Steve Fan, Linda Yu, Deborah Beyer and Scott Beyer
This paper jointly examines how firm size and idiosyncratic risk impact momentum returns.
Abstract
Purpose
This paper jointly examines how firm size and idiosyncratic risk impact momentum returns.
Design/methodology/approach
Using regression analysis, the authors investigate how firm size and idiosyncratic risk impact price momentum. The authors review firm price data in 25 country markets in the Thomson Financial Datastream database from 1979 to 2009.
Findings
This study’s findings suggest price momentum is more significant among stocks with smaller size and higher idiosyncratic risk. The authors find that winner and loser portfolios have significantly smaller size and higher idiosyncratic risk than portfolios in the middle quintiles.
Research limitations/implications
This study’s results are consistent with the notion that firm size matters in price momentum and mispricing is greatest for small firms because of the greater risk potential to arbitrageurs. In addition, this finding that firms with higher idiosyncratic risk have greater price momentum supports the idea that investors underreact to firm-specific information.
Practical implications
This work finds evidence that investors underreact to firm-specific information. As such, these findings are of particular interest for investors looking to exploit opportunities for abnormal returns through price momentum trading.
Originality/value
This paper jointly examines the effects of firm size and idiosyncratic risk on momentum returns. This investigation considers these effects in the global markets. This work adds to the research base by illustrating that both winner and loser portfolios have significantly smaller size and higher idiosyncratic risk than portfolios in the middle quintiles. Also unique to this study, the authors capture the time-variation of expected IdioRisk and the asymmetric effects of volatility by using an exponential general autoregressive conditional heteroskedastic (EGARCH) model to calculate conditional idiosyncratic risk.
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Scott B. Beyer, J. Christopher Hughen and Robert A. Kunkel
The authors examine the relation between noise trading in equity markets and stochastic volatility by estimating a two-factor jump diffusion model. Their analysis shows that…
Abstract
Purpose
The authors examine the relation between noise trading in equity markets and stochastic volatility by estimating a two-factor jump diffusion model. Their analysis shows that contemporaneous price deviations in the derivatives market are statistically significant in explaining movements in index futures prices and option-market volatility measures.
Design/methodology/approach
To understand the impact noise may have in the S&P 500 derivatives market, the authors first measure and evaluate the influence noise exerts on futures prices and then investigate its influence on option volatility.
Findings
In the period from 1996 to 2003, this study finds significant changes in the volatility and mean reversion in the noise level and a significant increase in its relation to implied volatility in option prices. The results are consistent with a bubble in technology stocks that occurred with significant increases in noise trading.
Research limitations/implications
This study provides estimates for this model during the periods preceding and during the technology bubble. The study analysis shows that the volatility and mean reversion in the noise level are much stronger during the bubble period. Furthermore, the relation between noise trading and implied volatility in the futures market was of a significantly larger magnitude during this period. The study results support the importance of noise trading in market bubbles.
Practical implications
Bloomfield, O'Hara and Saar (2009) find that noise traders lower bid–ask spreads and improve liquidity through increases in trading volume and market depth. Such improved market conditions could have positive effects on market quality, and this impact could be evidenced by lower implied volatility when noise traders are more active. Indeed, the results in this study indicate that the level and characteristics of noise trading are fundamentally different during the technology bubble, and this noise trading activity has a larger impact during this period on implied volatility in the options market.
Originality/value
This paper uniquely analyzes derivatives on the S&P 500 Index in order to detect the presence and influence of noise traders. The authors derive and implement a two-factor jump diffusion noise model. In their model, noise rectifies the difference of analysts' opinions, market information and beliefs among traders. By incorporating a reduced-form temporal expression of heterogeneities among traders, the model is rich enough to capture salient time-series characteristics of equity prices (i.e. stochastic volatility and jumps). A singular feature of the authors’ model is that stochastic volatility represents the random movements in asset prices that are attributed to nonmarket fundamentals.
Scott Beyer, Luis Garcia-Feijoo, Gerry Jensen and Robert R. Johnson
The purpose of this paper is to analyze security-market returns relative to the political party of the president, the Federal Reserve’s monetary policy, the year of the…
Abstract
Purpose
The purpose of this paper is to analyze security-market returns relative to the political party of the president, the Federal Reserve’s monetary policy, the year of the president’s term, and the state of political gridlock. Contrary to prior studies, which evaluated the influences separately, the authors jointly evaluate these variables.
Design/methodology/approach
The analysis supports the notion that security returns are significantly related to shifts in Fed monetary policy, political gridlock, and the year of the presidential term; however, returns are generally invariant to the president’s political party affiliation. Overall, the findings suggest that investors should focus less attention on the party of the president and instead more closely monitor Fed actions.
Findings
It appears that political harmony should be welcomed by equity investors, but not debt investors. Finally, regardless of the political outcome, if the past serves as a guide, investors may have to wait until year three of the next presidential term to enjoy the fruits of the current political season.
