Dennis Philip

Media Content and Stock Returns: The Predictive Power of Press

This paper examines whether tone (positive and negative) and volume of firm-specific news media content provide valuable information about future stock returns, using UK news media data from 1981–2010. The results indicate that both tone and volume of news media content significantly predict next period abnormal returns, with the impact of volume more pronounced than tone. Additionally, the predictive power of tone is found to be stronger among lower visibility firms. Further, the paper finds evidence of an attention-grabbing effect for firm-specific news stories with high media coverage, mainly seen among larger firms. A simple news-based trading strategy produces statistically significant risk-adjusted returns of 14.2 to 19 basis points in the period 2003–2010. At the aggregate level, price pressure induced by semantics in news stories is corrected only in part by subsequent reversals. Overall, the findings suggest firm-specific news media content incorporates valuable information that predicts asset returns.

CEO duality, agency costs, and internal capital allocation efficiency.

This study examines the impact of CEO duality on firms’ internal capital allocation efficiency. We observe that when the CEO is also chair of the board, diversified firms make inefficient investments, as they allocate more capital to business segments with relatively low growth opportunities over segments with high growth opportunities. The adverse impact of CEO duality on investment efficiency prevails only among firms that face high agency problems, as captured by high free cash flows, staggered board structure and low board independence. Depending on the severity of the agency problem, CEO duality is associated with a decrease in industry-adjusted investment in high-growth segments of 1% to 2.1% over the following year, relative to that in low-growth segments. However, CEOs’ equity-based compensation curbs the negative effect of CEO duality on internal capital allocation efficiency. Overall, the findings of this study offer strong support for the agency theory and postulate the internal capital allocation policy as an important channel through which CEO duality lowers firm value in diversified firms.

CEO Duality, Agency Costs, and Internal Capital Allocations

This study examines the impact of CEO duality on firms’ internal capital allocation efficiency. We observe that when the CEO is also chair of the board, diversified firms make inefficient investments, as they allocate more capital to business segments with relatively low growth opportunities over segments with high growth opportunities. The adverse impact of CEO duality on investment efficiency prevails only among firms that face high agency problems, as captured by high free cash flows, staggered board structure and low board independence. Depending on the severity of the agency problem, CEO duality is associated with a decrease in industry-adjusted investment in high growth segments of 1% to 2.1% over the following year, relative to those in low growth segments. However, CEOs’ equity-based compensation curbs the negative effect of CEO duality on internal capital allocation efficiency. Overall, the findings of this study offer strong support for the agency theory and postulate the internal capital allocation policy as an important channel through which CEO duality lowers firm value in diversified firms.

Multifactor Models and the APT: Evidence from a Broad Cross-Section of Stock Returns

We examine the consistency of several prominent multifactor models from the asset pricing literature with the Arbitrage Pricing Theory (APT) framework. We follow the APT-related literature and estimate the common factor structure from a cross-section containing 420 equity portfolios (associated with 42 major CAPM anomalies) by employing the asymptotic principal components method. Our benchmark model contains six statistical factors and clearly dominates (both in economic and statistical terms) most of the empirical multifactor models. These results represent a critical challenge to the current workhorse models in terms of explaining large-scale portfolio equity risk premia and achieving consistency with the APT.

Econometric Identification of Foreign Exchange Options Volatility Surfaces Recovering Foreign Exchange Option Prices from Spot Price Dynamics

Over-the-counter foreign exchange options are the fourth largest derivatives market (by asset class) in the world, but this market is little studied in the finance literature. We propose a new set of modelling tools for pricing options on this market and demonstrate their applicability to five liquid currencies versus the dollar. Our discrete time affine nested GARCH based model specification is the first of its type to be estimated directly from spot foreign exchange and short rate (timed deposit) quotes. Out-of-sample testing suggests that an affine term structure with stochastic volatility model estimated at a monthly frequency outperforms most specifications with no recourse to option market quotes to assist calibration. Indeed, this model outperforms a realized variance model by almost an order of magnitude, across all quote types, when compared to observed option market data.

Economic Activity and Momentum Profits

We show that economic activity plays an important role in explaining momentum-based anomalies. A simple two-factor model containing the market and alternative indicators of economic activity as risk factors -- industrial production, capacity utilization rate, employees on nonfarm payrolls, retail sales, and a broad economic index -- offers considerable explanatory power for the cross-section of price and industry momentum portfolios. The model compares favorably with alternative multifactor models and is consistent with Mertons Intertemporal CAPM framework. Moreover, the models fit is generally higher for value-weighted than for equal-weighted portfolios. Economic activity is, however, significantly less successful in explaining the earnings momentum anomaly.

Differences in Expectations and the Cross Section of Stock Returns

We provide strong evidence that differences in expectations (DiE) among options investors, measured from the dispersion of equity options trading volume across moneyness levels, contain valuable information about future stock returns. Stocks with high DiE consistently underperform on average those with low DiE by more than 1% per month, with the negative DiE-return relationship strongest when short-sale constraints are high and among stocks that exhibit relatively high arbitrage risk. Moreover, we document that the DiE effect is highly persistent, pronounced in high sentiment periods, and is robustly distinct from a large array of previously documented cross-sectional return predictors.

Estimation of Factors for Term Structures with Dependence Clusters

This paper studies the importance of accounting for term structure maturity clusters while estimating latent factors, for the purpose of forecasting yield curves. The maturity clusters are identified using a hierarchical clustering algorithm. We then propose a new block dynamic Nelson-Siegel model to account for the separate dynamics driving the different clusters. For the US zero coupon bond term structure, we find two (short and long) maturity clusters. The level, slope, and curvature factors driving the two clusters are loosely dependent on each other and further, this dependence is also time-varying. The block dynamic model fits the clustered bond term structure well and produces superior out-of-sample forecasts for the short and medium term maturities, suggesting that clustering is a vital feature that cannot be ignored when estimating common factors in term structures. We further extend the empirical application to the case of Libor-Swap term structure and draw similar conclusions.