Stock Valuations and Learning about Profitability

Question 1

Lowry and Schwert 2002

Answer 1

• Both IPO volume and average initial returns are highly autocorrelated.
• companies tend to go public following periods of high initial returns.
• However, we find that the level of average initial returns at the time of filing contains no information about that company’s eventual underpricing.
• Both the cycles in initial returns and the lead-lag relation between initial returns and IPO volume are predominantly driven by information learned during the registration period.
• More positive information results in higher initial returns and more companies filing IPOs soon thereafter.

Question 2

Pastor and Veronesi 2003

Answer 2

• market-to-book ratio (M/B) increases with uncertainty about average profitability, especially for firms that pay no dividends.
• M/B is predicted to decline over a firm’s lifetime due to learning, with steeper decline when the firm is young.
• These predictions are confirmed empirically.
• Data also support the predictions that younger stocks and stocks that pay no dividends have more volatile returns.
• Firm profitability has become more volatile recently, helping explain the puzzling increase in average idiosyncratic return volatility observed over the past few decades.

Question 3

Zhang 2006

Answer 3

• Gist: price continuation anomaly driven by behavirial bias as evidenced by news causing relatively greater swings in expected returns when ex ante information uncertain.
• If short-term price continuation is due to investor behavioral biases, we should observe greater price drift when there is greater information uncertainty.
• As a result, greater information uncertainty should produce relatively higher expected returns following good news and relatively lower expected returns following bad news.

Question 4

Pastor and Veronesi 2009

Answer 4

• We survey the recent literature on learning in financial markets.
• Our main theme is that parameters in financial models are uncertain and subject to learning.
• discuss phenomena related to the volatility and predictability of asset returns, stock price bubbles, portfolio choice, mutual fund flows, trading volume, and firm profitability

Question 5

Van Nieuwerburgh and Veldkamp 2009

Answer 5

• model investors, endowed with a small home information advantage, who choose what information to learn before they invest.
• Surprisingly, even when home investors can learn what foreigners know, they choose not to: Investors profit more from knowing information others do not know.
• Learning amplifies information asymmetry.
• model matches patterns of local and industry bias, foreign investments, portfolio outperformance, and asset prices

Question 6

Hund, Monk and Tice 2010

Answer 6

• Method: examine changes in excess value conditioned on firm organizational form and how these changes vary across the business cycle; also examine idiosyncratic return volatility.
• Results:
• (1) diversified firms are older and have lower volatility in profitability
• (2) while inefficient cross-subsidization of low-quality projects can explain the diversification discount, it cannot account for a smaller drop in subsequent changes in excess value for diversified firms, or the dynamic movement of excess values across the business cycle, or the idiosyncratic return volatility results.
• (3) the difference in the change in excess value across time for single segment and diversified firms is larger during economic booms (when the equity risk premium is low) and smaller during economic recessions (when the equity risk premium is high)