Infrequent Trading Research Articles

The Influence of Anchoring and Overconfidence on Investment Decision-Making in the Saudi Stock Market: A Moderated Mediation Model

Abstract This research sheds light on the relationships between heuristic biases and investment decisions as demonstrated by Saudi investors by establishing a mediating role for investor overconfidence in the relationship between anchoring heuristics and investment decision-making. The first to present evidence for this role, the study takes into account specific types of investment decisions – i.e. decisions to buy, sell, and engage in frequent trading. Based on a sample of 598 responses, empirical evidence is presented to show that anchoring directly increases the extent to which investment decisions are irrational and also does so indirectly through its impact on overconfidence. Given that this is the case, investors would be well-advised to critically assess the influence on their investment decision-making of overconfidence, which may, in turn, be rooted in deep-seated biases such as anchoring. Further, the potential moderating effect of trading frequency on overconfidence and investment decisions is examined and a moderated mediation model presented to elucidate the relationship between anchoring bias and investment decisions. The findings underscore the importance of understanding these biases and taking a scientific approach to trading, including by engaging in infrequent trading, to producing more rational investment decisions. Put differently, the study highlights the benefit of infrequent over frequent trading: Compared to those who trade less frequently, investors who trade more frequently are more susceptible to overconfidence and anchoring biases.

Pricing Liquidity Risk in the Korean Corporate Bond Market*

AbstractThis study investigates the pricing of liquidity risk in the Korean corporate bond market. We use three different liquidity factors — namely, aggregate market liquidity, liquidity innovation, and predicted liquidity. The empirical results show that, while a liquidity premium exists in the Korean corporate bond market when measured by the market liquidity factor, a liquidity discount occurs when measured by the predicted liquidity factor. Drawing on prior studies, we further describe that the lower (higher) returns for portfolios with a high sensitivity to unexpected liquidity shocks may be attributable to the infrequent (frequent) trading of AAA(A)‐rated bonds in the Korean market. Finally, our findings suggest that while a liquidity premium exists in expectation, investors are penalized for taking predicted liquidity risks in the Korean corporate bond market.

Contrarian Profits and the Overreaction Hypothesis: The Case of the Athens Stock Exchange

This paper investigates the existence of contrarian profits and their sources for the Athens Stock Exchange (ASE). The empirical analysis decomposes contrarian profits to sources due to common factor reactions, overreaction to firm-specific information, and profits not related to the previous two terms, as suggested by Jegadeesh and Titman (1995). Furthermore, in view of recent evidence that common stock returns are related to firm characteristics such as size and book-to-market equity, the paper decomposes contrarian profits to sources due to factors derived from the Fama and French (1993, 1996) three-factor model. For the empirical testing, size-sorted sub-samples that are rebalanced annually are employed, and in addition, adjustments for thin and infrequent trading are made to the data. The results indicate that serial correlation is present in equity returns and that it leads to significant short-run contrarian profits that persist even after we adjust for market frictions. Consistent with findings for the US market, contrarian profits decline as one moves from small stocks to large stocks, but only when market frictions are considered. Furthermore, the contribution to contrarian profits due to the overreaction to the firm-specific component appears larger than the underreaction to the common factors.

Asset Pricing Tests of Infrequently Traded Securities: The Case of Municipal Bonds

Abstract Using a dynamic selection model, we obtain consistent and unbiased estimates of risk and returns for infrequently traded bonds and conduct the first comprehensive asset pricing test of municipal bonds using the multifactor approach. Correction for sample selection and infrequent trading problems results in substantially higher beta estimates. Besides conventional risk factors, illiquidity and taxes are important for the pricing of municipal bonds. Importantly, bond returns contain a significant liquidity risk premium. Failing to account for sample selection bias leads to erroneous inference on the magnitude of systematic risk and substantial underestimation of risk premiums. (JEL G12, G14)

Dynamic ownership and private benefits

We quantify private benefits of control by estimating a structural model of optimal shareholding using data on the ownership dynamics of Italian public companies. In the model, shareholders must maintain a minimum stake in the company to extract control benefits, which leads to infrequent trading of large blocks, and which is consistent with the empirical evidence. We estimate that control benefits account for 2% (4%) of the market value of the equity (block), and controlling shareholders earn a sizeable premium from the block holding on top of the market value of the shares. Also, we provide evidence that large block ownership and ownership persistence are associated with higher stock returns.

