Place Your Bets
Market Madness? The Case of Mad Money
Joseph Engelberg, Caroline Sasseville & Jared Williams
Management Science, forthcoming
Abstract:
We use the popular television show Mad Money, hosted by Jim Cramer, to test theories of attention and limits to arbitrage. Stock recommendations on Mad Money constitute attention shocks to a large audience of individual traders. We find that stock recommendations lead to large overnight returns that subsequently reverse over the next few months. The spike-reversal pattern is strongest among small, illiquid stocks that are hard to arbitrage. Using daily Nielsen ratings as a direct measure of attention, we find that the overnight return is strongest when high-income viewership is high. We also find weak price effects among sell recommendations. Taken together, the evidence supports the retail attention hypothesis of Barber and Odean (Barber, B., T. Odean. 2008. All that glitters: The effect of attention and news on the buying behavior of individual and institutional investors. Rev. Financial Stud. 21(2) 785-818) and illustrates the potential role of media in generating mispricing.
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The Role of Skill Versus Luck in Poker: Evidence from the World Series of Poker
Steven Levitt & Thomas Miles
NBER Working Paper, May 2011
Abstract:
In determining the legality of online poker - a multibillion dollar industry - courts have relied heavily on the issue of whether or not poker is a game of skill. Using newly available data, we analyze that question by examining the performance in the 2010 World Series of Poker of a group of poker players identified as being highly skilled prior to the start of the events. Those players identified a priori as being highly skilled achieved an average return on investment of over 30 percent, compared to a -15 percent for all other players. This large gap in returns is strong evidence in support of the idea that poker is a game of skill.
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Financial capability and psychological health
Mark Taylor, Stephen Jenkins & Amanda Sacker
Journal of Economic Psychology, forthcoming
Abstract:
Financial capability is receiving increasing interest among policy makers, who wish to reduce problem debt and welfare dependency and increase savings and general skills. We examine whether financial capability has impacts on psychological health independent of income and financial resources more generally using a nationally representative survey. Data from the British Household Panel Survey 1991-2006 are used to construct a measure of financial capability, which we relate to respondents' psychological health using the 12-item General Health Questionnaire. Estimates from within-group panel data models indicate that financial capability has significant and substantial effects on psychological health over and above those associated with income and material wellbeing more generally. For men, having low financial capability has an effect larger than that associated with being unemployed, while for women it is similar to that of being divorced. Furthermore having low financial capability exacerbates the psychological costs associated with unemployment and divorce, while high financial capability reduces these costs.
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Brock Mendel & Andrei Shleifer
Journal of Financial Economics, forthcoming
Abstract:
We present a simple model in which rational but uninformed traders occasionally chase noise as if it were information, thereby amplifying sentiment shocks and moving prices away from fundamental values. In the model, noise traders can have an impact on market equilibrium disproportionate to their size in the market. The model offers a partial explanation for the surprisingly low market price of financial risk in the spring of 2007.
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Did Gold-Standard Adherence Reduce Sovereign Capital Costs?
Ron Alquist & Benjamin Chabot
Journal of Monetary Economics, forthcoming
Abstract:
A commonly cited benefit of the classical gold standard is that it reduced borrowing costs by signaling a country's commitment to financial probity. Using a new dataset, this paper tests whether gold-standard adherence was negatively correlated with the cost of capital. Conditional on UK risk factors, there is no evidence that the bonds issued by countries off gold earned systematically higher excess returns than the bonds issued by countries on gold. This conclusion is robust to allowing betas to differ across exchange-rate regimes; to including other determinants of the country risk premium; and to controlling for the British Empire effect.
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Selective Publicity and Stock Prices
David Solomon
Journal of Finance, forthcoming
Abstract:
I examine how media coverage of good and bad corporate news affects stock prices, by studying the effect of investor relations (IR) firms. I find that IR firms "spin‟ their clients' news, generating more media coverage of positive press releases than negative press releases. This spin increases announcement returns. Around earnings announcements, IR firms cannot spin the news, and their clients' returns are significantly lower. This is consistent with positive media coverage increasing investor expectations, creating disappointment around hard information. Using reporter connections and geographical links to newspapers, I argue that IR firms causally affect both media coverage and returns.
