When I was looking at research-Finance.com,I stumbled upon this one by Andersen, Bollerslev, Christoffersen, and Diebold.
They provide a very interesting look at the volatility forecasting. The piece is largely a summary article that shows what has been done and the results. VERY good! It is part of a forthcoming Handbook of Economic Forecasting edited by Elliott, Granger, and Timmermann.
A warning: it is LONG! 114 pages.
The paper is also available through the UPenn site.
Suggested Citation
Andersen, Torben G., Bollerslev, Tim, Christoffersen, Peter and Diebold, Francis X., "Volatility Forecasting" (February 22, 2005). Penn Institute for Economic Research (PIER), Research Paper Series http://ssrn.com/abstract=678861
Thursday, March 31, 2005
Wednesday, March 30, 2005
More Fuel for the Fire on social security reform
I hope you have been following the "discussion"--via comments at the end of my last blog entry on Social Security reform. The discussion is very interesting. My views have not been changed, but interesting discussion none the less.
Today I was reading what some others have to say about Social Security Reform.
Harvard's Robert Barro is against privatization but not for the normal reasons. He is opposed to anything that will make social security bigger (which is a very good point!).
A few quotes :
"The strongest points for personal accounts involve property rights and the freedom of choice. When people contribute to a personal account, property rights insulate benefits from future Congresses who can change the program as they wish. The rights also mean that, unlike the current program, the contributions are not a tax that discourages work. Personal
accounts also allow for differing preferences on which assets to hold, how much risk to take, and when to receive income. Forcing everyone into a one-size-fits-all plan is usually unwise."
* " From the perspective of the trust fund, returns look low because the fund's government bonds have paid less than stocks. But the premium on stocks is compensation for risk, as gauged by financial markets. Although the ability to hold stocks is a plus, there is no free lunch of assured higher returns."
* "An opposing myth is that the transition requires too much government borrowing. In fact, a debt-financed transition entails substitution of explicit liabilities (government bonds) for unfunded liabilities (future benefits in the present system). There are no substantial effects on interest rates, national saving, and the current-account imbalance."
*" A SERIOUS ANALYSIS STARTS with asking why we have Social Security. If we were not so used to it, we would find it odd for the government to collect money from young workers and give it to the old (mostly workers' parents). One rationale is that the government should help people who lack discipline to save for old age. I have never embraced this paternalistic view. It's true that society will inevitably provide welfare to the needy elderly. Knowing this, some people will save too little and rely on public support when old. Thus, there is reason to require workers to save for retirement. How much depends on what is viewed as a minimal standard of living....
Contributions that fund just the minimum cannot go into a meaningful personal account. People would opt for too much risk, knowing they would be bailed out if they fell short. Also, contributions that cover the minimum provide no individual return and, therefore, amount to a tax that discourages work."
* "Personal accounts have to supplement the minimum payout. But then why have a public program at all, rather than relying on individual choices on saving? I think there is no good reason to go beyond the minimum standard; that is why I view personal accounts as a mistake -- they enlarge a Social Security program that already promises too much."
Good Stuff!!!
Barro's Business Week Piece as PDF file
Over at Market Week, Thomas Saving (what a great name!) lays out some myths about social security and shows why something has to be done (for both SS and Medicare). I highly recommend reading it.
Saving's conclusion:
Today I was reading what some others have to say about Social Security Reform.
Harvard's Robert Barro is against privatization but not for the normal reasons. He is opposed to anything that will make social security bigger (which is a very good point!).
A few quotes :
"The strongest points for personal accounts involve property rights and the freedom of choice. When people contribute to a personal account, property rights insulate benefits from future Congresses who can change the program as they wish. The rights also mean that, unlike the current program, the contributions are not a tax that discourages work. Personal
accounts also allow for differing preferences on which assets to hold, how much risk to take, and when to receive income. Forcing everyone into a one-size-fits-all plan is usually unwise."
* " From the perspective of the trust fund, returns look low because the fund's government bonds have paid less than stocks. But the premium on stocks is compensation for risk, as gauged by financial markets. Although the ability to hold stocks is a plus, there is no free lunch of assured higher returns."
* "An opposing myth is that the transition requires too much government borrowing. In fact, a debt-financed transition entails substitution of explicit liabilities (government bonds) for unfunded liabilities (future benefits in the present system). There are no substantial effects on interest rates, national saving, and the current-account imbalance."
*" A SERIOUS ANALYSIS STARTS with asking why we have Social Security. If we were not so used to it, we would find it odd for the government to collect money from young workers and give it to the old (mostly workers' parents). One rationale is that the government should help people who lack discipline to save for old age. I have never embraced this paternalistic view. It's true that society will inevitably provide welfare to the needy elderly. Knowing this, some people will save too little and rely on public support when old. Thus, there is reason to require workers to save for retirement. How much depends on what is viewed as a minimal standard of living....
Contributions that fund just the minimum cannot go into a meaningful personal account. People would opt for too much risk, knowing they would be bailed out if they fell short. Also, contributions that cover the minimum provide no individual return and, therefore, amount to a tax that discourages work."
* "Personal accounts have to supplement the minimum payout. But then why have a public program at all, rather than relying on individual choices on saving? I think there is no good reason to go beyond the minimum standard; that is why I view personal accounts as a mistake -- they enlarge a Social Security program that already promises too much."
