Two-pass cross sectional regression (TPCSR) is frequently used in estimating factor risk premiums. Recent papers argue that the common practice of grouping assets into portfolios to reduce the errors-in-variables (EIV) problem leads to loss of efficiency and masks potential deviations from asset pricing models. One solution that allows the use of individual assets while overcoming the EIV problem is iterated TPCSR (ITPCSR). ITSCSR converges to a fixed point regardless of the initial factors chosen. ITPCSR is intimately linked to the asymptotic principal components (APC) method of estimating factors since the ITPCSR estimates are the APC estimates, up to a rotation.
{"title":"A Synthesis of Two Factor Estimation Methods","authors":"Gregory Connor, Robert A. Korajczyk, R. Uhlaner","doi":"10.2139/ssrn.1452864","DOIUrl":"https://doi.org/10.2139/ssrn.1452864","url":null,"abstract":"Two-pass cross sectional regression (TPCSR) is frequently used in estimating factor risk premiums. Recent papers argue that the common practice of grouping assets into portfolios to reduce the errors-in-variables (EIV) problem leads to loss of efficiency and masks potential deviations from asset pricing models. One solution that allows the use of individual assets while overcoming the EIV problem is iterated TPCSR (ITPCSR). ITSCSR converges to a fixed point regardless of the initial factors chosen. ITPCSR is intimately linked to the asymptotic principal components (APC) method of estimating factors since the ITPCSR estimates are the APC estimates, up to a rotation.","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"123 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-08-06","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125540247","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Commodities are physical, not financial assets. We investigate the effects on equilibrium spot-price behavior of frictions in the storage process, which introduce an element of irreversibility to storage decisions and lead to periods when storage operators do not trade in the spot market. We value the real option to delay selling a stored commodity, which comes bundled with the stored commodity itself and generates a convenience yield. The latter arises if the spot price is incorrectly used to measure the market value of the stored commodity, ignoring the embedded real option. It can be interpreted as the expected excess return on the real option to delay selling the stored commodity. Rather than equaling a flow of benefits received during the period over which the return from storage is being calculated, it actually represents changes in the present value of benefits that will be received only some time after the measurement period, when the commodity is released from storage. Storage frictions also generate heteroskedastic spot prices, with volatility being much higher when storage operators decide not to trade in the spot market.
{"title":"Commodity Prices and the Option Value of Storage","authors":"L. Evans, G. Guthrie","doi":"10.2139/ssrn.1003751","DOIUrl":"https://doi.org/10.2139/ssrn.1003751","url":null,"abstract":"Commodities are physical, not financial assets. We investigate the effects on equilibrium spot-price behavior of frictions in the storage process, which introduce an element of irreversibility to storage decisions and lead to periods when storage operators do not trade in the spot market. We value the real option to delay selling a stored commodity, which comes bundled with the stored commodity itself and generates a convenience yield. The latter arises if the spot price is incorrectly used to measure the market value of the stored commodity, ignoring the embedded real option. It can be interpreted as the expected excess return on the real option to delay selling the stored commodity. Rather than equaling a flow of benefits received during the period over which the return from storage is being calculated, it actually represents changes in the present value of benefits that will be received only some time after the measurement period, when the commodity is released from storage. Storage frictions also generate heteroskedastic spot prices, with volatility being much higher when storage operators decide not to trade in the spot market.","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"159 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2014-11-14","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121418780","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article evaluates out-of-sample portfolio performance for a real-time investor who can exploit time variation in the conditional mean and volatility of stock returns in optimizing a multiperiod portfolio choice problem. With the presence of parameter uncertainty, our out-of-sample analysis shows that ignoring time variation in the first two return moments leads to significant utility costs of at least 1.97% of annualized certainty equivalent return. Accounting for the time-varying risk premium plays a more important role than considering time-varying volatility in improving portfolio performance. Interestingly, behaving myopically or ignoring the hedge against changes in future investment opportunities can lead to small out-of-sample utility losses or even utility gains.
