SSRN-Facts and Fantasies about Commodity Futures by K. Rouwenhorst, Gary Gorton

SSRN-Facts and Fantasies about Commodity Futures by K. Rouwenhorst, Gary Gorton

If you talk to most investors, they consider investments as only stocks and bonds. However, other assets should also be considered. For example real estate and commodities can be very useful as ways of reducing risk.

Why are commodities so important? They play an important role in diversifying a portfolio. For instance, Rouwenhorst and Gorton find that "While the risk premium on commodity futures is essentially the same as equities, commodity futures returns are negatively correlated with equity returns and bond returns."

Which of course is ideal from a diversification perspective! :)

Rouwenhorst, K. Geert and Gorton, Gary B., "Facts and Fantasies about Commodity Futures" (June 14, 2004). Yale ICF Working Paper No. 04-20. http://ssrn.com/abstract=560042

CBC News: Gene therapy turns lazy monkeys into workaholics

CBC News: Gene therapy turns lazy monkeys into workaholics

Compensation (which is essentially reward for work) is one of my favorite topics in finance. So of course this story on monkeys made me take notice!

Short version: how hard you work may be partially genetic. Which might help to explain why some people do not respond to changes in pay plans etc.

From the CBC:
"Without the dopamine receptor, they consistently stayed on-task and made few errors, because they could no longer learn to use visual cues to predict how their work was going to get them a reward," said Richmond said.

In effect, the monkeys became workaholics. "This was conspicuously out-of-character for these animals," he said.

Both monkeys and humans tend to procrastinate when they know they have to do more work before getting a reward, and then work harder as a deadline looms.

The researchers hope the study will help them to understand some mental disorders. People who are depressed often find work unrewarding while those with obsessive-compulsive disorder may work incessantly for little reward.

The study appears in this week's online issue of the Proceedings of the National Academy of Sciences"


Also :
http://www.abc.net.au/news/newsitems/200408/s1175369.htm
http://news.bbc.co.uk/2/hi/science/nature/3557310.stm

gee, this would make a perfect Dilbert episode!

SSRN-The Rational-Behavioral Debate in Financial Economics by Alon Brav, James Heaton , Alex Rosenberg

SSRN-The Rational-Behavioral Debate in Financial Economics by Alon Brav, James Heaton , Alex Rosenberg

Looking for a finance paper without complex models or rigorous math? This is it! Brav, Heaton, and Rosenberg discuss the debate over behavioral finance and conclude that neither side is totally correct.


Most of the existing debate centers on findings of apparent irrationality (example over trading, over confidence, price bounces, etc). The behavorialists find this anomaly and then the rationalist attempts to explain it in the context of rationality. Thus, when something that apparently does not jive with rationality, it must be that the model that the researcher is using must be incorrect.

In what is the paper's biggest contribution, Brav, Heaton, and Rosenberg correctly point out that in doing this, rationalists are making an implicit assumption, namely that people are rational. And this assumption, which may or may not be valid, flies in the face of what Milton Friedman position that the key part of any positive science is its predictive ability.

"The most controversial consequence of Friedman's approach is' the idea that the
realism of "assumptions" is irrelevant to the assessment of a theory follows
from the primacy of predictive success. Put simply, those who worry about the
realism of assumptions unnecessarily constrain the 'proper' objective function
of a predictive science. Since that constraint may eliminate highly
'unrealistic' assumptions that nevertheless maximize predictive power, the
constraint hinders the 'ultimate goal of a positive science' and is therefore
ill-advised. "

However, as the authors point out this lack of assumption importance is not the case. "Rather, rational finance seeks to 'explain' price behavior with coherent stories based on a constrained portion of the assumption space-- that portion that includes only assumptions consistent with complete rationality."