Good Stuff!!!
Barro's Business Week Piece as PDF file
Over at Market Week, Thomas Saving (what a great name!) lays out some myths about social security and shows why something has to be done (for both SS and Medicare). I highly recommend reading it.
Saving's conclusion:
"People may have honest disagreements about the best way to move to a funded system (for example, whether we should have individual accounts or have government make the investments). But, there should be no disagreement about our need to move to a new system of finance as quickly as possible, and personal accounts is one way to do that, although not the only way."
Are Super Star CEOs bad for firm? It seem so.
In my MBA 610 class we now devote a bit more than a week to corporate governance. One of the lessons is that Super Star CEOs are rarely good for the long term prospects of the firm.
The NY Times has an interesting article that largely endorses this view: The New York Times Lo! A White Knight! So Why Isn't the Market Cheering?
Before getting to the article, let me suggest that at least some of these problems likely stem from CEO superstars trying to live up their own hype. To do so they are forced to take unwise gambles. Moreover, these CEOs often feel above the law and more important that both shareholders and their appointed Board of Directors.
Some quotes from NY Times Article:
* "Investors are often thrilled when well-known outsiders come in as white knights to run a company. But a growing body of evidence suggests that a company will perform better over the long run when it is led by a relatively anonymous insider"
* A "recent study helps to show why. The study, called "Governance and C.E.O. Turnover," was conducted by Ray Fisman and Matthew Rhodes-Kropf, associate professors of economics and finance at Columbia Business School, and Rakesh Khurana, an associate professor of organizational behavior at Harvard Business School. Their study has been circulating since last summer as an academic working paper; a version is at http://ssrn.com/abstract=656085.
Though the professors did not focus specifically on superstar or white-knight chief executives, they did study the pressures that sometimes lead companies' boards to hire them. Specifically, they were interested in the circumstances in which a board could resist shareholder demands to fire the chief because of disappointing performance."
* "From this study and other research, Professor Khurana concludes that when companies hire superstars, the result "more often than not is disappointment or even disaster." "
The NY Times has an interesting article that largely endorses this view: The New York Times Lo! A White Knight! So Why Isn't the Market Cheering?
Before getting to the article, let me suggest that at least some of these problems likely stem from CEO superstars trying to live up their own hype. To do so they are forced to take unwise gambles. Moreover, these CEOs often feel above the law and more important that both shareholders and their appointed Board of Directors.
Some quotes from NY Times Article:
* "Investors are often thrilled when well-known outsiders come in as white knights to run a company. But a growing body of evidence suggests that a company will perform better over the long run when it is led by a relatively anonymous insider"
* A "recent study helps to show why. The study, called "Governance and C.E.O. Turnover," was conducted by Ray Fisman and Matthew Rhodes-Kropf, associate professors of economics and finance at Columbia Business School, and Rakesh Khurana, an associate professor of organizational behavior at Harvard Business School. Their study has been circulating since last summer as an academic working paper; a version is at http://ssrn.com/abstract=656085.
Though the professors did not focus specifically on superstar or white-knight chief executives, they did study the pressures that sometimes lead companies' boards to hire them. Specifically, they were interested in the circumstances in which a board could resist shareholder demands to fire the chief because of disappointing performance."
* "From this study and other research, Professor Khurana concludes that when companies hire superstars, the result "more often than not is disappointment or even disaster." "
Monday, March 28, 2005
The New York Times > Business > Your Money > If I Only Had a Hedge Fund
An artcile on hedge funds that mentions the Counting Crows. It is a lock to get mentioned :)
The New York Times > Business > Your Money > If I Only Had a Hedge Fund: "15 years ago, hedge funds managed less than $40 billion. Today, the figure is approaching $1 trillion. By contrast, assets in mutual funds grew at an impressive but much slower rate, to $8.1 trillion from $1 trillion, during the same period. The number of hedge fund firms has also grown - to 3,307 last year, up 74 percent from 1,903 in 1999. "
"In a way, hedge funds are to mutual funds what Evel Knievel was to weekend motorcyclists. Unlike mutual funds, which are restricted in the ways they can invest, hedge funds can use leverage, trade derivatives and bet that stocks will fall, a technique called shorting."
"A recent report published by Credit Suisse First Boston said that hedge funds were responsible for up to half of all activity in major markets, including the New York Stock Exchange and the London Stock Exchange"
The New York Times > Business > Your Money > If I Only Had a Hedge Fund: "15 years ago, hedge funds managed less than $40 billion. Today, the figure is approaching $1 trillion. By contrast, assets in mutual funds grew at an impressive but much slower rate, to $8.1 trillion from $1 trillion, during the same period. The number of hedge fund firms has also grown - to 3,307 last year, up 74 percent from 1,903 in 1999. "
"In a way, hedge funds are to mutual funds what Evel Knievel was to weekend motorcyclists. Unlike mutual funds, which are restricted in the ways they can invest, hedge funds can use leverage, trade derivatives and bet that stocks will fall, a technique called shorting."
