Forthcoming Articles

Full text of published articles can be found on the Wiley page here:

November 2018 Issue

A time to scatter stones, and a time to gather them: The annual cycle in managerial risk taking.

By Achim Mattes, Olga Kolokolova

Analyzing a sample of hedge fund daily returns from Bloomberg, we find a seasonal pattern in their risk taking. During earlier months of a year, poorly performing funds reduce risk. The reduction is stronger for funds with higher management fees, shorter redemption periods, and recently deteriorating performance, consistent with a managerial aversion to early fund liquidation. Towards the end of a year, poorly performing funds gamble for resurrection by increasing risk. It is largely achieved by increasing exposure to market factors, and can be linked to stronger indirect managerial incentives during the second half of a year. Download pdf

Shiller’s CAPE: Market Efficiency and Risk

By Valentin Dimitrov, Prem C. Jain

Robert Shiller shows that Cyclically Adjusted Price to Earnings Ratio (CAPE) is strongly associated with future long-term stock returns. This is often interpreted as evidence of market inefficiency. We present two findings contrary to such an interpretation. First, if markets are efficient, stock returns should be higher than the riskfree rate. We find that even when CAPE is in its ninth decile, future 10-year stock returns, on average, are higher than future returns on 10-year U.S. Treasurys. Thus, the results are largely consistent with market efficiency. Second, consistent with a risk-return tradeoff, we find that CAPE is negatively associated with future stock market volatility. Download pdf

Endogenous Financial Constraint and Investment-Cash-Flow Sensitivity

By Rui Li

This paper studies a dynamic investment model with moral hazard. The moral hazard problem implies an endogenous financial constraint on investment that makes the firm’s investment sensitive to cash flows. I show that the production technology and the severity of the moral hazard problem substantially affect the dependence of the investment-cash-flow sensitivity on the financial constraint. Specifically, if the production technology exhibits almost constant returns to scale in capital or the moral hazard problem is relatively severe, the dependence is negative. Otherwise, the pattern is reversed to some extent. Moreover, the calibrated benchmark model can quantitatively account for the negative dependence of investment and Tobin’s Q on size and age observed in the data. Download pdf

Improving Volatility Forecasts Using Market-elicited Ambiguity Aversion Information

By Raymond H.Y. So and Tarik Driouchi

Distinguishing between risk and uncertainty, this paper proposes a volatility forecasting framework that incorporates asymmetric ambiguity shocks in the (exponential) GARCH-M conditional volatility process. Spanning 25 years of daily data and considering the differential role of ambiguity attitudes in the gain and loss domains, our models capture a rich set of information and provide more accurate volatility forecasts both in-sample and out- of-sample when compared to ambiguity-free or risk-based counterparts. Volatility-timing trading strategies confirm the economic significance of our proposed framework and indicate that an annualized excess return of 3.2% over the benchmark could be earned from 1995 to 2014. Download pdf

February 2019 Issue

Its a Sweetheart of a Deal: Political Connections and Corporate-Federal Contracting

by Stephen Ferris, Reza Houston and David Javakhadze

We examine whether political connections measured by political contributions influence the choice of terms included in government contracts awarded to firms. We construct an index of four “sweetheart” contract terms and find that firms making larger political contributions more frequently have these favorable terms included in their contracts. We also find that political contributions have explanatory power for contract design after controlling for lobbying, negotiation power, and the employment of former government employees. These results are robust to alternative model specifications, different estimation techniques, various variable measurements, and adjustments for possible endogeneity.

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Trading on Private Information: Evidence from Members of Congress

by Serkan Karadas

We examine the stock trades of members of Congress and find that over 2004-2010 the buy-minus-sell portfolios of powerful Republicans have the highest abnormal returns, exceeding 35% on an annual basis under a one-week holding period. Among powerful Republicans, the abnormal returns are mostly concentrated in the portfolios of those with less trading experience. We also find that the positive abnormal returns disappear after the Stop Trading on Congressional Knowledge (STOCK) Act was passed in 2012. Our results imply that the STOCK Act affected politicians’ incentives to trade on private information, which they acquired through their power and party membership.