{"title":"An Out-of-Sample Evaluation of Dynamic Portfolio Strategies","authors":"Chunhua Lan","doi":"10.2139/ssrn.1108775","DOIUrl":"https://doi.org/10.2139/ssrn.1108775","url":null,"abstract":"This article evaluates out-of-sample portfolio performance for a real-time investor who can exploit time variation in the conditional mean and volatility of stock returns in optimizing a multiperiod portfolio choice problem. With the presence of parameter uncertainty, our out-of-sample analysis shows that ignoring time variation in the first two return moments leads to significant utility costs of at least 1.97% of annualized certainty equivalent return. Accounting for the time-varying risk premium plays a more important role than considering time-varying volatility in improving portfolio performance. Interestingly, behaving myopically or ignoring the hedge against changes in future investment opportunities can lead to small out-of-sample utility losses or even utility gains.","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"17 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2014-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114657400","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We examine how an exogenous improvement in market efficiency, which allows the stock market to obtain more precise information about the firm's intrinsic value, affects the shareholder-manager contracting problem, managerial incentives, and shareholder value. A key assumption in the model is that stock market investors do not observe the manager's pay-performance sensitivity ex ante. We show that an increase in market efficiency weakens managerial incentives by making the firm's stock price less sensitive to the firm's current performance. The impact on real efficiency and shareholder value varies depending on the composition of the firm's intrinsic value.
{"title":"Market Efficiency, Managerial Compensation, and Real Efficiency","authors":"Rajdeep Singh, Vijay Yerramilli","doi":"10.2139/ssrn.891298","DOIUrl":"https://doi.org/10.2139/ssrn.891298","url":null,"abstract":"We examine how an exogenous improvement in market efficiency, which allows the stock market to obtain more precise information about the firm's intrinsic value, affects the shareholder-manager contracting problem, managerial incentives, and shareholder value. A key assumption in the model is that stock market investors do not observe the manager's pay-performance sensitivity ex ante. We show that an increase in market efficiency weakens managerial incentives by making the firm's stock price less sensitive to the firm's current performance. The impact on real efficiency and shareholder value varies depending on the composition of the firm's intrinsic value.","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"36 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2014-03-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123508570","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Corporate bond spreads are affected by both credit risk and liquidity and it is difficult to disentangle the two factors empirically. In this paper we separate out the credit risk component by examining bonds that are issued by the same firm and that trade on the same day. Our sample of bond pairs provides two yield spreads which, if they differ, vary only because of differences in liquidity. We then investigate the determinants of the differences in yield spreads. We find that standard liquidity measures do a poor job of explaining spreads, and that incorporating the information from other bonds issued by the firm and from bonds of other firms can significantly improve the explanatory power of those liquidity measures. Still, a significant portion of the spread is left unexplained and it is largely driven by a common unknown factor. We conclude that good proxies for the liquidity component of corporate bond spreads remain elusive.
{"title":"Liquidity Effects in Corporate Bond Spreads","authors":"Jean Helwege, Jing-Zhi Huang, Y. Wang","doi":"10.2139/ssrn.1364681","DOIUrl":"https://doi.org/10.2139/ssrn.1364681","url":null,"abstract":"Corporate bond spreads are affected by both credit risk and liquidity and it is difficult to disentangle the two factors empirically. In this paper we separate out the credit risk component by examining bonds that are issued by the same firm and that trade on the same day. Our sample of bond pairs provides two yield spreads which, if they differ, vary only because of differences in liquidity. We then investigate the determinants of the differences in yield spreads. We find that standard liquidity measures do a poor job of explaining spreads, and that incorporating the information from other bonds issued by the firm and from bonds of other firms can significantly improve the explanatory power of those liquidity measures. Still, a significant portion of the spread is left unexplained and it is largely driven by a common unknown factor. We conclude that good proxies for the liquidity component of corporate bond spreads remain elusive.","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"100 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-08-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124753974","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We examine the impact on stock prices of a major upgrade to the New York Stock Exchange's trading environment. The upgrade improved information dissemination on the trading floor and reduced the latency in reporting trades and quotes. The portion of the upgrade that reduced latency for electronic orders had significant impacts on liquidity, turnover, and returns. A portfolio that is long stocks undergoing the upgrade in the first 20 days of the upgrade and short stocks receiving the upgrade later has a return of roughly 3% over the period. The abnormal return was a priced effect of the improved liquidity produced by the upgrade.
