"The stampede into bonds... may be intensifying. A recent survey of financial advisers by Charles Schwab found that 77% planned....Yet bond prices are near all-time highs and future returns are likely to shrink.
Financial advisers contend that one of their most important functions is encouraging clients to 'rebalance,' or sell whatever has gone up and buy whatever has gone down.
The TD Ameritrade and Schwab numbers suggest, however, that financial advisers have been unbalancing instead of rebalancing their clients' accounts. "
Sunday, October 31, 2010
Halloween best time to buy shares - NZ varsity study | The National Business Review - New Zealand - business, markets, finance, politics, property, technology and more
"A Massey University research team say their study supports the 'Halloween Indicator' theory - which suggests investors get the best bang for their buck if they only buy stock after November and sell by May.
Professor Ben Jacobsen and finance PhD student Cherry Zhang, from the university's School of Economics and Finance, reviewed 300 years of data from the British stock exchange from 1693."
Friday, October 29, 2010
"Katherine Blouin from the University of Toronto publishes on a papyrus text regarding a Greek loan of money with interest in kind, the interest being paid in cabbages. Such in-kind interest protected the lender from currency inflation, which was rampant after 275 AD."
Bonds are pay interest in some asset other than money are still around but clearly not the norm. They are often called Payment in kind bonds where the payment can be in anything from oil, to an other bond, or gold.
Class: Explain why this would be a useful hedge.
"..research by Johan Bollen, an associate professor in the School of Informatics and Computing at IU, supports speculation that these components could be related.Here is a video interview with the author from Bloomberg (can not embed).
Bollen conducted an empirical study of more than 10 million Twitter posts — tweets — during 10 months in 2008.
His findings revealed a startling correlation between aggregate mood expressed on Twitter and the Dow Jones Industrial Average.
The predictions are nearly 90 percent accurate up to a week in advance of the Dow’s close.
Some more papers from last week's FMA conference.
Shorts: Gundy, Lim, and Verwijmeren give a fascinating analysis of whether option markets allow market participants to get around short sale bans. The short answer is NO. This is likely because many who sell the puts, hedge their risk by shorting the stock. When the short is disallowed, the put contract volume for shares of firms on the "do not short" list also falls. This leades to more "mispricing" in option markets as well. Very interesting.
Is it time to change fund managers? If you do, you can expect cash outflows even if performance increases. So you better think twice. Robeco, Lansdorp and Verbeek examine fund flows following the replacement of a money manager. They find that net flows are negative following the replacement even though on average the fund performs better (which may be caused by mean reversion?) Surprisingly this is more pronounced for institutional funds than retail funds. Why? Good question. Maybe the new manager does not fit the style the investor desires? Or maybe people just do not like change.
Financial flexibility is valuable. That is the key finding from a paper by Clark who confirms the long-held view (just ask any manager) that having the ability to raise new money quickly (debt issuance) is an important benefit. This helps to explain the supposed "under leverage" issues that we often see in Capital Structure models.
So you are on the board of a firm that allowed backdating. You also sit on other boards. You notice that fewer shareholders are supporting you. You are not alone. Ertimur, Ferri, and Maber find that investors "punish" Board Members of firms for transgressions done at the past at other firms by withholding votes. This is shownby looking at baord members of firms that allowed backdating, and then looking at shareholder voting for or against those baord members at other firms. The authors find "the percentage of votes withheld from directors at backdating firms is twice the percentage withheld from their counterparts at non-backdating firms. This voting penalty is more pronounced for directors sitting on the compensation committee (CC)...."
previous FMA article posts:
Thursday, October 28, 2010
Two of my favorite papers happened to be in the same session (a fact that I doubt was independent, watching a good (or bad) presentation no doubt has carryover effects to the next paper).
Jayaraman and Millburn examine two simultaneous long term trends of increased market liquidity (which is presumed to make stock prices more informative) and paying executives with more market based pay and find that the latter is dependent on the former. That is, as liquidity increases, so too does pay sensitivity that is tied to stock performance. (Notably, they find no such increase for pay to earnings sensitivity which presumably is seen as a second best solution to paying managers for performance.) Using the change to decimalization and inclusion into S&P 500 as robustness checks gives further support to this idea. (it should be noted that SP inclusion was used because it leads to LESS informative prices and consequently lower equity pay sensitivity.
