Holding Period Returns Research Articles

The role of the variance premium in Jump-GARCH option pricing models

Abstract We develop a discrete-time option pricing model incorporating a variance-dependent pricing kernel of Christoffersen et al. (2013) under an economic framework allowing for dynamic volatility and jump intensity. Based on the model, we examine the role of the variance premium and jump risk premium in explaining S&P 500 index option prices and returns. According to the results, the variance premium is equally important as the jump risk premium in explaining the empirical option data. Whereas the incorporation of the jump risk premium improves the model fit on option prices, the incorporation of the variance premium improves the fit on option returns. In particular, the variance premium can explain both 1-month holding period returns of 2-month maturity straddles, which are significantly negative, and call returns, which decrease according to moneyness. The model incorporating the jump risk premium only has a limitation in explaining the above two stylized returns. The outperformance of the model incorporating the variance premium on option returns stems from its ability to capture the wedge between physical and risk-neutral volatilities.

The Buffett critique: volatility and long-dated options

In his 2008 letter to shareholders, Warren Buffett, Chairman and CEO of Berkshire Hathaway, criticizes the ability of the Black-Scholes model to accurately price long-dated options. Buffet discusses how the model leads to over-pricing of put options with long maturities using examples of Berkshire’s investments in derivatives contracts. We confirm that traditional implied volatility estimates do indeed overstate long-term volatility. As an alternative, we propose a maturity-matching technique for estimating long-term volatility using historical holding period returns. We focus on three large asset classes, large cap stocks, long-term bonds, and treasury bills, to demonstrate how volatility evolves over different holding periods. We apply this rolling-period simulation method to estimate volatility for annual maturities ranging from 1 to 30-years within the Black-Scholes model. This method generates superior long-dated option values, and effectively answers Buffett’s critique. This is of particular importance for firms with significant investment holdings, as the issuance and valuation of these derivatives can have a substantial effect on firm capital.

The cross section of expected holding period returns and their dynamics: A present value approach

We provide a tractable model of firm-level expected holding period returns using two firm fundamentals—book-to-market ratio and return on equity—and study the cross-sectional properties of the model-implied expected returns. We find that firm-level expected returns and expected profitability are time-varying but highly persistent and that forecasts of holding period returns strongly predict the cross section of future returns up to three years ahead. We show a highly significant predictive pooled regression slope for future quarterly returns of 0.86. The popular factor-based expected return models have either an insignificant or a significantly negative association with future returns. In supplemental analyses, we show that these forecasts are also informative of the time series variation in aggregate conditions. For a representative firm, the slope of the conditional expected return curve is more positive in good times, when expected short-run returns are relatively low, and the model-implied forecaster of aggregate returns exhibits modest predictive ability. Collectively, we provide a simple, theoretically motivated, and practically useful approach to estimating multi-period-ahead expected returns.

Momentum Loses its Momentum: Implications for Market Efficiency

We evaluate the robustness of momentum returns in the US stock market over the period 1965 to 2010. We find that momentum profits have become insignificant since the late 1990s partially driven by pronounced increase in the volatility of momentum profits in the last 12 years. Past returns no longer explain the cross-sectional variation in stock returns, not even following up markets. The patterns in the post holding period returns of momentum portfolios and risk adjusted identification period buy and hold returns of stocks in momentum supports improvement in market efficiency as a possible explanation for the declining momentum profits.

A New January Barometer: The Index of Consumer Sentiment

We examine the ability of the Index of Consumer Sentiment (ICS) to predict stock returns over subsequent 11 months and to explain the other January effect (OJE) puzzle (stock returns in January predicting monthly returns for the remainder of the year). We find that the change in the ICS in January predicts the subsequent 11 months returns and the 11-month holding-period returns and when controlling for this prediction, the stock return OJE vanishes. The empirical results suggest that such predictive power of the ICS may derive from the correlation between the ICS and the unexpected proportion of equity mutual fund net cash flow in the subsequent 11 months.

