Evan Gatev

Momentum Trading and Performance with Wrong Return Expectations

Many long-term institutional investors use strategic portfolio allocation to maximize net asset value assuming that long-run expected returns are constant. This approach is complemented by tactical asset allocation when an asset class is perceived to offer higher expected returns in the short run. When investment performance is evaluated in the interim, it can be difficult to assess the merit of private beliefs about changing expected returns. The authors examine the annual expected return and dynamic trading under wrong assumptions about time-varying expected returns and show that a misspecified portfolio policy can outperform the correct policy. They also find that the particular assumptions about how expected returns vary through time can be identified from observed rebalancing of a portfolio. The assumption that expected returns are changing implies that momentum trading is optimal under certain conditions. In contrast, contrarian trading is always optimal when prices are assumed to follow a random walk around a constant long-term trend. These results can inform the annual performance evaluation of institutions, such as endowments, pension plans, mutual funds, and hedge funds that have long-term investment objectives.

The corporate governance and financing of small-cap firms in Canada

Purpose - – The purpose of this paper is to examine the interaction between corporate governance and capital structure for small publicly traded firms in Canada. Design/methodology/approach - – The authors hand-collect data for all companies listed on the Canadian junior stock exchange and construct measures of corporate governance. The authors focus on a time period when the sample firms were unregulated in their governance choices. Since firms decide simultaneously on the level of corporate governance provisions and capital structure, the authors use simultaneous equation models as well as instrumental variables analysis to address endogeneity. Findings - – The authors find that a strong relation exists between small-firm capital structure and corporate governance practices. Firms with low level of collateralizable assets have low leverage and chose better corporate governance provisions. All else equal, the firms with better corporate governance are more likely to issue new equity than debt. Overall the results support theories that predict a link between corporate governance and financing policy, where small-cap firms with low debt capacity incur costly shareholder protection to facilitate access to equity financing. Originality/value - – The authors contribute to prior research by providing the first empirical evidence on the choice and impact of corporate governance on capital structure for junior small- and micro-cap firms.