Then in a paper so good that I really enjoyed it even though the presenter was not an author. Intuitively I just love the idea and can not figure out why firms are not doing it! The author York's Yisone Sam Tian shows that using Asian options (which uses the average stock price instead of closing stock price) helps alleviate some of the incentive problems that arise when using traditional executive stock options. For instance the risk manager would be not need as large of premium for accepting the pay, there would be less incentive to withhold bad news, etc. That said, there might be increased incentive for earnings smoothing as the discussant pointed out. Genius!
Durham, Perry, and Carpenter examine pay equity in NFL football and find that it a team has a wide dispersion of pay (paying some a great deal and many others near the league minimum for example), turnover increases and winning percentages drop. This is not the first time for similar findings. Past researchers have examined pay equity issues in many settings, including professional sports. The past results have been quite mixed, but in a nutshell have suggested that for "large team games" such as US football, baseball, soccer some measure of fairness matters, where in smaller team games (basketball) it matters less (presumably where a few superstars can carry the team). And I really wish they had looked at whether turnover led to turnovers. LOL..
previous posts from the FMAs
Wednesday, October 27, 2010
Fung and Wen gave is a preliminary look at CDS usage in the insurance industry. Insurance makes a particularly good study because of data availability due state regulatory filings. The authors lay out a breakdown of why firms would sell CDS (income generation, replication of bond cash flows, and speculation) as opposed to why a firm would buy (hedging or speculating). Then showed that while not the largest (clearly banks) insurance companies made up about 18% of selling volume and 6% of buying volume so they were not insignificant players. Based on cash flow profiles the authors hypothesized that life insurers would be more interested in replication than property insurers and then empirically show that this in fact is true life insurers sell more and when they do buy, hold longer, than property casualty insurance firms. Moreover those organized as stock (as opposed to mutual) insurance firms tended to speculate more. Finally that the insurance industry as a whole seemed to speculate more as the crisis approached.
Altuntas, Berry-Stolze, and Hoyt used an intensive survey of German Insurance firms to look at the state of risk management. They report (remember it was a survey and thus at least somewhat suspect due to behavioral biases) that firms are doing MUCH more risk mangement than in the past. They show this in numerous ways firms do this (qualitatively as quantitatively), who does it (CEO 41%, 23% CFO, 10% CRO), what risks are managed (Investment risk 99%, major claims 91%, liquidity 55% for a few examples), and overall show a definite trend towards more risk management. The authors then make the case that this increased risk management is being done more holistically across the whole firm, which is Enterprise Risk Management. (FYI-I discussed this paper.)
Borokhovich, Hegabm and Marciukaityte give a thought provoking, although not totally convincing, discussion of the merits of excessive leverage as a proxy for managerial overconfidence. Once this is established they build on previous findings that managers are overconfident (the majority believing their stock is undervalued) and that post financing price declines are tied to this excessive leverage measure as are errors in analyst forecasts. This is interpreted as being consistent with overconfidence and not market timing.
Elkamhi, Pungaliya, and Vijh examine whether credit markets price target debt levels or just current levels. The findings which are largely based on CDS markets suggest that these target ratios do get priced and play a more important role in longer term contracts. This has implications for both capital structure (Target Ratios don't make much sense in a pecking order world) and market efficiency discussions.
Sanyal and Bulan give more evidence on the trade-off between incentives and risk aversion by examining the link between innovation and compensation of top level executives. Innovation, as measured by patent quantity, quality, and type of innovation, is shown to not be monotonically increasing with pay sensitivity but to be a concave (think upside down U) relation that at first increases with pay sensitivity, but then decreases as risk aversion begins to dominate. (And yes I confess, I was thinking of the family owned (yeah my family) Park and Shop when I was watching this presentation.)
Rest of the series:
Tuesday, October 26, 2010
Politics matter. Kim, Panzalis, and Park create a Political Alignment Index (PAI) that looks at whether state and federal representatives (House, Senate, Governor, and State Legislature) are in "alignment" with the president. They then document a positive return for firms in high PAI states (a zero cost portfolio created by buying high PAI firms and selling low PAI firms yielded .27% per month!) . Findings most pronounced in multiterm office holders, when a Democrat is in power, when incumbents win, and for smaller firms.
Location matters. Engleberg, Ozoguz, and Wang look at Industry Clusters. That is when a group of similar firms are headquartered in the same area. The authors show analyst coverage is greater for firms in such a cluster. Which seems to make sense since their transaction costs (cost to understand industry and cost to go to visit sites etc), would be lower.
Insider Trading I Rajan, Lei, and Wang show that insider trading is indeed profitable even after accounting for higher than ordinary transaction costs (due to the price impact of their trades).
