trading Behavior and Performances: Evidence from Taiwan Stock Index Options", Bing Han, Yi-Tsung Lee and Yu-Jane Liu examine trading behavior and net returns for all traders of Taiwan stock index options. Using the complete record of transactions, orders and quotes for Taiwan stock index options during 2002-2005 (involving 238,303 individual investors, 1,076 domestic institutions, 50 foreign institutions and 29 market makers), they conclude that: More...

April 22, 2009 - Collaring a Broad Equity ETF for Stable Returns?

Does a long options collar effectively hedge a broad equity exchange-traded fund (ETF), protecting against the downside while capturing a reasonable upside? In their April 2008 paper entitled "Collaring the Cube: Protection Options for a QQQ ETF Portfolio", Edward Szado and Hossein Kazemi examine the risk-return characteristics of a passive (mechanical, no market timing) long collar strategy on the Powershares QQQ trust ETF (QQQQ), including transaction costs. A collar consists of a put option position to protect an underlying long equity position, combined with covered call options on the same underlying to fund the puts (thereby limiting upside potential). The authors consider 27 different collar combinations by varying moneyness of the puts and calls (5% out-of-the-money, 2% out-of-the-money and at-the-money) and the initial time to maturity of the puts (one, three and six months). Initial time to maturity for calls is always one month. Using daily closing prices for QQQQ and the selected put and call options over the period March 1999 to March 2008 (108 months), they conclude that: More...

April 21, 2009 - The Performance of Leveraged ETFs over Extended Holding Periods

How closely do leveraged exchange-traded funds (ETF) track their nominal, short-term design leverages over extended holding periods? In their February 2009 paper entitled "Long Term Performance of Leveraged ETFs", Lei Lu, Jun Wang and Ge Zhang measure the realized leverages for several Ultra (2x) and UltraShort (-2x) ETFs from the ProShares family. Using daily returns for Diamond Trust Series 1 (DIA), S&P Depository Receipts (SPY), PowerShares QQQ (QQQQ) and iShares Russell 2000 Index (IWM), and for their corresponding 2x and -2x ProShares leveraged ETF pairs, from inception of the leveraged funds through December 15, 2008, they conclude that: More...

April 16, 2009 - Correlation Variability as Driver of the Volatility Risk Premium

Correlations among asset returns vary over time, introducing risk to the benefits of diversification. Intervals of extraordinarily high correlation amplify marketwide volatility and are disruptive to asset allocation policies. Does the risk of such correlation shocks explain the volatility risk premium associated with marketwide (equity index) options? In the July 2008 version of their paper entitled "The Price of Correlation Risk: Evidence from Equity Options", Joost Driessen, Pascal Maenhout and Grigory Vilkov examine how correlation shocks affect the returns of options for a broad stock index and of options for its individual component stocks. Using daily returns for the S&P 100 index, its components and associated options over the period 1996-2003, they conclude that: More...

April 14, 2009 - The Why of the Volatility Risk Premium

Why does the volatility of the stock market as implied by the prices of equity index options generally exceed actual (realized) volatility, thereby indicating large returns for sellers of index options? Is the reward of selling such options commensurate with the risk? In the June 2008 version of his paper entitled "The Volatility Premium", Bjorn Eraker models the volatility risk premium based on the long-run effects of small (normal diffusion) and large (non-normal jumps) shocks to volatility. Using daily returns for the S&P 500 index and daily levels of the CBOE Volatility Index (VIX) over the period 1990-2007, he concludes that: More...

April 13, 2009 - The Effect of Stock Market Momentum on Index Options Prices

Do stock index option prices incorporate stock market price momentum, an expectation of continuation of a recent market trend? In their 2004 journal article entitled "Index Option Prices and Stock Market Momentum", Kaushik Amin, Joshua Coval and Nejat Seyhun test the dependence of broad equity market index option prices on past market returns. Using price data for S&P 100 index (OEX) options for the period 1983-1995, they conclude that: More...

April 8, 2009 - Classic Paper: Financial Instability Hypothesis

We occasionally select for retrospective review an all-time "best selling" research paper of the past from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize Hyman Minsky's May 1992 paper entitled "The Financial Instability Hypothesis" (download count over 3,400), a theory of the impact of debt on economic system behavior. The Financial Instability Hypothesis (FIH) challenges the view that a capitalist economy with a sophisticated financial system constantly seeks equilibrium, instead proposing that some conditions are deviation-amplifying. Specifically, he proposes that: More...

April 2, 2009 - Update: Predictive Power of the Gap Between Stock Earnings Yield and T-note Yield

Does the gap between the aggregate stock market forward-looking earnings yield and the yield on 10-year Treasury notes (T-note) predict future stock market and bond returns? In the November 2008 update to his paper entitled "The FED Model and Expected Asset Returns", Paulo Maio examines the statistical and economic significance of the Fed model as an indicator of future stock market and bond returns. Said differently, he investigates whether mean reversion in stock and bond yields results in mean reversion of the yield gap. Using monthly data for a broad U.S. stock index and T-notes, and for contemporaneous benchmark indicators, over the period July 1954 through December 2003, he concludes that: More...

April 1, 2009 - Optimal Asset Class Allocations

Based on Modern Portfolio Theory (MPT) and inferences from historical asset class returns, what are the best portfolio allocations for different levels of risk? In their February 2009 paper entitled "Strategic Asset Allocation: Determining the Optimal Portfolio with Ten Asset Classes", Niels Bekkers, Ronald Doeswijk and Trevin Lam explore which asset classes add mean-variance diversification value to a traditional portfolio of stocks, bonds and cash and determine the weights of asset classes in optimal portfolios (maximum Sharpe ratio). Their total set of ten asset classes consists of stocks, government bonds, cash, private equity, real estate, hedge funds, commodities, high yield bonds, credits and inflation-linked bonds. Using mostly U.S. data as available for historical asset class returns and volatilities, they conclude that: More...

March 31, 2009 - Critically Delegating, or Fearfully Abrogating?

Do individuals tend to think critically about financial advisor recommendations, or blindly follow them? In the March 2009 article entitled "Expert Financial Advice Neurobiologically 'Offloads' Financial Decision-Making under Risk", Jan Engelmann, Monica Capra, Charles Noussair and Gregory Berns investigate the neurobiological basis of the influence of expert advice on financial decisions via functional Magnetic Resonance Imaging monitoring of individuals choosing between a certain payment and a lottery, with and without expert advice. Using test results for 24 individuals (mostly female and mostly undergraduate students), they conclude that: More...

March 27, 2009 - Combining Value and Momentum Across Asset Classes

The value premium and the momentum effect are arguably complementary drivers of financial asset pricing dynamics, with the latter alternatively creating and extinguishing the former. Does empirical evidence support this view across asset classes? In the February 2009 version of their paper entitled "Value and Momentum Everywhere", Clifford Asness, Tobias Moskowitz, and Lasse Pedersen investigate the interplay of value and momentum across asset classes worldwide, as follows: (1) stocks within four major countries; (2) country equity indexes; (3) government bonds; (4) currencies; and, (5) commodities. They calculate momentum based on return over the past 12 months, excluding the most recent month, for all asset classes. They estimate value based on measures commonly used for each asset class (such as book-to-market ratio for stocks). Using price and value characteristics data for broad samples of these asset classes, they conclude that: More...

March 26, 2009 - Update: Mutual Fund Stock Selection vs. Market Timing

Can investors assess the performance of an active fund manager without access to the fund's detailed trading records (especially trades not evident from quarterly holdings reports)? In the February 2009 update of his paper entitled "Active Alpha and Active Beta - Detecting the Unobserved Actions of Portfolio Managers", Anders Ekholm presents a new methodology for indirectly measuring the effects of a fund manager's trading that relies exclusively on portfolio returns. His approach decomposes fund tracking error into two aspects of active management: stock selection (idiosyncratic risk, or active alpha) and general market timing (systemic risk, or active beta). Applying this methodology to daily returns for a sample of actively managed U.S. equity mutual funds over the period 12/31/99-3/31/08, he finds that: More...

March 25, 2009 - Update: Beat the Market with Hot-Anomaly Switching?

Can investors beat the market by iteratively finding and exploiting the current hot anomaly? In the February 2009 version of his 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, with a specific objective of suppressing data snooping bias. 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 11 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, debt/equity ratio, sales growth and trading volume/turnover) as available from 1926 through 2006, he concludes that: More...

March 24, 2009 - Google Search Data as a Measure of Investor Attention

Do new technologies offer more powerful and immediate ways to measure investor sentiment? In the March 2009 version of their paper entitled "In Search of Attention", Zhi Da, Joseph Engelberg and Pengjie Gao investigate the link between investor attention and asset pricing dynamics based on the levels of and changes in the Google Search Volume Index. Using weekly search frequency data for Russell 3000 and Initial Public Offering (IPO) stock ticker symbols over the period January 2004 through June 2008, along with contemporaneous trading, firm characteristics and news data, they conclude that: More...

March 23, 2009 - More Motivated by Being Right Than Making Money

Do stock traders learn rationally from past trading experience? In the March 2009 version of their paper entitled "Trading and Learning: How Different Are Different Categories of Investors?", Sankar De, Vishal Mangla, P. Bhimasankaram and Simran Singh investigate how different categories of traders revise their beliefs about the prospects for future trading success in response to past trading experiences. Using a sample of 124 million transactions on the National Stock Exchange of India within 1.2 million accounts over the period April 2006 through June 2006, they conclude that: More...

March 20, 2009 - Stock and Bond Returns Correlation Variability (Revised 5/11/09 to Reflect a Revision to the Paper and a Reader Comment)

Stocks and bonds are two of the most frequently considered asset classes in asset allocation strategies. How stable is the correlation between stock returns and bond returns? In their December 2008 paper entitled "The Dynamic Correlation between Stock and Bond Returns", Thomas Chiang and Jiandong Li apply rolling regressions to analyze variations in the correlation between stock market returns and bond market returns. Using daily returns for the Vanguard Total Bond Market Index Fund (VBMFX) and the Vanguard Total Stock Market Index Fund (VTSMX) as proxies for their respective markets over the period 6/20/96 through 6/30/08, along with contemporaneous U.S. economic data, they conclude that: More...

March 18, 2009 - Morningstar Ratings and Future Returns

Does the Morningstar mutual fund rating system work? If so, how? In their March 2009 paper entitled "Selectivity, Market Timing and the Morningstar Star-Rating System", Antonios Antypas, Guglielmo Caporale, Nikolaos Kourogenis and Nikitas Pittis investigate whether Morningstar mutual fund ratings enable investors to select funds that are likely to outperform in the future. Using data for 1,511 rated equity mutual funds since January 1998, they conclude that: More...

March 17, 2009 - Speed/Determinants of Stock Price Reversion

Do mispriced stocks systematically revert to value under the long-term guidance of information traders? If so, what factors affect the rate of reversion for a particular stock? In their March 2009 paper entitled "How Quickly do Equity Prices Converge to Intrinsic Value?", Dennis Capozza and Ryan Israelsen investigate the predictability of the reversion of stock price to a changing fundamental valuation baseline. They use annual fundamental (intrinsic) values for stocks from AFG Research, as derived from from estimates of future earnings based on growth rate and the decay of the spread between return on equity and cost of capital. Using monthly return/trading data, annual intrinsic value data and firm characteristics for 8,845 stocks over the period 1997 through 2006, they conclude that: More...

March 11, 2009 - The Advised, the Non-advised and Frequent Traders

How do financial advisors affect the investing practices of individual investors? Does their advice decisively improve client performance, or are other factors more explanatory? In their February 2009 paper entitled "The Influence of Financial Advisors on Household Portfolios: A Study on Private Investors Switching to Financial Advice", Ralf Gerhardt and Andreas Hackethal compare the portfolios and transactions of advised and non-advised German investors to determine the effects of advice. They further decompose the sample of investors to explore whether differences between advised and non-advised arise from the advice per se or from investor socio-demographics or trading frequency. Using portfolio compositions and transactions for over 65,000 German investors during February 2006 through July 2007, including 597 who initiated a relationship with a financial advisor during that period, they conclude that: More...

March 9, 2009 - The Actual Return Experience of Hedge Fund Investors

Do hedge fund investors actually receive the returns reported for hedge funds, or does the timing of investments in these funds substantially affect experienced returns? In the March 2009 version of their paper entitled "Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn", Ilia Dichev and Gwen Yu measure actual hedge fund investor returns by integrating the returns of the funds they hold with the timing and magnitude of their capital flows into and out of these funds. Specifically, they calculate an aggregate internal rate of return (dollar-weighted return) that treats funds as time-ordered investor capital flows, with initial fund market value and fund inflows counted as negative flows and fund outflows and ending market value counted as positive flows. Using monthly net-of-fee return and assets under management data for a large sample of hedge funds over the period 1980-2006, they conclude that: More...

March 6, 2009 - Hedging/Speculative Pressure and Commodity Futures Returns

Do commodity hedgers offer a reliable risk premium to speculators via commodity futures? In other words, can commodity futures traders generate dependable returns by trading against the net position of hedgers and with the net position of speculators as summarized in the weekly Commodity Futures Trading Commission's Commitments of Traders (COT) reports? In the February 2009 version of their paper entitled "The Performance of Simple Dynamic Commodity Strategies", Devraj Basu and Joelle Miffre construct real-time trading strategies based on the aggregate positions of hedgers and speculators for liquid commodity futures. They test the relative informativeness of hedgers and speculators and the effectiveness of applying active strategies to commodities that are backwardated (positive roll return) and contangoed (negative roll return). Using Wednesday closing prices on near-maturity contracts for 13 commodities (identified on the chart below) and weekly COT hedgers/speculators position data over the period 1994-2006 (1999-2006 for corn), they find that: More...

March 3, 2009 - Following the "Hot" Economic Indicators

In the absence of solid theory, can an adaptive empirical model successfully infer which economic indicators are driving near-term equity investor/trader behavior? In other words, can a model that continually reselects the current best economic indicators predict stock returns? In her October 2008 paper entitled "Equity Premium Predictions with Adaptive Macro Indices", Jennie Bai uses time-varying combinations of a large number of economic variables to predict excess (relative to one-month Treasury bills) stock returns. Specifically, she iteratively selects the best macro index of economic indicators according to empirical measurement of the out-of-sample (training interval) power of competing indexes to predict stock returns. Using monthly datasets for 100 economic indicators, one-month Treasury bill (T-bill) yields and returns for a broad value-weighted stock index spanning January 1960 through November 2006, she concludes that: More...

March 2, 2009 - The Usefulness of Non-U.S. Analyst Stock Recommendations and Earnings Forecasts

Are stock recommendations and earnings forecasts from analysts in markets outside the U.S. useful to investors? In their February 2009 paper entitled "International Evidence on Analyst Stock Recommendations, Valuations, and Returns", Ran Barniv, Ole-Kristian Hope, Mark Myring and Wayne Thomas examine the usefulness of non-U.S. analyst outputs by testing relationships between: (1) valuation estimates and stock recommendations; (2) valuation estimates and future excess returns; and, (3) stock recommendations and future stock returns. They segment results according to level of investor legal protection within the analyst's country, as indicated by assessments of rule of law, judicial system efficiency and corruption. Using earnings forecasts, stock recommendations and monthly stock return data for 30 countries over the period January 1993 to May 2007, they conclude that: More...

February 27, 2009 - Performance of Fundamental-weighted Indexes in Europe

Capitalization-weighted stock indexes arguably incorporate a performance drag by overweighting overvalued stocks and underweighting undervalued stocks. In their February 2009 paper entitled "Fundamental Indexing: An Analysis of the Returns, Risks and Costs of Applying the Strategy", Roel Houwer and Auke Plantinga examine the raw and risk-adjusted returns of hypothetical indexes of European stocks weighted by dividend, book value, revenue and operating income. They take the capitalization-weighted Stoxx 600 Index as a benchmark. Using monthly stock returns and firm fundamental data for the Stoxx 600, along with relevant risk-adjustment data, for the period 1993-2007, they conclude that: More...

February 26, 2009 - Comparing German and American Investor Sentiment Indicators

Does investor sentiment predict future stock returns, and does the release of new investor sentiment data therefore cause an immediate market reaction? In the February 2009 version of their paper entitled "Not so Dumb Money: The Prognostic Power of Investor Sentiment over Time", Jördis Hengelbrock, Erik Theissen and Christian Westheide measure the predictive power of German and U.S. investor sentiment indicators and test whether the market responds immediately to the release of new sentiment data. For the German market, they define investor sentiment using the Sentix value index (percent bullish minus percent bearish), derived from a weekly survey of institutional and individual investors regarding their outlook for German equities over the next six months and published on weekends. For the U.S. market, they define investor sentiment using an American Association of Individual Investors (AAII) value index (percent bullish minus percent bearish), derived from a weekly survey of individual investors regarding their outlook for U.S. equities over the next six months and published before the market open on Thursdays. Using AAII survey results for July 1987 to June 2008 and Sentix survey results for February 2001 to June 2008, along with contemporaneous stock index levels, they conclude that: More...

February 25, 2009 - Winners and Losers Among Equity Investors

Who wins and who loses among equity investors, and why? In the December 2008 version of their paper entitled "Who Win and Who Lose Among Individual Investors?", Kingsley Fong, David Gallagher and Adrian Lee compare the trading performances of three investor groups, those trading through: (1) institutional brokers; (2) discount retail brokers; and, (3) non-discount retail brokers. They define discount brokers as those offering trading services but no in-house research. They compare performances of these groups based on raw and risk-adjusted trading returns at the close on the trade date and at horizons of 1, 10, 25, 140 and 254 trading days. Using detailed intraday trading records for the Australian stock market spanning February 19, 1990 to December 1, 2005, they conclude that: More...

February 24, 2009 - Stock Price as a Future Return Indicator

Do investors fool themselves into thinking a low share price means a cheap price? In other words, are the simple nominal prices of stocks predictive of their future returns? In their December 2008 paper entitled "Is Share Price Relevant?", Soosung Hwang and Chensheng Lu investigate this question by measuring the performance of portfolios formed annually by sorting listed common stocks by nominal price into five ranges: less than or equal to $5, $5 to $10, $10 to $15, $15 to $20, and more than $20. Using delisting-adjusted price data for a broad sample of NYSE/AMEX/NASDAQ common stocks over the period July 1963 through December 2006, they conclude that: More...

February 23, 2009 - Asset Allocation Driven by Four Economic Phases

Is there an effective way to enhance allocation of investment funds across asset classes according to economic conditions, from either a risk or a return perspective? In their January 2009 paper entitled "Dynamic Strategic Asset Allocation: Risk and Return Across Economic Regimes", Pim Van Vliet and David Blitz present constant-risk and return-maximizing asset allocation strategies driven by four economic states: expansion, peak, recession and recovery (see the first chart below). Using data for four U.S. economic indicators (credit spread, earnings yield, Institute for Supply Management manufacturing index and unemployment rate) and returns for eight mostly U.S. asset classes (equities, bonds, cash, small-capitalization stocks, value stocks, growth stocks, credits and commodities) over the period 1948 through 2007 (60 years), they conclude that: More...

February 20, 2009 - De-Snooping Market Timing Rules Based on Fundamental and Sentiment Indicators

Some analysts fail to account for data snooping bias in their analyses of market timing indicators. This bias amounts to incorporating pure luck into results by testing many different rule variations or parameter settings within rules (or inhaling the "secondary smoke" of other analysts who have already screened a set of rules/parameters). This luck does not persist out-of-sample. Do any market timing rules generate outperformance after correcting for this bias? In their February 2009 paper entitled "Data Snooping and Market-Timing Rule Performance", Andreas Neuhierl and Bernd Schlusche assess the profitability of a comprehensive set of simple and complex market timing rules based on fundamental indicators and investor sentiment indicators after correcting for data snooping bias. Simple rules derive from a single indicator, and complex rules derive from multiple indicators. Using thousands of simple and complex rules based on data for the S&P 500 to time the daily close of the S&P 500 index over the period 1980-2007, they conclude that: More...

February 19, 2009 - The 2008 Equity Risk Premium from Academia

What is the current academic estimate of the annual premium over the risk-free rate demanded by equity investors. How has that estimate changed over the past year and since 2000? In his February 2009 paper entitled "Market Risk Premium Used in 2008: A Survey of More Than a 1,000 Professors", Pablo Fernández summarizes the results of an early 2009 email survey soliciting the risk premium "that we, professors, use to calculate the required return to equity" in 2008 and in previous years. Based on 1,161 responses to the survey from finance and economic professors around the world, he finds that: More...

February 18, 2009 - The Advised Versus the Self-directed

Do individuals who use investment advisors achieve higher returns than those who do not? Two closely related papers entitled "Investment Advice and Individual Investor Portfolio Performance" of January 2009 by Marc Kramer and "The Impact of Financial Advisors on Individual Investor Portfolio Performance" of February 2009 by Marc Kramer and Robert Lensink address this question. Using monthly portfolio returns for thousands of advised and self-directed individual Dutch investors during April 2003 through August 2007 (52 months), they conclude that: More...

February 17, 2009 - Surviving by Staying Out of the Fourth Quadrant

Can one survive over the long run in the "wild" Fourth Quadrant, in which many investments appear to reside and for which normal (Gaussian) statistics mislead rather than guide. In his February 2009 draft paper entitled "Errors, Robustness, and The Fourth Quadrant", Nassim Taleb investigates the (in)tractability of economic and financial series and characterizes approaches to accommodating such fundamental unpredictability. Based on a broad set of worldwide economic data that includes 38 tradable variables with daily price data, he concludes that: More...

February 16, 2009 - A 19th Century Test of the Size and Value Factors

Are the size effect and the value premium peculiar to 20th century markets, or are they enduring characteristics of equity market behavior? In the January 2009 preliminary version of their paper entitled "The Asset Pricing Anomalies in 19th Century Britain", Qing Ye, Charles Hickson and John Turner measure the size and value anomalies using an original 19th century dataset. Using monthly stock prices and annual dividends for 1,051 stocks traded on the London Stock Exchange during March 1825 to December 1870, they conclude that: More...

February 13, 2009 - The Downside Risk Factor

Is downside risk (beta as measured only during overall market declines) better than normal beta as an indicator of differences in future returns among individual stocks? In their February 2009 paper entitled "Sorting Out Downside Beta", Thierry Post, Pim Van Vliet and Simon Lansdorp explore empirically the power of downside beta to explain the variation in future returns across stocks. They measure beta and downside beta based on five years of historical stock and market returns. Using return data for a broad sample of U.S. common stocks spanning 1926-2007 (82 years) and various measures of downside beta, they conclude that: More...

February 12, 2009 - Asset Growth Rate as a Return Indicator

Is firm total asset growth rate an independently valuable indicator of future stock returns? In their January 2009 paper entitled "The Asset Growth Effect in Stock Returns", Michael Cooper, Huseyin Gulen and Michael Schill review the evidence for a strong asset growth effect in U.S. stock returns unexplained by other widely cited effects. Using firm fundamentals and stock return data for all non-financial U.S. public companies over the period 1968-2007, they conclude that: More...

February 11, 2009 - The Relative Cash Holdings Premium

Does the percentage of assets held in cash by a company, as an indicator of operating and investment flexibility, predict stock returns? In his January 2009 paper entitled "Firm's Cash Holdings and the Cross-Section of Equity Returns", Dino Palazzo measures and interprets the significance of relative cash holdings for future stock returns. Using stock return and firm fundamentals data spanning July 1967 through June 2007, he concludes that: More...