(As an aside, the section by Mark Rubenstein is very good! Short version?: When I went to financial economist training school I was taught 'the Prime Directive': explain asset pricing by rational models. Only if all attempts fail, resort to irrational behavior. That is, as a trained financial economist, with the special knowledge about financial markets and statistics that I had gained and aided by the new high tech computers, databases and software, I must be careful how I used my power. Whatever else I did, I should follow the Prime Directive." Which while funny, is not that far from the truth. )

Following this opening, the authors shoot down most of the so-called successes of rational finance (no arbitrage, market efficiency, and NPV) as lacking predictive success or as being untestable (reversing the traditional attack on behavioral finance). The big success of rational finance? "the relative success of predictive models in derivative pricing is undeniable. Tellingly, derivative pricing theory may be the only theoretical endeavor in which assumptions regarding market structure are reasonably 'realistic'.

Moreover, many of these failures are derived (no pun intended) from institutional particularites that do limit the ability of participants (even those who are behaving rationally) from acting as so called rationalists would expect. Thus "the very flexibility of rational modeling that may help support the
existence of irrationality-induced anomalies in financial markets"

The authors conclude with a desire for a peace.

"Taunts traded by each side in the rational-behavioral debate are often both
inconsistent and unconstructive. Rational finance advocates have long criticized
behavioral finance for lacking novel and quantifiable predictions of financial
market behavior. But rational finance itself has few achievements of that sort.
At the same time, behavioral finance advocates criticize the effort to
'rationalize' behavior by factoring information sets, utility functions, and
transactions costs into the rational choice model [see De Bondt (2002)].
Behavioral finance advocates are perhaps right to criticize the flexibility of
the rational apparatus. But they go too far when they deny the role that
'rationalization' plays in supporting the limits of arbitrage."

[....]

"At the end of the day, however, the pretended debate over 'testability'
and 'prediction' often hides the real successes and failures of both sides,
and masks the interesting but unexplored links between the two approaches."

I told you it would get you thinking! :)

Source:
Brav, Alon, Heaton , James Breckinridge and Rosenberg, Alex, "The Rational-Behavioral Debate in Financial Economics". Journal of Economic Methodology, Forthcoming http://ssrn.com/abstract=473807

SSRN-How the Inflation Illusion Killed the CAPM by Randolph Cohen, Christopher Polk, Tuomo Vuolteenaho

SSRN-How the Inflation Illusion Killed the CAPM by Randolph Cohen, Christopher Polk, Tuomo Vuolteenaho

Wow! It seems like I say that frequently, but what this paper definitely deserves a wow.

CAPM is dead. We know that. Only the most optimistic of those (myself included) hold out hope of its recovery.

Its death has been widely reported since Fama and French (1992). However, that does more to say that CAPM is dead, not why or how it died.

The CAPM had been on its sickbed for years. Looking back we see the evidence. In addition to a slew of anomalies (size, market to book, calendar to name but a few), there was more serious trouble in the findings that suggested CAPM worked sometimes and didn’t work at other times. For instance CAPM did a bad job of explaining returns in the in the 1950s and in the post 1980 period. Additionally, previous literature (for instance Black, Jensen, and Scholes (1972) had found the empirical SML to be flatter than expected and to have an intercept (zero beta portfolio return) that is greater than the Risk Free rate.

Maybe, just maybe we now know some of the details of CAPM’s death thanks to the work of the great detectives Cohen, Polk, and Vuolteenaho (who are in reality professors but will play the role of detectives in this report). They released their findings in the paper “How the Inflation Illusion Killed the CAPM.” (http://papers.ssrn.com/abstract=548402)

The short version of the work is as follows:

To set the stage a bit: remember that the Expected market risk premium is the expected return on the market minus the expected inflation rate (which is largely the risk-free rate). So (ERm – RF) equals the expected market risk premium.

They begin off by further investigating Modigliani and Cohn’s 1979 suggestion that the market incorrectly values assets because of irrationally accounting for expected inflation rates. While this irrationality was difficult to accept when the M&C paper was published in 1979, there has been enough time-series evidence since that time to make the hypothesis more palatable (Sharpe 1999, Asness (2000), Campbell and Vuolteenaho (2004) etc.).

In simple terms, Modigliani and Cohn (1979) stated that investors irrationally accounted for inflation by overemphasizing recent inflation rates. Thus, when inflation is high, investors expect inflation to remain high. This is ok as far as it goes, but the error comes when they (the investors) fail to realize that earnings will also grow with inflation. Consequentially, when inflation is high, the market risk premium is too low (since the expected inflation rate is subtracted in the risk premium calculation).