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Is market fragmentation harming market quality?
Maureen O'Hara & Mao Ye
Journal of Financial Economics, June 2011, Pages 459-474
Abstract:
We examine how fragmentation is affecting market quality in US equity markets. We use newly available trade reporting facilities (TRFs) data to measure fragmentation, and we use a variety of empirical approaches to compare execution quality and efficiency of stocks with more and less fragmented trading. We find that fragmentation affects all stocks; more fragmented stocks have lower transactions costs and faster execution speeds; and fragmentation is associated with higher short-term volatility but greater market efficiency, in that prices are closer to being a random walk. Our results that fragmentation does not appear to harm market quality are consistent with US markets being a single virtual market with multiple points of entry.
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The Social Cost of Near-Rational Investment
Tarek Hassan & Thomas Mertens
NBER Working Paper, May 2011
Abstract:
We show that the stock market may fail to aggregate information even if it appears to be efficient and that the resulting decrease in the information content of stock prices may drastically reduce welfare. We solve a macroeconomic model in which information about fundamentals is dispersed and households make small, correlated errors around their optimal investment policies. As information aggregates in the market, these errors amplify and crowd out the information content of stock prices. When stock prices reflect less information, the volatility of stock returns rises. The increase in volatility makes holding stocks unattractive, distorts the long-run level of capital accumulation, and causes costly (first-order) distortions in the long-run level of consumption.
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Do Stock Investors Value Corporate Sustainability? Evidence from an Event Study
Adrian Wai Kong Cheung
Journal of Business Ethics, March 2011, Pages 145-165
Abstract:
This paper analyzes the impacts of index inclusions and exclusions on corporate sustainable firms by studying a sample of US stocks that are added to or deleted from the Dow Jones Sustainability World Index over the period 2002-2008. The impacts are measured in terms of stock return, risk and liquidity. We cannot find any strong evidence that announcement per se has any significant impact on stock return and risk. However, on the day of change, index inclusion (exclusion) stocks experience a significant but temporary increase (decrease) in stock return. Liquidity deteriorates after the announcement day and bounces back significantly near the day of change. Systematic risk shows little change after announcements. But, idiosyncratic risk is higher after announcements. The overall results support Harris and Eitan's (The Journal of Finance 41(4), 815-829, 1986) price pressure hypothesis, which posits that event announcement does not carry information and any shift in demand (and hence the corresponding price change and liquidity change) is temporary.
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Behavioral biases of mutual fund investors
Warren Bailey, Alok Kumar & David Ng
Journal of Financial Economics, forthcoming
Abstract:
We examine the effect of behavioral biases on the mutual fund choices of a large sample of US discount brokerage investors using new measures of attention to news, tax awareness, and fund-level familiarity bias, in addition to behavioral and demographic characteristics of earlier studies. Behaviorally biased investors typically make poor decisions about fund style and expenses, trading frequency, and timing, resulting in poor performance. Furthermore, trend chasing appears related to behavioral biases, rather than to rationally inferring managerial skill from past performance. Factor analysis suggests that biased investors often conform to stereotypes that can be characterized as Gambler, Smart, Overconfident, Narrow Framer, and Mature.
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Steffen Andersen & Kasper Meisner Nielsen
Review of Financial Studies, May 2011, Pages 1667-1697
Abstract:
We use a natural experiment to investigate the impact of participation constraints on individuals' decisions to invest in the stock market. Unexpected inheritance due to sudden deaths results in exogenous variation in financial wealth, and allows us to examine whether fixed entry and ongoing participation costs cause non-participation. We have three key findings. First, windfall wealth has a positive effect on participation. Second, the majority of households do not react to sizeable windfalls by entering the stock market, but hold on to substantial safe assets - even over longer horizons. Third, the majority of households inheriting stock holdings actively sell the entire portfolio. Overall, these findings suggest that participation by many individuals is unlikely to be constrained by financial participation costs.
