Abnormal Trading Profits Research Articles

The Booms and Busts of Beta Arbitrage

Low-beta stocks deliver high average returns and low risk relative to high-beta stocks, an opportunity for professional investors to “arbitrage” away. We argue that beta-arbitrage activity generates booms and busts in the strategy’s abnormal trading profits. In times of low arbitrage activity, the beta-arbitrage strategy exhibits delayed correction, taking up to three years for abnormal returns to be realized. In contrast, when arbitrage activity is high, prices overshoot and then revert in the long run. We document a novel positive-feedback channel operating through firm leverage that facilitates these boom-and-bust cycles. This paper was accepted by Lukas Schmid, finance. Funding: This work is financially supported by National Natural Science Foundation of China [NSFC Grant Number 72303226] and the Key Program of National Natural Science Foundation of China [NSFC Grant Number 72233003]. Supplemental Material: The internet appendix and data are available at https://doi.org/10.1287/mnsc.2023.4929 .

Institutional trading, information production, and forced CEO turnovers

We analyze transaction-level data on institutional trading and examine information flows around CEO turnovers. We find that institutional trading prior to a CEO turnover is positively related to the nature of a CEO turnover (forced versus voluntary). We further find that institutions produce information partly by analyzing insider trading prior to a CEO turnover, though they are able to produce additional information independently as well. Finally, we find that trading by institutions after a forced CEO turnover with an insider as successor CEO is positively related to subsequent long-run stock returns, and realizes significant abnormal trading profits. Overall, our results are consistent with the notion that information production by institutions, and their trading making use of this information, improves the information environment around CEO turnovers.

The Impact of High-Frequency Trading on Australian Futures Market Liquidity and Efficiency

This article examines the co-location of high-frequency trading (HFT) facilities and capacity of the Australian futures market to absorb information following major scheduled macroeconomic announcements. The findings show that the co-location of HFT facilities has increased trading activities and liquidity across the four futures contracts investigated. The four futures contracts also demonstrate a market capacity to absorb information from major announcements efficiently. For instance, the majority of price adjustments are impounded within 30 seconds following major announcements. The authors conclude that abnormal trading profits are unlikely to be generated by HFT in the Australian futures market. TOPICS:Futures and forward contracts, derivatives Key Findings • The co-location of HFT facilities has increased trading activities and liquidity across the four futures contracts investigated in the Australian futures market. • These futures contracts also demonstrate a market capacity to absorb information from major announcements efficiently. • Abnormal trading profits are unlikely to be generated by HFT in the Australian futures market.

Short-horizon incentives and stock price inflation

Do managerial incentive horizons have capital market consequences? We find that they do when short-sale constraints are more binding. Firms experience significant stock price inflation when their CEOs have short horizon incentives. The short-horizon CEOs sell more shares at inflated prices and generate greater abnormal trading profits. The stock price inflation is partly explained by greater earnings surprises and more positive investor reaction to the surprises. To inflate stock prices, short-horizon firms are more likely to employ income-increasing discretionary accruals. Consistent with theoretical predictions, all these effects are attenuated or statistically insignificant when short-sale constraints are less binding.

Profitability of insider trading in Europe: A performance evaluation approach

We use the largest cross-country sample of reported share transactions by corporate insiders to date to establish that insiders in the majority of European countries do not make statistically significant abnormal trading profits. This finding stands in contrast to the earlier evidence from the U.S. The result holds across subsamples of firms with different characteristics. Furthermore, the introduction of the European Union Market Abuse Directive (MAD) had a mixed impact on the frequency and volume of insider trading across countries but generally did not affect profits of insider-mimicking portfolios. We build on the heterogeneity of our sample countries to show that several country-level regulatory, economic and cultural factors are linked with the level of insider profits which can explain why the profitability of insider trading differs starkly across countries.

The Booms and Busts of Beta Arbitrage

Low-beta stocks deliver high average returns and low risk relative to high-beta stocks, an opportunity for professional investors to �arbitrage� away. We argue that beta-arbitrage activity instead generates booms and busts in the strategy�s abnormal trading profits. In times of low activity, the beta-arbitrage strategy exhibits delayed correction, taking up to three years for abnormal returns to be realized. In stark contrast, when activity is high, prices overshoot as short-run abnormal returns are much larger and then revert in the long run. These cyclical patterns also show up in hedge fund exposures to beta arbitrage, particularly exposures of smaller and thus more nimble funds, and can be linked to the past performance of the strategy. We document a novel positive-feedback channel operating through firm-level leverage that facilitates these boom and bust cycles.

