Behavior Of Security Prices Research Articles

Investor Confidence, Short-Sales Constraints, and the Behavior of Security Prices

Investor confidence affects financial markets. Information, noise, market frictions cause investor confidence to influence security prices, leading to a price different from the rational expectations value. This paper presents a simple theoretical model of asset prices where investor confidence is allowed to differ across traders, and across time – depending on observed outcomes. The presence of short-sales constraints causes asset prices to behave asymmetrically: short-run returns display reversal after good news, but momentum after bad news. This can change somewhat if investor confidence varies because of biased self-attribution: good news causes returns to exhibit short-run momentum and long-run reversal. We also investigate the extent to which asset supply affects the price paths. In case of zero net supply the equilibrium prices are set unilaterally by either of two investor groups. Yet if we allow for positive asset supply we find an intermediate range of information signals and resulting prices consistent with both trader types being active in the market – this happens if news events are moderate. We further identify the shrinkage effect: the range of signals where both groups of traders have positive asset demands may shrink in subsequent trading due to biased self-attribution.

An Empirical Investigation Of the Security Price Impact Of The FASBS R&D Policy Intervention

A number of empirical accounting research studies from the late 1960s to the present have been concerned with the effects of the policy behavior of accounting rule-making bodies on the behavior of security prices affected by the accounting pronouncement, and are occasionally referred to as policy intervention studies.

Discretionary behavior with respect to the adoption of SFAS no. 142 and the behavior of security prices

PurposeThis study aims to examine whether managers use discretion in determining transitional goodwill impairment loss (initial impairment loss or IIL) upon the adoption of SFAS no. 142, Goodwill and Other Intangible Assets, and whether and how the market reacts to the impairment loss and to the absence of goodwill amortization.Design/methodology/approachVarious empirical models are applied to a sample of 870 firms that completed the IIL test.FindingsIt is found that more highly leveraged firms (firms that have undergone a recent management change) report lower (greater) goodwill impairment. Stock return is not associated with a boost in earnings caused by elimination of goodwill amortization, but it is negatively associated with an unexpected IIL, with the association being stronger for highly leveraged firms. Subsequently, analysts revise earnings forecasts for upcoming quarters downward in response to the unexpected IIL.Research limitations/implicationsPossibility of measurement errors in proxies is a caveat.Practical implicationsThe findings are consistent with the strategic reduction of the goodwill impairment by management to avoid the violation of debt covenants and with the notion that new managers take a big bath so they can report higher earnings in the future. The market tests imply that unexpected IIL provides value‐relevant information about a negative view of the future profit‐making potential of the firm or an adverse impact on its debt contracts. No association with elimination of goodwill amortization can be interpreted as the market's anticipation or the lack of information content in goodwill amortization.Originality/valueThis research helps better understand the importance of managers' incentives in determining IIL as well as the stock market effect of the announcement of the IIL and the exclusion of goodwill amortization.

Asset pricing with heterogeneous beliefs

This paper studies the dynamic behavior of security prices in the presence of investors’ heterogeneous beliefs. We provide a tractable continuous-time pure-exchange model and highlight the mechanism through which investors’ differences of opinion enter into security prices. In the determination of equilibrium, we employ a representative investor with stochastic weights and solve for all economic quantities in closed form, including the perceived market prices of risk and interest rate. The basic analysis is generalized to incorporate multiple sources of risk, disagreement about nonfundamentals, and multiple investors. Other applications involving multiple goods and nominal asset pricing within monetary economies are discussed.

Testing behavioral finance theories using trends and consistency in financial performance

Assessing the predictive ability of behavioral finance theories using out-of-sample data is important. Otherwise, the potentially boundless set of psychological biases underlying the behavioral explanations for security price behavior can lead to overfitting of theories to data. We test pricing effects attributed to two psychological biases, representativeness and conservatism, which underlie many behavioral finance theories. Using trends and consistency of accounting performance, we look for the pricing consequences of representativeness and conservatism. We find mixed evidence consistent with behavioral finance. Specifically, the theories based on representativeness are not supported, but we find some evidence of the pricing implications of conservatism.

Asset Pricing with Heterogeneous Beliefs

This article studies the dynamic behavior of security prices in the presence of investors' heterogeneous beliefs. We provide a tractable continuous-time pure-exchange model and highlight the mechanism through which investors' differences of opinion enter into security prices. In the determination of equilibrium, we employ a representative investor with stochastic weights and solve for all economic quantities in closed form, including the perceived market prices of risk and interest rate. The basic analysis is generalized to incorporate multiple sources of risk, disagreement about nonfundamentals, and multiple investors. Other applications involving multiple goods and nominal asset pricing within monetary economies are discussed.

