Return Premium Research Articles

Expected idiosyncratic moment risk and the cross-section of REIT returns

ABSTRACT In this paper, we investigate whether expected idiosyncratic volatility (IV) and expected idiosyncratic skewness (IS) risk are both present and significant in the cross-section of expected REIT returns. Our firm-level empirical tests indicate a significant and negative relationship between REIT returns and both IV and IS risk. The observed risk-return trade-off remains significant even after controlling for firm-level characteristics and common risk factors. The empirical results document that firm-level IS risk is consonant with firm-level IV and that IS risk is not subsumed by IV and vice versa. Using Hou and Loh’s (2016) cross-sectional decomposition analysis, we find that firm-level IV and IS capture a very small percentage of each other’s average return premium, while a residual component accounts for the rest.

The confusion of taste and consumption: Evidence from a stated-choice experiment

In this paper, we conduct a stated-choice experiment with German retail investors to examine how labeling sustainability information as financially material or immaterial influences investment decisions. Results reveal a strong non-pecuniary preference for sustainability. However, emotional affect leads some investors to erroneously project sustainability information onto firms’ financial performance, regardless of financial materiality. When poor sustainability ratings are labeled as financially material, investors demand further an additional return premium, indicating a misinterpretation of these labels as financial indicators. This bias is particularly evident among investors who incorporate sustainability for pecuniary reasons in the experiment but do not use such information in real-life investing. Our findings suggest that while sustainability labels can guide investor behavior, they also risk distorting financial expectations. This underscores the need for careful design in sustainability disclosure practices and better investor education on the implications of sustainability information.

Decomposing momentum: The forgotten component

We split up the standard momentum return over months t−12 to t−2 at the highest stock price within this formation period. Of the overall momentum profits in month t, 84% can be attributed to the return prior to this peak price although research has exclusively focused on the post-peak return so far. The return predictability of the forgotten component is consistent with investor underreaction as underlying mechanism. Contrary to standard momentum strategies, the corresponding long-short returns are positively skewed, avoid momentum crashes, show no market state dependence, and yield consistent return premiums in both the US and international stock markets.

Investor demand in syndicated EFSF/ESM bond issuances

The European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) were set up at the peak of the European sovereign debt crisis to issue bonds and lend to countries under current funding stress. This study analyses investor demand in syndicated bond issuances of EFSF and ESM from 2014 to 2020 on an unprecedented granularity level using a dataset of individual orders with statistical inference. Particularly, we investigate orderbook dynamics for three main aspects: first, we determine the main factors segmenting investor demand. Second, we analyse price dynamics in the transactions and their relation to investor demand. Third, we investigate whether any indications of orderbook inflation might explain the increased volatility in orderbook volume. We identify issuance tranche and tenor as the main determinants of investor demand that are largely anticipated in the notional. Further, we note that ESM is doing economical pricing, where the new issue premium tends to be lower in a market context with larger demand. Lastly, we find a mixture of an increasing number and an increasing volume of orders as drivers of large order books. This confirms that there are no indications of orderbook inflation tendencies in the analysed time period.

The asset growth return premium and anchoring on the 52‐week high

AbstractResearch shows that year‐over‐year growth in a firm's assets is associated with a negative stock return premium. A possible explanation for this premium is based on mispricing correction, due in part to investors' overvaluation related to investment. In this article, we argue that a correction of any type is more likely to occur when stock prices are further away from their 52‐week high. To the extent that the 52‐week high acts as a viable anchor, when stocks are closer to this anchor, investors might become less inclined to contribute to the typical downward correction for these types of growth firms. In several tests, we find that stocks that are furthest away exhibit the strongest return premium. The return premium, however, begins to disappear as stocks approach their 52‐week high. These results are robust to various risk factors and cross‐sectional tests that include several firm‐specific characteristics.

