Linda H. Chen

Dissecting the Idiosyncratic Volatility Anomaly

The idiosyncratic volatility anomaly, as first documented in Ang, Hodrick, Xing, and Zhang (2006), has received considerable attention in the literature. In this paper, we examine the pervasiveness of the anomaly in various stock samples and provide evidence towards distinguishing potential explanations. Our results show that the idiosyncratic volatility anomaly is a common stock phenomenon. It is rather robust once we exclude microcaps, as defined in Fama and French (2008), or penny stocks (with prices below

The Impact of Earnings Management and Tax Planning on the Information Content of Earnings

5), or the month of January, corroborating the findings in Doran, Jiang, and Peterson (2010). In addition, we show that the idiosyncratic volatility anomaly is not due to the market microstructure effect and cannot be explained by short-term stock return reversal.

Momentum strategies for style and sector indexes

This paper examines the effect of tax planning and earnings management on the relative informativeness of book income and taxable income. We conduct two sets of tests documenting (1) the incremental effect of tax planning and earnings management on the relative informativeness of book and taxable income and (2) the relation between voluntary conformity and the relative informativeness of book and taxable income. Based on these two sets of tests, we conclude that tax planning and earnings quality jointly affect the relative informativeness of book and taxable income.

The Pricing of Climate Risk

The existing literature shows that cross-sectional stock returns exhibit both price momentum and earnings momentum. In this paper, we examine whether commonly used style and sector indexes also have momentum patterns. We show that style indexes exhibit strong price momentum, but give little evidence of earnings momentum. On the other hand, sector indexes exhibit both significant price momentum and earnings momentum. Moreover, we provide evidence that price momentum in style indexes can be explained by individual stock return momentum, whereas price momentum in sector indexes is driven by earnings momentum. Finally, we show that a dynamic momentum strategy can further enhance the performance of style investment even after adjusting for transaction costs.

The Effects of Board Gender Diversity on a Firm's Risk Strategies

This study investigates whether corporate climate risk is priced by the capital markets. Using carbon dioxide emission rates of publicly traded U.S. electric companies, we find that climate risk is positively associated with cost of capital measures, more specifically the implied cost of equity and the cost of debt. Additionally, we find that equity and debt investors evaluate corporate climate risk differently. The results show that the cost of debt decreases with the level of capital intensity, suggesting that debt investors value the increase in efficiency resulting from current capital investments. The results also show that the cost of equity decreases and the cost of debt increases with the newness of assets in places. Newer equipment is likely to be operationally and environmentally more efficient. While the results concerning the cost of debt are puzzling, we consider that debt investors may account for other performance indicators. We conclude that equity and debt investors evaluate climate risk differently according to their different payoff functions.

Interactive Distraction: The Effect of Macroeconomic News on Market Reaction to Earnings News

We study whether board gender diversity (BGD) affects corporate risk strategies. Specifically, we investigate the association between BGD and firms’ reputation risk and financial risk. Using S&P data from 1997 to 2013, we find that BGD is negatively associated with tax avoidance, suggesting firms with gender-diverse boards are more cautious about potential reputation risks associated with aggressive tax strategies. However, we find that BGD is positively associated with firms’ financial risk. The combined findings illustrate that BGD aligns a firm’s risk exposure closer to risk-neutral shareholders’ preferences by reducing reputation risk exposure while enabling necessary financial risk exposure.

Herding on Earnings News: The Role of Institutional Investors in Post-Earnings-Announcement Drift

We show evidence that consistent with category-learning behavior, investors allocate more attention to macroeconomic news than to firm-specific news, such as earnings announcements. Despite the distracting effect of macroeconomic news on investor attention, we find that earnings announcements with concurrent macroeconomic news announcements actually have significantly stronger immediate market response and weaker post-earnings announcement drift. We hypothesize that the combined total attention to macroeconomic news and earnings announcements helps investors understand both the systematic and firm-specific components of earnings surprises. Consistent with the hypothesis, our results show that the macroeconomic news effect is mainly driven by firms with high exposure to macroeconomic news. Moreover, we show that the effect is stronger when macroeconomic news contains more information and for firms with greater information uncertainty. Finally, we provide evidence that macroeconomic news helps reduce stock return uncertainty and enhance stock price efficiency.

Biases in CAPM Beta Estimation

We examine the role of institutional investors underlying post–earnings-announcement drift (PEAD). Our results show that while institutional investors generally herd on earnings news, such correlated trading among institutions does not eliminate or reduce market underreaction to earnings surprises. Instead, PEAD is significant only in the subsample of stocks where institutions herd in the same direction as earnings surprises. In fact, institutional herding is also positively related to next-quarter earnings announcement returns. We provide evidence that institutional herding on or against earnings news is largely driven by firm characteristics, particularly past firm performance and stock returns. In addition, we find that relative to nontransient institutions, transient institutions have a stronger tendency to herd on earnings information. Finally, based on long-run stock returns, we show that when institutions herd on earnings surprises, institutional trading represents a gradual process of incorporating information into stock prices. However, when institutions herd against earnings surprises, institutional trading slows down stock price discovery.

Drift or Jump: What Drives Post-Earnings Announcement Stock Returns?

In this paper, we show that conditions derived under the CAPM ensure only weak exogeneity in a linear regression setting. Since strong exogeneity is not guaranteed, the OLS estimator of CAPM beta is only consistent but not necessarily unbiased. We provide empirical evidence that individual daily stock returns exibit regime-switching patterns and may violate strong exogeneity conditions. As such, the OLS estimator of CAPM beta is likely biased. Based on the empirical patterns of daily stock returns, we use three regime-switching models to illustrate thatthe OLS estimator of CAPM beta can be consistent but at the same time biased. Simulation results based on these three regime-switching models show that biases of the OLS beta estimator can be substantial.

The Effect of Fundamental Risk on the Market Pricing of Accruals Quality

One of the contentious issues regarding the post-earnings announcement drift (PEAD) is whether the abnormal stock return is driven by investors’ delayed reaction to earnings information or by unexpected information shocks subsequent to earnings announcement. In this paper, we disentangle unexpected large changes in stock prices, known as jumps, from total stock returns. Although on average jump occurs only once per firm quarter, it accounts for up to 40% of the return differential between top and bottom SUE deciles. This is evidence that a significant part of PAED is driven by unexpected information shocks. Nevertheless, the drift component still explains at least 50% of the variation of anomalous PEAD returns. The findings suggest that PEAD cannot be entirely attributed to investors’ delayed reaction to earnings information, but neither can the hypothesis be ruled out. In particular, we find that delayed reaction is more pronounced following positive earnings surprises.