Market Frictions Flashcards
1
Q
Lo and MacKinlay 1990
A
- Challenges overreaction literature (e.g. DeBondt and Thaler 1985, 1987)
- Argues this lit implies that price changes neg autocorrelated
- Distill overreaction lit into a single Q: are return reversal responsible for predictability in stock returns?
- Simulation shows that even serially independent returns yield pos expected profits for pf strategy that buys losers, sells winners
- This is due to cross-autocovariances across securities: intuition – suppose mkt consists of only two stocks, A & B. If A’s return high than mkt today, contrarian sells A, buys B. But, if A and B positively cross-autocorrelated, then A’s high price today implies a higher return for B tommorow.
- Find empirical support
2
Q
Boudoukh, Richardson and Whitelaw 1994
A
- Gist: institutional factors, such nonsynchronous trading, explain autocorrelation in short-run stock returns. EMH wins out over overreaction story
- document empirical results which imply that these autocorrelations have been overstated in the existing literature.
- provide support for a market efficiency-based explanation of the evidence.
- analysis suggests that institutional factors are the most likely source of the autocorrelation patterns.
- For example, the effect of nonsynchronous trading, in a case where returns are not autocorrelated, can conceiv- ably be 18 percent or higher, for the portfolios of interest
3
Q
Barinath, Kale and Noe 1995
A
- Gist: institutional trader portfolios positively correlated with portfolios of noise traders, which provides a channel for cross-autocorr explains “overreaction” story of Lo and MacKinlay (1990)
- Argue that the past returns on stocks held by informed institutional traders will be positively correlated with the contemporaneous returns on stocks held by noninstitutional uninformed traders.
- Document that the returns on the portfolio of stocks with the highest level of institutional ownership lead the returns on portfolios of stocks with lower levels of institutional ownership.
4
Q
Hasbrouck 1995
A
- Gist: Title “One security, many markets”
- When homogeneous or closely-linked securities trade in multiple markets, it is often of interest to determine where price discovery (the incorporation of new information) occurs.
- information share associated with a particular market is defined as the proportional contribution of that market’s innovations to the innovation in the common efficient price.
- Applied to quotes for the thirty Dow stocks, the technique suggests that the preponderance of the price discovery takes place at the New York Stock Exchange (NYSE) (a median 92.7 percent information share).
5
Q
McQueen, Pinegar and Thorley 1996
A
- document a directional asymmetry in the small stock concurrent and lagged response to large stock movements.
- When returns on large stocks are negative, the concurrent beta for small stocks is high, but the lagged beta is insignificant.
- When returns on large stocks are positive, small stocks have small concurrent betas and very significant lagged betas.
- That is, the cross-autocorrelation puzzle documented by Lo and MacKinlay (1990a) is associated with a slow response by some small stocks to good, but not to bad, common news.
6
Q
Hong, Lim and Stein 2000
A
- theories have been proposed to explain momentum in stock returns.
- test the gradual-information-diffusion model of Hong and Stein (1999) and establish three key results.
- First, once one moves past the very smallest stocks, the profitability of momentum strategies declines sharply with firm size.
- Second, holding size fixed, momentum strategies work better among stocks with low analyst coverage.
- Finally, the effect of analyst coverage is greater for stocks that are past losers than for past winners.
- findings are consistent with the hypothesis that firm-specific information, especially negative information, diffuses only gradually across the investing public.
7
Q
Booth, Lin, Martikainen and Tse 2002
A
- Using Helsinki Stock Exchange data, we find that upstairs trades tend to have lower information content and lower price impacts than downstairs trades.
- consistent with the hypotheses that the (1) upstairs market better at pricing uninformed liquidity trades and that (2) upstairs brokers can give better prices if know unexpressed demands of other customers.
- find that these economic benefits depend on price discovery occurring in the downstairs market.
8
Q
Bessembinder and Venkataraman 2004
A
- examine Paris Bourse, whose electronic limit order market closely resembles the downstairs markets envisioned by theorists
- present direct evidence for hypothesis that upstairs brokers lower execution costs by tapping into unexpressed liquidity
- actual execution costs upstairs are on average only 20% (35%) as large as they would be if block trades were executed against displayed (displayed and hidden) liquidity in the downstairs limit order book.
- find support for hypothesis that upstairs brokers certify trades as uninformed.
- find that participants in stocks with less restrictive crossing rules agree to outside-the-quote executions for more difficult trades and at times when downstairs liquidity is lacking
9
Q
Chae 2005
A
- investigates trading volume before scheduled and unscheduled corporate announcements to explore how traders respond to private information
- cumulative trading volume decreases inversely to information asymmetry prior to scheduled announcements,
- while the opposite relation holds for volume after the announcement.
- In contrast, trading volume before unscheduled announcements increases dramatically and shows little relation to proxies for information asymmetry.
- investigate the behavior of market makers and find that they act appropriately by increasing price sensitivity before all announcements, implying that they extract timing information from their order books.
10
Q
Mitchell, Pedersen and Pulvino 2007
A
- Intuition: arbitrageurs may face capital constraints and contrary to dissipating deviations from fundamental values, may sell cheap securities causing further deviation.
- Find in covertible bond market of 2005, hedge funds faced large redemptions of capital from investors –> massive bond sales —> reduced prices relative to fundamental values
- Studying merger targets during ‘87 crash. Find that this and proposed antitakeover legisation –> widened merger spreads –> large losses for merger arbitrageurs –> dumped targets’ stocks —> spreads remained wide even after legislation dropped
