Optimistic Investors Research Articles

Short-Termist CEO Compensation in Speculative Markets: A Controlled Experiment

Bolton, Scheinkman, and Xiong (2006) model a setting where investors disagree and short-sales constraints cause pessimistic views of stock prices to be less influential, which leads to speculative stock prices. A theoretical implication of the model is that existing shareholders can exploit the speculative stock prices by: (1) designing managerial compensation contracts that encourage short-term performance, and (2) subsequently selling their shares to more optimistic investors. We document empirical support for this theory by finding that an exogenous removal (Regulation SHO) of short-sales constraints curbs the provision of short-term incentives, an effect reflected in longer CEO compensation duration. The effect is concentrated among stocks with high investor disagreement and short-term-oriented institutional ownership. Consistent with prior work, we also find that longer CEO compensation duration leads to longer CEO investment horizons, less over-investment, and less earnings management. Collectively, our results speak to the contributing role of speculative stock prices in corporate short-termism. Finally, our study implies that effective policies to curb corporate short-termism should address stock market speculation and promote mechanisms that tie executive compensation to longer-term stock price performance.

What drives the amount of capital raised at IPO? Evidence from the Warsaw Stock Exchange

This paper examines the impact of market timing and legal changes in 2005, aimed at aligning Polish regulations on financial markets with the UE standards, on the amount of capital raised at initial public offerings (IPOs) on the Warsaw Stock Exchange. We find that although during IPOs firms sell, on average, quite the same fraction of firm ownership regardless of the year of the IPO, they raise much more capital in hot- rather than in cold-market conditions. We also find that firms going public in hot and cold markets as well as before and after the legal changes in 2005 do not differ significantly with regard to their profitability, leverage, or liquidity ratios. The amount of money raised in hot- and cold-market conditions is, however, determined by different factors. In cold-market conditions, only the terms of share issue determine the amount of money raised at IPO. In hot-issue markets, the size of the company is the most important factor and the financial situation of companies and investor optimism also have a significant impact on the amount of money raised at IPO. On the other hand, contrary to the cold-market conditions, the terms of share issue are almost insignificant. The changes in the law did not affect the market timing phenomenon, but after the year 2005 there was observed an increasing role of profitability and investor optimism in the investors’ evaluation of new share issues.

What Drives the Amount of Capital Raised at IPO? Evidence from the Warsaw Stock Exchange

This paper examines the impact of market timing and legal changes in 2005, aimed at aligning Polish regulations on financial markets with the UE standards, on the amount of capital raised at initial public offerings (IPOs) on the Warsaw Stock Exchange. We find that although during IPOs firms sell, on average, quite the same fraction of firm ownership regardless of the year of the IPO, they raise much more capital in hot- rather than in cold-market conditions. We also find that firms going public in hot and cold markets as well as before and after the legal changes in 2005 do not differ significantly with regard to their profitability, leverage, or liquidity ratios. The amount of money raised in hot- and cold-market conditions is, however, determined by different factors. In cold-market conditions, only the terms of share issue determine the amount of money raised at IPO. In hot-issue markets, the size of the company is the most important factor and the financial situation of companies and investor optimism also have a significant impact on the amount of money raised at IPO. On the other hand, contrary to the cold-market conditions, the terms of share issue are almost insignificant. The changes in the law did not affect the market timing phenomenon, but after the year 2005 there was observed an increasing role of profitability and investor optimism in the investors’ evaluation of new share issues.

Optimistic Investors and Long-Run Performance of IPOs: Testing the Theory of Heterogeneous Beliefs and Short-Sale Constraints

This study tests speculative bubble theory, which assumes investors’ heterogeneous beliefs and short-sale constraints, as a potential explanation for the long-run underperformance of initial public offerings (IPOs). The prediction of speculative bubble theory is difficult to test directly because of the unobservability of the distribution of investors' opinions. This study thus focuses on Japanese auction-method IPOs and estimates the distribution of investors' beliefs. It finds that both the level of optimism and the divergence of investors' opinions cause the overvaluation of the first-day market price, but that the former has more explanatory power for post-IPO underperformance.

Share Issuance and Expected Returns Around the World

Practitioners and academics often consider initial public offering activity to be a gauge of investor optimism and market valuation. This study investigates the cross-sectional implications of this concept at the country level. The authors use sorting and cross-sectional tests to examine linkages between past share issuance and future returns across 78 countries from 1995 to 2015. They find convincing and robust evidence that share issuance is negatively related with future returns across countries. Markets with high past stock issuance markedly underperform markets with low stock issuance. This phenomenon is particularly strong across small countries but is insignificant across large ones.

Optimism bias, portfolio delegation, and economic welfare

This study explores the effects of investor optimism bias in a portfolio delegation framework. We show that the optimistic investor increases his portfolio delegation, while the risk-averse manager reduces investment in the risky asset. The investor suffers welfare loss due to lower expected return, but the manager enjoys increased compensation. The investor’s optimism bias aggravates the moral hazard problem.