The Idiosyncratic Volatility Puzzle: A Time-Specific Anomaly

Given the availability of daily data over 1926-1962, it is surprising that there is no research examining the idiosyncratic volatility (IV) puzzle over this early period. This paper conducts an out-of-sample test on the IV phenomenon. We find that the negative relation between IV and expected returns only exists during the period 07/1963-12/1989, implying that the puzzle may be a result of data snooping bias. The result on time-special anomaly is robust for different sorting breakpoints and alternative measure of idiosyncratic volatility. Infrequent trading cannot account for the low average returns of stocks with high idiosyncratic volatility. With a striking contrast, the involving of short-term return reversals eliminates this dilemma.

Кривые доходностей на низколиквидных рынках облигаций: особенности оценки

There are many different models for estimation of a yield curve from bond market quotes. These models are well suited for developed markets with high liquidity level and market data readily available. However, this is not always the case for developing markets that are characterized by infrequent trading, heterogeneous liquidity and frequent missing data.In this article we provide a review of the existing and theoretically possible solutions to the problems arising in the process of yield curve construction in developing markets. Our review shows, that all these problems can be effectively tackled by adapting traditional yield curves mo­dels to the observer liquidity level of developing market.Heterogeneous liquidity can be addressed by introducing liquidity-based weights into a yield curve model and by removing observations with atypical liquidity from the dataset. To solve missing data problem, we suggest using dynamic yield curve models or recreating missing observations with help of a supplementary model. In special cases when there are not enough bond issues on the market one is recommended to simplify yield curve model and use the data from other markets (e.g. derivative market).The article might be of a great use for market practitioners who operate on developing bond markets as well as for quants who are engaged in construction of yield curves. It also serves as a starting point for a further academic research in the area of term structure modelling in illiquid bond markets.

Liquidity Premium and Transaction Cost

Low infrequent trading implies low liquidity. Liquidity and transaction cost are two sides of the coin. Whether transaction cost is the determinant of stock liquidity premium? This paper selects common stocks of NYSE/Amex/Arca/ Nasdaq from 1926 to 2011 as research samples, makes a comprehensive analysis through Fama-French three factor model and Fama-French five factor model, LCAPM model and Pástor Stambaugh model. The results show that the ability of BA12, LOT12, CS12, and Cgibbs is limited, which means that transaction cost is not the determinant of liquidity premium, and the influence of transaction cost on the expected return of stock is indirect and secondary. The research provides a strong empirical experience for the asset pricing power of transaction cost is the second order. Thus, from the perspective of pricing meaning, transaction cost is not the decisive factor of price.

Liquidity risk and exchange-traded fund returns, variances, and tracking errors

We investigate the effect of exchange-traded fund (ETF) liquidity on ETF tracking errors, returns, and volatility in the US. We find that illiquid ETFs have large tracking errors. The effect is more pronounced when underlying assets are less liquid. Returns and liquidity of illiquid ETFs are more sensitive to underlying index returns or ETF market liquidity, or both. Thus, a positive liquidity premium exists in US ETF markets. The ETF variance could be larger than its net asst value variance owing to infrequent trading. In summary, illiquid ETFs are more likely to deviate from their underlying indexes and could be riskier than underlying portfolios.

