Aggregate Returns Research Articles

Ambiguity aversion and stock market participation: An empirical analysis

Theoretical models of portfolio choice that incorporate ambiguity predict that investors’ propensity to invest in equities is reduced when ambiguity in the stock market increases. Although this hypothesis stems from the extant theoretical literature, there is no empirical work examining whether it is supported in the data. We test this hypothesis, measuring participation using equity fund flows and ambiguity with dispersion in analyst forecasts about aggregate returns. Our results confirm this hypothesis, as we show that, controlling for other factors that affect flows, increases in ambiguity are associated with outflows from equity funds. Moreover, using data from the Survey of Consumer Finances, we find that increases in ambiguity significantly reduce the likelihood that the average household invests in equities.

Discussion of What Do Management Earnings Forecasts Convey About the Macroeconomy?

While numerous studies in accounting and finance are devoted to predicting firm-specific earnings and understanding the forecasting behavior of analysts and management, it is unclear whether or how accounting information at the micro level can be applied to the macroeconomy. Bonsall, Bozanic, and Fischer [2012], henceforth BBF, are part of a growing literature that seeks to address this question. BBF document that firm-specific management forecast releases are significantly positively associated with announcement-window aggregate stock market returns and further show that this significant market reaction is concentrated among “bellwether” firms. In this discussion, I argue that although BBF provide convincing evidence on the presence of timely macroeconomic information in management earnings forecasts, the exact nature of this information is somewhat of a black box. BBF’s results also raise the question of how the macroeconomic information content of management earnings forecasts differs from that of realized earnings. The answers to these questions can help reconcile the significantly positive association between management forecast surprises and aggregate stock returns with the previously documented negative relation between realized earnings surprises and aggregate stock returns.

Economically-Linked Economies and Forecasting Chinese Stock Returns

We explore whether economic links via trade affect aggregate Chinese stock market returns. We find that market return indices from countries that China net exports from can forecast the Chinese aggregate market return at the weekly time horizon. Countries that China net exports to have no consistently significant OOS predictability.The economic intuition for our results follows from the fact that China has positioned itself as a low-cost provider competing on price. As a low-cost provider China has a more difficult time passing cost increases through to export customers because of sticky prices. However, production must meet demand implying that costs will drive short term economic gains for the overall Chinese economy. One interpretation of our results is that supply shocks are absorbed within 2 weeks.

Cross-Sectional PEG Ratios, Market Equity Premium, and Macroeconomic Activity

This paper exploits information contained in cross-sectional PEG ratios to extract estimates of the market's expectations for aggregate returns and economic fundamentals. By combining the loglinear present-valuation model and the Capital Asset Pricing Model (CAPM) logic, we establish a theoretic link between PEG ratios and expected returns of stocks. Using this theoretic link, we construct one proxy for aggregate market equity premium and one proxy for macroeconomic fundamentals. The equity premium proxy outperforms alternative predictors and has considerable power in forecasting future market returns over the period of May 1983 to December 2009. The equity premium proxy is also able to forecast future macroeconomic activity such as nonfarm payroll growth, personal consumption expenditure growth, nondurable consumption growth, inflation, and unemployment rate. The fundamentals proxy is highly correlated with unemployment rates both concurrently and intertemporally. The results are generally robust across subsample and to various econometric methods for standard-error adjustments. Our study suggests that the choice of cross-section data is critical to information extraction and that the CAPM remains a vital theoretic tool to guide empirical work.

Arbitrage and the Law of One Price in the market for American depository receipts

Ours is the first paper to highlight pairs trading as the main price-correcting mechanism by which arbitrage can maintain stock–ADR parity. We show that arbitraging stock–ADR pairs extracts small per-trade profits which accumulate to a substantial aggregate return. The observed strong tendency of pricing disequilibria to mean-revert, along with the two-way convertibility between stocks and ADRs, mean that arbitrageurs face minimal risks toward price divergence. They do, however, face uncertainty about the duration of individual trades. The magnitude of this uncertainty relates directly to the profit target arbitrageurs set after a long/short position is established. This fact can explain why some disequilibria go unexploited. Overall, our work provides evidence against automatically efficient prices, and supports the view that mispricings incentivize arbitrageurs to enforce market efficiency.

