Showing papers in "Journal of Finance in 2001"
TL;DR: This article analyzed the capital structure choices of firms in 10 developing countries and provided evidence that these decisions are affected by the same variables as in developed countries, indicating that specific country factors are at work.
Abstract: This study uses a new data set to assess whether capital structure theory is portable across countries with different institutional structures. We analyze capital structure choices of firms in 10 developing countries, and provide evidence that these decisions are affected by the same variables as in developed countries. However, there are persistent differences across countries, indicating that specific country factors are at work. Our findings suggest that although some of the insights from modern finance theory are portable across countries, much remains to be done to understand the impact of different institutional features on capital structure choices. OUR KNOWLEDGE OF CAPITAL STRUCTURES has mostly been derived from data from developed economies that have many institutional similarities. The purpose of this paper is to analyze the capital structure choices made by companies from developing countries that have different institutional structures. The prevailing view, for example Mayer ~1990!, seems to be that financial decisions in developing countries are somehow different. Mayer is the most recent researcher to use aggregate f low of funds data to differentiate between financial systems based on the “Anglo-Saxon” capital markets model and those based on a “Continental-German-Japanese” banking model. However, because Mayer’s data comes from aggregate f low of funds data and not from individual firms, there is a problem with this approach. The differences between private, public, and foreign ownership structures have a profound inf luence on such data, but the differences may tell us little about how profit-oriented firms make their individual financial decisions. This paper uses a new firm-level database to examine the financial structures of firms in a sample of 10 developing countries. Thus, this study helps determine whether the stylized facts we have learned from studies of developed countries apply only to these markets, or whether they have more general applicability. Our focus is on answering three questions:
2,215 citations
TL;DR: This article showed that correlation is not related to market volatility per se but to the market trend and that correlation increases in bear markets, but not in bull markets, and they also showed that the distribution of extreme correlation for a wide class of return distributions can be derived using extreme value theory.
Abstract: Testing the hypothesis that international equity market correlation increases in volatile times is a difficult exercise and misleading results have often been reported in the past because of a spurious relationship between correlation and volatility. Using “extreme value theory” to model the multivariate distribution tails, we derive the distribution of extreme correlation for a wide class of return distributions. Empirically, we reject the null hypothesis of multivariate normality for the negative tail, but not for the positive tail. We also find that correlation is not related to market volatility per se but to the market trend. Correlation increases in bear markets, but not in bull markets. INTERNATIONAL EQUITY MARKET CORRELATION has been widely studied. Previous studies 1 suggest that correlation is larger when focusing on large absolutevalue returns, and that this seems more important in bear markets. The conclusion that international correlation is much higher in periods of volatile markets ~large absolute returns! has indeed become part of the accepted wisdom among practitioners and the financial press. However, one should exert great care in testing such a proposition. The usual approach is to condition the estimated correlation on the observed ~or ex post! realization of market returns. Unfortunately correlation is a complex function of returns and such tests can lead to wrong conclusions, unless the null hypothesis and
2,204 citations
TL;DR: In this paper, the authors used a disaggregated approach to study the volatility of common stocks at the market, industry, and firm levels and found that over the period from 1962 to 1997 there has been a noticeable increase in firm-level volatility relative to market volatility.
Abstract: This paper uses a disaggregated approach to study the volatility of common stocks at the market, industry, and firm levels. Over the period from 1962 to 1997 there has been a noticeable increase in firm-level volatility relative to market volatility. Accordingly, correlations among individual stocks and the explanatory power of the market model for a typical stock have declined, whereas the number of stocks needed to achieve a given level of diversification has increased. All the volatility measures move together countercyclically and help to predict GDP growth. Market volatility tends to lead the other volatility series. Factors that may be responsible for these findings are suggested.
1,950 citations
TL;DR: In this article, the authors evaluate various explanations for the profitability of momentum strategies documented in Jegadeesh and Titman ~1993!. The evidence indicates that momentum profits have continued in the 1990s, suggesting that the original results were not a product of data snooping bias.