Trading Frequency Anomalies in Infant Markets: The Test for Returns and Sensitivity of Shares and Portfolios

Beta, as a measure of risk based on market prices of shares, has been widely debated and researched in the strong, semi-strong and weak markets. It has been proved that there is neither negative nor abnormal beta. Past studies rarely considered frontier and infant markets such as Dar es Salaam Stock Exchange (DSE) while studying beta and its behavior. By means of the corresponding closing share prices of 17 companies during a continuous 246-day trading period in 2018 extracted from DSE database, this study examines the trading frequency anomalies in infant markets by testing returns and sensitivity of shares and portfolios. Through computing the betas of DSE traded shares, this study has found many abnormalities. The shares showed infrequent trading like bonds. The prices were constant over a short period of time, and sometimes the shares were not traded at all. Due to this small volatility, the shares showed abnormal behavior which resulted in negative beta sometimes. We concluded that this could be due to two major reasons. Firstly, there is insufficient knowledge on the share market among the East African investors and the public, and secondly, the markets are rather young and the trading platforms and infrastructures are not so well-established. We, therefore, suggest the policy makers to optimize share trading in the region by considering the findings of this study.

Portfolio optimization under dynamic risk constraints: Continuous vs. discrete time trading

AbstractWe consider an investor facing a classical portfolio problem of optimal investment in a log-Brownian stock and a fixed-interest bond, but constrained to choose portfolio and consumption strategies that reduce a dynamic shortfall risk measure. For continuous- and discrete-time financial markets we investigate the loss in expected utility of intermediate consumption and terminal wealth caused by imposing a dynamic risk constraint. We derive the dynamic programming equations for the resulting stochastic optimal control problems and solve them numerically. Our numerical results indicate that the loss of portfolio performance is not too large while the risk is notably reduced. We then investigate time discretization effects and find that the loss of portfolio performance resulting from imposing a risk constraint is typically bigger than the loss resulting from infrequent trading.

Stock Price Synchronicity and Information Environment

This study investigates the relationship between Stock Price Synchronicity and information environment variables in Pakistani equity market by using data of 133 stocks for the period of June 2002 to June 2016. The results indicate that liquidity, book to market ratio, percentage of zero volume days and size have significant impact on stock price synchronicity. The findings of the study suggest that low R-squared stocks are smaller, have less turnover rate and infrequent trading, which makes them less profitable. During global financial crisis, the stocks are more synchronized with the market. This study further suggests that low-stock-price synchronicity is a result of firm-specific variables.

Testing Weak Form of Market Efficiency in Nepal

The paper investigates the weak form of market efficiency for overall and sectorial indices. The Nepalese stock returns are found not being normally distributed during the study period. The autocorrelation of the stock returns was reduced by correcting the data with the application of the methodology suggested by Miller et al. (1994). The Nepalese stock market has suffered from the problem of thin-trading. Overall, the Nepalese market is not weak-form efficient on the basis of the analysis performed by employing observed returns series; but it is found a weak-form efficient in case of the analysis while using corrected data after adjusting infrequent trading. Hence, the study is supported to the random-walk and weak form of market efficiency.

Measuring the Effect of the Real Estate Bubble: A House Price Index for Bilbao

Houses are traded at relatively infrequent times and can hardly be standardized: two equally built and furnished houses may command widely different prices in the market on account of their different location or even orientation. Clearly, the computation of an index such as Laspeyres’ cannot be contemplated, both because of lack of standardization and infrequent trading. On the other hand, there is little market visibility; transaction prices are seldom published, further increasing the difficulties inherent to the construction of a house price index. In this paper we use advertised (selling) prices as a proxy of transaction prices, and geographically weighted hedonic models to account for heterogeneity in quality and location. This gives a workable alternative to conventional approaches with the added benefit that it can provide price information in near-real time.

Informed Trading in Hybrid Bond Markets

This paper studies the effects of pre-trade transparency on the price discovery process by investigating the choice of trading venue and order type by informed dealers who can choose between an electronic limit order book (LOB) and the over-the-counter (OTC) market. A detailed data set from the hybrid Norwegian government bond market shows that informed dealers, defined as dealers whose order flows predict bond excess returns, prefer market orders in the LOB. The results further show that uninformed dealers tend to provide liquidity to informed dealers in the LOB. Informed dealers' preference for speed can reflect that limit orders are exposed to high waiting costs in markets with infrequent trading and that OTC trades are exposed to a costly leakage of information in markets dominated by a few central dealers.

