Nicholas Rueilin Lee

Firm ratings, momentum strategies, and crises: evidence from the US and Taiwanese stock markets

This paper investigates whether there is a link between momentum profitability and firm ratings. We follow traditional and practical (non-) investment-grade classifications to divide into three rating groups, high, median, and non investment-grade group (HIG, MIG, and NIG) since firm ratings express risk in relative rank order to contain valuable information. This study considers the US and Taiwanese stock markets. We find that firm ratings momentum strategies can even earn positive profits, larger than naïve momentum, supporting that firm ratings can be used to strengthen naive momentum effects. By comparisons, the US firm ratings momentum with NIG produces larger profits than HIG but opposite in direction and V-shaped pattern in Taiwan. With an examination of crises on firm ratings momentum, we find that firm ratings momentum indeed helps increase the payoff during (non-)crises although firm ratings momentum profits should be strong following non-crises states and weak following crises states. However, firm ratings momentum profits partially result from the predictability of business cycle, calendar months, and information asymmetries. Our results highlight the critical importance of using firm ratings screens in empirical momentum studies.

Energy Futures Volatility, Trading Activity, and Regime Switching

This paper examines asymmetric impacts of various percentages of futures trading activities on price volatility for energy futures of crude oil and heating oil at the New York Mercantile Exchange (NYMEX). Due of turbulent energy futures prices from the early 2000s, this paper applies threshold autoregressive model to determine structure changes, and the sample prior to and beginning 2000s are also analyzed separately. Results for periods beginning 2000s strongly confirm findings by Bessembinder and Seguin (1993) of a significant positive relation between unexpected volume and volatility and a significant negative relation between expected open interest and volatility. We further find stronger impacts of extremely higher or lower unexpected volume for both two and extremely higher unexpected open interest for heating oil on the volatility since 2000s whereas smaller impacts are found prior to 2000s. Hence, it provides more valuable insights on varying relations of volatility, volume, and open interest in energy futures markets throughout the time.

Threshold Cointegration and Dynamics of Crude Oil Futures Volatility and Financial Speculation

This paper investigates threshold cointegration and dynamics of New York Mercantile Exchange (NYMEX) crude oil futures volatility and speculation in the framework of a threshold vector error correction model (TVECM). Two regimes are determined by the model and divided into the usual and unusual regime. We use the ratio of volume over open interest as speculation variable while we consider two volatilities measures, absolute return and high-low volatilities. Our findings present different and strong asymmetric error correction effects of volatility and speculation in the speed of adjustment to the long-run equilibrium in two regimes. In addition of speculation leading volatility based on former measure, speculation following volatility is found in the usual regime, suggesting relative market efficient. Bidirectional causalities of speculation and different volatilities measures in the unusual regime suggest that market instability mitigated in the unusual regime. In sum, crude oil futures markets seem to work well with the existence of threshold cointegration.

Default probability anomalies in the momentum strategies

This study examines the usefulness of default probability (DP) in explaining momentum profits. We follow Merton (1974) in computing the DP and then follow Jegadeesh and Titman (1993) in conducting default momentum investing. We consider emerging Taiwanese stock market and divide its stocks into three DP groups. Our findings show that adding DP to momentum investing leads to an increase in momentum profits, suggesting that momentum pay-off increases as DP increases. Moreover, a significant and positive momentum profit of buying winners in the high-DP group and selling losers in the low-DP group is observed, implying that DP anomalies exit in momentum strategies. These findings shed light on the source of profitability of momentum strategies.

Taiwan Index Options, Implied Volatility and Nonlinear Panel Unit Root Test

This study applies nonlinear panel unit root tests proposed by Wu and Lee (2009) to examine stationarities of implied volatility for Taiwan index options with moneyness. We find that more than half of implied volatility for calls and puts are nonlinear stationary, especially for puts. Results indicate mean-reverting process for implied volatility, suggesting that adjustment process towards implied volatility is mean-reverting and in a nonlinear way. In addition, short-maturity options tend to overreact to the dynamics of underlying index as maturity decreases. Our findings point out significant nonlinearity in the dynamics of implied volatility for short-maturity options.

Firm Ratings, Momentum Investing Strategy, and Market Crisis: Evidence from US and Taiwan Markets

This paper considers a link between momentum profitability and firm ratings. Credit risks for naive momentum strategies present a U-shaped pattern across momentum portfolios. Due to firms ratings containing valuable information and predicting the cross-sectional stock returns, firm ratings based momentum strategies can even earn positive profits, larger than naive momentum strategies. Specifically, a comparison of firm ratings momentum in both US and Taiwan markets suggest different risk preference where investors in US prefer stocks with higher risk while those in Taiwan prefer stocks with lower risk. Additionally, firm ratings can be used to strengthen naive momentum effects. Next, firm ratings momentum profits partially result from the predictability of macroeconomic factors and non-January months. Moreover, firm ratings may independently explain the momentum effects not captured by factors that proxy for information asymmetries. Finally, with an examination of the 2007 subprime crisis on the firm ratings momentum, we find that firm ratings momentum indeed helps increase the payoff during the period for the crisis, especially for middle investment-grade group in US market.

The Information Content of Initial Firm Rating Announcements

Credit rating announcements can be for either initial ratings or rating changes, but past research has focused mainly on the market reaction to the latter. This study examines the information content of initial rating announcements and thus fills the void in the literature and broadens our understanding about the informational role played by credit ratings in the market. Using data from Taiwan, a financial market with newly established credit rating system, this study examines the rating announcement effect on firms that receive their first-time ratings from a private rating agency. Contrary to the common belief that investors respond more favorably the higher the rating a firm receives, we show that significant and positive equity price responses occur only for less credit-worthy firms in the market. Counterintuitive as it may seem, our finding is consistent with the prediction of signaling theory. More specifically, our evidence suggests that initial firm ratings do carry information value, but only for lower-quality or smaller-size firms that have been penalized by information asymmetry until credit rating becomes available as a cost-effective signaling alternative. This finding has important implications for many smaller or lower quality firms that traditionally are more reluctant to seek ratings, because signaling through ratings indeed helps reduce information asymmetry and can actually enhance value for these firms.