Paul Marsh

Event study methodologies and the size effect: The case of UK press recommendations

Abstract This study of 862 press recommendations demonstrates that the size effect can distort longer-term performance measures, and hence event studies. Relative to similar sized companies, post-publication performance is neutral. However, market adjustments, the CAPM and Market Model, with equally or capitalization weighted indexes, all produce biased results. Event studies are most exposed to such bias when the measurement interval is long, event securities differ systematically in size or weighting from the index constituents, the size effect is large and/or volatile, and when CAPM-type methodologies are used. These distortions are avoided by explicitly controlling for size.

The Worldwide Equity Premium: A Smaller Puzzle

We use a new database of long-run stock, bond, bill, inflation, and currency returns to estimate the equity risk premium for 17 countries and a world index over a 106-year interval. Taking U.S. Treasury bills (government bonds) as the risk-free asset, the annualised equity premium for the world index was 4.7% (4.0%). We report the historical equity premium for each market in local currency and US dollars, and decompose the premium into dividend growth, multiple expansion, the dividend yield, and changes in the real exchange rate. We infer that investors expect a premium on the world index of around 3-3 1/2% on a geometric mean basis, or approximately 4 1/2-5% on an arithmetic basis.

Global Evidence on the Equity Risk Premium

The size of the equity risk premium—the incremental return that shareholders require to hold risky equities rather than risk‐free securities—is a key issue in corporate finance. Financial economists generally measure the equity premium over long periods of time in order to obtain reliable estimates. These estimates are widely used by investors, finance professionals, corporate executives, regulators, lawyers, and consultants. But because the 20th century proved to be a period of such remarkable growth in the U.S. economy, estimates of the risk premium that rely on past market performance may be too high to serve as a reliable guide to the future. The authors analyze a 103‐year history of risk premiums in 16 countries and conclude that the U.S. risk premium relative to Treasury bills was 5.3% for that period—lower than previous studies suggest—as compared to 4.2% for the U.K. and 4.5% for a world index. But the article goes on to observe that the historical record may still overstate expectations of the future risk premium, partly because market volatility in the future may be lower than in the past, and partly because of a general decline in risk resulting from new technological advances and increased diversification opportunities for investors. After adjusting for the expected impact of these factors, the authors calculate forward‐looking equity risk premiums of 4.3% for the U.S., 3.9% for the U.K., and 3.5% for the world index. At the same time, however, they caution that the risk premium can fluctuate over time and that managers should make appropriate adjustments when there are compelling economic reasons to think that expected premiums are unusually high or low.

Volatility forecasting without data-snooping

Abstract Data-snooping arises when the properties of a data series influence the researchers choice of model specification. When data has been snooped, tests undertaken using the same series are likely to be misleading. This study seeks to predict equity market volatility, using daily data on U.K. stock market returns over the period 1955–1989. We find that even apparently innocuous forms of data-snooping significantly enhance reported forecast quality, and that relatively sophisticated forecasting methods operated without data-snooping often perform worse than naive benchmarks. For predicting stock market volatility, we therefore recommend two alternative models, both of which are extremely simple.

U.K. Financial Market Returns, 1955-2000

We present and analyze new monthly index series for U.K. financial assets, covering equities, bonds, bills, and inflation. The data are consistent with the CRSP/Ibbotson series for the United States. We use our indices to estimate equity and bond premia and to make international comparisons, especially with the United States, Germany, and Japan. We illustrate potential uses of the new series by investigating stock market seasonality, inflation-linked bonds, real dividend growth rates, and the small-firm effect. While some of our findings resemble U.S. results, we also report differences between U.K. and U.S. stock market behavior. Copyright 2001 by University of Chicago Press.

Stress Tests of Capital Requirements

A simplified data link protocol which may be implemented in a very high-speed transmission system, e.g., SONET, processes a datagram received from an IP facility according to QoS considerations and scrambles a datagram before it is again scrambled by a transmission system, e.g., a SONET transmitter, to ensure that the pattern of a users data does not match the transmission scrambling pattern. The data link protocol scrambler also employs a novel synchronization scheme. We also use a pointer system which identifies the location of a datagram in a frame to eliminate flags and the need to process user data to ensure that it does not contain and a boundary flag.

Equity Premia Around the World

We update our global evidence on the long-term realized equity risk premium, relative to both bills and bonds, in 19 different countries. Our study now runs from 1900 to the start of 2011. While there is considerable variation across countries, the realized equity risk premium was substantial everywhere. For our 19-country World index, over the entire 111 years, geometric mean real returns were an annualized 5.5%; the equity premium relative to Treasury bills was an annualized 4.5%; and the equity premium relative to long-term government bonds was an annualized 3.8%. The expected equity premium is lower, around 3% to 3½% on an annualized basis.

Calculating the cost of capital

Abstract One of the most important recent advances in corporate finance is the use of risk measures in setting discount rates or required rates of return for capital projects. An understanding of this area is of crucial importance to senior managers and corporate planners. This article explains how to calculate required rates of return using the modern approach to the cost of capital.

Does top management add value to investment decisions

Abstract This paper presents the findings of a survey into investment decision-making in large divisionalized U.K. companies, as seen from the points of view of both senior head office and divisional managers. It sheds new light on the role the parent company plays in the investment decision-making process, and compares divisional perceptions of strategic investment processes with the views of those from head office, including judgements about the value added by the corporate centre. Finally, it provides suggestive evidence that the behaviour of many head offices could be leading to internally-generated short-termism, and myopic underinvestment in British industry. The paper concludes by outlining a number of ways in which such short-termist behaviour might be avoided.

Low-Cap and Low-Rated Companies

Low-cap and low-rated companies have tended to outperform large stocks and growth stocks, according to studies of U.S. and other stock markets published in the 1980s and 1990s. The results turn out to be different in this examination of the longer-term returns of small-caps and value stocks in 14 European countries. Smaller company returns have been lower than, or only modestly ahead of, big company returns, and out-of-sample returns on value stocks mostly remained higher than those on other companies. Historically, across the countries and over periods of as long as 104 years, investing in value stocks has generated larger and more persistent rewards than investing in small companies.