Investing Research Articles

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”, Rene 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: Keep Reading

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 aggregate sentiment index derived from principal component analysis of 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: Keep Reading

When the market trend challenges their beliefs, what do we hear from market “experts?” Keep Reading

The Financial Forecast Center (FFC) forecasts the average value by month for the S&P 500 index for the current month and the next five months , including fairly large error ranges for 50% and 90% confidence levels. FFC’s “forecasts are generated in-house using artificial intelligence. The forecast models are 100% quantitative and use a global, long-range economic dataset. Thus, the forecasts are very objective.” Using nine of these forecasts since May 2006, we conclude that: Keep Reading

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: Keep Reading

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: Keep Reading

…is fear as a sales pitch. Keep Reading

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: Keep Reading

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: Keep Reading

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: Keep Reading