January 29, 2009 - The Hedge Fund Size Effect

Do small hedge funds tend to prosper in their chosen niches while large ones outgrow their opportunity sets? In his January 2009 paper entitled "Does Size Matter in the Hedge Fund Industry?", Melvyn Teo examines the relationship between hedge fund size and future risk-adjusted (for seven factors) returns. Using monthly net-of-fee returns, assets managed and other characteristics for a large sample of live (3,177) and dead (4,240) hedge funds allocated to four styles over the period January 1994 through June 2008, he concludes that: More...

January 28, 2009 - Four Factors and Two Regimes

Do returns associated with the four famous factors (market, size, book-to-market, momentum) vary systematically with the state of the market (such as bull or bear)? In their January 2009 paper entitled "The Effect of Market Regimes on Style Allocation", Manuel Ammann and Michael Verhofen investigate how returns for the four factors differ between market states as determined by a multivariate two-state model of the overall equity market. Using U.S. stock market and factor data spanning 1927-2004, they conclude that: More...

January 27, 2009 - Determinants of Pairs Trading Profitability

How do the returns from pairs trading (bets on the re-convergence of prices for similar stocks that have historically tracked but recently diverged) play out? Are there systematic ways to enhance pairs trading profitability? In the November 2008 version of their paper entitled "An Anatomy of Pairs Trading: the Role of Idiosyncratic News, Common Information and Liquidity", Joseph Engelberg, Pengjie Gao and Ravi Jagannathan explore how news events and liquidity shocks relate to pairs trading profitability. Using daily prices for a broad set of stocks spanning January 1992 through June 2006 and related news items and trading data for January 1993 through December 2005, they conclude that: More...

January 23, 2009 - Stock Market Returns and Inflation: Illusion or Regimes?

Which better explains the relationship between the inflation rate and stock market returns: the inflation illusion hypothesis, or a two-regime hypothesis? The former proposes that the typical investor irrationally raises (lowers) the required rate of return from equities (discount rate) as the inflation rate rises (falls), thereby undervaluing (overvaluing) stocks. The latter proposes that aggregate demand (supply) shocks drive a positive (negative) relationship between the inflation rate and stock returns. In his January 2009 paper entitled "Stock Returns and Inflation Revisited", Bong-Soo Lee re-examines these hypotheses using long run U.S. data. Using stock return and inflation rate data spanning 1927-2007, he concludes that: More...

January 22, 2009 - An International Test of Momentum Strategies

Do momentum trading strategies work consistently across country markets? In his December 2008 paper entitled "Are Anomalies Still Anomalous? An Examination of Momentum Strategies in Four Financial Markets ", Daxue Wang applies various tests to measure the profitability of momentum strategies in the two largest stock markets in each of Europe (UK and Germany) and Asia (Japan and China). He tests overlapping equally weighted portfolios formed on returns over the past 3, 6, 9 or 12 months (no wait month) and held for 3, 6, 9 or 12 months. Using monthly stock price data and firm characteristics for companies comprising more than 95% of market capitalization in each country over the period 1990 (1994 for China) through 2006, he concludes that: More...

January 16, 2009 - Cash as a Valuation Indicator

Does the level of cash held by a company, appropriately normalized for its business characteristics, reliably indicate the prospects for its stock? If so, is a high or low level of cash better for the stock? In his January 2009 paper entitled "Excess Cash Holdings, Risk, and Stock Returns", Mikhail Simutin investigates the relationship between excess corporate cash holdings and future stock returns. He defines "excess" via multi-factor regression to normalize for key firm characteristics. Using characteristics, fundamentals and stock return data for non-financial U.S. companies over the period 1960-2006, he concludes that: More...

January 15, 2009 - The Volatility Premium and the Four Factors

Does the volatility risk premium, the difference between options-implied volatility and future realized (actual) volatility, vary systematically with the four most widely used equity risk factors (market, size, book-to-market and momentum)? In other words, might the four factors point to pockets of underpriced or overpriced options? In their November 2008 paper entitled "Implied and Realized Volatility in the Cross-Section of Equity Options", Manuel Ammann, David Skovmand and Michael Verhofen investigate the factor dependence of the volatility premium for U.S. equities. Using a sample of all U.S. equity at-the-money call options 91 days from expiration over the period January 1996 through April 2006, along with associated stock price and firm fundamentals data, they conclude that: More...

January 14, 2009 - Methods and Results for ValueInvestorsClub.com Members

How do professional value investors make investment decisions? Do they beat the market? In their January 2009 preliminary paper entitled "Fundamental Value Investors: Characteristics and Performance", Wesley Gray and Andrew Kern examine the detailed investment decision process and aggregate performance of professional value investors who participate in ValueInvestorsClub.com, an "exclusive [and confidential] online investment club where top investors share their best ideas." The founders of ValueInvestorsClub.com are Joel Greenblatt and John Petry of Gotham Capital. Using a sample of 2,912 investment recommendations by ValueInvestorsClub.com members during January 2000 through June 2008, along with associated firm fundamentals and stock return data, they conclude that: More...

December 19, 2008 - The Big Winners from Stock Buybacks?

Do shareholders realize the full benefits of open market stock buybacks, or are corporate executives increasingly gaming accounting rules and stock buybacks to maximize the value of management stock options? In their December 2008 paper entitled "Accounting Rules? Stock Buybacks and Stock Options: Additional Evidence", Paul Griffin and Ning Zhu investigate how stock option compensation influences whether, how much and when companies distribute funds as open market stock buybacks rather than dividends. Using data for fiscal years 2005 through 2007 of U.S. public companies, they conclude that: More...

December 16, 2008 - "It’s the P/E, stupid!"

Is there a relationship between investor risk-aversion, as indicated by the aggregate U.S. stock market price-earnings ratio (P/E), and level of public satisfaction with the performance of the President? In their December 2008 paper entitled "Speculating on Presidential Success: Exploring the Link between the Price-Earnings Ratio and Approval Ratings", Tomasz Wisniewski, Geoffrey Lightfoot and Simon Lilley examine the relationship between aggregate stock market P/E and the surveyed level of public approval of the current President. Using quarterly P/E for the S&P Composite Stock Price Index derived from Robert Shiller's long-run dataset and Gallup presidential approval survey data from the beginning of 1950 through the third quarter of 2007 (231 observations), they conclude that: More...

December 15, 2008 - The Best Kind of Stocks to Pick?

Are stock pickers more likely to out-pick the market by focusing on stocks that resist market efficiency? In their December 2008 paper entitled "When is Stock-Picking Likely to be Successful? Evidence from Mutual Funds", Ying Duan, Gang Hu and David McLean examine changes in quarterly holdings of mutual funds to measure how the stock-picking performance of fund managers varies with stock idiosyncratic volatility (volatility that indicates risk factors different from those of the overall stock market). Using quarterly mutual fund stock holdings data and monthly stock return data for the period 1980-2003, they conclude that: More...

December 12, 2008 - New Funds Outperform (Again)?

Do new mutual funds bring fresh alpha to the marketplace, outperforming until the market catches up and extinguishes it? In their August 2008 paper entitled "Performance and Characteristics of Mutual Fund Starts", Aymen Karoui and Iwan Meier examine the performance and portfolio characteristics of U.S. equity mutual funds launched during 1991-2005. Using monthly return, quarterly holdings and fund characteristics/fee data for 1,374 U.S. domestic equity mutual funds and 828 fund starts over this period, they conclude that: More...

December 10, 2008 - An Alternative Measure of Investment Risk

Standard deviation is likely the most widely used measure of investment risk, but quadratic dispersion from the mean not be the most intuitive measure. There is evidence that investors confuse standard deviation with mean absolute deviation, and they may further misinterpret standard deviation due to its "normal" association with the Gaussian distribution (inapplicable for some financial data series). Would some other baggage-free measure of risk make more sense to investors? In his November 2008 paper entitled "The Gain-Loss Spread: A New and Intuitive Measure of Risk", Javier Estrada proposes the gain-loss spread (GLS) as an intuitive and useful measure of investment risk. GLS is the difference between the expected gain (probability of gain times average gain) and the expected loss (probability of loss times average loss). Using monthly return data for 49 country indexes (22 developed and 27 emerging) and 57 industry indexes from initial availability through December 2007, he concludes that: More...

December 4, 2008 - Time for Momentum ETFs?

Why are there no "momentum" exchange-traded funds (ETF)? What would it take to create them? How might they have performed in recent years? In their November 2008 paper entitled "Momentum and Contrarian Stock-Market Indices", Jon Eggins and Robert Hill propose a new class of diversified momentum (overweighting stocks that have recently outperformed) and contrarian (underweighting these same stocks) ETFs derived from partitions of a benchmark index. Their methodology allows adjustment of the degree to which a partition is momentum or contrarian via a single parameter, with associated turnover increasing as the degree of momentumness or contrarianness increases. ETFs based on such index partitions would allow individual investors practical access to diversified momentum/contrarian strategies and provide performance benchmarks for momentum and contrarian investment managers. Using price data for the components of the Russell 1000 index over the period June 1995-June 2007 to construct baseline momentum and contrarian indexes, they conclude that: More...

December 3, 2008 - The Achilles' Heel of Pre-determined Lifecycle Funds?

Is a "Rip Van Winkle" asset allocation strategy, wherein an investor gradually migrates from stocks to fixed income in pre-specified steps, optimum? Or, is there some simple, less passive alternative that takes equity bull and bear markets into account? In their November 2008 paper entitled "Dynamic Lifecycle Strategies for Target Date Retirement Funds", Anup Basu, Alistair Byrne and Michael Drew question the rationale for pre-determined lifecycle equity/fixed income rebalancing and compare it to an alternative 40-year dynamic lifecycle strategy that flexibly rebalances depending on success to date. The dynamic strategy holds 100% stocks for the first 20 or 30 years and then annually switches partially to fixed income or remains 100% in stocks depending on whether or not it is achieving a target 10% annualized rate of return. The authors include 100% stocks and static balanced 60/30/10 stocks/bonds/cash strategies as benchmarks. Using bootstrapping to augment a dataset of annual nominal returns for U.S. stocks, bonds and bills spanning 1900-2004 (105 years), they conclude that: More...

December 2, 2008 - Spectral Analysis of Stock Market Cyclicality

Are there reliable periodicities in U.S. stock returns tied to national election cycles? In their October 2008 paper entitled "Financial Astrology: Mapping the Presidential Election Cycle in US Stock Markets", Wing-Keung Wong and Michael McAleer apply spectral analysis to identify and quantify cycles in U.S. stock market returns, including a presidential election cycle. Using weekly S&P 500 index data for the period 1965-2003, they conclude that: More...

December 1, 2008 - Predictable Pieces of the Market?

Are commonly used stock market indicators more predictive for some subsets of stocks than for the stock market overall? In the November 2008 update of their paper entitled "How Predictable are Components of the Aggregate Market Portfolio?", Aiguo Kong, David Rapach, Jack Strauss, Jun Tu and Guofu Zhou analyze return predictability for various subsets of the overall U.S. stock market, defined by portfolios sorted into 33 industry, 10 market capitalization and 10 book-to-market ratio segments. They consider 14 economic variables and lagged returns for 33 industries as predictors. Using economic indicator and industry/size/book-to-market return data from the end of 1945 through 2004, they conclude that: More...

November 28, 2008 - Hedge Fund Outperformance: Skill or Liquidity Risk?

Can outperforming hedge funds readily convert assets into cash for fund investors? In their October 2008 paper entitled "Hedge Fund Alphas: Do They Reflect Managerial Skills or Mere Compensation for Liquidity Risk Bearing?", Rajna Gibson and Songtao Wang study the effect of market-wide liquidity risk (the time and costs of transforming a given position into cash and vice versa) on the performance of various hedge fund portfolio strategies. The strategies they consider are: Convertible Arbitrage, Dedicated Short Bias, Emerging Markets, Equity Market Neutral, Event-Driven, Fixed Income Arbitrage, Global Macro, Long/Short Equity Hedge, Managed Futures and Multi-Strategy. Using performance data for a broad sample of live (2,743) and defunct (1,955) hedge funds during 1994-2006 and contemporaneous measures of market-wide (U.S. equities) liquidity, they conclude that: More...

November 26, 2008 - The Numerology of Trading

Are the marketers right in believing that $1.99 attracts many more buyers than $2.00? In other words, do buyers irrationally fixate on the left-most digit of a price? If so, is there a way to exploit any associated stock trading tendencies? In their November 2008 paper entitled "Penny Wise, Dollar Foolish: The Left-Digit Effect in Security Trading", Utpal Bhattacharya, Craig Holden and Stacey Jacobsen investigate the extent to which traders anchor on the left digit in stock prices. Using 100 million randomly selected stock trades during normal trading hours that are either above (buys) or below (sells) the bid-ask midpoint during 2001-2006, they conclude that: More...

November 25, 2008 - An Expansive Value vs. Growth Update

How does the value premium fare when analysis appends data from the last few years to the data used in seminal studies? Does it persist, both in the U.S. and worldwide? In their October 2008 paper entitled "Value vs. Glamour: A Global Phenomenon", the Brandes Institute refines and extends the duration of past value-growth research and expands its reach to global equity markets. The research focuses on price-to-book value ratio (P/B) as the principal value indicator, but also considers price-to-cash flow ratio (P/CF) and price-to-earnings ratio (P/E). Using stock returns and firm fundamentals for a broad sample of U.S. companies over the period April 1968-April 2008, and comparable data for 23 other country equity markets over the period June 1980-June 2008, they conclude that: More...

November 24, 2008 - Sector Rotation vs. Stock Picking

Do expert investors outperform more by being in the right sectors (top-down economic analysis) or by picking the right stocks (bottom-up firm analysis)? In their November 2008 paper entitled "Impact of Sector Versus Security Choice on Equity Portfolios", Jason Hall and Ben McVicar investigate the relative impact on equity mutual fund returns of industry sector allocation versus individual stock picks. They perform this investigation by constructing sector-neutral and stocks-within-sector-neutral benchmarks. Using data for 3,350 U.S. equity mutual funds over the period 1980-2005 (113,614 fund-quarter observations), they conclude that: More...

November 20, 2008 - Exchange Traded Funds vs. Index Mutual Funds

Do Exchange Traded Funds (ETF) outperform comparable index mutual funds because of lower fees? In their November 2008 preliminary paper entitled "Exchange Traded Funds: Performance and Competition", Marko Svetina and Sunil Wahal examine the performance of a very large number of ETFs over their entire histories relative both to their theoretical indexes and to matched index mutual funds. Using data for 584 domestic equity, international equity and fixed income ETFs and their indexes from their inception to the end of 2007, along with comparable data for matched index mutual funds, they conclude that: More...

November 17, 2008 - Stock Returns for New Industries

Do new industries offer exceptionally good stock returns, whether through strong growth or investor exuberance? In their September 2008 paper entitled "Returns to Investors in Stocks in New Industries", Gerald Dwyer Jr. and Cora Barnhart examine stock return distributions and summary statistics for the following major new industries in the U.S. over the periods of their initial development (15-23 years): personal computers, airlines, aircraft manufacturing, automobile manufacturing, railroads and telegraph. Using return data for the stocks of companies in the selected industries and contemporaneous market indexes, they conclude that: More...

November 13, 2008 - A Factor Fishing Expedition

Many equity market researchers assume conventional three-factor (excess market return or beta, size, book-to-market ratio) and four-factor (plus momentum) models as standards of comparison for discovery of new sources of abnormal returns. Are they the best standards? In their November 2008 paper entitled "Fishing with a Licence: an Empirical Search for Asset Pricing Factors", Soosung Hwang and Alexandre Rubesam investigate the empirical power of 12 previously identified asset pricing factors using a Bayesian variable selection method called Stochastic Search Variable Selection (see the paper for a description). The factor candidates are: excess market return, liquidity, coskewness, cokurtosis, downside risk, size, book-to-market ratio, momentum, asset growth, idiosyncratic volatility, volume and long-term reversal. Using data for thousands of individual U.S. stocks and associated firm characteristics, 25 factor-based portfolios and 30 industry portfolios over the period 1967-2006, they conclude that: More...

November 12, 2008 - Update: The January Barometer Retested

As goes January, so goes the rest of the year? In the November 2008 update of their paper entitled "The Illusionary Market Timing Ability of the Other January Effect", Ben Marshall and Nuttawat Visaltanachoti examine the ability of January returns to predict February-December returns and support a market timing strategy in the U.S. and other equity markets. They consider multiple robustness tests to determine the statistical and economic significance of this January Barometer based on both equally weighted and value weighted returns. Using U.S. stock return data spanning 1925-2007 (focusing on 1940-2007) and stock return data for 18 other countries and the world spanning 1970-2007, they conclude that: More...

November 10, 2008 - The History and Meaning of VIX

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) gets special attention from investing experts and the financial media as the "investor fear gauge." What are the origins of VIX, and why was it created? In his November 2008 draft paper entitled Understanding VIX, VIX creator Robert Whaley describes the purpose, history and essential characteristics of this index. Using historical data from January 1986 through October 2008, he explains that: More...

November 7, 2008 - Long-term Market Timing Model Flyoff

Do long-term stock market timing models work? If so, which type works best? In their October 2005 paper entitled Timing is Everything: A Comparison and Evaluation of Market Timing Strategies, flagged by a reader, Chris Brooks, Apostolos Katsaris and Gita Persand investigate the profitability of several timing models over a very long sample of S&P 500 index returns. Specifically, they test the timing power of: (1) the ratio of the long-term Treasury bond yield to the stock dividend yield; (2) the spreads between the stock earnings yield and the yields on either the three-month Treasury bills (T-bills) or the 10-year Treasury notes (T-notes); (3) a model for predicting when bear markets will occur based on the spread between T-note and T-bill yields; and, (4) an approach for predicting market turning points based on speculative bubbles. Timing signals trigger binary switching between stocks and T-bills. Using monthly stock return and model parameter data from January 1871-December 1926 for initial model calibration and January 1927-August 2003 for model testing and recalibration (a total of 1,592 months), they find that: More...

October 30, 2008 - The Fourth Quadrant: No Realm for the Normal

New sample points from the past two months are substantially shifting correlations in several our past analyses of relationships between indicators and future stock returns (published updates pending). Here are some recent relevant observations from Nassim Taleb's September 2008 essay in Edge entitled "The Fourth Quadrant: A Map of the Limits of Statistics". In the aftermath of the collapse of Fannie Mae, Bear Stearns and Lehman Brothers, he observes that: More...

October 22, 2008 - Combining Short Interest and Analyst Recommendations

Are short sellers and expert equity analysts generally in synch or out of synch? What does it mean when short sellers and analysts disagree? In their September 2008 paper entitled "Trading Against the Prophets: Using Short Interest to Profit from Analyst Recommendations", Michael Drake, Lynn Rees and Edward Swanson investigate whether investors/traders can earn abnormal returns by trading on information provided by expert sell-side analysts (recommendations and recommendation changes) and short sellers (short interest). In their tests, they rebalance portfolios quarterly, hold for six months and adjust returns for firm size. Using a large sample of quarterly return, short interest and analyst recommendation data for the period 1994-2006 period, they conclude that: More...

October 16, 2008 - The Sensitivity of Stock Market Return Predictability to Predictor Measurement Interval

Does the predictability of stock market returns depend on exactly when and for how long one measures the predictive variable? In the October 2008 draft of their paper entitled "Return Predictability Revisited", Ben Jacobsen, Ben Marshall and Nuttawat Visaltanachoti anticipate a substantial fraction of the variation in monthly stock market returns by judiciously refining the observation intervals for a set of predictive variables (prices for the 22 commodities with the largest world production during 2003-2008). The causality chain is, presumably, commodity price changes affect future corporate earnings and/or inflation, and investor expectations about earnings and inflation affect equity valuation. The authors test the predictive power of commodity price changes over a range of measurement intervals under assumptions of both near efficiency (rapid response of equity prices to commodity prices) and gradual information diffusion (delayed response of equity prices). Using daily commodity spot prices as available and monthly stock market returns for the U.S. and 18 other countries since 1970, they conclude that: More...

October 7, 2008 - Anomalies Tested with Expected (Rather Than Historical) Returns

Are the major known stock return anomalies as exploitable as they seem to investors looking back at historical returns? In their September 2008 paper entitled "Do Anomalies Exist Ex Ante?", Ginger Wu and Lu Zhang examine a wide range of anomalies (book-to-market, composite issuance, net stock issues, abnormal investment, asset growth, price momentum, earnings surprises, total and discretionary accruals, net operating assets, and failure probability) from the perspective of a forward-looking investor. They employ in their analysis expected returns derived from growth rates of fundamentals (dividends, earnings, sales and equity), rather than backward-looking historical (realized) returns. Using monthly price and return data for a broad sample of stocks, along with contemporaneous firm fundamentals, over the period 1965-2007, they conclude that: More...

October 6, 2008 - The Countercyclical Value Premium?

Does the value premium vary systematically with the state of the economy? More specifically, do value and growth stocks respond differently to negative macroeconomic shocks? In their September 2008 paper entitled "Value versus Growth: Time-Varying Expected Stock Returns", Huseyin Gulen, Yuhang Xing and Lu Zhang investigate the relationship between economic conditions (recession or expansion) and the value premium. Using monthly returns for a broad sample of stocks over the period 1954-2007 (648 months), along with contemporaneous firm fundamentals and macroeconomic data, they conclude that: More...

September 15, 2008 - Trading After 52-week Highs and Lows

Do 52-week highs and lows trigger unusual trading and returns for individual stocks? In their recent paper entitled "Volume and Price Patterns Around a Stock's 52-Week Highs and Lows: Theory and Evidence", Steven Huddart, Mark Lang and Michelle Yetman examine the evidence that past price extremes influence trading decisions, with focus on 52-week highs and lows. Using weekly volume and closing prices for a random sample of 2,000 stocks listed for at least a year during November 1982 through December 2006 (24 years), they conclude that: More...

September 12, 2008 - Which Economic Data Announcements Matter?

Which of those morning economic data releases really move markets? In their August 2008 paper entitled "How Economic News Moves Markets", Leonardo Bartolini, Linda Goldberg and Adam Sacarny explore how surprises in economic data releases affect asset prices in the stock, bond and currency exchange markets. They consider the following releases: (1) nonfarm payrolls and unemployment rate; (2) consumer price index (CPI) and CPI excluding food and energy; (3) personal consumption expenditures excluding food and energy, personal income and personal spending;(4), gross domestic product (GDP) advance; (5) Institute of Supply Management (ISM) manufacturing: (6) housing starts; (7), Conference Board Consumer Confidence Index; (8) University of Michigan Survey of Consumers; and, (9) retail sales less autos. They quantify "surprise" as the difference between the announced value for an indicator and value previously expected by key market participants. Using economic data releases and contemporaneous intraday asset and futures prices for the period January 1998 to July 2007, they conclude that: More...

September 10, 2008 - Mispricing Versus Liquidity for Earnings Uncertainty

Does the market efficiently bound the mispricings of stocks within the costs of exploiting the mispricings? In their August 2008 paper entitled "Mispricing and Costly Arbitrage", Ronnie Sadka and Anna Scherbina explore the difficulty of exploiting short-term mispricings of stocks derived from analyst disagreement about future earnings (with mispricing likely due to very pessimistic analysts withholding their views). Using stock price and earnings forecast data for a broad sample of stocks over the period January 1983 through August 2001, they conclude that: More...

