Anthony W. Lynch

New Evidence on Stock Price Effects Associated with Changes in the S&P 500 Index

Since October 1989, Standard and Poors has (when possible) announced changes in the composition of the S&P 500 index one week in advance. Because index funds hold S&P 500 stocks to minimize tracking error, index composition changes since this date provide an opportunity to examine the market reaction to an anticipated change in the demand for a stock. Using post-October 1989 data, the authors document significantly positive (negative) postannouncement abnormal returns that are only partially reversed following additions (deletions). These results indicate the existence of temporary price pressing and downward-sloping long-run demand curves for stocks and represent a violation of market efficiency. Copyright 1997 by University of Chicago Press.

Survivorship Bias and Attrition Effects in Measures of Performance Persistence

We generate samples of fund returns calibrated to match the U.S. mutual fund industry and simulate standard tests of performance persistence. We consider a variety of alternative return generating processes, survival criteria, and test methodologies. When survival depends on performance over several periods, survivorship bias induces spurious reversals, despite the presence of cross-sectional heteroskedasticity in performance. In samples which are largely free of survivorship bias, look-ahead biased methodologies and missing returns still affect statistics. In samples with no true persistence, the spurious persistence caused by survivorship bias in the presence of single-period survival criteria never reaches the magnitude found in recent empirical studies. When fund returns are truly persistent, the simulations reveal an attrition effect, distinct from survivorship bias. The systematic disappearance of poor performers causes mean persistence measures to differ from those in a hypothetical sample in which funds never disappear, even in tests which incorporate all data on disappearing funds. The magnitude and direction of this effect depends on the return generating process. We also examine the specification and power of the persistence tests. The t-test for the difference between top and bottom portfolios ranked by past performance is the best specified under the null and among the most powerful against the alternatives we consider.

Predictability and Transaction Costs: The Impact on Rebalancing Rules and Behavior

We consider the impact of transaction costs on the portfolio decisions of a long-lived agent with isoelastic preferences. In particular, we focus on how portfolio choice, rebalancing frequency and average cost incurred change over the lifecycle are affected by return predictability. Two types of costs are evaluated: proportional to the change in the holding of the risky asset and a fixed fraction of portfolio value. We find that realistic transaction costs can materially affect rebalancing behavior, creating no-trade regions that widen near the investors terminal date. At the same time, realistic proportional and fixed costs have little effect on the midpoint of the no-trade region, unless liquidation costs differ across assets. Return predictability calibrated to U.S. stock returns is found to have large effects on rebalancing behavior relative to independent and identically distributed (i.i.d.) returns with the same unconditional distribution. For example, return predictability causes rebalancing frequency to increase, and cost incurred to increase by an order of magnitude, at all points in the investors life. No-trade regions early in life are wider when returns are predictable than when they are not. Finally, we find that the nature of the return predictability, including the presence or not of return heteroscedasticity, can have large effects on rebalancing behavior.

Multiple Risky Assets, Transaction Costs, and Return Predictability: Allocation Rules and Implications for U.S. Investors

This paper numerically solves the decision problem of a multiperiod constant relative risk aversion individual who faces transaction costs and has access to two risky assets, both with predictable returns. With proportional transaction costs and independent and identically distributed returns, we numerically find the rebalancing rule to be a no-trade region for the portfolio weights with rebalancing to the boundary. The shape of the no-trade region depends on the correlation between the two risky assets. With predictable returns, there is instead a no-trade region for each state. We also examine several important economic questions, including the utility cost of not being able to buy on margin or short stock.

Do Redemption Fees Hurt Long-Term U.S. MutualFund Investors?

Redemption fees have been proposed as a way to curb trading on stale prices by short-horizon investors to make profits at the expense of long-horizon investors who only trade to rebalance back to their optimal allocations. For redemption fees to be a viable device to curb stale price trading, they must have a negligible impact on the utility of these long-horizon agents. To assess this impact, we examine how the imposition of redemption fees affects the utility of long-horizon agents, allowing for the possibility that the long-horizon investors are rebalancing to take advantage of return predictability. Restricting the imposition of the fee to sales of shares purchased within 6 months, the utility cost of the redemption fee is never more than 0.12% of wealth when returns are i.i.d. and never more than 0.54% of wealth when returns are predictable. These utility costs are very small. For redemption fees to be a viable device to curb stale price trading, they must also be large enough to deter short-horizon investors from taking advantage of the stale prices. We find that they are, based on the documented profitability of such strategies, at least for the typical domestic fund and for the typical large capitalization domestic fund.

Generalized Method of Moments for Samples of Unequal Length

This paper extends the generalized method of moments technique of Hansen (1982) to cases where moment conditions are observed over different sample periods. Many applications in financial economics use data series that have different starting dates, or, more rarely, different ending dates. Common practice is to take the intersection of the sample periods over which the data are observed; the intersection then becomes the sample period for the study and the rest of the data are ignored. This paper describes an alternative that allows the researcher to make use of all of the data available for each moment condition. We describe two asymptotically equivalent estimators that are consistent, asymptotically normal, and more efficient asymptotically than standard GMM. The first uses sample averages over the full sample to estimate the moments for which full-sample data are available, and sample averages over the short sample to estimate moments for which only the short-sample data are available, and then adjusts the short-sample moment using coefficients from a regression of the short-sample moments on the full-sample moments. The second uses the non-overlapping segment of the data available for the full-sample moments to form an additional set of moment conditions. We extend both of these estimators to settings with more general patterns of missing data. We show that the extended estimators are asymptotically equivalent, consistent, asymptotically normal, and asymptotically more e±cient than estimators that ignore a portion of the sample, whether or not it is observed for all series. By implication, the extended estimators are more efficient than standard GMM.