Optimal stop-loss rules in markets with long-range dependence

Stop-loss is a common risk management tool for limiting risks and improving trading strategy performance. The effectiveness of stop-loss depends critically on asset price characteristics. This study is the first to analyze stop-loss strategy incorporating long-range dependence of asset prices through a fractional Brownian motion-based market model. It is shown that stop-loss strategy yields a positive return premium over the buy-and-hold return when asset price exhibits long-range dependence. The efficacy of stop-loss strategies and the determining criterions are investigated through both theoretical analysis and simulation studies. The performance of a stop-loss rule depends on the Hurst parameter, mean and volatility of the asset returns. The optimal stop-loss threshold model in a chosen strategy class is fitted by polynomial regression. Empirical analysis demonstrates that the class-specific optimal rules outperform stop-loss rules under alternative asset return-generating models.

A Review of Research on Factors Influencing IPO Premiums

The IPO (Initial Public Offering) market has garnered increasing attention in recent years, and the IPO issue premium, as an important indication, is vital for both investors and firms. The purpose of this research is to investigate the elements that influence the IPO offering premium. This article discover numerous crucial factors after examining and organizing related papers. First, the registration system, including its development history, is a key component in determining the IPO issue premium. Second, the market environment, such as market volatility and market maturity, influences the IPO issue premium. Furthermore, investor mood has a significant impact on the IPO issue premium. Finally, the prominence and experience of underwriting organizations have an impact on IPO issuance premiums. This study verifies the impact of the aforementioned factors on IPO issuance premiums and makes some interesting results by gathering relevant data and employing appropriate statistical methodologies. With a better grasp of these aspects, investors and firms can make more educated investment decisions by better understanding the mechanism of IPO issuance premium development.

How does currency risk impact firms? New evidence from bank loan contracts

We use unique features of the private credit market to examine if and how currency risk impacts firms' financing and whether currency risk is a priced systematic risk at the firm level. We find that currency exposure has a large impact on loan spreads. Decomposing loan spreads, we find that exposure increases the expected default loss premium and that internationalization, growth opportunities, and relationship intensify exposure's impact. Further, exposure exacerbates firms' financing risk by increasing the need for collateral, reducing loan maturity, inducing monitoring and covenant intensity, and influencing syndicate structure. However, exposure does not affect the expected return premium in loan spreads; hence, currency risk does not appear priced in the classical sense and, therefore, should not affect the “true” cost of debt. Our findings imply that while managers should be concerned about exposure's impact on their access to, and terms of, bank financing, they should not adjust hurdle rates on account of exposure when assessing investment projects.

Stock returns in global value chains: The role of upstreamness and downstreamness

We study how upstreamness and downstreamness affect stock returns in global value chains. Upstreamness and downstreamness, which are computed from world input–output tables, measure the average distance from final consumption and primary inputs. We find that downstreamness explains expected returns, whereas upstreamness does not. The downstreamness return premium reflects investors’ compensation for taking on supply-side risks that accumulate along global value chains, such as labor and competition risks. We show that investors perceive far downstream industries as riskier when their suppliers have high unionization rates or labor shares. In addition, far downstream industries operate in more competitive value chains and are characterized by elevated input and output price uncertainties, which makes them particularly risky.

Downside liquidity risk premium: From the perspective of higher moment

Considering the serious negative impact of crisis events on stock liquidity, we construct the liquidity skewness to depict the asymmetric distribution of liquidity, which is drawn inspiration from the idea of higher moment in statistics, to measure the downside liquidity risk. Our study focuses on the issue of downside liquidity risk premium in Chinese stock market, and further analyze its underlying source from the dual perspectives of behavior and risk. Our findings provide convincing evidence that the downside liquidity risk measured by liquidity skewness has a significant return premium, and the premium is long-term since the liquidity skewness has a persistent impact on the cumulative returns. Furthermore, the downside liquidity risk premium derives from risk compensation instead of behavioral factors such as mispricing and investor sentiment. The conclusions have certain theoretical value for improving and enriching the research on liquidity premium, clarifying the mechanism of the impact of downside change in liquidity on cross-sectional returns, and provide valuable references for investors to allocate portfolios that meet their own risk preferences and regulators to supervise the market.