September 9, 2008 - A Retrospective Value-Growth Contest

Do equity investors systematically overpay for growth? In the September 2008 draft of their paper entitled "Clairvoyant Value and the Value Effect", Robert Arnott, Feifei Li and Katrina Sherrerd compare the past prices of stocks with the discounted value of their actual subsequent cash flows (clairvoyant value) to measure the extent to which the market correctly anticipates firm growth. Using stock price and firm fundamentals data from the end of 1956 through the end of 2007 (51 years), they conclude that: More...

September 8, 2008 - The Futility of Timing Emerging Equity Markets?

Can investors/traders outperform by exploiting (or avoiding) the black swans that populate daily emerging market equity returns? In his September 2008 paper entitled "Black Swans in Emerging Markets", Javier Estrada investigates the influence of the best and worst days on long-term equity returns in emerging markets and the naive likelihood that investors can predict when these outliers will occur. Using evidence from 16 international equity markets and over 110,000 daily returns from start dates based on data availability through 2007, he concludes that: More...

September 5, 2008 - Overpaying for Jumpy Stocks?

Are investors/traders irrationally attracted to stocks that have recently acted like winning lottery tickets? In their August 2008 paper entitled "Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns", Turan Bali, Nusret Cakici and Robert Whitelaw investigate the significance of extreme positive past daily returns for future returns. Specifically, they examine next-month returns for stocks sorted by maximum daily return during the past month. Using daily and monthly returns, and contemporaneous firm characteristics, for a broad sample of stocks over the period July 1962 thorough December 2005, they conclude that: More...

September 2, 2008 - Enhancing Momentum Returns with Stylishness

Do growth and value investing styles have momentum? If so, can investors/traders enhance momentum trading returns by accounting for the stylishness of stocks (the degree to which they fit into either a growth or value style)? In their August 2008 paper entitled "Style Investing, Comovement and Return Predictability", Sunil Wahal and Deniz Yavuz measure returns from the combination of stock momentum and stock stylishness. They consider momentum portfolio formation and holding intervals of three, six and 12 months, with an intervening skipped month. They define stock stylishness (but do not use that term) as the degree of stock price comovement with either growth stocks or value stocks over the past three months. Using monthly returns, book-to-market ratios and market capitalizations for a broad set of stocks over the period 1965-2006, they conclude that: More...

August 28, 2008 - Returns for Call Options on Individual Stocks

Are out-of-the-money (OTM) call options a good way to speculate on spikes in the price of underlying stocks? In other words, are such options reliably underpriced or overpriced? In her August 2008 paper entitled "Stock Option Returns: A Puzzle", Sophie Xiaoyan Ni investigates one-month returns for call options on individual stocks that do not have an ex-dividend day prior to expiration. Using expiration date option price data for a broad sample of qualifying stocks during January 1996 through June 2005, she concludes that: More...

August 26, 2008 - A Two-Year Reversion Effect?

Cycles, whether empirical or tied to economic/political fundamentals, are a recurring theme in efforts to predict financial markets. Is there a two-year cycle for the stock market? In his August 2008 paper entitled "The Two-Year Effect", Graham Bornholt investigates a two-year reversion effect in the U.S. equity market. He defines low and high stock market return years, from which reversion occurs, relative to a lagged 10-year moving average of annual market returns. Using value-weighted annual returns from broad samples of stocks during 1871-1925 for in-sample model specification and during 1926-2005 for out-of-sample testing, he concludes that: More...

August 21, 2008 - Outperformance of Distinctive Hedge Fund Strategies?

Exceptional performance can stem from: (1) doing something others are doing, but doing it better; and (2) doing something different. Do hedge funds that have innovative strategies (do something different) systematically outperform? In their August 2008 paper entitled "Strategy Distinctiveness and Hedge Fund Performance", Ashley Wang and Lu Zheng construct a "Hedge Fund Strategy Distinctiveness Index" (SDI) and test the predictive power of this index for future hedge fund returns. Specifically, they define SDI as [1 - R-squared] from a two-year regression of the returns for an individual hedge fund against the average returns of funds with the same investing style. This index represents the percentage of variation in a fund's returns not explained by the variation of its peer's returns. Using monthly return data for 2767 live and dead hedge funds over the period January 1994 through June 2007, they conclude that: More...

August 15, 2008 - Quantitative Finance in a Nutshell

Just what does it mean to be a quant? In his December 2002 article entitled "The Boy's Guide to Pricing & Hedging " Emanuel Derman offers an "abbreviated poor man’s guide" to quantitative finance. He observes that: More...

August 13, 2008 - Classic Paper: Matched Pairs Trading

We occasionally select for retrospective review an all-time "best selling" research paper of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the February 2006 version of the paper entitled "Pairs Trading: Performance of a Relative Value Arbitrage Rule" (download count over 14,500) by Evan Gatev, William Goetzmann and Geert Rouwenhorst. The study tests the trading of mismatches in the dividend-adjusted prices of pairs of stocks that historically move together. Specifically, when the price spread between such a pair widens, short the winner and buy the loser and hold until prices converge. Using daily stock prices for a broad sample of reasonably liquid stocks over the period 1962-2002, the authors conclude that: More...

August 12, 2008 - Value Premium and Size Effect in Australia

Do stocks in Australia confirm pervasiveness of the value premium and the size effect? In their August 2008 paper entitled "Size and Book-to-market Factors in Australia" Michael O’Brien, Tim Brailsford and Clive Gaunt measure the value premium and the size effect in the Australian market. Using company-specific accounting information from annual reports and contemporaneous stock prices for 98% of all Australian listed firms during 1982-2006 (25 years), they conclude that: More...

August 11, 2008 - Using Trailing Stop Losses to Reduce Risk

Do stop-loss orders (automated position exits based on a cumulative loss threshold) enhance returns and reduce risk? In their 2008 paper entitled "The Value of Stop Loss Strategies" Adam Lei and Huihua Li investigate whether traders using stop-loss strategies to exit losing positions in individual stocks outperform a comparable buy-and-hold strategy. They test the following strategy alternatives: holding periods of three months, six months or one year; stop-loss thresholds of 5, 10 or 20 daily return standard deviations; reinvestment of stopped out positions in either the S&P 500 index or the one-month Treasury bill; and, a fixed stop price or a trailing stop price that follows stock price upward (but not downward). Using historical and simulated daily return data for a broad sample of NYSE/AMEX-listed stocks and random buy dates over the period 1970-2005, they conclude that: More...

August 7, 2008 - Combining Momentum and Roll Return Signals for Commodity Futures

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...

August 5, 2008 - Why the Story on Predictability Keeps Changing

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...

August 4, 2008 - Do Stop Losses Work?

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...

August 1, 2008 - Technical Analysis Tested Globally

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...

July 30, 2008 - Momentum Returns for Large Caps

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...

July 25, 2008 - Smirking Because They Know Something?

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...

July 24, 2008 - Persistence of the January Effect

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...

July 23, 2008 - Hedge Fund Performance Persistence

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...

July 22, 2008 - Perspectives on Earnings Growth Forecasts

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...

July 17, 2008 - The Cost of Hope?

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...

July 14, 2008 - An International Test of Common Stock Return Indicators

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...

July 10, 2008 - (Not) Paying for Performance

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...

July 7, 2008 - Extracting Disaster from Index Option Prices

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...

July 1, 2008 - Investor Sentiment and Returns for Different Types of Stocks

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...

June 27, 2008 - Exploiting Industry Momentum Via ETFs?

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...

June 20, 2008 - Effects of Macroeconomic News on Commodity Futures

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...

June 17, 2008 - The Value of Financial Advisors?

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...

June 10, 2008 - Peer Pressure and Individual Investing Behavior

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...

June 2, 2008 - Using Leverage (While Young) to Beat the Market Over the Long Term

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...

May 28, 2008 - Classic Essay: The Foolish, the Theoretical and the Practical

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...

May 23, 2008 - A Drag on Capitalization-weighted Portfolios?

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...

May 22, 2008 - Oil Price Shocks and the Stock Market: The Good, the Bad and the Indifferent

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...

May 20, 2008 - Regulations Suppressing Analysts' Earnings Optimism?

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...

May 16, 2008 - Pros and Cons of 130/30 Funds

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...

May 9, 2008 - Macroeconomic Shocks and the Stock Market

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...

May 7, 2008 - Returns of High-Momentum Stocks Around Earnings Announcements

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...

May 6, 2008 - Industrial Production as a Predictor of Stock Returns

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...

May 1, 2008 - Returns and Success Factors for Commodity Futures Speculators

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...

April 30, 2008 - Inflation as Fed Model Intermediator

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...

April 28, 2008 - Classic Paper: Physical Inventories and Commodity Futures Returns

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...

April 24, 2008 - Cash Flow Trumps Discount Rate in Stock Valuations?

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...

April 23, 2008 - Redemption Fees Signal Mutual Fund Outperformance?

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...

April 21, 2008 - Seasonal Environmental Factors and Perceived Risk

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...

April 17, 2008 - Success for Collaborating Individual Active Traders?

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...

April 16, 2008 - Trading After N-day Highs and Lows

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...

April 10, 2008 - Testing Momentum and Contrarian Commodity Futures Returns

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...

April 8, 2008 - Classic Paper: Returns from Commodity Futures

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...

April 4, 2008 - Outperformance of High-Yield Stocks in the UK

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...

April 2, 2008 - The Outperformance of (Truly) New Hedge Funds

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...

April 1, 2008 - Institutional Trading, Returns and Strength of Anomalies

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...

March 27, 2008 - Do Informed Traders Tip Their Hands Via Option Purchases?

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...

March 26, 2008 - Intraday/Daily Stock Return Patterns

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...

March 25, 2008 - Presidential Politics and Industry Returns

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...

March 21, 2008 - The Timing Performance of Expert Futures Traders

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...

March 20, 2008 - Do Stock Recommendations on Blogs Have Value and Move the Market?

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...

March 19, 2008 - The Volatility Risk Premium and De-biased Equity Option Returns

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...

March 18, 2008 - Predicting Bear Markets

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...

March 17, 2008 - The Interplay of Short Interest and Institutional Ownership

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...

March 10, 2008 - Filtering the Luck Out of Mutual Fund Performance Data

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...

March 7, 2008 - Technical Analysis Tested on Long-run DJIA Data

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...

February 27, 2008 - The Wall Street Journal's SmartMoney Fund Screen

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...

February 25, 2008 - Local Bias and Regional Abnormal Returns: Invest in Depressed States?

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...

February 21, 2008 - Comprehensive Overview of Research on Equity Analyst Forecasting

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...

February 20, 2008 - The Pervasiveness and Persistence of Momentum

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...

February 19, 2008 - The Behavioral Asset Pricing Model

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...

February 8, 2008 - Unconditional Love for Losers?

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...

February 7, 2008 - A Fresh Hedge Fund Horse Every Couple of Years?

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...

February 1, 2008 - Still Irrationally Exuberant?

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...

January 25, 2008 - Reliable Outperformance Among Bond Fund Managers?

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...

January 24, 2008 - Do Hedge Fund Investors Chase or Successfully Time Returns?

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...

January 21, 2008 - The Prospective "Academic" Equity Risk Premium

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...

January 18, 2008 - The January Barometer Retested

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...

January 16, 2008 - Do Hedge Funds Play the "Famous" Anomalies?

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...

January 14, 2008 - Fama and French Dissect Anomalies

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...

January 11, 2008 - Gaming the Earnings/Accruals Gamers?

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...

January 7, 2008 - Combined Value-Momentum Tactical Asset Class Allocation

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...

December 31, 2007 - Analyst Ratings: Levels or Changes?

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...

December 21, 2007 - Bubbles: Ride, Watch or Play the Pop?

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...

December 20, 2007 - Mirror Image Seasonality for Stocks and Treasuries?

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...

December 19, 2007 - Modernizing Equity Return Benchmarks

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...

December 14, 2007 - Mutual Fund Investors Underperform Their Underperforming Funds?

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...

December 12, 2007 - Stock Picking or Industry Picking?

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...

December 11, 2007 - When Momentum Does and Doesn't Work

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...

December 7, 2007 - The Belief Component of Risk Premiums

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...

December 5, 2007 - Do Funds Focused on Just a Few Stocks Outperform?

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...

December 4, 2007 - Does the Fiscal Deficit Really Affect Asset Valuations?

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...

November 30, 2007 - The (Worldwide) Futility of Market Timing?

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...

November 29, 2007 - Reliable Intraday Trades on Federal Funds Rate Decisions?

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...

November 28, 2007 - Recent Speculations on Prediction Markets

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...

November 26, 2007 - How Fund Managers React to Success and Failure

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...

November 21, 2007 - A Tradable Accruals Anomaly

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...

November 16, 2007 - Sector Rotation Based on Monetary Policy

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...

November 15, 2007 - Misunderestimating Volatility?

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:

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November 14, 2007 - Sources of Volatility's Predictive Power for Stock Returns

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...

November 12, 2007 - Asset Growth Rate as a Return Indicator

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...

November 9, 2007 - Invest Like the Ivy League?

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...

November 7, 2007 - Measuring the Level and Persistence of Active Fund Management

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...

November 5, 2007 - Implications of Short Selling with No Tick Test

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...

October 25, 2007 - Evaluating Hedge Fund Managers on Walk, Not Talk

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...

October 24, 2007 - The Stock Picking Expertise of the Business Media

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...

October 19, 2007 - 99 Cents Is Not a Sale Price

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...

October 16, 2007 - Slim Pickings Among Stock Picks of Columnists?

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...

October 11, 2007 - Consistently Expensive Types of Equity Options

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...

October 9, 2007 - Concentrating the Superior Knowledge of Short Sellers

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...

October 3, 2007 - A Different Factor Model for Each Group of Stocks?

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...

October 2, 2007 - Strategies for Investing in Options of Individual Stocks

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...

October 1, 2007 - The Cramer Size Effect?

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...

September 27, 2007 - A Five-Factor Model of Differences in Stock Returns

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...

September 24, 2007 - No Fire Exit at the Overcrowded Hedge Fund Party?

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...

September 21, 2007 - Characteristics of Persistently Outperforming Hedge Funds

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...

September 19, 2007 - Anger Management Training for Traders?

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...

September 18, 2007 - The Disconnected Federal Funds Rate?

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...

September 12, 2007 - The Out-of-Country Experiences of Individual U.S. Investors

How and why do individual U.S. investors diversify internationally? How significantly does this diversification affect their portfolio results? In their April 2007 paper entitled "Foreign Investments of U.S. Individual Investors: Causes and Consequences", Warren Bailey, Alok Kumar and David Ng analyze the motivations and consequences of foreign equity investment by individual U.S. investors. Using personal characteristics and portfolio/trading data from tens of thousands of individual brokerage accounts at a major U.S. discount broker for the period 1/91-12/96, they conclude that: More...

September 10, 2007 - Is 40% Per Month Shorting Index Puts a Fair Return? (Updated 9/8/09 to add a forward link)

Selling put options, with limited upside and potentially very large downside, seems very risky. Are actual returns from selling puts commensurate with the risk? In the May 2004 version of his paper entitled "Why are Put Options So Expensive?", Oleg Bondarenko confirms large returns for shorting puts options on a broad market index and investigates whether these large returns: (1) represent normal risk premiums; (2) are reasonably priced protection against market crashes; or, (3) indicate incorrect investor beliefs about the probability of negative market returns (crashes). Using a flexible testing methodology and daily price data for put options on S&P 500 index futures during 8/87-12/00, he concludes that: More...

September 5, 2007 - Thrill Factor: The Stock Market as Amusement Park?

Has disintermediation of trading, enabled by the Internet, changed the level of risk that individual investors/traders routinely assume? In his 2005 paper entitled "Where the Action is: Internet Stock Trading as Edgework", Detlev Zwick argues that the transition of stock trading from pre-Internet communication modes (telephone, fax and in-person) to the computer screen creates new types of individual experiences and practices that existing economic and finance theories do not predict or understand. Using in-depth oral interviews extended by email follow-ups with 25 experienced online investors in Germany, Denmark, and the United States during 2000-2002, he concludes that: More...

August 31, 2007 - Does the Bullish Percent Index Predict Market Direction?

A reader asked whether the Bullish Percent Index is a useful indicator of overall stock market or sector direction. Does it reliably identify overbought/oversold conditions from which stock prices are likely to revert? In a study published in the 2005 Journal of Technical Analysis, Andrew Hyer relates the simple average Bullish Percent across 40 stock market sectors (BPAVG) to future broad stock market returns. Using weekly levels of BPAVG as calculated by Dorsey, Wright & Associates and overall stock market returns over the next 100 calendar days based on the Value Line Geometric Index for a total sample period of 1/6/98-1/24/05 (about 368 weeks or 26 intervals of 100 calendar days), he concludes that: More...

August 30, 2007 - Finding the Sources and Methods of Financial Expertise in a Haystack

What evidence is there that economically significant financial expertise exists? How can research best discover where such expertise comes from and how it works? In the September 2005 draft of their paper entitled "The Enigma of Financial Expertise: Superior and Reproducible Investment Performance in Efficient Markets", Anders Ericsson, Patric Andersson and Edward Cokely tackle these questions. Based on review of prior research in the context of a broad perspective on expertise across many fields, they conclude that: More...

August 27, 2007 - Modeling the Logic of Valuation-motivated Short Sellers

Can analysis of firm financial data reliably identify future underperformers? Reader Mike Long of Short ALERT suggested for review a "paper that reverse engineers the short recommendations of an independent research firm into a model for selecting good short candidates" (disclosing that the research firm is Short ALERT). In the April 2007 draft of their paper entitled "The Role of Fundamental Analysis in Information Arbitrage: Evidence from Short Seller Recommendations", Hemang Desai, Srinivasan Krishnamurthy and Kumar Venkataraman investigate whether analysis of company financial data reveals good shorting candidates. They first create a model of shorting demand by correlating company financial data for 1997-2004 with 54 valuation-motivated short sale recommendations from 67 reports issued by an independent research firm during 1998-2005. They then test the model out-of-sample (1990-1996) for a larger set of companies. Using the 67 reports, company financial data for 1990-2004 and monthly stock return data for 1990-2006, they conclude that: More...

August 24, 2007 - An International Test of Share Buyback and Secondary Offering Effects on Stock Returns

Are share buybacks/secondary offerings consistently predictive of good/poor future stock returns around the globe? In their August 2007 draft paper entitled "Share Issuance and Cross-Sectional Returns: International Evidence", David McLean, Jeffrey Pontiff and Akiko Watanabe look at the predictive power in international markets of firm-level net share issuance over the past one and five years for stock returns over future periods ranging from the next month to the next three years. Using share issuance data, firm fundamental data and monthly stock returns over the period July 1981 through June 2006 for a large sample of non-U.S. companies in 41 countries, they conclude that: More...

August 21, 2007 - Using Insider Trading to Find Informed Short Sellers

Conventional wisdom says that both short sellers and corporate insiders are typically better informed than most traders. However, much short selling comes from programmed (uninformed) hedging, and much insider trading is pre-planned diversification of concentrated positions by firm executives. Is there a way to overlay the activities of these two groups to isolate truly informed trading? In their July 2007 draft paper entitled "Shorts and Insiders", Amiyatosh Purnanandam and Nejat Seyhun investigate the combined power of unusual levels of short interest and unusual insider trading to predict stock returns. They test for "unusual" short interest and insider trading by subtracting the historical mean from the current value and dividing this difference by the historical standard deviation on a firm-by-firm basis. Using monthly short interest, insider trading and stock return data for all NYSE/AMEX-listed firms during 9/91-12/03, they find that: More...

August 16, 2007 - Trading Friction as a Momentum Killer

Are momentum trading strategies profitable after accounting for trading costs? In their August 2007 draft paper entitled "Low-Cost Momentum Strategies", Xiafei Li, Chris Brooks and Joëlle Miffre analyze the impact of transaction costs on the profitability of momentum strategies for UK stocks. They consider all combinations of 3-month, 6-month and 12 month ranking and holding periods. Using stock price data for 3,520 UK companies and separately for the constituents of the FTSE 100 index (large capitalization stock sample) and the Alternative Investment Market (AIM - small capitalization stock sample) over the period 1986-2005, they conclude that: More...

August 15, 2007 - Do Finance Professors Believe in Market Efficiency?

Do the experts who arguably should have the most informed opinions, finance professors, believe that the U.S. stock market is efficient? Do they invest in accordance with their beliefs? In their August 2007 paper entitled "Market Efficiency and Its Importance to Individual Investors – Surveying the Experts", James Doran, David Peterson and Colby Wright seek to answer these questions via an email-initiated electronic survey of over 4,000 finance professors at accredited U.S. universities and colleges. Using data provided by 642 qualified respondents, they conclude that: More...

August 10, 2007 - Do Some Individual Investors Consistently Outperform?

Is individual investing an inevitable series of randomly spaced ups and downs, or do some investors persistently enjoy more success than others? In their August 2007 paper entitled "Performance Persistence of Individual Investors", Limei Che, Øyvind Norli and Richard Priestley investigate performance persistence among individual stock market investors/traders. Using monthly stock portfolio data for all individual investors who traded at least six times every 24 months on the Oslo Stock Exchange during January 1993 through June 2003 (65,848 investors), they find that: More...

August 9, 2007 - Buy at the Close and Sell at the Open?

What part of the day offers the best stock returns? Does this sweet spot vary by day of the week, time of the month or calendar month? In their July 2007 paper entitled "Return Differences between Trading and Non-trading Hours: Like Night and Day", Michael Cliff, Michael Cooper and Huseyin Gulen use transaction-level data to decompose returns for individual stocks and exchange-traded funds (ETF) into four time intervals: Night (4:00 PM to 9:30 AM), AM (9:30 AM to 10:30 AM), Mid-day (10:30 AM to 3:00 PM), and PM (3:00 PM - 4:00 PM). Using intraday price data for the period 1993-2006, they conclude that: More...

July 31, 2007 - Does Technical Trading Work with Commodity Futures?

Do relatively low transaction costs and ease of short selling enable profitable technical trading in commodity futures markets? In their recent paper entitled "Can Commodity Futures be Profitably Traded with Quantitative Market Timing Strategies?", Ben Marshall, Rochester Cahan and Jared Cahan investigate the effectiveness of 7,846 quantitative trading rules from five rule families (Filter, Moving Average, Support and Resistance, Channel Breakouts, and On-Balance Volume) for 15 kinds of commodity futures contracts. They test these rules for cocoa, coffee, cotton, crude oil, feeder cattle, gold, heating oil, live cattle, oats, platinum, silver, soy beans, soy oil, sugar and wheat futures. Their testing includes two bootstrapping methodologies, adjustment for data snooping bias and evaluations over different time periods. Using daily price and volume data for 1984-2005, they conclude that: More...

July 26, 2007 - Political Influences on Stock Valuation Levels

Do political factors influence stock valuation levels? In his July 2007 paper entitled "Can Political Factors Explain the Behavior of Stock Prices Beyond the Standard Present Value Models?", Tomasz Wisniewski explores the degree to which political factors affect valuation of U.S. equities. Specifically, he examines whether party holding the Presidency (12 presidencies), Presidential approval ratings and timing of eight major military conflicts affect stock price levels relative to rational valuation models. Using data from a variety of sources for the period 1945-2005, he concludes that: More...

