Week 8 - Other anomalies, Asset Prices Flashcards
Open-ended funds v closed-ended funds
Open-ended funds create new share, cost = NAV
Closed-end funds issue fixed number of shares
How are shares traded
on exchanges, buy at the prevailing price from another investor
Closed-end Funds Puzzle
puzzle: fund share prices differ NAV - typical fund trades at a discount to NAV of about 10% on average
Difference between price and NAV varies substantially over time
When closed-end funds are created, share price is typically above NAV
When they are terminated, either through liquidation or open-ending, gap between price and NAV closes
Rational explanations
- Expenses
- expectations about future fund manager performance
- tax liabilities
BUT: none of them can explain all aspects of the evidence - management fees explain why fund usually sell at discounts but not why they sell at a premium or why discounts vary from week to week
Behavioural explanations
Investor sentiment
- individuals who are the primary owners of closed-ended funds are noise traders
- Sometimes they are too optimistic, other times they are too pessimistic
- changes in sentiment affect fund share prices and hence difference between prices and NAV
Owners of closed-end funds have two sources of risk
- fluctuations in value of assets and noise trader sentiments
- rational investors demand compensation for this
This also explains why new closed-end funds are sold at a premium
- entrepreneurs whill choose to create closed-end funds at times of investor exhuberance
Limited Attention 1
Because of limited attention, investors may underreact to news
May explain PEAD
How to test Limited attention
- PEAD is stronger for firms that announce earnings at the same time as many other firms
- PEAD stronger for firms that announce earnings on Friday
- PEAD stronger for low volume stocks
Underreaction to Customer links
firms are required to report their major customers - investors are slow to recognise that good news for a customer is good news for associated firm
Underreaction to Demographic news
Investors are slow to recognise impact of demographic shifts on the future profitability of firms with age-sensitive products
Limited Attention 2
Attention more important for individual investor’s buying decisions than for selling decisions
Barber and Odean (2008) - there is stronger buying interest than selling interest for attention grabbing stocks (stocks with extreme returns, high volume or news announcements)
How do prices comove according to traditional view
- Common factor in future cash flows
- Changes in rf
- changes in risk aversion
- common factor in news about risk
Example of comovement anomaly 1
Twin shares (eg. Royal Dutch and Shell)
- Shares should move in lock-step, but they dont
- Royal Dutch shares comove strongly with S&P
Example of Comovement anomaly 2
Closed-end Funds
- CEFs comove strongly with one another even though their asset fundamentals are weakly related
- CEFs comove with small stocks even when they hold only large stocks
-Closed-end country funds comove as strongly with the national market in the country where fund is traded as with the market where the assets are traded
Frictional explanation for Comovement
- Based on investor Habitats
- Some investors choose to hold and trade only subset of all securities
- As risk aversion or sentiment changes, they buy or sell this subset - common factor in returns of securities in this subset
Behavioural explanation for Comovement
Assumptions:
- Investors group stocks into categories (eg. value, growth, small-cap, large-cap, etc.)
- investors’ beliefs about future return on a category is a weighted average of its past returns
Predictions:
- excessive comovement within a category
Applications:
- Comovement of value stocks, small stocks
- Comovement of commodities
Categorical thinking
Barberis, Shleifer, Wurgler predict that stocks added to the S&P500 will comove more with the index after addition than before
Bubble definition
Bubble is an episode in which an asset become significantly overvalued for some period of time
- price is higher than a reasonable present value of its future cash flows
- Price is higher than it would be in an economy with fully rational investors
Empirically-based definition of bubble
Episode in which the price of an asset rises sharply over some period of time and then collapses
- during the price rise, there is much talk of overvaluation in the media and among investors
Facts about Bubbles
- Very high trading volumes
- Extrapolative expectations
- Sophisticated investors ‘riding the bubble’
- Good fundamental news near the start of the price rise
New models to understand bubbles
-All use extrapolation to get rising prices
- Different in volume mechanisms
Barberis et al. Model for Bubbles
- Extrapolators form their beliefs based on two signals - value and growth signal (opposite directions)
- relative weight an extrapolator puts on the two signals varies slightly over time
- this is called wavering
- variations stem from small fluctuations in relative attention extrapolators pay to the two signals
Barberis et Al. Volume mechanism
- degree of wavering is constant over time but endogenously generates much higher volumes during the bubble
Extrapolator i’s demand:
Wi,tVt + (1-Wi,t)Gt
- 0.01 shift in Wi,t leads to a change in share demand of 0.01(|V-G|)
- during normal times, value and growth signals have small magnitudes so shift in W leads to small demand shift
- During Bubble, Value and growth signals have much higher values so shifts are much more impactful for demand
DeFusco et al Model for bubbles
- more tailored to the housing market
- investors have different holding horizons - price increases endogenously attract short-term buyers more strongly than long-term buyers
- Short-term buyers amplify volume by selling more frequently, and they destabilise prices through positive feedback
- Model predicts a lead-lag relationship between volume and prices
Liao, Peng, Zhu model for bubbles
- Theory based on extrapolation and the disposition effect
- Disposition effect: investors’ tendency to sell stocks trading at a gain and hold on to stocks with losses
During a bubble:
- Extrapolation induces outsiders to get in
- Disposition effect prompts insiders to get out
- leads to high volume