Abstract: This paper evaluates various explanations for the profitability of momentum strategies documented in Jegadeesh and Titman ~1993!. The evidence indicates that momentum profits have continued in the 1990s, suggesting that the original results were not a product of data snooping bias. The paper also examines the predictions of recent behavioral models that propose that momentum profits are due to delayed overreactions that are eventually reversed. Our evidence provides support for the behavioral models, but this support should be tempered with caution. Many portfolio managers and stock analysts subscribe to the view that momentum strategies yield significant profits. Jegadeesh and Titman ~1993! examine a variety of momentum strategies and document that strategies that buy stocks with high returns over the previous 3 to 12 months and sell stocks with poor returns over the same time period earn profits of about one percent per month for the following year. 1 Although these results have been well accepted, the source of the profits and the interpretation of the evidence are widely debated. Although some have argued that the results provide strong evidence of “market inefficiency,” others have argued that the returns from these strategies are either compensation for risk, or alternatively, the product of data mining. The criticism that observed empirical regularities arise because of data mining is typically the hardest to address because empirical research in nonexperimental settings is limited by data availability. Fortunately, with
1,935 citations
TL;DR: In this paper, the authors present a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models.
Abstract: The basic paradigm of asset pricing is in vibrant f lux. The purely rational approach is being subsumed by a broader approach based upon the psychology of investors. In this approach, security expected returns are determined by both risk and misvaluation. This survey sketches a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models.
1,796 citations
TL;DR: This article found that investors are more likely to hold, buy, and sell the stocks of Finnish firms that are located close to the investor, that communicate in the investor's native tongue, and that have chief executives of the same cultural background.
Abstract: This paper documents that investors are more likely to hold, buy, and sell the stocks of Finnish firms that are located close to the investor, that communicate in the investor’s native tongue, and that have chief executives of the same cultural background. The inf luence of distance, language, and culture is less prominent among the most investment-savvy institutions than among both households and less savvy institutions. Regression analysis indicates that the marginal effect of distance is less for firms that are more nationally known, for distances that exceed 100 kilometers, and for investors with more diversified portfolios.
1,657 citations
TL;DR: In this article, the role of f luctuations in the aggregate consumption-wealth ratio for predicting stock returns was studied using U.S. quarterly stock market data, and it was shown that these fluctuations in the consumption-aggregate wealth ratio are strong predictors of both real stock returns and excess returns over a Treasury bill rate.
Abstract: This paper studies the role of f luctuations in the aggregate consumption‐wealth ratio for predicting stock returns. Using U.S. quarterly stock market data, we find that these f luctuations in the consumption‐wealth ratio are strong predictors of both real stock returns and excess returns over a Treasury bill rate. We also find that this variable is a better forecaster of future returns at short and intermediate horizons than is the dividend yield, the dividend payout ratio, and several other popular forecasting variables. Why should the consumption‐wealth ratio forecast asset returns? We show that a wide class of optimal models of consumer behavior imply that the log consumption‐aggregate wealth ~human capital plus asset holdings! ratio summarizes expected returns on aggregate wealth, or the market portfolio. Although this ratio is not observable, we provide assumptions under which its important predictive components for future asset returns may be expressed in terms of observable variables, namely in terms of consumption, asset holdings and labor income. The framework implies that these variables are cointegrated, and that deviations from this shared trend summarize agents’ expectations of future returns on the market portfolio. UNDERSTANDING THE EMPIRICAL LINKAGES between macroeconomic variables and financial markets has long been a goal of financial economics. One reason
1,655 citations
TL;DR: In this article, the determinants of credit spread changes were investigated using dealer's quotes and transactions prices on straight industrial bonds, and the residuals from this regression are highly cross-correlated, and principal components analysis implies they are mostly driven by a single common factor.
Abstract: Using dealer's quotes and transactions prices on straight industrial bonds, we investigate the determinants of credit spread changes. Variables that should in theory determine credit spread changes have rather limited explanatory power. Further, the residuals from this regression are highly cross-correlated, and principal components analysis implies they are mostly driven by a single common factor. Although we consider several macroeconomic and financial variables as candidate proxies, we cannot explain this common systematic component. Our results suggest that monthly credit spread changes are principally driven by local supply/demand shocks that are independent of both credit-risk factors and standard proxies for liquidity.
1,618 citations
TL;DR: In this article, the authors estimate the equity premium from the discount rate that equates market valuations with prevailing expectations of future flows, and find that the average equity premium is around three percent (or less) in the United States and five other markets.
Abstract: The returns earned by U.S. equities since 1926 exceed estimates derived from theory, from other periods and markets, and from surveys of institutional investors. Rather than examine historic experience, we estimate the equity premium from the discount rate that equates market valuations with prevailing expectations of future flows. The accounting flows we project are isomorphic to projected dividends but use more available information and narrow the range of reasonable growth rates. For each year between 1985 and 1998, we find that the equity premium is around three percent (or less) in the United States and five other markets.