Scale, Congestion and Growth

This paper explores the relationship between aggregate and relative congestion, returns to scale and economic growth. Aggregate congestion reduces the effective productivity of capital; relative congestion reduces the effective productivity of labour. Both forms of congestion adversely affect the equilibrium growth rate, although their relative effects depend upon aggregate returns to scale. The two forms of congestion have contrasting effects on the transitional dynamics. Relative congestion retards the rate of adjustment; aggregate congestion accelerates it. The externalities generated by congestion and non-optimal expenditure can be fully corrected, both during the transition and in steady state, by a time-invariant income tax.

An Analysis of Aggregate Market Liquidity: The Case of Amman Stock Exchange

The purpose of this study is to analyze the behavior, the day-of-the-week regularities and the macroeconomic determinants of aggregate market liquidity of emerging stock markets through studying Amman Stock Exchange (ASE). The study investigates all the stocks traded in ASE over the period 2002-2010. Aggregate market liquidity is measured by several proxies, each reflecting a certain dimension. It is calculated as an average of individual stock liquidity proxies and as a sum of trading activity measures. Aggregate market liquidity shows a fluctuating pattern throughout the study period. It gets worse in the mid-week. Spread and depths show their maximum values on Mondays and Sundays, respectively. The trading activity reaches its minimum on Sunday and its maximum on Thursday. Major macroeconomic factors significantly affect aggregate market liquidity, though; aggregate market return and volatility exercise a larger effect. This study is the first to conduct a comprehensive analysis of aggregate market liquidity in an emerging stock market.

An Analysis of Stock Returns and Aggregate Earnings

We reexamine the time-series properties and determinants of the relation between aggregate earnings and returns (earnings response coefficient, ERC) employing return decompositions with longer historical data. We find that aggregate ERC is time-varying, above and beyond the evidence documented in prior literature that aggregate ERC is negative. We also find the aggregate ERC components - expected return ERC, cash flow news ERC, and discount rate news ERC - are time-varying. We reconcile the prior findings and show that both news and expectations of returns contribute to aggregate ERC and the relative importance of each varies over time. We further show that the time-varying aggregate ERC and the relative importance of aggregate ERC components are strongly associated with macroeconomic conditions and the stock market regulation environment.

Aggregate Earnings and Corporate Bond Markets

I examine the previously unexplored relation between aggregate earnings changes and corporate bond market returns. I find that aggregate earnings changes have a negative relation to investment-grade corporate bond market returns and a positive relation to high-yield corporate bond market returns. The aggregate earnings-returns relation is lower (i.e., less positive or more negative) for bonds with higher credit ratings and longer maturities. Further, I show that the aggregate earnings-returns relation is driven by both the expected and the news component of aggregate earnings changes. The expected component is negatively related to expected returns, and the news component is positively related to cash flow news and changes in nominal interest rates, and negatively related to changes in default premia. My results contribute to the understanding of the role of earnings in corporate bond markets as well as the macroeconomic role of accounting information.

Do 'Firms Lean Against the Wind'? Earnings Management and Stock Market Returns

We investigate whether firms “lean against the wind,” i.e., manage earnings upward to offset aggregate (market wide) undervaluation, by examining how firm-specific measures of earnings management correlate with aggregate market conditions. Leaning against the wind has been proposed by prior research as a behavioral explanation for a negative contemporaneous relation and a positive predictive relation between aggregate accruals (both total and discretionary) and aggregate market returns. We find no empirical evidence to support the “lean against the wind” hypothesis. In particular, when the overall market return is negative, only firms whose own return is negative have positive discretionary accruals; if firms were to lean against the wind, all firms should have positive discretionary accruals in down markets. Moreover, the tendency of firms to manage earnings upward to beat benchmarks is positively related to market-wide conditions, implying that firms lean toward the wind. Importantly, since growth may explain the relation between aggregate accruals and returns but has been omitted from standard accruals models, we also adjust our discretionary accruals measures for growth and our results are robust to this specification. Since earnings management in response to aggregate market fluctuations does not appear to explain the relation between aggregate accruals and aggregate returns, our results suggest a fundamentals-based explanation.