July 25, 2007 - Naive Investors: Illusions of Personal Past Performance

Do individuals understand their actual aggregate investing/trading performance? In their July 2007 paper entitled "Why Inexperienced Investors Do Not Learn: They Don't Know Their Past Portfolio Performance", Markus Glaser and Martin Weber measure whether individual investors can correctly estimate personal absolute and relative stock portfolio performance. Using the responses of 215 online investors to a 2001 internet survey and actual portfolio returns for these investors during 1997-2000 as calculated from their holdings during that period, they find that: More...

July 24, 2007 - Australian Stock Market Anomalies

Are anomalies observed with varying and changing levels of confidence among U.S. stocks, such as the size effect and the value premium, evident among stocks of other countries? In their recent paper entitled "Anomalies and Stock Returns: Australian Evidence", Philip Gharghori, Ronald Lee and Madhu Veeraraghavan test for the existence among Australian stocks of a size effect, book-to-market effect, earnings-to-price (E/P) effect, cash flow-to-price (C/P) effect, leverage (debt-to-equity) effect and liquidity (share turnover) effect. Using stock price data for 1/92-12/05 and associated accounting data for 1/92-12/04, they conclude that: More...

July 20, 2007 - The Truly Active Part of Active Fund Management

In his May 2007 paper entitled "Where Do Alphas Come From?: A New Measure of the Value of Active Investment Management", Andrew Lo proposes a decomposition of the economic value of a fund's management into two components, one measuring security selection (a weighted average of portfolio asset returns) and the other measuring timing (the correlation between portfolio asset weights and asset returns). When correlation between portfolio weights and returns is positive, management is moving assets toward optimization of overall portfolio returns. In other words, a manager can add value by: (1) picking the right assets; and, (2) continually growing positions with the highest future returns and shrinking positions with the lowest future returns. Using multiple examples, he argues that: More...

July 17, 2007 - Responding to Energy Price Inflation at the Federal Reserve

Our Real Earnings Yield Model comes in two flavors, one that uses total inflation and one that uses core inflation to specify the "correct" aggregate stock market earnings yield. What are the implications of strong energy price inflation for these model alternatives? In their July 2007 paper entitled "Taylor Rules with Headline Inflation: A Bad Idea", Rajeev Dhawan and Karsten Jeske examine how central bankers should respond to energy price inflation in setting interest rates. Specifically, they test a modeled economy's behavior when a central bank following a Taylor rule (interest rate response rule) faces a doubling of energy prices. Using a complex rational expectations model, they conclude that: More...

July 16, 2007 - (Low) Volatility as an Indicator of Persistent Hedge Fund Outperformance

Market conditions vary considerably across the business cycle, presumably affecting the opportunity set for a given investing style/strategy. What are the return characteristics that predict which hedge funds can best navigate changing economic conditions? In his 2007 paper entitled "The Sustainability of Hedge Fund Performance: New Insights", Daniel Capocci decomposes hedge fund returns to determine how investors can reliably identify funds that outperform equity and bond indexes in both bull and bear markets. Using monthly return data for the 1994-2002 business cycle from two sources (3,060 individual funds and 907 funds of funds) to investigate 14 potentially useful persistence discriminators, he concludes that: More...

July 12, 2007 - Professional Economists Forecasting Stock Returns

Via the semiannual Livingston Survey, the Federal Reserve Bank of Philadelphia solicits forecasts for the S&P 500 index (and many other U.S. economic measures) from economists in industry, government, banking and academia. How good are their forecasts? In his June 2007 paper entitled "Predicting Stock Price Movements: Regressions versus Economists", Paul Söderlind examines the aggregate stock return forecasting ability of surveyed experts. Using median forecasts for stock market gains during the interval 6-12 months after survey dates and associated actual data for 1952-2005, he concludes that: More...

July 10, 2007 - Perfect Sector Rotation

Is the conventional wisdom that stocks of different sectors outperform systematically during different phases of the business cycle correct, and exploitable? In their July 2007 paper entitled "Sector Rotation over Business-Cycles", Jeffrey Stangl, Ben Jacobsen and Nuttawat Visaltanachoti test a sector rotation strategy that times U.S. sector stock holdings over U.S. business cycles, as defined by the National Bureau for Economic Research (NBER). The conventional sector outperformance wisdom they evaluate comes from Standard & Poor's Guide to Sector Investing 1995. Using monthly industry returns, market returns and Treasury bill rates for 1948-2006 (nine complete business cycles), they find that: More...

July 9, 2007 - Multi-year Reversals for Past Winners and Losers

Are multi-year runs of bad (good) performance by individual stocks indicative of future returns? In other words, does the long-run behavior of stocks on average persist, reverse or fade to random? In their October 2006 paper entitled "Return Reversal in UK Shares", Glen Arnold and Rose Baker examine the magnitude, persistence and source of reversals for UK stock returns. Using monthly total return and associated fundamentals data for stocks listed on the London Stock Exchange over the prior five calendar years during 1975-2002 (48 years), they find that: More...

July 6, 2007 - When the Going Gets Tough, the Predictive Power Gets Going?

When times are good, the powers that be (central banks for interest rates and corporate boards for payouts to shareholders) have more latitude to buffer reactions to changes in the business environment. Does this latitude make widely used indicators of future stock returns less useful, or useless, during expansions? In their June 2007 draft paper entitled "Short-Horizon Predictability and Information Erosion", Sam James Henkel, Spencer Martin and Federico Nardari investigate how the predictability of equity market returns varies across the business cycle. They focus on the dividend yield, the short-term interest rate, the slope of the term structure and the default premium as predictors of stock returns. Using monthly data spanning April 1953 to December 2005 for the U.S. (634 months) and comparable data as available for Canada, France, Germany, Italy, Japan and the UK, they find that: More...

June 28, 2007 - Calibrating Ancient History

Our blog entry of 6/18/07 offers a simple taxonomy of financial markets research with four categories. Quadrant 3 of this taxonomy involves studies that use relatively large sampling intervals and very long overall sample durations, thereby achieving the inherent statistical reliability of large samples but risking the disruption of confounding factors (structural breaks in data relationships). Is there a way to deal with structural breaks more precisely than just expressing vague skepticism about the usefulness of old data? In the April 2007 draft of their paper entitled "How Useful Are Historical Data for Forecasting the Long-run Equity Return Distribution?", John Maheu and Thomas McCurdy describe and test a methodology for identifying and calibrating structural breaks in long-term excess equity returns. Using monthly U.S. equity return and risk-free rate data for the period February 1885 through December 2003, they conclude that: More...

June 27, 2007 - Abnormal Returns from Selling Index Put Options?

Are equity investors on average irrationally afraid of market plunges, and therefore willing to overpay for index put options? In their October 2004 paper entitled "A Portfolio Perspective on Option Pricing Anomalies", Joost Driessen and Pascal Maenhout investigate the benefits of index options positions to asset allocating investors. In the June 2007 version of their paper entitled "Understanding Index Option Returns", Mark Broadie, Mikhail Chernov and Michael Johannes compare historical option returns to those generated by commonly used option pricing models. These studies find that: More...

June 26, 2007 - Do Investors Fairly Value Stocks of the Most Admired Companies?

Reader Laurent Condon, a hedge-fund manager at Zen Asset Management SA, flagged a study of the performance of stocks of the most admired companies. In their 2005 paper entitled "A Great Company Can Be a Great Investment", Jeff Anderson and Gary Smith evaluate the stock returns of companies rated highest in Fortune magazine’s annual surveys of "America’s Most Admired Companies." Survey respondents are senior executives, directors and securities analysts, and the questions asked seemingly relate indirectly or directly to the investment value of the companies named. Using lists for 1983 (survey inception) through 2004 (a total of 22 years) and associated stock return data for the publicly held companies on the lists, they conclude that: More...

June 22, 2007 - The Predictive Power of the Put-Call Ratio for Individual Stocks

In our blog entries of 5/8/07 and 5/9/07, we conclude that the aggregate put-call ratio is of little help in predicting the future direction of the overall stock market. How about put-call ratios for individual stocks? In their 2006 paper entitled "The Information in Option Volume for Future Stock Prices", published in The Review of Financial Studies, Jun Pan and Allen Poteshman investigate the predictive power of put-call ratios for the returns of individual stocks. They define the put-call ratio as put buy-to-open volume divided by the sum of put and call buy-to-open volumes. Using daily volumes for all Chicago Board Options Exchange (CBOE) listed options and associated stock price data during 1990-2001, they find that: More...

June 20, 2007 - Using Firm Productivity Measures to Enhance Stock Returns

Investors ought to reward a company that employs capital productively. One measure of firm productivity is return on invested capital (ROIC), the ratio of operating income to invested capital (debt plus equity minus cash from the balance sheet). Do stocks of high-ROIC firms outperform those of low-ROIC firms? In their June 2007 paper entitled "The Productivity Premium in Equity Returns", David Brown and Bradford Rowe examine the relationship between ROIC and stock returns for both value stocks and growth stocks. They define value (growth) companies as those with high (low) CTEV, the ratio of invested capital (book value of equity plus debt minus cash) to enterprise value (market value of equity plus debt minus cash). Using monthly stock price data and contemporaneously available accounting fundamentals for the 1,000 largest U.S. companies during 1970-2005, they conclude that: More...

June 19, 2007 - Hiring and Firing Investment Managers

The sponsors of retirement/endowment plans (public and corporate pension plans, unions, foundations and endowments) retain professionals to manage their funds. Do their decisions to hire and fire such professionals pan out? In other words, do their plans outperform the market after they change managers? In their May 2006 paper entitled "The Selection and Termination of Investment Management Firms by Plan Sponsors", Amit Goyal and Sunil Wahal examine this question. Using data for 8,204/910 hiring/firing decisions by 3,591 plan sponsors during 1994-2003, they conclude that: More...

June 15, 2007 - Some Notes on Financial Econometrics

Financial econometrics gives empirical life (and death) to financial market models. Where has this rapidly growing branch of economics been, where is it now and where is it going? In the October 2006 revision of his article entitled "Financial Econometrics", Andrew Lo provides an introduction to four decades of the field's most influential academic papers. Some of his key points are: More...

June 8, 2007 - Evolution of the Efficient Markets Hypothesis

Are investing results ultimately just good or bad luck? In conflict with intuition perhaps derived from an essential human sense of self-worth, the strictest form of the Efficient Markets Hypothesis (EMH) says yes. Where has the EMH been and where is it going? In his recent article for The New Palgrave: A Dictionary of Economics, Second Edition entitled "Efficient Markets Hypothesis", Andrew Lo assesses the past and the future of the EMH. Some of his key points are: More...

June 6, 2007 - Chumming with Sharks?

When hedge funds publicly demand that management of firms in which the funds hold large stakes take steps to improve stock prices, should other investors take notice? Do such demands distract or focus management regarding shareholder interests? In the November 2006 draft of their paper entitled "Hedge Fund Activism, Corporate Governance, and Firm Performance" (flagged by reader Marvin Kline), Alon Brav, Wei Jiang, Frank Partnoy and Randall Thomas investigate the relationship between hedge fund activism and stock returns. They identify instances of fund activism by (1) searching 2001-2005 news databases for stories mentioning both "activism" and "hedge fund" and (2) analyzing associated SEC Schedule 13D filings, with special attention to the reasons for the transactions as stated in the filings. Using the resulting set of 888 events involving 131 funds and 775 companies, they conclude that: More...

June 1, 2007 - How Well Do Experts Time Trades of Individual Stocks?

At Guru Grades, we measure the ability of stock market experts to time the overall stock market. While much of the movement of individual stock prices correlates with overall market behavior, timing of trades for individual stocks involves additional industry-related and company-specific decision factors. How well do experts perform in timing individual stock trades? In their May 2007 paper entitled "Individual Security Timing Ability and Fund Manager Performance", David Gallagher, Andrew Ross and Peter Swan define individual security timing ability as the proportion of potential returns obtained by a trader over the holding period and measure this ability for a set of active Australian equity fund managers. Using a unique database of daily trades and monthly portfolio holdings for 30 fund managers from January 1996 through December 2001, they conclude that: More...

May 31, 2007 - Value Versus Growth Among Large European Firms

Does value beat growth among the stocks of large European firms? In their May 2007 paper entitled "Style Migration in the European Markets", Antti Pirjetä and Vesa Puttonen compare the performances of simple value and growth styles against MSCI Europe as a benchmark index. They employ a market value-book value ratio (P/BV) to define four style portfolios formed at the end of 2001 and held for five years: (1) median value, consisting of companies with P/BV below the median; (2) median growth, consisting of companies with P/BV above the median; (3) 30-70 value, consisting of companies with P/BV in the bottom 30%; and, (4) 30-70 growth, consisting of companies with P/BV in the top 30%. Using stock return and accounting data for more than 500 of the largest European firms over the period 2001-2006, they conclude that: More...

May 30, 2007 - The Long and Short of Beta

Beta measures the volatility of a stock with respect to the broad market. However, after accounting for the value premium and size effect, the generally accepted beta has no predictive power for future stock returns. Is that all there is to beta? In their May 2007 paper entitled "Long-Term and Short-Term Market Betas in Securities Prices", Gerard Hoberg and Ivo Welch decompose beta into short-term (the last 12 months) and long-term (one to ten years ago) components and investigate whether these components can separately forecast stock returns. Using daily stock prices and financial data for a large sample of companies (an average of over 3,300 firms per month) over the period 1962-2005, they find that: More...

May 23, 2007 - The 52-Week High as a Momentum Indicator for Individual Stocks

A reader notes and asks: "It is frequently said that stocks at 52-week highs are the most likely to outperform in the future. Is there any academic evidence to support this assertion?" In their October 2004 Journal of Finance article entitled "The 52-Week High and Momentum Investing", Thomas George and Chuan-Yang Hwang examine the explanatory power of the 52-week high in the context of momentum investing. They compare the 52-week high as a momentum indicator to benchmark momentum strategies that employ six months of past returns to forecast six months of future returns. Using price data for a broad range of stocks over the period 1963-2001, they find that: More...

May 22, 2007 - Inflation, Monetary Policy and the Stock Market

What conditions lead to stock market booms and busts, and how does monetary policy relate to boom-bust transitions? In the May 2007 version of their paper entitled "Monetary Policy and Stock Market Booms and Busts in the 20th Century", Michael Bordo, Michael Dueker and David Wheelock examine the relationship between monetary policy and stock market booms/busts in the U.S., U.K. and Germany during the 20th century. They define booms (busts) as periods of at least 36 (24) months from trough to peak (peak to trough) with at least 10% (20%) average annual increase (decrease) in real stock prices. Using monthly inflation-adjusted stock price indexes, they conclude that: More...

May 21, 2007 - Does Customer Satisfaction Translate to Excess Stock Returns?

Do companies with high marks for customer satisfaction outperform as investments? Or, instead, does making customers happy crimp profit margins and stock returns? In their January 2006 Journal of Marketing article entitled "Customer Satisfaction and Stock Prices: High Returns, Low Risk", Claes Fornell, Sunil Mithas, Forrest Morgeson III and M.S. Krishnan investigate the relationship between customer satisfaction as measured by the American Customer Satisfaction Index (ACSI) and stock returns. ACSI measurements are updated annually for each company rated. Using ACSI ratings for publicly traded companies during 1994-2004 and associated firm accounting and stock price data, they find that: More...

May 18, 2007 - Increased Reliability for Buyback Announcements?

Since the mid-1980s, stock repurchases have increasingly displaced dividends as a means for companies to return cash to the equity market. Buybacks affect stock prices by reducing the the denominator in the earnings per share calculation, thereby elevating the value of shares still outstanding. However, firms that announce buybacks may not actually execute them, or may execute them only partially. Are stock buybacks, due to increased information transparency, more reliable now than they used to be? In his recent paper entitled "The Effect of Enhanced Disclosure on Open Market Stock Repurchases", Michael Simkovic examines whether the SEC requirement that companies disclose repurchase activity on a quarterly basis as of 2004 has increased the likelihood that firms will follow through on buyback announcements. Using repurchase activity data over the 20 months after each of 365 buybacks announced during 2004 for comparison with data from two pre-disclosure studies, he concludes that: More...

May 17, 2007 - Do Good Employers Make Good Investments?

Do companies famously known as good places to work outperform as investments? Or, contrarily, do they waste resources keeping employees happy? In his May 2007 paper entitled "Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices", Alex Edmans analyzes the relationship between employee satisfaction and long-term stock performance. He identifies companies with exceptionally satisfied employees via Fortune magazine's annual list of the "100 Best Companies to Work for in America." Using these lists for 1998-2005 and monthly stock price data for the publicly traded companies in the lists (about 60 per year), he finds that: More...

May 7, 2007 - Testing the Value Premium Down Under

Is the value premium so fundamental that its exists generally among stock markets? In their recent paper entitled "Value versus Growth: Australian Evidence", Philip Gharghori, Sebastian Stryjkowski and Madhu Veeraraghavan test the abilities of indicators based on several alternative definitions of "value" to explain the cross-sectional variation in stock returns in Australia. Specifically, they test book-to-market value ratio (B/M), sales-to-price ratio (S/P), cash flow-to-price ratio (C/P) and earnings-to-price ratio (E/P). They also compare the predictive powers of these value indicators to those of size and debt-to-equity ratio (D/E). Using firm financial data for 1/92-12/04 and associated monthly stock prices for 1/93-12/04 (a total of 137,139 firm-month observations), they find that: More...

May 3, 2007 - Left Versus Right Down Under

Are "hands-off" (right-leaning) governments better for stocks than "hands-on" (left-leaning) governments? In their recent paper entitled "Investment Returns Under Right- and Left-Wing Governments in Australasia", Hamish Anderson, Christopher Malone and Ben Marshall examine the effect of ruling party orientation on inflation, and thereby on stock, property and bond returns, in Australia and New Zealand. Using monthly, annual and political-term data as available across the period 1910-2006, they find that: More...

April 25, 2007 - Technical Analysis: "Anathema to the Academic World"?

Technical analysis seeks to exploit stock mispricings derived from postulated investor/trader psychological biases. Does short-term technical analysis actually produce abnormal returns? Or, do its adherents persist based on a misperception that they are to some degree in control of random rewards. In their February 2006 paper entitled "Does Intraday Technical Analysis in the U.S. Equity Market Have Value?", Ben Marshall, Rochester Cahan and Jared Cahan investigate whether intraday technical analysis is profitable in the overall U.S. equity market. Specifically, they apply a combination of statistically rigorous bootstrapping tests to 7,846 trading rules from five rule families (Filter, Moving Average, Support and Resistance, Channel Breakouts, and On-Balance Volume). Using 5-minute data for Standard and Poor’s Depository Receipts (SPDR) over the period 1/1/02-12/31/03 (encompassing both bear and bull trends), they conclude that: More...

April 24, 2007 - Wet Beats Dry for Portfolio Growth?

Do stocks that are difficult to trade (have low liquidity) offer abnormal returns as compensation for the risk of getting out of them? Or, is this reward-for-risk intuition unsound? In their recent paper entitled "Cross-Sectional Stock Returns in the UK Market: the Role of Liquidity Risk", Soosung Hwang and Chensheng Lu investigate the relationship between liquidity and return for individual stocks, with focus on the link between liquidity and the value premium. They introduce a new measure of liquidity based on the absolute change in stock price per unit of turnover, with turnover calculated as the fraction of firm market capitalization traded. Using price, trading volume, capitalization and fundamentals data for UK stocks over the period 1987-2004, they conclude that: More...

April 23, 2007 - Low Risk and High Return?

Stocks with high historical volatility should produce high returns as reward for extra risk. Shouldn't they? In the April 2007 version of their paper entitled "The Volatility Effect: Lower Risk without Lower Return", David Blitz and Pim van Vliet examine the relationship between long-term (past three years) historical return volatility and risk-adjusted return for stocks worldwide. Ranking stocks based on historical volatility has some similarity to ranking them based on beta. Using monthly price and fundamental data for a large number of large-capitalization stocks over the period December 1985 through January 2006, they find that: More...

April 19, 2007 - Testing the Head-and-Shoulders Pattern

Does the head-and-shoulders stock price pattern embody investor attitudes that traders can exploit to earn abnormal returns? Or, does it represent an opportunity for the statistics-challenged to be fooled by randomness? In their October 2006 paper entitled "The Predictive Power of 'Head-and-Shoulders' Price Patterns in the U.S. Stock Market", Gene Savin, Paul Weller and Janis Zvingelis use a pattern recognition algorithm, as filtered based on the experience of a technical analyst, to determine whether head-and-shoulders price patterns formed across intervals of 63 trading days have predictive power for future stock returns over the next few months. Using daily price data during 1990-1999 for all stocks in the S&P 500 and Russell 2000 indexes as of June 1990, they conclude that: More...

April 18, 2007 - Candlesticks? Fiddlesticks! (Updated 4/18/07)

Does candlestick technical analysis (examining relationships among opening, high, low and closing prices over the past 1-3 days to identify continuation and reversal signals) generate abnormal returns? In their recent paper entitled "Market Timing with Candlestick Technical Analysis", Ben Marshall, Martin Young and Lawrence Rose test the profitability of trading stocks included in the Dow Jones Industrial Average based on 28 different candlestick signals. They assume a ten-day holding period after trading at the close on the day after a signal appears. Using stock price data for 1/1/92-12/31/02, they conclude that: More...

April 17, 2007 - How Finance Professors Invest

How does "the group that is arguably best qualified, finance professors, ...assess the importance of valuation techniques, asset-pricing models, market anomalies, firm characteristics, corporate events, seasonal variables, and other information" when they invest for themselves? In their April 2007 paper entitled "What Really Matters When Buying and Selling Stocks?", James Doran and Colby Wright seek to answer this question via an email-initiated electronic survey of 4,525 finance professors at accredited U.S. universities and colleges. Using data provided by 642 qualified respondents, all with Ph.D.'s, they conclude that: More...

April 11, 2007 - The Value Premium Looking Forward

How much of a long-term total return advantage do investors perceive for high book-to-market (value) stocks over low book-to-market (growth) stocks? Is this perceived premium stable over time? In their April 2007 paper entitled "The Expected Value Premium", Long Chen, Ralitsa Petkova and Lu Zhang measure investor expectations for the value premium based on economic fundamentals rather than noisy historical returns. They assume that dividend growth rate equals capital gain rate over long periods, and that the top (bottom) 20% represents a high (low) the book-to-market ratio. Using monthly data for the period 1945-2005, they find that: More...

April 10, 2007 - A Survey of the Factor Landscape

Many equity market researchers assume conventional three-factor (market return, size, book-to-market) and four-factor (plus momentum) models as standards of comparison for discovery of new sources of abnormal returns. Are they the best standards? Could they be derivatives of more economically fundamental sources of differences among individual stock returns? In their March 2007 paper entitled "Too Many Factors! Do We Need Them All?", Soosung Hwang and Chensheng Lu seek to identify the minimum number of economically fundamental factors needed to explain why different stocks generate different returns. They investigate 16 factors (12 firm characteristics and four macroeconomic measures) that others have found to explain such return differences. Their principal test is to measure returns from zero-cost portfolios that are long stocks with high (top third) values and short stocks with low (bottom third) values of evaluated factors. Using data for a large sample of non-financial stocks during 1963-2005 and contemporaneous macroeconomic data, they conclude that: More...