1,478 citations
TL;DR: In this paper, the authors studied aggregate market spreads, depths, and trading activity for U.S. equities over an extended time sample and found that daily changes in market averages of liquidity and trading activities are highly volatile and negatively serially dependent.
Abstract: Previous studies of liquidity span short time periods and focus on the individual security. In contrast, we study aggregate market spreads, depths, and trading activity for U.S. equities over an extended time sample. Daily changes in market averages of liquidity and trading activity are highly volatile and negatively serially dependent. Liquidity plummets significantly in down markets. Recent market volatility induces a decrease in trading activity and spreads. There are strong dayof-the-week effects; Fridays accompany a significant decrease in trading activity and liquidity, while Tuesdays display the opposite pattern. Long- and short-term interest rates inf luence liquidity. Depth and trading activity increase just prior to major macroeconomic announcements. LIQUIDITY AND TRADING ACTIVITY are important features of financial markets, yet little is known about their evolution over time or about their time-series determinants. Their fundamental importance is exemplified by the inf luence of trading costs on required returns ~Amihud and Mendelson ~1986!, and Jacoby, Fowler, and Gottesman ~2000!! which implies a direct link between liquidity and corporate costs of capital. More generally, exchange organization, regulation, and investment management could all be improved by knowledge of factors that inf luence liquidity and trading activity. A better understanding of these determinants should increase investor confidence in financial markets and thereby enhance the efficacy of corporate resource allocation. Notwithstanding the importance of research about liquidity, existing studies of trading costs have all been performed over short time spans of a year or less. In addition, these studies have usually focused on the liquidity of individual securities. This is probably due to the tedious task of handling voluminous intraday data and, until recently, the paucity of intraday data going back more than a few years. Thus, virtually nothing is known about
1,460 citations
TL;DR: The authors examined whether stock prices fully value firms' intangible assets, specifically research and development (R&D), under current U.S. accounting standards, financial statements do not report intangible assets and R&D spending is expensed.
Abstract: We examine whether stock prices fully value firms’ intangible assets, specifically research and development ~R&D!. Under current U.S. accounting standards, financial statements do not report intangible assets and R&D spending is expensed. Nonetheless, the average historical stock returns of firms doing R&D matches the returns of firms without R&D. However, the market is apparently too pessimistic about beaten-down R&D-intensive technology stocks’ prospects. Companies with high R&D to equity market value ~which tend to have poor past returns! earn large excess returns. A similar relation exists between advertising and stock returns. R&D intensity is positively associated with return volatility.
TL;DR: In this article, the authors examined and explained the differences in the rates offered on corporate bonds and those offered on government bonds, and examined whether there is a risk premium in corporate bond spreads and, if so, why it exists.
Abstract: The purpose of this article is to explain the spread between rates on corporate and government bonds. We show that expected default accounts for a surprisingly small fraction of the premium in corporate rates over treasuries. While state taxes explain a substantial portion of the difference, the remaining portion of the spread is closely related to the factors that we commonly accept as explaining risk premiums for common stocks. Both our time series and cross-sectional tests support the existence of a risk premium on corporate bonds. THE PURPOSE OF THIS ARTICLE is to examine and explain the differences in the rates offered on corporate bonds and those offered on government bonds ~spreads!, and, in particular, to examine whether there is a risk premium in corporate bond spreads and, if so, why it exists. Spreads in rates between corporate and government bonds differ across rating classes and should be positive for each rating class for the following reasons: 1. Expected default loss—some corporate bonds will default and investors require a higher promised payment to compensate for the expected loss from defaults. 2. Tax premium—interest payments on corporate bonds are taxed at the state level whereas interest payments on government bonds are not. 3. Risk premium—The return on corporate bonds is riskier than the return on government bonds, and investors should require a premium for the higher risk. As we will show, this occurs because a large part of the risk on corporate bonds is systematic rather than diversifiable. The only controversial part of the above analyses is the third point. Some authors in their analyses assume that the risk premium is zero in the corporate bond market.1
TL;DR: In this article, the authors report evidence on chief executive officer (CEO) turnover during the 1971 to 1994 period and find that the nature of CEO turnover activity has changed over time.
