Negative Excess Returns Research Articles

In China A-Shares, Big Money Is Smart Money

Using a dataset unique to China, the authors provide evidence that large trades earn excess returns in the China A-shares market. Stocks with net flows through large trades earn positive excess returns in the subsequent month, while stocks with net flows through small trades earn negative excess returns. The predictive power lasts up to two years. Large trades are correlated with institutional holdings by Qualified Foreign Institutional Investors (QFII) and Northbound Stock Connect investors. Moreover, mutual fund returns negatively load on the small net flows factor, suggesting that mutual funds earn their alpha partially from trading against uninformed small retail investors. Small net flows gravitate toward unprofitable, high-valuation, and low-momentum stocks, matching what the literature has found for small retail trader preference. Lastly, small- and medium-sized net flows predict negative subsequent profitability, while large and extra-large net flows predict positive subsequent profitability.

Forward-Looking Policy Rules and Currency Premia

AbstractWe evaluate the cross-sectional predictive ability of a forward-looking monetary policy reaction function, or Taylor rule, in both statistical and economic terms. We find that investors require a premium for holding currency portfolios with high implied interest rates while currency portfolios with low implied rates offer negative currency excess returns. Our forward-looking Taylor rule signals are orthogonal to current nominal interest rates and disconnected from carry trade portfolios and other currency investment strategies. The profitability of the Taylor rule portfolio spread is mainly driven by inflation forecasts rather than the output gap and is robust to data snooping and a wide range of robustness checks.

Combined Dividend and Earnings Reporting Policies: Signaling or Managerial Opportunism##x003F;

In the context of controversy over the effect of dividend policy and earnings management on corporate value, this study analyzes future stock returns to investigate whether combinations of dividend and earnings reporting policies signal true firm value or managerial opportunism. We classify firms as low, high, and no-dividend firms, and identify earnings reporting as aggressive or conservative. Our findings are summarized as follows. First, low-dividend policy firms showed the largest negative excess return, and firms that reported aggressive earnings showed negative excess returns. We also find that low dividend firms choose aggressive earnings reporting. These results suggest the possibility that managers link dividend and earnings reporting policies. Second, firms that combine low dividends with aggressive earnings reporting experience more negative excess stock returns, and this effect is more pronounced with low ownership concentration and share repurchases. This result suggests that in firms with large agency risk and information asymmetry, managers have an incentive to manipulate stock prices by combining low dividends and aggressive earnings reporting policies. Overall, our findings suggest that opportunistic managers may combine low cost signals to inflate stock prices, taking advantage of weak monitoring environments.

Investment dynamics of fund managers under evolutionary games

We investigate the investment behavior of fund managers in financial markets according to evolutionary dynamics. We consider both the absolute and relative portfolio returns in the payoff gradient, to which the fund managers respond, and find the equilibrium proportion of risky investment. Compared to the case where only relative performance affects the payoff gradient, we find that, as the absolute performance affects the managers’ belief, the equilibrium of long and short positions increases. If short sales are not allowed, negative excess returns will force the managers to stay out of the market until the excess return becomes positive. Furthermore, we use a quadratic function to depict the relative performance. The quadratic setting captures the exaggerated sentiments of winners and losers arising from certain behavioral biases, and leads to a lower speed of convergence, which implies that herding decelerates and the managers are likely to adhere longer to their own strategies.

How Do Financial Markets React to Long Term Development of Industries?

We develop quantitative methodologies to classify industries by their development phase and apply this to analyze whether stock markets over- or underreact to industries shifting to another phase of development. We find little evidence for such market inefficiencies. On the contrary, a substantial portion of the (negative) excess returns for growing (declining) industries are earned in the run-up to the phase shift. These results suggest that stock markets reflect the information with regards to industrial development in stock market prices in the run-up to an industry entering a new phase. Consequently, bubbles at the industry level may be more of an exception than a rule and more difficult to identify ex-ante than sometimes thought.

