Alex Dontoh

The Declining Value Relevance of Accounting Information and Non Information-Based Trading: An Empirical Analysis

Recently, a growing body of literature has suggested that financial statements have lost their value relevance because of a shift from a traditional capital-intensive economy to a high-technology, service-oriented economy. These conclusions are based on studies that find a temporal decline in the association between stock prices and accounting information (earnings and book values). This paper empirically tests a theoretical prediction arising from the Noisy Rational Expectations Equilibrium model that suggests that the decline could be driven by non-information-based (NIB) trading activity, because such trading reduces the ability of stock prices to reflect accounting information. Specifically, Dontoh et al. (2004) show that when NIB trading increases, the R-squares of a regression of stock price on accounting information declines. Our empirical tests confirm this prediction; i.e., the decline in the association between stock prices and accounting information as measured by R-squares is driven by an increase in NIB trading.

On the Rationality of the Post-Announcement Drift

This paper demonstrates that a post-announcement earnings drift, which is often advanced as an example of market irrationality, can arise even if traders act rationally on their information. Specifically, we show that in the presence of share supply variations which are unrelated to information, there is a positive correlation between the unexpected component of current public signals and future price changes. Such a correlation arises from the fact that while prices reveal private information that cannot be found in public signals, non-information based trading distorts the information content of prices relative to the implications of both private and public information. Under these circumstances, markets may appear semi-strong inefficient and slow to respond to earnings announcements even though information is processed in a timely and efficient manner. Our findings correspond well with previously documented empirical evidence and suggest that the robustness of earnings-based “anomalies” may be rational outcomes of varying uncertain share supply.

Unfair 'Fair Value' in an Opaque Credit Default Swap Market: How Marking-to-Market Pushed the International Credit Crunch

Mark-to-market accounting, as required by FAS No. 157, has been implicated as a contributor to the financial meltdown caused by the housing crisis and the consequent write-down of securities backed by mortgages (MBS) and collateralized debt obligations (CDO). In this paper, we investigate the effects of mark-to-market accounting write-downs by financial institutions on equity returns, trading volume, and CDS premiums and whether the write-downs induced contagion effects on similar institutions without write-downs. Specifically, we examine whether equity returns and CDS premiums of the similar institutions responded significantly to write downs by peer firms. We find that firms that write down assets to their exit values in accordance with FAS No. 157 not only experience significant abnormal negative returns and a spike in the premiums of CDS written on their obligations – indicating higher default probability – but that similar firms without write downs exhibit a sympathetic and significant negative abnormal returns as well at the same time as the write-down firms. This is clear evidence of contagion effects induced by FAS No. 157 mark-to-market accounting. The analysis shows significant cross-sectional determinants of both equity abnormal returns and CDS premiums to generally include the measurement levels under FAS 157, liquidity, the amount of the write-down and rating changes.

Differences in Prior Beliefs, Differential Interpretation and the Consensus Effect of Quarterly Earnings Signals and Trading Volume

Models of financial economists including Karpoff, Varian, Holthausen and Verrecchia, and Dontoh and Ronen have demonstrated that there are three distinct fundamental determinants of trading volume reaction to new information releases: first, the extent of differences in investors’ prior beliefs; second, differences in their interpretations of the information; and third, the level of consensus that the information release induces among them. Although these effects are well understood theoretically, empirical studies that investigate trading volume reaction to the arrival of new information have tended to combine these three fundamental determinants, thereby masking their distinct incremental effects on trade. In this article, we examine all three potential sources of trade in response to information: heterogeneous prior beliefs, differential interpretation, and the consensus effect of the news. We find that all three of these effects have a distinct incremental impact on trading volume, thereby corroborating the theoretical models of financial economists.