The Performance of Institutional Investor Trades Across the Supply Chain

In this study, we investigate the significance of supply-chain relationships for institutional investors. We find that supply-chain relationships are an important determinant of institutional ownership – an institution that owns a customer firm is five times more likely than other institutions to also have an ownership stake in the firm’s supplier. Further, institutions experience abnormal trading profits in supplier firms. Trading profits are concentrated in small suppliers with negative future abnormal performance, consistent with institutional investors trading on negative information shocks across the supply chain. Robustness tests help to support a conclusion that supply-chain relationships provide a rich source of information through which institutions realize abnormal trading profits.

Abnormal Profit Opportunities and the Informational Advantage of High Frequency Trading

In a frictionless and competitive economy, where high frequency (HF) traders possess no market power, this paper characterizes necessary and sufficient conditions on the price process and information sets for HF traders to earn abnormal trading profits. Two sufficient conditions shown to generate abnormal returns are that HF trading enables the observation of short-term price momentum/reversals, not otherwise visible, or it enables the observation of signals correlated to future price movements. The welfare considerations of the existence of such abnormal trading profits are also discussed.

Profitability of Insider Trading in Europe: A Performance Evaluation Approach

We use the largest cross-country sample of reported share transactions by corporate insiders to date to establish that, generally, insiders in Europe, and particularly in continental Europe, do not make significant abnormal trading profits. The result holds across subsamples of firms with different characteristics. We explain the lack of profitability with the specific information environment of closely-held corporations prevalent in many European countries. Furthermore, we find that introduction of the Market Abuse Directive (MAD) had a mixed impact on frequency and volume of insider trading across countries but had no significant impact on profits of insider-mimicking portfolios. We also find that insiders’ buy (sale) trades generate higher (lower) profits in countries in which the MAD is more strictly enforced.

The Impact of Increased Segment Disclosure on Insider Trading Profits: Evidence from SFAS No. 131

This paper examines the impact of segment disclosure on the trading profits of corporate insiders. We focus specifically on the firms that increased their number of reported segments after the adoption of a new segment disclosure standard – SFAS No. 131 (CHG firms). Using a difference-in-differences method, we show that the insider profits of CHG firms are significantly greater than those of NOCHG firms in the pre-131 era. Additionally, we show that CHG firms exhibit a significant decline in insider profits relative to NOCHG firms in the post-131 era, which is consistent with Baiman and Verrecchia’s (1996) finding that the enhanced disclosure mitigates insiders’ ability to earn abnormal profits. This decrease is particularly pronounced in large firms whose segment information is more complex and difficult to disentangle, in firms not covered by analysts, and in pre-131 single-segment firms. Our results are robust to an alternative definition of insider trading activities and to alternative disaggregation measures. Overall, the results of this paper suggest that insiders use private segment information to obtain abnormal trading profits and that these profits are reduced when firms provide more segment data.

The Impact of Increased Segment Disclosure on Trading Profits of Corporate Managers: Evidence from SFAS No. 131

This paper examines the impact of segment disclosure on the trading profits of corporate insiders. We focus specifically on the firms that increased their number of reported segments after the adoption of a new segment disclosure standard – SFAS No. 131 (CHG firms). Using a difference-in-differences method, we show that the insider profits of CHG firms are significantly greater than those of NOCHG firms in the pre-131 era. Additionally, we show that CHG firms exhibit a significant decline in insider profits relative to NOCHG firms in the post-131 era, which is consistent with Baiman and Verrecchia’s (1996) finding that the enhanced disclosure mitigates insiders’ ability to earn abnormal profits. This decrease is particularly pronounced in large firms whose segment information is more complex and difficult to disentangle, in firms not covered by analysts, and in pre-131 single-segment firms. Our results are robust to an alternative definition of insider trading activities and to alternative disaggregation measures. Overall, the results of this paper suggest that insiders use private segment information to obtain abnormal trading profits and that these profits are reduced when firms provide more segment data.

Commercial Mortgage‐Backed Securities (CMBS) and Market Efficiency with Respect to Costly Information

Commercial mortgage‐backed securities (CMBS) are complex asset‐backed securities trading in markets that do not currently use derivatives pricing technology. This lack of usage is due to the complexity of the modeling exercise, and only the recent and costly availability of historical data. As such, CMBS markets provide a natural environment for the testing of market efficiency with respect to this costly information. Using this information, this article develops a CMBS pricing model to provide a joint test of the model and market efficiency. Backtesting our pricing model for 4 years, although there is some evidence of abnormal trading profits, we cannot reject the efficiency of the CMBS markets.

