Shmuel Hauser

Does the stock market predict real activity? Time series evidence from the G-7 countries

This paper extends one aspect of the US stock market study of Fama (1990) and Schwert (1990). We examine the relationship between industrial production (IP) growth rates and lagged real stock returns for the G-7 countries using both in-sample cointegration and error-correction models and the out-of-sample forecast-evaluation procedure of Ashley et al. (1980). The cointegration tests show a long-run equilibrium relationship between the log levels of IP and real stock prices, while the error-correction models indicate a correlation between IP growth and lagged real stock returns for all countries except Italy. The out-of-sample tests show that in several sub-periods the US, UK, Japanese, and Canadian stock markets enhance predictions of future IP. ” 1999 Elsevier Science B.V. All rights reserved.

The Price of Options Illiquidity

The purpose of this paper is to examine the effect of illiquidity on the value of currency options. We use a unique data set which allows us to explore this issue in special circumstances where options are issued by a central bank and are not traded prior to maturity. The value of these options is compared to similar options traded on the exchange. We find that the non-tradable options are priced about 21% less than the exchange traded options. It is an anomaly that cannot be explained by non-hedgeable risks like jumps in the prices of the liquid options which we use in replicating the payoffs of the illiquid options.

A characterization of the price behavior of international dual stocks: an error correction approach

This paper deals with the interrelations between stocks listed and traded in two international unsynchronized markets. The data exhibits first order nonstationarity and the series across markets are cointegrated. This gives a justification for an error correction model which incorporates a short run adjustment mechanism. The model is applied for different day-groups. The main findings are: (1) The domestic country emerges as the dominant market and the foreign market as the satellite one; (2) The adjustment mechanism coefficient is highly significant for most shares; (3) Different behavioural patterns emerge for middle-of-the- week days as compared with beginning/end-of-week days; (4) The model fits better for the more heavily traded shares.

Using a Stochastic Complexity Measure to Check the Efficient Market Hypothesis

The weak form of the Efficient Market Hypothesis (EMH) states that current market price reflects fully the information from past prices and rules out prediction based on price data alone. No recent test of time series of stock returns rejects this weak-form hypothesis. This research offers another test of the weak form of the EHM that leads to different conclusions for some time series.The stochastic complexity of a time series is a measure of the number of bits needed to represent and reproduce the information in the time series. In an efficient market, compression of the time series is not possible, because there are no patterns and the stochastic complexity is high. In this research, Rissanens context tree algorithm is used to identify recurring patterns in the data, and use them for compression. The weak form of the EMH is tested for 13 international stock indices and for all the stocks that comprise the Tel-Aviv 25 index (TA25), using sliding windows of 50, 75, and 100 consecutive daily returns. Statistically significant compression is detected in ten of the international stock index series. In the aggregate, 60% to 84% of the TA25 stocks tested demonstrate compressibility beyond randomness. This indicates potential market inefficiency.

The Impact of Minimum Trading Units on Stock Value and Price Volatility

We study how minimum trading unit changes on the Tel-Aviv Stock Exchange impact a stocks trading activity, price volatility, and value. The value effects are consistent with Mertons (1987) model, i.e., an increase in the investor base (trading volume) and a decrease in price noisiness affect stock value positively. Our results extend Amihud, Mendelson, and Unos (1999) tests of Merton by demonstrating a clear relation between price noisiness changes and stock value changes, and by showing that the response to a minimum trading unit decrease becomes less favorable (and arguably even negative) in the thinnest trading stocks.