To test this, the authors (err detectives) “propose a behavioral hypothesis that the market uses the Sharpe-Lintner Capital Asset Pricing Model (CAPM, Sharpe 1964, Lintner 1965) but suffers from inflation illusion.” They then proceed to “ show that an implication of this joint hypothesis is that the security market line (the relation between an asset’s average return and its CAPM beta) is steeper [i.e there is a larger risk premium] than predicted by the Sharpe-Lintner CAPM when inflation is low or negative. Conversely, when inflation is high, the security market line is shallower [i.e. there is a smaller risk premium] than the Sharpe-Lintner CAPM’s prediction.”

The results? Sure enough, the empirical evidence supports the hypothesis of Modigliani and Cohn. And the author/detectives conclude that “we find that the CAPM fails predictably with inflation, consistent with the Modigliani-Cohn inflation illusion hypothesis.”

So what does this all mean? For starters, we may have an important piece of the puzzle as to how assets are priced. Moreover, there is more evidence that investors are not always perfectly rational and that they may over emphasize recent conditions.

A question that merits future attention is whether this finding could help to explain the growth and value anomalies. For example, if value stocks do better when the economy is doing well (and hence inflation may be higher), is the apparent outperformance a market problem or a model problem? I do not know but definitely look forward to finding out!

BTW this is definitely going to be required reading for my classes, I hope you read it as well and do not just rely on this review.

As an aside, Richard Cohen (yes one of the authors) sugggested the following which makes the paper more readily understandable:

"One point might be worthy of clarification if it can be done without making things too complicated. It's not that investors are wrong to assume inflation will be similar to recent inflation. Their mistake is forgetting that earnings will go up with inflation. Thus if T-Bills pay 12% because of 10% expected inflation, and earnings yields are at 11%, investors look and say, hey, the (safe) T-Bill return beats the yield available in the market [I'm oversimplifying here]; let's sell our stocks and buy T-Bills." They should be saying, "not only do stocks yield 10%, but the earnings will grow at 11% next year because of high inflation, making stocks very attractive indeed." "

SOURCE:
Cohen, Randolph B., Polk, Christopher Keith and Vuolteenaho, Tuomo , "How the Inflation Illusion Killed the CAPM" (May 12, 2004). http://ssrn.com/abstract=548402

A newer version of this, entitled "How Inflation Illusion Killed CAPM" is available at
http://post.economics.harvard.edu/faculty/vuolteenaho/papers/csinf20040717.pdf

The New York Times > Washington > Crucial Unpaid Internships Increasingly Separate the Haves From the Have-Nots

The New York Times > Washington > Crucial Unpaid Internships Increasingly Separate the Haves From the Have-Nots


I can not stress enough the importance of internships. They are critical in getting a permanent job. Internships provide valuable experience that serve both as a learning experience and a test job. I definite;y recommend that any student get one (or more) before they graduate. That said, non paying internships do make for difficult decisions: take a job that pays or an internship that will pay off in the future.

The NY Times reports on internships by correctly stating that internships continue to increase in importance: "The focus on internships as a tool for professional success has never been greater, according to Mark Oldman, co-author of "The Internship Bible" and co-founder of Vault Inc., a career counseling company. About 80 percent of graduating college seniors now have done a paid or unpaid internship, according to surveys by Vault, compared with about 60 percent a decade ago. "

"The interest in internships is at a fever pitch," Mr. Oldman said. "It used to be that internships used to be a useful enhancement to one's résumé. Now it's universally perceived as an essential stepping stone to career success"

However, the article points out that non-paying internships are particularly difficult for those from lower economic classes who need a paying job. "As internships rise in importance as critical milestones along the path to success, questions are emerging about whether they are creating a class system that discriminates against students from less affluent families who have to turn down unpaid internships to earn money for college expenses"

http://www.nytimes.com/2004/08/10/politics/10interns.html

BW Online | August 9, 2004 | Oil Prices Could Get Even Worse

Business Week speculates that we could see $50 a barrel oil sooner than we expect.