"A recent report published by Credit Suisse First Boston said that hedge funds were responsible for up to half of all activity in major markets, including the New York Stock Exchange and the London Stock Exchange"
Thursday, March 24, 2005
USATODAY.com - Public cool about heart of Bush's Social Security plan
There are things that I just do not understand. From Yesterday's USA Today:
USATODAY.com - Public cool about heart of Bush's Social Security plan: "The heart of President Bush's plan for Social Security, allowing younger workers to create personal accounts in exchange for a lower guaranteed government benefit, is among the least popular elements with the public"
"Younger workers would have the option of investing a portion of their payroll taxes on their own and would receive a lower guaranteed government benefit when they retire. Supporters of the plan argue that earnings on the investments would make up the difference."
Huh? Obviously Social Security is in the news every hour, but somehow people are still not getting the message.
More important than when the money is going to run out (For instance, yesterday we heard that Social Security is probably going to run out of money by 2041), is how low of returns one gets from social security.
Michael Tanner of the Cato Institute writes the following:
Now of course, this does not mean guaranteed. For instance recently the Christian Science Monitor reported the case of Stanley Logue a 1994 retiree who was getting more through social security than he would have had he invested on his own. Why? Timing. He invested when market went sideways or down. But as I tell people all the time, you can not manage to the exception. (indeed, a much more common "exception" can be seen by examining what happens when someone who has paid into the social security system and dies early.)
In a related note, Auburn's Jonathan Godbey (who has been described as a "financial genius"--yeah it was by his wife) recently gave his class a cool assignment. They had to compare how much they could expect under the current plan vs if they were allowed to invest 4% in private accounts. The results of course suggest that private accounts increase retirement income substantially. He will be updating this in the near future by examining it for each year of retirement to capture the magnitude of the Logue Exception.
So what will happen? I have no idea, but do not necessarily disagree with Tom Morgan (who many of you may hear on the radio) who published an interesting article on how he things the reform movement could play out. The short version of his view: higher taxes, lower payments, and a voluntary private account program.
Stay Tuned...
USATODAY.com - Public cool about heart of Bush's Social Security plan: "The heart of President Bush's plan for Social Security, allowing younger workers to create personal accounts in exchange for a lower guaranteed government benefit, is among the least popular elements with the public"
"Younger workers would have the option of investing a portion of their payroll taxes on their own and would receive a lower guaranteed government benefit when they retire. Supporters of the plan argue that earnings on the investments would make up the difference."
Huh? Obviously Social Security is in the news every hour, but somehow people are still not getting the message.
More important than when the money is going to run out (For instance, yesterday we heard that Social Security is probably going to run out of money by 2041), is how low of returns one gets from social security.
Michael Tanner of the Cato Institute writes the following:
"While "the term “rate of return” may be slightly misleading when applied to Social Security. Indeed, some observers object to the entire concept of applying rate-of-return analysis to Social Security....most economists attribute an “implicit” rate of return to Social Security, based on a comparison of a person’s contributions (taxes) and benefits. This rate of return can be summed up as the average interest rate that a person would have to earn on his or her contributions to pay for all of the benefits that he or she will receive from Social Security, or more technically, “the constant discount rate that equates the present discounted value of contributionsThe result of his analysis?
with the present discounted value of benefits.” It is important to note that this rate of return has nothing to do with the interest attributed to “assets” held by the Social Security Trust Fund."
"We can assume that workers retiring today receive a rate of return of approximately 2 percent and that future retirees will receive even lower rates of return."Yes I understand risk aversion, but wow. The people who are against reform must expect to be hit by the sky every time they go outside.
Now of course, this does not mean guaranteed. For instance recently the Christian Science Monitor reported the case of Stanley Logue a 1994 retiree who was getting more through social security than he would have had he invested on his own. Why? Timing. He invested when market went sideways or down. But as I tell people all the time, you can not manage to the exception. (indeed, a much more common "exception" can be seen by examining what happens when someone who has paid into the social security system and dies early.)
In a related note, Auburn's Jonathan Godbey (who has been described as a "financial genius"--yeah it was by his wife) recently gave his class a cool assignment. They had to compare how much they could expect under the current plan vs if they were allowed to invest 4% in private accounts. The results of course suggest that private accounts increase retirement income substantially. He will be updating this in the near future by examining it for each year of retirement to capture the magnitude of the Logue Exception.
So what will happen? I have no idea, but do not necessarily disagree with Tom Morgan (who many of you may hear on the radio) who published an interesting article on how he things the reform movement could play out. The short version of his view: higher taxes, lower payments, and a voluntary private account program.
Stay Tuned...
Wednesday, March 23, 2005
A Defense of Economics
Economics Wins, Psychology Loses, and Society Pays by Max Bazerman, Deepak Malhotra
The short version of the Bazerman and Malhotra chapter is that the authors believe that economics has come to dominate (to the exclusion of other fields) the social sciences and political arena. (Somewhat analogous to the idea that rational economics has dominated in finance to the detriment of psychology and behavioral finance).
The authors identify "five predominant myths, adapted from pervasive economic assumptions, which serve as guiding policy principles and serve to destroy value in society. These myths include:
1) Individuals have stable and consistent preferences
2) Individuals know their preferences and they pursue known preferences with volition
3) Individuals make decisions based on all of the evidence available to them
4) Free markets solve economic problems
5) Credible empirical evidence consists of outcome data, not of mechanism data"
While I have reservations about each of these, I will concede some truth in their views. For instance, Does psychology matter? Undoubtedly (see for instance their discussion of spending increases had the term "bonus" been used instead of "rebate" with respect to taxes).
