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November 2018
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Higher Moments and Exchange Rate Behavior

by Susan Sharma, Siroos Khademalomoom, Paresh Narayan,

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

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

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

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

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


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August 2018 Issue

Relationship Banking and Loan Syndicate Structure: The Role of Private Equity Sponsors

By Donghang Zhang, Rongbing Huang, Yijia Zhao

Using a sample of syndicated loans to private equity (PE)-backed IPO companies, we examine how a third-party bank relationship influences the syndicate structure of a loan. We find that a stronger relationship between the lead bank and the borrower’s PE firm enables the lead bank to retain a smaller share of the loan and form a larger and less concentrated syndicate, especially when the borrower is less transparent. A stronger PE-bank relationship also attracts greater foreign bank participation. Our findings suggest that the lead bank’s relationship with a large equity holder of the borrower facilitates information production in lending. Download pdf

A Dynamic Model of Firm Valuation

By Natalia Lazzati, Amilcar Menichini

We propose a dynamic version of the dividend discount model, solve it in closed-form, and assess its empirical validity. The valuation method is tractable and can be easily implemented. We find that our model produces equity value forecasts that are very close to market prices, and explains a large proportion of the observed variation in share prices. Moreover, we show that a simple portfolio strategy based on the difference between market and estimated values earns considerably positive returns. These returns cannot be simply explained neither by the Fama French 3-factor model (even after adding a momentum factor) nor the Fama French 5-factor model. Download pdf

The Wealth Effects of Fairness Opinions in Takeovers

By Tingting Liu

This paper explores the wealth effects associated with a bidder’s decision to solicit a fairness opinion in a takeover transaction. Using a hand-collected sample with bidders’ filing proxy statements, this paper finds that the use of fairness opinions does not negatively affect bidder shareholders’ wealth, a finding that contradicts prior studies’ findings. In addition, I find a positive wealth effect associated with bidder use of fairness opinions in the post–Rule 2290 period. Collectively, these results are consistent with a fairness opinion being used by bidder management as a means to facilitate transactions rather than a mechanism to entrench management. Download pdf

Investor Recognition and Post-Acquisition Performance of Acquirers

By Di Cui

The literature has documented a negative relation between investor recognition and expected returns. This negative relation is consistent with the prediction in Merton (1987). This paper investigates whether the changes in investor recognition of acquirers around the time of the acquisitions can explain the post-acquisition under-performance of acquirer stocks. Using a large sample of U.S. acquisitions from 1980 to 2010, this paper finds that investor recognition, proxied by the number of institutional investors and the number of common shareholders, increases significantly during acquisitions. Once the increases in investor recognition are controlled for, the “puzzling” long-run under-performances of acquirers disappears. Download pdf

National Culture and Takeover Contests

By Timo Korkeamäki, Magnus Blomkvist, Karl Felixson

We examine the effects of cultural differences on the outcome of takeover contests. Our main focus is on individuality, which we posit to have an effect on firm behavior in international takeover contests. In a sample of international acquisitions with bidders from multiple countries, we find that individuality positively relates to the probability of placing the winning bid. We further find that takeover contest winners with high individuality scores experience lower announcement returns. Our results are consistent with the literature that links individuality to overconfidence. Our evidence suggests that firms should control culture-related behavioral biases in their M&A activity. Download pdf

The Information Content of Short Selling Around Close Supply Chain Relationships

By Jocelyn Evans, Dominique Outlaw

Supply chain relationships are sometimes detrimental to the partnering firms, and short sellers recognize this before the rest of the market. Suppliers and customers that are in linked, close supply chain relationships have higher short interest on average. Further, higher short interest increases the likelihood of large, linked customers reporting negative earnings surprises, whereas suppliers with high short interest are more likely to report negative earnings surprises, irrespective of the supply chain structure. Short selling is informative to capital markets because these suboptimal relationships eventually lead to dependent suppliers being delisted from a stock exchange for financial distress reasons. Download pdf

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