Time-Varying Rating Standards and the Distorted Incentives of Credit Rating Agencies

Time-Varying Rating Standards and the Distorted Incentives of Credit Rating Agencies

Bond Market Event Study Methodology

The procedures used in corporate bond event studies to date fail to control for heteroskedasticity due to differences in return volatility by term-to-maturity, rating, and other factors resulting in low test power. Bond return standardization yields considerably more powerful tests. Also, due to infrequent trading, use of bond transaction price observations over several days before and after an event, while giving more weight to returns calculated from transactions closer to the event, yields considerably more powerful tests than returns based solely on transactions the day before and the day after the event. Exploring the test bias caused by overlapping event dates, we find that, adjusted for rating and maturity, the correlation among standardized abnormal bond returns is small but that even fairly small correlations can result in biased test statistics. A bond market modification of the Kolari and Pynnonen (2010) procedure corrects this bias.

Intervalling-Effect Bias and Competition Policy

The purpose of this paper is twofold. First, it aims to investigate whether the security's systematic risk beta estimates change as the infrequent trading phenomenon appears. Second, it attempts to provide useful insight on the impact of mergers and acquisitions on competition policy. For this reason, we employ the models of Scholes and Williams (1977), Dimson (1979), Cohen et al. (1983a) and Maynes and Rumsey (1993) on a small stock exchange with thickly infrequent trading stocks. The empirical results reveal that for some securities the models employed by Scholes and Williams (1977) and Cohen et al. (1983a) improve the biasness of the Ordinary Least Squares Market Model (Maynes and Rumsey, 1993). We argue that competitors gain while merged entities loose or at least do not gain from the clearness of the investigated mergers.

Thin-Trading and Beta Estimation: Results From a Simulated Environment

This study contributes to the literature on common stock Beta estimation in an environment of varying levels of infrequent trading, or market frictions. In this study a stock market environment with a range of Beta relationships and varying levels of trading infrequency is artificially created using Normal and Bernoulli-distributed Monte Carlo simulations. Four different modified Beta estimation techniques are compared to the OLS-Beta. The rate of deterioration of the various models is investigated with respect to systematic bias (bias of the mean) as well as a measurement bias (bias of the estimate's standard error). The Trade-to-Trade model performed best overall followed by the simple OLS-adjustment with respect to systematic bias; however, both models showed increasing levels of measurement bias from an early stage. Due to the data-intensive nature of the Trade-to-Trade model it does not serve as a one-size-fits-all solution. The strongest alternative is shown to be the adjusted OLS estimate. The choice of an appropriate thin-trading filter is a function of the choice of the Beta estimator which is in-turn determined by the researchers’ tolerance for either systematic or measurement bias. The contribution of this study is that it provides guidance to the use of alternative methods to estimate risk coefficients.

Overreaction evidence from large-cap stocks

Purpose – The purpose of this paper is to assess the performance of a contrarian investment strategy focusing on frequently traded large-cap US stocks. Previous criticisms that losers’ gains are not due to overreaction but due to their tendency to be thinly traded and smaller-sized firms than winners are addressed. Design/methodology/approach – Portfolios based on past performance are constructed and it is examined whether contrarian returns exist. The Capital Asset Pricing Model (CAPM), Fama and French three-factor model and the Carhart’s (1997) momentum portfolio are used to test whether excess returns are feasible in a contrarian strategy. Findings – The results show an asymmetric performance following portfolio formation. Although both, winners and losers portfolios, have gains during holding periods, losers outperform winners at all times, and with a differential of up to 29.2 per cent 36 months after portfolio formation. Furthermore, the loser and the winner portfolios’ alphas are significant, suggesting that the CAPM and the multifactor models are unable to explain return differentials between winners and losers. Our evidence supports two main conclusions. First, stock market overreaction still holds for a sample of large firms. Second, this is robust to the Fama and French’s (1993, 1996) three-factor model and Carhart’s (1997) momentum portfolio. Findings emphasize the relevance of a contrarian strategy when rebalancing investment portfolios. Practical implications – Portfolio managers can improve stock returns by selling past winners and buying previous loser large-cap US stocks. Originality/value – This paper is the first, to the authors’ knowledge, to examine frequently traded large-cap US stocks to avoid infrequent trading and size concerns.