However I disagree with much of the paper. Rather than being the norm, I would argue that it is only the rare close-minded financial economist who does not understand that other social sciences also have roles to play (even the most ardent of financial economists now concede some things to behavioral finance). That economics, and by extention finance, has become dominant is because it has shown it to be the best way we have of dealing with problems and limited resources.
Are there problems with economics/finance/free markets? Yes. Do some rights get trampled? Yes. Should we consider other models? Sure. Given enough time, we should consider all things, but given limited amounts of time and resources, we could do MUCH worse than relying predominantly on economic principles!
And in that spirit, I hope society grows more (and not less) economic in our thinking. That is not to say growth for growth sake. That is not even to say always growth--retrenchment can be value maximizing. But ideally growth through positive NPV investments. Where all costs and benefits are considered. Why? Because with a proper assigning of property rights (including environmental, intellectual etc), economics does work.
Suggested Citation
The short version of the Bazerman and Malhotra chapter is that the authors believe that economics has come to dominate (to the exclusion of other fields) the social sciences and political arena. (Somewhat analogous to the idea that rational economics has dominated in finance to the detriment of psychology and behavioral finance).
The authors identify "five predominant myths, adapted from pervasive economic assumptions, which serve as guiding policy principles and serve to destroy value in society. These myths include:
1) Individuals have stable and consistent preferences
2) Individuals know their preferences and they pursue known preferences with volition
3) Individuals make decisions based on all of the evidence available to them
4) Free markets solve economic problems
5) Credible empirical evidence consists of outcome data, not of mechanism data"
While I have reservations about each of these, I will concede some truth in their views. For instance, Does psychology matter? Undoubtedly (see for instance their discussion of spending increases had the term "bonus" been used instead of "rebate" with respect to taxes).
However I disagree with much of the paper. Rather than being the norm, I would argue that it is only the rare close-minded financial economist who does not understand that other social sciences also have roles to play (even the most ardent of financial economists now concede some things to behavioral finance). That economics, and by extention finance, has become dominant is because it has shown it to be the best way we have of dealing with problems and limited resources.
Are there problems with economics/finance/free markets? Yes. Do some rights get trampled? Yes. Should we consider other models? Sure. Given enough time, we should consider all things, but given limited amounts of time and resources, we could do MUCH worse than relying predominantly on economic principles!
And in that spirit, I hope society grows more (and not less) economic in our thinking. That is not to say growth for growth sake. That is not even to say always growth--retrenchment can be value maximizing. But ideally growth through positive NPV investments. Where all costs and benefits are considered. Why? Because with a proper assigning of property rights (including environmental, intellectual etc), economics does work.
Suggested Citation
Bazerman, Max and Malhotra, Deepak K., "Economics Wins, Psychology Loses, and Society Pays" (2005). Harvard NOM Working Paper No. 05-07. http://ssrn.com/abstract=683200
Is ICE hot or cold?
Ok, so the joke was really bad, I couldn't resist! (not that I tired...lol)...
Latest News and Financial Information | Reuters.com: "Energy and commodities exchange IntercontinentalExchange Inc., owner of Europe's biggest energy bourse, may raise up to $115 million in an initial public offering of stock, "
As we have often seen, it is not only industrial corporations that go public, more and more often financial markets themselves are selling shares to the public.
Interestingly, even in the ICE's IPO plans, we see some suggestion of market timing:
"ICE, launched in 2000 primarily as an Internet-based platform for trading U.S. power and gas, is hoping to capitalise on rising interest from investors and hedge funds in energy markets, which have lately yielded better returns than other asset classes."
Some other NYMEX news (gee can you guess we are doing derivatives in class next ;) )
The same Reuters article pointed out the ICE is facing competition in Europe (Ireland and now England) from the NYMEX as the NYMEX takes its open outcry market to fill the void left when ICE went to all electronic trading. (As an aside to those of you who went with the Finance Club to the NYMEX this past fall may remember them explaining this reason as why so many of them were "going to Ireland.") Well now that there will sooon be a bigger void in outcry trading, The NYMEX announced they would also open trading in London.
The NYMEX has recently formed a joint venture to open the Dubai Exchange "which aims to offer the world's only benchmark sour crude futures contract, probably will trade in both open-outcry and electronic environments, Nymex officials said."
OK, enough market talk about ICE, I am getting cold! :)
Latest News and Financial Information | Reuters.com: "Energy and commodities exchange IntercontinentalExchange Inc., owner of Europe's biggest energy bourse, may raise up to $115 million in an initial public offering of stock, "
As we have often seen, it is not only industrial corporations that go public, more and more often financial markets themselves are selling shares to the public.
Interestingly, even in the ICE's IPO plans, we see some suggestion of market timing:
"ICE, launched in 2000 primarily as an Internet-based platform for trading U.S. power and gas, is hoping to capitalise on rising interest from investors and hedge funds in energy markets, which have lately yielded better returns than other asset classes."
Some other NYMEX news (gee can you guess we are doing derivatives in class next ;) )
The same Reuters article pointed out the ICE is facing competition in Europe (Ireland and now England) from the NYMEX as the NYMEX takes its open outcry market to fill the void left when ICE went to all electronic trading. (As an aside to those of you who went with the Finance Club to the NYMEX this past fall may remember them explaining this reason as why so many of them were "going to Ireland.") Well now that there will sooon be a bigger void in outcry trading, The NYMEX announced they would also open trading in London.