Testing Behavioral Finance Theories Using Trends and Sequences in Financial Performance

Assessing the predictive ability of behavioral finance theories using out-of-sample data is important. Without predictive tests, the risk of overfitting theory to data is large considering the potentially boundless set of psychological biases underlying the behavioral explanations for observed security price behavior. We test pricing effects attributed to a central psychological bias, representativeness, which underlies many behavioral-finance theories. This bias influences individuals beliefs about future outcomes based on how closely past outcomes represent certain categories. To produce out-of-sample tests, we use accounting performance to identify these categories and test the idea that investors misclassify firms and thus systematically misprice them. Evidence fails to suggest that trends and sequences of accounting performance, as a proxy for representativeness bias, influence investor expectations to generate return predictability.

Random Walks and Technical Theories: Some Additional Evidence

THE RANDOM WALK and martingale efficient market theories of security price behavior imply that stock market trading rules based solely on the past price series cannot earn profits greater than those generated by a simple buy-and-hold policy1. A vast amount of statistical testing of the behavior of security prices indicates very little evidence of any important dependencies in security price changes through time.2 Technical analysts or chartists, however, have insisted that this evidence does not imply their methods are invalid and have argued that the dependencies upon which their rules are based are much too subtle to be captured by simple statistical tests. In an effort to meet these criticisms Alexander (1961, 1964) and later Fama and Blume (1966) have examined the profitability of various "filter" trading rules based only on the past price series which purportedly capture the essential characteristics of many technical theories. These studies indicate the "filter" rules do not yield profits net of transactions costs which are higher than those earned by a simple buy-andhold strategy. Similarly, James (1968) and Van Horne and Parker (1967) have found that various trading rules based upon moving averages of past prices do not yield profits greater than those of a buy-and-hold policy.

The differential information hypothesis, firm size, and earnings information transfer: An empirical investigation

This study examines the effects of the sizes of the announcing and non-announcing firms on information transfers. Atiase's [Atiase RK. Predisclosure information, firm capitalization and security price behavior around earnings announcements. J Account Res 1985;23:21–36 (Spring)] differential information hypothesis suggests that, relative to small firms, more pre-announcement information is available on large firms. An implication of the differential information hypothesis is that abnormal returns of large firms around earnings disclosures are caused by new information regarding the economy and industry. Thus, earnings disclosures by large firms may contain information that is useful for other firms in the industry. Consistent with our prediction, we find that information transfers within an industry are positively related to the announcing firm's size. The differential information hypothesis also suggests that information transfer will be inversely related to the non-announcing firm's size. However, our results support the null hypothesis that information transfer is not a function of the non-announcing firm's size. Possible explanations of this finding are discussed in the paper.

Fuzzy inductive reasoning, expectation formation and the behavior of security prices

This paper extends the Santa Fe Artificial Stock Market Model (SFASM) studied by LeBaron, Arthur and Palmer (1999, Journal of Economic Dynamics and Control 23, 1487–1516) in two important directions. First, some might question whether it is reasonable to assume that traders are capable of handling a large number of rules, each with numerous conditions, as is assumed in the SFASM. We demonstrate that similar results can be obtained even after severely limiting the reasoning process. We show this by allowing agents the ability to compress information into a few fuzzy notions which they can in turn process and analyze with fuzzy logic. Second, LeBaron et al. have reported that the kurtosis of their simulated stock returns is too small as compared to real data. We demonstrate that with a minor modification to how traders go about deciding which of their prediction rules to rely on when making demand decisions, the model can in fact produce return kurtosis that is comparable to that of actual returns data.

Anomalous security price behavior following management earnings forecasts

This study provides evidence that most of the stock price reactions to bad news management forecasts of annual earnings are reversed in the 60 days following the forecast. In addition, a significant amount of the price reaction to bad news forecasts of quarterly earnings is reversed in the market's reaction to the following quarterly earnings announcement. Unlike the previous overreaction evidence, this study is not subject to the criticisms of beta-shifts, cross-firm comparisons, or lengthy intertemporal comparisons. In addition, the results are robust to include many additional variables that could be hypothesized to affect the observed results.

Price reversal and drift following earnings announcements

AbstractSystematic patterns in returns following earnings announcements are difficult to interpret. This study provides additional insights into the observation of price reversal and drift by examining the effects of both the method used to identify winners and losers and also the length of the subsequent period analyzed. The results show that both drift and reversal can be observed for the same sample and event. This evidence indicates that security price behavior following earnings announcements, especially in the short‐term, depends not only on the earnings information, as in the drift studies, but also on the price reaction to the earnings information.