{"title":"Levelling the Trading Field","authors":"D. Easley, T. Hendershott, Tarun Ramadorai","doi":"10.2139/ssrn.961041","DOIUrl":"https://doi.org/10.2139/ssrn.961041","url":null,"abstract":"We examine the impact on stock prices of a major upgrade to the New York Stock Exchange's trading environment. The upgrade improved information dissemination on the trading floor and reduced the latency in reporting trades and quotes. The portion of the upgrade that reduced latency for electronic orders had significant impacts on liquidity, turnover, and returns. A portfolio that is long stocks undergoing the upgrade in the first 20 days of the upgrade and short stocks receiving the upgrade later has a return of roughly 3% over the period. The abnormal return was a priced effect of the improved liquidity produced by the upgrade.","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"267 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-03-24","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"133366006","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper studies two frequently observed portfolio behaviors that are seemingly inconsistent with rational portfolio choice. The first is the tendency of workers and entrepreneurs to hold their company's stock. The second is the propensity of workers to limit their equity holdings through time. The explanation offered here for both of these behaviors lies in the option to switch jobs when one's company does poorly. This is equivalent to holding put options on one's own company stock and call options on the other company's stock, where both options must be exercised at the same time. Given these initial undiversified implicit financial holdings, workers need to allocate a relatively large share of their regular financial assets to their own company's stock and a relatively small share to the stock of their alternative employment simply to restore overall portfolio balance. Although this effect can only create some hedging demand for company's stock, it is a factor of potentially major import for assessing the suitability of workers' financial decisions. I find that, under certain conditions, workers optimally hold almost 40% of their financial wealth in their company's stock. (Copyright: Elsevier)
{"title":"Resuscitating Businessman Risk: A Rationale For Familiarity-Based Portfolios","authors":"Doriana Ruffino","doi":"10.2139/ssrn.1013342","DOIUrl":"https://doi.org/10.2139/ssrn.1013342","url":null,"abstract":"This paper studies two frequently observed portfolio behaviors that are seemingly inconsistent with rational portfolio choice. The first is the tendency of workers and entrepreneurs to hold their company's stock. The second is the propensity of workers to limit their equity holdings through time. The explanation offered here for both of these behaviors lies in the option to switch jobs when one's company does poorly. This is equivalent to holding put options on one's own company stock and call options on the other company's stock, where both options must be exercised at the same time. Given these initial undiversified implicit financial holdings, workers need to allocate a relatively large share of their regular financial assets to their own company's stock and a relatively small share to the stock of their alternative employment simply to restore overall portfolio balance. Although this effect can only create some hedging demand for company's stock, it is a factor of potentially major import for assessing the suitability of workers' financial decisions. I find that, under certain conditions, workers optimally hold almost 40% of their financial wealth in their company's stock. (Copyright: Elsevier)","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"60 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-03-23","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115289195","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Using an innovative random regime shift detection methodology, we identify and confirm two distinct regime types in the dynamics of credit spreads: a level regime and a volatility regime. The level regime is long lived and shown to be linked to Federal Reserve policy and credit market conditions, whereas the volatility regime is short lived and, apart from recessionary periods, detected during major financial crises. Our methodology provides an independent way of supporting structural equilibrium models and points toward monetary and credit supply effects to account for the persistence of credit spreads and their predictive power over the business cycle.
{"title":"Detecting Regime Shifts in Credit Spreads","authors":"Olfa Maalaoui Chun, G. Dionne, Pascal François","doi":"10.2139/ssrn.1146583","DOIUrl":"https://doi.org/10.2139/ssrn.1146583","url":null,"abstract":"Using an innovative random regime shift detection methodology, we identify and confirm two distinct regime types in the dynamics of credit spreads: a level regime and a volatility regime. The level regime is long lived and shown to be linked to Federal Reserve policy and credit market conditions, whereas the volatility regime is short lived and, apart from recessionary periods, detected during major financial crises. Our methodology provides an independent way of supporting structural equilibrium models and points toward monetary and credit supply effects to account for the persistence of credit spreads and their predictive power over the business cycle.","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"56 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-03-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116923509","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
type="main"> This paper provides a novel theoretical analysis of how endogenous time-varying margin requirements affect capital market equilibrium. I find that margin requirements, when there are no other market frictions, reduce the volatility and correlation of returns as well as the risk-free rate, but increase the market price of risk, the risk premium, and the price of risky assets. Furthermore, margin requirements generate a strong cross-sectional dispersion of stock return volatilities. The results emphasize that a general equilibrium analysis may reverse the conclusions of a partial equilibrium analysis often employed in the literature.