The NYMEX has recently formed a joint venture to open the Dubai Exchange "which aims to offer the world's only benchmark sour crude futures contract, probably will trade in both open-outcry and electronic environments, Nymex officials said."
OK, enough market talk about ICE, I am getting cold! :)
Tuesday, March 22, 2005
SSRN-Sharpening Sharpe Ratios by William Goetzmann, Jonathan Ingersoll, Matthew Spiegel, Ivo Welch
SSRN-Sharpening Sharpe Ratios by William Goetzmann, Jonathan Ingersoll, Matthew Spiegel, Ivo Welch
Measuring fund manager performance is not as easy as it sounds. Sure you know the basic measures: Sharpe Ratio, Treynor measure, and Jensen's alpha.
There really has been no good solution to this. Indeed in Robert Strong's Portfolio Construction, Management, and Construction Text, he concludes a discussion on the topic with a true, but unsatisfying statement:
The paper then shows how these biases can be "gamed" by fund managers using options to take advantage of the limitations of the Sharpe Ratio. Once this is established, the authors develop a "manipulation-free" measure.
While on simplicity grounds alone, I doubt the new measure will be a big hit in undergrad classes, it definitely addresses the key attributes that a new measure should have. To understand the derivation, I recommend you read the paper. :) I tried to copy the equation in (equation 30) but I could not paste it and have top get to class now...sorry...
Suggested Citation
Measuring fund manager performance is not as easy as it sounds. Sure you know the basic measures: Sharpe Ratio, Treynor measure, and Jensen's alpha.
Sharpe: (Return-Risk Free)/ Standard DeviationBut each measure has its problems. For instance as far back as the early 1980s, financial economists (including Henricksson and Merton 1981) showed that the Sharpe Ratio could be a poor measure in the presence of "non-linear payoffs".
Treynor: ( Return-Risk Free)/ Beta)
Jensen's Alpha: Return = RF + Beta (Market Risk Premium) + Alpha
There really has been no good solution to this. Indeed in Robert Strong's Portfolio Construction, Management, and Construction Text, he concludes a discussion on the topic with a true, but unsatisfying statement:
"We have numerous analytical tools and we have a brain; we should use both in evaluating the performance of a portfolio."In Sharpening Sharpe Ratios, William Goetzmann, Jonathan Ingersoll, Matthew Spiegel, and Ivo Welch discuss the problems of the traditional performance appraisal methods and show that this is particulary troubling with the widespread use of derivatives (because their payoffs are inherently non-linear).
The paper then shows how these biases can be "gamed" by fund managers using options to take advantage of the limitations of the Sharpe Ratio. Once this is established, the authors develop a "manipulation-free" measure.
While on simplicity grounds alone, I doubt the new measure will be a big hit in undergrad classes, it definitely addresses the key attributes that a new measure should have. To understand the derivation, I recommend you read the paper. :) I tried to copy the equation in (equation 30) but I could not paste it and have top get to class now...sorry...
Suggested Citation
Goetzmann, William N., Ingersoll, Jonathan E., Spiegel, Matthew I. and Welch, Ivo, "Sharpening Sharpe Ratios" (November 2004). Yale ICF Working Paper No. 02-08; AFA 2003 Washington, DC Meetings. http://ssrn.com/abstract=302815
Monday, March 21, 2005
A look at IPO price stabilization by Lewellen
Katharina Lewellen provides is an interesting look at price stabilization in the IPO market.
Price stabilization is the practice of investment bankers going into the secondary market to support the price of newly issued shares. There has been much debate in the academic literature as to the rationale and the extent of this practice. For instance, is it a reward to institutional investors as some previous researchers (e.g. Chowdry and Nanda 1996) suggest? Or a means of helping the syndicate sell shares? Or some combo of each? One problem with these studies is that there is little publicly available data on the stabilization activities.
In her forthcoming JF article, Lewellen sheds light on this practice using a proprietary data set from the NASDAQ. She finds
Previous papers have suggested that stabilization is partially a substitute for underpricing as a means of handling information asymmetries. It is somewhat surprising therefore when Lewellen finds little support for this:
The forthcoming JF version of the paper is available for a short time. A previous version is available from SSRN.
Price stabilization is the practice of investment bankers going into the secondary market to support the price of newly issued shares. There has been much debate in the academic literature as to the rationale and the extent of this practice. For instance, is it a reward to institutional investors as some previous researchers (e.g. Chowdry and Nanda 1996) suggest? Or a means of helping the syndicate sell shares? Or some combo of each? One problem with these studies is that there is little publicly available data on the stabilization activities.
In her forthcoming JF article, Lewellen sheds light on this practice using a proprietary data set from the NASDAQ. She finds
"that underwriters accumulate large inventories of cold IPOs on the first day of trading, consistent with price support. Stock prices are extremely rigid at and below the offer price, in the sense that it requires large selling pressure to induce a price decline. For example, if a stock opens the first day at the offer price, marketmakers repurchase, on average, 6.0% of shares offered before they allow the bid to drop. The corresponding number is 2.1% for IPOs that open below the offer price, and only 0.4% for stocks that open above the offer price.What is weird however is that once stabilization ends, the stock prices do not seem to fall. This suggests that, as investment bankers claim, stabilization is only a temporary support to allow the market to develop. (or as the author points out, it cold also be that the investment bankers have inside information and only support those stocks that in fact are not overpriced.)
