Return Premium Research Articles

Disaggregated IPO returns, economic uncertainty and the long-run performance of SME IPOs

PurposeSmall and medium enterprises (SMEs) play a crucial role in national economies worldwide, generating employment and contributing to innovation. This study tries to investigate the performance of the newly started IPO platform for the SMEs in India through a two-staged framework developed to measure pre-market and post-market underpricing separately and the impact of economic policy uncertainty (EPU) on the IPO returns using the EPU index which is based on newspaper coverage frequency. Further, the long-run performance of SME IPOs and the factors affecting the same have also been analyzed. The two-staged framework is helpful in capturing the impact of different factors separately on the two distinctive markets and providing effective investment strategies to the investors.Design/methodology/approachA sample of 384 SME IPOs issued during 2012–2018 has been analyzed using robust regression analysis.FindingsThe study highlights the fact that there are differences in the factors affecting pre-market and post-market underpricing and reports that investors subscription rate, issue expenses, lead manager reputation and EPU are positively associated, whereas the age of the firm is negatively associated with the pre-market underpricing, and lead manager reputation positively impacts the post-market underpricing whereas issue premium and pre-market underpricing are negatively associated. Pre-market underpricing subsumes all the impact of EPU (publicly available information) in it, hence providing credence to the semi-strong market hypothesis of the Efficient Market Hypothesis (EMH). The long-run performance of SME IPOs increases with time, and lead manager reputation, pre-market and post-market underpricing are positively related to the one-year return whereas issue size, turnover and issue expense are negatively related.Originality/valueThis paper is believed to be the first attempt to analyze the performance of SME IPOs by disaggregating IPO underpricing. The findings of this study will have a great insight for the investors and policymakers.

Politics and equity markets: Evidence from Canada

We examine how political power, polarization, and economic policy uncertainty (EPU) in Canada and the US affect the Canadian equity market from 1985 to 2019. We document little evidence of significant liberal government return premiums and the corresponding risk for the overall market and many industry sectors. Only the IT sector witnesses the “second half effect” of election cycles. The Canadian equity market seems to outperform during strong Democratic control in the US, with mixed findings for the individual sectors. Political polarization in the two countries and trade uncertainty have little impact on Canadian equity returns except for the venture, small-cap, and IT sectors from the US polarization. The US EPU index affects the average returns of the overall Canadian equity market and the energy, industrials, retail, and transportation industries, while domestic EPU in Canada reduces the overall equity market, small-cap, and venture firm returns. The alignment of political ideology in the two countries has little impact on the equity market in Canada. Collectively, the results show that the impact of political environments on the Canadian equity market tends to be limited, dynamic, and industry-specific, suggesting that investors should not blindly mix their portfolios with their political views or affiliations.

Should Equity Factors Be Betting on Industries?

Asset managers are increasingly incorporating equity factors that deviate from traditional academic definitions in their stock selection process. The authors show that these factors frequently exhibit strong industry biases, making it crucial to understand the interaction between factor exposure and traditional industry exposure. Industry exposure plays a major role in the risk profile of a portfolio, making unintended industry exposures costly. For an extensive set of 21 equity factors, beyond the standard academic factors, the authors examine which equity factors are rewarded for their industry allocation. This set spans the value, quality, momentum, low-volatility, and size investment styles. The authors use a global and liquid investment universe, as is commonly used by large institutional asset managers. They find that equity factors from the same investment style, most notably momentum and quality, exhibit strong differences in their returns from industry allocation. Understanding the interaction between factors and industry exposures can lead to higher return premiums and lower portfolio volatility without harming performance. <b>Key Findings</b> ▪ Asset managers are increasingly using nontraditional equity factors to select stocks. Many of these factors have biases toward and away from certain industries. ▪ Some equity factors are rewarded for industry exposure; for others, this is an unrewarded risk. We assess industry allocation efficacy for 21 equity factors. ▪ Industry allocation efficacy differs significantly across equity factors, even among factors associated with the same investment style.