Abnormal Short-Term Returns Following Market-Moving Events in the International Government Bond Market

We examine short-run patterns in government bond returns after market-moving events. Our sample covers government bond series from 17 developed countries. We find that abnormal returns follow momentum for about two weeks following an event and then reverse for a period of up to 60 days after the event. This pattern is the same for positive and negative events. However, we find that the potential to generate abnormal trading profits based on these patterns is limited.

Net buying pressure, volatility smile, and abnormal profit of Hang Seng Index options

AbstractWe use the net buying pressure hypothesis of N. P. B. Bollen and R. Whaley (2004) to examine the implied volatilities, options premiums, and options trading profits at various time‐intervals across five different moneyness categories of Hong Kong Hang Seng Index (HSI) options. The results show that the hypothesis can well describe the newly developed Hong Kong index options markets. The abnormal trading profits by selling out‐of‐the‐money puts with delta hedge are statistically and economically significant across all options maturities. The findings are robust with or without outlier adjustment. Moreover, we provide two insights about the hypothesis. First, net buying pressure is attributed to hedging activities. Second, the net buying pressure on calls is much weaker than that on put options. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:1165–1194, 2004

Implied volatility dynamics in the foreign exchange markets

The purpose of this study is to examine the dynamics of implied volatilities derived from the major currency options on futures. Several studies have examined the properties of implied volatilities in the equity and interest markets. However, very little is known about the dynamics of implied volatilities derived from the currency options markets, which is the subject of this paper. The results show that participants in the currency market tend to expect higher future volatility when the currency market fluctuates in a large scale regardless of the direction, implying that uncertainty, as measured by implied volatility, would be higher when movements of exchange rates are large. We also provide evidence that in the foreign exchange markets, the traders’ trading pattern, or the private information, in addition to the public information, also drive the intraweek implied volatility patterns. Finally, we document that it would be difficult to earn abnormal trading profits with portfolios based on the observed patterns of implied volatilities, and conclude that the foreign exchange options on futures market is efficient in this sense.

Market Efficiency Anomalies in Korea: Mispricing vs. Omitted Risk Factors

Using a sample of Korean firms, this paper examines whether abnormal returns to various trading strategies based on publicly available information are consistent with mispricing (market inefficiency) or with the fundamental variables proxying for omitted risk factors. Results of various tests indicate that significant abnormal trading profits observed from DeBondt and Thaler';s (1985) contrarian strategy and Ou and Penman';s (1989) and Holthausen and Larcker';s (1992) Pr-strategies are likely to be a result of market mispricing, while those from trading strategies based on firm size, earnings-to-price ratios, and book-to-price ratios are likely to be a result of omitted risk factors.

Trading Profits in Dutch Auction Self-Tender Offers

We document abnormal trading profits in Dutch auction self-tenders. Tender period profits-buying after announcement and selling just before expiration-are 1.74 percent (Bhagat, Brickley, and Lowenstein (1987) report similar profits for interfirm tenders). Buying just before expiration and tendering yields abnormal profits of 1.36 percent (Lakonishok and Vermaelen (1990) report 9 percent for fixed-price self-tenders using a filter rule). Total profits from buying just after announcement and tendering remain positive after adjusting for bid-ask spreads. Trading profits are higher for smaller firms, and positively correlated with tender period unsystematic risk, suggesting that they arise due to the pricing of event risk. Two RECENT PAPERS DOCUMENT that abnormal profits can be earned by trading in the shares of firms subject to a tender offer. Bhagat, Brickley, and Lowenstein (1987) examine interfirm tender offers, and report a cumulative abnormal return of about 2 percent to a strategy of buying shares two days after announcement of the offer, and selling on the day before expiration. They point out that, due to a substantial decline in beta during the tender period, the return of 2 percent is an underestimate of abnormal profits. For fixed-price self-tenders, Lakonishok and Vermaelen (1990) find that buying shares just before expiration (using a simple filter rule), and tendering, generates abnormal returns of more than 9 percent. The abnormal returns are positive for more than 90 percent of the trades, and have not declined over time; they are 11 percent during 1980 to 1986 compared with 8 percent during 1962 to 1979. Taken together, this evidence calls into question the efficiency of market

Trading Profits in Dutch Auction Self-Tender Offers

We document abnormal trading profits in Dutch auction self-tenders. Tender period profits buying after announcement and selling just before expiration are 1.74 percent (Bhagat, Brickley, and Lowenstein (1987) report similar profits for interfirm tenders). Buying just before expiration and tendering yields abnormal profits of 1.36 percent (Lakonishok and Vermaelen (1990) report 9 percent for fixed-price self-tenders using a filter rule). Total profits from buying just after announcement and tendering remain positive after adjusting for bid-ask spreads. Trading profits are higher for smaller firms, and positively correlated with tender period unsystematic risk, suggesting that they arise due to the pricing of event risk.