Retail investor recognition and the cross section of stock returns

Academic Paper Sessions: Session 151 – The Cross-Section of Returns: Cash, Investor Recognition, and Idiosyncratic VolatilityWe test and offer support to Merton’s (1987) theory that difference in a stock’s investor recognition affects its cost of capital. In the U.S. market, using the breadth of ownership among retail investors as a proxy for investor recognition, we show that a long-short portfolio based on the annual change of shareholder base earns a compounded annual abnormal return of 6.42% after controlling for the Fama-French three factors. These results are more pronounced among young, low visibility and high idiosyncratic volatility stocks, and are robust to various controls such as momentum, breadth of institutional ownership, analyst coverage, liquidity, idiosyncratic volatility, trading volume, accruals, capital investment, probability of informed trading (PIN), and retail investor sentiment. Moreover, we present evidence that the investor recognition effect can explain approximately 20% of the net equity issuance effect documented by Pontiff and Woodgate (2008).postprintThe 2010 Annual Meeting of the Financial Management Association (FMA), New York, N.Y., 20-23 October 2010

Cross-hedging with currency options and futures

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.published_or_final_versio

Less is more when analysts report bad news

Session 166: Sell-Side AnalystsTop Ten SessionThis study documents the existence of a positive-negative asymmetry in analysts’ consensus earnings forecast revisions. We find that upward revisions are more informative than downward revisions. After controlling for momentum, extreme downward revisions contain little incremental information compared with moderate downward revisions. The differential richness of information set in good and bad news revisions is more pronounced among bigger, more heavily covered stocks and stocks with higher institutional holding, i.e. stocks typically are more prone to the analyst agency problem. These findings are consistent with the claim that analysts systematically struggle with bad news reporting as conflicts are exacerbated with bad news but are attenuated with good news.postprin

Short-selling, margin-trading, and price efficiency: Evidence from the Chinese market

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Expected stock returns and the conditional skewness

Motivated by the parsimonious jump-di®usion model of Zhang, Zhao and Chang (2010), we show that the aggregate market returns can be predicted by the conditional skewness of returns and the variance risk premium, a di®erence between the physical and risk-neutral variance of market returns, even though the variance is supposed to be constant only if jump exists. The magnitude of the predictability is particularly striking at the intermediate quarterly return horizon, even combing other predictor variables, like P/D ratio, the default spread and the consumption-wealth ratio (CAY). We also ¯nd that the third central moments are signi¯cant in explaining the variance risk premium, which further implies that the potential link between the variance risk premium and the excess market return is the third central moments, not the skewness.postprintThe 2011 China International Conference in Finance, Wuhan, China, 4-7 July 2011.2011中国金融国际年会, 中国, 武汉, 2011年7月4日至7日

The relation between physical and risk-neutral cumulants

Variance swaps are natural instruments for investors taking directional bets on volatility and are often used for portfolio protection. But the crucial observation suggests that derivative professionals may desire to hedge beyond volatility risk and there exists the need to hedge higher-moment market risks, such as skewness and kurtosis risks. We propose new derivative contracts: skewness swap and kurtosis swap, which trade the forward realized third and fourth cumulants. Using S&P 500 index options data from 1996 to 2005, we document the returns of these swap contracts, i.e., skewness risk premium and kurtosis risk premium. We find that the skewness risk premium is significantly negative and kurtosis risk premium for 90 day maturity is significantly positive.postprintThe 2009 Annual Meeting of the Financial Management Association (FMA), Reno, NV., 21-24 October 2009

Equilibrium asset and option pricing under jump diffusion

This paper develops an equilibrium asset and option pricing model in a production economy under jump diiffusion. The model provides analytical formulas for an equity premium and a more general pricing kernel that links the physical and risk-neutral densities. The model explains the two empirical phenomena of the negative variance risk premium and implied volatility smirk if market crashes are expected. Model estimation with the S&P 500 index from 1985 to 2005 shows that jump size is indeed negative and the risk aversion coe±cient has a reasonable value when taking the jump into account. This is a joint work with Huimin Zhao and Eric C. Chang.postprin

Short Sale Constraints, Heterogeneous Interpretations, and Asymmetric Price Reactions to Earnings Announcements

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Does short selling discipline managerial empire building?

The Conference program's website is located at http://www.fma.org/Tokyo/TokyoProgramPrelim.htmSession 20 - Monitors and Governance QualityThis paper explores the discipline effect of short selling on managerial empire building. Employing short-selling data from 2002-2011, we document a negative association between the stock lending supply and the subsequent abnormal capital investment. We also find a positive association between the lending supply and the mergers and acquisitions announcement returns of acquiring firms. Firms with higher lending supplies also have higher Tobin’s Q in the subsequent year. In addition, the discipline effect is stronger for firms with higher managers’ wealth-performance sensitivity and with lower financial constraints, and for stock-financing acquisition deals. Alleviating the endogeneity concern, our multivariate difference-in-difference analysis shows that the lending supply is a more effective discipline force for firms that are in the Regulation SHO-Pilot Program during 2005 to 2007.postprin

Cross-listing and pricing efficiency: The informational and anchoring role played by the reference price

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