Skewness in Stock Returns: Reconciling the Evidence on Firm Versus Aggregate Returns

Aggregate stock market returns display negative skewness. Firm stock returns display positive skewness. The large literature that tries to explain the first stylized fact ignores the second. This article provides a unified theory that reconciles the two facts by explicitly modeling firm-level heterogeneity. I build a stationary asset pricing model of firm announcement events where firm returns display positive skewness. I then show that cross-sectional heterogeneity in firm announcement events can lead to conditional asymmetric stock return correlations and negative skewness in aggregate returns. I provide evidence consistent with the model predictions. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

The Media and the Diffusion of Information in Financial Markets: Evidence from Newspaper Strikes

The media are increasingly recognized as key players in financial markets. I investigate their causal impact on trading and price formation by examining national newspaper strikes in several countries. Trading volume falls 12% on strike days. The dispersion of stock returns and their intraday volatility are reduced by 7%, while aggregate returns are unaffected. Moreover, an analysis of return predictability indicates that newspapers propagate news from the previous day. These findings demonstrate that the media contribute to the efficiency of the stock market by improving the dissemination of information among investors and its incorporation into stock prices.

Forecasting Returns: New European Evidence

This paper builds on the recent debate on the in-sample and out-of-sample predictability of US aggregate returns using a wide range of predictors by providing new evidence for smaller and less market-oriented European countries. We find evidence that macro and technical predictors can (statistically) improve forecast accuracy and (economically) generate gains to investors; in contrast to the US results, predictability in our sample of European countries exists in recent data. We also find that simple forecast combinations consistently yield substantial benefits both in forecast accuracy and economic gain. For example, the magnitude of the forecasting gains for our European countries is often larger than those found for the US and other G7 countries. We provide initial evidence on the link between country characteristics and out-of-sample forecast performance. Our empirical results suggest forecast performance is not strongly related to market size. However market liquidity is related to the forecast performance of fundamental variables and market development is related to the forecast performance of macro variables.

Tracking-Error Models for Multiple Benchmarks: Theory and Empirical Performance

We propose a new multiple-benchmark tracking-error model for the portfolio selection problem. We construct a strategy to track the performance of the highest return from a set of benchmarks, by minimizing a quadratic loss function. The portfolio rule constructed this way retains features of the linear combination rule, with weights mainly determined by the probability that each benchmark portfolio attains the highest return among all the benchmark portfolios considered. We use this approach to deal with the issue of estimation errors in portfolio construction. A common strategy here is to use a re-sampling technique to construct portfolios from the data, and use the average of the portfolio weights as the solution. We can view each portfolio constructed from sampling as a benchmark, and use the tracking error method proposed in this paper to enhance the performance of any portfolio selection method. We perform comprehensive numerical experiments with various empirical data sets to demonstrate that our approach can consistently provide higher net Sharpe ratio (even after accounting for transaction cost), higher net aggregate return, smaller tracking error, and lower turnover rates in out-of-sample performance, compared to twelve dierent benchmark portfolios proposed in the literature, including the equally weighted portfolio (the 1=n strategy).

Aggregate Investment and its Consequences

I use financial statement information to examine intertemporal investment decisions by publicly traded firms at the aggregate level. I find that aggregate corporate investment negatively predicts aggregate returns in the US and abroad. Corporations invest more when investor sentiment is higher, the yield curve is flatter, and analysts are more optimistic. Higher aggregate investment forecasts lower aggregate profitability, lower earnings announcement returns, a widening of the ‘value premium’, lower returns on growth stocks and lower macroeconomic growth. My findings are consistent with the long-held conjecture that aggregate investment is inefficient, with consequences for prices and fundamentals at the aggregate level.