The Impact of Deviations from Random Walk in Security Prices on Option Prices

This paper examines the effects of deviations from random walk in asset prices on option prices. Several approaches can be taken to model asset price processes as non-random walk processes. We choose to model the equity prices as fractional Brownian motions (FBM). Though FMB is not the most ideal model for the behavior of security prices, it offers many advantages namely it allows for short-term and long-term memory in asset prices. This paper uses Monte Carlo simulations to determine option prices under the assumption that equity prices follow FBM. The simulated prices and their implied volatilities are then compared to prices that one would obtain using the Black-Scholes-Merton option price model. The results show that even a small deviation from random walk can have a significant impact on option prices. The volatilities implied by the simulated prices generally increase as the call options go deeper into the money when security prices have short-term memory. In other words, short-term memory in security prices contributes to the presence of the so-called smile effect in implied volatilities.

Discretionary behavior with respect to allowances for loan losses and the behavior of security prices

The study examines the capital market pricing of discretionary and nondiscretionary components of a major accrual in the banking industry, the allowance for loan losses. The analysis employs a two-stage approach in which the allowance account is first decomposed into estimates of its nondiscretionary and discretionary components. The second stage evaluates the market's valuation of the estimates of the components. Evidence suggests that the capital market perceives the allowance to be comprised of two components, a nondiscretionary component which is negatively priced and a discretionary component whose incremental pricing coefficient is positive.

Stock Market Reactions To the Tax Reform Act of 1986: an Analysis of the Agribusiness Industry

This study assesses the impact of tax legislation on the agribusiness industry by examining security price behavior at major stages in the development of the Tax Reform Act of 1986. The findings of the study indicate that investors in agribusiness firms responded negatively to proposed tax changes as the legislation evolved. The market reaction to the legislative developments indicates that tax-driven investment in the agribusiness industry will be significantly reduced.

The "Dartboard" Column: Second-Hand Information and Price Pressure

This study analyzes the effect of second-hand information on the behavior of security prices and volume using analysts' recommendations published in the monthly Dartboard column of the Wall Street Journal. For the two days following the publication of the recommendations, average positive abnormal returns of 4 percent?nearly twice the level of abnormal returns documented in previous research on analyst recommendations?and average volume double normal volume levels on the two days following publication of the recommendations are documented. The positive abnormal return on announcement is partially reversed within 25 trading days. The authors conclude that the positive abnormal return on announcement of the recommendations is a result of naive buying pressure as well as the information content of the analysts' recommendations.

Oil and gas stock price reactions to federal tax legislation

The purpose of this research is to assess the effects of major tax legislation on the stock prices of firms in the oil and gas industry. Event study methodology is used to examine the behavior of security prices of oil and gas firms in response to the Joint Conference Committee vote in August 1986.

Trading, Communication and the Response of Asset Prices to News

The dynamic behavior of security prices is studied in a setting where two agents trade strategically and learn over time from market prices. The model introduces an information structure that is intended to capture the notion that information is difficult to interpret. Strategic interaction and the complexity of the information result in a protracted price response. Equilibrium price paths of the model may display reversals in which the two traders rationally revise their beliefs, first in one direction and then in the opposite direction, even though no new information has entered the system. Copyright 1993 by Royal Economic Society.

A Theory of Intraday Patterns: Volume and Price Variability

This article develops a theory in which concentrated-trading patterns arise endogenously as a result of the strategic behavior of liquidity traders and informed traders. Our results provide a partial explanation for some of the recent empitical findings concerning the patterns of volume and price variability in intraday transaction data. In the last few years, intraday trading data for a number of securities have become available. Several empirical studies have used these data to identify various patterns in trading volume and in the daily behavior of security prices. This article focuses on two of these patterns; trading volume and the variability of returns. Consider, for example, the data in Table 1 concerning shares of Exxon traded during 1981.1 The U-shaped pattern of the average volume of shares traded-namely, the heavy trading in the beginning and the end of the trading day and the relatively light trading in the middle of the day-is very typical and has been documented in a number of studies. [For example,Jain andJoh (1986) examine hourly data for the aggregate volume on the NYSE, which is reported in the Wall StreetJournal, and find the same pattern.] Both the variance of price changes

Anomalies: Seasonal Movements in Security Prices II: Weekend, Holiday, Turn of the Month, and Intraday Effects

This feature will report successful searches for disconfirming evidence--economic anomalies. As suggested by Thomas Kuhn, an economic anomaly is a result inconsistent with the economics paradigm. Economics is distinguished from other social sciences by the belief that most (all?) behavior can be explained by assuming that agents have stable, well-defined preferences and make rational choices consistent with those preferences in markets that (eventually) clear. An empirical result is anomalous if it is difficult to “rationalize,” or if implausible assumptions are necessary to explain it within the paradigm. In the previous issue, I reviewed the peculiar behavior of security prices in January. Stock prices tend to rise in January, particularly the prices of small firms and firms whose stock price has declined substantially over the past few years. Also, risky stocks earn most of their risk premiums in January. This issue will conclude our survey of seasonal anomalies in security prices with a review of four additional effects: the behavior of prices over weekends, before holidays, at the turn of each month, and within the day.