Is there persistence among non-professionals? Evidence from the Chicago Mercantile Exchange Group Trading Challenges

PurposeThe study systematically investigates persistence in performance for simulated trading among non-professional traders in the futures market.Design/methodology/approachIn this study, the authors employ a novel data set from the Chicago Mercantile Exchange (CME) Group's Trading Challenges for years 2014 through 2018 and expand upon the empirical methodology of Malkiel (1995) through improved interval estimations in testing for persistence in performance. The authors implement Fama-MacBeth style regressions to understand the degree of persistence in performance and the extent to which non-professionals extrapolate from prior returns. They adjust returns for risk through the Fama and French (2015) five-factor model in understanding whether the sample of non-professionals is able to produce excess returns after expenses and whether there is evidence of excess gross to cover expenses.FindingsThe empirical analysis suggests strong evidence for performance persistence among non-professionals participating in the Preliminary Rounds. In the Championship Rounds, the authors find that the persistence effect becomes stronger in economic and statistical significance after accounting for expenses. The results suggest that competition and transaction costs help to distinguish between winners and losers. When conducting Fama-MacBeth style regressions, the authors present evidence that strongly supports the persistence effect and over-extrapolation. While the results of the multi-factor model analysis suggest that, after adjusting for risk, most teams are experiencing negative excess returns prior to expenses, the authors also uncover evidence of teams earning returns sufficient to cover their expenses.Originality/valueThe authors bridge the gap between the literature on performance persistence and the emerging literature on non-professionals in the financial markets. Data from the CME Group’s Trading Challenge provide a rich source in studying the beliefs of non-professionals, and this study is helpful for understanding how beliefs, operationalized in simulated trades, perform over short time horizons, thereby providing insights into the behavioral dynamics of the financial markets. The results provide new empirical evidence for performance persistence among non-professionals.

The Weakening Index Effect

The Index Effect has weakened significantly since 2011. The Index Effect is the phenomenon where stocks that are added to an index experience positive excess returns in the days before being officially added, while stocks that are removed from an index experience negative excess returns. The weakening of the Index Effect has been pronounced for large- and mid-cap stocks, though it still can be observed in many indexes with small-cap stocks. The article also examines the importance of several other aspects related to the Index Effect, including illiquidity and unscheduled rebalances. The weakening of the Index Effect has occurred concurrently with a substantial increase in passive investing. One potential explanation for the weakening is that the ETF market makers (e.g., authorized participants) trade on price disparities as soon as they occur, eliminating any sustained positive or negative price movements. If true, this would be evidence that ETF trading adds liquidity to the market. TOPICS:Exchange-traded funds and applications, mutual funds/passive investing/indexing, mutual fund performance, passive strategies Key Findings • This article examines the Index Effect, in which stocks that are added to or dropped from an index experience positive/negative excess returns in the days immediately before they are officially added/dropped. The Index Effect has weakened significantly since 2011. • The Index Effect can still be found in indexes with small cap stocks and those with notably illiquid names. • One potential explanation for the weakening of the Index Effect is that the ETF market makers trade on price disparities as soon as they occur, eliminating any sustained positive or negative price movements. If true, this would be evidence that ETF trading adds liquidity to the market.

Modified Sharpe Ratio Application in Calculation of Mutual Fund Star Ranking

Purpose of this study is to apply to modify Sharpe Ratio to calculate Star Ranking of Equity-based mutual funds registered in Mutual Fund Association of Pakistan, further, the idea was to recalibrate locally developed models being used in Pakistan by autonomous professional bodies who professionally assigns star ranking of mutual funds, equity market exhibited negative returns from July 2017 onwards this research which brought the problem to assign star ranking due to model structure, model relies on risk-adjusted return (Sharpe Ratio), therefore Sharpe Ratio has a limitation in negative excess return. Two developed models were simultaneously compared to witness the predictive power of these models, (1) modified Sharpe and (2) VIS Credit Rating Company (Explaining the Stars) Model. Data was collected from March 2013 to March 2018 quarterly and the exercise was done quarterly. Findings revealed a magnificent piece of work, (1) there is no difference between model 1 and model 2 by both way results exhibited same mutual fund star rankings, (2) both methods have a different way of calculating final score with same results, and (3) modified Sharpe ratio is quite well when excess return is negative but when there is a mix of negative and positive better to use VIS model as well as in positive excess returns. A research paper could not calibrate other models developed by rating companies (Pakistan Credit Rating Company) which is a future research gap.

Does switching trading venues create value? Evidence from Hong Kong

PurposeThe purpose of this paper is to study whether switching trading venues create value in the Hong Kong stock market.Design/methodology/approachBy using an event study, the paper investigates the abnormal returns (AR) earned by firms in the Growth Enterprise Market (GEM) relating to switching to the Main Board (MB). Two measures, turnover of the stock and Amihud’s (2002) illiquidity ratio, are used to examine the liquidity effects.FindingsThe switch is accompanied by a long-term increase in stock price for low liquidity firms only. High liquidity firms underperform with persistent negative excess returns after switching, while the transient negative excess returns in low liquidity firms reverse gradually. The results further show a significant increase in trading activity for low liquidity firms following the switch, while there is a significant decline in both trading activity and liquidity in firms with high liquidity. The overall results suggest that moving from GEM to the MB is beneficial to low liquidity firms but detrimental to high liquidity firms.Originality/valueThis study is the first to investigate whether moving from GEM to the MB creates value in the Hong Kong stock market.

