Good Times or Bad Times? Investors\u27 Uncertainty and Stock Returns

This paper investigates empirically the dynamics of investors\u27 beliefs and Bayesian uncertainty about the state of the economy as state variables that describe the time-variation in investment opportunities. Using measures of uncertainty constructed from the state probabilities estimated from two-state regime-switching models of aggregate market return and of aggregate output, I find a negative relationship between the level of uncertainty and asset valuations. This relationship shows substantial cross-sectional variation across portfolios sorted on size, book-to-market, and past returns, especially conditional on the state of the economy. I show that a conditional model with investors\u27 beliefs and an uncertainty risk factor is remarkably successful in explaining a large part of the cross-sectional variation in average portfolio returns. The uncertainty risk factor retains its incremental explanatory power when compared to other conditional models such as the conditional CAPM

Good Times or Bad Times? Investors\u27 Uncertainty and Stock Returns

This paper investigates empirically the dynamics of investors\u27 beliefs and Bayesian uncertainty on the state of the economy as state variables that describes the time-variation in investment opportunities. Using measures of uncertainty constructed from the state probabilities estimated from two-state regime-switching regime models of aggregate market return, and of aggregate output, I find a negative relationship between the level of uncertainty and asset valuations. This relationship shows substantial cross-sectional variation across portfolios sorted on size, book-to-market and past returns, especially conditional on the state of the economy. I show that a conditional model with investors\u27 beliefs and uncertainty risk factor, is remarkably successful in explaining a large part of the cross-sectional variation in average portfolio returns. The uncertainty risk factor retains its incremental explanatory power when contrasted with other economically-motivated factors such as GDP news, or other conditional models such as (C)CAPM

Good Times or Bad Times? Investors' Uncertainty and Stock Returns

This paper investigates empirically the dynamics of investors' beliefs and Bayesian uncertainty about the state of the economy as state variables that describe the time-variation in investment opportunities. Using measures of uncertainty constructed from the state probabilities estimated from two-state regime-switching models of aggregate market return and of aggregate output, I find a negative relationship between the level of uncertainty and asset valuations. This relationship shows substantial cross-sectional variation across portfolios sorted on size, book-to-market, and past returns, especially conditional on the state of the economy. I show that a conditional model with investors' beliefs and an uncertainty risk factor is remarkably successful in explaining a large part of the cross-sectional variation in average portfolio returns. The uncertainty risk factor retains its incremental explanatory power when compared to other conditional models such as the conditional CAPM. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

Information, Competition, and Investment Sensitivity to Peer Stock Prices

We show empirically that firms\u27 investment responds to innovations in stock prices of peer firms. This response is stronger and more positive when peer firms have greater informed trading and more informative prices. We also find higher competition, faster growth, greater correlation in fundamentals, and higher capital intensity within the peer group all increase this sensitivity. Our results suggest that managers rely on information in peer firms\u27 prices in making capital allocation decisions, especially when, because of a challenging or rapidly changing operating environment, they face higher costs of inaction and higher rewards from a strong and prompt response

Know Thy Neighbor: Industry Clusters, Information Spillovers and Market Efficiency

Abstract: We find that firms in industry clusters – those in both the same industry and geographic area – have market prices that are more efficient than firms outside clusters. We argue this is the case because geography allows for information spillovers, reducing the marginal cost to information producers like analysts and fund managers. To support the view, we find firms inside (outside) clusters have fundamentals such as investment and earnings that have stronger (weaker) co-movement. We also find analysts are more likely to cover stocks inside industry clusters and that, when mutual fund managers have a large position in one stock in the industry cluster, they are more likely to hold other stocks in the same industry cluster

Information, Competition, and Investment Sensitivity to Peer Stock Prices

We examine the response of investment to peers\u27 stock prices. While the response to average peer-Q is typically positive, the response to prices of peer firms that are more threatening and those of industry leaders is reliably negative. The responses are more strongly negative when the prices contain more firm-specific information. We also show that different measures of peer price informativeness can capture either positive or negative investment signals. Thus, the response to peer prices varies with industry competition and whether the prices reflect firm-specific or industry information, clouding the traditional interpretation of variation in the responses to peers prices

Foreign Market Cash Flow Exposure: A Multi-Country, Firm-Level Study

Prompted by recent financial integration and increasingly regional nature of trade and investment flows, we investigate the existence and characteristics of international market-related cash flow exposures for international and domestic companies. Specifically, we study whether firm-level cash flow exposure varies with a regional or global market index in addition to the usual domestic market index. We investigate how this exposure varies with identifiable firm characteristics such international sales exposure and whether this exposure differs systematically across a variety of different countries. We also investigate whether the same model may be used to measure exposure in crisis and non-crisis periods using the Asian economic and financial crisis as a natural experiment. Our empirical investigation relies on a sample of 1325 companies from eight (non-U.S.) countries for the period July 1996 - June 1998. We find significant evidence of regional cash flow exposure across our sample, and this exposure increases in proportion to firm sales in the region. We also find evidence that even domestic companies are influenced by the stock market in other regions. Finally, we find clear evidence of increased exposure for companies with significant sales in Asia during the crisis in that region

Do Foreigners Facilitate Information Transmission in Emerging Markets?

Using the degree of accessibility of foreign investors to emerging stock markets, or investibility, as a proxy for the extent of foreign investments, we assess whether investibility has a significant influence on the diffusion of global market information across stocks in emerging markets. We show that greater investibility reduces price delay to global market information where the price delay is measured as the proportion of stock returns explained by the lagged world market returns in the regression of stock returns on contemporaneous and lagged world and local market returns. We also find that returns of highly investible stocks lead those of non-investible stocks because they incorporate global information more quickly. These results are consistent with the idea that financial liberalization in the form of greater investibility yields informationally more efficient stock prices in emerging markets

Do Foreigners Facilitate Information Transmission in Emerging Markets?

Using the degree of accessibility of foreign investors to emerging stock markets, or investibility, as a proxy for the extent of foreign investments, we assess whether investibility has a significant influence on the diffusion of global market information across stocks in emerging markets. We show that greater investibility reduces price delay to global market information where the price delay is measured as the proportion of stock returns explained by the lagged world market returns in the regression of stock returns on contemporaneous and lagged world and local market returns. We also find that returns of highly investible stocks lead those of non-investible stocks because they incorporate global information more quickly. These results are consistent with the idea that financial liberalization in the form of greater investibility yields informationally more efficient stock prices in emerging markets