Past Stock Returns Research Articles

Investigação da hipótese de sobrerreação e sub-reação com o sentimento do investidor

This paper aims to analyze the hypothesis of overreaction and under-reaction over the profitability of the Brazilian stock market. The theoretical review was based on the Market Efficiency and Behavioral Finance Hypothesis. Economática SA’s database was used, from where it was collected information about 1,283 stocks (571 active and 712 canceled) between January 1999 to December 2017, representing a sample of 228 months. It was applied the methodology developed by DeBondt and Thaler (1985) and Jegadeesh and Titman (1993), where portfolios composed of the upper and lower quintiles were created, based on the ranking of past stock returns. Through the means comparison test, it was possible to verify evidence that there is a phenomenon of overreaction for events of negative character after 6, 12 or 18 months of holding. However, no abnormal return was observed for overreaction of positive character events, nor any sub-reaction phenomena. Regarding investor sentiment, the results show that there is a relationship between it and the return of some strategies based on past return, contrary to Efficiency Market Hypothesis in its weak form.

Household willingness to take financial risk: Stockmarket movements and life‐cycle effects

Using panel data on Australian households, the relationship between risk tolerance and past stock returns is investigated across economic and financial cycles, as well as over the life-cycle and across generations. Risk tolerance is found to be procyclical with stock returns over an eight year horizon. The empirical results also reveal an inverted J-curve age risk profile, and the presence of a longer cycle across generations. Results are robust to controlling for financial crises, return volatility, real estate returns and home bias.

Cross-asset time-series momentum: Crude oil volatility and global stock markets

We examine the profitability of a cross-asset time-series momentum strategy (XTSMOM) constructed using past changes in crude oil–implied volatility (OVX) and stock market returns as joint predictors. We show that employing the past changes in OVX in addition to past stock returns helps better predict future stock market returns globally. The XTSMOM outperforms the single-asset time-series momentum (TSMOM) and buy & hold strategies with higher mean returns, lower standard deviations, and higher Sharpe ratios. The XTSMOM can also forecast economic cycles. We contribute to the literature on cross-asset momentum spillovers as well as on the impacts of crude oil uncertainty on stock markets.

Monetary policy expectation errors

How are financial markets pricing the monetary policy outlook? We use surveys to decompose excess returns on money market instruments into expectation errors and term premia. Excess returns are primarily driven by expectation errors, whereas term premia are negligible. Investors face challenges when learning about the Federal Reserve’s response to large, but infrequent, negative shocks in real-time. Rather than reflecting risk compensation, excess returns stem from investors underestimating how much the central bank eases policy in response to such rare shocks. We show, for the US and internationally, that expectation errors imply excess return predictability from past stock returns.

Should managers be incentivized with stock or options? Evidence from China

Which type of managerial compensation—stock or options—is more effective as an incentive to maximize shareholder value and curb excessive risk-taking has been debated often in the literature. By investigating the stock and option grants by Chinese firms from 2005 to 2015, we find that higher past stock return volatility increases the preference for stock over options, while a significant upward trend in stock price results in a tendency to choose options over stock. Both stock and option grants as forms of managerial compensation lead to better financial performance, with no significant difference. We present evidence to exclude earnings management as the source of improvement in financial performance. Firms using stock as compensation exhibit higher productivity than those using options. In contrast, there is no improvement in managerial ability from using either stock or options as compensation. Our study deepens the understanding of the relationship between the composition of managerial compensation and firm performance.

Past Stock Returns and the MAX Effect

This paper investigates how past stock returns affect investors’ lottery demand. We show that the maximum daily return (MAX) effect, first documented by Bali et al. (Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns) is predominantly concentrated among stocks that have worst returns in the recent past. In contrast, for stocks that have recorded best past returns, the MAX effect becomes much weaker or even disappears. Our findings hold in the presence of a variety of control variables including the conventional return predictors, stock mispricing, stock price proximity to its 52-week high, and capital gains overhang. We interpret it as evidence that investors’ lottery demand intensifies in the presence of investment losses, consistent with the notion of time varying and state dependent nature of investors’ lottery preference. We further show that a self-financing portfolio that goes long in stocks with the worst past returns and low MAX and short in stocks with worst past returns and high MAX yields statistically and economically significant abnormal returns after risk adjustment by standard asset pricing models.

Do Firms Exploit Mispricing of Their Stock in Their Financing Decisions? Evidence from the Share Lending Market

Short sale constrained stocks are overpriced on average. I use borrowing fees, utilization, and IHS Markit’s DCBS measure as proxies for overpricing. I show that the likelihood that a firm conducts an SEO increases with measures of short sale constraints associated with overpricing even after adjusting for firm identity, excess cash, firm age, and past stock returns. Stocks underperform after an SEO if but only if they were short sale constrained. Firms are far more likely to repurchase shares if the stock is not hard-to-borrow. When firms repurchase hard-to-borrow shares, the firm is usually right and shorts are usually wrong.

