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Volume 53: Issue 6 (December 1998)

Investor Psychology and Security Market Under‐ and Overreactions

Pages: 1839-1885  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00077  |  Cited by: 3603

Kent Daniel, David Hirshleifer, Avanidhar Subrahmanyam

We propose a theory of securities market under‐ and overreactions based on two well‐known psychological biases: investor overconfidence about the precision of private information; and biased self‐attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes. We show that overconfidence implies negative long‐lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public‐event‐based return predictability. Biased self‐attribution adds positive short‐lag autocorrelations (“momentum”), short‐run earnings “drift,” but negative correlation between future returns and long‐term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate financial policy.

Volume, Volatility, Price, and Profit When All Traders Are Above Average

Pages: 1887-1934  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00078  |  Cited by: 1220

Terrance Odean

People are overconfident. Overconfidence affects financial markets. How depends on who in the market is overconfident and on how information is distributed. This paper examines markets in which price‐taking traders, a strategic‐trading insider, and risk‐averse marketmakers are overconfident. Overconfidence increases expected trading volume, increases market depth, and decreases the expected utility of overconfident traders. Its effect on volatility and price quality depend on who is overconfident. Overconfident traders can cause markets to underreact to the information of rational traders. Markets also underreact to abstract, statistical, and highly relevant information, and they overreact to salient, anecdotal, and less relevant information.

Earnings Management and the Long‐Run Market Performance of Initial Public Offerings

Pages: 1935-1974  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00079  |  Cited by: 1476

Siew Hong Teoh, Ivo Welch, T.J. Wong

Issuers of initial public offerings (IPOs) can report earnings in excess of cash flows by taking positive accruals. This paper provides evidence that issuers with unusually high accruals in the IPO year experience poor stock return performance in the three years thereafter. IPO issuers in the most “aggressive” quartile of earnings managers have a three‐year aftermarket stock return of approximately 20 percent less than IPO issuers in the most “conservative” quartile. They also issue about 20 percent fewer seasoned equity offerings. These differences are statistically and economically significant in a variety of specifications.

Value versus Growth: The International Evidence

Pages: 1975-1999  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00080  |  Cited by: 1302

Eugene F. Fama, Kenneth R. French

Value stocks have higher returns than growth stocks in markets around the world. For the period 1975 through 1995, the difference between the average returns on global portfolios of high and low book‐to‐market stocks is 7.68 percent per year, and value stocks outperform growth stocks in twelve of thirteen major markets. An international capital asset pricing model cannot explain the value premium, but a two‐factor model that includes a risk factor for relative distress captures the value premium in international returns.

International Cross‐Listing and Order Flow Migration: Evidence from an Emerging Market

Pages: 2001-2027  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00081  |  Cited by: 271

Ian Domowitz, Jack Glen, Ananth Madhavan

Policymakers in emerging markets are increasingly concerned about the consequences for the domestic equity market when companies list stock abroad. We show that the effects of cross‐listing depend on the quality of intermarket information linkages. We investigate these issues with unique data from the Mexican equity market. The impact of cross‐listing is complex—balancing the costs of order flow migration against the benefits of increased intermarket competition. These effects are exacerbated by equity investment barriers that induce segmentation of the domestic equity market. Consequently, the benefits and costs of cross‐listing are not evenly spread over all classes of shareholders.

Stock Returns, Dividend Yields, and Taxes

Pages: 2029-2057  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00082  |  Cited by: 110

Andy Naranjo, M. Nimalendran, Mike Ryngaert

Using an improved measure of a common stock's annualized dividend yield, we document that risk‐adjusted NYSE stock returns increase in dividend yield during the period from 1963 to 1994. This relation between return and yield is robust to various specifications of multifactor asset pricing models that incorporate the Fama–French factors. The magnitude of the yield effect is too large to be explained by a “tax penalty” on dividend income and is not explained by previously documented anomalies. Interestingly, the effect is primarily driven by smaller market capitalization stocks and zero‐yield stocks.

Implied Volatility Functions: Empirical Tests

Pages: 2059-2106  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00083  |  Cited by: 883

Bernard Dumas, Jeff Fleming, Robert E. Whaley

Derman and Kani (1994), Dupire (1994), and Rubinstein (1994) hypothesize that asset return volatility is a deterministic function of asset price and time, and develop a deterministic volatility function (DVF) option valuation model that has the potential of fitting the observed cross section of option prices exactly. Using S&P 500 options from June 1988 through December 1993, we examine the predictive and hedging performance of the DVF option valuation model and find it is no better than an ad hoc procedure that merely smooths Black–Scholes (1973) implied volatilities across exercise prices and times to expiration.

Law, Finance, and Firm Growth

Pages: 2107-2137  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00084  |  Cited by: 1293

Asli Demirgüç-Kunt, Vojislav Maksimovic

We investigate how differences in legal and financial systems affect firms' use of external financing to fund growth. We show that in countries whose legal systems score high on an efficiency index, a greater proportion of firms use long‐term external financing. An active, though not necessarily large, stock market and a large banking sector are also associated with externally financed firm growth. The increased reliance on external financing occurs in part because established firms in countries with well‐functioning institutions have lower profit rates. Government subsidies to industry do not increase the proportion of firms relying on external financing.