Arbitrage asymmetry, mispricing and the illiquidity premium

AbstractIlliquid assets require a return premium; illiquidity is also a limit‐to‐arbitrage. We find that Amihud's illiquidity premium is significantly higher among underpriced stocks than among overpriced stocks. Excluding the most mispriced stocks leads to a higher and more reliably estimated illiquidity premium. Amihud's illiquidity measure is positively correlated with overpricing, consistent with arbitrage asymmetry, while inconsistent with Lou and Shu's contention that the return premium associated with the Amihud measure reflects mispricing rather than compensation for illiquidity. Our results demonstrate that it is important to account for their role as limits‐to‐arbitrage when evaluating the pricing of illiquidity measures.

Liquidity shocks and the negative premium of liquidity volatility around the world

We find that liquidity volatility negatively affects stock returns across international markets. This association remains consistent across various liquidity metrics and cannot be attributed to the influence of idiosyncratic volatility. Further analysis shows that the omitted liquidity decrease variable is the key driver of the negative premium of liquidity volatility. Considering the asymmetrical impact of liquidity decrease and increase on future stock returns, stocks displaying high liquidity volatility tend to experience significant liquidity decreases, which lead to lower average returns. Once the liquidity decrease is integrated into the pricing model, the negative return premium of liquidity volatility dissipates. Subsequent analysis underscores that the effect of liquidity decrease on returns is more pronounced in markets and periods characterized by diminished efficiency and heightened arbitrage costs.

Event Study: The Effect of the Passing Away of Queen Elizabeth II on the UK Stock Market

This study assesses the heterogeneous impact of the death of Queen Elizabeth II on industry leaders in the United Kingdom. It reveals the firm-specific characteristics that lead to this heterogeneity. This study applies an event study methodology to a sample of 20 leading UK companies across a 250-day estimation window and a 40-day event window. According to the event study, the death of Queen Elizabeth II has had a differential impact on most UK companies for different industries. In contrast, companies in the Biotech, Oil & Gas, Mining, and Tobacco industries were less affected. However, companies in the Retail, Telecommunications, Banks, and Defense Contractors sectors show significant negative CARs. This article has implications for investors in identifying company sector-specific characteristics that drive premium returns and guiding diversification by improving the sectoral diversity of portfolios. However, the study is limited by a relatively small sample size. There is a gap in earlier research on the related change of kingship and stock market performance, and this study makes two contributions to the literature. The authors first analyze the impact of the death of Queen Elizabeth II on British firms. Secondly, the study also provides guidance on how investors can diversify across different sectors in the UK to reduce risk.

Probability distortions, collectivism, and international stock prices

There are substantial differences in the return premia due to probability distortions in individualist and collectivist cultures. Consistent with the substantially lesser degree of probabilistic thinking in collectivist cultures documented by the psychology literature, probability-distortion-related return premia are substantially higher there than in individualist cultures. Our methodology applies a novel composite probability distortion (CPD) score based on cumulative prospect theory and salience theory. This measure is priced among all size groups in the cross-section of international stock returns: low-CPD-score stocks are underpriced while those with high scores appear overpriced. Collectivism is the main driver of differences in the CPD premium across countries and U.S. states.

On the conditional performance of the IVOL anomaly

This paper proposes that the well-known idiosyncratic volatility (IVOL) puzzle is partly due to an overconditioning bias in IVOL estimates when there exists nonlinearity between stock and factor returns. We analytically derive the overconditioning bias when beta and IVOL are contemporaneously estimated using daily returns. To mitigate the estimation bias, we employ a conditional factor model, as in Avramov and Chordia (2006), to estimate systematic risk exposure and IVOL. Our empirical results show that the conditional IVOL estimates do not imply a negative return premium when firm fundamentals are used as conditioning variables, and the associated conditional factor-adjusted alpha is much smaller than the original IVOL puzzle. Our findings are robust in the U.S. and Chinese stock markets.