After examining trades from 1993-2008, the authors report that "corporate insiders as a group have an average trading alpha of 4.2 cents for purchases and 3.6 cents for sales" which is positive even after adjusting for transaction costs. Interestingly, the paper also reports that if managers can successfully feign a liquidity motivation for their trades, they incur lower transaction costs.
Insider Trading II. Frino, Satchell, Wong, and Zheng use hand collected data from 1996-2004 to look at how much insiders who are caught trading illegally are actually trading. Their findings suggest that trading increases with expected return and is negatively related to expected punishment, volatility (your so-called "info" could be a noisy signal), and the likelihood of getting caught. Overall, the median amount of trading (remember these were only the ones that got caught): traded 7 days before announcement, trades 4,625 shares (about 4.5% of daily volume for the stocks in question), most only made one trade (the maximum number of trades was 12), the scaled penalty was just over 2Xs the profits.
Here is Part I.
"Mr. Buffett, 80, has said that upon his death or retirement, his roles of chairman, chief executive and chief investment officer will be split among multiple people. Mr. Combs now stands as the heir apparent to the chief investor position, though Mr. Buffett made clear such an appointment had not been decided.In class yesterday we just spoke if Buffett and his excellent long run performance. Here is his year by year record from CNBC.
“He’s got the best chance of being the successor, but if we find the right guy or gal, we’d take that person, too,” he said.
(Class assignment idea: calculate various performance measures--Sharpe, Treynor etc. based on his Berkshire Hathaway's Returns.)
- Berkshire Hathaway names Combs investment manager (seattletimes.nwsource.com)
- Buffett's New Hire to Manage 'Significant' Chunk of Berkshire's Portfolio (dailyfinance.com)
- Potential Buffett Successor Out of the Running? (dealbook.blogs.nytimes.com)
Monday, October 25, 2010
So What Is Insider Trading? -- DealBook Column by Andrew Ross Sorkin - NYTimes.com:
"Late last month, the Securities and Exchange Commission brought an unusual and colorful insider-trading case: It accused two employees who worked in the rail yard of Florida East Coast Industries and their relatives of making more than $1 million by trading on inside information about the takeover of the company.
How did these employees — a mechanical engineer and a trainman — know their company was on the block?
Well, they were very observant.
They noticed “there were an unusual number of daytime tours” of the rail yard, the S.E.C. said in its complaint, with “people dressed in business attire.”
(Note there will be more papers mentioned in the coming days. These were all from before lunch on the first day.)
Chung, Hung, and Yeh find weak support for investor sentiment being able to preduct future stock returns. Sentiment does a particularly poor job in down markets.
Anand, Irvine, Puckett, and Venkataraman examine trading during Market crashes and report that there was a significant change in trading patterns during crash. Notably, trading migrated to more liquid securities as transaction costs increased in the midst of the crash. These more liquid securities tended to be larger and less volatile. As a result, the relative volume for some in the high transaction costs/low liquidity cohort dropped by about half. Also the more liquid securities bounced back faster.
Asparouhova, Bessembinder, and Kalcheva look at noise induced biases in the reporting of anomalies. While not totally new, (Think Blume and Satmbaugh 1983 and/or Arnot et al 2006), it is well worth reading! Indeed, it may help explain the size (about 1/2 of the size anomaly from 1963-1980!) and illiquidity anomaly better than almost anything I have seen. (yeah it will change my class notes)
Stocks move together more than their underlying fundamentals suggest (see Shiller 1989 and many others). Isrealsen tries to identify why this is true. He finds that at least part of the explanation is that some analysts (especially those that either work together (now or in the past) or are otherwise "connected") lead to greater co-movement of the stocks they follow. (My translation of this is that the previously found "excessive" correlations can be explained not only changing investor sentiment, but also a lack of independent thinking by analysts.)
Active investing has a bad name in academia. So I watched it was with added attention when Ye defended it not from a return perspective, but when he found that active institutions reduce comovements after S&P 500 inclusions and after 2:1 splits (both events which were previously associated with increased comovements). The intuition is that rather than just blindly doing what others are doing (as is the case in passive investing), active investors become more informed had something good to say about
Saturday, October 16, 2010
Friday, October 15, 2010
Early Retirement May Diminish Brain Power, Memory: Study | Life | Epoch Times:
"“Early retirement appears to have a significant negative impact on the cognitive ability of people in their early 60s that is both quantitatively important and causal,” the study concluded. It was co-authored by Susann Rohwedder, a senior economist at the RAND Center for the Study of Aging, and Robert J. Willis, Professor of Economics at the University of Michigan."