Why? Demand increases as well as production limits brought about not so much by OPEC but by not having excess capacity in the production of more oil. This lack of capacity is in part driven by lack of investment in the past, in part due to political turmoil, and partially because of OPEC's production limits. With this little excess, any small problem would quickly be magnified and it would lead to higher oil prices.

What would higher oil prices do? For starters, higher prices would slow the economy. For instance, the BBC reports current prices could already be "[shaving] as much as half a percentage point off global growth."
http://news.bbc.co.uk/1/hi/business/3546248.stm

Longer term however, higher prices would also encourage the market-driven development of alternative energy sources. It is for this reason that some in OPEC are beginning to worry.


http://www.businessweek.com/bwdaily/dnflash/aug2004/nf2004086_1412_db039.htm

BBC NEWS | Business | First Islamic bank to open in UK

BBC NEWS Business First Islamic bank to open in UK

Well it took a long time, but finally the first purely Islamic Bank is set to open in the UK. Of course, traditional British banks have been offering some "products tailored for Muslims".

The biggest difference between traditional Western banking and Islamic Banking is the absence of Interest. Consequentially the banks have to come up with alternative ways to make money. They do this with leasing and arrangements similar to repurchase agreements.


For more in Islamic Finance (including its relation to socially responsible investing), please check the notes I use for my International Finance Classes. The notes were developed with the help of my friend Luma Zetani.

The New York Times > Financial Times > International Accounting Reform is on the way :)

The New York Times > Financial Times > Business > Hand that guides EU accounting reform


The New York Times > Financial Times > Business > Hand that guides EU accounting reform: "More than 7,000 listed companies in the EU will use international accounting standards, in what will be the biggest accounting reform in Europe for a generation"


John Tiner, the chairman of the Committee of European Securities Regulators' financial reporting group is interviewed in the Financial Times today. He is the regulator in charge of helping to guide EU members' accounting regulation.

Short version: some reform and standardization are on the horizon, but not complete standardization. As anyone who has ever looked over international financial statements will vouch, more standardization is necessary! Standardized accounting systems will increase transparency, lower transaction costs, and allow international investing to increase. While this it is not the end of the story, but it is a step in the right direction!


A few highlites from article:

* "Mr Tiner's CESR group is focused on how to ensure the 25 EU countries have strong enforcement bodies that can spot and correct accounting abuses"

* "The biggest challenge is how to prevent the emergence of 25 versions of international accounting standards. This could happen if the bodies make significantly different interpretations of the 36 international standards"

* "Mr Tiner does not rule out the possibility of a pan-European enforcement body emerging"


Source:
http://www.nytimes.com/financialtimes/business/FT20040808_13220_64359.html

SSRN-Lifetime Earnings, Social Security Benefits, and the Adequacy of Retirement Wealth Accumulation by Eric Engen, William Gale, Cori Uccello

SSRN-Lifetime Earnings, Social Security Benefits, and the Adequacy of Retirement Wealth Accumulation by Eric Engen, William Gale, Cori Uccello: "Engen, Galle, and Uccello provide new evidence on the adequacy of household retirement saving." Their findings may surprise some given the gloom and doom reporting by many in the popular press.

Short Version: the wealthy and middle class largely are saving enough, but the poor are not.


Longer version: It is no secret that "The United States has traditionally depended on the so-called three-legged stool -- Social Security, private pensions, and additional personal saving -- to finance retirement, but all three legs are becoming increasingly creaky. " So Engen, Galle, and Uccello provide a valuable service when they investigate (via simulation) the degree to which the "additional personal savings" leg is up to the task of filling in any gaps that may (will?) exist after pensions and social security.

The paper is remarkably thorough and well done in investigating everything from tax rates, to death rates, to savings rates, to returns on investment, to the optimal color of kitchen sinks (ok, you got me there, just wanted to make sure people were still reading :) )

Not surprisingly they find the wealthy are doing fine with respect to savings. Somewhat surprisingly, the middle income earners seem to be doing OK as well. The poorest 25% of the population however is not saving enough (SHOCK!).