Understanding the role of aggregate analyst attention in resolving stock market uncertainty

This paper investigates whether sell-side analyst attention effect extends to the aggregate stock market. Our findings demonstrate that: (i) aggregate analyst coverage negatively predict future stock market returns while controlling for a rich set of predictors related to economic fundamentals and investor sentiment. (ii) higher aggregate analyst coverage also precede lower market-wide cash-flow volatility, cash holdings, absolute magnitude of unexpected earnings, investor information-search demand, and greater capital expenditures, long-term debt, indicating that the negative return premium stems from less compensation for lower expected market uncertainty. (iii) long-short profits of overreaction-related and lottery-related anomalies significantly decrease following high levels of aggregate analyst attention. Our results highlight the important role of aggregate analyst attention in reducing stock market uncertainty and enhancing investor rationality, thereby mitigating anomalies induced by psychological biases.

Betting against low nominal prices: Evidence from China

We offer evidence of a positive low-nominal-price return premium in China’s stock markets. We explain this by using Campbell and Vuolteenaho’s (2004) cash-flow and discount-rate betas. Low-priced stocks have high cash-flow that delivers high expected returns. The negative low-nominal-price return premium is negative in US markets and this discrepancy is attributed to reverse ranking of cash-flow betas for low-priced stocks. We find that high cash-flow risk for low-priced (high-priced) stocks in China (US) is associated with low price informativeness and analyst attention; the discrepancy of cash-flow betas in US and China is driven by book-to-market ratios and idiosyncratic volatility.

Investor demand in syndicated EFSF/ESM bond issuances.

The European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) were set up at the peak of the European sovereign debt crisis to issue bonds and lend to countries under current funding stress. This study analyses investor demand in syndicated bond issuances of EFSF and ESM from 2014 to 2020 on an unprecedented granularity level using a dataset of individual orders with statistical inference. Particularly, we investigate orderbook dynamics for three main aspects: first, we determine the main factors segmenting investor demand. Second, we analyse price dynamics in the transactions and their relation to investor demand. Third, we investigate whether any indications of orderbook inflation might explain the increased volatility in orderbook volume. We identify issuance tranche and tenor as the main determinants of investor demand that are largely anticipated in the notional. Further, we note that ESM is doing economical pricing, where the new issue premium tends to be lower in a market context with larger demand. Lastly, we find a mixture of an increasing number and an increasing volume of orders as drivers of large order books. This confirms that there are no indications of orderbook inflation tendencies in the analysed time period.

Risk-adjusted farm returns and farm size

PurposeThe average U.S. farm size has risen dramatically over the last three decades. Motives for this trend are the subject of a large body of literature. This study incorporates farm size risk and return analysis into this research stream. In this paper, cross-sectional and temporal relations between farm size and returns are examined and characterized.Design/methodology/approachRelying on farm level panel data from Kansas Farm Management Association (KFMA) for 140 farms from 1996 to 2018, this article examines the relationship between farm size and returns and investigates whether farm size is related to risk. Two measures of farm returns are used: excess return on equity and risk-adjusted return on equity. Value of farm production and total farm acres are used as measures of farm size.FindingsFindings suggest a significant and positive relationship between farm size and excess return on equity as well as farm size and risk-adjusted return on equity. However, this return premium associated with farm size is not associated with additional risk. Stated differently, farm size can be viewed as a farm characteristic that is associated with higher return without additional risk.Practical implicationsThese findings provide further support for ongoing farm consolidation.Originality/valueThe results suggest the trend towards consolidation in production agriculture is likely to continue. Larger farms bear less risk.

The differential effects of climate risks on non-fossil and fossil fuel stock markets: Evidence from China

This paper estimates the effects of climate risks on the stock returns in China, differentiating between non-fossil and fossil fuel firms, using a time-varying parametric vector autoregressive (TVP-VAR) model. The news-based climate physical risk (CPR) and climate transition risk (CTR) indexes for China are constructed. The results show that both types of climate risks have time-varying and differential effects on the returns of non-fossil and fossil fuel stocks. The differential effects are associated with investor preference and cash-flow effects. Besides, CTR contributes more connectedness to the return premium between the two stock types than CPR.