Stock Market Downturn Research Articles

Could diamonds become an investor’s best friend?

Currently, the role of diamonds in the global financial system is under intense discussion in the financial media because individual investors and portfolio managers have begun to consider them as potential investment assets. To address the growing interest in diamonds, this article examines the historical performance of investments in various diamond quality grades. Furthermore, it investigates their relation to stock market and currency risk. Specifically, we focus on two important practical investment questions: Can diamonds function as a hedge or a safe haven against stock market volatility or fluctuations of the US dollar? Can diamonds be regarded as effective diversifiers in a stock or a currency portfolio context? Key findings are as follows: (1) The investment performance of diamonds is lower than the one of gold and silver. (2) Diamonds have only acted as a weak hedge and a weak safe haven against stock market downturns and currency risk associated with the US dollar. (3) Within global stock and currency portfolios, 1.0 carat fine diamonds show valuable diversification potential in that they can increase portfolio performance to an economically significant extent. Interestingly, this final result is fairly robust to the choice of performance measure.

Identifying Asymmetric Comovements of International Stock Market Returns

Based on a new approach for measuring the comovements between stock market returns, we provide a nonparametric test for asymmetric comovements in the sense that stock market downturns will lead to stronger comovements than market upturns.

Break-Even Point Between Short-Termand Long-Term Capital Gain (Loss) Strategies

A loss sale of stock allows investors to take a capital loss deduction. However, it has always been unclear whether it is advisable for individual investors to engage in loss sales of stock to take advantage of the tax benefit. Indeed, determining at what point the investment becomes indifferent as it relates to short-term and long-term capital gains (losses) is the focus of this article. The authors use three important variables to develop a model to help investors reach a conclusion regarding the loss sale quandary: tax rate, life of investment, and capital-gain (loss) growth rate. The break-even equation used in this research identifies the relationship among these variables, and the resulting model enables investors to make an optimum choice between short-term and long-term investment strategies. Ultimately, the model shows that a short-term investment strategy is more preferable for a longer-life investment, with a lower short-term capital gain tax rate, and a higher capital-gain growth rate. In contrast, a long-term investment would favor a shorter-life investment, with a higher short-term capital-gain tax rate, and lower capital-gain growth rate. The article also applies the model to the current stock market downturn and sudden climb.

Are short sellers positive feedback traders? Evidence from the global financial crisis

Short sellers are routinely blamed for destabilizing stock markets by exacerbating deviations from fundamental values. In response, regulators periodically impose short sale constraints aimed at preventing excessive stock market declines. One explanation is that policy makers regard short sellers as behaving like positive feedback traders. Relying on the theoretical model put forward by Sentana and Wadhwani (1992), which stresses the conditional nature of returns’ persistence, bans on selected financial stocks in six countries during the 2008/2009 global financial crisis are examined. These provide us with a setting to analyze the impact of short sale restrictions on feedback trading. Our findings suggest that, in the majority of markets examined, restrictions of this kind amplify positive feedback trading during periods of high volatility and, hence, contribute to stock market downturns. On balance then, short selling bans do not contribute to enhancing financial stability.

Are Short Sellers Positive Feedback Traders? Evidence from the Global Financial Crisis

Short sellers are routinely blamed for destabilizing stock markets by exacerbating deviations from fundamental values. In response, regulators periodically impose short sale constraints aimed at preventing excessive stock market declines. One explanation is that policy makers regard short sellers as behaving like positive feedback traders. Relying on the theoretical model put forward by Sentana and Wadhwani (1992), which stresses the conditional nature of returns' persistence, bans on selected financial stocks in six countries during the 2008/2009 global financial crisis are examined. These provide us with a setting to analyze the impact of short sale restrictions on feedback trading. Our findings suggests that, in the majority of markets examined, restrictions of this kind amplify positive feedback trading during periods of high volatility and, hence, contribute to stock market downturns. On balance then, short selling bans do not contribute to enhancing financial stability.

