R. Jared DeLisle

Pricing of Volatility Risk in REITs

We examine the pricing of volatility risk in the cross-section of equity real estate investment trust (REIT) stock returns over the 1996 to 2010 period. We consider both aggregate (systematic) volatility and firm-specific (idiosyncratic) volatility. In contrast to the negative and significant price of systematic volatility risk for non-REIT equities, we find that systematic volatility is not priced in REIT returns. Idiosyncratic volatility, estimated using the Fama and French (1993) three-factor model, is negatively priced in the cross-section and is largely independent of non-REIT idiosyncratic volatility. Within the total volatility risk profile, idiosyncratic volatility dominates aggregate volatility in REIT pricing.

The Role of Skewness in Mergers and Acquisitions

Investors prefer stocks with idiosyncratic skewness in their returns, which may be evidence of behavioral biases. Previous research suggests that skewness is related to the choice of target in corporate acquisitions, which may reflect CEOs’ behavioral biases. However, if the acquiring firms’ stock returns are also skewed, then the acquirer CEOs may rationally use their stock as currency in these deals. We investigate the skewness of the acquiring firm and the method of payment to determine if takeovers involving high skewness stocks are consistent with shareholder wealth maximization. We find that firms with high levels of skewness are more likely to become takeover targets and that takeover premiums increase with skewness, but there is no relation between the target’s skewness level and acquirer announcement returns. We also find that acquirers with high skewness are more likely to pay with stock and have higher announcement returns. We conclude that acquirer CEOs often take advantage of investor preference for skewness when undertaking mergers and acquisitions activity.

The Dynamic Relation Between Options Trading, Short Selling, and Aggregate Stock Returns

We examine the information contained in option trading and short selling using a dynamic VAR model. First, we address whether options and shorts are complements or substitutes. Contrary to existing event studies around option listing introductions, we show short selling and options trading are complements rather than substitutes. Second, we examine which group is relatively more informed. The results indicate that options traders are relatively more informed. Finally, we examine if options are redundant. Our results indicate that options markets are non-redundant.

Idiosyncratic Volatility and Firm-Specific News: Beyond Limited Arbitrage

Recent evidence (Stambaugh, Yu, and Yuan, 2015) indicates that the most promising explanation for the negative price of idiosyncratic volatility is from its function as a limit arbitrage. Our evidence incorporating firm specific news is inconsistent with the limited arbitrage explanation. Since mispricing is most likely to occur during news announcements, the pricing of news volatility (volatility contemporaneous to news announcements) should be stronger than that of non-news volatility (volatility without an identified news announcement). We find the opposite. Non-news volatility has robust negative price and lacks some of the key features expected from the limited arbitrage explanation. We conclude that the pricing of idiosyncratic volatility is beyond its function as a limit of arbitrage. In addition, we consider evidence at odds with explanations based on difference of investor opinion and investor sentiment. Hence the pricing of idiosyncratic volatility is a deeper puzzle.

Passive Institutional Ownership, R2 Trends, and Price Informativeness

A distinctive trend in the capital markets over the past two decades is the rise in equity ownership of passive financial institutions. We propose that this rise has a negative effect on price informativeness. By not trading around firm-specific news, passive investors reduce the firm-specific component of total volatility and increase stock correlations. Consistent with this hypothesis, we find that the growth in passive institutional ownership is robustly associated with the growth in market model R2s of individual stocks since the early 1990s. Additionally, we find a negative relation between passive ownership and earnings predictability, an informativeness proxy.

Systematic Limited Arbitrage and the Cross-Section of Stock Returns: Evidence from Exchange Traded Funds

We propose a parsimonious, comprehensive proxy for innovations in limited arbitrage: innovations in ETFs’ premium. Consistent with a common component, we confirm limited arbitrage factors, LAFs, constructed from ETFs’ premium innovations spanning four asset classes are correlated. Further, we find that equity LAFs are negatively priced in the cross-section of stock returns. Our pricing tests also confirm that LAFs provide pricing information beyond well-known limits of arbitrage: illiquidity and idiosyncratic volatility. Overall, our findings suggest that limited arbitrage risk is priced and LAF is a relevant risk-factor.

Anchoring and Probability Weighting in Option Prices

Cumulative prospect theory argues that the human decision-making process tends to both incorporate reference points and improperly weight low probability events. In this study, we find evidence that equity option market investors anchor to prices and incorporate a probability weighting function similar to that proposed by cumulative prospect theory. The biases result in inefficient prices for put options when firms have relatively high or relatively low implied volatilities. This has implication for the cost of hedging long portfolios and long individual equity positions.