Abstract: We report evidence on chief executive officer (CEO) turnover during the 1971 to 1994 period. We find that the nature of CEO turnover activity has changed over time. The frequencies of forced CEO turnover and outside succession both increased. However, the relation between the likelihood of forced CEO turnover and firm performance did not change significantly from the beginning to the end of the period we examine, despite substantial changes in internal governance mechanisms. The evidence also indicates that changes in the intensity of the takeover market are not associated with changes in the sensitivity of CEO turnover to firm performance. STOCKHOLDERS RELY ON INTERNAL AND EXTERNAL monitoring mechanisms to help resolve agency problems that arise from the separation of ownership and control in modern corporations. Boards of directors and blockholders are important internal control mechanisms whereas the takeover market is a major source of external control. Both academicians and practitioners have speculated that improvements in corporate governance structures would enhance the internal control mechanisms. For example, Jensen (1993) argues that the corporate governance structures of LBO associations and venture capital funds should be models for corporations that desire more efficient control systems. Among the desirable features Jensen points to are smaller, outsider-dominated boards, and substantial equity ownership by managers and board members. Similarly, Blair (1995) discusses corporate governance reformers who advocate changes like those cited by Jensen as well as greater institutional investor involvement in corporate decisions. In addition to pro
TL;DR: In this article, a quadratic-loos utility function was proposed and tested for modeling corporate earnings forecasting, where financial analysts trade off bias to improve management access and forecast accuracy.
Abstract: This paper proposes and tests a quadratic-loos utility function for modeling corporate earnings forecasting, where financial analysts trade off bias to improve management access and forecast accuracy. Optimal forecasts with minimum expected error are optimistically biased and exhibit predictable cross-sectional variation related to analyst and company characteristics. Empirical evidence from individual analyst forecasts is consistent with the model's predictions. These results suggest that positive and predictable bias may be a rational property of optimal earnings forecasts. Prior studies using classical notions of unbiasedness may have prematurely dismissed analysts' forecasts as being irrational or inaccurate.
TL;DR: In this article, the authors propose a model in which asset prices are correlated with covariance risk and misperceptions of firms' prospects, and arbitrageurs trade against mispricing.
Abstract: This paper offers a model in which asset prices ref lect both covariance risk and misperceptions of firms’ prospects, and in which arbitrageurs trade against mispricing. In equilibrium, expected returns are linearly related to both risk and mispricing measures ~e.g., fundamental0price ratios!. With many securities, mispricing of idiosyncratic value components diminishes but systematic mispricing does not. The theory offers untested empirical implications about volume, volatility, fundamental0price ratios, and mean returns, and is consistent with several empirical findings. These include the ability of fundamental0price ratios and market value to forecast returns, and the domination of beta by these variables in some studies.
TL;DR: In this paper, a unique data set allows monitoring the buys, sells, and holds of individuals and institutions in the Finnish stock market on a daily basis, and they employ Logit regressions to identify the determinants of buying and selling activity over a two-year period.
Abstract: A unique data set allows us to monitor the buys, sells, and holds of individuals and institutions in the Finnish stock market on a daily basis. With this data set, we employ Logit regressions to identify the determinants of buying and selling activity over a two-year period. We find evidence that investors are reluctant to realize losses, that they engage in tax-loss selling activity, and that past returns and historical price patterns, such as being at a monthly high or low, affect trading. There also is modest evidence that life-cycle trading plays a role in the pattern of buys and sells.
TL;DR: In this article, the authors describe financial contagion as a wealth effect in a continuous-time model with two risky assets and three types of traders, i.e., convergence traders with logarithmic utility trade optimally in both markets, while noise traders trade randomly in one market.
Abstract: Financial contagion is described as a wealth effect in a continuous-time model with two risky assets and three types of traders. Noise traders trade randomly in one market. Long-term investors provide liquidity using a linear rule based on fundamentals. Convergence traders with logarithmic utility trade optimally in both markets. Asset price dynamics are endogenously determined ~numerically! as functions of endogenous wealth and exogenous noise. When convergence traders lose money, they liquidate positions in both markets. This creates contagion, in that returns become more volatile and more correlated. Contagion reduces benefits from portfolio diversification and raises issues for risk management. DURING THE F INANCIAL PANIC ASSOCIATED with the default of the Russian government in August 1998 and the subsequent collapse of the hedge fund Long Term Capital Management, numerous hedge funds, banks, and securities firms tried simultaneously to reduce exposures to a variety of financial instruments, such as Russian bonds, Brazilian stocks, U.S. mortgages, spreads between on-therun and off-the-run government securities, and spreads between swaps and U.S. Treasuries. Although the fundamental values of these positions would appear to have little correlation, during this financial crisis, the asset prices in these markets exhibited the following common empirical pattern: 1. Financial intermediaries suffered losses as prices moved against their positions; 2. Market depth and liquidity decreased simultaneously in several markets; 3. The volatility of prices increased simultaneously in several markets; and,
TL;DR: A Sunday "New York Times" article on a potential development of new cancer-curing drugs caused EntreMed's stock price to rise, and the enthusiasm spilled over to other biotechnology stocks.
