Price mechanism
The Genetics of Investment Biases
Henrik Cronqvist & Stephan Siegel
Journal of Financial Economics, August 2014, Pages 215–234
Abstract:
For a long list of investment “biases,” including lack of diversification, excessive trading, and the disposition effect, we find that genetic differences explain up to 45% of the remaining variation across individual investors, after controlling for observable individual characteristics. The evidence is consistent with a view that investment biases are manifestations of innate and evolutionary ancient features of human behavior. We find that work experience with finance reduces genetic predispositions to investment biases. Finally, we find that even genetically identical investors, who grew up in the same family environment, often differ substantially in their investment behaviors due to individual-specific experiences or events.
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Political Uncertainty and Financial Market Quality
Paolo Pasquariello & Christina Zafeiridou
University of Michigan Working Paper, April 2014
Abstract:
We examine the effects of political uncertainty surrounding the outcome of U.S. presidential elections on financial market quality. We postulate those effects to depend on a positive relation between political uncertainty and information asymmetry among investors, ambiguity about the quality of their information, or dispersion of their beliefs. We find that market quality deteriorates (trading volume and various measures of liquidity decrease) in the months leading up to those elections (when political uncertainty is likely highest), but it improves (trading volume and liquidity increase) in the months afterwards. These effects are more pronounced for more uncertain elections and more speculative, difficult-to-value stocks (small, high book-to-market, low beta, traded on NASDAQ, or in less politically sensitive industries), but not for direct proxies of the market-wide extent of information asymmetry and heterogeneity among market participants (accruals, analysts' forecast dispersion, and forecast error). These findings provide the strongest support for the predictions of the ambiguity hypothesis.
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Facebook's daily sentiment and international stock markets
Antonios Siganos, Evangelos Vagenas-Nanos & Patrick Verwijmeren
Journal of Economic Behavior & Organization, forthcoming
Abstract:
We examine the relation between daily sentiment and trading behavior within 20 international markets by exploiting Facebook's Gross National Happiness Index. We find that sentiment has a positive contemporaneous relation to stock returns. Moreover, sentiment on Sunday affects stock returns on Monday, suggesting causality from sentiment to stock markets. We observe that the relation between sentiment and returns reverses the following weeks. We further show that negative sentiments are related to increases in trading volume and return volatility. These results highlight the importance of behavioral factors in stock investing.
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The Stock Market Speaks: How Dr. Alchian Learned to Build the Bomb
Joseph Michael Newhard
Journal of Corporate Finance, August 2014, Pages 116–132
Abstract:
At RAND in 1954, Armen A. Alchian conducted the world’s first event study to infer the fissile fuel material used in the manufacturing of the newly-developed hydrogen bomb. Successfully identifying lithium as the fissile fuel using only publicly available financial data, the paper was seen as a threat to national security and was immediately confiscated and destroyed. The bomb’s construction being secret at the time but having since been partially declassified, the nuclear tests of the early 1950s provide an opportunity to observe market efficiency through the dissemination of private information as it becomes public. I replicate Alchian’s event study of capital market reactions to the Operation Castle series of nuclear detonations in the Marshall Islands, beginning with the Bravo shot on March 1, 1954 at Bikini Atoll which remains the largest nuclear detonation in US history, confirming Alchian’s results. The Operation Castle tests pioneered the use of lithium deuteride dry fuel which paved the way for the development of high yield nuclear weapons deliverable by aircraft. I find significant upward movement in the price of Lithium Corp. relative to the other corporations and to DJIA in March 1954; within three weeks of Castle Bravo the stock was up 48% before settling down to a monthly return of 28% despite secrecy, scientific uncertainty, and public confusion surrounding the test; the company saw a return of 461% for the year.
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Amanda Sharkey
American Journal of Sociology, March 2014, Pages 1380-1433
Abstract:
Extant research in organizational and economic sociology posits that organizations derive status from their prior demonstrations of quality, as well as their affiliations with high-status alters. Yet there are also indications that organizations may acquire status by virtue of their membership in salient social categories that are themselves status valued. In this article, the author explicitly theorizes and measure the concept of categorical status among organizations and test whether it influences the evaluation of organizational actions. More concretely, she develops a measure of industry status and test whether it affects the market reaction to U.S. firms announcing earnings restatements between 2000 and 2009. Results of the empirical analyses indicate that investors react less negatively to earnings restatements announced by firms from higher-status industries, supporting the argument that category status acts as a lens that shapes the extent to which an organization’s actions are viewed favorably.
