John A. Doukas

International stock market linkages: Evidence from the pre- and post-October 1987 period

Abstract This paper uses recent developments in the theory of cointegration to provide new methods of testing the linkage and dynamic interactions among stock market movements. Our findings are in sharp contrast with previous research which discovered strong interdependence among national stock markets prior to October 1987. For the post-October 1987 period, however, our results show that the degree of international co-movements among stock price indices has increased substantially, with the Nikkei index the only exception. Furthermore, the US stock market is found to have a considerable impact on the French, German and UK markets in the post-crash period. We also find the response of the French, German and UK markets to US stock market innovations to be consistent with the view of cross-border informationally efficient stock markets. Finally, we find the Japanese equity market performance to have no links with both the US stock market and the stock markets in France, Germany and UK during the pre-and post-October crash period.

Acquisitions, Overconfident Managers and Self-Attribution Bias

We examine whether acquisitions by overconfident managers generate superior abnormal returns and whether managerial overconfidence stems from self-attribution. Self-attribution bias suggests that overconfidence plays a greater role in higher order acquisition deals predicting lower wealth effects for higher order acquisition deals. Using two alternative measures of overconfidence (1) high order acquisition deals and (2) insider dealings we find evidence supporting the view that average stock returns are related to managerial overconfidence. Overconfident bidders realise lower announcement returns than rational bidders and exhibit poor long-term performance. Second, we find that managerial overconfidence stems from self-attribution bias. Specifically, we find that high-order acquisitions (five or more deals within a three-year period) are associated with lower wealth effects than low-order acquisitions (first deals). That is, managers tend to credit the initial success to their own ability and therefore become overconfident and engage in more deals. In our analysis we control for endogeneity of the decision to engage in high-order acquisitions and find evidence that does not support the self-selection of excessive acquisitive firms. Our analysis is robust to the influence of merger waves, industry shocks, and macroeconomic conditions.

Overinvestment, Tobin's q and gains from foreign acquisitions

Abstract U.S. acquisitions of foreign firms, show that bidder abnormal returns are substantially higher for high q bidders than low q bidders; further, bidder returns are significantly and inversely related to free cash flow for low q bidders but not for high q bidders. There is also evidence that financial markets reward more the initial than subsequent foreign investments of value maximizing U.S. multinational firms. Finally, bidder returns are found tc be higher when foreign acquisitions take place in low-tax-rate jurisdictions; in addition, the results show that the 1986 Tax Reform Act exerted a negative effect on bidder returns.

Pre and post-October 1987 stock market linkages between U.S. and Asian markets☆

Abstract This paper documents the presence of a common stochastic trend between the U.S. and the Asian stock market movements during the post-October 1987 period. The evidence suggests that the “cointegrating structure” that ties these stock market together has substantially increased since October 1987. The influence of the U.S. stock market innovations was also found to be greater during the post-October period. The results also indicate that the Asian equity markets are less integrated with Japans equity market than they are with the U.S. market.

A Test of the Errors-in-Expectations Explanation of the Value/Glamour Stock Returns Performance: Evidence from Analysts' Forecasts

Several empirical studies show that investment strategies that favor the purchase of stocks with low prices relative to conventional measures of value yield higher returns. Some of these studies imply that investors are too optimistic about (glamour) stocks that have had good performance in the recent past and too pessimistic about (value) stocks that have performed poorly. We examine whether investors systematically overestimate (underestimate) the future earnings performance of glamour (value) stocks over the 1976 to 1997 period. Our results fail to support the extrapolation hypothesis that posits that the superior performance of value stocks is because investors make systematic errors in predicting future growth in earnings of out-of-favor stocks. Copyright The American Finance Association 2002.

Cognitive Dissonance, Sentiment, and Momentum

We consider whether sentiment affects the profitability of momentum strategies. We hypothesize that news that contradicts investors’ sentiment causes cognitive dissonance, slowing the diffusion of such news. Thus, losers (winners) become underpriced under optimism (pessimism). Short-selling constraints may impede arbitraging of losers and thus strengthen momentum during optimistic periods. Supporting this notion, we empirically show that momentum profits arise only under optimism. An analysis of net order flows from small and large trades indicates that small investors are slow to sell losers during optimistic periods. Momentum-based hedge portfolios formed during optimistic periods experience long-run reversals.

