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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: Keep Reading

Reclama from Jack Schannep

Jack Schannep, editor of The DowTheory.com, has several times requested that we reconsider parts of our assessment of his specific stock market forecasts, as follows: Keep Reading

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: Keep Reading

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: Keep Reading

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: Keep Reading

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: Keep Reading

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: Keep Reading

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: Keep Reading

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: Keep Reading

An Equity Risk Premium Opus

What excess return have you gotten, do you expect, should you require, 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 Fernandez 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: Keep Reading

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