In possibly the biggest contribution of the paper, it acknowledges that life is risky. Doing so forces the researcher to incorporate this randomness into any analysis. This makes for a much more robust and complete model.

A further consequence of the risk is that people do not know exactly how much to save and that some people may not be able to save as much as they had planned. In the words of the authors: "in a stochastic life-cycle model that allows for uncertainty in earnings and mortality. Uncertainty about future earnings implies that there will be a distribution of optimal wealth-earnings ratios, rather than a single benchmark ratio, among households that are otherwise observationally equivalent (that is, have the same age, education, pension status, marital status, and wage history). This finding fundamentally changes the interpretation of observed saving patterns relative to a non-stochastic model. In particular, it implies that some households should be expected to exhibit low ratios of wealth to lifetime earnings even if every households is forward-looking and making optimal choices."

Of course, everyone wants to know what would happen in the event of a cut in social security. The authors test this and find that a cut would be harmful to those without enough savings (really!?).

More shocking is their claim that "The overall effect of a 30 percent social security benefit reduction is several times as large as the effects of a 40 percent reduction in stock market values." (FTR they unfortunately have seemingly ignored the economic effects of a 40% drop in stock value. (Example it would also impact pensions, income, etc)). Predictably, they find that a 40% decline in stock values would not impact all families equally:

1. "There is essentially no effect on highly-educated households".
2. "The change would hit moderate earnings households particularly hard."

Overall: An important paper that should take some of the fear out of retirement savings discussions.



http://papers.ssrn.com/sol3/papers.cfm?abstract_id=546243


All quotes signify direct quotes of the authors work. The actual paper is copyrighted by the authors. (not sure why that would not be assumed, but the paper says to put it in, so I did.

Save the environment, call a financier.

Finance to the rescue! An interesting deal with Amazon “açaí (pronounced ah-sigh-EE) - a dark purple berry rich in nutrients that sprouts atop the millions of palm trees lining the riverbanks in the Brazilian jungle” harvestors/farmers allows them to lock in a better price in return for preserving some wild areas. (gee hedging again! Do you notice a theme?) The buyer? Sambazon, short for Saving and Managing the Brazilian Amazon Rainforest, who is now selling the products in the US and around the world.

http://www.nytimes.com/2004/08/04/business/worldbusiness/04acai.html
http://www.sambazon.com/NewsStory.aspx?storyid=29
http://www.sambazon.com/mission.html

Today’s accounting lesson? Tell people when you change accounting policies!

Without admitting guilt, Halliburton agreed to pay a $7.5 million fine to the SEC. This investigation has drawn much attention because the reason for the investigation (questionable accounting practices) happened during John Cheney’s (current VP of US) reign as CEO. “The accounting change dealt with the way Halliburton booked cost overruns on projects….The actual change in accounting, the commission said, was permissible under generally accepted accounting principles, but the failure to inform investors that the change had been made - and of its effect on the company's reported profit - violated securities laws.” NY Times 8/4/2004

Score another one for increased transparency!!! :)


http://www.nytimes.com/2004/08/04/business/04halliburton.html
http://quote.bloomberg.com/apps/news?pid=10000103&sid=aHJV.RQF4R4k&refer=us
http://www.tucsoncitizen.com/index.php?page=business&story_id=080404d1_halliburton

Hedging: It’s good for you and good for your company

European Airlines Review Hedging As Oil Prices Rise: "Already grappling with stiff competition and deep cost cuts following a slump in global travel, rising fuel costs are the latest blow to the beleaguered industry"



Oil prices are at all time highs (in nominal terms) on both supply (OPEC said they could not pump much more at present) and demand (higher than expected) concerns. Now I am guessing you have heard that from a zillion places. And moreover, I would wager that you probably expected oil prices to fluctuate. So is it just me who is angry every time airlines (this time it was American Airlines) complain about the price of fuel.

Why? They can easily be hedging this risk.