Portfolio Optimization With Illiquid Life Insurance Investments

Endowment life insurance products contain a collective component resulting in smoothed returns. By unsmoothing the data of German life insurers we are able to extract the risk/return pattern of the underlying financial assets. Thus, we can analyze mean-variance optimal portfolios including a smoothed with-profit contract compared to an unsmoothed unit-linked contract. We find that life insurance is attractive for conservative investors and cannot be easily replicated. Furthermore the investor cannot regain his expected utility when being allocated to an undesirable amount of the illiquid with-profit contract -- neither through reallocation of his liquid investments nor through collateral lending. Overall, the with-profit contract shows similar characteristics than other illiquid assets. The main difference is that the regulation by law allows the investor to participate in the smoothed returns -- contrarily to all other financial market products where the investor shall participate in his holding period returns.

Farmland: Is It Currently Priced as an Attractive Investment?

Farmland prices have risen dramatically in recent years, which has attracted interest from the broader investment community. At the same time, concern is being expressed regarding another bubble in farmland prices. This paper studies and compares the farmland price to cash rent ratio (P/rent) with the price to earnings (P/E) ratio of stocks. We find that the farmland P/rent ratio has reached historical highs and is currently at the level of the P/E ratio of the S&P 500 during the tech bubble. Data from 1911 to 2012 are used to estimate the beta of farmland, a measure of the risk that farmland adds to a diversified portfolio. The beta is found to be very low over this period. Farmland returns are also regressed against expected and unexpected inflation, and we find that farmland moves relatively close to one‐to‐one with inflation. We also report 10‐ and 20‐year holding period returns for farmland and find that the relationship between return and the cyclically adjusted P/rent ratio is strongly negative. Moreover, the current cyclically adjusted P/rent ratio is extremely high, indicating a reason for caution when investors are considering farmland purchases.

Do Mutual Fund Investors Chase False Returns?

Mutual funds report performance in the form of a holding period return (HPR) over standardized horizons. Changes in HPRs are equally influenced by new and previously reported stale returns which enter and exit the horizon. Investors appear unable to differentiate between the joint determinants, reacting with equal strength to both signals. Stale performance chasing is amplified for funds which promote performance via advertising and is more pronounced during periods of uncertainty in financial markets. Fund managers exploit this behavior by preferentially timing fee increases to align with periods of heightened investor demand resulting from stale performance chasing.

Cost of Capital Dynamics Implied by Firm Fundamentals

We provide a tractable model of firm-level expected holding period returns using two firm fundamentals ― book-to-market ratio and ROE ― and study the cross-sectional properties of the model-implied expected returns. We find that: 1) firm level expected returns and expected profitability are time-varying, but highly persistent; 2) forecasts of holding period returns strongly predict the cross section of future returns up to three years ahead. We document a highly significant predictive pooled regression slope for future quarterly returns of 0.86, whereas the popular factor-based expected return models have either an insignificant or a significantly negative association with future returns. In supplemental analyses, we show that these forecasts are also informative of the time-series variation in aggregate conditions: 1) for a representative firm, the slope of the conditional expected return curve is more positive in good times, when expected short-run returns are relatively low; 2) the model-implied forecaster of aggregate returns exhibits modest predictive ability. Collectively, we provide a simple, theoretically-motivated, and practically useful approach to estimating multi-period ahead expected returns.

Is there a right time for corporate investment?

Purpose – The purpose of this paper is to determine whether corporate investment in real fixed assets in hot issue markets leads to higher income to shareholders than that in other equity market conditions. Design/methodology/approach – The authors address the research question in two steps: first, the authors identify how security issuances in hot and cold issue markets influence corporate investment decisions. Second, the authors examine how debt- and equity-financed investments in two different market conditions affect future holding period returns. The sample includes an unbalanced panel data set consisting of all non-financial and non-utility US companies from 1973 to 2006. The authors apply both firm- and industry-level fixed effect methods to estimate the coefficients of two separate empirical models. Findings – The authors find that equity issuances increase firms' capital investments in hot issue markets. These equity-financed investments in hot equity markets result in higher returns to shareholders compared to those in other market conditions. Therefore, there exists a window of opportunity for firms to issue new equities and make investments, which in turn improve shareholders' wealth. Practical implications – The findings convey a critical message to corporate managers about the right timing of equity-financed capital investments. Originality/value – While earlier research focuses on determining a specific equity market condition that favours new issuances, this paper determines a particular equity market condition when firms typically choose value-enhancing equity-backed projects for investment.