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The Effect of CEO Extraversion on Analyst Forecasts: Stereotypes and Similarity Bias

by Christoph Merkle, Jochen Becker, Josip Medjedovic

In an experiment with professional analysts, we study their reliance on CEO personality information when producing financial forecasts. Drawing on social cognition research, we suggest analysts apply a stereotyping heuristic, believing that extraverted CEOs are more successful. The between-subjects results with CEO extraversion as treatment variable confirm that analysts issue more favorable forecasts (earnings per share, long-term earnings growth, and target price) for firms led by extraverted CEOs. Increased forecast uncertainty leads to even stronger stereotyping. Additionally, personality similarity between analysts and CEOs has a large effect on financial forecasts. Analysts issue more positive forecasts for CEOs similar to themselves. Download pdf

Three one-factor processes for option pricing with a mean-reverting underlying: The case of VIX

by Stewart Hodges, Cheng Yan, Bo Zhao

We challenge the two most prominent one-factor mean-reverting models for variance/volatility indices and propose the Inhomogeneous Geometric Brownian Motion (IGBM) process to price VIX options. We study the roles of the equilibrium level, speed of reversion, volatility and expiration date in the pricing of VIX options and obtain analytic solutions for perpetual American options as well as some Greeks. We price the finite-lived American options using their transformed process to build a binomial tree. We also derive the closed-form Mean First-Passage Time (MFPT) for perpetual American options and find a long optimal exercising time. Other things being equal, the European ones are cheaper than their American counterparts, which reflects an early exercise premium.

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Higher Moments and Exchange Rate Behavior

by Siroos Khademalomoom, Paresh Narayan and Susan Sharma

This paper uses 15-minute exchange rate returns data for six most liquid currencies (i.e., the Australian Dollar, British Pound, Canadian Dollar, Euro, Japanese Yen, and Swiss Franc) vis-à-vis the United States Dollar to examine whether a GARCH model augmented with higher moments (HM-GARCH) performs better than a traditional GARCH (TG) model. Two findings are unraveled. First, the inclusion of odd/even moments in modeling the return/variance improves the statistical performance of the HM-GARCH model. Second, trading strategies that extract buy and sell trading signals based on exchange rate forecasts from HM-GARCH models are more profitable than those that depend on TG models. Download pdf

May 2019 Issue

Early Movers Advantage? Evidence from Short Selling during After Hours on Earnings Announcement Days

by Chinmay Jain, Archana Jain, Christine Jiang

We examine short sellers’ after-hours trading (AHT) following quarterly earnings announcements released outside of the normal trading hours. Our innovation is to use the actual short trades immediately after the announcements. We find that on these earnings announcement days, there is significant shorting activity in AHT relative to shorting activity both during AHT on non-announcements days as well as during regular trading sessions around announcements. Short sellers who trade after-hours on announcement days earn an excess return of 0.82 percent and 1.40 percent during before-market-open (BMO) and after-market-close sessions (AMC), respectively. The magnitude of these returns increases to 1.48 (3.92) percent for BMO (AMC) earnings announcements with negative surprise. We find that the reactive short selling during AHT has information in predicting future returns. Short-sellers’ trades have no predictive power if they wait for the market to open to trade during regular hours. In addition, we find that the weighted price contribution during AHT increases with an increase in after-hours short selling. Overall, our results suggest that short sellers in AHT are informed. Our findings remain robust using alternative holding periods and after controlling for macroeconomic news announcements during BMO sessions. Download pdf

The Endogeneity of Trading Volume in Stock and Bond Returns: An Instrumental Variable Approach

by Ehab Yamani and David Rakowski
This paper investigates the joint determination of trading volume and returns. Our approach follows from the argument that trading activity depends on security returns, thus resulting in a reverse causality from returns to trading activity. Using exogenous instruments for security trading activity, we estimate a system of two-stage simultaneous equations to better model the return-volume relationship. Our results confirm that returns and trading volume are determined simultaneously in both stock and corporate bond markets and that conclusions about the direction and significance of causality between volume and returns can be reversed once one corrects for the endogeneity of volume.

Is Financial Flexibility a Priced Factor in the Stock Market?

by Suresh Kumar Oad Rajput, Udomsak Wongchoti, Jianguo Chen, Robert Faff

This paper develops a factor analysis–based measure for shifts in corporate financial flexibility (FFLEX) that can be observed from public accounting information. Companies that experience positive shifts in FFLEX are associated with higher future investment growth opportunities. We show that FFLEX is a robust determinant of future stock returns. Firms that have increased their financial flexibility are associated with lower stock returns in the subsequent period. A zero-cost return portfolio produces a significant positive monthly premium of 0.69%, which is driven by covariance (risk). Risk inherent in the flexibility factor is not explained away by either prominent pricing characteristics or factors. Download pdf