ESG Controversies and Their Impact on Performance

This article introduces an aggregated controversy metric—derived from environmental, social, and governance (ESG) data—that targets specific issues companies face in the environmental, social, or governance fields. By building portfolios based on this controversy measure, the study shows that in Europe and the US, stocks that undergo severe controversies significantly underperform both their benchmarks and other portfolios consisting of stocks with low controversy or no controversy at all. The main reason for this result is that, in both cases, markets tend to react strongly to changes in controversy levels, penalizing stocks that experience ESG downgrades. These results make a clear case for the potential benefits of excluding stocks with high-controversy levels from investment universes. However, these findings are not confirmed for the Asia-Pacific region, where the portfolios consisting of highly controversial stocks outperform their benchmarks, although the number of such portfolios is lower compared to the number in Europe and the US. TOPICS:Portfolio theory, portfolio construction, ESG investing Key Findings • High levels of ESG controversies have a significant impact on stock returns for US and European stocks. • Europe displays a clear surprise effect, where unexpected severe downgrades in the controversy levels are usually associated with persistent negative excess returns up to 12 months after the downgrading. For the US, we do not notice a surprise effect, but progressive downgrades are penalized by the market (a deteriorating effect). • For Asia-Pacific stocks, there is little evidence so far that stock markets react negatively to ESG controversies and rating downgrades.

Optimal Learning, Overvaluation and Overinvestment

Periods of technological revolution are usually associated with overvaluation of and over-investment by innovating firms. This paper develops a model that explains this behavior in a frictionless rational setting. When fully rational innovating firms face uncertainty about the returns to scale of their production functions, over-investment emerges as the optimal way to learn about the returns to scale. The optimal learning is also shown to produce overvaluation. The model is also able to generate what an observer ex-post would identify as bubbles followed by over-correction, negative excess returns in early periods, negative auto-correlation in excess returns and market-to-book and size effects.

Do Growth Expectations Help Explain Characteristic-Sorted Portfolio Returns?

We find that accounting ratios (asset and sales growth, profitability, and equity dilution) that predict stock returns are associated with errors in analyst long-term growth forecasts. Specifically, accounting information that is associated with favorable long-term growth forecasts tends to predict negative analyst forecast errors and negative future excess returns. This and other evidence we present is consistent with the idea that biased long-term growth forecasts generate the observed return premia of popular characteristic-sorted portfolios.

Information Transfer of Bankruptcy Announcements: Examining the Impact of Auditor Opinions

SYNOPSIS Auditing standards require auditors to consider whether there is “substantial doubt” that their client will remain a going concern and to, accordingly, modify the audit report (PCAOB AS 2415). Prior research reports larger negative excess returns for bankrupt firms when bankruptcies occur without a prior going concern opinion. We investigate whether such audit opinions can also have an impact on industry peer firms. We find that peer firms experience significantly larger negative stock price drops when rivals' bankruptcies are not preceded by a going concern opinion. In addition, we find evidence of incremental stock price declines for peer firms when Big N audit firms fail to issue a going concern opinion. These findings should be of significant interest to regulators, auditors, and capital market participants as they serve to enhance our current understanding of the importance of going concern opinions for the share pricing of industry peer firms. JEL Classifications: G14; G33; M4; M42. Data Availability: All data are from public sources identified in the manuscript.

Extreme high surface temperature events and equity-related physical climate risk

By matching the timing and geography of extreme high surface temperature (EHST) events in the United States to the location of firms' headquarters, we are able to measure the equity market's response to an exogenous shock deemed by climate scientists to relate proximately causally to equity-related physical climate risk. Measured as the cumulative excess return over EHST day 0 (the initial shock) to EHST day 20, we find that the equity market responds negatively to EHST events (−0.42%), and more negatively to costlier events (−1.38%) and those of longer duration (−0.68%). Firms in counties in the South and Southeast climate regions, the month of July, and the most recent decade of the study period (2008–2017) experience the most negative cumulative excess returns in response to EHST events. In addition, consistent with equity investors' recognition of physical climate risk, equity price volatility increases over EHST days 0–20, rising even more for costly and long-duration events. Our findings imply that the equity market recognizes but underprices physical climate risk, consistent with forming biased expectations of future equity returns.