Zodiac Calendar and Market Returns

Throughout history, Chinese zodiac astrology has significantly influenced the way people in that area think, feel, or make daily decisions. In the zodiac calendar, each year is marked by one of twelve symbolic animals and each animal is associated with its own specific traits. Previous literature suggests investors’ mood, attitude, and behavior are influenced by natural events such as cloudy or sunny weather, or lunar cycles. Cultural events such as holidays or religious feasts are also shown to have impact on investing decisions. In this paper we study the stock market returns in different lunar years in the zodiac calendar. We find that Hang Seng’s mean returns are higher in Rat years and both mean and median returns are lower in Snake years. These results are statistically significant despite a small sample size. For S&P 500, only Snake and Rooster years show lower, statistically significant, holding period return. Results are inconclusive for other animal-years or other categorizations in the zodiac astrology.

Anticipating Uncertainty: Straddles Around Earnings Announcements

On average, straddles on individual stocks earn significantly negative returns: daily holding period return is -0.19% and weekly holding period return is -2.09%. In sharp contrast, straddle returns are significantly positive around earnings announcements: average at-the-money straddle returns from one day before earnings announcement to the earnings announcement date yields a highly significant 2.3% return. The positive straddle returns around earnings announcements are robust to different stock and option characteristics. This finding suggests that investors underestimate the magnitude of uncertainty during the earnings announcement period, consistent with the cognitive bias “conservatism.” Furthermore, we find the underestimation of uncertainty is more pronounced for smaller firms, firms with less analyst coverage, higher past jump frequency, higher kurtosis and more volatile past earnings surprises. This supports the notion that when there is more noise in the data, it is more likely for investors to display “conservatism.”

Impact of EVA Adoption on Long-Term Shareholder Value: An Empirical Investigation

Our study examines Economic Value Added metric’s link to long term shareholder value creation. We assume that EVA adoption directs a positive change in managerial behavior that in turn affects long-term value generation. Unlike most prior research that uses only one sample, we employ two samples. The first sample is based on 57 U.S. firms that Stern Stewart & Company has posted on its website. They report that these firms have achieved superior financialperformance as a consequence of the adoption of EVA for the 1994-98 periods. The second sample is based on 178 U.S. firms’ proxy statements for the 1994-1999 periods in which these firms have described EVA use as a part of their performance evaluation and compensation metric. Our study’s results, using both long-term abnormal holding period returns and analyst forecast based on five-year growth of earnings per share show that EVA adoption has no significant impact on a firm’s long-run performance when compared to a control sample matched on industry, size and past performance. Moreover, we find no evidence that EVA adoption induces greater shortsightedness as EVA adopters do not underperform, on average, the non-EVA firms.

Zero-Coupon Yields and the Cross-Section of Bond Prices

I estimate a dynamic term-structure model with time-varying risk premia on a panel of Treasury coupon bonds, without relying on an interpolated zero-coupon yield curve or a selection of maturities. The model implies that coupon-bond prices are linear functions of latent factors. I use the model to quantify the large deviations between the prices of bonds older and younger than 15 years during the financial crisis. I show that prices of risk estimated from short-horizon vector autoregressions of latent factors lead to biased forecasts of long-horizon holding-period returns; prices of risk estimated on realized holding-period returns lead to better forecasts.

Information in the U.S. Treasury Term Structure of Interest Rates

AbstractWe provide evidence of a significant change in the information content of the U.S. Treasury term structure of interest rates over the last 20 years. We apply a regression approach to measure the information in forward interest rates and introduce both a curve fitting method and an alternative data source. We find more information in the recent U.S. Treasury term structure about future interest rates than about expected holding period returns. These results document a significant departure from prior empirical findings.

Shareholder wealth reaction to officer leave of absence announcements

PurposeThis paper seeks to explore empirically the shareholder reactions to an officer leave of absence (OLOA) announcement.Design/methodology/approachA standard event study methodology is applied to daily stock holding period returns. The sample studied consists of 104 firms announcing an OLOA and is further delineated by both reasons offered and the title of the officers in the event. A cross‐sectional analysis is used to study the reactions found.FindingsThe paper documents a statistically significant negative response from shareholders: a 4.9 percent mean loss across 104 firms in the sample. Cross‐sectional results indicate that board independence and the passage of the Sarbanes‐Oxley Act of 2002 (SOX) influence abnormal returns.Practical implicationsThe evidence in this study clearly suggests the value‐relevance of the OLOA announcements. Therefore, a thorough understanding of the impact of OLOA announcements on firm value is important to investors.Originality/valueEvent studies of management turnover primarily focus on the event of formal executive turnover per se and largely ignore events of temporary turnovers. This paper examines market response to OLOA (a corporate event that may precede permanent management turnover). It uncovers varied significant market reactions. Some insignificant results in prior event studies may be partially explained by information released through preceding events of temporary turnovers.

