Heterogeneous Expectations, Short Sales Regulation and the Risk Return Relationship

L'étude traite de l'effet de la réglementation des ventes à découvert sur la relation rendement-risque, au Canada. ¸ partir du cadre développé par Jarrow (1980), nous développons une expression de la relation rendement-risque lorsque les anticipations des agents sont hétérogènes et les ventes à découvert sont restreintes. Il apparaît alors que les restrictions sur les ventes à découvert induisent un coût d'opportunité qui réduit le taux de rendement anticipé. Ce coût d'opportunité devrait être une fonction positive de la dispersion des anticipations et une fonction négative du niveau de liquidité du titre. Ces hypothèses sont vérifiées à l'aide de données mensuelles, qui couvrent la période de0101 1985 à1101 1989. La méthodologie de Litzenberger et Ramaswamy (1979), est utilisée afin de résoudre les divers problèmes économétriques. Les résultats montrent une relation linéaire négative entre le rendement des titres et le niveau d'hétérogénéité des anticipations, mesuré par la dispersion des prévisions des analystes financiers. Cette relation est surtout observable pour les titres les moins liquides, qui sont ici les moins suivis par les analystes financiers. Ces résultats valent pour chaque sous période et résistent à l'introduction de variables de contrôle.This paper examines, in a Canadian context, the effect of short sales regulation on the risk-return relationship. Drawing from Jarrow's work (1980), we derive an equilibrium risk-return relationship that accounts for both heterogeneous expectations and short sales regulation. We conclude that the required rate of return on risky assets in a world where short sales are forbidden is equal to the required rate which would prevail in a world free of short sales restrictions, minus an opportunity cost induced by short sales regulation. We show that, theoretically, this opportunity cost is positively related to the dispersion of agents' beliefs and negatively related to the security's liquidity level. We test the model over the sixty-month period from January 1985 through December 1989 and use 13079 observations (220 companies on average). We pool all the observations into a time series cross-sectional model and use Litzenberger and Ramaswamy's methodology (1979) to address three econometric problems: heteroscedasticity, cross-correlation of disturbance terms and beta measurement errors. The results permit us to establish that a negative linear relationship links expected risky asset returns and the divergence of agents' beliefs. This negative relationship is consistent with the presence of opportunity costs resulting from short sales regulation when return beliefs are heterogeneous. We find that the negative relationship between security returns and dispersion of beliefs is essentially confined to illiquid securities, that is, those monitored by a small number of analysts. Finally, these results are not modified when tested on two sub-periods nor when we introduce two control variables (size, as measured by the number of analysts monitoring the stock, and January effect)

Do Redemption Fees Hurt Long-term U.S. Mutual Fund Investors? *

Abstract Redemption fees have been proposed as a way to curb trading on "stale" prices by short-horizon investors to make profits at the expense of long-horizon investors who only trade to rebalance back to their optimal allocations. For redemption fees to be a viable device to curb "stale" price trading, they must have a negligible impact on the utility of these long-horizon agents. To assess this impact, we examine how the imposition of redemption fees affects the utility of long-horizon agents, allowing for the possibility that the long-horizon investors are rebalancing to take advantage of return predictability. Restricting the imposition of the fee to sales of shares purchased within 6 months, the utility cost of the redemption fee is never more than 0.12% of wealth when returns are i.i.d. and never more than 0.54% of wealth when returns are predictable. These utility costs are very small. For redemption fees to be a viable device to curb "stale" price trading, they must also be large enough to deter short-horizon investors from taking advantage of the "stale" prices. We find that they are, based on the documented profitability of such strategies, at least for the typical domestic fund and for the typical large capitalization domestic fund

Disentangling the Contribution of Return-Jumps and Volatility-Jumps: Insights from Individual Equity Options

This article investigates option models in the encompassing class of stochastic volatility, returnjumps, and volatility-jumps. Relying on individual equity options and method of simulated moments estimation, several major results obtained are, first, that the double-jump process is the least misspecified and the least demanding in fitting the tail-size and tail-asymmetry of individual risk-neutral return distributions; second, the double-jump model improves pricing performance beyond return-jumps absent volatility-jumps, and beyond volatility-jumps absent return-jumps; third, between return-jumps and volatility-jumps, the former is empirically more relevant than the latter for pricing options; fourth, the inverse link between volatility-jumps and return-jumps is instrumental for explaining the valuation of deep out-of-money puts and option dynamics of firms with high kurtosis; fifth, stochastic volatility is not as important for individual equity options as it is for index options. Incremental insights that emerge from individual equity options bring clarity to divergent findings on the role of return-jumps and volatility-jumps

Do Redemption Fees Hurt Long-term U.S. Mutual Fund Investors? *

Abstract Redemption fees have been proposed as a way to curb trading on "stale" prices by short-horizon investors to make profits at the expense of long-horizon investors who only trade to rebalance back to their optimal allocations. For redemption fees to be a viable device to curb "stale" price trading, they must have a negligible impact on the utility of these long-horizon agents. To assess this impact, we examine how the imposition of redemption fees affects the utility of long-horizon agents, allowing for the possibility that the long-horizon investors are rebalancing to take advantage of return predictability. Restricting the imposition of the fee to sales of shares purchased within 6 months, the utility cost of the redemption fee is never more than 0.12% of wealth when returns are i.i.d. and never more than 0.54% of wealth when returns are predictable. These utility costs are very small. For redemption fees to be a viable device to curb "stale" price trading, they must also be large enough to deter short-horizon investors from taking advantage of the "stale" prices. We find that they are, based on the documented profitability of such strategies, at least for the typical domestic fund and for the typical large capitalization domestic fund

Crash Discovery in Stock and Option Markets

This article investigates, both theoretically and empirically, the economics of stock market crashes. Using more than 100 years of daily data on the DJIA (and shorter series on NASDAQ, IBM, and Caterpillar), we first document empirically that (a) the probability of a daily stock market decline in excess of 5% is non-negligible (about 0.25%); (b) stock market crashes are not only relatively more likely to occur than rallies (higher crash arrival rates), but substantially more brutal; (c) the pre-1945 crash valuation measures depart radically from the post-1945 counterpart with the left tail decaying to zero much slower than the right tail; and (d) the motion of large percentage price declines and rises conforms closely with the characteristics of the Fr'echet distribution (asymptotically). To realistically model the empirical properties of crashes and extremes, we propose a family of Markov processes for which the density of the maximum percentage price drop can also be derived. The objective probability of the crash is found to be related, in an intuitive manner, to higher-order moments of the return distribution. Examination of this model suggests that the implied probabilities are not at odds with the empirical counterparts. To assess the implications of our findings for real-life investment analysis, we generated buy/sell signals contingent on the crash probability. Investment trading rules relying on the model's prediction outperform traditional ones (e.g., buy and hold). Our implementation methods are sufficiently versatile to discover crash/rally information embedded in option markets. Exploiting more than 17,000 out-of-money option prices, the framework quantifies three dimensions of crash discovery (i) time-variations in Arrow-Debreu security price on the extre..