While hopefully their CFOs are all subscribers to the FinanceProfessor Newsletter and read all about the good aspects of hedging when we reviewed the Simkins, Carter, and Rogers paper on airline industry hedging practices. The paper is so interesting we reviewed it a twice. First in 2001 and then again this past spring-the latter review is listed below. But maybe the executives missed those issues (spam filters being what they are and all).

So if they did miss that, and are still not reading this, maybe these constantly complaining executives may happen to have heard of a firm called Southwest Airlines ;) The low cost airline from Texas recently named Gary Kelly as their new CEO. Kelly, an accountant who was formerly the CFO, is probably most famous for his hedging of jet fuel. How well did he hedge? The firm is reported to have locked in oil at $24 and $25 a barrel for much of the next two years. Remember current market price is over $44 a barrel! Gee, I bet that helped his reputation 
It is interesting to see the how other airlines (both in the US and abroad) are dealing with the high jet fuel prices. For instance, Ryanair had hedged much of their fuel only through October. When this fact was admitted, the stock price fell about 3% on volume that was twice its average. “Scandinavian airline SAS plans to announce next week it has decided to resume hedging after being left exposed since the first quarter, while Swiss International Air Lines faces more potential losses after selling hedges to boost cash reserves.”

I will concede that there is truth to the claims that hedging long term risks is more expensive for firms with high financial risks, but the added cost is not a good excuse! So get out there and hedge! You too may end up as CEO.



**************************
Sources:

Articles on Southwest’s hedging
http://www.freep.com/money/business/irep16e_20040716.htm
http://www.ctnow.com/business/hc-southwestair.artaug04,1,6498775.story?coll=hc-headlines-business

Article on other airlines hedging
http://news.airwise.com/stories/2004/08/1091563644.html —VERY GOOD!

For complaints on high jet fuel prices:
From Reuters on July 31, 2004:
http://news.moneycentral.msn.com/breaking/breakingnewsarticle.asp?feed=OBR&Date=20040731&ID=3877152
“``Record-high fuel prices and an intensely competitive domestic revenue environment have made the need for further cost-cutting all the more clear,'' Gerard Arpey, chief executive of American parent AMR Corp. (AMR), said earlier this month.
Continental Airlines (CAL) has said in recent months that fuel prices would add an extra $700 million in operating expenses this year, and it might have to lay off workers as a result.
``The current revenue and fuel environment have overwhelmed our efforts to return to profitability, and we now must achieve significant additional cost reductions,'' Continental CEO Gordon Bethune said when the airline released its quarterly earning in July.


**************************


From the January 13, 2004 FinanceProfessor newsletter:

My chairman Jeff Peterson complained recently that academic publications travel at "glacial speed". The paper is by Simkins, Carter, and Rogers and looks at hedging in the US Airline industry is one such paper. It really is one of my favorites. I saw it presented a few years ago and I thought it was close to publication then, but I guess the glacier has not yet completed its journey as the paper was presented at this year's AFAs. Their findings? Hedging does create value. Using regression analysis, they report that hedging increases firm value by over 10%! How? One hypothesis is that hedgers can better afford to maintain capital spending when jet fuel prices climb. This view is supported by their finding that there is a "positive relation between hedging and…increases in capital investment."
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=325402

Do takeovers destroy wealth for acquiring firms? Yes, according to Moeller, Schlingemann, and Stulz.

Moeller, Schlingemann, and Stulz examine the returns to acquiring firms in takeovers. They find that "from 1991 to 2001 (the 1990s), acquiring firms' shareholders lost an aggregate $216 billion, or more than 50 times the $4 billion they lost from 1980 to 1990 (the 1980s), yet firms spent just 6 times as much on acquisitions in the latter period."

However, before you say that all takeovers are bad, there are several key points that can get buried in the headline. For instance, most firms did not lose money. The large losses seem to be concentrated in the 1998-2001 time period and further concentrated in a relatively few large deals.

