Lee M. Dunham

An Empirical Examination of Jump Risk in U.S. Equity and Bond Markets

Abstract Actuaries manage risk, and asset price volatility is the most fundamental parameter in models of risk management. This study utilizes recent advances in econometric theory to decompose total asset price volatility into a smooth, continuous component and a discrete (jump) component. We analyze a data set that consists of high-frequency tick-by-tick data for all stocks in the S&P 100 Index, as well as similar futures contract data on three U.S. equity indexes and three U.S. Treasury securities during the period 1999-2005. We find that discrete jumps contribute between 15% and 25% of total asset risk for all equity index futures, and between 45% and 75% of total risk for Treasury bond futures. Jumps occur roughly once every five trading days for equity index futures, and slightly more frequently for Treasury bond futures. For the S&P 100 component stocks, on days when a jump occurs, the absolute jump is between 80% and 90% of the total absolute return for that day. We also demonstrate that, in the cross section of individual stocks, the average jump beta is significantly lower than the average continuous beta. Cross-correlations within the bond and stock markets are significantly higher on days when jumps occur, but stockbond correlations are relatively constant regardless of whether or not a jump occurs. We conclude with a discussion of the implications of our findings for risk management.

Do Index Fund Managers Trade Opportunistically Around Index Changes? An Empirical Examination of S&P 500 Index Funds

Numerous studies have documented abnormal returns available to investors around index changes. S&P 500 index fund managers face competitive pressures to replicate the index as close as possible or risk the loss of investors to competing funds. As a result, these fund managers have incentive to take actions to reduce any underperformance. The authors examine whether S&P 500 index funds are able to opportunistically trade around index changes between the announcement date and the effective date in an effort to reduce tracking error. They do find evidence of these funds using changes to the S&P 500 as a source of opportunity to capture performance and reduce tracking error. This evidence suggests that the wealth transfer from index fund investors to arbitrageurs around S&P 500 index changes documented in the literature may be far less pronounced than originally thought.

The Impact of Securities Lending on Index Fund Performance

Managers of index funds face competitive pressures to replicate their respective benchmarks as close as possible or risk the loss of investors to competing index funds. As a result, these managers have incentive to take actions to reduce any tracking error. One particular way index funds reduce tracking error is through securities lending activities. The authors examine the impact of securities lending activities on the return performance of index funds and document that reliance on securities lending activity as a means of reducing tracking error has increased significantly over time.

Vertical Versus Horizontal Integration in the Biopharma Industry: The Link between Acquisition Announcements and Stock Market Performance

Declining productivity and disappointing lack of profitability after three decades of biotechnology commercialization, despite enormous investment and the great promise of breakthrough solutions, have led researchers to question whether traditional horizontal acquisition strategies result in superior firm performance. Our chapter explores the answer to this question as well as to the role that disclosure plays in this important emerging industry. Using standard event study methodology, we examine differences in market performance of vertical versus horizontal acquisition strategies, along with the role played by the amount of information disclosed in the announcement. Our results suggest that vertical acquisitions underperform horizontal acquisitions, with the amount of disclosure playing a role in the markets ability to react to a firms acquisition strategy accurately and quickly. Our results suggest that accountants who have called for additional disclosure, especially in complex industries such as biopharma, are correct in assuming that nonfinancial information plays a significant role in investors’ valuation of an acquisition event. Managers of biopharma firms, however, are cautioned that more disclosure, through the reduction of uncertainty, may result in lower market valuations for acquirers.

Building a Better Mousetrap: Enhanced Dollar Cost Averaging

This article presents a simple, intuitive investment strategy that improves upon the popular dollar-cost-averaging (DCA) approach. The investment strategy, called enhanced dollarcost-averaging (EDCA), is a simple, rule-based strategy that retains most of the attributes of traditional DCA that are appealing to most investors yet adjusts to new information, which traditional DCA does not. Simulation results show that the EDCA strategy reliably outperforms the DCA strategy in terms of higher dollar-weighted returns about 90% of the time and nearly always delivers greater terminal wealth for reasonable values of the risk premium. EDCA is most effective when applied to high-volatility assets, when cash flows are highly sensitive to past returns, and during secular bear markets. Historical back-testing on equity indexes and mutual funds indicates that investor dollar-weighted returns can be enhanced by between 30 and 70 basis points a year simply by switching from DCA to EDCA.

An Analysis of the Impact of Securities Lending on the Performance of ETFs

Securities lending has been a lucrative business for mutual funds and ETFs over the past decade. The authors examine the impact of securities lending activities on the return performance of U.S. equity ETFs. They find that income from securities lending has surged in recent years and was at extreme levels during the financial crisis years of 2008 and 2009. They further document that income from securities lending activities has been used by these ETFs as a means of considerably reducing tracking errors over time. These findings have important implications for investors, particularly those who use tracking error to evaluate the performance of ETFs.

An Empirical Analysis of the Dynamic Relation among Investment, Earnings and Dividends

The separation principle implies independence among a firm’s financing, investment, and dividend decisions and that investment policy is the sole determinant of firm value. One important implication of the separation principle is that investment decisions of the firm should never be impacted by the firm’s dividend decisions. However, recent work suggests that payout policy is also a first-order value determinant, suggesting interdependence between a firm’s dividend and investment decisions. We empirically examine and quantify the relation between dividends and investment by modeling the dynamics of investment, earnings and dividends at the firm level in a vector autoregression (VAR) framework for a large cross-section of firms. Results show that shocks to dividends do have long-run consequences for investment and vice versa, implying bi-directional interdependence, evidence against the separation principle. Long-run dynamics from impulse responses show that on average, for a

Price Trends and Patterns in Technical Analysis: A Theoretical and Empirical Examination

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Managerial Hedging Ability and Firm Risk

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Building a bioeconomy in the heartland: Bridging the gap between resources and perceptions

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