April 9, 2007 - Conservatism Bias in Earnings Forecasts

Do earnings forecasts contain information that investors can exploit to generate abnormal stock returns, or does the market efficiently discount these forecasts? In the November 2006 version of their paper entitled "Forecasted Earnings per Share and the Cross Section of Expected Stock Returns", Ling Cen, John Wei and Jie Zhang investigate whether stocks with high forecasted earnings per share (FEPS) substantially outperform those with low forecasts, after controlling for commonly used risk factors. Using data for a large sample of NYSE, AMEX and Nasdaq-listed common stocks for the period January 1983 through December 2005 (712,563 stock-month observations), they conclude that: More...

April 4, 2007 - Investors as Social (Relative Wealth) Climbers

Are investors/traders motivated primarily by absolute wealth or relative wealth? Is outperforming peers a strong motivation? In the February 2007 draft of his paper entitled "Why Risk is Not Related to Return", Eric Falkenstein examines evidence for and implications of relative wealth as the principal motivator of investors. Using a wide range of examples, he argues that: More...

April 3, 2007 - Does Earnings Acceleration Mean Anything for Investors?

How does the second derivative (acceleration) of earnings relate to stock returns? In their March 2007 paper entitled "Does Earnings Acceleration Convey Information?", Ying Cao, Linda Myers and Theodore Sougiannis investigate how the change in earnings growth rate (earnings acceleration) relates to stock returns. They examine separately conditions in which earnings growth rate and earnings acceleration have the same and opposite signs. Using a large sample of U.S. non-financial and non-utility firms over the period 1965 to 2002 (66,150 firm-year observations), they conclude that: More...

March 30, 2007 - A 12-Month Cycle for Stock Returns?

Do stocks have annual rhythms beyond the January effect? In their March 2007 paper entitled "Common Patterns of Predictability in the Cross-Section of International Stock Returns", Steven Heston and Ronnie Sadka investigate cyclic patterns of return predictability for stocks in Canada, Japan and twelve European countries (chosen based on the number of firms available for analysis). Using monthly returns over the period January 1985 through June 2006 (258 months), they conclude that: More...

March 28, 2007 - The Size Effect in Up and Down Markets

Does the size effect, the tendency of small capitalization stocks to outperform, hold in both advancing and declining markets? In their March 2007 paper entitled "Stock Market Returns and Size Premium", Jungshik Hur and Vivek Sharma explore how the size premium differs when the overall stock market is moving up and down. Using monthly return data for a sample of NYSE/AMEX stocks for July 1931 through December 2004 and NASDAQ stocks for June 1975 through December 2004, they conclude that: More...

March 27, 2007 - Why Gurus Go to Extremes

Are stock market forecasters prone to hyperbole? Is there logic to predicting plunges and melt-ups at probabilities unjustified by rigorous empirical analysis? In their February 2007 paper entitled "Probability Elicitation, Scoring Rules, and Competition among Forecasters", Kenneth Lichtendahl, Jr. and Robert Winkler apply game theory to model the behavior of forecasters who pit themselves not only against the data, but also against each other. In other words, they examine the logical behavior of a forecaster whose reward depends not only on own accuracy but also on the accuracies of competing forecasters. When forecasters compete, they conclude that: More...

March 26, 2007 - Testing Benjamin Graham Out of Sample

Does old-fashioned value investing still work? In their recent paper entitled "Testing Benjamin Graham’s Net Current Asset Value Strategy", Ying Xiao and Glen Arnold test Benjamin Graham's approach to valuation based on net current asset value to market value (NCAV/MV) to see whether it outperforms in a modern market environment. NCAV is current assets minus all current and long-term liabilities, divided by the number of shares outstanding. The strategy assumes that a stock is substantially undervalued when NCAV/MV is 1.5 or greater. Using accounting and return data for stocks listed on the London Stock Exchange during 1980-2005, they find that: More...

March 23, 2007 - Shark Attacks?

Do some short sellers employ sharp intraday attacks on targeted stocks to trigger temporary plunges, during which they cover at a profit? In the March 2007 draft of his paper entitled "Predatory Short Selling", Andriy Shkilko examines empirical evidence of such behavior. Using all trades and quotes in Nasdaq-listed stocks during regular trading hours from April 2005 to April 2006, he identifies 1,482 potential predatory attacks and concludes that: More...

March 22, 2007 - The Ignored-by-the-MSM (Information Risk) Premium?

How does main-stream media (MSM) coverage of companies relate to returns on their stocks? Does coverage reduce risk by disseminating information? In their February 2007 paper entitled "Media Coverage and the Cross-Section of Stock Returns", Lily Fang and Joel Peress examine how media coverage (Wall Street Journal, New York Times, USA Today and Washington Post) relates to stock returns. Using article counts and other data (on trading, accounting, analyst coverage and ownership) for all NYSE-lilsted companies and 500 randomly selected Nasdaq-listed companies over the period 1993-2002, they find that: More...

March 19, 2007 - Hedge Fund Stock Picking and Trade Timing

Are hedge fund managers the best and brightest when it comes to stock picking and market timing? In their March 2007 paper entitled "How Smart are the Smart Guys? A Unique View from Hedge Fund Stock Holdings", John Griffin and Jin Xu investigate whether hedge fund managers are better at picking stocks and investing styles than mutual fund managers. Using the stock holdings of 306 hedge fund companies from 1980 to 2004 as reported in quarterly SEC Form 13F equity filings, they conclude that: More...

March 16, 2007 - The Buyback Indicator Still Going Strong?

Are stock buybacks still good indicators of future strong returns, or have investors driven this anomaly from the market? If they still work, why? In their January 2007 paper entitled "The Nature and Persistence of Buyback Anomalies", flagged by reader Marvin Kline, Urs Peyer and Theo Vermaelen investigate whether market recognition has eliminated or attenuated the stock repurchase anomaly. Using a sample of 3,481 repurchase announcements spanning 1991-2001, they find that: More...

March 14, 2007 - Whose Sentiment Matters, and for What Horizon?

Is sentiment a useful trading indicator? In their December 2006 paper entitled "On the Predictive Power of Sentiment: Why Institutional Investors Are Worth Their Pay", Bernhard Zwergel and Christian Klein measure the forecasting abilities of institutional and private investors and test out of sample a related trading strategy. Their source data comes from the sentix weekly sentiment survey, asking as many as 700 investors (25% institutional and 75% private investors) about the future one-month (short term) and six-month (medium term) directions of ten stock markets. Using this data for six of these markets over the period 2/23/01-2/2/06, they conclude that: More...

March 13, 2007 - Enhancing the Value Premium Via P/E Analysis

Reader Richard Beddard, editor of Interactive Investor, flagged a series of three studies by Keith Anderson and Chris Brooks on approaches to enhancing the value premium via empirical analysis of the price-earnings ratio (P/E) calculated with lagged earnings. One study seeks to optimize value indication based on the extent and weighting of historical earnings used in the P/E calculation. The second study seeks to concentrate the value premium by decomposing P/E into components related to market, firm size, industry and company-specific factors. The third study combines the findings of the first two and examines the returns for the extreme tails of the enhanced P/E distribution. All three studies use earnings and stock return data for a broad range of UK companies (excluding the smallest) for the period 1975-2004. Summaries of the three studies follow. More...

March 12, 2007 - The Stock Supply Cycle

Does the business cycle beget a stock supply cycle? In their January 2007 paper entitled "Corporate Event Waves", Raghavendra Rau and Aris Stouraitis examine the relationships among five different kinds of stock supply additions and subtractions: initial public offerings (IPO); seasoned equity offerings (SEO); stock-financed acquisitions; cash-financed acquisitions; and, stock repurchases. Using data for 151,000 U.S. corporate stock supply transactions during the period 1980-2004, they conclude that: More...

March 9, 2007 - Institutional Herding and the Value Premium

What causes the value premium, a rational risk factor or an irrational overreaction? If the latter, who overreacts and to what? In his February 2007 paper entitled "Institutional Investors, Intangible Information and the Book-to-Market Effect", Hao Jiang investigates a connection between the value premium and the trading behavior of institutional investors. Specifically, he tests whether institutions overreact to intangible information (that not derived directly from firm accounting measures). Using data on returns, accounting fundamentals and institutional ownership encompassing 49,164 firm-years over the period 1981-2004, he concludes that: More...

March 8, 2007 - Loss of Momentum?

Has the focus of investors/traders (especially hedge funds) on stock return momentum, the persistence of outperformance and underperformance, killed the effect? In their March 2007 paper entitled "The Disappearance of Momentum", Soosung Hwang and Alexandre Rubesam investigate trends in the momentum effect over a long period. Their baseline analysis examines sets of ten momentum-ranked portfolios formed on past five-month returns and held for six months, with an intervening month skipped. Using monthly return data for a large number of individual NYSE, AMEX and Nasdaq stocks over the period July 1926 through December 2005, they conclude that: More...

March 7, 2007 - Outperformance from Mechanically Selling Covered Calls on a Stock Index

Are there simple and safe equity option strategies that work? In their January 2007 paper entitled "The Risk and Return Characteristics of the Buy Write Strategy On The Russell 2000 Index", Nikunj Kapadia and Edward Szado evaluate returns for a mechanical buy-write (covered call) strategy based on the Russell 2000 index. Strategy variations encompass selling calls the day before each options expiration date that are: (1) at the money, 2% away from the money or 5% away from the money; and (2) one or two months from expiration. The strategy closes each expiring call position at intrinsic value. Using data from January 18, 1996 to November 16, 2006 to analyze returns on an monthly expiration-to-expiration cycle, they find that: More...

March 6, 2007 - Recent Evidence on Individual Investor Performance

What is the recent evidence on the performance of individual investors? Do some persistently outperform and, if so, why? In the February 2007 draft of their paper entitled "The Performance and Persistence of Individual Investors: Rational Agents or Tulip Maniacs?", Rob Bauer, Mathijs Cosemans and Piet Eichholtz examine the performance and persistence of individual investors trading at a Dutch online broker. Using a database consisting of more than 68,000 accounts and eight million trades in stocks, bonds and derivatives during January 2000 to March 2006, they find that: More...

March 5, 2007 - Net Flow of Cash from Company to Investors as a Return Indicator

Are company stock buybacks equivalent to cash dividends for stockholders? Conversely, are company sales of stock "undividends" for stockholders? Reader Marvin Kline flagged a forthcoming article in the April 2007 Journal of Finance that addresses these questions. In the underlying September 2005 paper entitled "On the Importance of Measuring Payout Yield: Implications for Empirical Asset Pricing", Jacob Boudoukh, Roni Michaely, Matthew Richardson and Michael Roberts compare the predictive powers of several alternative measures of company payout encompassing dividends, stock repurchases and stock issuances. Using a maximum sample period of 1926-2003 (with stock repurchase data available only since 1971), they find that: More...

March 1, 2007 - What Puts Brits in the Mood (for Buying or Selling Stocks)?

Do macroenvironmental variables affect stock returns by influencing aggregate investor mood? In their February 2007 paper entitled "Mood and Uk Equity Pricing", Michael Dowling and Brian Lucey investigate the relationship between between a variety of mood variables (temperature, precipitation, wind speed, geomagnetic storms, Seasonal Affective Disorder, Daylight Savings Time Changes and lunar phases) and returns for a broad UK stock index and a small-capitalization UK stock index. Using daily data for the period 12/12/04-11/10/04, they conclude that: More...

February 28, 2007 - Fear Factor?

In one of the financial markets alternate universes, anchored on the Fama-French three-factor model, the central explanatory theme is reward-for-risk. The three factors in this model are the market (equity) premium , the value premium and the size effect. Within this model, each factor presents to investors an opportunity to boost mean return in exchange for bearing more violent variation of return. The Carhart four-factor model adds a momentum effect as an additional risk factor. Should implied market volatility (the "investor fear gauge"), as measured by such variables as the CBOE Volatility Index (VIX) be a fifth risk factor? In their February 2007 paper entitled "Fear and the Fama-French Factors", Robert Durand, Dominic Lim and Kenton Zumwalt examine the case for adding investor expectations for overall market volatility (a "fear factor") to establish a five-factor model of equity market behavior. Using daily data for the period 2/93-12/03, they find that: More...

February 27, 2007 - An Investor's Asset Class Momentum Trading Strategy

How well does momentum trading of asset classes work in the real world? In his January 2006 investing policy entitled "Class OutPerformance (COP) Strategy", reader and individual investor Mal Williams describes and justifies a dynamic investing strategy based on recent asset class outperformance. His historical justification is based on monthly return data (from Morningstar Principia) for 50 asset class proxies (exchange-traded funds and mutual funds) over a 17-year period. His implementation strategy selects the 10-15 asset class proxies with the highest momentum over the past 12 months, rebalanced monthly. He finds that: More...

February 23, 2007 - Rise of the Machines? Attack of the Clones?

Do real live hedge funds beat mechanical trading systems designed to replicate their statistical return distribution and diversification properties? In their February 2007 paper entitled "Replication-Based Evaluation of Hedge Fund Performance", Harry Kat and Helder Palaro update their comparison of the after-fee performances of a wide range of hedge funds to the performances of mechanical replicants. In short, they attempt to isolate true hedge fund outperformance by pitting each actual fund against a replicant that mechanically trades a basket of Eurodollar, 5-year note, 10-year note, S&P 500, Russell 2000 and GSCI futures. Their replication process assumes an existing investor portfolio (to be hedged) that is 50% S&P 500 index and 50% long-term T-bonds. Using return data for 2073 individual hedge funds and 875 funds of hedge funds through November 2006, they find that: More...

February 20, 2007 - The Quarterly Earnings Forecast Walk-Down

How do analyst earnings forecasts vary across financial reporting periods? Does the desire of analysts to maintain a good relationship with firm management affect earnings forecasts? In their February 2007 paper entitled "Relationship Incentives and the Optimistic/Pessimistic Pattern in Analysts' Forecasts", Robert Libby, James Hunton, Hun-Tong Tan and Nicholas Seybert report the results of controlled blind experiments involving experienced sell-side financial analysts that address these questions. Using information gained from "training sessions" for a group of 47 analysts from a single large investment banking/brokerage firm and 34 analysts from a medium-sized regional brokerage firm, they conclude that: More...

February 16, 2007 - The Diversity and Persistence of Quacks

Suppose quack financial advisors offered their services to naive investors. What would happen? In the December 2005 version of his paper entitled "The Market for Quacks", Ran Spiegler applies game theory to a scenario that fits by analogy. He imagines a group of "quacks" in a price competition to attract and retain "patients" who recover with some probability, regardless of whether they pay a quack for "treatment." If the patients were rational, they would induce that the quack services are worthless and would acquire none. However, if the patients succumb to anecdotal evidence (random, casual stories rather than statistically reliable analyses), he deduces that: More...

February 15, 2007 - Long-Term Outperformance from Trends Defined by Moving Averages

Does trading based on simple moving average crossovers outperform? In his November 2006 paper entitled "A Quantitative Approach to Tactical Asset Allocation", Mebane Faber presents a simple moving-average timing model that improves the risk-adjusted returns across various asset classes (represented, for example, by the S&P 500 index, the Morgan Stanley Capital International Developed Markets Index, the Goldman Sachs Commodity Index, the National Association of Real Estate Investment Trusts index and 10-Year Treasury notes). Using a model that mechanically buys (sells) an index when it crosses above (below) its 10-month simple moving average, he shows that: More...

February 14, 2007 - Buy Stocks of Companies Experts Hate?

Are the most admired companies the best investments? Or, is current state of admiration a contrarian indicator for future returns? In their February 2007 paper entitled "Stocks of Admired Companies and Despised Ones", Deniz Anginer, Kenneth Fisher and Meir Statman test these hypotheses. The authors define state of admiration using Fortune magazine’s annual survey-based lists of "America’s Most Admired Companies." Survey respondents are senior executives, directors and securities analysts, and the questions asked seemingly relate indirectly or directly to the investment value of the companies named. Using these lists for April 1983 (survey inception) through March 2006, associated stock return data and a separate survey of high-net worth investors, they conclude that: More...

February 13, 2007 - Hedge Funds Versus Mutual Funds

How are hedge funds like, and not like, mutual funds? How is the hedge fund industry likely to evolve? In his February 2007 paper entitled "Hedge Funds: Past, Present and Future", René Stulz compares the performance and risks of hedge funds to those of mutual funds and examines the likelihood that hedge funds will become more like mutual funds in the future. Based on a review of relevant research, he concludes that: More...

February 9, 2007 - Aggregate Investor Sentiment and Stock Returns

Is aggregate investor sentiment a useful trading indicator? For what kinds of stocks is sentiment trading most likely to work? In their December 2006 paper entitled "Investor Sentiment in the Stock Market", Malcolm Baker and Jeffrey Wurgler summarize a top down approach to addressing these questions, focusing on the measurement of aggregate sentiment and its relationship to stock returns. They devise a long-run sentiment index based on the 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 index and stock return data for 1966-2005, they conclude that: More...

February 1, 2007 - Why Rational Asset Pricing Models Don't Work Well

Proponents of rational markets build on a common-sense foundation of reward for risk, with price variability (beta) as the fundamental risk. Since this single source of risk does not predict asset prices very well, rationalists have empirically appended to their models other sources of risk (proxied by size, value and momentum factors) in search of better predictions. Proponents of behavioral finance counter with innate cognitive and emotional biases (irrationality) as causes of rational model failures. Is there a way to prove one of these two views more correct? Should rationalists look for additional risk factors? Does some third perspective offer insight? In their January 2007 preliminary paper entitled "Failure of Asset Pricing Models: Transaction Cost, Irrationality, or Missing Factors" Joon Chae and Cheol-Won Yang tackle these questions. Using monthly stock return data for 700 Korean firms over the period December 1997 to November 2004 (84 months), along with associated measures for both potential degree of trader rationality (sophistication) and transaction costs, they conclude that: More...

January 29, 2007 - Classic Paper: Empirical Overview of Commodity Futures

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 February 2005 paper entitled "Facts and Fantasies About Commodity Futures" (download count over 12,000) by Gary Gorton and Geert Rouwenhorst. Commodity futures are derivative, short-maturity claims on real assets. Many commodities have pronounced price/volatility seasonality. In this paper, the authors compare and contrast the basic properties of commodity futures, equities and corporate bonds. Using monthly returns for stocks (the S&P 500 index), corporate bonds and a broad equally-weighted index of for commodity futures over the period July 1959 through December 2004, they conclude that: More...

January 25, 2007 - A Fed Model Defense

Is the Fed Model fit only for statistics-challenged practitioners, or does it offer some trading intelligence? In the January 2007 version of his paper entitled "A Behavioral Defense of the Fed Model", Michael Clemens combines the concepts of mean reversion of key financial variables and confidence intervals to present a behavioral defense of the Fed model. He examines the version of the model based on the spread between the S&P 500 forward earnings yield (E/P) and the yield on the 10-year Treasury note. His defense includes identification of ten potential chinks in the armor of model detractors. Using monthly data for the period January 1979 through August 2006 (322 monthly observations over 26 years) , he finds that: More...

January 23, 2007 - The Accuracies of Different Valuation Multiples (Ratios)

How well do commonly used valuation multiples align with actual stock prices? In their January 2007 paper entitled "Multiples and Their Valuation Accuracy in European Equity Markets", Andreas Schreiner and Klaus Spremann investigate the accuracy of the valuation multiple method in general and the properties of 50 different multiples (see the figure below). They define a valuation multiple as a market price variable (e.g., stock price) divided by a particular value driver (e.g., earnings). Using stock price and firm financial data over the period 1996-2005 primarily for the Dow Jones STOXX 600 (ten industries, 18 supersectors, 39 sectors, and 104 subsectors) and secondarily for the S&P 500 index, they find that: More...

January 22, 2007 - The Rareness and Elusiveness of Mutual Fund Outperformance

What are an investor's chances of reaping abnormal returns from mutual funds? Is it possible to identify the funds that will outperform? In their December 2006 paper entitled "Mutual Fund Performance", Keith Cuthbertson, Dirk Nitzsche and Niall O’Sullivan address these questions via review of past academic research on US and UK managed mutual funds, with focus on studies done within the last 20 years. They conclude that: More...

January 16, 2007 - "Media"ting Your Portfolio?

What is the role of journalists in the stock selection process? Are they experts, signal amplifiers or noise amplifiers? Is their collective view short-term or long-term? In two recent papers, Alexander Kerl and Andreas Walter examine the nature and value of the stock filtering role of journalists writing for German personal finance magazines (such as Effecten-Spiegel and Börse Online). More...

January 15, 2007 - Any Holes in SOX?

Have accounting scandals (e.g., Enron, WorldCom and Global Crossing) and the 2002 Sarbanes-Oxley Act (SOX) changed management-analyst earnings dynamics? In their December 2006 paper entitled "Mechanisms to Meet/Beat Analyst Earnings Expectations in the Pre- and Post-Sarbanes-Oxley Eras", Eli Bartov and Daniel Cohen examine whether companies have changed behaviors post-SOX with respect to accrual earnings management, real (transaction-based) earnings management and earnings expectations management. Using earnings forecast and financial data for thousands of companies during 1987-2005, they conclude that: More...

January 12, 2007 - Aggregate Earnings and Stock Market Returns

Do aggregate earnings guidance and actual aggregate earnings predict overall stock market returns? In his September 2006 paper entitled "Aggregate Earnings, Stock Market Returns and Macroeconomic Activity", Lakshmanan Shivakumar discusses the relationships among aggregate earnings, stock market returns and the economy. He frames his discussion as commentary on prior research on earnings guidance, earnings news and stock returns as summarized in our blog entry of 8/8/05. Using earnings, inflation and gross domestic product (GDP) data for 1972-2004, he finds and suggests that: More...

January 11, 2007 - Follow the Leaders to Capture Short-term Abnormal Returns

Do investors/traders taking cues from the trades of top performers produce the momentum effect? In his December 2006 paper entitled "Follow the Leader: Peer Effects in Mutual Fund Portfolio Decisions", Lukasz Pomorski investigates whether actively managed equity mutual funds tend to follow the stock trading leads of outperforming peers as the picks become known via the media and quarterly filings. He defines outperforming (leader) funds in two ways: (1) funds with alphas in the top 5% over the past two years, and (2) funds on the Forbes Honor Roll (high media exposure). He calculates overall leader activity in a stock based only on trades by leader funds with a position in the stock. Using mutual fund holdings and performance data for 1980-2003 (96 quarters), he finds that: More...

January 10, 2007 - The Sharpe Ratio: Blunted by Noise?

Many investors and analysts use the Sharpe ratio (mean excess return per unit of risk) as a field-leveling measure of investment performance. Does this variable reliably indicate the best portfolio? In his brief January 2007 summary paper entitled "Beware the Sharpe Ratio", Steve Christie applies the Generalized Method of Moments to test the portfolio discrimination power of the Sharpe ratio. Using two monthly data sets spanning 24 years for a set of multi-asset class portfolios created from index series and 18 years for a large group of mutual funds, he concludes that: More...

January 9, 2007 - Quantifying and Exploiting Long (Bull and Bear) Trends

Attempting to follow long stock market trends is a common investment approach, with much guru attention focused on calling long-term tops and bottoms. Is this approach meaningful for investors as an avenue to improve upon buy-and-hold performance? In the December 2006 version of his paper entitled "Analyzing Regime Switching in Stock Returns: An Investment Perspective", Jun Tu investigates the potential importance to investors of exploiting differences between bull and bear markets within a Bayesian framework that accommodates considerable uncertainty. Using monthly value-weighted stock return and volatility data for July 1963 to February 2006 (512 observations), he finds that: More...