{"title":"Asset Pricing with Dynamic Margin Constraints","authors":"O. Rytchkov","doi":"10.2139/ssrn.1341959","DOIUrl":"https://doi.org/10.2139/ssrn.1341959","url":null,"abstract":"type=\"main\"> This paper provides a novel theoretical analysis of how endogenous time-varying margin requirements affect capital market equilibrium. I find that margin requirements, when there are no other market frictions, reduce the volatility and correlation of returns as well as the risk-free rate, but increase the market price of risk, the risk premium, and the price of risky assets. Furthermore, margin requirements generate a strong cross-sectional dispersion of stock return volatilities. The results emphasize that a general equilibrium analysis may reverse the conclusions of a partial equilibrium analysis often employed in the literature.","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"4 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-02-06","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130239390","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Holger Daske, Luzi Hail, C. Leuz, Rodrigo S. Verdi
This study examines liquidity and cost of capital effects around voluntary and mandatory IAS/IFRS adoptions. In contrast to prior work, we focus on the firm-level heterogeneity in the economic consequences, recognizing that firms have considerable discretion in how they implement the new standards. Some firms may make very few changes and adopt IAS/IFRS more in name, while for others the change in standards could be part of a strategy to increase their commitment to transparency. To test these predictions, we classify firms into ‘label’ and ‘serious’ adopters using firm-level changes in reporting incentives, actual reporting behavior, and the external reporting environment around the switch to IAS/IFRS. We analyze whether capital-market effects are different across ‘serious’ and ‘label’ firms. While on average liquidity and costs of capital often do not change around voluntary IAS/IFRS adoptions, we find considerable heterogeneity: ‘Serious’ adoptions are associated with an increase in liquidity and a decline in cost of capital, whereas ‘label’ adoptions are not. We obtain similar results when classifying firms around mandatory IFRS adoption. Our findings imply that we have to exercise caution when interpreting capital-market effects around IAS/IFRS adoption as they also reflect changes in reporting incentives or broader changes in firms’ reporting strategies, and not just the standards.
{"title":"Adopting a Label: Heterogeneity in the Economic Consequences Around IAS/IFRS Adoptions","authors":"Holger Daske, Luzi Hail, C. Leuz, Rodrigo S. Verdi","doi":"10.2139/ssrn.1864771","DOIUrl":"https://doi.org/10.2139/ssrn.1864771","url":null,"abstract":"This study examines liquidity and cost of capital effects around voluntary and mandatory IAS/IFRS adoptions. In contrast to prior work, we focus on the firm-level heterogeneity in the economic consequences, recognizing that firms have considerable discretion in how they implement the new standards. Some firms may make very few changes and adopt IAS/IFRS more in name, while for others the change in standards could be part of a strategy to increase their commitment to transparency. To test these predictions, we classify firms into ‘label’ and ‘serious’ adopters using firm-level changes in reporting incentives, actual reporting behavior, and the external reporting environment around the switch to IAS/IFRS. We analyze whether capital-market effects are different across ‘serious’ and ‘label’ firms. While on average liquidity and costs of capital often do not change around voluntary IAS/IFRS adoptions, we find considerable heterogeneity: ‘Serious’ adoptions are associated with an increase in liquidity and a decline in cost of capital, whereas ‘label’ adoptions are not. We obtain similar results when classifying firms around mandatory IFRS adoption. Our findings imply that we have to exercise caution when interpreting capital-market effects around IAS/IFRS adoption as they also reflect changes in reporting incentives or broader changes in firms’ reporting strategies, and not just the standards.","PeriodicalId":297991,"journal":{"name":"Capital Markets: Asset Pricing & Valuation","volume":"47 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-01-08","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"128003803","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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