Industry-level media tone and the cross-section of stock returns

This paper investigates the cross-sectional relation between industry-level media tone and expected stock returns in China. Using a machine learning technique to establish a proxy for industry-level media tone, we find that stocks in industries with more positive media tone earn significantly higher future returns than these with more negative media tone. Specifically, relative to stock-specific media tone, industry media tone plays a dominant role in forecasting stock returns. Moreover, the return premium for higher industry-level media tone continues for two months, and the returns are positive though insignificant within half a year, indicating that the media contains fundamental information.

Media coverage of industry and the cross‐section of stock returns

AbstractThis paper investigates the cross‐sectional relation between media coverage of industry and expected stock returns. Using abnormal industry‐level news volume as a proxy for industry‐level media coverage, we find that stocks in industries with lower media coverage earn significantly higher future returns than stocks in industries with higher media coverage. This finding is robust even after controlling for well‐known stock characteristics and proxies for stock‐specific attention. Moreover, the return premium of lower industry‐level media coverage experiences continuation in the following 2 months, only to be followed by a reversal in the third month, due to the erosion of media coverage.

Hedging macroeconomic and financial uncertainty and volatility

We study the pricing of shocks to uncertainty and volatility using a wide-ranging set of options contracts covering a variety of different markets. If uncertainty shocks are viewed as bad by investors, they should carry negative risk premiums. Empirically, however, uncertainty risk premiums are positive in most markets. Instead, it is the realization of large shocks to fundamentals that has historically carried a negative premium. In other words, we find that the return premium for gamma is negative, while that for vega is positive. These results imply that it is jumps, for which exposure is measured by gamma, not forward-looking uncertainty shocks, measured by vega, that drive investors’ marginal utility. In further support of the jump interpretation, the return patterns are more extreme for deeper out-of-the-money options.

The Volatility Premium

The difference, average risk-neutral and physical volatility, is substantial and translates into a large return premium for sellers of index options. This paper studies a general equilibrium model based on long-run risk in an effort to explain the premium. In estimating the model using data on stock returns and volatility (VIX), the model captures the premium and also the large negative correlation between shocks to volatility and stock prices. Numerical simulations verify that writers of index options earn high rates of return in equilibrium and that the return patterns are similar to that seen in the S&amp;P 500 index options data.

Manacled short sellers and return premium: New evidence

AbstractInvestigating the short‐selling regulation of the Hong Kong market, we document that shortable stocks, on average, earn significantly higher returns than non‐shortable stocks. However, loadings of stocks/portfolios on the shortable minus non‐shortable misvaluation factor SMN predict a significant negative return premium in the cross‐section of returns. We measure SMN by applying both value‐ and return‐weighted methods with various time lags. We propose a behavioural model to rationalize our results. The model shows that, if investors are overconfident regarding short‐selling regulatory factor signals, it is possible to detect a positive average/abnormal return but a negative future return premium on SMN.

Size and Operating Profitability Portfolio Returns and Return Premia in Japan—A Tour d’horizon

This study examines the Japanese equity returns and return premia by focusing on firm size- and corporate operating profitability-sorted portfolios over the period from 1990 to 2020. As a result of our explorations, this study derives the following much beneficial findings. (1) The effects of corporate operating profitability and firm size are generally continuously seen in the Japanese equity market. More specifically, (2) the size effect is much stronger in our latter half sub-period; while the operating profitability effect is similarly seen in both our former half and latter half sub-periods. Furthermore, (3) we stress that this study employs the data in US dollars, and calculates several key statistics and measures for not only our full sample period but also many different sub-periods, in which economic and business circumstances are much different. Therefore, for both Japanese and international equity investors, our findings shall be highly useful for enriching and furthering the understanding of returns and return premia of Japanese equity portfolios.