The Aggregate Earnings-Return Relationship: A Global Perspective

This article examines the relationship between aggregate earnings and returns (ERC) in a global context. We examine a broad international sample of countries which encompass markets with different levels of stock market development, shareholder protection and legal origin. Recent literature finds a puzzlingly negative relationship between aggregate earnings and aggregate returns in the US (Kothari, Lewellen and Warner, 2006; Sadka and Sadka, 2009). Our first main finding is that this puzzlingly negative relationship is not universal. The relationship between aggregate earnings and each return component (Campbell, 1991) is examined. Empirical results suggest each of these three components play a role in explaining the overall ERC. In particular, we find that cash flow news and discount rate news are both individually important determinants of the earnings-return relationship but they generally offset each other. The expected earnings-return relation also contributes to the aggregate earnings-return coefficient; this effect varies substantially across countries. The dispersion of aggregate ERC across countries is weakly associated with stock market development, shareholder protection and legal origin.

A THEORY OF ECONOMIC DEVELOPMENT WITH ENDOGENOUS FERTILITY

In this paper I build a unified model of economic growth to account for the time-series evolution of output, fertility, and population in the industrialization of an economy. Specifically, I merge the unified growth models of Galor and Weil [American Economic Review 90 (2000), 806–828] and Hansen and Prescott [American Economic Review 92 (2002), 1205–1217] to capture the importance of human capital formation, fertility decline, and the transition from agriculture to industry in transition from stagnation to growth. Moreover, I also incorporate young adult mortality into the model. Initially, the aggregate human capital and return to education are low and the mortality rate is high; therefore parents invest in quantity of children. Once sufficient human capital is accumulated and mortality rates are reduced, thanks to increasing life expectancy, with the activation of the modern human capital–intensive sector, parents start to invest in the quality of their children. The simulation of the model economy improves upon the quantitative performance of the existing literature and successfully captures the evolution of fertility, population, and GDP in the British economy between 1750 and 2000.

Eurozone Stock Market Reactions to Unexpected ECB Monetary Policy Announcements

To examine the Eurozone stock market reactions to European Central Bank (ECB) monetary policy announcement surprises, we study the effect of unexpected changes in the ECB's main refinancing rate on aggregate and sectorial Eurozone equity returns. We also analyse the results according to varying business conditions. We estimate unexpected changes on the basis of the market's expectations released in the financial press just before the monetary policy announcement. Using an event study methodology for the 1999-2008 period, we found that the impact of ECB monetary policy surprise is not significant for Euro-zone stock markets. However, we find a significant stock market reaction around unexpected ECB monetary policy announcements when we account for business conditions.

The Asset Pricing Implications of Dividend Volatility

This paper establishes dividend volatility as a fundamental risk metric that prices assets. We theoretically incorporate dividend volatility clustering into a model in which narrow-framing investors are loss averse over fluctuations in the value of their investments. Our model shows that dividend volatility positively predicts future asset returns, with the predictive power increasing with the forecasting horizon; our model also sheds light on a variety of other asset-pricing phenomena. We further provide supporting empirical evidence that dividend volatility is indeed priced in the data. More specifically, aggregate dividend volatility predicts and is predicted by aggregate price-to-dividend ratios; aggregate dividend volatility predicts future aggregate market returns; and dividend volatility of portfolios sorted by size, book-to-market ratios, and past returns predicts future portfolio-level returns respectively.

Earnings Dispersion and the Stock Market Reaction to Aggregate Earnings News

Using monthly and quarterly cross-sectional dispersion in firm level earnings news as a proxy for investor uncertainty about the implications of current aggregate earnings for future discount rates, I find that higher investor uncertainty leads to a lower stock market reaction to aggregate earnings surprises. An increase in the monthly cross-sectional dispersion in seasonally differenced earnings from the 25th to the 75th percentile of its time series distribution renders the contemporaneous market return−aggregate earnings relation positive and even significant depending on the measure of earning used. The stock market reaction to aggregate earnings surprises becomes insignificant when earnings data for the 2008-2009 period are included in the analysis. This suggests that the most recent economic crisis has distorted the aggregate earnings-market return relation which has generally been found to be negative in the prior literature. Finally, in contrast to Jorgensen, Li, and Sadka (2009) and consistent with the predictions of the modern portfolio theory, I find that there is no relation between dispersion in earnings surprises and stock market returns using monthly and quarterly time series of seasonally differenced earnings and dispersion in these differences. This relation depends on the magnitude of the earnings change: significantly negative (positive) if the earnings change is in the bottom (top) quartile of its time series distribution.