Abstract: A Sunday New York Times article on a potential development of new cancer-curing drugs caused EntreMed’s stock price to rise from 12.063 at the Friday close, to open at 85 and close near 52 on Monday. It closed above 30 in the three following weeks. The enthusiasm spilled over to other biotechnology stocks. The potential breakthrough in cancer research already had been reported, however, in the journal Nature, and in various popular newspapers ~including the Times! more than five months earlier. Thus, enthusiastic public attention induced a permanent rise in share prices, even though no genuinely new information had been presented. A CENTRAL TENET OF F INANCIAL ECONOMICS is that an asset should trade at the risk-adjusted present value of its expected future cash f lows. These expected future cash f lows exist in people’s minds, and do not normally lend themselves to direct observation. An equilibrium price in a frictionless market does not tolerate disagreements among market participants: If some people deem the price too low, they will buy the asset; if others think it is too high, they will sell it ~short, if necessary!. Although the efficient-markets hypothesis predicts that price changes are unpredictable, it associates them with changes in traders’ beliefs about future cash f lows or the appropriate discount rate. Beliefs change with the arrival of new information. Thus, in hindsight at least, we should be able to ascribe price changes to the arrival of specific new information. We examine this view in the context of a series of news reports in the media pertaining to EntreMed ~ENMD!, a biotechnology company, and other members of its sector. The Sunday, May 3, 1998, edition of the New York Times reports on a recent breakthrough in cancer research, and mentions ENMD, a company with licensing rights to the breakthrough ~Kolata ~1998!!. The story’s impact on the stock prices was immediate, huge, and to a large extent permanent. The new-news content of the Times story was nil, though: the substance of the story had been published as a scientific piece in Nature ~Boehm et al. ~1997!! and in the popular press @including the Times itself ~Wade ~1997!!# more than five months earlier, in November 1997.
TL;DR: In this paper, the authors investigate the role of trading activity in terms of the information it contains about future prices and find that stocks experiencing unusually high ~low! trading volume over a day or a week tend to appreciate ~depreciate! over the course of the following month.
Abstract: The idea that extreme trading activity contains information about the future evolution of stock prices is investigated. We find that stocks experiencing unusually high ~low! trading volume over a day or a week tend to appreciate ~depreciate! over the course of the following month. We argue that this high-volume return premium is consistent with the idea that shocks in the trading activity of a stock affect its visibility, and in turn the subsequent demand and price for that stock. Return autocorrelations, firm announcements, market risk, and liquidity do not seem to explain our results. THE OBJECTIVE OF THIS PAPER is to investigate the role of trading activity in terms of the information it contains about future prices. More precisely, we are interested in the power of trading volume in predicting the direction of future price movements. We find that individual stocks whose trading activity is unusually large ~small! over periods of a day or a week, as measured by trading volume during those periods, tend to experience large ~small! returns over the subsequent month. In other words, a high-volume return premium seems to exist in stock prices. The essence of our paper’s results is captured in Figure 1. In this figure, we show the evolution of the average cumulative return of three groups of stocks: stocks that experienced unusually high, unusually low, and normal trading volume, relative to their recent history of trading volume, on the trading day preceding the portfolio formation date. We see that the stocks that experienced unusually high ~low! trading volume outperform ~are outperformed by! the stocks which had normal trading volume. Moreover, this effect appears to grow over time, especially for the high-volume stocks. We postulate that the high-volume premium is due to shocks in trader interest in a given stock, that is, the stock’s visibility. Miller ~1977! and
TL;DR: In this paper, it was shown that purchasing short stocks with the most favorable consensus recommendations, in conjunction with daily portfolio rebalancing and a timely response to recommendation changes, yield annual abnormal gross returns greater than four percent.
Abstract: We document that purchasing ~selling short! stocks with the most ~least! favorable consensus recommendations, in conjunction with daily portfolio rebalancing and a timely response to recommendation changes, yield annual abnormal gross returns greater than four percent. Less frequent portfolio rebalancing or a delay in reacting to recommendation changes diminishes these returns; however, they remain significant for the least favorably rated stocks. We also show that high trading levels are required to capture the excess returns generated by the strategies analyzed, entailing substantial transactions costs and leading to abnormal net returns for these strategies that are not reliably greater than zero. THIS STUDY EXAMINES WHETHER INVESTORS can profit from the publicly available recommendations of security analysts. Academic theory and Wall Street practice are clearly at odds regarding this issue. On the one hand, the semistrong form of market efficiency posits that investors should not be able to trade profitably on the basis of publicly available information, such as analyst recommendations. On the other hand, research departments of brokerage houses spend large sums of money on security analysis, presumably because these firms and their clients believe its use can generate superior returns.