The pricing of currency risk in Japan

Abstract Previous work on the pricing of exchange-rate risk has primarily focused on US firms and, surprisingly, found stock returns were not significantly affected by exchange-rate fluctuations. In this paper we conduct an in-depth investigation that examines whether exchange-rate risk is priced in the equity market of Japan using an intertemporal asset pricing testing procedure that allows risk premia to change through time in response to changes in macroeconomic conditions. Our multiperiod asset pricing tests show that the foreign exchange-rate risk premium is a significant component of Japanese stock returns. Specifically, the results suggest that currency-risk exposure commands a significant risk premium for multinationals and high-exporting Japanese firms. The currency-risk factor is found to be less influential in explaining the behavior of average returns for low-exporting and domestic firms. However, it is shown to exhibit large return volatility that is likely to be perceived by investors, who wish to control portfolio risk, as an important underlying source of risk. Furthermore, Japanese stock returns are found to be related to the relative distress and size factors above and beyond the covariation explained by the currency-risk factor.

Multifactor Asset Pricing Analysis of International Value Investment Strategies

Using a large international equity market database that has not been previously used for such a purpose, this paper documents that value (i.e., high book-to-market ) stocks outperform growth (i.e., low book-to-market ) stocks, on average, in most countries during the January 1975 December 1995 period, both absolutely and after adjusting for risk. The international evidence confirms the findings of previous work reported for the U.S.. For 1975-1995, the annual difference between the average returns on portfolios of high and low book-to-market stocks is 12.94% in North America, 10.42% in Europe, 17.26% in Pacific-Rim per year, and value stocks outperform growth stocks in 17 out of 18 national capital markets. Our analysis also shows that a three-factor model explains most of the cross-sectional variation in average returns on industry portfolios across countries and that the superior performance of the value investing strategy, documented in this study, is a manifestation of size and book-to-market effects. These results are consistent with those reported by Fama and French (1994, 1996) that show that the value-growth pattern in stock returns is largely explained by a three-factor asset pricing model. Our results suggest that the Fama and French (1996) three-factor asset pricing model is not limited to the U.S. stock market. Several recent studies have documented that value strategies (i.e., investing in stocks that have low prices relative to earnings, dividends, historical prices, book assets, or other measures of value) produce higher returns. Among these studies are Basu (1977), Rosenberg, Reid, and Lanstein (1985), De Bondt and Thaler (1985, 1987), Jaffe, Keim, and Westerfield (1989), Chan, Hamao, and Lakonishok (1991), Fama and French (1992), and Lakonishok, Shleifer, and Vishny (1994), all of which show that stocks with high earnings/price ratios or high book-to-market values of equity earn higher returns. A number of alternative explanations for the observed superior returns of value strategies exist. Fama and French (1992, 1993) argue that value strategies are fundamentally riskier and therefore the higher average returns associated with high book-to-market stocks reflect compensation for bearing this risk. A similar argument has been made by Chan (1988) and Ball and Kothari (1989). They suggest that the market overreaction (i.e., winner-loser effect) result of De Bondt and Thaler (1985) is due almost entirely to intertemporal changes in risks and expected returns. Lakonishok, Shleifer, and Vishny (1994), however, argue that value strategies yield higher returns because investors are able to identify mispriced stocks and not because they are fundamentally riskier. Ball, Kothari and Shanken (1995) report that the profitability of the value investing strategy is driven by performance measurement problems and microstructure effects. Kothari, Shanken and Sloan (1995) attribute the superior performance of value strategies to the research design and database used to conduct these studies [i.e., survivorship bias (see Davis (1994)], look-ahead bias [see Banz and Breen (1986)] and data snooping [see Lo and MacKinlay (1990)] in the selection of firms that are included in the CRSP and Compustat databases. Chan, Jagadeesh and Lakonishok (1995) show that this is not the case. Davis (1994) reports a value premium in U.S.stock returns prior to 1963 as well. In a recent study, Fama and French (1996) document that the superior performance of the value investing strategy is a manifestation of size and book-to-market effects. Empirical work has 3 discovered some stylized facts on the behavior of stock prices that cannot be explained by the capital asset pricing model (CAPM) of Sharpe (1964) and Lintner (1965). However, this evidence is largely based on firms in the U.S., and it is not at all clear how these facts relate to different countries. Without testing the robustness of these findings outside the environment in which they were found, it is hard to determine whether these empirical regularities are merely spurious correlations that may not be confirmed across capital markets. This study fills this gap in the literature. In addition, we document for the first time the cross-sectional relationship between beta, size (SMB), book-to-market (HML) and average industry portfolio returns in a sample of 2,629 stocks in 18 equity markets ( including the U.S.) over the 1975-1995 period. The first objective of this article is to examine the robustness of the value-investing strategy using monthly data for 18 equity markets and four regions of the world economy (i.e., North America, Europe, Pacific Basin and International) obtained from the Independence International Associates, Inc.(IIA) database for the 1975-1995 period. We note that in this study the term “international” refers to both the U.S. and non-U.S. stock markets. There are 1,554-2,629 stocks in this database that are tracked by Morgan Stanley Capital International (MSCI) throughout this period. For each country there is a set of five portfolio returns: market, value, growth, small and large. The sample covers more than 75 percent of each country’s market capitalization. There is no survivorship bias in the data set ( as defined by the MSCI database ) since each portfolio is calculated based on the companies that were actually in the MSCI database as of the Januaryrebalance date of each year. The use of such a broad international data set provides a unique opportunity for this analysis. By focusing on the 1975 to 1995 period, this paper studies the behavior of stock returns across countries using a large and updated database that has not been previously used for such a 4 purpose. To the extent that other countries are similar to the U.S., they provide an independent sample to reproduce the regularities found in the U.S. and compare the results to those reported in earlier studies . To the extent that our sample contains countries that are not similar to the U.S., it will increase our ability to shed additional light and help us understand the forces behind the superiority of value strategies. The second objective of the article is to investigate whether value stocks are riskier than growth stocks, since this issue remains controversial among researchers. We focus on betas, coefficients of variation and Sharpe ratios for value and growth strategies. Consistent with the empirical findings of Lakonishok, Shleifer, and Vishny (1994), our analysis provides evidence in support of (i) the superior performance of the value-investing strategy and (ii) the view that such strategies are not fundamentally riskier in 18 equity markets. However, this pattern in international stock returns cannot rule out the possibility that the superior performance of the value-investing strategy is a manifestation of size and book-to-market effects, as reported for the U.S. by Fama and French (1996). The third objective of this study is to examine whether the superior performance of valueinvesting in 18 capital markes is a CAPM related anomaly as argued by Fama and French (1996). This issue is addressed by implementing the Fama and French (1996) three-factor model internationally. However, our empirical investigation is based on portfolios that allow the slopes of the factors to vary over time as opposed to forming portfolios on size, book-to-market and other measures of value that result in factor loadings that are essentially non-time varying [ see Fama and French (1996 ) ]. Our evidence shows that the three-factor model explains most of the cross-sectional variation in average returns on industry portfolios across countries, and that the superior performance 5 of value investing documented in eighteen stock markets ( including the U.S.) is driven by relative size (SMB ) and distress (HML ) effects. Our results are consistent with those found for the U.S. by Fama (1994) and Fama and French (1996). Furthermore, the stock market evidence from around the world suggests that the Fama and French (1996) multi factor asset pricing model is not limited to the U.S. capital market. It holds across capital markets and regions of the world, although it does not uniformly explain portfolio returns in all markets. The rest of the paper is organized as follows. Section I describes the data used in this study. Section II presents annualized return spreads for value and growth strategies based on value and growth portfolios formed on an annual basis for three different investment horizons. Section III examines whether the superior performance of value stocks is related to the upward movements in stock markets. Section IV investigates whether the arbitrage portfolio formed by buying value stocks and selling growth stocks is associated with the effects of firm size. Section V analyzes the robustness of value investing strategies using the Fama and French (1996) three-factor asset pricing framework, and Section VI concludes the paper.

