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Investing Research Articles

Classic Paper: Emergence of Behavioral Finance

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 October 2002 paper entitled “From Efficient Markets Theory to Behavioral Finance” (download count over 4,100) by Robert Shiller, author of the book Irrational Exuberance. This paper traces the recent history of financial market research, from an erosion of faith in the efficient markets theory to a growing collaboration between the social sciences and finance. Shiller’s key points are: Keep Reading

Classic Research: Demography and the Stock Market

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. Here we summarize the August 2002 paper entitled “Demography and the Long-Run Predictability of the Stock Market” by John Geanakoplos, Michael Magill and Martine Quinzii (download count over 4,400). In this paper, the authors link cyclic demographic behavior (borrowing when young, investing for retirement in middle age and disinvesting in retirement) with stock market price-earnings ratio (P/E) cycles. Using the overlapping generations model, they conclude that: Keep Reading

Benchmarking Returns for Hedge Funds

In a set of April 2005 charts entitled “The Topography of Hedge Fund Returns”, Craig French and David Abuaf of Corbin Capital Partners, L.P. map the annual returns of a range of hedge fund strategies over the past 15 years. Using data for all hedge funds that existed for all 12 months of each calendar year in the HFR database over 1990-2004, they find that: Keep Reading

Recognition: Is That a Good Thing?

In the September 2005 version of their paper entitled “Investor Recognition and Stock Returns”, Reuven LeHavy and Richard Sloan analyze the relation between how widely a stock is recognized and its returns (past and future). They use change in the proportion of quarterly SEC Form 13-F filers (institutional investment managers who exercise investment discretion over $100 million) holding a stock to represent the change in investor recognition of that stock. Using Form 13-F and stock price data over the period 1982-2004, they find that: Keep Reading

Comprehensive Analysis of Calendar Effects

In the January 2005 version of their working paper entitled “Testing the Significance of Calendar Effects”, Peter Reinhard Hansen, Asger Lunde and James Nason test a broad range of possible calendar effects in multiple equity markets. They examine the following effects: day-of-the-week, month-of-the-year, day-of-the-month, week-of-the-month, semi-month, turn-of-the-month, end-of-the-year and holiday. Calendar effects could be a result of data mining (finding anomalies of randomness), an especially plausible explanation when theoretical explanations are suggested only subsequent to empirical “discovery.” Applying robust tests to daily closing prices of stock indices from Denmark, France, Germany, Hong Kong, Italy, Japan, Norway, Sweden, the United Kingdom and the United States through early May 2002, they find that: Keep Reading

When Stock Market Models Crash

Didier Sornette has an interest in financial markets as examples of complex systems. He authored Why Stock Markets Crash : Critical Events in Complex Financial Systems, published in November 2002. He has maintained on his web site for several years a series of predictions regarding the behavior of the S&P 500 index. In initiating this series, he wrote:

“Based on a theory of cooperative herding and imitation working both in bullish as well as in bearish regimes that we have developed in a series of papers, we have detected the existence of a clear signature of herding in the decay of the US S&P 500 index since August 2000 with high statistical significance, in the form of strong log-periodic components.”

His September 2002 paper (with Wei Zhou) entitled “The US 2000-2002 Market Descent: How Much Longer and Deeper?” provides a detailed justification of this assertion, including a comparison of the 1990 Japanese and 2000 U.S. stock market crashes. The evolution of Professor Sornette’s predictions is as follows: Keep Reading

Book (Value) It?

In the September 2005 version of their paper entitled “The Anatomy of Value and Growth Stock Returns”, Eugene Fama and Kenneth French separate the average returns on both value and growth portfolios into dividends and three sources of capital gains: (1) reinvestment of earnings (growth in book value); (2) change in price-to-book ratios (P/B) due to mean reversion in profitability, and (3) a secular upward drift in P/B. Using data spanning 1926-2003 for NYSE, AMEX and NASDAQ stocks, they find that: Keep Reading

Warren Buffett’s Track Record: Luck or Skill?

In their August 2005 paper entitled “Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway”, Gerald Martin and John Puthenpurackal rigorously examine various possible explanations for Berkshire Hathaway’s superior investment performance. Is it luck? Is it reward-for-risk? Is it outstanding stock-picking skill? Using information on 261 common equity investments from Berkshire Hathaway’s SEC filings and market databases for 1980-2003, they conclude that: Keep Reading

Sophistication + Experience > Behavioral Bias?

In their March 2005 paper entitled “Do Investor Sophistication and Trading Experience Eliminate Behavioral Biases in Financial Markets?”, Lei Feng and Mark Seasholes analyze how sophistication and trading experience of investors affect their disposition behavioral bias (reluctance to realize losses and propensity to realize gains). They define sophistication based on four factors: number of trading rights; initial level of portfolio diversification; age; and, gender. They define trading experience as the number of positions taken since account initiation. Using data from a national brokerage firm in the People’s Republic of China for 1,511 individual accounts initiated on or after 1/1/99 and monitored through 12/31/00, they conclude that: Keep Reading

Fooled by Randomness: A Review

Nassim Taleb’s central theme in Fooled by Randomness (the 2004 second edition) is that noise generally swamps signal (true outperformance or underperformance) in financial markets, and in life generally. A standard deviation much larger than an associated average excess return, encountered consistently in the search for outperforming investing/trading strategies, is an indicator of such swamping. The book effectively uses corollaries and examples to reinforce Nassim Taleb’s contention that past performance is neither a guarantee of future returns nor a proof of either intelligence or stupidity. Rather than recount his arguments, we focus this review on his conclusions as they relate specifically to speculating in financial markets. These conclusions are: Keep Reading

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