TL;DR: This paper proposed a structural model of default with stochastic interest rates that captures the mean reversion of leverage ratios, which is more consistent with empirical findings than predictions of extant models.
Abstract: Most structural models of default preclude the firm from altering its capital structure. In practice, firms adjust outstanding debt levels in response to changes in firm value, thus generating mean-reverting leverage ratios. We propose a structural model of default with stochastic interest rates that captures this mean reversion. Our model generates credit spreads that are larger for low-leverage firms, and less sensitive to changes in firm value, both of which are more consistent with empirical findings than predictions of extant models. Further, the term structure of credit spreads can be upward sloping for speculative-grade debt, consistent with recent empirical findings.
TL;DR: In this paper, the role of excessive extrapolation in employees' company stock holdings was explored, and it was found that employees of firms that experienced the worst stock performance over the last 10 years allocate 10.37 percent of their discretionary contributions to company stock, whereas employees whose firms experienced the best stock performance allocate 39.70 percent.
Abstract: About a third of the assets in large retirement savings plans are invested in company stock, and about a quarter of the discretionary contributions are invested in company stock. From a diversification perspective, this is a dubious strategy. This paper explores the role of excessive extrapolation in employees’ company stock holdings. I find that employees of firms that experienced the worst stock performance over the last 10 years allocate 10.37 percent of their discretionary contributions to company stock, whereas employees whose firms experienced the best stock performance allocate 39.70 percent. Allocations to company stock, however, do not predict future performance. ROUGHLY A THIRD OF THE ASSETS in large retirement savings plans are invested in company stock ~i.e., stocks issued by the employing firm! .I n extreme cases, such as Coca-Cola, the allocation to company stock reaches 90 percent of the plan assets. From a diversification perspective, it is even more puzzling that Coca-Cola employees allocate 76 percent of their own discretionary contributions to Coca-Cola shares. This strategy seems dubious, and it is in complete contrast to Markowitz ~1952! and Sharpe ~1964!, who predict that people will hold well-diversified portfolios. This paper examines whether excessive extrapolation of past returns could explain at least part of the discretionary allocations to company stock. 1 The empirical analysis utilizes a unique database of SEC filings that describes the variation in investment elections across companies for 1993. There are at least two reasons why the allocation to company stock is an interesting topic to study. First, the costs of insufficient diversification can be substantial. For example, with the assumption of a constant relative risk aversion of two, Brennan and Torous ~1999! find that the certainty equivalent of investing one dollar in a single stock over a 10-year period is only 36 cents! In the case of company stock, the costs of insufficient diversification
TL;DR: This paper showed that industries with higher dependence on trade credit financing exhibit higher rates of growth in countries with weaker financial institutions, consistent with barriers to trade credit access among young firms, and most of the effect that they report comes from growth in the size of preexisting firms.
Abstract: Recent work suggests that financial development is important for economic growth, since financial markets more effectively allocate capital to firms with high value projects. For firms in poorly developed financial markets, implicit borrowing in the form of trade credit may provide an alternative source of funds. We show that industries with higher dependence on trade credit financing exhibit higher rates of growth in countries with weaker financial institutions. Furthermore, consistent with barriers to trade credit access among young firms, we show that most of the effect that we report comes from growth in the size of preexisting firms. IN RECENT YEARS, there has been increasing interest in the economics literature in the role of financial intermediaries in promoting economic growth. Recent papers have shown that improved financial market development is associated with growth, using a variety of methodologies and data sets. 1 One of the basic explanations for this pattern is that the financial sector serves to reallocate funds from those with an excess of capital, given their investment opportunities, to those with a shortage of funds (relative to opportunities). Thus, an economy with welldeveloped financial institutions will be better able to allocate resources to projects that yield the highest returns. This allocative role of financial institutions in promoting development was the focus of Rajan and Zingales (1998), who found that industrial sectors with a greater need for external finance developdisproportionately faster in countries with more developed financial markets. This then begs the question of whether firms with high return projects in countries with poorly developed financial institu
TL;DR: In this paper, the authors study equilibrium firm-level stock returns in two economies: one in which investors are loss averse over the f luctuations of their stock portfolio, and another in which they are loss-averse over individual stocks that they own, and find that the typical individual stock return has high mean and excess volatility, and there is a large value premium in the cross section which can, to some extent, be captured by a commonly used multifactor model.