Investor Sentiment, Misstatements, and Auditor Behavior

Although higher investor sentiment has been linked with opportunistic managerial behavior in the face of more optimistic investors and analysts, its impact on external auditors’ risk assessment has yet to be examined. As such, we examine how firms’ external auditors react to investor sentiment. We document that although the likelihood of misstatements is higher when sentiment is high, suggesting elevated audit risk, auditors charge lower audit fees and report going concern opinions (GCO) less conservatively during such periods. This reduction in reporting conservatism is unwarranted; results reveal that auditors are less likely to issue GCOs to clients which subsequently file for bankruptcy (Type II error) during high sentiment periods. We conjecture and find that auditors’ response to high sentiment is best explained by a reduction in auditors’ litigation risk. Specifically, we document that auditors are less likely to be sued and the market reacts less negatively to misstatement announcements when sentiment is high. Collectively, our findings suggest that, although misstatement risk is increasing with sentiment, auditors’ legal risk actually declines, prompting a conflict between auditors’ professional and commercial incentives.

ANALISIS DAMPAK PEMILU PRESIDEN JOKOWI TERHADAP RETURN SAHAM (Studi Kasus Saham LQ-45 di Bursa Efek Indonesia)

Election is one of the political events that influence on a country’s economy. Capital market as one of insrumen economy can not be separated from environmental influences, both economic and environmental non-economicenvironment. This study aimed to analyze the reaction of the capital market to market anomaly events in Indonesia, in this case the 2014 Presidential Election. The reaction of the stock market measured by the abnormal return and trading volume activity stock. The population in this study are the companies whose shares are included in the LQ- 45. This study using event study. The results showed that the positive reaction of investors where the 4 days before and 2 days sebelumm July 9 2014 Presidential Election investors reacted positively. These conditions indicate the existence of investor optimism that the elections will be held on July 9, 2014. And an increase in the average volume of stock trading at before and after the presidential elections July 9, 2014.

Beauty contest, bounded rationality, and sentiment pricing dynamics

We present a dynamic asset pricing model that incorporates investor sentiment, bounded rationality and higher-order expectations to study how these factors affect asset pricing equilibrium. In the model, we utilize a two-period trading market and investors make decisions based on the heterogeneous expectations principle and the “sparsity-based bounded rational” sentiment. We find that bounded rationality results in mispricing and reduces it in next period. Investor sentiment produces more significant effects than private signals, optimistic investor sentiment increases hedging demand, thus causing prices to soar. Higher-order investors are more rational and attentive to the strategies of other participants rather than private signals. This model also derives the dampening effect of higher-order expectations to price volatility and the heterogeneity expectation depicts inconsistent investor behavior in financial markets. In the model, investors' expectations about future price is distorted by their sentiment and bounded rationality, so they obtain a biased mean from the signal extraction.

Gender attitudes and investor behaviour: evidence from individual investors in north western province

Individual investment behaviour has become more sophisticated in past decades. Some scholars have explored how various demographic factors, predominantly gender, influence individual investor behaviour. Besides, they have concluded that there are three behavioural factors affecting the investment decisions of individual investors, such as cognitive factors (i.e. overconfidence, anchoring, hindsight bias, gambler’s fallacy, investor optimism), emotional factors (i.e. mental accounting, endowment effect, loss aversion, regret aversion), and herding factors (i.e. following the habits of other investors in buying , selling , choice and trading of investments). This paper discusses the influence of investors’ gender attitudes on investor behaviour, and in turn, their impact on the selection of different investment avenues in the Colombo Stock Exchange (CSE) in Sri Lanka. It reports the views of 97 (N=97) individual investors in the CSE, randomly selected from the North Western Province (NWP). The results reveal that, though people accepted the importance of investing in the CSE, less investors actually have an appropriate plan to invest in shares a majority of them male. The results validate that individual gender attitude differences significantly influence cognitive factors, emotional factors, and herding factors, and in turn, individual investor behaviour in CSE. These findings also illustrate that there seems to be a strong correlation among the investor’s demographic factors, market factors, risk-bearing capacity, lifestyle characteristics, and behaviour.

Effects of Spot Market Short-Sale Constraints on Index Futures Trading

We analyze the effects of spot market short-sale constraints on derivatives trading using a unique Chinese stock market futures trading database. Due to short-sale constraints, investors’ pessimistic views on the underlying index can be expressed solely through short futures positions, while investors’ optimistic views are dispersed through their spot and futures trading. We hypothesize that trading of pessimistic investors (with net short futures positions) contains more information than that of optimistic investors. We document the negative volatility–volume relation is associated with pessimistic investors’ trading, which attenuates with less-restricted spot market short-sale rules. Large pessimistic investors’ net demand can predict future returns, but not the case for optimistic investors.

A New Investor Sentiment Indicator Based on Return Decomposition

AbstractThis paper extends the DSSW model to accommodate rational arbitrageurs, optimistic investors and pessimistic investors. We model the price impact by using daily data and create a new methodology to calculate the optimistic and the pessimistic. The new sentiment indicator has high correlation with the other traditional ones, and as a proxy variable of individual share or financial market on daily, it could distinguish the optimistic and the pessimistic. In the empirical research, we develop a time-series model and a cross-section model respectively to explore the explanatory power of highly frequent investor sentiment to idiosyncratic volatility and capital asset mispricing. The results show that the new sentiment indicator can explain 21.31% of idiosyncratic volatility to individual share on average, and it has a great explanation of 36% to capital asset mispricing.