January 5, 2007 - More Information is Better, Isn't It?

Is more investment information always better? Are there unintended consequences for individual investors/traders acquiring investment information? Specifically, do individual investors/traders systematically acquire information to support rational future decision-making, or do they focus on information that confirms (and builds overconfidence in) decisions already made? The following two recent studies examine these questions, with results as follows: More...

January 4, 2007 - Screening for Fear When Portfolio Building

Implied idiosyncratic volatility is the "investor fear gauge" or perceived risk for an individual stock based on the pricing of its associated options, as contrasted with: (1) overall stock market volatility as measured by variables such as the CBOE Volatility Index (VIX); and, (2) realized idiosyncratic volatility based on variation of the stock's historical price. Can investors use the return due this perceived risk in an individual stock as a building block in constructing outperforming portfolios? In their December 2006 paper entitled "Idiosyncratic Implied Volatility and the Cross-Section of Stock Returns", Dean Diavatopoulos, James Doran and David Peterson examine the relationship between idiosyncratic implied volatility and 30-day, 60-day and 91-day future returns for different kinds of equities. Using daily data on 240 stocks with actively traded options for the period January 1996 to June 2005, they find that: More...

December 28, 2006 - Can Real Estate Experts Provide Reliable Advice for Commercial Property Investing?

While we normally do not stray far from the stock market, an article on the forecasting ability of commercial real estate gurus relates strongly to our ongoing investigation of investing expertise. Do these experts add value for investors in the relatively illiquid real estate market? In his 2005 paper entitled "A Random Walk Down Main Street: Can Experts Predict Returns on Commercial Real Estate?" David Ling examines the ability of institutional owners and managers to predict commercial real estate investment performance for various property types across major metropolitan markets. Using (1) predicted relative property returns (desirability rankings) for nine property types and 16 metropolitan markets from the Real Estate Research Corporation’s (RERC) quarterly Real Estate Investment Survey over a thirteen-year period and (2) corresponding returns data from the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index, he concludes that: More...

December 19, 2006 - The (Dynamic) Meanings of Buy, Hold and Sell

Do broker stock recommendations predict future returns? Are analysts at independent brokers more accurate than those associated with investment banking firms? Did the changes in research rules after the Internet bubble affect analyst behavior? In his November 2006 paper entitled "Do Affiliated Analysts Mean What They Say?", Michael Cliff compares the performance of stock recommendations made by analysts employed by lead underwriters to that of recommendations made by analysts working at independent brokers. Using data for the period 1994-2005 (13,794 recommendations from lead underwriters and 10,216 from independent brokers), he finds that: More...

December 13, 2006 - A Contrarian Play on Small Profitability Laggers?

Why do small capitalization stocks as a group tend to outperform the broad market? Do small firms represent relatively high risk of financial distress (with attendant reward), or are they victims of systematic investor overreaction to past poor performance? In the 2006 update of their paper entitled "Can Overreaction Explain Part of the Size Premium?" Ozgur Demirtas and Burak Güner investigate irregularities in the historical returns of small capitalization stocks to identify the source of the size effect. Using returns and financial data for NYSE/Amex/Nasdaq stocks over the period July 1971 through June 2001, they conclude that: More...

December 12, 2006 - Bet Against Big Sympathy Moves?

Are investor actions well-calibrated when they punish or reward the stocks of all the companies in an industry based on the earliest earnings announcements among peer companies? In the December 2006 version of their paper entitled "Overreaction to Intra-Industry Information Transfers?", Jacob Thomas and Frank Zhang test the efficiency of intra-industry information transfers by measuring whether the price responses of non-announcing firms to earlier peer group earnings announcements systematically relate to subsequent price responses when these same companies announce their own earnings a few days later. Using a sample of earnings announcement dates, stock returns and firm financial variables spanning 132 quarters over 1973-2005 (245,742 firm-quarter observations), they conclude that: More...

December 6, 2006 - Success Factors for Mutual Funds Worldwide

When investors shop for mutual funds internationally, what variables should they consider as indicators of potential outperformance? In their November 2006 paper entitled "The Determinants of Mutual Fund Performance: A Cross-Country Study", Miguel Ferreira, António Miguel and Sofia Ramos relate risk-adjusted performance for mutual funds around the world to: (1) fund characteristics such as size, age, fees (initial charges, annual charges, and redemption charges), management structure and management tenure; (2) country variables, such as economic development, financial development and investor protection; and, (3) management geographic familiarity via segmentation into domestic, foreign and global funds. Using a sample of 10,568 open-end actively managed equity funds from 19 countries for the period 1999-2005, they conclude that: More...

December 5, 2006 - Paying the Most for the Least?

Do mutual fund investors pay for performance, or for something else? Are some of them oblivious to fund performance? In their November 2006 paper entitled "Yet Another Puzzle? The Relation between Price and Performance in the Mutual Fund Industry", Javier Gil-Bazo and Pablo Ruiz-Verdú explore the relationship between mutual fund fees and before-fee performance. Using monthly data for diversified and seasoned U.S. domestic equity mutual funds during 1961-2003 (538,813 fund-month observations), they find that: More...

November 30, 2006 - When a Secondary Stock Offering Is (or Is Not) Bad News

Do firms issue more stock when their officers see compelling uses for new funds, or when these executives think company stock is overvalued? In the November 2006 draft of their paper entitled "Behavioral and Rational Explanations of Stock Price Performance around SEO's: Evidence from a Decomposition of Market-to-Book Ratios", Michael Hertzel and Zhi Li first use firm accounting data to decompose market-to-book ratios into misvaluation and growth opportunity components, and then examine how these components relate to company stock returns after secondary offerings. Using financial and stock return data for a sample of 4,325 seasoned equity offerings during 1970-2004, they conclude that: More...

November 29, 2006 - Selling Too Soon, and Holding on Hope?

Do investors really sell winners and hold losers, thereby helping the market beat them? In other words, are they reluctant to admit mistakes? In their November 2006 paper entitled "Is the Aggregate Investor Reluctant to Realize Losses? Evidence from Taiwan", Brad Barber, Yi-Tsung Lee, Yu-Jane Liu and Terrance Odean investigate whether the average investor exhibits the disposition effect, the tendency to sell winning investments at a faster rate than losing investments. Using data for all trades on the Taiwan Stock Exchange during 1995-1999 (over one billion trades by nearly four million traders), they conclude that: More...

November 27, 2006 - Stock Buybacks Are Set-ups?

Investors might suppose that a company repurchases shares when firm officers believe that the market is undervaluing its stock. Since these officers are highly informed, the stock is subsequently likely to outperform the market. How could executives be sure that their company's stock is undervalued? In their November 2006 paper entitled "Earnings Management and Firm Performance Following Open-market Repurchases", Guojin Gong, Henock Louis and Amy Sun investigate whether company management orchestrates stock undervaluation through earnings management (abnormal accruals) prior to executing share repurchases. Using financial and stock price data over the period 1984-2002 (1,720 open-market repurchase announcements that are followed by actual repurchases), they conclude that: More...

November 22, 2006 - Honing in on the Prospective U.S. Equity Risk Premium

What is the latest from academia regarding the prospective equity risk premium? In their November 2006 paper entitled "Estimating the Ex Ante Equity Premium", Glen Donaldson, Mark Kamstra and Lisa Kramer apply new simulation techniques across ten distinct models to calculate what they claim "is by far the most precise equity premium estimate that has been reported in the literature to date." Using U.S. dividend growth rates, interest rates, Sharpe ratios, price-dividend ratios, return volatilities and the historical equity premium for 1952-2004 to calibrate their simulations, they conclude that: More...

November 21, 2006 - Avoid Companies Stretching for Diminishing Returns?

The stocks of companies issuing equity/debt tend to underperform. Are there explanations for this tendency other than good market timing by corporate executives of such companies? Are these executives in the driver's seat, selling high, or are they just along for a ride? In their November 2006 paper entitled "The New Issues Puzzle: Testing the Investment-Based Explanation", Evgeny Lyandres, Le Sun and Lu Zhang investigate alternative theories of corporate investment as explanations for the subsequent underperformance of companies issuing equity/debt. Using equity/debt issuance data for 1970-2005, they conclude that: More...

November 16, 2006 - Automating the "Hedge" in Hedge Funds

Can quantitative analysts replicate the statistical performance of a given hedge fund using a set of easily tradable assets, thereby: (1) recreating the "hedge" as a transparent, liquid and cheap trading system; and, (2) establishing benchmarks truly applicable to specific hedge fund performance? A series of related papers from the Cass Business School say "yes." In their June 1995 paper entitled "Hedge Fund Returns: You Can Make Them Yourself!", Harry Kat and Helder Palaro describe and illustrate a statistical fund replication process. In their February 2006 paper entitled "Superstars or Average Joes? A Replication-Based Performance Evaluation of 1917 Individual Hedge Funds", they compare the performance of hedge funds to the performance of their mechanical replicants. And, in their October 2006 paper entitled "Tell Me What You Want, What You Really, Really Want! An Exercise in Tailor-Made Synthetic Fund Creation", they present out-of-sample tests of synthetic hedge funds with specific properties. Following are some highlights from these three papers: More...

November 6, 2006 - Stock Valuation Indicator Flyoff

Deterioration over the past decade in the forecasting power of traditional indicators (such as price-dividend and price-earnings ratios) have stimulated searches for better ones, with recent emphasis on macroeconomic variables. Which financial and economic variables best predict stock returns over the short, intermediate and long terms? Is "best" good enough for market timing? In her October 2006 paper entitled "How Well Do Financial and Macroeconomic Variables Predict Stock Returns: Time-series and Cross-sectional Evidence", Anne-Sofie Reng Rasmussen evaluates the relative performance of a wide range of variables in forecasting excess stock returns (above the one-month T-bill rate) over horizons from one quarter to eight years. Using annual data for periods as long as 1930-2005 and quarterly data for periods as long as 1926-2005, she concludes that: More...

November 2, 2006 - How Investors Do (or Don't) Take Advice

How do typical investors/traders process advice from others? Are they overconfidently dismissive, or underconfidently trading on the latest guru pronouncement? In their February 2006 paper entitled "Effects of Task Difficulty on Use of Advice", Francesca Gino and Don Moore perform two controlled experiments to examine the tendencies of people to reject or accept advice depending on the complexity of the associated task. In one experiment, the 61 participants (mostly university students) must seek advice, and in the other they have the option of seeking advice. Since the advice came from other participants who were generally no better informed, the best strategy for each participant was to reduce noise by averaging own opinion and advisor's opinion. Based on the results of these experiments, the authors conclude that: More...

October 31, 2006 - The Political Campaign Contribution Effect

Do companies that "grease the wheels" of our political system via campaign contributions benefit from such participation? In other words, is there a significant positive correlation between company campaign contributions and stock returns? In their October 2006 paper entitled "Corporate Political Contributions and Stock Returns", Michael Cooper, Huseyin Gulen and Alexei Ovtchinnikov construct a measure of the breadth of company campaign contribution activity and investigate whether this measure relates systematically to returns for shareholders. Combining data from the Federal Election Commission on political action committee (PAC) contributions of publicly traded firms for the period 1979-2004 (over 800,000 contributions by 1,930 firms) with associated stock price and financial data, they conclude that: More...

October 24, 2006 - Classic Papers: Returns from Pattern-Based Technical Analysis?

Are trades based on complex technical patterns, such as head-and-shoulders, rational speculations or noise? In other words, do such patterns reliably indicate opportunities to capture excess returns? In her July 1998 paper entitled "Identifying Noise Traders: The Head-And-Shoulders Pattern in U.S. Equities", Carol Osler investigates whether head-and-shoulders trading is significant and whether it is profitable. In their August 2000 paper entitled "Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation", Andrew Lo, Harry Mamaysky and Jiang Wang apply advanced empirical methods (compare with fingerprint identification or face recognition) to evaluate technical analysis patterns such as head-and-shoulders and double-bottoms. These papers conclude that: More...

October 20, 2006 - Trade Against Overnight Moves?

Does an opening stock price above or below the prior session close indicate price movement for the rest of the trading day? If so, is the indication tradable. In their September 2006 paper entitled "The Overnight Return: One More Anomaly", Ben Branch and Aixin Ma investigate the relationships between overnight and adjacent intraday returns for individual stocks. Using NYSE, AMEX and NASDAQ data over the period 1994-2005, they find that: More...

October 19, 2006 - Classic Paper: Any Excess Returns from Investment Newsletters?

Are newsletters good sources of stock picks? Specifically, do their recommendations persistently generate excess returns? In their October 1998 paper entitled "The Performance of Investment Newsletters", Jeffrey Jaffe and James Mahoney tackle these questions. Using the investment newsletter archive of the Hulbert Financial Digest for 1980-1996, they determine that: More...

October 17, 2006 - Combining Value Indicators with Stock Repurchasing

Can investors/traders amplify excess returns by combining value investing with stock repurchase activities? In other words, do companies with low price-fundamentals ratios that buy back stock outperform value companies in general? In their recent paper entitled "Corporate Financing Activities and Contrarian Investment", Turan Bali, Ozgur Demirtas and Armen Hovakimian examine returns for investing strategies that combine value indicators and stock repurchase/issuance activities. Using monthly return data and company financial statements for the period May 1972 to April 2002, they find that: More...

October 16, 2006 - Emergent Size-Value Patterns of Noise?

Are there investing/trading strategies that can turn stock price noise into alpha? More specifically, are there types of stocks for which the noise has a systematic effect on price? In the October 2006 draft of their paper entitled "Does Noise Create the Size and Value Effects?", Robert Arnott, Jason Hsu, Jun Liu and Harry Markowitz model the cross-sectional effects of mean-reverting noise on randomly walking stock values. Noise (for example, from overreacting, informationally challenged and/or liquidity-driven investors/traders) introduces random transients of inefficiency. Based on this model, they conclude that: More...

October 11, 2006 - Good Deals in Broad Market Index Options?

Are investors on average overly fearful/greedy regarding overall stock market volatility, and therefore willing to overpay for insurance/leverage in the form of broad market index options? If so, what reliable strategies could a trader use to exploit this fear and capture the overpayments? In their January 2006 paper entitled "Option Strategies: Good Deals and Margin Calls", Pedro Santa-Clara and Alessio Saretto investigate potential mispricings of S&P 500 index options and a range of trading strategies that might exploit those mispricings. Using daily S&P 500 index options data from the Chicago Mercantile Exchange for January 1985-May 2001 and from the Chicago Board Options Exchange for January 1996-May 2004, they conclude that: More...

October 10, 2006 - Making Money with Options Based on Superior Volatility Forecasts

Are there systematic errors in market expectations about the future volatilities of individual stock prices? If so, what reliable strategy could a trader use to exploit these errors? In their August 2006 paper entitled "Option Returns and the Cross-Sectional Predictability of Implied Volatility", Amit Goyal and Alessio Saretto examine the complete range of implied stock price volatilities for all U.S. equity options to devise an volatility forecasting model more efficient than that inherent in the market. They then test the model's ability (out of sample) to identify outperforming options trading strategies that exploit this market inefficiency. Using daily data for all U.S. equity options over the period January 1996 to May 2005, they conclude that: More...

October 9, 2006 - The Options Trading Landscape

How do individuals really trade in equity options? Do they mostly just buy speculative calls and protective puts? In their May 2006 paper entitled "Option Market Activity", Josef Lakonishok, Inmoo Lee, Neil Pearson and Allen Poteshman examine actual option trading behaviors of firm proprietary traders (most sophisticated), customers of full-service brokers (including hedge funds?) and customers of discount brokers (least sophisticated). Using a unique dataset with detailed purchase-write and open-close transaction information for each equity option series listed by the Chicago Board Options Exchange (CBOE) from 1990 through 2001, they conclude that: More...

October 6, 2006 - Are Individual Investors Entrepreneurs? If So...

Is success as an entrepreneur all luck, or is there a provable contribution from skill? Do winners win just because they are willing to roll the dice, or because they consistently bring innovative insights to the market? In their July 2006 paper entitled "Skill vs. Luck in Entrepreneurship and Venture Capital: Evidence from Serial Entrepreneurs", Paul Gompers, Anna Kovner, Josh Lerner and David Scharfstein pit skill against luck by investigating the persistence of success among serial entrepreneurs. Focusing on the founders of companies listed by Venture Source as recipients of venture capital during the period 1975-2000, they conclude that: More...

October 5, 2006 - Diminishing Returns from Hedge Funds? Or Not?

Has dramatic growth and proliferation of hedge funds used up all the alpha, or do opportunities for excess returns still abound? In their October 2006 paper entitled "Net Inflows and Time-Varying Alphas: The Case of Hedge Funds", Andrea Beltratti and Claudio Morana investigate whether dramatic asset growth has eroded the performance of hedge fund managers. Their analysis encompasses the following categories of hedge funds: convertible arbitrage (CA - 8%), dedicated short bias (DSB - 1%), emerging markets (EM - 4%), equity market neutral (EMN - 7%), event driven (ED - 17%), fixed income arbitrage (FIA - 7%), global macro (GM - 11%), long/short equity (LSE - 32%), managed futures (MF - 5%). The percentages indicate the share of total hedge fund assets by category as of December 2005. Using quarterly fund net returns and asset flows and appropriate return benchmarks for each fund category over the period 1994-2005, they conclude that: More...

October 4, 2006 - Predicting Stock Returns Using Accounting Fundamentals

Which accounting data is most important in predicting future stock returns? In their July 2006 paper entitled "How Do Accounting Variables Explain Stock Price Movements? Theory and Evidence", Peter Chen and Guochang Zhang test the predictive power of a model that combines the discount rate with four indicators of company cash flow: (1) earnings yield; (2) capital investment; (3) changes in profitability; and, (4) changes in growth opportunities. Earnings yield indicates current cash flow generation, while the other three factors indicate future changes in cash flow generation. Using annual company-level accounting data and analyst growth forecasts for cash flow indicators (27,897 firm-year observations over the period 1983-2001) and the yield on 10-year Treasury notes for the discount rate, they conclude that: More...

October 2, 2006 - An Equity Risk Premium Opus

What excess return have you gotten, do you expect, should you get, does the market imply for taking the risk of owning stocks? In his September 2006 paper entitled "Equity Premium: Historical, Expected, Required and Implied", Pablo Fernández addresses all these questions in a comprehensive overview/history and analysis of the equity risk premium in the U.S. and other countries. He begins with definitions of four perspectives on the equity premium, the first equal for all investors and the other three varying among investors:

1. Historical equity premium (HEP) - the historical differential return of the stock market over treasury bonds.
2. Expected equity premium (EEP) - the expected differential return of the stock market over treasury bonds.
3. Required equity premium (REP) - the incremental return of a diversified portfolio (the market) over the risk-free rate (return of treasury bonds) required by an investor.
4. Implied equity premium (IEP) - the equity premium that arises from assuming that the market price is correct.

He concludes that: More...

September 29, 2006 - Sell Risk to Growth Investors and Buy It from Value Investors?

Are value (growth) investors stolid conservatives (wild risk-takers)? If so, is there a way to trade on the difference in behavioral preferences? In their September 2006 paper entitled "Risk Aversion and Clientele Effects", Douglas Blackburn, William Goetzmann and Andrey Ukhov compare the risk preferences of value and growth investors by examining: (1) option prices for pairs of value-growth indexes, and (2) funds flows for value and growth mutual funds. They further investigate whether any profitable options trading strategies devolve from the difference in risk preferences. Using recent data for five value-growth index pairs and for several value and growth mutual funds, they find that: More...

September 28, 2006 - International Diversification with Small Stocks: A Two-fold Size Effect

Are there diversification and return advantages from getting off the beaten path (to small-capitalization stocks) when diversifying internationally? In their September 2006 paper entitled "International Diversification with Large- and Small-Cap Stocks", Cheol Eun, Wei Huang and Sandy Lai compare the benefits of using large-capitalization and small-capitalization stocks to diversify across countries. Taking the perspective of a dollar-based investor, they examine diversification across ten countries with open capital markets (Australia, Canada, France, Germany, Hong Kong, Italy, Japan, the Netherlands, the United Kingdom and the United States). Using monthly size and return data for three market capitalization-based funds (large-cap, mid-cap and small-cap) for each country over the period 1980-1999, they conclude that: More...

September 25, 2006 - Measuring Investor/Trader Risk Aversion

Does a willingness to pay more or less for options than indicated by recent actual levels of stock return volatility reflect the current level of investor/trader risk aversion? In other words, does the gap between option-implied and historical stock return volatilities provide a tradable measure of fearfulness? In the September 2006 draft of their paper entitled "Expected Stock Returns and Variance Risk Premia", Tim Bollerslev, George Tauchen and Hao Zhou investigate the predictive power of the implied-historical volatility gap for future stock returns. Using monthly data for the S&P 500 index (VIX for implied volatility and a summation of five-minute squared returns for historical volatility) for the period 1990-2005, they find that: More...

September 22, 2006 - The Timing (In)Ability of Mutual Fund Investors

Do mutual fund investors move their money into and out of the stock market at the right times, or the wrong times? In their August 2006 paper entitled "Mutual Fund Flows and Investor Returns: An Empirical Examination of Fund Investor Timing Ability", Geoffrey Friesen and Travis Sapp examine the flows of funds to/from individual mutual funds to measure the timing ability of fund investors. They define a "performance gap" between the time-weighted (buy-and-hold) return and the dollar-weighted (actual investor average) return as the measure of investor timing ability. Using monthly data for 7,125 mutual funds over the period 1991-2004, they find that: More...

September 21, 2006 - Technical Analysis as Folk Medicine

Is there a way to end the endless debate on the merits of technical analysis? In his September 2006 paper entitled "On the Analogy Between Scientific Study of Technical Analysis and Ethnopharmacology", Waldemar Stronka proposes bringing technical analysis into the financial economics fold in a manner analogous to the successful incorporation of folk medicine by pharmacology. Specifically, he notes that: More...

September 20, 2006 - Do Mutual Funds That Practice Behavioral Finance Principles Outperform?

Do mutual funds that implement the tenets of behavioral finance, in defiance of the Efficient Markets Hypothesis, outperform? Can they find and exploit systematic behavioral mispricings? In their August 2006 paper entitled "Behavioral Finance: Are the Disciples Profiting from the Doctrine?", Colby Wright, Prithviraj Banerjee and Vaneesha Boney assess whether expert investors have validated the principles of behavioral finance by examining the aggregate performance of a group of mutual funds that practice them. Using equal-weighted data for 16 mutual funds most visibly associated with behavioral finance (see table below), they find that: More...

September 19, 2006 - Essential Ingredients for a Stock Market Boom

What kind of economic environment makes a stock market boom? What changes in that environment lead to bust? In their September 2006 paper entitled "When Do Stock Market Booms Occur? The Macroeconomic and Policy Environments of 20th Century Booms", Michael Bordo and David Wheelock examine the economic and policy conditions that supported equity market booms in ten developed countries (Australia, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, the United Kingdom and the United States) during the 20th century. Using monthly inflation-adjusted stock prices from these countries, they conclude that: More...

September 18, 2006 - Does Technical Trading Work for Certain Kinds of Stocks?

Can technical traders make money if they focus on stocks that are small, illiquid or in specific industries? In their September 2006 paper entitled "Is Technical Analysis Profitable on U.S. Stocks with Certain Size, Liquidity or Industry Characteristics?", Ben Marshall, Sun Qian and Martin Young test three widely used technical trading rules: (1) the variable length moving average rule: (2) the fixed length moving average rule; and, (3) the trading range break-out rule. Using daily close data for 1,065 NYSE and NASDAQ stocks trading over the entire period 1990-2004, they find that: More...

