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The After-January Effect?

In case you are sick of hearing about the January effect… Keep Reading

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: Keep Reading

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: Keep Reading

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: Keep Reading

A Few Notes from My Life as a Quant, Reflections on Physics and Finance

In his 2004 autobiography, My Life as a Quant, Reflections on Physics and Finance, Emanuel Derman recounts his experiences as a physicist driven by the forces of employment supply and demand to redirect his labor toward quantitative financial analysis/strategy. Knowledge and skills critical to his transition are: a sense of how the world works, modeling and programming. Much of the book is a straightforward recounting of activities, personalities and reactions, culminating in Mr. Derman’s derivatives modeling accomplishments. Toward the end of the book, he offers a few essential distillations, as follows: Keep Reading

Value Versus Growth When the Economy Is Bad

Does value beat growth because: (1) investors/traders irrationally overreact to recent bad (good) news about value (growth) stocks; or, (2) they rationally recognize that value stocks are inherently more risky than growth stocks? In their March 2005 paper entitled “Value versus Growth: Movements in Economic Fundamentals”, Yuhang Xing and Lu Zhang seek to clarify the value-growth contest by examining how the fundamentals (earnings growth, dividend growth, sales growth, investment growth, profitability and investment rate) of value and growth companies behave during different parts of the business cycle. Using two samples for manufacturing companies for 1963-2002 and 1928-2002 and defining “value” (“growth”) as the top (bottom) 20% in book-value-to-market capitalization, they find that: Keep Reading

Regulation FD: Have Some Big Shots Lost Their Privileges?

The Securities and Exchange Commission (SEC) adopted Regulation FD (Fair Disclosure) effective October 2000, seeking to eliminate selective disclosure (for example, to favored securities analysts) by requiring companies to disseminate widely and publicly all material information. In their recent paper entitled “An Examination of the Differential Impact of Regulation FD on Analysts’ Forecast Accuracy”, Scott Findlay and Prem Mathew investigate the effects of Regulation FD on the relative accuracy of earnings forecasts. Have previously privileged analysts lost a private information edge? Using a database covering quarterly and annual earnings forecasts for 3,000 individual analysts, they determine that: Keep Reading

Unexplained Volume as a Critical Indicator

Researchers have recently focused on divergence of investor opinion as an indicator of future stock returns, but measuring this divergence using publicly available data has been problematic. In his April 2005 paper entitled “Measuring Investors’ Opinion Divergence”, Jon Garfinkel uses a non-public indicator of the stock valuations of investors to validate four public indicators: bid-ask spread, unexplained volume, forecast variability among analysts and stock return volatility. His non-public indicator is the standard deviation of the differences between all limit order prices and the most recent trade price, capturing actual investor price targets. Using data from 1995-1996 for the one non-public and four public indicators and focusing on activities before and after 150 selected NYSE trading halts, he concludes that: Keep Reading

Classic Research: Stock Returns in the Long Run

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 2002 paper entitled “Stock Market Returns in the Long Run: Participating in the Real Economy” (download count over 3,400) by Roger Ibbotson and Peng Chen. The authors examine the relationships during 1926-2000 between historical equity returns and key supply side factors such as inflation, earnings, dividends, price-to-earnings ratio (P/E), dividend payout ratio, book value, return on equity and GDP per capita. They extrapolate these supply side connections with the real economy to estimate the future long-term equity risk premium. They conclude that: Keep Reading

January Effect Alive and Well?

In their October 2005 paper entitled “The January Effect”, Mark Haug and Mark Hirschey examine the persistence of the January effect (abnormally high rates of return during the month of January). Using broad samples of value-weighted and equally-weighted returns spanning 1802-2004 for large-capitalization stocks and 1927-2004 for small-capitalization stocks, they conclude that: Keep Reading

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