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The wisdom of the few or the wisdom of the many? An indirect test of the marginal trader hypothesis
Calvin Blackwell & Robert Pickford
Journal of Economics and Finance, April 2011, Pages 164-180
Abstract:
The Marginal Trader Hypothesis (Forsythe et al. 1992, in American Economic Review 82(5): 1142-1161) posits that a small group of well-informed traders keep an asset's market price equal to its fundamental value. Forsythe et al. base this claim on evidence from U.S. presidential prediction markets. We test the Marginal Trader Hypothesis by examining a decision task that precludes marginal traders. Specifically, students are asked to predict the class average for a given exam. We show that performance on our task is similar to that reported for the Iowa Electronic Markets, and that accuracy is unrelated to academic performance and does not correlate across tasks.
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Canada and the United States: Different roots, different routes to financial sector regulation
Donald Brean, Lawrence Kryzanowski & Gordon Roberts
Business History, Spring 2011, Pages 249-269
Abstract:
This paper explores the lessons to be learned from why the neighbouring banking systems of Canada and the United States, that share numerous commonalities, fared so differently during two major financial crises. The explanations are deeply rooted in different tolerances for industry concentration and state involvement, and the divergent routes of the development of their financial systems, founding institutions, on-going governance and regulation, and competitive structures. Canada's success during the more recent 2007-09 financial crisis is attributed to more effective regulation and conservative banking practices, including (self-) imposed stricter limits on bank leverage, much stricter limits on unconventional mortgages, and less reliance on the use of more 'creative' investment types (e.g. subprime lending) and structured products.
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On the information content of ratings: An analysis of the origin of Moody's stock and bond ratings
Berry Wilson
Financial History Review, forthcoming
Abstract:
John Moody published his first railroad security analysis and ratings manual in April 1909. This study analyzes several current issues by looking back at Moody's original intentions for constructing a ratings system. The study analyzes whether Moody intended his ratings to reflect his private information, or rather, to serve some alternative role, as with monitoring conflicts of interests or realizing informational economies of scale. The study uses an ordinal regression approach to evaluate a set of explanatory variables, constructed from both the manual itself and the panic months of 1907, to test the potential information content of Moody's ratings. At the time of Moody's first rating system, the illiquidity of the US Treasury market forced investors to seek alternative ‘high-quality' securities. Indeed, Moody rated 38.94 percent of railroad bonds as Aaa, and rated 85.25 percent of railroad bonds as A, Aa or Aaa in his universe of railroad bonds rated. To further test the informational content of Moody's ratings, the study pursues a structural default analysis during the panic year of 1907, which yields results that indicate that the default risk of railroad securities was quite low at the time. These results provide justification for the high overall ratings that Moody assigned to railroad securities, and thus their role as near risk-free securities. Therefore, railroad securities, and Moody's ratings, played a particularly important role in the financial system at the time.
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Dror Kenett et al.
PLoS ONE, April 2011, e19378
Background: The 2007-2009 financial crisis, and its fallout, has strongly emphasized the need to define new ways and measures to study and assess the stock market dynamics.
Methodology/Principal Findings: The S&P500 dynamics during 4/1999-4/2010 is investigated in terms of the index cohesive force (ICF - the balance between the stock correlations and the partial correlations after subtraction of the index contribution), and the Eigenvalue entropy of the stock correlation matrices. We found a rapid market transition at the end of 2001 from a flexible state of low ICF into a stiff (nonflexible) state of high ICF that is prone to market systemic collapses. The stiff state is also marked by strong effect of the market index on the stock-stock correlations as well as bursts of high stock correlations reminiscence of epileptic brain activity.
Conclusions/Significance: The market dynamical states, stability and transition between economic states was studies using new quantitative measures. Doing so shed new light on the origin and nature of the current crisis. The new approach is likely to be applicable to other classes of complex systems from gene networks to the human brain.