Why Do Individual Investors Disregard Accounting Information? The Roles of Information Awareness and Acquisition Costs

ABSTRACTWe investigate the frictions that impede individual investors’ use of accounting information and, in particular, their costs of monitoring and acquiring accounting disclosures. We do so using an archival setting in which individuals are presented with automated media articles that report both current earnings news and past stock returns. Although these investors have earnings information readily available, we find no evidence that their trades incorporate it. Instead we find that their trading responds to the trailing stock returns presented in the articles. Our study raises questions about the efficacy of regulations that aim to aid less sophisticated investors by increasing their awareness of and access to accounting information.

THE RELATIONSHIP BETWEEN STOCK RETURN SKEWNESS AND BANK FEATURES

This paper studies to what extent bank-specific characteristics relate to stock return skewness. The main finding is that stock return skewness decreases significantly in bank size, measured in terms of total assets, i.e stocks of large banks are less skewed than those of small banks. This result holds for backward-looking skewness computed using the past stock returns, as well as for forward-looking skewness extracted from stock options. We interpret the empirical evidence by arguing that bank size increases the likelihood to have severe losses, to the point that investors expect to be compensated by receiving higher expected returns.

Managerial overconfidence and the buyback anomaly

Abstract While positive, long-run abnormal returns following share repurchase announcements are substantially lower when CEOs are overconfident. This effect is particularly strong for (i) difficult to value firms, such as small, young, non-dividend paying, distressed, and having negative earnings firms, (ii) firms with poor past stock return performance and high book-to-market ratio, indicators of possible overreaction to bad news, and (iii) financially constrained firms. Overall, these results are consistent with the mispricing hypothesis as a motive for repurchases and as an explanation for the buyback anomaly. Additionally, irrespective of the CEO’s level of confidence, abnormal returns are considerably larger for financially constrained firms, implying their managers require larger undervaluation due to the higher cost of capital.

The interactions between OPEC oil price and sectoral stock returns: Evidence from China

This paper examines the volatility spillover between OPEC oil price and the Chinese sectoral stock returns from December 31, 2004 through October 17, 2014. In order to achieve this task, we used the VAR-GARCH model for the daily closing prices of six sectoral stock indices including: Construction, Machinery, Automobile, Military, Agriculture, and Financial indices. In addition, we analyzed the optimal weights and hedge ratios for oil–stock portfolio holdings. The findings show significant volatility spillover between OPEC oil prices and the Chinese sectoral stock returns. The volatility spillover is unidirectional from oil to stock returns. The spillover effects mainly come from past shocks. The past oil shocks have negative and significant impact on the conditional volatility of Construction, Machinery, Automobile, Military and Agriculture stock indices. On the contrary, with the exception of the Military stock index, there is no significant impact of the past stock return shocks on the volatility of oil returns. Moreover, our findings for optimal weights and hedge ratios suggest that oil can improve the risk-adjusted performance of a well-diversified portfolio of stocks.

Option prices and stock market momentum: evidence from China

Option prices tend to be correlated to past stock market returns due to market imperfections. We unprecedentedly examine this issue on the SSE 50 ETF option in the Chinese derivatives market. To measure the price pressure in the options market, we construct an implied volatility spread based on pairs of the SSE 50 ETF option with identical expiration dates and strike prices. By regressing the implied volatility spread on past stock returns, we find that past stock returns exert a strong influence on the pricing of index options. Specifically, we find that SSE 50 ETF calls are significantly overvalued relative to SSE 50 ETF puts after stock price increases and the reverse is also true after the stock price decreases. Moreover, we validate the momentum effects in the underlying stock market to be responsible for the price pressure. These findings are both economically and statistically significant and have important implications.

Co-movement of international copper prices, China's economic activity, and stock returns: Structural breaks and volatility dynamics

This study empirically investigates both causal nexus and time-varying correlations among international copper prices, China's real economic activity, and stock returns from January 1991 to December 2015. Using a cross-correlation function approach with structural breaks and dynamic conditional correlation models, we find, first, significant volatility cross-effects between international copper prices and real economic activity in China. Second, China's past stock returns play a pivotal role in forecasting future volatility in international copper prices, but not vice versa. Third, negative dynamic correlations between copper prices and China's stock returns around the 2008 global financial crisis suggest that a copper asset can hedge the risk of stock investment in China. Our results have important implications for investors, portfolio managers, and Chinese policymakers, who should regulate extreme financial speculation in copper to minimize the impact of excess volatility on the real economy.