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Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market
Alain Chaboud et al.
Journal of Finance, forthcoming
Abstract:
We study the impact of algorithmic trading in the foreign exchange market using a long time series of high-frequency data that identify computer-generated trading activity. We find that algorithmic trading causes an improvement in two measures of price efficiency: the frequency of triangular arbitrage opportunities and the autocorrelation of high-frequency returns. We show that the reduction in arbitrage opportunities is associated primarily with computers taking liquidity. This result is consistent with the view that AT improves informational efficiency by speeding up price discovery, but that it may also impose higher adverse selection costs on slower traders. In contrast, the reduction in the autocorrelation of returns owes more to the algorithmic provision of liquidity. We also find evidence consistent with the strategies of algorithmic traders being highly correlated. This correlation, however, does not appear to cause a degradation in market quality, at least not on average.
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Investor Sentiment from Internet Message Postings and the Predictability of Stock Returns
Soon-Ho Kim & Dongcheol Kim
Journal of Economic Behavior & Organization, forthcoming
Abstract:
By using an extensive dataset of more than 32 million messages on 91 firms posted on the Yahoo! Finance message board over the period January 2005 to December 2010, we examine whether investor sentiment as expressed in posted messages has predictive power for stock returns, volatility, and trading volume. In intertemporal and cross-sectional regression analyses, we find no evidence that investor sentiment forecasts future stock returns either at the aggregate or at the individual firm level. Rather, we find evidence that investor sentiment is positively affected by prior stock price performance. We also find no significant evidence that investor sentiment from Internet postings has predictive power for volatility and trading volume. A distinctive feature of our study is the use of sentiment information explicitly revealed by retail investors as well as classified by a machine learning classification algorithm and a much longer sample period relative to prior studies.
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Religious Holidays, Investor Distraction, and Earnings Announcement Effects
Christos Pantzalis & Erdem Ucar
Journal of Banking & Finance, forthcoming
Abstract:
We examine price reactions to U.S. firms’ earnings announcements during Easter week in order to analyze whether and how the religious holiday calendar impacts investors’ information processing. We find that there is an asymmetric pattern of immediate and delayed responses to earnings surprises experienced during Easter, entailing similar immediate reactions to both good and bad news and a stronger delayed response to bad news. Moreover, local religious characteristics affect investor’s response to firm news. The results are consistent with a religion-induced distraction effect on investors’ information processing ability. We also show that this effect can form the basis for a profitable trading strategy. The findings highlight the importance of religion for firms’ information environment and for the local component of stock prices.
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High-Frequency Trading and Price Discovery
Jonathan Brogaard, Terrence Hendershott & Ryan Riordan
Review of Financial Studies, forthcoming
Abstract:
We examine the role of high-frequency traders (HFTs) in price discovery and price efficiency. Overall HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs' liquidity supplying orders are adversely selected. The direction of HFTs' trading predicts price changes over short horizons measured in seconds. The direction of HFTs' trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances.
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Which Limited Partners Limit VC Opportunism?
Vladimir Atanasov et al.
Northwestern University Working Paper, April 2014
Abstract:
We examine the response of different types of Limited Partners (LPs) to alleged opportunistic behavior on the part of Venture Capitalists (VCs). We use a sample of litigated VCs (identified by Atanasov, et al, 2012, Journal of Finance) to proxy for VC opportunistic behavior. Based on their presumed sensitivity to VC malfeasance and headline risk, we predict that university endowments and economic development authorities will be most likely to respond negatively to potential bad press. To test our hypothesis, we employ differences-in-differences (DiD) analysis and compare the participation of different types of LPs in VC funds before and after litigation relative to the LPs of otherwise similar, matched VCs that are not subject to litigation. We find that endowments reduce by more than 50% their participation in follow-on investment funds offered by litigated VCs relative to other types of LPs. Our results suggest that the threat of university endowment withdrawal of funding can deter VC opportunism.