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Working for the enemy? The impact of investment banker job changes on deal flow
Daniel Bradley, Hyung-Suk Choi & Jonathan Clarke
Journal of Empirical Finance, forthcoming
Abstract:
This paper examines the impact of job changes by prominent investment bankers on the M&A and equity market shares of investment banks. Using a hand-collected sample of job changes between 1998 and 2006, we find that after controlling for deal and bank-level characteristics, hiring a banker from an investment bank with a more prominent industry presence has a positive impact on both equity and M&A market share for the gaining bank and a negative impact on the losing bank's M&A market share. After the banker switches firms, we find a significant amount of business follows the banker from the losing bank to the gaining bank, particularly when the relationship is strong between the client firm and the banker. Abnormal returns around the announcement of a banker changing employers are positive and significant for the gaining bank, suggesting that the market views banker additions as value increasing. Overall, our results suggest human capital is a critical component of investment banking deal flow.
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Friends or foes? Target selection decisions of sovereign wealth funds and their consequences
Jason Kotter & Ugur Lel
Journal of Financial Economics, forthcoming
Abstract:
This paper examines investment strategies of sovereign wealth funds (SWFs), their effect on target firm valuation, and how both of these are related to SWF transparency. We find that SWFs prefer large and poorly performing firms facing financial difficulties. Their investments have a positive effect on target firms' stock prices around the announcement date but no substantial effect on firm performance and governance in the long run. We also find that transparent SWFs are more likely to invest in financially constrained firms and have a greater impact on target firm value than opaque SWFs. Overall, SWFs are similar to passive institutional investors in their preference for target characteristics and in their effect on target performance, and SWF transparency influences SWFs' investment activities and their impact on target firm value.
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When a Halt is Not a Halt: An Analysis of Off-NYSE Trading during NYSE Market Closures
Bidisha Chakrabarty, Shane Corwin & Marios Panayides
Journal of Financial Intermediation, July 2011, Pages 361-386
Abstract:
Though trading halts are a common feature in securities markets, the issues associated with the coordination of these halts across markets are not well understood. In fact, regulations often allow traders to circumvent trading halts through the use of alternative venues. Using a sample of order imbalance delayed openings on the NYSE, we examine the costs and benefits of continued trading on alternative venues when the main market calls a halt. We find that trades routed to off-NYSE venues during NYSE halts are associated with significant price discovery and lead to an improved post-halt trading environment. In addition, limit orders routed through ECNs reflect price relevant information even prior to the halt, with limit book imbalances decreasing and depth filling in during the halt around the eventual reopening NYSE price. However, these informational benefits come at a substantial cost, as both execution costs and volatility are extremely high on off-NYSE venues during NYSE halts.
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Shell games: On the value of shell companies
Ioannis Floros & Travis Sapp
Journal of Corporate Finance, September 2011, Pages 850-867
Abstract:
A reverse merger allows a private company to assume the current reporting status of another company that is public. This can be done quickly, without fundraising, road show, underwriter, substantial ownership dilution, or great expense. Private firms that go public via reverse merger are often motivated by the need to quickly secure financing through privately placed stock (PIPEs) and the desire to make acquisitions using stock as payment. In each of the last eight years reverse mergers have outnumbered traditional IPOs as a mechanism for going public, and reporting shell companies are providing fuel for much of this growth. We study 585 trading shell companies over the period 2006-2008. The purpose of most of these shell firms is to find a suitor for a reverse merger agreement. These companies have no systematic risk, operations, or assets, and their share price tends to decline over time. Yet, these firms have investors. When a takeover agreement is consummated, shell company three-month abnormal returns are 48.1%. We argue that this exceptional return is compensation to investors for shell stock illiquidity and the uncertainty of finding a reverse merger suitor. We show that shell company returns are much greater at the consummation of a merger than those of a similar entity that in dollar terms is more popular among investors - Special Purpose Acquisition Companies (SPACs).
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Investment Decisions with Loss Aversion over Relative Consumption
Georg Gebhardt
Journal of Economic Behavior & Organization, forthcoming
Abstract:
We study an exchange economy in which investors are loss averse over relative consumption, that is, they suffer a utility loss if they consume less than members of their reference group. As a consequence there is an incentive to hold the same portfolio of risky assets as the reference group. Thus, risk premia can be supported in equilibrium that diverge from the risk premia obtained without loss aversion over relative consumption. This effect may be used to explain time-varying risk premia that are empirically observed for many assets.
