Robert Neal

Do Measures of Investor Sentiment Predict Returns

It has long been market folklore that the best time to buy stocks is when individual investors are bearish, and the best time to sell is when individual investors are bullish. We examine the forecast power of three popular measures of individual investor sentiment: the level of discounts on closed-end funds, the ratio of odd-lot sales to purchases, and net mutual fund redemptions. Using data from 1933 to 1993, we find that fund discounts and net redemptions predict the size premium, the difference between small and large firm returns, but little evidence that the odd-lot ratio predicts returns.

Adverse selection and bid-ask spreads: Evidence from closed-end funds

Abstract This paper uses closed-end funds to analyze two commonly used empirical models for estimating the adverse selection component of a firms bid–ask spread. In contrast to stocks, closed-end funds report their net asset values weekly, all but eliminating uncertainty about their current liquidation values. Estimates of the adverse selection component, however, are large and significant for both the funds and a matched sample of common stocks. This suggests that either adverse selection arises primarily from factors other than current liquidation value or the empirical models are misspecified.

Direct Tests of Index Arbitrage Models

Previous tests of stock index arbitrage models have rejected the no-arbitrage constraint imposed by these models. This paper provides a detailed analysis of actual S&P 500 arbitrage trades and directly relates these trades to the predictions of index arbitrage models. An analysis of arbitrage trades suggests that i) short-sale rules are unlikely to affect the cash-futures mispricing, ii) the opportunity cost of arbitrage funds exceeds the Treasury bill rate, and iii) the average price discrepancy captured by arbitrage trades is small. Tests of the models provide some support for a version of the arbitrage model that incorporates an early liquidation option. The ability of these models to explain arbitrage trades, however, is surprisingly low.

Emerging market transaction costs: Evidence from Indonesia

Abstract Despite investor interest in emerging stock markets, relatively little is known about the cost of transacting on these markets. This paper uses transactions data to estimate the execution costs of trading on one emerging market, the Jakarta Stock Exchange (JSX) in Indonesia. We find that JSX execution costs appear surprisingly similar to those of non-U.S. developed markets. Factors influencing these costs include the difficulty of the trade, the size of the firm traded, and the broker executing the trade. We also find that trades initiated by foreigners have a much larger price impact than trades initiated by local investors.

Option Investor Rationality Revisited: The Role of Exercise Boundary Violations

The authors dispute the theory that American call options should not be exercised early. By looking at intraday pricing, they find that the best bid price available is often lower than the option’s...

Exercise Boundary Violations in American-Style Options: The Rule, not the Exception

An exercise boundary violation (EBV) occurs when the current bid price for an American option in the market is below intrinsic value. A seller at this price leaves money on the table and the buyer receives an arbitrage profit. In a liquid market, competition among dealers should drive up the bid prices and eliminate the arbitrage. An analysis of intraday data shows that EBVs are the norm, not the exception, with near-term in-the-money equity calls and puts the most affected. In March 2010 48.6% of all in-the-money call options had EBV bid quotes and 11.5% of trading volume in those options occurred below the intrinsic value, costing the sellers an estimated

Credit Derivatives and Emerging Markets

39 million. EBVs are highly persistent throughout the day, making it rational to liquidate an option by exercise rather than selling it in the market, in sharp contrast to textbook theory. Our empirical results show early exercise is strongly related to an options EBV. In addition to altering optimal exercise strategy and the value of the early exercise premium, the possibility of early exercise to avoid an EBV makes intrinsic value the effective bid price. This narrows the spread and raises its midpoint, which affects customary measures of market liquidity, the options market price, and its implied volatility.

International Investment Restrictions and Closed- End Country Fund Prices

This chapter examines recent developments in the management of emerging-market credit risk. Traditional strategies for managing credit exposure often provide insufficient protection. In general, better protection can be obtained by using credit derivatives, derivative contracts whose payoff is linked to the performance of credit-sensitive assets. This chapter discusses alternative types of credit derivatives, as well as their application to managing credit risk in emerging markets.