Abstract: We study equilibrium firm-level stock returns in two economies: one in which investors are loss averse over the f luctuations of their stock portfolio, and another in which they are loss averse over the f luctuations of individual stocks that they own Both approaches can shed light on empirical phenomena, but we find the second approach to be more successful: In that economy, the typical individual stock return has a high mean and excess volatility, and there is a large value premium in the cross section which can, to some extent, be captured by a commonly used multifactor model OVER THE PAST TWO DECADES, researchers analyzing the structure of individual stock returns have uncovered a wide range of phenomena, both in the time series and the cross section In the time series, the returns of a typical individual stock have a high mean, are excessively volatile, and are slightly predictable using lagged variables In the cross section, there is a substantial “value” premium, in that stocks with low ratios of price to fundamentals have higher average returns, and this premium can to some extent be captured by certain empirically motivated multifactor models 1 These findings have attracted a good deal of attention from finance theorists It has proved something of a challenge, though, to explain both the time series and crosssectional effects in the context of an equilibrium model where investors maximize a clearly specified utility function In this paper, we argue that it may be possible to improve our understanding of firm-level stock returns by refining the way we model investor preferences For guidance as to what kind of refinements might be important, we turn to the experimental evidence that has been accumulated on how people choose among risky gambles Many of the studies in this literature suggest that loss aversion and narrow framing play an important
TL;DR: In this article, the authors explore the empirical relevance of banking market structure on growth and find evidence that bank concentration promotes the growth of those industrial sectors that are more in need of external finance by facilitating credit access to younger firms.
Abstract: This paper explores the empirical relevance of banking market structure on growth. There is substantial evidence of a positive relationship between the level of development of the banking sector of an economy and its long-run output growth. Little is known, however, about the role played by the market structure of the banking sector on the dynamics of capital accumulation. This paper provides evidence that bank concentration promotes the growth of those industrial sectors that are more in need of external finance by facilitating credit access to younger firms. However, we also find evidence of a general depressing effect on growth associated with a concentrated banking industry, which impacts all sectors and all firms indiscriminately.
TL;DR: This paper examined the economic value of volatility timing to risk-averse investors and found that the volatility timing strategies outperform the unconditionally efficient static portfolios that have the same target expected return and volatility.
Abstract: Numerous studies report that standard volatility models have low explanatory power, leading some researchers to question whether these models have economic value. We examine this question by using conditional mean-variance analysis to assess the value of volatility timing to short-horizon investors. We find that the volatility timing strategies outperform the unconditionally efficient static portfolios that have the same target expected return and volatility. This finding is robust to estimation risk and transaction costs. VOLATILITY PLAYS A CENTRAL ROLE in derivatives pricing, optimal portfolio selection, and risk management. These applications motivate an extensive literature on volatility modeling. Starting with Engle (1982), researchers have fit a variety of autoregressive conditional heteroskedasticity (ARCH), generalized ARCH (Bollerslev (1986)), exponential ARCH (Nelson (1991)), and stochastic volatility models to asset returns. This literature, however, has centered on evaluating the statistical performance of volatility models rather than the economic significance of time-varying, predictable volatility. In contrast, we focus on the latter. Specifically, we examine the economic value of volatility timing to risk-averse investors. Several review articles summarize the empirical findings on volatility (see, e.g., Bollerslev, Chou, and Kroner (1992), Bollerslev, Engle, and Nelson (1994), Diebold and Lopez (1995), and Palm (1996)). The evidence is generally consistent across a broad range of assets and econometric specifications, and overwhelmingly suggests that volatility is to some extent predictable. However, standard volatility models typically explain only a small fraction of the variation in squared returns. This has led some researchers to question the relevance of these models. Andersen and Bollerslev (1998) argue that the
TL;DR: In this article, the authors explore informational asymmetries across the trader population: traders located outside Germany in non-German-speaking cities show lower proprietary trading profit and their underperformance is statistically significant, it is also of economically significant magnitude and occurs for the 11 largest German blue-chip stocks.