Published stock recommendations as investor sentiment in the near-term stock market

This paper investigates the role of published stock recommendations in print and online media as investor sentiment in the near-term German stock market. In line with extant literature on other sentiment measures, vector autoregressions reveal that past stock returns drive today’s sentiment, but not the other way around, and that sentiment is a powerful predictor of itself. In particular, sentiment based on printed analyst recommendations follows reversals, that is, when analysts face a stock market downturn, they see a buying opportunity and become optimistic.

The performance of global brands in the 2008 financial crisis: A test of two brand value measures

Previous literature has argued that high brand equity helps stabilize financial returns and reduce share price volatility. This research investigates how some of the strongest brands in the U.S. market fared in terms of financial performance during the Fall 2008 stock market downturn. Initial results using a financially based measure of brand value (Interbrand) show that, counter to expectations, these top brands did not outperform the market as a whole. However, the findings are in the hypothesized direction when an alternative, consumer-based brand equity measure (EquiTrend) is used to replicate the analysis. After first employing the three Fama–French factors to evaluate stock performance, we assess the added brand equity effect using both aforementioned measures. The consumer-based measure shows a significant incremental effect on stock performance after controlling for risk and financial fundamentals. Furthermore, this positive effect also applies to share volatility and firm betas. None of these effects hold for the financially based measure.

The Performance of Global Brands in the 2008 Financial Crisis: A Test of Two Brand Value Measures

Previous literature has argued that high brand equity helps stabilize financial returns and reduce share price volatility. This research investigates how some of the strongest brands in the U.S. market fared in terms of financial performance during the Fall 2008 stock market downturn. Initial results using a financially based measure of brand value (Interbrand) show that, counter to expectations, these top brands did not outperform the market as a whole. However, the findings are in the hypothesized direction when an alternative, consumer-based brand equity measure (EquiTrend) is used to replicate the analysis. After first employing the three Fama-French factors to evaluate stock performance, we assess the added brand equity effect using both aforementioned measures. The customer-based measure shows a significant incremental effect on stock performance, helping explain more variance than the classic Fama-French model alone accounts for. Furthermore, this positive effect on returns holds even when controlling for financial fundamentals and also applies to stock volatility and firm betas. None of these effects hold for the financially-based measure.

The Role of Equity Funds in the Financial Crisis Propagation

The early stage of the recent financial crisis was marked by large value losses for bank stocks. This paper identifies the equity funds most affected by this valuation shock and examines its consequences for the non-financial stocks owned by the respective funds. We find that (i) ownership links to these 'distressed equity funds' lead to large underperformance of the most exposed non-financial stocks, and in aggregate this contributes an additional 10.9% to the overall stock market downturn; (ii) distressed fire sales and the associated price discounts are concentrated among those exposed stocks which perform relatively well; and (iii) stocks with higher fund ownership generally performed much better throughout the crisis.

How can defined contribution pension plans benefit from momentum and mean reversion?

In this paper, we assess whether the stock market downturn can be an opportunity for Defined Contribution pension plan members to reinforce their risky assets exposure? In line with the framework developed by Kojein et al. (Manag Sci 55(7):1199–1213, 2009), we consider a DC plan investor, during the accumulation phase, whose aim is to maximize his terminal wealth. Within a continuous portfolio choice model, in which stock returns exhibit both momentum and mean reversion, DC plan members are allowed to invest their pension wealth into stocks as well as cash and bond assets. We derived the optimal portfolio candidate and we show how a DC plan investor can benefit from market opportunities by taking advantage of the momentum and mean reversion stock return properties. We find that long term investors such as DC plan members would benefit from a temporary increase of the share of risky assets in their portfolio in preparation of their retirement.

The ‘Dogs of the Dow’ strategy revisited: Finnish evidence

This paper re-examines the performance of the ‘Dogs of the Dow’ (DoD) investment strategy in a different market setting and over a different time period. In particular, we use Finnish data over the period 1988–2008 to examine whether the DoD strategy can be successfully replicated in different types of markets and in different market conditions. Our empirical findings suggest that the DoD investment strategy is profitable in the Finnish stock market. The DoD strategy outperforms the market index with an average (median) annual abnormal return of 4.5% (7.5%). The outperformance of the DoD strategy appears particularly pronounced in stock market downturns. Furthermore, our results indicate that the DoD strategy outperforms the market index even after most risk adjustments and thereby suggest that the outperformance of the strategy is not merely a compensation for higher risk. Nevertheless, we also document that the superior returns of the DoD strategy may be largely attributed to the winner–loser effect.