The Performance of Newly Issued Stocks in Thailand

This paper aims to examine the relative long-run performance of the newly issued stocks in the Stock Exchange of Thailand (SET). The sample of 325 newly issued stocks in Stock Exchange of Thailand during the year 1990–2006 is filtered to 314 stocks by excluding the issues during the mid-1997 to 1998 Asian Financial Crisis period. 3-year and 5-year holding period returns of IPOs portfolio are compared with those of the matching firms. In addition to the event study, the time series cross-sectional regressions are employed to investigate the long-run overpriced of newly issued stocks when controlling for size and Book-to-Market Value ratio. The overall results show that, relative to that of the size-matched portfolio, the long-run performance of portfolio consist of was underperformed by approximately 15% and 29% for the three-year holding period portfolio and five-year holding period portfolio, respectively.

Locals, foreigners, and multi-market trading of equities: Intraday evidence from Thailand

We study stock market orders and trades in a developing country, Thailand, where foreign ownership limits partially segment local and foreign investors into two distinct markets. Some foreigners forgo voting rights and distributions to trade on the “local board”, while some locals forgo such benefits and pay a price premium to trade on the “foreign board”. Regardless of nationality, these cross-market traders typically submit orders when liquidity is high, fill orders at relatively beneficial prices, exploit patterns in stock prices across markets, display profitable holding-period returns, and enhance price discovery. This suggests that skilled, informed trading that affects market quality does not depend on trader nationality.

Initial Public Offerings: The Case Of Health Maintenance Organizations (HMOs)

Objective: To determine whether the returns of initial public offerings (IPOs) of HMOs in the days following issue are similar to the return behavior of IPOs in previous studies.Data Source: The Center for Research in Security Prices (CRSP) tapes compiled by the Graduate School of Business at the University of Chicago provides daily stock prices, holding period returns, and other data pertinent to research in traded securities.Study Design: The hypothesis to be tested is whether the mean excess return surrounding the offer date is equal to zero. To adjust the initial returns of the IPOs for overall market movements, Standard & Poors Composite Index (S&P 500) was selected as the proxy for the market in general. We compute the long-run performance for the HMOs and compare that return to the S&P 500 and the CRSP AMEX/NYSE equally-weighted and value-weighted indices.Data Collection/Extraction Method: We matched for-profit HMOs listed in the National Directory of Managed & Integrated Care Organizations to the commitment offerings reported by Securities Data Corporation to the same firms on the daily CRSP tapes. This left 49 firms that went public between 1971 through 1997. The Wharton Research and Data Services External (WRDSX) was used for data extraction and SAS was used for statistical analysis.Principal Findings: IPOs of HMOs are underpriced and demonstrate abnormal returns. The average initial return on these IPOs is less than that of the average in the United States. On a long-run performance basis, they performed better than the broad market indices.Conclusions: Returns follow a similar pattern as do IPOs in general except for the long-run performance. This needs further research as well as a comparison of performance before and after going public in cases where accounting data is available.

Asset Choice And Time Diversification Benefits

The issue of time diversification has been controversial. While some findings support time diversification, others do not. For example, Hodges, Taylor and Yoder (1997) find bonds outperform stocks, but Mukherji (2002) finds stocks provide time diversification benefits. This paper investigates whether the differences in the findings of Hodges, Taylor and Yoder (1997) and Mukherji (2002) stem from methodological variation. Results indicate that the differences in the procedure used to estimate the holding period returns may in fact be the reason for the difference in findings. Using a procedure to estimate holding period returns that is similar to Hodges, Taylor and Yoder (1997), and a performance measure that is similar to Mukherji (2002), we do not find that stocks provide time diversification benefits.