Abstract: The electronic trading system Xetra of the German Security Exchange provides a unique data source on the equity trades of 756 professional traders located in 23 different cities and eight European countries. We explore informational asymmetries across the trader population: Traders located outside Germany in non-German-speaking cities show lower proprietary trading profit. Their underperformance is not only statistically significant, it is also of economically significant magnitude and occurs for the 11 largest German blue-chip stocks. We also examine whether a trader location in Frankfurt as the financial center, or local proximity of the trader to the corporate headquarters of the traded stock, or affiliation with a large financial institution results in superior trading performance. The data provide no evidence for a financial center advantage or of increasing institutional scale economies in proprietary trading. However, we find evidence for an information advantage due to corporate headquarters proximity for high-frequency (intraday) trading.
TL;DR: In this paper, the authors investigated the relation between dividend changes and future profitability, measured in terms of either future earnings or future abnormal earnings, and found that dividend changes provided information about the level of profitability in subsequent years, incremental to market and accounting data.
Abstract: We investigate the relation between dividend changes and future profitability, measured in terms of either future earnings or future abnormal earnings. Supporting "the information content of dividends hypothesis," we find that dividend changes provide information about the level of profitability in subsequent years, incremental to market and accounting data. We also document that dividend changes are positively related to earnings changes in each of the two years after the dividend change. It is well documented that dividend changes are positively associated with stock returns in the days surrounding the dividend change announcement (see, e.g., Aharony and Swary (1980), Asquith and Mullins (1983), Kalay and Loewenstein (1985), and Petit (1972)). According to "the information content of dividends hypothesis" (Miller and Modigliani (1961)), dividend changes trigger stock returns because they convey new information about the firm's future profitability. However, recent studies have not supported this hypothesized relation between dividend changes and future earnings (e.g., DeAngelo, DeAngelo, and Skinner (1996), Benartzi, Michaely, and Thaler (BMT, 1997)). We reexamine the relation between dividend changes and alternative measures of future profitability, and provide strong evidence that dividend changes are positively related to future earnings changes, future earnings, and future abnormal earnings. To investigate whether dividend changes convey new information about future profitability, one has to estimate expected profitability. Most prior studies assume that earnings follow a random walk with drift, and measure unexpected profitability as the realized change in earnings minus the estimated drift. They then examine the association between dividend changes and unexpected earnings. We first use a similar approach and find, like prior studies, that dividend changes are not positively related to future earnings changes. We then modify the regression model to address two specifi
TL;DR: In this article, the authors analyze the market for corporate assets and find that the probability of asset sales and whole-firm transactions is related to firm organization and ex ante efficiency of buyers and sellers.
Abstract: We analyze the market for corporate assets There is an active market for corporate assets, with close to seven percent of plants changing ownership annually through mergers, acquisitions, and asset sales in peak expansion years The probability of asset sales and whole-firm transactions is related to firm organization and ex ante efficiency of buyers and sellers The timing of sales and the pattern of efficiency gains suggests that the transactions that occur, especially through asset sales of plants and divisions, tend to improve the allocation of resources and are consistent with a simple neoclassical model of profit maximizing by firms
TL;DR: In this article, the authors characterize the forward premium anomaly in the context of affine models of the term structure of interest rates and find the quantitative properties of either alternative to have important shortcomings.
Abstract: One of the most puzzling features of currency prices is the forward premium anomaly: the tendency for high interest rate currencies to appreciate. We characterize the anomaly in the context of affine models of the term structure of interest rates. In affine models, the anomaly requires either that state variables have asymmetric effects on state prices in different currencies or that nominal interest rates take on negative values with positive probability. We find the quantitative properties of either alternative to have important shortcomings. PERHAPS THE MOST PUZZLING FEATURE of currency prices is the tendency for high interest rate currencies to appreciate when one might guess, instead, that investors would demand higher interest rates on currencies expected to fall in value. This departure from uncovered interest parity, which we term the forward premium anomaly, has been documented in dozens—and possibly hundreds—of studies, and has spawned a second generation of papers attempting to account for it. One of the most inf luential of these is Fama ~1984!, who attributes the behavior of forward and spot exchange rates to a time-varying risk premium. Fama shows that the implied risk premium on a currency must ~1! be negatively correlated with its expected rate of depreciation and ~2! have greater variance. We refer to this feature of the data as an anomaly because asset pricing theory to date has been notably unsuccessful in producing a risk premium with the requisite properties. Attempts include applications of the capital asset pricing model to currency prices ~Frankel and Engel ~1984!, Mark ~1988!!, statistical models relating risk premiums to changing second moments ~Hansen and Hodrick ~1983!, Domowitz and Hakkio ~1985!, Cumby ~1988!!, and consumption-based asset pricing theories, including departures from time