Previous papers have suggested that stabilization is partially a substitute for underpricing as a means of handling information asymmetries. It is somewhat surprising therefore when Lewellen finds little support for this:
"A natural empirical implication is that, other things equal, stocks with more information asymmetries should exhibit more underpricing or stronger price support. I do not find support for this hypothesis. Instead, price support appears strongest for IPOs that are less risky,... and for IPOs underwritten by larger, moreAnother surprising finding is that investment banks with large retail operations tend to engage in more stabilization. This runs counter to previous papers. Lewellen offers several explanations:
reputable underwriters. A story that is consistent with these findings is that while underwriters avoid stabilizing risky IPOs, large underwriters absorb inventory risk better and, hence, stabilize more strongly. However, Aggarwal (2000) finds that underwriters usually oversell the issue and begin the first day of trading with a short position.....Alternatively, large underwriters may be more willing to support overpriced IPOs to protect their reputation with investors.
Consistent with the reputation hypothesis, I find that underwriters stabilize less
extensively on days when the stock market is doing poorly, that is, when the weak IPO performance can be attributed to market-wide events outside the underwriter’s control."
"First, retail banks might value price support because it allows them to discriminate among investors: A promise to repurchase weak IPOs can be targeted to specific investors. Second, Hanley, Kumar, and Seguin (1993) suggest that underwritersDefinitely an interesting and important paper!
support prices to disguise weak offerings from initial investors. If such tactics indeed take place, they are probably targeted at unsophisticated investors, and therefore may be favored by retail banks. Third, it is possible that retail banks suffer larger reputational damage from ex post overpriced IPOs."
The forthcoming JF version of the paper is available for a short time. A previous version is available from SSRN.
Sunday, March 20, 2005
Rodney Paul at Forbes.com: Ten Betting Tips For March Madness
Forbes.com: Ten Betting Tips For March Madness
Rodney Paul is in Forbes again. This time for his comments on betting on the NCAA basketball tourney. SHort version: market is pretty efficient. But don't take my word for it, watch the video--No it is not of him.
I am convinced that NCAA pools can tell us quite a bit about stock market investing. For instance, if we acknowledge the existence of the value anomaly, then one explanation is that these out of favor stocks are boring and you miss picking the bragging rights of being able to talk about them. The same holds true with pools. Picking the top seed yields the highest expected number correct, but you miss the excitement of picking the Vermonts and Bucknells.
Want a much better explanation of this idea and how it is impacts financial markets? William Bernstein (yes the author) does a great job in his INEPT model.
Rodney Paul is in Forbes again. This time for his comments on betting on the NCAA basketball tourney. SHort version: market is pretty efficient. But don't take my word for it, watch the video--No it is not of him.
I am convinced that NCAA pools can tell us quite a bit about stock market investing. For instance, if we acknowledge the existence of the value anomaly, then one explanation is that these out of favor stocks are boring and you miss picking the bragging rights of being able to talk about them. The same holds true with pools. Picking the top seed yields the highest expected number correct, but you miss the excitement of picking the Vermonts and Bucknells.
Want a much better explanation of this idea and how it is impacts financial markets? William Bernstein (yes the author) does a great job in his INEPT model.
Saturday, March 19, 2005
Signs of spring and market efficiency!
Sure signs of Spring: spring training, seeing robins, March Madness, now finance articles about baseball! (ok, so the last one is a stretch).
Hakes and Sauer (yes the same Skip Sauer who has the excellent Sports Economist Blog) have an interesting paper that looks at the premise of Michael Lewis' Moneyball book. WHat makes the paper interesting is what it says about markets in general.
For those of you who have not read Moneyball (I highly recommend it by the way), the basic story is about whether stats and computers can be used to effectively take advantage of inefficiencies in the baseball player market. It is centered around the Oakland A's GM Billy Beane who was an early adaptor of the technological/statistical approach) and very succesful at building the A's into a winning organization for millions less than other teams.
The paper's findings? "support Lewis's argument that the valuation of different skills was inefficient in the early part of this period, and that this was profitably exploited by managers with the ability to generate and interpret statistical knowledge. This knowledge became increasingly dispersed across baseball teams during this period. Consistent with Lewis's story and economic reasoning, the spread of this knowledge is associated with the market correcting the original mis-pricing. "
So how does this matter from an efficient markets perspective? It shows that markets do evolve and learn. This suggests that occasionally (with new technology--either electronic, mathmatical, operational, or financial) it may be possible to earn abnormal returns but that the success will quickly be copied and the abnormal returns will likely disappear. Given that financial markets have low barriers to entry and hence many participants, this can explain why financial markets are so difficult to beat.
Suggested Citation: Hakes, Jahn Karl and Sauer, Raymond D. "Skip", "An Economic Evaluation of the Moneyball Hypothesis" (November 3, 2004). http://ssrn.com/abstract=618401
Hakes and Sauer (yes the same Skip Sauer who has the excellent Sports Economist Blog) have an interesting paper that looks at the premise of Michael Lewis' Moneyball book. WHat makes the paper interesting is what it says about markets in general.