Family Control and Financing Decisions

This study uses a comprehensive European dataset to investigate the role of family control in corporate financing decisions during the period 1998-2008. We find that family firms have a preference for debt financing, a non-control-diluting security, and are more reluctant than non-family firms to raise capital through equity offerings. We also find that credit markets are prone to provide long-term debt to family firms, indicating that they view their investment decisions as less risky. In fact, our empirical results demonstrate that family firms invest less than non-family firms in high-risk, research and development (R&D) projects, but not in low-risk, fixed-asset capital expenditure (CAPEX) projects, suggesting that fear of control loss in family firms deters risk-taking. Overall, our findings reveal that the external financing (and investment) decisions of family firms are in greater (lesser) conflict with the interests of minority shareholders (bondholders).

Common stock returns and international listing announcements: Conditional tests of the mild segmentation hypothesis

Recent theoretical work on mild segmentation suggests that tests of dual listing should be conducted as joint tests: (a) a test of changes in market integration that may aAect asset returns through investors portfolio reallocations as the choice set changes, and (b) a test of changing risk premium/information eAects. Previous empirical studies on common stocks have been unable to identify significant positive abnormal returns associated with international listing. However, such studies have not formally tested for changes in market integration through time. In addition, they have not examined announcement dates, which should be the focal point in testing for valuation eAects. Unlike previous studies, our analysis concentrates on both the period surrounding the earliest public announcements by Canadian companies of their intentions to seek a US listing for their common shares on the NYSE, AMEX, or NASDAQ as well as the date of US listing during the period 1985‐96. This period encompasses significant changes in the regulatory environment which might be perceived to enhance the integration of the two markets. Relying on a conditional asset pricing model subject to time-varying volatility, the results