Regional Economic Impacts from Timber Check Dam Construction—A Comparison with Concrete Check Dam Construction, Part II: The Question of Premium Vouchers

The regional economic impacts of the construction of timber and concrete check dams in Akita prefecture, Japan, were compared. When functions are appropriately unified, a concrete check dam is cheaper to build than a timber one; the difference in construction costs can be used by the government to issue premium vouchers as a regional promotion measure. To evaluate the effect of this, we extended the latest input–output table for Akita Prefecture to include timber and concrete check dam construction sectors. Concrete check dam construction with premium-voucher issuance had a total effect of 46,064,000 yen (economic impact ratio: 1.49; increased employment: 4.68 people). It also had an indirect economic impact on the plywood sector, since plywood was used as formwork, and issuing premium vouchers had a ripple effect on many industries in the region. However, timber check-dam construction had a total effect of 57,706,000 yen (economic impact ratio: 1.86; increased employment: 5.11 people) and a larger effect on the timber, logs, and silviculture sectors. Therefore, despite higher initial costs, timber check dam construction has the greater economic and employment impact on a region through its large ripple effects on the forestry and wood industries.

The Real Side of the High-Volume Return Premium

Prior literature demonstrates that increased trading activity of a firm’s stock is associated with abnormal future stock returns (the high-volume return premium) and interprets this phenomenon as evidence that increased visibility generates reductions in cost of capital. Motivated by this interpretation, we investigate whether increased trading activity entails changes in real corporate actions. We document a positive relation between abnormal trading volume, future investment expenditures, and financing cash flows. This positive relation is not subsumed by the arrival of investment-related news or other corporate disclosures or by subsequent earnings information and is concentrated among firms with high financial constraints and firms with lower levels of investor recognition. This paper was accepted by David Simchi-Levi, finance.

Carbon Premium around the World

This paper explores how the carbon premium varies around the world. We estimate the stock return premium associated with carbon emissions at the firm level in a cross-section of over 14,400 firms in 77 countries. We find that there is a widespread carbon premium-higher stock returns for companies with higher carbon emissions-in all sectors over three continents, Asia, Europe, and North America. Stock returns are affected by both direct and indirect emissions through the supply chain. In addition, the carbon premium has been rising in recent years. We also find widespread divestment based on carbon emissions by institutional investors around the world, but institutional investors tend to focus their divestment on foreign companies.

Frequency dependent risk

We provide a model-free framework for studying the dynamics of the state vector and its risk prices. Specifically, we derive a frequency domain decomposition of the unconditional asset return premium in a general setting with a log-affine stochastic discount factor (SDF). Importantly, we show that the cospectrum between returns and the SDF only displays frequency dependencies through the state vector and that its dynamics and risk prices can be inferred from covariances between asset (portfolio) returns, that is, from the cross-section. Empirically, we find low and high-frequency state vector risk to be differentially priced for US equities.

Frequency Dependent Risk

We provide a model-free framework for studying the dynamics of the state vector and its risk prices. Specifically, we derive a frequency domain decomposition of the unconditional asset return premium in a general setting with a log-affine stochastic discount factor (SDF). Importantly, we show that the co-spectrum between returns and the SDF only displays frequency dependencies through the state vector, and that its dynamics and risk prices can be infered from covariances between asset (portfolio) returns, i.e., from the cross-section. Empirically, we find low \textit{and} high-frequency state vector risk to be differentially priced for US equities.

Characteristics of private equity return: evidence from Brazil

Private equity (PE) stands out significantly in the world as one of the main development tools of the capital market in emerging economies and alternative sources of finance for companies. Particularly, the increase in fund value and continuous returns are objects of intense study in Brazil. The paper aims to find determinants to Brazilian private equity returns, regarding three relevant variables funds characteristics and GDP to a macroeconomic view. A sample of 1,112 PE funds registered at the Brazilian Securities and Exchange Commission (CVM) was used and analyzed by three main variables: period of establishment, equity size, and exclusivity as possible determinants of funds’ performance using multiple regression model and fourth variable GDP is applied as a descriptive variable. The results indicate that older funds had a return premium of 1.5% monthly over young funds, smaller funds had a return premium of 1.4% over larger funds, and exclusivity does not influence the funds’ performance. Thus, the paper provides a basis for the relevant factors that an investor should verify in Brazil’s private equity fund before allocating the resources.