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The effect of macroeconomic news on stock returns: New evidence from newspaper coverage
Gene Birz & John Lott
Journal of Banking & Finance, forthcoming
Abstract:
Previous literature has produced weak evidence to support the hypothesis that real economic news affects stock returns. This is, in part, attributed to the difficulty of measuring how investors interpret macroeconomic announcements in different economic environments. In this paper, we choose a different approach of measuring macroeconomic news to better estimate its effect on stock returns. Since newspaper stories provide an interpretation of the statistical releases, we choose newspaper stories as our measure of news. Our findings indicate that news about GDP and unemployment does affect stock returns.
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Dividend Policies in an Unregulated Market: The London Stock Exchange, 1895-1905
Fabio Braggion & Lyndon Moore
Review of Financial Studies, forthcoming
Abstract:
Miller and Modigliani (1961) show that in perfect and complete financial markets a firm's value is unaffected by its dividend policy. Much of the more recent research has demonstrated that dividend policy becomes important in the presence of taxation, asymmetric information, incomplete contracts, institutional constraints, and transaction costs. By examining the effects of dividend policies on 475 British firms existing between 1895 and 1905, and consequently operating in an environment of very low taxation with an absence of institutional constraints, we find strong support for asymmetric information theories of dividend policy, and little support for agency models.
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What Drives Sell-Side Analyst Compensation at High-Status Investment Banks?
Boris Groysberg, Paul Healy & David Maber
Journal of Accounting Research, forthcoming
Abstract:
We use proprietary data from a major investment bank to investigate factors associated with analysts' annual compensation. We find compensation to be positively related to "All-Star" recognition, investment-banking contributions, the size of analysts' portfolios, and whether an analyst is identified as a top stock-picker by the Wall Street Journal. We find no evidence that compensation is related to earnings forecast accuracy. But consistent with prior studies, we find analyst turnover to be related to forecast accuracy, suggesting that analyst forecasting incentives are primarily termination-based. Additional analyses indicate that "All-Star" recognition proxies for buy-side client votes on analyst research quality used to allocate commissions across banks and analysts. Taken as a whole, our evidence is consistent with analyst compensation being designed to reward actions that increase brokerage and investment-banking revenues. To assess the generality of our findings, we test the same relations using compensation data from a second high-status bank and obtain similar results.
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Eugene Kandel, Massimo Massa & Andrei Simonov
Journal of Financial Economics, forthcoming
Abstract:
We hypothesize that age similarity among small shareholders acts as an implicit coordinating device for their actions and, thus, could represent an indirect source of corporate governance in firms with dispersed ownership. We test this hypothesis on a sample of Swedish firms during the 1995-2000 period. Consistent with our hypothesis, we find that compared with shareholders of differing ages, same-age noncontrolling shareholders sell more aggressively following negative firm news; firms with more age-similar small shareholders are more profitable and command higher valuation; and an increase (decline) in a firm's small shareholder age similarity brings a significantly large increase (decline) in its stock price. The last effects are more pronounced in the absence of a controlling shareholder.
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The Paradox of "Fraud-on-the-Market Theory": Who Relies on the Efficiency of Market Prices?
Grigori Erenburg, Janet Kiholm Smith & Richard Smith
Journal of Empirical Legal Studies, June 2011, Pages 260-303
Abstract:
Our evidence points to an inconsistency between the efficient markets hypothesis and the way U.S. courts have applied the hypothesis in cases involving allegations of fraud on the market. Based on a sample of securities class action cases, we find that (1) some cases certified for class action status do not satisfy the conditions for even weak-form efficiency; (2) numerous opportunities exist for cost-effective investors (those who can trade quickly and at low cost) to profit by using simple momentum-based strategies; (3) including such investors as class members effectively subsidizes their strategies and overstates damages from reliance on market efficiency; (4) when such investors can profit by rejecting market efficiency, standard measures of damage overstate the fraud-related damage of other investors; and (5) because of endogeneity, the factors that commonly are relied on by the courts for determining market efficiency bear little or no relation to weak-form efficiency.