For those of you who have not read Moneyball (I highly recommend it by the way), the basic story is about whether stats and computers can be used to effectively take advantage of inefficiencies in the baseball player market. It is centered around the Oakland A's GM Billy Beane who was an early adaptor of the technological/statistical approach) and very succesful at building the A's into a winning organization for millions less than other teams.
The paper's findings? "support Lewis's argument that the valuation of different skills was inefficient in the early part of this period, and that this was profitably exploited by managers with the ability to generate and interpret statistical knowledge. This knowledge became increasingly dispersed across baseball teams during this period. Consistent with Lewis's story and economic reasoning, the spread of this knowledge is associated with the market correcting the original mis-pricing. "
So how does this matter from an efficient markets perspective? It shows that markets do evolve and learn. This suggests that occasionally (with new technology--either electronic, mathmatical, operational, or financial) it may be possible to earn abnormal returns but that the success will quickly be copied and the abnormal returns will likely disappear. Given that financial markets have low barriers to entry and hence many participants, this can explain why financial markets are so difficult to beat.
Suggested Citation: Hakes, Jahn Karl and Sauer, Raymond D. "Skip", "An Economic Evaluation of the Moneyball Hypothesis" (November 3, 2004). http://ssrn.com/abstract=618401
Wednesday, March 16, 2005
Air Grasso??
New York Post Online Edition: business: "Former New York Stock Exchange chairman Dick Grasso turned the Big Board's corporate jet into Air Grasso."
It seems like it is 2003 all over again: not only is Worldcom front and center , Eliot Spitzer is investigating firms, and Richard Grasso is back in the news.
Why? There is now evidence that he used the NYSE's corporate jet as his family's own jet. FWIW the family seemed to be partial to Miami.
How did this come to light now? "Grasso's alleged use of the NYSE jet for personal reasons came up when Attorney General Eliot Spitzer asked Grasso to turn over his tax returns for the years 1995 through 2003.
Spitzer is trying to determine how much Grasso earned during those years, both from the NYSE and other sources, such as Grasso's time spent on the Board of Home Depot."
It seems like it is 2003 all over again: not only is Worldcom front and center , Eliot Spitzer is investigating firms, and Richard Grasso is back in the news.
Why? There is now evidence that he used the NYSE's corporate jet as his family's own jet. FWIW the family seemed to be partial to Miami.
How did this come to light now? "Grasso's alleged use of the NYSE jet for personal reasons came up when Attorney General Eliot Spitzer asked Grasso to turn over his tax returns for the years 1995 through 2003.
Spitzer is trying to determine how much Grasso earned during those years, both from the NYSE and other sources, such as Grasso's time spent on the Board of Home Depot."
A quick look at the Bernie Ebbers case
Of course there is just a ton of coverage on the Bernie Ebbers' conviction today. If you have somehow missed it: He was found guilty on all charges and faces up to 85 years in jail (although USAToday reports 25 years is more likely.
Some interesting quotes from various sources:
USAToday:
- "John Coffee, an expert in securities law at Columbia University. "But the 'CEO as dupe' defense did not sell. Ultimately, the jury did not believe Ebbers."
- "The jury clearly concluded that the testimony of Mr. Sullivan was more credible than that of Mr. Ebbers, even though the jurors did not fully believe Mr. Sullivan either, according to Peter Nulty, the father of Sarah Nulty, juror No. 10. Mr. Nulty posted his daughter's views of the jury's deliberations at estrong.com, a financial newsletter's Web site, last night, writing that "no one on the jury trusted the testimony of the prosecution's star witness."
- "Clearly any one of these individuals is looking at these trials and this verdict and thinking 'My god. What is going to happen to me?'" said Stanley Twardy, a former U.S. attorney in Connecticut who is now a partner in Day, Berry & Howard."
Tuesday, March 15, 2005
Why do firms go public?
In a piece of fortuitous timing given that last night in class we began a section on raising capital and IPOs, today's NY Times DealBook mentions two firms that are selling shares so that the firms' current owners can cash out a portion of their shares.
- From the NY Post: "National Lampoon Inc., the media company that cast comedian John Belushi as an irreverent fraternity boy in "Animal House" in 1978, is planning an $8 million stock sale designed to raise its profile on Wall Street and finance the buyout of a former owner." As an aside, the hope to list shares on the American and Pacific exchanges.
- And from the Guardian: "Stead & Simpson, the British shoe seller that can trace its lineage back 171 years, is considering a return to the London stock market as its main shareholder looks for an exit."
Monday, March 14, 2005
Where have you been?
Sorry for the infrequent posts of late. I made and gave out 4 tests last week. Coupled with three papers in various states of completeness, I just have been a bit short on time. But the tests are done (and graded), one of the papers is 99.9% done, and I should be back to a more normal schedule later today. (I hope :) ) Sorry for any inconvenience!
jim
jim
Wednesday, March 09, 2005
A Non-Technical Introduction to Brownian Motion by Don Chance
A Non-Technical Introduction to Brownian Motion
Wow--I wish I had had this during the Financial Econometrics class at Penn State. I was quite lost for the better part of the semester in that one! I have since made some sense of it, but the description from Financial Engineering News by Don Chance is a nice review and description! Definitely recommended!