Variance risk premium and expected currency return: the story is different at the tails of the distribution

ABSTRACT This paper investigates the prediction power of variance risk premium of domestic currency over the currency return for five major emerging market currencies controlling after the impact of past exchange rate developments and asymmetries in the variance risk premium, and the dependence between variance risk premium and currency return at different quantiles. The OLS regression results show that higher (lower) variance risk premium leads appreciation (depreciation) of domestic currency against US Dollar and this relationship holds in after controlling asymmetries in the variance risk premium and past currency returns. Besides, the results don’t confirm an asymmetric effect of the variance risk premium and a linearly increasing effect of variance risk premium conditional on different quantiles of past currency return. Finally, quantile-on-quantile regression (QQR) results show that the negative association of variance risk premium and currency return reverse to be positive at the tails.

Returns and Return Premia of Size and Investment Portfolios in Japan—A Conspectus

This article conducts an overview of the performance of Japanese firm size- and firms’ investment-sorted stock portfolios from 1990 to 2020, and we derive the following contributions. First, we find that in our second half sub-period, the size effect is much clearer; while overall, the effect of investment is not so clear, suggesting that the portfolio constructions by firms’ investment are not so effective in Japan. Second, as we analyzed the performance of Japanese size- and investment-sorted portfolios using the data, which are in US dollars and for almost 30 years, our findings should be highly meaningful for both industrial practitioners and academic researchers, much deepening our understanding of stock portfolio returns and return premia in Japan.

To explore the mystery of the idiosyncratic volatility of the A-share market

Return and risk are inevitable topics in financial research. This paper explores the relationship between IVOL (idiosyncratic volatility) and cross-sectional return (risk premium and excess return) of the Chinese A-share market. With the monthly data of 237 months from January 2001 to September 2019 of Ashare of Shanghai and Shenzhen stock exchange, IVOL of each stock by the regressions is conducted through rolling window based on the four factors model of Carhart. Whether there is a significant positive or negative relationship between the IVOL and the cross-sectional return of the stock by combination analysis and crosssection regression are tested in the paper. The research shows that, after excluding the influence of financial crisis and stock disaster, from January 2001 to September 2019, there is a significant positive relationship between the special volatility and cross-sectional return in Chinese A-share market under normal market conditions, and there is no so-called “mystery of the special volatility”.

ESG and Expected Returns on Equities: The Case of Environmental Ratings

Using long-standing models for expected returns of US equities, we show that firm environmental ratings interact with those forecasted returns and produce excess returns both unconditionally and conditionally. Well-known factor models subsume neither environmental-related return differentials nor expected return premia from those scores and models. In addition, combining information from both inputs—expected return models and economic, social, and governance (ESG) information—may provide an advantage in selecting investments. For financial fiduciaries, this notion shifts the conversation about ESG reflecting only constraints to one of an expanded information and possibly investment opportunity set.

Price Clustering, Preferences for Round Prices, and Expected Returns

Researchers have documented that individuals have a strong penchant for round numbers in a variety of settings, such as trading in financial markets. Beginning as early as the 1930s, empirical research has shown that security prices tend to cluster on round increments. This anomalous finding has persisted over time and in a wide range of different types of securities markets. We examine whether stocks with greater price clustering experience excess demand and consequently, negative return premia. Using a variety of traditional asset pricing tests, we find support for this argument as price clustering is associated with a robust, negative return premium. Our results are robust to transaction-level clustering, cross-sectional regressions, and multi-factor models.