Price behavior and insider trading around seasoned equity offerings: the case of majority-owned firms

Abstract Small public firms in the US and elsewhere are often managed by majority owners. This paper offers the hypothesis that majority insiders have an incentive to engage in insider trading around seasoned equity offerings (SEOs), primarily for the sake of preserving control. This hypothesis is tested side-by-side with traditional hypotheses regarding insider trading, such as signaling or growth opportunities that are often considered in the context of firms with dispersed ownership. The empirical analysis in this paper utilizes data of 76 SEOs announced by firms listed on the Tel Aviv Stock Exchange (TASE) between June 1989 and December 1997, whose inside ownership exceeds 50%. The results demonstrate the strong effect of expected post-announcement share price changes on insider trading, and a weaker effect of pre-announcement insider trading on price changes. Unlike minority insiders, who may have an incentive to trade on inside information in order to extract short-term capital gains, majority insiders appear to take the long-term view by buying shares before the offering in order to preserve or increase their control over the firm. This activity does not seem to be dependent upon the firms growth opportunities. Rather, it seems to be market-dependent; that is, the ownership ratio of majority insiders is increased in a bear market and remains the same in a bull market.

Initial Public Offering Discount and Competition

Lacking examples of initial public offering (IPO) mechanisms that are open to the public and priced competitively, previous studies could not determine what size discount, if any, is economically efficient. We compare two pricing regimes on the Tel Aviv Stock Exchange: an investor‐driven Dutch auction limited by a binding maximum price replaced by one that is free of that constraint. Our evidence shows that rationing and herding disappear, improving the access of uninformed investors to strong issues and alleviating their exposure to losses attached to weak issues; pricing quality increases by the elimination of the underpricing bias, decreased price dispersion, and increased price sensitivity to IPO‐unique factors. Underwriter services do not deteriorate but garner moderately higher fees, apparently to compensate for a higher risk. Consistently, there is no deterioration in IPO efficiency as a screen from weak issues. Our evidence does not support the view that underpricing is competitive or efficient.

The effects of domestic and foreign yield curves on the value of currency American call options

This paper examines the sensitivity of the values of foreign currency American call options to the domestic and foreign term structures of interest rates. Pricing performances of currency option models are compared with and without the term structure effects. It is shown that there exist significant pricing biases if flat yield curves are assumed, and that different shapes of domestic and foreign yield curves can have major impacts on currency option prices.

Trading Frequency and the Efficiency of Price Discovery in a Non-Dealer Market

The increasing popularity of non-dealer security markets that offer automated, computer-based, continuous trading reflects a presumption that institutionally-set trading sessions are economically obsolete. This theoretical paper investigates the effect of the trading frequency, a key feature of the trading mechanism, on the efficiency of price discovery in a non-dealer market. By tracing the market pricing error to the correlation structures of arriving information and pricing errors of individual traders, the effect of diverging expectations on error-based and overall return volatility is isolated. The analysis reveals that, due to a portfolio effect, an increase in the trading time interval has contradictory effects on the portion of return volatility stemming from pricing errors. The greater accumulation of information increases error-based return volatility, but the greater volume and number of traders per session have the opposite effect. The net effect on overall return volatility can go either way. It is found that the return volatility of heavily traded securities is likely to be minimized under continuous trading, but that of thinly traded securities may be minimized under discrete trading at moderate time intervals. The latter is more likely to occur the greater is the divergence of expectations among traders. These findings challenge the presumption that automated continuous trading in a non-dealer market is more efficient than discrete trading for all securities, regardless of trading volume. The findings are applicable to all economies, but have special importance for developing countries where typically a single market is dominated by small issues and a low volume of trade. As a by-product of the analysis, it is shown how to correct the biased estimate of inter-session price volatility when observations are less frequent than the trading sessions themselves.

Effect of exchange rate and interest rate risk on international fixed-income portfolios

Abstract The purpose of this study was to investigate empirically the effect of interest rate and currency risk on international currency and fixed-income security allocation during the period of 1983 through 1988. It is shown that bonds of various maturities have different characteristics and cannot substitute for one another in an international portfolio. Among these characteristics, the correlation between the foreign and domestic bond returns and between foreign bonds and exchange-rate returns are significantly lower for long-term than for short-term bonds. Consequently, in some cases, it may be more efficient to increase portfolio expected return by altering the duration of the bonds rather than by increasing the foreign position of the portfolio. A comparison of foreign exchange hedge with the unhedged strategies further emphasizes the different roles of short-term and long-term bonds in internationally diversified portfolios.