Asymmetric Correlation and Volatility Dynamics among Stock, Bond, and Securitized Real Estate Markets

We apply a multivariate asymmetric generalized dynamic conditional correlation GARCH model to daily index returns of S&P500, US corporate bonds, and their real estate counterparts (REITs and CMBS) from 1999 to 2008. We document, for the first time, evidence for asymmetric volatilities and correlations in CMBS and REITs. Due to their high levels of leverage, REIT returns exhibit stronger asymmetric volatilities. Also, both REIT and stock returns show strong evidence of asymmetries in their conditional correlation, suggesting reduced hedging potential of REITs against the stock market downturn during the sample period. There is also evidence that corporate bonds and CMBS may provide diversification benefits for stocks and REITs. Furthermore, we demonstrate that default spread and stock market volatility play a significant role in driving dynamics of these conditional correlations and that there is a significant structural break in the correlations caused by the recent financial crisis.

How Do Pension Changes Affect Retirement Preparedness? The Trend to Defined Contribution Plans and the Vulnerability of the Retirement Age Population to the Stock Market Decline of 2008-2009

Our findings suggest that although the consequences of the decline in the stock market are serious for those approaching their retirement, the average person approaching retirement age is not likely to suffer a life changing financial loss from the stock market downturn of 2008-2009. Similarly, the likely effects of the stock market downturn on retirements have been greatly exaggerated. If there is any postponement of retirement due to stock market losses, on average it will be a matter of a few months rather than years. Counting layoffs, retirements may be accelerated rather than reduced. We provide background information that corrects misperceptions about pension holdings of the retirement age population. Pension coverage is much more extensive than is usually recognized. Over three quarters of the households with a person ages 51 to 56 in 2004 are currently covered by a pension, or have enjoyed pension coverage in the past. Pension wealth accounts for 23 percent of the total wealth of those on the cusp of retirement. For those nearing retirement age, defined contribution plans remain immature. As a result, almost two thirds of pension wealth held by those 51 to 56 in 2004 is in the form of a defined benefit plan. Lastly, women approaching retirement age are more likely to be covered by a pension than are women from earlier cohorts and they account for a significantly larger share of household pension wealth.

Empirical evidence on feedback trading in mature and emerging stock markets

We investigate the hypothesis that some participants in mature and emerging stock markets engage in feedback trading. The analysis is based on the Shiller–Sentana–Wadhwani model, which has the attractive property that it yields testable implications about the presence of positive and negative feedback traders in stock markets. In addition, the Shiller–Sentana–Wadhwani model is particularly well-suited to investigate whether momentum type behaviour might be present during periods of large stock market downturns. This theoretical framework, together with asymmetric GARCH-type models, allows us to draw conclusions whether differences exist between mature and emerging stock markets in terms of the degree of feedback trading as well as the behaviour of traders during stock market crashes.

International Stock Market Liquidity and Financial Crisis

This paper is the first to examine liquidity in 37 stock markets around the world. We find volatility to be a very important driving factor for market illiquidity. A highly volatile market leads to a illiquid financial market. Stock market illiquidity condition also tends to persist. Using a series of regression and Granger causality tests, we find a strong contemporaneous negative relationship between illiquidity shocks and market returns. Also stock market downturn has Granger caused illiquidity and not the other way round. Regional and U.S. stock market returns donot affect local stock market illiquidity. Regional and U.S. stock market illiquidity, on the hand, affect local illiquidity. Nevertheless, the greatest cause of illiquidity is local stock market returns. Similar relationships were observed during the Asian financial crisis. Hong Kong illiquidity shocks have propagated to the other countries around the world except the Latin American stock markets.