September 12, 2006 - Spam Spasms: This Stock Ready to Explode!

Does touting of penny stocks via email spam work? If so, for whom? In their July 2006 paper entitled "Spam Works: Evidence from Stock Touts and Corresponding Market Activity", Laura Frieder and Jonathan Zittrain assess the impact of unsolicited email touting on Pink Sheet stock prices. They also investigate who wins and who loses from such attempted manipulation. They construct their test sample from 75,415 unsolicited email messages touting a total of 307 mostly Pink Sheet stocks between January 2004 and July 2005, along with associated price and volume data for these stocks. They then create a control sample of randomly selected comparable Pink Sheet stocks. By comparing the test and control samples, they conclude that: More...

September 7, 2006 - Buying and Selling Noise?

If noise is a significant component of stock prices, does a portfolio that favors large market capitalization stocks automatically underperform? In the May 2006 draft of their paper entitled "Pricing Noise, Rejecting the CAPM and the Size and Value Effects", Robert Arnott and Jason Hsu examine the implications of a very simple model that assumes stock prices deviate from fundamental value based on a single source of unknown risk (noise). They assume the deviations revert to a mean of zero, with no long-term effect on stock returns. Based on this model, they conclude that: More...

September 6, 2006 - Hedge Fund Success: Timing or Stock Picking?

Do equity hedge fund managers achieve positive alpha by timing the market or by picking (for or against) the right stocks? In their July 2006 paper entitled "How Hedge Funds Beat the Market", Craig French and Damian Ko investigate the degrees to which these two potential sources of excess returns contribute to market outperformance by hedge fund managers. Using monthly returns for a sample of 157 long-short equity hedge funds reporting over the entire period 1996-2005, they conclude that: More...

September 5, 2006 - Hedge Funds Strongest Around the Turns of Odd Years?

Do hedge funds eliminate, or even reverse, seasonal effects in the returns of the stock market? In his September 2006 paper entitled "Seasonality in Hedge Fund Strategies", Yan Olszewski investigates general seasonal effects for various hedge fund strategies. Using monthly excess return data during 1990-2005 for 30 of the 37 equally-weighted Hedge Fund Research strategy indexes encompassing over 1600 funds, he finds that: More...

August 31, 2006 - Dynamics of Size and Value Investing

As companies evolve, their characteristics may migrate from one category to another (for example, from small to large, or from growth to value). Does such migration, in aggregate, help explain differences in average returns for different categories of stocks? In the August 2006 draft of their paper entitled "Migration", Eugene Fama and Kenneth French investigate how migration of firms across categories contributes to the size effect and the value premium. Specifically, at the end of each June from 1926 through 2004 they construct six value-weighted portfolios of stocks from the major U.S. exchanges based on market capitalization and price-to-book ratio. They then examine the effects on portfolio returns of four kinds of annual rebalancing actions: (1) firms that do not move (Same); (2) firms that change size (dSize); (3) firms that improve toward growth, or are acquired (Plus); and, (4) firms that deteriorate toward value, or are delisted (Minus). Using subsequent-year return data for 1927-2005, they conclude that: More...

August 30, 2006 - Synthetic Hedge Funds?

Is it possible to replicate the returns of hedge funds by decomposing these returns into contributions from easily tradable risk factors? In the August 2006 draft of their paper entitled "Can Hedge-Fund Returns Be Replicated?: The Linear Case", Jasmina Hasanhodzic and Andrew Lo investigate simple models of the performance of 11 types of hedge funds based on six risk factors (related to stocks, bonds, currencies, commodities, credit, and volatility). They then use the results for the five factors that are easily tradable to create hedge fund "clones" (synthetic hedge funds) from exchange-traded assets and derivatives in two ways: (1) applying data from the full sample period (with the associated look-ahead bias); and, (2) applying data from a rolling historical 24-month period. Using data for the period February 1986 through September 2005 on 1,610 hedge funds still active ("live") at the end of the period, they find that: More...

August 29, 2006 - Which Financial Performance Measure Best Fits Stock Valuation?

Is cash flow or earnings a better indicator of stock valuation? In their August 2006 paper entitled "Cash Flow is King? Comparing Valuations Based on Cash Flow Versus Earnings Multiples", Jing Liu, Doron Nissim and Jacob Thomas extend their prior work on comparing cash flow and earnings as indicators of firm market valuation. The authors assume that financial markets efficiently price stocks and compare the accuracies with which different simple valuation ratios predict stock prices. They hypothesize that: (1) earnings should outperform cash flows as predictors of valuation because earnings include information about both cash flow and accruals; and, (2) forecasts should outperform historical results as predictors of valuation because forecasts typically exclude non-recurring events. Using data from the prior study for the U.S. (1992-1999) and for a large sample of firms across ten international markets (1987-2004), they conclude that: More...

August 25, 2006 - Risky Stocks + Short Sellers = Low Returns

Do short sellers avoid highly volatile stocks, and thereby leave them overvalued? If so, when short sellers do attack volatile stocks, is the level of overvaluation therefore compelling? In the August 2006 update of their paper entitled "Costly Arbitrage and Idiosyncratic Risk: Evidence from Short Sellers", Ying Duan, Gang Hu and David McLean test the hypothesis that short sellers tend to avoid stocks with high idiosyncratic risk because of the high cost of hedging such risk. Using data for stock prices, short interest levels and other factors spanning 1988-2003, they find that: More...

August 23, 2006 - Momentum Strategies Sputtering?

How are momentum stock trading strategies doing these days? In their January 2006 paper entitled "The Vanishing Abnormal Returns of Momentum Strategies and 'Front-running' Momentum Strategies", Thomas Henker, Martin Martens and Robert Huynh examine the returns of various momentum trading strategies in general and during specific market conditions (rising or falling) over the period 1993-2004. They construct a series of self-financing portfolios (equal-weighted) for various holding periods by buying past winners and selling past losers based on various past performance (ranking) periods. Some strategies include a one-month gap between the ranking and holding periods. They repeat portfolio construction monthly over the sample period for each strategy, resulting in overlapping portfolios. Finally, they test "front-running" strategies that set momentum rankings five days before the ends of months rather than at month-ends. Using daily data to calculate monthly returns for a broad sample of stocks (with all distributions reinvested), they find that: More...

August 22, 2006 - A Republican Risk Premium?

Is the media more likely to accentuate the negative when Republicans hold the Presidency? In their October 2004 paper entitled "Is Newspaper Coverage of Economic Events Politically Biased?", John Lott Jr. and Kevin Hassett of the American Enterprise Institute test for political bias in the economic (durable goods, GDP, retail sales and unemployment) news coverage of American newspapers, after controlling for economic content. Using headlines from a database of newspaper and wire service articles from 389 newspapers covering January 1991 through May 2004 (and back to 1985 for the top ten newspapers: USA Today, Wall Street Journal, New York Times, Los Angeles Times, Washington Post, New York Daily News, New York Post, Chicago Tribune, Newsday and Houston Chronicle), they find that: More...

August 16, 2006 - Financial News Sentiment Predicts Stock Returns?

Does exceptionally negative news coverage predict hard times for a company and its stock price? In their August 2006 paper entitled "More Than Words: Quantifying Language to Measure Firms' Fundamentals", Paul Tetlock, Maytal Saar-Tsechansky and Sofus Mackassy test whether they can predict a company's future performance and stock returns by quantifying the sentiment in its financial news coverage. Their sentiment measure is a standardized level of negativity based on word counts and the Harvard psychosocial dictionary. Using Wall Street Journal (WSJ) and Dow Jones News Service (DJNS) stories about individual S&P 500 firms during 1980-2004 (350,000 significant articles), along with contemporaneous financial and stock price data, they find that: More...

August 15, 2006 - It's a Mad, Mad, Mad, Mad Market?

Can traders exploit irrational reactions to Jim Cramer's stock recommendations by viewers of CNBC's Mad Money? In their March 2006 paper entitled "Is the Market Mad? Evidence from Mad Money", Joseph Engelberg, Caroline Sasseville and Jared Williams measure the market's reaction to Mr. Cramer's buy recommendations. Using a sample of 246 initial recommendations made by Jim Cramer on Mad Money episodes between July 28, 2005 and October 14, 2005, as recorded by YourMoneyWatch.com, they conclude that: More...

August 14, 2006 - Classic Paper: Company Valuation Methods

We have selected for retrospective review a few all-time "best selling" research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the March 2004 update of the paper entitled "Company Valuation Methods: The Most Common Errors in Valuations" (download count over 6,000) by Pablo Fernandez. In this paper, the author describes the four most widely used company valuation methods: (1) balance sheet-based; (2) income statement-based; (3) goodwill-based; and, (4) cash flow discounting-based. He also illustrates a break-up value calculation and summarizes the valuation errors he has most commonly encountered. He states that: More...

August 11, 2006 - Better to Have a Fund Manager with an Ownership Stake?

As of 2005, the Securities and Exchange Commission requires most mutual funds "to disclose...each portfolio manager's ownership of securities in the fund" using dollar ranges. Should investors favor funds in which the fund managers hold direct stakes? In other words, do funds with management ownership outperform? In their August 2006 paper entitled "Portfolio Manager Ownership and Fund Performance", Ajay Khorana, Henri Servaes and Lei Wedge exploit the new data to test the relationship between fund manager ownership and fund performance. Using monthly return data for a sample of 1,406 mutual funds having ownership data available as of the end of December 2004, they find that: More...

August 8, 2006 - Left or Right, and Up or Down

Should investors lean toward governments at one end of the country political spectrum to find outperforming equity markets? In their October 2003 paper entitled "The Presidential Puzzle: Political Cycles and the Stock Market", Pedro Santa-Clara and Rossen Valkanov examine monthly U.S. stock market performance versus executive branch party across 18 presidential elections (1927-1998, 864 months) encompassing 10 Democratic and 8 Republican presidencies. In their July 2006 paper entitled "Political Orientation of Government and Stock Market Returns", Jedrzej Bialkowski, Katrin Gottschalk and Tomasz Wisniewski investigate whether the political orientation of 173 different governments systematically affects the performance of 24 international (mostly European) stock markets. Findings are: More...

August 7, 2006 - Mutual Fund Advertising: Does Harrison Ford Offer a Better Return?

Do the billions of dollars of annual mutual fund advertising work to attract investors? If so, are the appeals rational or emotional? Does the advertising connect investors with the right funds? In his July 2006 paper entitled "Advertising and Portfolio Choice", Henrik Cronqvist examines how mutual fund industry advertising affects investor choices and returns. Focusing on the effects of 50,000 multimedia advertisements by 454 funds on 4.4 million workers during the year 2000 launch of a new pension system in Sweden, he finds that: More...

July 31, 2006 - Can You Learn Anything from Stock Message Boards?

Are stock message boards worth reading? If so, what clues point to useful information? In their recent paper entitled "e-Information: A Clinical Study of Investor Discussion and Sentiment", Sanjiv Das, Asís Martínez-Jerez and Peter Tufano examine relationships among on-line stock message board discussions and related news and stock prices. They further employ content analysis software to measure the intensity and dispersion (level of disagreement) of message board sentiment. They focus on 170,000 messages from four stock message boards (Yahoo!, The Motley Fool, Silicon Investor and Raging Bull) for four stocks chosen to represent extremes of stock information flow (Amazon, Delta Air Lines, General Magic and Geoworks) during July 1998 through January 1999. Integrating the message board content with contemporaneous news items, stock price movements and one interview of a frequent message board poster, they conclude that: More...

July 21, 2006 - A Warm Embrace or Cold Shoulder for Hot Hands?

Do sophisticated (wealthy) investors chase hedge fund returns? If so, should they? In their March 2006 paper entitled "Do Sophisticated Investors Believe in the Law of Small Numbers?", Guillermo Baquero and Marno Verbeek investigate whether sophisticated hedge fund investors exhibit "hot hands" bias by overreacting to small samples of fund performance. They hypothesize that investors who believe that hedge fund performance is predominantly skill (luck) are prone to overestimate the likelihood of performance persistence (mean reversion) in small samples, leading to an overly trend-following (contrarian) investing style. Using quarterly performance and funds flow data for 752 hedge funds between 1994 and 2000, they conclude that: More...

July 20, 2006 - The Turn-of-the-Month Effect

Do stock prices move systematically at the turn of calendar months? In the July 2006 draft of their paper entitled "Equity Returns at the Turn of the Month", Wei Xu and John McConnell examine equity returns from the beginning the last trading day of one month through the first three trading days of the next month. Using daily returns for a broad range of stocks across exchanges over the period 1926-2005 (with focus on the segment 1987-2005), they conclude that: More...

July 19, 2006 - Stock Picking in a "Fruit Fly Lab"

Does a natural selection metaphor apply to stock picking models? In other words, can competition among a large set of dynamic models to mimic historical stock performance data evolve the most fit models? In their May 2006 paper entitled "Stock Selection – An Innovative Application of Genetic Programming Methodology", Ying Becker, Peng Fei and Anna Lester address these questions by applying genetic programming to stock picking. Genetic programming enables the testing of a wide range of stock performance indicators in linear, non-linear and non-obvious combinations. The authors choose the S&P 500, excluding financials and utilities, as their universe of stocks and define two distinct types of stock-picking model fitness: (1) risk-adjusted outperformance compared to a traditional stock-picking model; and, (2) highest possible return independent of risk. They construct for comparison a traditional stock return forecasting model based on a linear combination of four composite factors: valuation, quality, analyst expectations and price. They use monthly data (65 variables for each of about 350 stocks) over the period January 1990 through December 2005 to create environments for model development and out-of-sample testing. They show that: More...

July 12, 2006 - A Short-term VIX Trading Strategy That Works?

Can you trade on the CBOE Volatility Index (VIX), the "investor fear gauge," or not? If so, what should you trade and should your trades be short-term or long-term? In their September 2005 paper entitled "VIX Signaled Switching for Style-Differential and Size-Differential Short-term Stock Investing", Dean Leistikow and Susana Yu test the usefulness of VIX level as a signal for short-term switching between: (1) value and growth stock indexes; and, (2) small-capitalization and large-capitalization stock indexes. They note that "...VIX can be viewed as a market-determined forecast of short-term market volatility that, by construction, has a constant one-month forecast horizon." They determine signals according to whether VIX is high or low compared to its 75-day moving average. They examine index returns for 1 day and 5 days after a VIX signal. Using data for the VIX and for various Standard & Poor's and Russell stock indexes from the early 1990s through 2004, they find that: More...

July 11, 2006 - Another Test of Hedge Fund Returns

Do most hedge funds outperform broad market indexes? Do some types of hedge funds do better than others? In their May 2006 paper entitled "The Performance of Hedge Fund Strategies and the Asymmetry of Return Distributions", Bill Ding and Hany Shawky examine returns for hedge funds in general. They also use four alternative models to investigate the performance distributions of several categories of equity hedge funds, comparing results with broad stock market indexes. Using monthly returns over the period 1990 (466 funds with $16 billion in assets) to 2003 (2,225 funds with $328 billion in assets), they find that: More...

July 5, 2006 - Worldwide Equity Returns in the 21st Century

In his June 2006 article entitled "Investing in the 21st Century: With Occam’s Razor and Bogle’s Wit", Javier Estrada evaluates the long-term forecasting abilities of two simple models over 10-year periods during 1973-2005. He then uses them to predict the returns for 12 country stock markets (Australia, Belgium, Canada, Denmark, France, Germany, Ireland, Japan, Netherlands, Switzerland, UK, USA) for 2006-2015. He finds that: More...

June 30, 2006 - Indicators of Persistent Fund Manager Outperformance

What makes some mutual fund managers better than others? A series of three recent papers triangulate on the answer to that question by investigating the importance of public and private information to fund managers. Using data for 1,700 equity mutual funds over the period 1993-2002, "Fund Manager Use of Public Information: New Evidence on Managerial Skills" by Marcin Kacperczyk and Amit Seru examines the responses of mutual fund managers to news (changes in public information). Using data for over 2,500 equity mutual funds over the period 1984-2003, "Unobserved Actions of Mutual Funds" by Marcin Kacperczyk, Clemens Sialm and Lu Zheng tests the impacts of unobserved (not immediately or precisely disclosed) mutual fund manager actions on fund returns. Using data for over 2,300 equity mutual funds over the period 1984-2003, "Industry Concentration and Mutual Fund Performance" by Marcin Kacperczyk, Clemens Sialm and Lu Zheng studies the relationship between industry concentration and fund returns. Respectively, these papers conclude that: More...

June 29, 2006 - Hedge Fund Industry: Declining Performance and Increasing Risk?

Is the hedge fund industry an alpha-generating juggernaut? Does it even really offer a "hedge?" In their March 2006 paper entitled "Hedge Funds: Performance, Risk and Capital Formation", William Fung, David Hsieh, Narayan Naik and Tarun Ramadorai investigate performance, risk and capital flows within the hedge fund industry over the past ten years. Using a comprehensive dataset of 1,603 Funds-of-Hedge-Funds (FoFs) covering the period 1995-2004, they find that: More...

June 28, 2006 - Classic Research: Separating Cash Flow and Discount Rate Contributions to Stock Returns

We have selected for retrospective review a few all-time "best selling" research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the August 2003 paper entitled "Bad Beta, Good Beta" (download count over 1,700) by John Campbell and Tuomo Vuolteenaho. In this research, the authors separate stock beta into two components, one reflecting news about cash flows and one reflecting news about discount rates. They apply this decomposition to explain the size effect and the value premium. They hypothesize that:

[Market] "value...may fall because investors receive bad news about future cash flows; but it may also fall because investors increase the discount rate...that they apply to these cash flows. In the first case, wealth decreases and investment opportunities are unchanged, while in the second case, wealth decreases but future investment opportunities improve. ...[A]n investor may demand a higher premium to hold assets that covary with the market's cash-flow news than to hold assets that covary with news about the market's discount rates, for poor returns driven by increases in discount rates are partially compensated by improved prospects for future returns. ...The required return on a stock is determined not by its overall beta with the market, but by its bad cash-flow beta and its good discount-rate beta. Of course, the good beta is good not in absolute terms, but in relation to the other type of beta." [Underlining is ours.]

Using monthly returns from an early period (January 1929 through June 1963) and a modern period (July 1963 through December 2001) to test this idea, the authors conclude that: More...

June 22, 2006 - Global Diversification: By Country or Industry?

With increasing business globalization and financial markets integration, can equity investors still get good risk reduction by diversifying their portfolios across country markets? Or, have other kinds of diversification become more important? In their paper entitled "The Changing Roles of Industry and Country Effects in the Global Equity Markets", Kate Phylaktis and Lichuan Xia examine the evolution of country and industry effects on stock returns and diversification. Using weekly returns from the Dow Jones Global Indexes (DJGI) database (encompassing 4,801 companies in 51 industry groups across 34 countries) over the period 1992 to 2001, they find that: More...

June 16, 2006 - The Odds of Winning as an Active Trader

How active are active traders? What are the odds that an active trader will make a profit? How are winners different from losers? In their recent paper entitled "The Profitability of Active Stock Traders", Ryan Garvey and Anthony Murphy examine the outcomes for a large group of active traders over a three-month period. Using data for over 400,000 trades by 1,386 day traders from a direct access broker in the U.S. over the period March 8, 2000 through June 13, 2000 (68 trading days), they find that: More...

June 15, 2006 - Diversification for "Peak" Performance

How many stocks are enough for the long-term investor to diversify stock-picking risks? Conventional wisdom says that 8 to 20 stocks are enough. In their recent paper entitled "Diversification in Portfolios of Individual Stocks: 100 Stocks Are Not Enough", Dale Domian, David Louton and Marie Racine examine the risk that long-term buy-and-hold stock portfolios will fall short of some minimum return goal. They use portfolios of different sizes constructed from a real sample of 1,000 U.S. stocks (the 100 largest by market capitalization in each of 10 industries) over the 20-year period from January 1985 through December 2004, inserting comparable replacements for the hundreds of delistings that occur in the sample (mostly due to mergers). They find that: More...

June 12, 2006 - Why Highly Volatile Stocks Tend to Underperform

Conventional wisdom holds that: (1) risk begets reward; and, (2) volatility is a manifestation of risk. Exceptionally high volatility in individual stock prices should, therefore, indicate future excess returns in those stocks. In their May 2006 paper entitled "The Relation between Time-Series and Cross-Sectional Effects of Idiosyncratic Variance on Stock Returns in G7 Countries", Hui Guo and Robert Savickas investigate why the realized idiosyncratic volatility (beta) of individual stocks correlates negatively with future returns -- why there is a penalty instead of a reward for this apparent risk. Using two sets of U.S. data (1926-2005 and 1963-2005) and one set of international data (1973-2003), they conclude that: More...

June 9, 2006 - Capturing the Value Premium by Avoiding Institutional Ownership

Which cheap (high book-to-market value) stocks drive the value premium? Can investors capture the value premium by simply buying a broad index of value stocks, or should they focus on some easily identifiable subset. The paper "Institutional Ownership and the Value Premium" by Ludovic Phalippou from April 2005 evaluates level of institutional ownership as the driver of the value premium, hypothesizing that mispricing of stocks is mostly like to come from unsophisticated individual investors. Using data for 1980-2001, he concludes that: More...

June 7, 2006 - UPDATE: Market-Leading Industries

A reader who is a strategist at a European equity hedge fund, alerted us to an (off-SSRN) update of a previously summarized paper. We update that summary here. More from the reader below...

Do certain industries tend to lead or lag stock market cycles? In the November 2004 update of their paper entitled "Do Industries Lead the Stock Market?", Harrison Hong, Walter Torous and Rossen Valkanov investigate whether returns from some industries predict future returns for the overall stock market. The authors hypothesize that the overall market only gradually recognizes valuable information contained in the returns of specific industries. Using U.S. data for 1946-2002 and international data for 1973-2002, they conclude that: More...

May 30, 2006 - Do What the Company Does?

The most informed investors in a firm's stock are the executives and board members of the company. They have access to more, and more current, private information than anyone else. Do their actions in buying or selling equity or debt on behalf of the company reliably indicate its concurrent stock valuation? Do financial analysts accurately interpret these signals for investors? In the June 2005 update of their paper entitled "The Relation Between Corporate Financing Activities, Analysts’ Forecasts and Stock Returns", Mark Bradshaw, Scott Richardson and Richard Sloan investigate the relationships among: (1) a simple cash flow-based measure of corporate financing activities; (2) analyst reactions to these activities; and, (3) stock returns. Corporate financing activities include selling and buying back of common stock, preferred stock, convertible debt, subordinated debt, notes payable, debentures and capitalized lease obligations. Using financial data spanning 1971-2000 and analyst forecast data spanning 1975-2000, they conclude that: More...

May 25, 2006 - Combining Momentum and Value Styles

Value and momentum are two very different equity investing styles, both with many adherents. Neither outperforms the overall market all the time. Is there some systematic way of combining these two approaches to enhance consistency of outperformance in global equity markets? In their March 2006 paper entitled "Generating Excess Returns through Global Industry Rotation", Geoffrey Loudon and John Okunev examine different investing styles (momentum, value, combination of value and momentum, and growth) to exploit cyclic industry returns, with the U.S. yield curve as the critical economic indicator. Using monthly global prices, dividends, earnings and returns data for 36 industries for 1973-2005, they conclude that: More...