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Limited Liability and Share Transferability: An Analysis of California Firms, 1920-1940
Leonce Bargeron & Kenneth Lehn
Journal of Corporate Finance, forthcoming
Abstract:
In 1931, California became the last U.S. state to adopt limited liability. Prior to that, from its inception as a state in 1849, stockholders of California corporations faced pro rata unlimited liability. California’s unique liability rule during 1849-1931 provides a natural experiment for testing Woodward’s (1985) and Alchian and Woodward’s (1987, 1988) hypothesis that limited liability reduces transaction costs and facilitates the transferability of shares. Using a small sample of publicly traded California firms and a corresponding sample of benchmark companies, we find that trading volume and share turnover were significantly lower for California firms when California had unlimited liability. After California adopted limited liability, trading volume and share turnover increased significantly for California firms relative to non-California firms. In addition, bid-ask spreads were significantly higher for California firms during the period of unlimited liability and they declined for California firms relative to non-California firms after California adopted limited liability. The results support Alchian and Woodward’s hypothesis that limited liability reduces transaction costs and promotes the transferability of shares.
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Attracting Early Stage Investors: Evidence from a Randomized Field Experiment
Shai Bernstein, Arthur Korteweg & Kevin Laws
Stanford Working Paper, May 2014
Abstract:
Which start-up characteristics are most important to investors in early-stage firms? This paper uses a randomized field experiment involving 4,500 active, early stage investors. The experiment takes place on AngelList, an online platform that matches investors with start-ups seeking capital. The experiment randomizes investors’ information sets on start-up characteristics through the use of nearly 17,000 emails. The average investor responds strongly to information about the founding team, but not to information about either firm traction or existing lead investors. This is in contrast to the least experienced investors, who respond to all categories of information. Our results suggest that information about human assets is causally important for the funding of early-stage firms.
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Alexandra Michel
Sociological Quarterly, Summer 2014, Pages 514–536
Abstract:
A 12-year ethnography illustrates how two investment banks' participative work practices entrapped bankers in indiscriminate overwork, and what the evolving consequences were for the banks and the organizations that the bankers joined subsequently. The banks' participative work practices eliminated all visible organizational controls. Invested in the task, the bankers collectively designed work practices that benefited the banks, but had the unintended consequences of intensifying work pace and habituating bankers to indiscriminate overwork that they experienced as self-chosen. Prior organizational behavioral research predicts outcomes only for about one year. During this time, the banks benefited from the bankers' hard work. Starting in year four, the practices' extremes produced opposite effects, namely declining performance because of body breakdowns, and cultural distance, because depleted bodies made it impossible for bankers to work in culturally normative ways. The bankers carried this pattern of overwork and subsequent breakdowns into the organizations that they joined subsequently, where they introduced the banks' practices.
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Second-order Beliefs and the Individual Investor
Daniel Egan, Christoph Merkle & Martin Weber
Journal of Economic Behavior & Organization, forthcoming
Abstract:
In a panel survey of individual investors, we show that investors’ second-order beliefs — their beliefs about the return expectations of other investors — influence investment decisions. Investors who believe others hold more optimistic stock market expectations allocate more of their own portfolio to stocks even after controlling for their own risk and return expectations. However, second-order beliefs are inaccurate and exhibit several well-known psychological biases. We observe both the tendency of investors to believe that their own opinion is relatively more common among the population (false consensus) and that others who hold divergent beliefs are considered to be biased (bias blind spot).
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The implications of high-frequency trading on market efficiency and price discovery
Viktor Manahov & Robert Hudson
Applied Economics Letters, forthcoming
Abstract:
This study investigates the implications of high-frequency trading (HFT) on market efficiency and price discovery by using state-space models and real-life one-minute high-frequency data of the six most traded currency pairs worldwide – USD/EUR, USD/JPY, USD/GBP, USD/AUD, USD/CHF and USD/CAD. We found significant evidence that HFT enhances market efficiency and has a beneficial role in price discovery by trading in the direction of the permanent component of the state-space model and in the opposite direction of its transitory component.