Originality/value
The academic literature is rich with studies that consider the aforementioned political effects and the influence that monetary policy have on the markets. To date, however, these factors have not been jointly considered when examining returns. This paper considers several dimensions of the political landscape – the party of the president, the presence or absence of political gridlock, and the presidential term cycle effect – in conjunction with Fed monetary policy in examining long-term security returns. By examining the relationship between security returns and both political and monetary conditions, the authors provide robust evidence regarding the relationships.
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J. Christopher Hughen and Scott Beyer
In the increasingly globalized economy, foreign exchange fluctuations have multiple, conflicting effects on domestic stock prices. The purpose of this paper is to examine return…
Abstract
Purpose
In the increasingly globalized economy, foreign exchange fluctuations have multiple, conflicting effects on domestic stock prices. The purpose of this paper is to examine return data to determine the relation between the dollar’s value and stock prices as it relates to monetary policy.
Design/methodology/approach
The authors examine US stock returns over a 40-year period, which is classified according to monetary policy and dollar trend. To better understand the impact of foreign exchange fluctuations, the authors estimate a model of stock returns using the three Fama-French factors and a momentum factor. Then the authors explore the underlying economic fundamentals that drive the sharp difference in annual returns between periods when the dollar is in an uptrend trend with loose monetary policy and periods when the dollar is in a downtrend with tight monetary policy.
Findings
Over the last 40 years, US stock returns were 2.5 times higher when the dollar was trending up vs down. The factor model of returns shows that equity returns are positively associated with periods when the dollar appreciated. Returns were particularly high when the dollar was in an uptrend during accommodative monetary policy. During these periods, stocks in the consumer goods and services industries provided relatively high returns. This occurred with strong economic growth due to consumer spending. Stocks exhibited the lowest returns when the dollar was depreciating and the Federal Reserve was tightening.
Originality/value
The key contribution of the research is that currency trends should be analyzed in the light of monetary policy. During periods of accommodative monetary policy and dollar appreciation, the US stock market provided average returns of 18.7 percent compared to −3.29 percent during a period of restrictive monetary policy and dollar depreciation. This result is driven by stronger economic growth, which is composed of consumer spending that more than offsets the dollar’s impact on net exports.
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Jeffery Scott Bredthauer, Brian C. Payne, Jiri Tresl and Gordon V. Karels
The purpose of this paper is to investigate the absolute and risk-adjusted stock return performance of the US health care industry conditional upon the presidential…
Abstract
Purpose
The purpose of this paper is to investigate the absolute and risk-adjusted stock return performance of the US health care industry conditional upon the presidential administration’s political party and the Federal Reserve’s monetary policy stance. It evaluates this return behavior across the 60-year time period from 1954 to 2013, and sub-divides this entire period into the pre-Medicare period (1954-1964), Medicare period (1965-1984), and Medicare-plus-high-health-care-inflation period (1985-2013).
Design/methodology/approach
The study uses monthly returns to the health care industry and overall market, characterizing each sample month as either having a Republican or Democratic president and either a contractionary or expansionary monetary policy regime determined by whether the Federal Reserve is increasing or decreasing interest rates, respectively. It incorporates univariate and multivariate analysis to quantify the return behavior of both the health care industry and the overall market during the entire period and all three sub-periods. Additionally, it utilizes a common four-factor multivariate regression model and associated hypothesis testing to characterize risk-adjusted excess returns (i.e. α) to the health care industry during the entire period and all three sub-periods.
Findings
The health care industry has earned robust, positive risk-adjusted returns with the magnitude of the returns sensitive to the political party of the administration and the monetary policy regime. The authors find that prior to 1965 (1954-1964), when the president was a Republican, during times of monetary contraction, health care earned an excess risk-adjusted return. There was no association between Democratic administrations and excess health care returns prior to 1965. In contrast, the authors find that after 1965 this relationship changes. The authors find that returns to health care were positive for Republicans during times of monetary expansion and positive for Democrats during monetary contraction. The authors also find this relationship has become more pronounced after 1984.
Originality/value
The study extends prior literature, which has shown that the health care industry is a priced factor in the US stock market and that it provides significant risk-adjusted returns in the recent past. Uniquely, this study shows that the excess returns to health care vary considerably over the past 60 years, and that these excess returns are quite sensitive to political policy, proxied by the presidential administration party, and monetary policy, as measured using Fed discount rate changes. These findings have implications for management and shareholders of highly regulated and subsidized industries and firms.
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Chris B Malone, Hamish Anderson and Peng Cheng
The purpose of this paper is to use firm-level data to examine whether the political cycle differentially relates to small vs large firms in New Zealand; a country that operates a…
Abstract
Purpose
The purpose of this paper is to use firm-level data to examine whether the political cycle differentially relates to small vs large firms in New Zealand; a country that operates a unicameral political system has a short three-year political term and a right-of-centre stock market premium exists.
Design/methodology/approach
Using firm-level data from 1972 to 2010, the authors examine monthly returns during right-of-centre National governments and left-of-centre Labour governments. The authors apply Santa Clara and Valkanov (2003) regression analysis approach to examine the political cycle impact on firm returns.
Findings
Like in the USA, New Zealand’s political cycle premium is driven by small firms; however, the results are opposite. In New Zealand, periods governed by the right of the political spectrum produce significantly higher stock returns than those from the left and this finding is primarily driven by small firms who perform particularly poorly under left-of-centre governments.