In the author's words: "the average acquisition creates wealth for acquiring-firm shareholders. Instead, this large loss is caused by an increase in the size of the dollar losses of acquisitions with the worst dollar returns that is not offset by an equivalent increase in the size of the dollar gains of acquisitions with the best dollar returns. Statistically, the distribution of dollar returns in the late 1990s exhibits substantially more skewness compared to earlier years"

They continue: "Out of the 4,136 acquisitions from 1998 through 2001, 87 are large loss deals. The aggregate wealth loss associated with these acquisitions is $397 billion, while all other acquisitions made a total gain of $157 billion. The large loss deals represent only 2.1% of the 1998 to 2001 acquisitions, but they account for 43.4% of the money spent on acquisitions." This negative return is both large and significant: "The excess return of the large loss deal portfolio over the matching-firm portfolio is -39%."

Prior to making the bad acquisition, the acquiring firms had been a. active in the acquisition market and b. outperforming the market. Thus, "the evidence is consistent with the view of Jensen (2003) that high valuations give management more discretion, so that management can make poor acquisitions if it [management] values growth more than shareholder wealth." However, the authors do not feel this high valuation " is not sufficient to explain the change in returns associated with acquisition announcements, since these firms have comparable valuations when they announce previous mergers or acquisitions that are associated with positive abnormal returns." Rather it is hypothesized that "the acquisitions led
investors to reconsider the extremely high stand-alone valuations of the announcing firms."

Attempts to explain this negative returns using regression analysis are only marginally useful and can only explain about 20% of the negative abnormal return.

Moreover it does not appear to be due to diversification: "Large loss deals are more likely to be hostile and more likely to be tender offers than other transactions, but the fraction of large loss deals that are tender offers or hostile is small enough that these deal characteristics seem unlikely explanations. The acquisitions in our large loss deal sample are more likely to be within the acquirer's industry than are the other acquisitions, but the difference is not significant. The large loss deals cannot be attributed to diversification attempts."


To summarize: most deals are slightly positive or at least neutral, however many of the larger deals (especially in the later 1990s) appear to be losers and the size of these deals is enough to make the overall average return negative. This is consistent with Jensen's overvaluation problem.


Of course what can not be measured is how far the firms would have fallen had they not done the deal (see Shleifer and Vishny 2003--yeah I know this version is a 2001 version, but I cannot find a link to their 2003 JFE article.


This paper is forthcoming in the Journal of Finance:
http://www.afajof.org/Pdf/forthcoming/Stulz_Schlingemann_Moeller.pdf

A previous version of this is available through FEN.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=476421

NYSE to increase electronic trading

As the NY Times reported "Electronic Trading on Big Board upstages Terror Talk"


It has long been assumed that sooner or later the NYSE would become more electronic. Today the world's most famous stock market decided that there is no time like the present and announced that the NYSE would become more of a hybrid market with both electronic and floor trading.

As the NYSE press release states "The New York Stock Exchange is undertaking a significant upgrade in the utilization of technology to execute securities transactions. On Aug. 2, the NYSE filed with the SEC to expand the NYSE Direct+® system, which currently accounts for approximately 10 percent of trades executed. Limits will be eliminated on the size, timing, and types of orders that can currently be submitted via Direct+, and a number of other new features requested by our customers will be incorporated. At the same time, the NYSE will retain the advantages of the agency auction model, which has proven to provide the most efficient, lowest cost executions and the best ability to cope with market stress."

Thus the current limits on electronic trading are being removed which will allow more electronic trading, BUT the current system of a specialist and floor traders will still exist (especially when there are market imbalances and at the open and close).

Why is it being done? Again the NY Times "Institutional investors have long complained that they cannot trade with speed and anonymity at the exchange and as a result they have directed much of their trading to the Big Board's electronic competitors"

Looking for people who will not be happy with the change? Look no further than specialists and floor brokers. They will not be in favor of the change (especially in active, liquid stocks that are currently most affected by the constraints) as they will be losing more market share.


Sources:
The press statement:
The NYSE's press releases and new conference
BTW Listen to the press conference--23 minutes and it is really interesting!
http://biz.yahoo.com/rf/040802/markets_nyse_trading_3.html
http://money.cnn.com/2004/07/30/markets/nyse_electronic_trading/
http://www.nytimes.com/2004/08/03/business/03wall.html