The Profitability in the CDS Market

The strategy by buying the CDS with the most negative past 1-day stock return and selling the CDS with the most positive past 1-day stock return generates 0.26 daily Sharpe ratio from 2002 to 2016. The profitability concentrates on the most liquid CDS with more quote counts, more market makers, and less bid-ask spreads. Our paper challenges this notion by proposing a hypothesis based on informed speculation and partially informed hedging in segmented stock and CDS markets to explain the profitability. One implication of the hypothesis is that CDS-based trading strategy captures information asymmetry of different hedging and speculative demands given distress risk. Consistent with the distress nature of the strategy, we find that the return dynamic represents the distress risk factor, which is priced in U.S. market. Particularly, using portfolio approach following Fama-French (1993), we find the positive distress risk and return trade-off. Additionally, we show that the momentum crashes (by Daniel and Moskowitz (2015)) is because loser stocks bear more distress risk thus earn higher distress risk premium than winner stocks.

Herding on Earnings News: The Role of Institutional Investors in Post-Earnings-Announcement Drift

We examine the role of institutional investors underlying post-earnings-announcement drift (PEAD). Our results show that while institutional investors generally herd on earnings news, such correlated trading among institutions does not eliminate or reduce market underreaction to earnings surprises. Instead, PEAD is significant only in the subsample of stocks where institutions herd in the same direction as earnings surprises. In fact, institutional herding is also positively related to next-quarter earnings announcement returns. We provide evidence that institutional herding on or against earnings news is largely driven by firm characteristics, particularly past firm performance and stock returns. In addition, we find that relative to non-transient institutions, transient institutions have a stronger tendency to herd on earnings information. Finally, based on long-run stock returns, we show that when institutions herd on earnings surprises, institutional trading represents a gradual process of incorporating information into stock prices. On the other hand, when institutions herd against earnings surprises, institutional trading slows down stock price discovery.

Why Do Individual Investors Disregard Accounting Information? The Roles of Information Awareness and Acquisition Costs

Individual investors often neglect value-relevant accounting information and instead underperform by trading on technical trends. We investigate the frictions that impede individual investors’ use of accounting information, and in particular their costs of monitoring and acquiring accounting disclosures. We do so using an archival setting where individuals are presented with automated media articles that report both current earnings news and past stock returns. Although these investors have earnings information readily available, we find no evidence that their trades incorporate earnings news. Instead we find that they trade in response to the trailing stock returns presented in the articles. Our study raises questions about the likely efficacy of regulations that aim to aid less sophisticated investors by increasing their awareness of, and access to, accounting information.

The Power of Past Stock Returns to Explain Future Stock Returns

Researchers have long argued over whether strategies based on past stock returns have power to explain future stock returns. This paper finds no convincing evidence that either short-run or long-run contrarian strategies represent important factors for explaining the cross-section of stock returns. In contrast, the properly specified one-year momentum strategy has explanatory power for stock returns when used alone, when tested against size and book-to-market, and when subjected to exhaustive robustness checks. We conclude that one-year momentum represents a necessary third factor, along with firm size and book-to-market, for explaining the cross-section of stock returns.

Related Securities and the Cross-Section of Stock Return Momentum: Evidence From Credit Default Swaps (CDS)

We document that related securities linked through firm fundamentals provide important cross-market return performance information. Using 1,074 firms during 2003-2014, we find stock return momentum for “joint” winners/losers whose past stock and CDS returns are in congruence, whereas return reversal for “disjoint” entities whose past stock returns disagree with their past CDS returns. Stock strategies combining momentum on joint winners/losers with contrarian on disjoint winners/losers outperform traditional stock momentum by 132 bps per month with an annualized Sharpe ratio of 1.11. Relative pricing of credit across related securities explains, in part, the cross-section of stock return momentum.

Option Return Predictability

The cross-section of delta-hedged equity option returns can be predicted by a variety of underlying stock characteristics and firm fundamentals including idiosyncratic volatility, past stock returns, profitability, cash holding, new share issuance, and dispersion of analyst forecasts, although they do not significantly predict stock returns in our sample. We document new option portfolio strategies that are profitable even after transaction costs. These profits are robust and cannot be explained by common risk factors. The systematic patterns in the relative valuation of options and the underlying stocks we uncover have important implications for option pricing models and option market efficiency.

Media Coverage and Stock Return in the Taiwan Stock Market

The purposes of this paper were to explore the relationship between media coverage and stock returns in Taiwan stock markets. The empirical results were as follows: (1) stock returns showed causality with either media coverage amounts or the degrees of good/bad media coverage; (2) when impacted by the past stock returns, the stock return might finish its response to the impulse around three days and showed a negative effect, whereas when impacted by the past media coverage amounts, the media coverage amount might also finish its response to the impulse within three day and showed a negative effect; (3) when impacted by the degrees of the past good media coverage, the good media coverage degree might finish its response in three days and showed a negative effect, in which a positive effect might be presented on the first two days, while the effect might turn negative on the third day. Given that, when impacted by the past stock returns, the stock return might finish its response to the impulse within three days and showed a negative effect and, when impacted by the degrees of the past good media coverage, the stock return might also finish its response in three days and showed a negative effect. That is, media coverage could be used as an indicator to predict stock returns in the Taiwan stock markets when making investment decisions.