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Do Firms Buy Their Stock at Bargain Prices? Evidence from Actual Stock Repurchase Disclosures
Azi Ben-Rephael, Jacob Oded & Avi Wohl
Review of Finance, July 2014, Pages 1299-1340
Abstract:
Using new monthly data, we investigate open-market repurchase executions of US firms. We find that firms repurchase at prices that are significantly lower than average market prices. This price discount is negatively related to size and positively related to market-to-book ratio. Firms’ repurchase activity is followed by a positive and significant abnormal return. Importantly, the market response occurs when firms disclose their actual repurchase data in earnings announcements, and this positive response is followed by a 1-month drift. Consistent with these results, we find that insider trading is positively related to actual repurchases.
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Gil Cohen
Economics Letters, forthcoming
Abstract:
In this research I examined a calendar anomaly that occurs at the beginning of each quarter. Through an examination of 34 years of daily and annual returns for the S&P500 and 13 years of returns for popular ETFs, I have demonstrated the existence of the First Day of Quarter (FDQ) effect. By trading only four days a year from the beginning of 2000 until the end of 2013, an investor could have gained 113.1% of the S&P500 return for that period, while being exposed to stock risk for only 56 days. Moreover, for 11 of those 14 years of trading, the FDQ was responsible for more than 10% of the annual return. Only for two years since 2000 (2001, 2005) has the FDQ yielded a negative return. The biggest beneficiary of the FDQ is the financial sector, which for the last 13 years of investing has been non-fertile, showing −6.12% total return. Investing only at the beginning of each quarter for a total of 52 days would have yielded a return of 40.17%. The next beneficiary of the FDQ is the technological sector. The 82.5% of total return gained in this sector over the last 13 years could have been gained in only 52 days of trading.
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Arvid Hoffmann & Thomas Post
Journal of Behavioral and Experimental Economics, forthcoming
Abstract:
Self-attribution bias is a long-standing concept in psychology research and refers to individuals’ tendency to attribute successes to personal skills and failures to factors beyond their control. Recently, this bias is also being studied in household finance research and is considered to underlie and reinforce investor overconfidence. To date, however, the existence of self-attribution bias amongst individual investors is not directly empirically tested. That is, it remains unclear whether good (vs. bad) returns indeed make investors believe more (vs. less) strongly that skills drive their performance. Using a unique combination of survey data and matching trading records of a sample of clients from a large discount brokerage firm, we find that: (1) the higher the returns in a previous period are, the more investors agree with a statement claiming that their recent performance accurately reflects their investment skills (and vice versa); and (2) while individual returns relate to more agreement, market returns have no such effect.
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Clustering of shareholder annual meetings: A ‘new anomaly’ in stock returns
Weishen Wang & Frank Hefner
Applied Financial Economics, Summer 2014, Pages 1103-1110
Abstract:
The study documents the clustering of annual general meetings (AGMs) in the months of March, April and May and shows that this clustering of AGMs in dates is positively related to average monthly stock returns in these months. The study not only documents a ‘new anomaly’ in the stock market in the recent two decades, but also provides explanations why it is so. The study shows that an economic event is behind the regularity in stock returns.
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Star Analysts’ Rankings and Strategic Announcements: The Case of Battleground Stocks
Gil Aharoni, Joshua Shemesh & Fernando Zapatero
University of Southern California Working Paper, April 2014
Abstract:
We find that direct competition among star analysts plays a key role in the annual rankings of the Institutional Investor magazine that selects them. When two or more star analysts cover the same stock (battleground stock), the most accurate star analyst is more likely to improve her ranking, which has substantial effects on income. We also find that the forecast error of star analysts is substantially lower in battleground stocks. Overall, our findings are consistent with star analysts optimally allocating more effort to battleground stocks than to stocks that are not covered by other star analysts.
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Friends Do Let Friends Buy Stocks Actively
Rawley Heimer
Journal of Economic Behavior & Organization, forthcoming
Abstract:
This research provides empirical evidence that social interaction is more prevalent among active rather than passive investors. While previous empirical work, spearheaded by Hong et al. (2004), shows that proxies for sociability are related to participation in asset markets, the literature is unable to distinguish between the types of participants because of data limitations. I address this shortcoming by using data from the Consumer Expenditure Quarterly Interview Survey, which contains information on individual holdings and the buying and selling of financial assets, as well as expenditure variables that imply variation in the level of social activity. This finding supports a new explanation for the active-investing puzzle in which informal communication tends to promote active rather than passive strategies (Han and Hirshleifer, 2012).