Wow--I wish I had had this during the Financial Econometrics class at Penn State. I was quite lost for the better part of the semester in that one! I have since made some sense of it, but the description from Financial Engineering News by Don Chance is a nice review and description! Definitely recommended!
Tuesday, March 08, 2005
Accounting games: How Banks Pretty Up The Profit Picture
Commentary: How Banks Pretty Up The Profit Picture
Need another example of why cash flow matters more than accounting numbers? BusinessWeek and the Financial Accounting Blog provide us with examples of how banks can play with their loan loss reserves to "manage" their earnings.
Need another example of why cash flow matters more than accounting numbers? BusinessWeek and the Financial Accounting Blog provide us with examples of how banks can play with their loan loss reserves to "manage" their earnings.
Thursday, March 03, 2005
FRB: Testimony, Greenspan --Economic outlook and current fiscal issues-- March 2, 2005
Network television executives must hate me. I almost never see anything on their networks except sports, but I am watching Cspan at 1:40 AM. Why? Because Alan Greenspan is talking! Most of his talk (and definitely the Q&A session that followed his remarks) focused on social security reform.
Short version? The economy is strong but deficits (including budget, social security, and Medicare) pose significant threats.
FRB: Testimony, Greenspan --Economic outlook and current fiscal issues-- March 2, 2005:
Short version? The economy is strong but deficits (including budget, social security, and Medicare) pose significant threats.
FRB: Testimony, Greenspan --Economic outlook and current fiscal issues-- March 2, 2005:
"I fear that we may have already committed more physical resources to the baby-boom generation in its retirement years than our economy has the capacity to deliver. If existing promises need to be changed, those changes should be made sooner rather than later. We owe future retirees as much time as possible to adjust their plans for work, saving, and retirement spending. They need to ensure that their personal resources, along with what they expect to receive from the government, will be sufficient to meet their retirement goals.Well said!
Addressing the government's own imbalances will require scrutiny of both spending and taxes. However, tax increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risks to economic growth and the revenue base."
Wednesday, March 02, 2005
A daily review of the Wall Street Journal (European version) and The Financial Times
Review of the Financial Press
Don't have time to read both the WSJ and the FT? Then I have a free solution! Vincent Colot summarizes some of the most interesting articles from both the Wall Street Journal Europe and the Financial Times. It is updated every morning.
Oh yeah, it is in French. Can't read French? Google's translation service does a manageable job.
Don't have time to read both the WSJ and the FT? Then I have a free solution! Vincent Colot summarizes some of the most interesting articles from both the Wall Street Journal Europe and the Financial Times. It is updated every morning.
Oh yeah, it is in French. Can't read French? Google's translation service does a manageable job.
SSRN-Psychological Barriers in Gold Prices? by Raj Aggarwal, Brian Lucey
The momentum for behavioral finance continues with a look at the importance of barrier prices in the Gold Market.
SSRN-Psychological Barriers in Gold Prices? by Raj Aggarwal, Brian Lucey
Aggarwal and Lucey "[present] evidence of psychological barriers in gold prices. [They] document that prices in round numbers act as barriers with important effects on the conditional mean and variance of the gold price series around psychological barriers."
At the risk of making some authors (who claim that these barriers are merely equilibrium outcomes) upset, the actual price of a security should not matter. For instance why is 10,000 any different than 10,040; the price should move through each with the same ease. However, most practioners claim that this is not the case.
In Aggarwal and Lucey's words:
Suggested Citation
SSRN-Psychological Barriers in Gold Prices? by Raj Aggarwal, Brian Lucey
Aggarwal and Lucey "[present] evidence of psychological barriers in gold prices. [They] document that prices in round numbers act as barriers with important effects on the conditional mean and variance of the gold price series around psychological barriers."
At the risk of making some authors (who claim that these barriers are merely equilibrium outcomes) upset, the actual price of a security should not matter. For instance why is 10,000 any different than 10,040; the price should move through each with the same ease. However, most practioners claim that this is not the case.
In Aggarwal and Lucey's words:
"If gold markets are rational and efficient, we should not expect to see any psychological price barriers. However, significant numbers of commentators attribute particular levels of the gold bullion price as being ‘barriers’ or ‘support levels’ or in some other manner as being intrinsically more ‘important’ than other price levels."Existing research has largely focused on equities and have found that there is some empirical existence for such psychological barriers.
"(see (R. G. Donaldson & Kim, 1993), (R. Glen Donaldson, 1990a, 1990b)) a variety of equity markets (not, however the Nikkei or the Wiltshire indices) are shown to deviate from this [uniform distribution] assumption"Looking at the gold market by using both tests of uniformity and looking for barrier prices, Aggrawal and Lucey find:
"psychological barriers at the 100’s digits (price levels such as $200, $300 etc) do exist in daily gold prices....We find some significant evidence of changes in conditionalVERY INTERESTING!
means around psychological barriers. However, we document very strong evidence of changes in the variances of returns in the vicinity of and when crossing psychological price barriers in gold markets.
Suggested Citation
Aggarwal, Raj and Lucey, Brian M., "Psychological Barriers in Gold Prices?" (January 2005). Institute for International Integration Studies Discussion Paper No. 53. http://ssrn.com/abstract=669761
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