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Animal Spirits

Are investors and traders cats, rationally and independently sniffing out returns? Or are they cows, flowing with a herd that must know something? These blog entries relate to behavioral finance, the study of the animal spirits of investing and trading.

Dividend Month Premium

Do investors focus on dividends, thereby elevating associated stock prices as ex-dividend date approaches? In the September 2011 draft of their paper entitled “The Dividend Month Premium”, Samuel Hartzmark and David Solomon examine the price behavior of stocks with scheduled quarterly, semiannual and annual dividends during the expected dividend month and around expected ex-dividend dates. Using daily and monthly price and cash dividend data for a broad sample of U.S. stocks during January 1927 through December 2009, along with widely used risk adjustment factors, they find that: Keep Reading

Announcement Tone and Short-term Reaction to Earnings News

Does the semantic tone of an earnings announcement, as measured independently of the level of earnings surprise, affect stock price reaction. In his September 2011 paper entitled “Short-term Reactions to News Announcements”, Michal Dzielinski investigates the effect of the tone (positive, neutral or negative) of the words in earnings announcements and other company news on stock prices from two days before to ten days after release. He averages news tone for each stock by day, with news released before (after) the market close counting as current-day (next-day) news. Using daily return data and over six million automatic, real-time Thomson Reuters news sentiment (tone) measurements (including those for over 68,000 earnings announcements) for 4,750 U.S. stocks during 2003 through 2010, he finds that: Keep Reading

Stock Spikes Around CEO Interviews

Do investors in aggregate respond to “staged” CEO visibility? In the August 2011 update of their paper entitled “CEO Interviews on CNBC”, Felix Meschke and Andy Kim investigate whether planned interviews with CEOs on financial television systematically affect associated stock prices over the days before and after the interview. The authors focus on the interval from two trading days before through ten trading days after interview date. Using daily stock price and trading data associated with 6,937 CEO interviews broadcast on CNBC during June 1997 through December 2006 (9.5 years), along with contemporaneous CNBC viewership levels and corporate news, they find that: Keep Reading

Overview of Research on Individual Investors

What does the body of academic research say about the stock trading behaviors and outcomes for individual investors? In their June 2011 paper entitled “The Behavior of Individual”, Brad Barber and Terrance Odean survey four areas of empirical research on the behavior of individual investors trading individual stocks: (1) performance, (2) the disposition effect, (3) buying behavior and (4) diversification. Using the findings of many studies performed over the last three decades, they conclude that: Keep Reading

A Few Notes on Investing and the Irrational Mind

In his 2011 book Investing and the Irrational Mind: Rethink Risk, Outwit Optimism, and Seize Opportunities Others Miss, author Robert Koppel posits that investing has “less to do with the science of computation and more to do the art of managing one’s outlook, emotions, and consciousness.” He seeks to explain “how to overcome debilitating emotions, irrational biases, and investment fallacies and arrive at an understanding of overall market risk through an approach that identifies, assesses, and controls losses. …how we can master our irrational minds to gain the skills necessary to control our financial decisions.” Some notable points from the book are: Keep Reading

Get Genetic Screening for Your Financial Advisor?

What accounts for the persistence in diversity of investor beliefs and behaviors? Why does logical inference from common data not drive common attitudes and actions? In their March 2011 paper entitled “Serotonin and Risk Taking: How Do Genes Change Financial Choices?”, Camelia Kuhnen, Gregory Samanez-Larkin and Brian Knutson investigate differences in investing beliefs and behaviors associated with variations of a single gene (the serotonin transporter). Using demographic and financial information, tests of cognitive ability and numeracy, and measurements of attitudes toward financial decisions for 60 individuals recruited to be representative of San Francisco Bay Area adults, they find that: Keep Reading

Prelude to Panic?

Are there internal or external signals that predict financial market panic attacks? In the February 2011 revision of their paper entitled “Predicting Economic Market Crises Using Measures of Collective Panic” (flagged by a reader), Dion Harmon, Marcus de Aguiar, David Chinellato, Dan Braha, Irving Epstein and Yaneer Bar-Yam investigate whether indications of the interplay between external shocks (news) and internal market mimicry (herding) predict U.S. stock market crises and panics. They measure the relative levels of external news and internal mimicry based on the distribution over a year of the daily fraction of stocks that move in the same direction (simply up or down). A strongly Gaussian (flattened) shape for this distribution implies that investors are focusing on business fundamentals (technical indications), and external news (internal mimicry) is therefore dominating their behavior. Left-right symmetry of this distribution implies that good news and bad news are in balance. Using random samples of daily returns of Russell 3000 stocks over the period 1985 through 2010, they find that: Keep Reading

Mutual Fund Investors Causing Their Own Demise?

Do mutual fund investors in aggregate exhibit good, bad or indifferent market timing? In their January 2011 article entitled “Past Performance is Indicative of Future Beliefs”, Philip Maymin and Gregg Fisher investigate how the aggregated timing of buying and selling by mutual fund investors affects their average returns. Using monthly returns and assets for approximately 25,000 mutual funds over the period November 1995 through October 2010, they find that: Keep Reading

A Few Notes on Trading the Trader

In his 2010 book Trade the Trader: Know Your Competition and Find Your Edge for Profitable Trading, author Quint Tatro observes that “…what most investors don’t understand as they start to learn their basic technical patterns…is they are the ones actually in play. Seasoned traders are no longer just cuing off of charts or indicators, they are also analyzing those same charts to determine what the amateurs are doing, and are seeking to profit from the ignorance of the newcomers. It’s a chess game where the successful traders are thinking two and three moves ahead, playing off the basic strategy of the newcomers. Those simply pursuing a basic path of understanding technical analysis will find it is a road that ultimately leads to frustration, whereas those looking to trade the traders will be met with an endless world of opportunity. …If you don’t know on which side you fall, odds are you are someone’s next meal.” Some notable points from the book are: Keep Reading

Total Fear Premium

Is aggregate equity investor fear multifaceted? In the August 2010 version of his paper entitled “The Equity Fear Premium and Daily Comovements of the S&P 500 E/P ratio and Treasury Yields before and during the 2007 Financial Crisis”, Christophe Faugère introduces a Total Fear Premium derived from independent flight-to-safety and flight-to-liquidity impulses. The flight-to-safety component assumes investors fleeing stocks buy long-term Treasuries, driving the real, after-tax yield on Treasury bonds below long-term trend (growth rate of real Gross Domestic Product per capita). The flight-to-liquidity component assumes investors fleeing stocks buy short-term instruments (such as Treasury bills), driving their yields below the federal funds target rate. Using daily levels of the S&P 500 forward earnings yield, Treasury yields and S&P 500 Index implied volatility (VIX) over the period July 2004 through February 2010, he finds that: Keep Reading

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