Cross-sectional return dispersion and currency momentum

Abstract I assess the relation between cross-sectional return dispersion in foreign exchange (FX) markets and currency momentum. I find that cross-sectional dispersion is priced in the cross-section of currency momentum returns and that an unexpected increase in cross-sectional dispersion is associated with positive (negative) excess returns to winner (loser) currencies. This mechanism can be related to monetary policy conditions. The empirical findings are robust to the inclusion of traditional currency risk factors, liquidity and market volatility variables, and transaction costs. Finally, the explanatory ability of cross-sectional dispersion extends to broader cross-sections of currency portfolios and to individual currencies.

Forward-Looking Policy Rules and Currency Premia

We evaluate the cross-sectional predictive ability of a forward-looking monetary policy reaction function, or Taylor rule, in both statistical and economic terms. We find that investors require a premium for holding currency portfolios with high implied interest rates while currency portfolios with low implied rates offer negative currency excess returns. Our forward- looking Taylor rule signals are orthogonal to current nominal interest rates and disconnected from carry trade portfolios and other currency investment strategies. The profitability of the Taylor rule portfolio spread is mainly driven by inflation forecasts rather than the output gap and is robust to data snooping and a wide range of robustness checks.

Demand curves for stocks do not slope down: Evidence using an exogenous supply shock

We analyze the price impact of an exogenous share sale by inside blockholders, who were forced to sell a part of their shareholdings due to a regulatory change in India. The affected firms experience a negative excess return of 4.3 during the issue week. Crucially, the price impact reverses in about 16 days after the event. Our results are consistent with the view that the long term demand curves for stocks are flat: a view echoed by classical finance theories. The short term price reaction to a sale is likely to be a result of temporary price pressure.

Post Macroeconomic Announcement Reversal

We document that on the two days following macroeconomic news announcements, the stock market has negative excess returns, and the security market line has a significantly negative slope. These findings concentrate on days after bad macroeconomic news, which indicates that the market does not fully incorporate negative macro shocks on the announcement day. The underreaction effect is stronger among stocks with higher information uncertainty, tighter short-selling constraints, and when intermediary capital is scarce, consistent with the theory of limits to arbitrage. Considering the underreaction effect, we argue that the risk premium on macroeconomic announcement days is lower than previously believed.

Profitability of Contrarian Strategies: Evidence From the Stock Exchange of Mauritius

The aim of this paper is to assess the profitability of contrarian strategies on the Stock exchange of Mauritius. Using data from 2001 till 2009 for all 40 listed companies on the official market, the study shows little support in favour of the contrarian effect. In particular, the losers portfolio seems to outperform the winners portfolio in one out of nine strategies. However, when considering the market return, negative excess returns are noted for all portfolios across all strategies, providing strong support for a passive portfolio management strategy and weak support for overreaction hypothesis. In addition, the Size, Price, Earnings to Price (E/P) and Book to Market (B/M) Effect has been tested. The results suggest that the average market return is greater than size-based portfolios and price-based portfolios. However, when accounting for the E/P and the B/M effect, there seems to be a strategy which can beat the market. Nevertheless, most strategies for E/P and B/M portfolios indicate insignificant excess returns. In general, the results of this paper are undoubtedly in sharp contrast with most popular studies in developed markets. However, it is observed that investors on the SEM may not possess similar characteristics to those of well-advanced markets. In particular, according to Harvey (1995), emerging market countries are sometimes relatively isolated from capital markets of other countries.

An Investigation of the Informational Role of Short Interest in the Nasdsaq Market

This paper examines the informational role of short interest in the Nasdaq market. Using the population of monthly short interest data over the period of June 1988 through December 1994 we find that firms with high short interest experience significant negative abnormal returns ranging from -0.76% to -1.13% per month during the period over which they are heavily shorted. In contrast to results in Aitken et al. (1998) that show that information in short interest is incorporated quickly into prices for Australian stocks, we find that information in short interest is incorporated gradually into prices for Nasdaq stocks. The negative excess returns are increasing in the level of short interest indicating that a higher level of short interest is a stronger signal. Consistent with short interest being a bearish signal, we find that the heavily shorted firms get delisted with a higher frequency relative to their size and industry matched control firms.