Are Financial Markets Overly Optimistic about the Prospects of Firms That Issue Equity? Evidence from Voluntary versus Involuntary Equity Issuances by Banks

Pages: 2139-2159  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00085  |  Cited by: 60

Marcia Millon Cornett, Hamid Mehran, Hassan Tehranian

This paper examines firm performance around announcements of common stock issues. We study the banking industry in which some stock issues are made voluntarily by managers, and other issues are involuntary. We find that banks that voluntarily issue common stock experience a significant drop in the matched adjusted operating performance following the issue, a significant drop in benchmark firms' adjusted stock prices following the issue, and systematically negative market reactions to post‐issue quarterly earnings announcements. Banks that issue common stock involuntarily experience values for these measures that are not significantly different from those of the benchmark firm(s).

Venture Capital Distributions: Short‐Run and Long‐Run Reactions

Pages: 2161-2183  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00086  |  Cited by: 183

Paul Gompers, Josh Lerner

Venture capital distributions, a legal form of insider trading, provides an ideal arena for examining the share price impact of transactions by informed parties. These sales, which occur after substantial run‐ups in share value, generate a substantial price reaction immediately around the event. In the months after distribution, returns apparently continue to be negative. When the short‐ and long‐run reactions are decomposed, they are consistent with the view that venture capitalists use inside information to time stock distributions: Distributions of firms brought public by lower quality underwriters and of less seasoned firms have more negative price reactions.

The Gains from Takeover Deregulation: Evidence from the End of Interstate Banking Restrictions

Pages: 2185-2204  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00087  |  Cited by: 62

Yaron Brook, Robert Hendershott, Darrell Lee

This paper uses interstate banking deregulation to explore the benefits of takeover deregulation and how these benefits are distributed across different firms. We find large and significant abnormal returns around the Interstate Banking and Branching Efficiency Act of 1994 which imply it created $85 billion of value in the banking industry. Consistent with an active market for corporate control allowing beneficial consolidation and providing needed discipline, there is a strong negative relationship between banks' abnormal returns and their prior performance. Consistent with managerial entrenchment limiting takeover discipline, banks with higher insider ownership, lower outside block ownership, and/or less independent boards have lower abnormal returns.

Short Sales Are Almost Instantaneously Bad News: Evidence from the Australian Stock Exchange

Pages: 2205-2223  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00088  |  Cited by: 252

Michael J. Aitken, Alex Frino, Michael S. McCorry, Peter L. Swan

This paper investigates the market reaction to short sales on an intraday basis in a market setting where short sales are transparent immediately following execution. We find a mean reassessment of stock value following short sales of up to −0.20 percent with adverse information impounded within fifteen minutes or twenty trades. Short sales executed near the end of the financial year and those related to arbitrage and hedging activities are associated with a smaller price reaction; trades near information events precipitate larger price reactions. The evidence is generally weaker for short sales executed using limit orders relative to market orders.

The Relation Between Treasury Yields and Corporate Bond Yield Spreads

Pages: 2225-2241  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00089  |  Cited by: 496

Gregory R. Duffee

Because the option to call a corporate bond should rise in value when bond yields fall, the relation between noncallable Treasury yields and spreads of corporate bond yields over Treasury yields should depend on the callability of the corporate bond. I confirm this hypothesis for investment‐grade corporate bonds. Although yield spreads on both callable and noncallable corporate bonds fall when Treasury yields rise, this relation is much stronger for callable bonds. This result has important implications for interpreting the behavior of yields on commonly used corporate bond indexes, which are composed primarily of callable bonds.

Output, Stock Volatility, and Political Uncertainty in a Natural Experiment: Germany, 1880–1940

Pages: 2243-2257  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00090  |  Cited by: 180

George Bittlingmayer

Why does stock volatility increase when output declines? The theory of investment under uncertainty implies that political uncertainty may simultaneously increase volatility and reduce output. Though cause and effect are typically hard to separate, the transition from Imperial to Weimar Germany offers a natural experiment because major political events left clear traces on stock prices. Current and past increases in volatility are associated with output declines, consistent with U.S. experience. However, political events are more clearly the source of volatility, and the results support the view that the relationship between volatility and output reflects the joint effects of political factors.

Book Reviews

Pages: 2259-2264  |  Published: 12/1998  |  DOI: 10.1111/1540-6261.t01-1-00091  |  Cited by: 0

Book Reviews

Pages: 2259-2264  |  Published: 12/1998  |  DOI: 10.1111/1540-6261.00091  |  Cited by: 0

David L. Ikenberry, Brad M. Barber

Zvi Bodie and Robert C. Merton, Finance.


Pages: 2265-2266  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00092  |  Cited by: 0

Association Meetings

Pages: 2267-2268  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00093  |  Cited by: 0

From the ExSec's Notebook

Pages: 2271-2273  |  Published: 12/1998  |  DOI: 10.1111/0022-1082.00094  |  Cited by: 0

Michael Keenan