Research limitations/implications
Small firms were relatively heavily affected by the move to an open, deregulated economy; they were also less able to cope with tight monetary conditions, and periods of sharply falling inflation. New Zealand’s three-year political term may encourage newly formed governments to implement relatively fast moving shifts in policy where a more reasoned and steady approach would be warranted.
Originality/value
This is the first paper to use firm-level data outside of the USA to examine the political cycle impact.
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John Banko, Scott Beyer and Richard Dowen
The purpose of this paper is to examine market concentration, economies of scale, economies of scope, and the relative size of a particular fund, within a fund family, as…
Abstract
Purpose
The purpose of this paper is to examine market concentration, economies of scale, economies of scope, and the relative size of a particular fund, within a fund family, as determinants of mutual‐fund expense ratio. This examination is focused at the asset‐manager level and is based on the Morningstar equity and fixed‐income style classifications.
Design/methodology/approach
All data used in this study come from the July Morningstar Principia database for the years 1997 through 2006. One challenge of working with these data is that Morningstar treats each separate class of a fund as though it were an individual fund. As a result all Morningstar data items are reported for each fund class as though they are data items for a separate fund. The data are modified so that the items for separate classes of a fund are merged into data for a single fund. For example, assets in a fund become the total of the assets in each class of the fund.
Findings
This study contributes to the literature on mutual‐fund managers, and the literature on the structure of mutual funds, by showing that market concentration at the asset‐manager level varies substantially across Morningstar styles, particularly for the fixed‐income funds. The paper shows that increased market concentration is associated with greater expenses for the funds under management, within a given Morningstar‐style box, for both equity funds and for fixed‐income funds. We also show that increased costs are partially offset by economies of scope for the fixed‐income funds.
Originality/value
This paper extends the current literature in several ways. First, it confirms the existence of economies of scale at the fund level within Morningstar style classifications. Second, it documents the existence of varying levels of market concentration within different Morningstar style classifications. Third, the results demonstrate that there is a negative relation between the scope of funds handled across the Morningstar classifications by a particular fund manager and the expense ratio for particular funds. Finally, the results presented in this paper show that the largest funds within a family are associated with the highest expense ratios in the family.
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Stephen P. Huffman, Scott B. Beyer and Michael H. Schellenger
The purpose of this paper is to illustrate the effectiveness of integrating a portfolio simulation‐based trading program with the top‐down approach to fundamental analysis in a…
Abstract
Purpose
The purpose of this paper is to illustrate the effectiveness of integrating a portfolio simulation‐based trading program with the top‐down approach to fundamental analysis in a security analysis course. The simulation allows for the application of class material using a combination of group and individual projects.
Design/methodology/approach
Students enrolled in the class completed a survey about the integrated approach and the required simulated trading.
Findings
Over 87 per cent of students agreed that the economic analysis provided more educational value as a group project than as an individual project, while over two‐thirds of the students disagreed that the trading simulation had more education value as a group project.
Research limitations/implications
Although the authors focus on the top‐down approach, the concepts of technical analysis, hedging, and income generation could be more formally incorporated into the trading simulation.
Practical implications
The outline of how to integrate a trading simulation into the top‐down approach, using a combination of group projects and a cumulating project completed by each student, can be used as a guide for how to make the top‐down approach a more meaningful task.
Social implications
The integration of the portfolio simulated trading program with the top‐down approach makes the course more applied and more enjoyable for both the students and the faculty.
Originality/value
The paper outlines how to integrate a trading simulation and the top‐down approach and reports the finding that students preferred the group approach to economic analysis and individual projects for the simulation and the company analysis.
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Andreea Stoian and Delia Tatu-Cornea
The purpose of this paper is to examine the influence of the political partisanship of government in charges of returns on the European stock markets. The authors found a large…
Abstract
Purpose
The purpose of this paper is to examine the influence of the political partisanship of government in charges of returns on the European stock markets. The authors found a large body of research investigating this issue for the case of US stock market but less evidence for the European stock markets.
Design/methodology/approach
The authors employ a panel data model with fixed-effects and an additional dynamic panel model using the bias-corrected LSDV estimator on a data set consisting of monthly and quarterly data. The data range from 2000 to 2010 and cover 20 European Union (EU) countries. The authors test several hypotheses, and run distinct regressions using political, financial, and economic variables. The authors also divide the data set into two sub-samples in order to reveal the distinctions between advanced and emerging economies in the EU.
Findings
The authors find that stock markets perform better under right-wing administrations. The result is consistent for the advanced EU economies, but the authors found no robust evidence in that sense for emerging countries. Additionally, the authors show that European stock market preferences for right/left-wing administrations is not necessarily related to the beliefs about the size of unemployment, inflation, deficit, and/or debt, which opens the field for further research in this area.
Originality/value
The study contributes to existing knowledge. It examines if Wall Street folklore, asserting for many decades that stock markets perform better under right-wing governments, also holds for European stock markets given the distinctions in the political and financial systems between USA and Europe. Moreover, the authors underline the introduction in the analysis of the Central and Eastern European countries.