May 19, 2006 - Scared by Randomness?

How often should an investor/trader check the performance of their positions? Does it make a difference (psychologically) whether one checks frequently or infrequently? In their 2005 paper entitled "The Scaling Property of Randomness: The Impact of Reporting Frequency on The Perceived Performance of Investment Funds", Nigel Finch, Guy Ford, Suresh Cuganesan and Tyrone Carlin use actual investment fund performance data to explore the likelihood that an investor would have viewed the performance as positive or negative based on sampling frequency. Applying prospect theory (a loss in wealth has a negative impact 2.25 times greater in magnitude than the positive impact of a gain in wealth) to data for four large Australian investment funds (see table below), they conclude that: More...

May 16, 2006 - An Equity Market Model: Focus on Return on Investment, Not P/E

Can one calculate what the return from the overall stock market, or from a specific stock, should be? In the never-ending quest to achieve this goal, Hollister Sykes presents his recent "An Equity Market Model and Its Implications". This model calculates investor return as a function of four variables: (1) earnings yield; (2) return on equity; (3) ratio of dividend payout to earnings; and, (4) ratio of share repurchases or sales value to earnings. Model details and implications, and the results of testing it with 133 years of aggregate market data, are as follows: More...

May 9, 2006 - Measuring Company Management Sentiment

Market mavens look at consumer, investor, analyst and forecaster sentiments. What about the sentiment of the executives of a company of interest? Does what they think about the prospects for their company matter? How can investors determine what they think? In the April 2006 version of his paper entitled "Do Stock Market Investors Understand the Risk Sentiment of Corporate Annual Reports?", Feng Li examines the relationship between management risk sentiment and future company earnings and stock returns. Managers arguably have more freedom to express themselves in text than with numbers. Using counts of words related to risk or uncertainty in 34,180 Securities and Exchange Commission (SEC) Form 10-Ks filed between calendar years 1994 and 2005 to measure management risk sentiment, he concludes that: More...

April 28, 2006 - Global Pricing of Large-capitalization Stocks?

As worldwide economic participation broadens and deepens, are large companies (more than small companies) becoming internationally owned and therefore priced? In other words, are large companies subject to a worldwide equity risk premium while small companies remain moored to local risk premiums? In his paper entitled "Financial Integration and the Price of World Covariance Risk: Large vs. Small-cap Stocks" (forthcoming in the Journal of International Money and Finance), Wei Huang investigates whether global pricing is peculiar to large-capitalization stocks. Using three size-based stock portfolios for nine developed countries (Australia, Netherlands, Canada, France, Germany, Italy, Japan, U.K. and U.S.) over the period 1980-2004, he concludes that: More...

April 26, 2006 - The Worldwide Equity Risk Premium

In the April 2006 version of their paper entitled "The Worldwide Equity Premium: A Smaller Puzzle", Elroy Dimson, Paul Marsh, and Mike Staunton estimate the equity risk premium for 17 countries and a world index over a period of 106 years. They report the historical equity premium for each country in both local currency and U.S. dollars, and they decompose the premium into dividend growth, multiple expansion, the dividend yield and changes in the real exchange rate. Using a new database of stock, bond, bill, inflation, and currency returns for the period 1900-2005, they conclude that: More...

April 25, 2006 - VIX as an Indicator for Different Kinds of Portfolios

Still on the trail of stock market volatility as a fundamental risk-means-reward indicator, we shift focus from the purely empirical realized volatility to the more mystical "investor fear gauge" of implied volatility. Implied volatility, represented by the CBOE Volatility Index (VIX), incorporates the bets of speculators on future stock market behavior. In the April 2006 revision of their paper entitled "Implied Volatility and Future Portfolio Returns", Prithviraj Banerjee, James Doran and David Peterson examine whether the predictive power of VIX applies to specific portfolio characteristics (value versus growth, small versus large and beta) and whether variations in VIX with respect to its short-term mean are predictive. Using data from June 1986 through June 2005 and future return periods of 22 and 44 trading days, they find that: More...

April 21, 2006 - Predicting Stock Returns Not with Volatility, But Volatilities

Conventional wisdom holds that high (low) overall stock market volatility forecasts high (low) stock returns, as a fundamental reward-for-risk phenomenon. However, analysis shows that this volatility-returns relationship is (for implied volatility) unreliable, with only an extremely high overall market volatility usefully predictive. In their March 2006 paper entitled "Understanding Stock Return Predictability", Hui Guo and Robert Savickas investigate a refinement to volatility-based prediction of stock market returns by combining the effects of realized overall market volatility and the average realized idiosyncratic volatility of individual stocks. They theorize that: (1) overall stock market volatility reflects the volatilities of both cash flow shocks and discount rate shocks; (2) overall stock market volatility overstates discount rate shock volatility; and, (3) average idiosyncratic volatility, which reflects the volatility of discount rate shocks only, corrects this overstatement. Using quarterly overall and idiosyncratic volatilities from 1927 through 2005, they conclude that: More...

April 19, 2006 - Classic Article: Seer-Suckers, or the Efficient Everything Hypothesis

Blog Synthesis: The Wisdom of Analysts, Experts and Gurus cites a a wide range of research on whether the typical "expert" has much to offer individual investors/traders. Is there corroboration of the findings there from other disciplines? In his article entitled "The Seer-Sucker Theory: The Value of Experts in Forecasting" from the June/July 1980 issue of Technology Review, Scott Armstrong investigates the general supply of and demand for expertise across several disciplines. Based upon his survey of decades of research in multiple fields (including financial markets, psychology, health care, politics, sports), he concludes that: More...

April 18, 2006 - Expert Political Judgment: How Good Is It? How Can We Know? (Chapter-by-Chapter Review)

In Blog Synthesis: The Wisdom of Analysts, Experts and Gurus, we summarize a wide range of research on investing expertise, concluding that "...the average "expert" has little to offer individual investors/traders." We also noted that: "Finding exceptional advisers is no easier than identifying outperforming stocks. Indiscriminately seeking the output of as many experts as possible is a waste of time. Learning what makes a good expert accurate is worthwhile." In his 2005 book Expert Political Judgment: How Good is It? How Can We Know?, Philip Tetlock describes the results of his long-term systematic measurement of the forecasting abilities of political experts. These results include insights into the critical success factors of forecasting. Making the very small leap that these insights apply also to experts in economics and financial markets, we offer here a chapter-by-chapter review of the insights in this book: More...

March 29, 2006 - The Secret Ingredients of Top Analysts?

What makes a guru, or analyst, good? The research on this question is predominantly "technical" rather than "fundamental," focusing on performance and performance persistence rather than process (hence, the frequent use of the word guru, implying mystical insight). In their preliminary and incomplete paper of November 2004 entitled "Determinants of Superior Stock Picking Ability", Michael Mikhail, Beverly Walther, Xin Wang and Richard Willis seek to identify the determinants of consistent analyst stock picking outperformance. Using a sample encompassing 268,170 recommendations issued by 4,923 analysts for 7,845 firms during 1985–1999 from Zacks Investment Research, they tentatively find that the best analysts tend to: More...

March 28, 2006 - Classic Papers: The Value of Investment Newsletters?

Recent research on the (stock picking and market timing) abilities of experts to generate excess returns has focused mostly on mutual funds and hedge funds. This focus stems from data availability (mutual funds via SEC filings) and headline value (hedge funds). Where is the research on investment newsletters? How do they rate in terms of excess returns? Digging deeper than usual, we find two on-target papers: (1) the February 1995 paper entitled "Market Timing Ability and Volatility Implied in Investment Newsletters' Asset Allocation Recommendations" by John Graham and Campbell Harvey; and, (2) the November 1997 paper entitled "The Equity Performance of Investment Newsletters" by Andrew Metrick. Both papers draw upon the investment newsletter archive of the Hulbert Financial Digest. Using different aspects of this archive, they determine that: More...

March 23, 2006 - The Morningstar Mutual Fund Rating System Works?

Can investors count on the widely cited Morningstar mutual fund rating system as an investment screener? In their recent paper "Morningstar Mutual Fund Ratings Redux", Matthew Morey and Aron Gottesman investigate the relationship between number of Morningstar stars and future performance of mutual funds since June 30, 2002, when Morningstar overhauled their rating system in terms of granularity, risk measurement and treatment of share classes. Focusing on the three-year performance of domestic equity funds that were rated by Morningstar as of 6/30/02 (1,902 funds) and adjusting for fund loads and survivorship bias, they conclude that: More...

March 21, 2006 - Finding a Use for Analyst Price Targets?

Even though analyst target prices for stocks are notoriously inaccurate, might the relative sizes of the gaps between target and actual prices indicate degrees of current misvaluation? In other words, is a stock with analyst target price twice its current price a better buy than a stock presently at or near its target price? In their February 2006 paper entitled "Target Prices, Relative Valuations and the Premium for Liquidity Provision", Zhi Da and Ernst Schaumburg investigate the usefulness of relative gaps between target and actual stock prices as an indicator of misvaluations. Using recently issued target prices for about 1,700 stocks each month over the period 1996-2004, they conclude that: More...

March 20, 2006 - Got a Winning Personality?

What personality traits, if any, support successful investing practices? In their March 2006 paper entitled "An Intimate Portrait of the Individual Investor", Robert Durand, Rick Newby and Jay Sanghani investigate the relationships between personality and both investment decisions and portfolio performance. To measure personality, they apply three perspectives: (1) the "Big Five" personality traits (Negative Emotion-Neurotic, Extraversion, Openness to Experience, Agreeableness and Conscientiousness); (2) psychological gender traits (Masculinity and Femininity); and, (3) personality traits of Preference for Innovation and Risk Taking Propensity. Using personality profiles for 21 Australian self-directed investors along with information about their trading and investment performance during July 2004-June 2005, they conclude that: More...

March 15, 2006 - The Two Habits of Highly Effective Investors?

What are the essential habits of highly effective (wealthy) investors? In his March 2006 paper entitled "Why do Wealthy Investors have a Higher Return on their Stocks?", Yosef Bonaparte analyzes data from the triennial Survey of Consumer Finances to find out why the wealthiest investors achieve superior stock returns. To frame the analysis, he defines two types of investment opportunity search: (1) informal (use of magazines, newspapers, online services and friends or relatives); and, (2) professional (use of experts such as accountants, financial planners and brokers). Using results from recent surveys, he concludes that: More...

March 14, 2006 - Is the Year's Boo! Already on the Books?

The Halloween effect suggests that investors should be in stocks during November through April and in cash during May through October. Is there a connection between the January effect and the Halloween effect, or are they distinct market anomalies? In their March 2006 paper entitled "Halloween or January? Yet Another Puzzle", Brian Lucey and Shelly Zhao examine seasonal returns to determine whether the Halloween effect is just an imprecise reflection of the January effect. Using monthly return data for U.S. stocks allocated to capitalization-based size deciles over the period 1926-2002, they conclude that: More...

March 10, 2006 - Reading Between the Numbers

When a company reports earnings or makes presentations to analysts, should investors tune out the verbiage and focus only on the hard financial data? Or, do company executives give soft clues to future firm performance? In their January 2006 working paper entitled "Beyond the Numbers: An Analysis of Optimistic and Pessimistic Language in Earnings Press Releases", Angela Davis, Jeremy Piger and Lisa Sedor examine the "body language" of the narratives of earnings press releases and test the response of the stock market to this qualitative information. Using textual-analysis software to measure systematically the levels of optimism and pessimism in a sample of 24,000 earnings press releases published on PR Newswire between 1998 and 2003, they find that: More...

March 7, 2006 - The Entropic Markets Hypothesis

Can the laws of physics and information theory help explain human psychology, specifically as exhibited by investors? In the December 2005 update of his paper entitled "The Physical Foundation of Human Mind and a New Theory of Investment", Jing Chen: (1) builds upon the similarities between the mathematics of information theory and of physical entropy to explain certain human thinking patterns; and, (2) uses this synthesis to unify understanding of the behavior of financial markets. He posits that human thinking patterns are adaptations evolved (mostly in hunter/gatherer mode) to acquire efficiently the resources needed for survival, as constrained by physical laws. In a mostly theoretical discussion, he offers the following insights: More...

March 6, 2006 - Aggregate Analyst Sentiment in the Long Run

Does the distribution of analyst buy-hold-sell ratings predict the overall stock market? Is the distribution of ratings for a given firm indicative of the value of those ratings to investors? In the September 2005 version of their paper entitled "Buys, Holds, and Sells: The Distribution of Investment Banks' Stock Ratings and the Implications for the Profitability of Analysts' Recommendations", Brad Barber, Reuven Lehavy, Maureen McNichols and Brett Trueman analyze the distribution of stock ratings at investment banks and brokerage firms and examine whether these distributions can be used to predict the profitability of analysts’ recommendations. Using 438,000 recommendations issued on more than 12,000 firms by 463 investment banks and brokerage firms from January 1996 through June 2003, they conclude that: More...

March 3, 2006 - The Illusionary Markets Hypothesis?

Can influential traders actively profit from the psychological biases, the not fully rational decisions, of others? In the January 2005 update of their paper entitled "Illusionary Finance and Trading Behavior", Malika Hamadi, Erick Rengifo and Diego Salzman introduce the concept of illusionary finance, based on the psychology of decision-making under time pressure and ambiguity, and analyze the creation and dissemination of illusions stock markets. They propose that: More...

February 22, 2006 - Just Protecting Their Investing/Trading Reputations?

People worry about their professional reputations. Does this worry on the part of institutional fund managers translate into any systematic investing/trading practices, and thereby create asset mispricings? In the November 2005 update of their paper entitled "Asset Price Dynamics When Traders Care About Reputation", Amil Dasgupta and Andrea Prat describe a model for incorporating concern about reputation into institutional (mutual) fund manager behavior and compare predictions of that model to results of other research. They conclude that: More...

February 16, 2006 - An Overview of Investor Animal Spirits

What formal studies does academia have to offer on the role of emotions in equity investing/trading? In their October 2004 paper entitled "The Role of Feelings in Investor Decision-Making", Michael Dowling and Brian Lucey synthesize the results of two threads of recent areas of research on whether and how emotions affect investing: (1) mood misattribution (the impact of environmental factors, such as the weather, the body's biorhythms and social factors); and (2) image (how investors feel about companies separately from any financial analysis). They note that: More...

February 15, 2006 - Classic Research: Embrace Risk, But Take Profits

We have selected for retrospective review a few all-time "best selling" research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the February 1999 paper entitled "Daily Momentum And Contrarian Behavior Of Index Fund Investors" (download count almost 1,900) by William Goetzmann and Massimo Massa. The authors investigate the existence and profitability of momentum and contrarian behaviors for stock index trading. They classify return momentum investors (trend followers) as those who buy (sell) when the market rises (drops) in the previous trading session, and return contrarian investors as "profit takers" who sell (buy) when the market rises (drops). They also examine investor response to changes in market volatility, defining both volatility momentum traders (risk chasers) and volatility contrarian traders (risk avoiders). Using daily activity records for 91,000 accounts trading an S&P 500 index during 1997 and 1998, the authors find that: More...

February 6, 2006 - Should Equity Investors Hope for Good or Bad Economic Forecasts?

Does forecasts for the economy at large predict returns for stock investors? In the September 2005 version of their paper entitled "Stock Returns and Expected Business Conditions: Half a Century of Direct Evidence", Sean Campbell and Francis Diebold characterize the relationship between expected business conditions (predictions of real growth in GDP six and 12 months ahead) and stock returns. Using half a century (1952-2002) of Livingston survey expected business conditions results and corresponding measures of expected stock returns, they conclude that: More...

February 3, 2006 - The Frailty of the Size Premium?

Do long-term investors in small-capitalization firms outperform? Is the size effect simply a manifestation of data snooping or defective statistical methodologies? In his paper entitled "Is Size Dead? A Review of the Size Effect in Equity Returns", Mathijs van Dijk reviews the international evidence for the size effect and synthesizes the debate on its theoretical validity and empirical persistence. He concludes that: More...

February 2, 2006 - (Not) Capturing the Elusive Value Premium

Do long-term value investors outperform? In their paper entitled "Do Investors Capture the Value Premium?", Todd Houge and Tim Loughran seek the answer to this question by examining groups of value and growth equity indexes, mutual funds and individual stocks over long periods. They conclude that: More...

January 26, 2006 - No Reward for Risk? Why Can't They Keep Their Story Straight?

The market rewards investors for taking risk Right? High volatility means high risk. Right? High volatility therefore means excess return. Right? In their January 2006 paper entitled "High Idiosyncratic Volatility and Low Returns: International and Further U.S. Evidence", Andrew Ang, Robert Hodrick, Yuhang Xing and Xiaoyan Zhang test the relationship between past idiosyncratic volatility and future returns for stocks in developed markets around the world. Using data from 23 countries mostly over the period January 1980 through December 2003, they find that: More...

January 24, 2006 - Last Nail in the Coffin of the Fed Model?

Fed Model proponents argue that there is an equilibrium relationship between the earnings yield of a stock index and the 10-year government bond yield. When the earnings yield is below (above) the 10-year government bond yield, the stock market is overvalued (undervalued). In his January 2006 paper entitled "The Fed Model: The Bad, the Worse, and the Ugly", Javier Estrada recaps the (lack of) theoretical basis for the Fed Model and tests its empirical support in the markets of 20 countries. Using both actual (trailing) and projected (forward) earnings for total market indices over various periods ending in June 2005, he concludes that: More...

January 12, 2006 - Classic Research: Mean Reversion in Corporate Profitability

We have selected for retrospective review a few all-time "best selling" research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the February 1999 paper entitled "Forecasting Profitability and Earnings" (download count over 3,600) by Eugene Fama and Kenneth French. Is corporate profitability mean reverting due to competitive forces, as entrepreneurs exit relatively unprofitable industries and enter relatively profitable industries. Are there therefore predictable patterns in corporate earnings? Using a simple return-on-assets model applied to an average of 2304 firms per year over the period 1964-1995, the authors conclude that: More...

January 9, 2006 - Can Individual Investors Enhance Returns with Options?

In the January 2006 revision of their paper entitled "Is There Money to be Made Investing in Options? A Historical Perspective", James Doran and Robert Hamernick examine the return and risk of a variety of option strategies for a typical investor. Specifically, they assess whether any of 12 S&P 500 index options trading strategies as marginal investments within a larger index portfolio would have enhanced buy-and-hold returns over long periods. They chose the 12 strategies in accordance with the basic strategies outlined by the Chicago Board of Options Exchange. Where historical options price data is unavailable, they estimate plausible reconstructions and transaction costs. Using two long periods (1970-2004 and 1995-2004) and focusing on overall portfolio returns, they find that: More...

January 7, 2006 - Classic Research: Explaining Large Stock Market Fluctuations

We have selected for retrospective review a few all-time "best selling" research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the August 2003 paper entitled "A Theory of Large Fluctuations in Stock Market Activity" (download count nearly 2,700) by Xavier Gabaix, Parameswaran Gopikrishnan, Vasiliki Plerou and Eugene Stanley. Why do stock prices vary more than company fundamentals. Why do stock markets crash? This paper proposes a theory of large stock market movements based upon a linkage between market activity and the size distribution of large financial institutions. Motivated by empirical findings that stock returns, trading volumes, number of trades, price impacts of trades and sizes of large investors all have power law distributions, the authors propose that: More...

December 26, 2005 - Abnormal Returns from Small Stocks with Good Prospects

In their December 2005 paper entitled "Information and Prospects: Investment Opportunities and Market Efficiency in the Small-Cap Segment", German Espinosa and Robert Veszteg examine the value of analysts as guides for selecting stocks that amplify the small firm effect. Is it better to search independently for "hidden gems" or to focus instead on small stocks followed by analysts? Are those analysts one step ahead in the relatively slow diffusion process for new information about small firms? The authors test the hypothesis that small firms with unusually large analyst followings tend to be those with the best prospects. Using monthly data on financial analyst coverage and returns for the stocks of U.S. and Canadian markets between June 1996 and June 2004, they find that: More...

December 20, 2005 - Challenging the Value Premium

Current research on the value premium, the outperformance of value stocks in comparison with other (growth) stocks, mostly involves explaining it through either behavioral or efficient-market mechanisms. However, in their November 2005 paper entitled "Does the Value Premium Really Exist in the UK Equity Market?", Panagiotis Andrikopoulos, Arief Daynes, David Latimer and Paraskevas Pagas challenge its existence. Their study focuses on eliminating any possible effects of survivorship bias, look-ahead bias and the method of calculating returns in comparing the performance of value and growth stocks of United Kingdom firms. They classify value versus growth via four selection factors (low for value, high for growth): book-to-market value, earnings-to-price ratio, dividend yield and weighted average sales growth. Using a new database of 2006 UK equity issues fully listed at any time during 1987-1996, they find that: More...

December 19, 2005 - Trading Signals from Retail Investor Behavior

What can small-trade volume tell us about the behavior and success of retail investors? Two December 2005 papers tackle this question. In a paper entitled "Small Trades and the Cross-section of Stock Returns", Soeren Hvidkjaer investigates the effect of retail investor trading behavior on stock returns by studying intermediate-term and long-term returns for stocks with small-trade buying or selling pressures. In a paper entitled "Do Noise Traders Move Markets?", Brad Barber, Terrance Odean and Ning Zhu offer a similar study, adding an analysis of the short-term returns for stocks with small-trade buying or selling pressures. Their joint findings are: More...

December 8, 2005 - Give Me Your Money Because...

Financial services firms must persuade investors to hand over their money. How do they do that? Do these companies rationally present their track records of excess risk-adjusted returns, or do they appeal for funds using less rational messages? In the October 2005 draft of their paper entitled "Persuasion in Finance", Sendhil Mullainathan and Andrei Shleifer review and interpret trends in financial advertising over the past decade. Their investigative framework assumes that investors shift relative emphasis between two broad investment motivations, growth (getting rich, or greed) and protection (securing the future, or fear), depending on the state of the market. High past returns activate greed, and low past returns activate fear. They use this framework to test the rationality of financial firm advertising. Using 1469 ads from Business Week during January 1994 through December 2003 and 4971 ads from Money during January 1995 through December 2003 aimed at investors, they find that: More...

November 29, 2005 - Are Some Shorts Smarter Than Others?

The prevailing wisdom is that, in general, short sellers know what they are doing. But there are different kinds of short sellers, likely in a range from highly informed to noise. Can we find the ones who are best informed? In the November 2005 version of their paper entitled "Which Shorts Are Informed?", Ekkehart Boehmer, Charles Jones and Xiaoyan Zhang examine a large proprietary dataset to segregate short-sellers according to the informativeness of their trading. Using data on short sales for an average of over 1,200 NYSE stocks daily during the period January 2000 through April 2004, they find that: More...

November 21, 2005 - The Decline of Stock Picking?

How much buying and selling comes from picking stocks rather than assuring diversification by use of stock indices? Is stock picking a dying practice? In their November 2005 paper entitled "Is Stock Picking Declining Around the World", Utpal Bhattacharya and Neal Galpin model and measure the relative proportions of stock picking and index use in the United States and elsewhere. Their model measures the level of stock picking via the relationship between stock trading volume and firm market capitalization. Using data for stocks in 43 countries (21 developed and 22 emerging) beginning with 1962 in the United States and focusing on 1995-2004 for cross-country analysis, they find that: More...</