This one has the potential to be HUGE....
Here is the actual paper.
"Professor Jacobsen says the theory sheds light on two key issues in finance. The first is the equity premium puzzle, that returns on stocks are too high relative to other investments, and the second is that the volatility of stockmarkets is too high to be explained by economic variables.
'For decades people have tried to explain these puzzles but, so far, not convincingly. However, this new theory would explain both. According to this theory, if investors account for a small probability of a rare disaster and if this probability fluctuates over time these two puzzles can be explained."
The article begins with a discussion of Eugene Fama and market efficiency--the reaction to new information:
"One also wonders why corn prices jumped more than 20 percent. The new information was not about a crop-destroying tsunami or a sudden attack by UFOs. The raw information about the weather and its impact had been out there for weeks. Since there is such potential profit in pre-guessing the USDA, why didn't traders put more resources into gathering such information themselves? And why doesn't such private production of information result in buying in anticipation of higher prices that would have reduced the eventual jump when authoritative government numbers were released?
Efficient markets adherents would say that this is just an ordinary example of a random error in expectations that, over time, will be offset by other errors in the other direction. But over time the sum of such errors will be zero. Perhaps."
Thursday, October 14, 2010
Now many economists have argued for years that it is bad. For instance, Ayn Rand in her writings and more recently from the Ayn Rand Institute.
Last week we ended class talking about this video where the monkeys shared their gains and acted in a manner that would be seen as uneconomic (giving away nuts, caring about "fairness" etc). If you have not seen that video, I highly recommend it. (oh and please give me a juicy grape :) ) So cooperation may be useful for the species.
Here is an example not in an artificial setting.
Here is a short video on monkeys
So what can we learn from animals? And here is a longer video from Emory University:
This is not a new phenomena. The idea sacrificing for others is seemingly well ingrained in the fabric of our DNA. For instance, SBU's own Joel Bennington presented this to our class last year. It is based on the Ultimatum Game this is from a classic economist.
- Fairness Is Relative - That Means it Changes (For Those in Rio Linda) (i2i-align.com)
- What's Fair is Fair (And Why) (psychologytoday.com)
- 3 Emotions That Will Destroy Your Retirement (money.usnews.com)
- How Greed Works (forbes.com)
- Physiological reactions, moral attitudes, and the ultimatum game (Andrea Lavazza and Mario De Caro) (kolber.typepad.com)
Tuesday, October 12, 2010
Enter the Neuro-Economists: Why Do Investors Do What They Do? - New York Times:
"For instance, when humans are in a 'positive arousal state,' they think about prospective benefits and enjoy the feeling of risk. All of us are familiar with the giddy excitement that accompanies a triumph. Camelia Kuhnen and Brian Knutson, two researchers at Stanford University, have found that people are more likely to take a foolish risk when their brains show this kind of activation.
But when people think about costs, they use different brain modules and become more anxious. They play it too safe, at least in the laboratory. Furthermore, people are especially afraid of ambiguous risks with unknown odds. This may help explain why so many investors are reluctant to seek out foreign stock markets, even when they could diversify their portfolios at low cost.
Thursday, October 07, 2010
"If there isn't an easy answer, ambivalent people, more than black-and-white thinkers, are likely to procrastinate and avoid making a choice....
Researchers can't say for sure why some people tend towards greater ambivalence. Certain personality traits play a role—people with a strong need to reach a conclusion in a given situation tend to black-and-white thinking, while ambivalent people tend to be more comfortable with uncertainty."
I THINK we will use this in class tonight, but then again maybe not...lol.
Wednesday, October 06, 2010
A great history lesson/refresher on traders who have lost billions (and in many cases put their company out of business...the list includes Jerome Kerviel, Nick Leeson, John Rusnak.
Will definitely use this one in classes!
Tuesday, October 05, 2010
"Jerome Kerviel, a former trader for Societe Generale SA, was convicted on all counts Tuesday in one of history's biggest trading frauds, sentenced to three years in jail and ordered to pay the bank a mind-numbing euro4.9 billion ($6.7 billion) in damages...Why not make the number bigger? There is ALMOST no way an individual will be able to pay it back anyways and the number was largely for show.
"I have the feeling Jerome Kerviel is paying for an entire system," said Metzner, noting that his client hadn't benefited financially from the fraud....It wasn't immediately clear how he could do so, or whether the bank really expects to see that money back.