Analyst Optimism and Stock Price Momentum

We examine the effect of security analyst recommendations on stock price momentum. Results show that momentum profits are directly linked to analyst optimism. Specifically, we find that a 1-unit change in recommendation quintile translates to about a 50 basis point change in subsequent 3-month momentum profits. We also examine uncovered stocks by using parallel projection methods to project analyst recommendations from covered stocks onto uncovered stocks. For uncovered stocks, projected recommendations are unrelated to subsequent momentum profits. Our findings show that investor optimism alone does not generate stock price momentum. Analyst affirmation is a key catalyst for stock price momentum.

Do Happy People Make Optimistic Investors?

Do Happy People Make Optimistic Investors?

Short selling restrictions in 2005–2009 in Indian market and underpricing of initial public offerings

Most research explains underpricing of initial public offerings (IPOs) as the rational response of investors to the valuation uncertainty and the existence of informational friction in the IPO market. In contrast, Miller (1977) demonstrates that irrational sentiments of optimistic investors lead to high underpricing which pessimistic investors are unable to correct due to short selling constraints. Using first day flipping ratio and the trading ratio as proxies for divergence of opinion, we provide evidence consistent with Miller (1977) from Indian market that the greater divergence of opinion among investors results into higher underpricing. Previous research is not unanimous on proxies for short selling constraints and also do not control for the cross-sectional differences in the severity of constraints. We test Miller’s hypothesis in a market that faced prohibitive regulatory restrictions on short selling. We also control for the period when constraints are marginally relaxed. Our findings provide more robust evidence. Our results suggest that short selling restrictions affect market efficiency adversely; there could still be other forces at play. Market regulators should take steps to facilitate short selling instead of restricting it.

Knowledge Is Power: The Impact of Investor Optimism and Director Accounting Expertise on Financial Misstatements

Knowledge Is Power: The Impact of Investor Optimism and Director Accounting Expertise on Financial Misstatements

Corporate divestitures: Spin-offs vs. sell-offs

We investigate the determinants of the choice between two forms of corporate divestitures—spin-offs versus sell-offs. We hypothesize that the choice is driven by the pre-divestiture market valuation of divesting firms relative to their intrinsic value, the pre-divestiture performance of the assets being divested relative to their full potential, and the prevailing degree of investor optimism or pessimism about the market at the time of divestiture. Our hypotheses generate testable predictions regarding the announcement effects of divestitures and the post-divestiture operating performance of divesting firms. Our empirical findings using a sample of 378 spin-offs and 4192 sell-offs from 1980 to 2011 are as follows. First, firms with lower market valuations relative to their intrinsic value are more likely to spin off their assets. Second, assets which underperform relative to their full potential are more likely to be sold off. Third, spin-offs are more likely during periods of investor optimism. Fourth, spin-offs are associated with more positive announcement effects than sell-offs. Finally, firms which sell off their assets exhibit better post-divesture long-term operating and stock return performance compared to those which spin off their assets.

Mispriced Stocks and Mutual Fund Performance

We find strong and persistent cross-sectional differences in the propensity of active mutual funds to hold mispriced stocks. Funds with high propensity to hold overpriced stocks display poor stock-picking skills as they further purchase overpriced stocks during episodes of fund inflows and significantly underperform in subsequent periods. Intriguingly, overpriced funds attract considerable capital inflows when investor sentiment is high. The positive overpricing-flow relation is concentrated in funds with high marketing expenses and skewed returns. The evidence is consistent with an innocuous matching in the preference for stock characteristics by sentiment-driven managers and optimistic investors rather than active catering to investor preferences.

Differences of Opinion, Endogenous Liquidity, and Asset Prices

This paper studies how investors' differences of opinion affect liquidity and asset prices. In our economy, excessively optimistic investors are subject to an endogenous funding constraint that prevents default due to ex-ante-limited commitment. When the funding constraint binds, optimists use their savings to increase their consumption share, deterring default. This allows them to place speculative trades, increasing market liquidity. Their losses on these trades make them prone to default, leading to a renewed binding of the funding constraint. This feedback between funding illiquidity, disagreement, and market liquidity is consistent with several empirical features of liquidity and financial asset prices.

Overreaction to Merger and Acquisition Announcements

We examine investor reactions to merger and acquisition announcements, focusing on the Initial Target Price (ITP) ratio, which is the target firm stock price on the first day after the announcement relative to the offer price, and can be interpreted as a measure of investor optimism regarding deal outcomes. We find that high price-to-offer-price ratios are associated with surprisingly low likelihoods of deal success, and significant negative abnormal returns of 3.5% over the two months following the announcement. We investigate potential explanations for the results, and find that they are most consistent with the interpretation that high ITP ratios indicate investor overreaction.