It was the best of times, it was the worst of times

Not-for-profit (NFP) hospitals' accumulations of financial assets have been growing steadily over the past 10 years. Surprisingly, little is known about how much investment reserves represent and how they are handled among NFP hospitals. The purpose of this study is to evaluate investment strategies in financial assets among NFP hospitals. Specifically, this article seeks to explore how NFP hospitals allocate and manage financial assets, how much risk hospitals employ in their investment strategies, and the risk and return trade-off under contrasting market conditions. Using two years of survey data from the Common fund Benchmarks Study for Health Care Institutions for fiscal years 2002 and 2003, we analyze NFP hospitals' investment strategies by comparing asset size, investment management characteristics, board characteristics, asset allocation, levels of risk, and annual returns. Univariate regression analysis is used to evaluate the relationship between risk and return. NFP hospitals have sizeable long-term financial assets, averaging over $558 million in 2002 and $634 million in 2003. Two thirds of these funds are invested in long-term operating funds followed by defined benefit pension funds and insurance reserves; management of these funds is primarily outsourced. NFP hospitals allocate, on average, 50% of their operating fund assets to equities. During the stock market downturn in 2002, each 1% investment in equities was significantly associated with a -0.18% decrease in annual returns. In contrast, the relationship is almost exactly opposite--consistent with the relationship typically associated with risk and return--in 2003. NFP hospitals with heavy reliance on investment income to boost total profit margins may have difficulty adjusting to periods of low performance. Evaluation of the performance and financial condition of the hospital must account for the size and composition of financial assets.

International Integration, Common Exposure and Systemic Risk in the Banking Sector: an Empirical Investigation

This paper analyzes the impact of ongoing financial integration and increase in crossborder activities on banks’ common exposure to shocks and on banking sector systemic risk. For that, we study the evolution of correlations between large international banks’ asset-to-debt ratios over 1993-2006 and compute a systemic risk index for the same period. We find that banks’ common exposure to shocks has significantly decreased until 2000 and rapidly increased afterwards. Systemic risk follows a totally different pattern. No trend emerges and, instead, we observe two peaks: one in 1998 (LTCM and Russian crisis) and one in 2002-2003 (stock market downturn). These findings suggest that, contrary to a widespread belief, higher correlations between banks do not necessarily induce higher systemic risk. We then provide evidence that systemic risk is mainly driven by banks’ individual risk-taking rather than by their common exposure to risks.

Rational Exuberance: The Stock Market and Public Support for Social Security Privatization

Some pundits argue that public support for Social Security privatization is unaffected by stock market downturns. Others worry that majorities might flip with each major market swing. Cross-sectional and longitudinal analyses support a third perspective, consistent with theories of a rational public, where citizens update their opinions in reasonable ways in response to changes in the Dow Jones Industrial Average, the Standard & Poor's 500 index, and an average of the major markets. Therefore, the stock market affects Social Security privatization attitudes, particularly when movements in the markets remind citizens of the risks inherent in investing. These findings open new possibilities and create new challenges for including the public in policy debates.

The Perception of Control and the Level of Overconfidence: Evidence from Analyst Earnings Estimates and Price Targets

The majority of analysts failed to predict the recent stock market downturn at all, or, if they did, then not to its full extent. Apart from the well-known conflicts of interest, forecasts can be distorted by psychological factors. On average, financial analysts forecast earnings and prices with a positive bias. This study examines why financial analysts are overconfident, i.e., why they overestimate their abilities to forecast earnings and prices. Our empirical findings support the hypothesis that overconfidence intensifies with an increasing perception of control.

Pension-Funding Potholes

1. Dennis I Simon 1. Managing principal at XRoads Solutions Group in New York, NY. (dsimon{at}xroadsllc.com) As we enter what may be another period of intense M&A deal making, players in the field must begin to realize the issues that surround private defined-benefit pension plans. Many of these are in extremely underfunded positions due to the stock market downturn and falling bond yields. More than 80% of all defined-benefit plans may be underfunded. These plans require careful due-diligence.