Tavy Ronen

Tests and Properties of Variance Ratios in Microstructure Studies

The properties of variance ratio tests across trading and non-trading periods are examined using the generalized method of moments. For the case of opening and closing return variances, the joint tests indicate that the null hypothesis that the variance of opening returns equals the variance of closing returns cannot be rejected for a sample of New York Stock Exchange stocks. This example demonstrates the importance of accounting for overlapping observations and cross correlation in such frameworks. The conventional average (across assets) variance ratio test is shown to be biased against the null in small samples. Specifically, when non-zero correlations are ignored, previous tests have the wrong asymptotic size. This bias persists in other frameworks as well: although this study confirms earlier findings that the return variance during non-trading periods is significantly lower than during trading periods, test statistics that ignore correlations are shown to be inflated.

Trading structure and overnight information: A natural experiment from the Tel-Aviv Stock Exchange

Abstract A unique data set from the Tel-Aviv Stock Exchange (TASE) is used to study the effect of trading mechanisms on stock return volatility. The TASE represents a natural experiment which allows separation of the overnight information effect from the trading mechanism effect. The data span a time period in which the order of the trading mechanisms (a sequential continuous mechanism and a call auction) was switched. Since overnight information should impact opening prices equally across periods, this affords an unparalleled opportunity to examine the trading mechanism effect without the confounding effect of the non-trading period. This paper finds that the null, that opening variances equal closing variances, cannot be rejected for either period. Further, the tests cannot reject null that the ratio of opening to closing return variances is equal across periods. This suggests that the trading mechanisms on the TASE do not differ in their effect upon return volatility.

The Effect of Voluntary Disclosure and Preemptive Preannouncements on Earnings Response Coefficients (ERC) When Firms Manage Earnings

We study analytically the effect of preliminary voluntary disclosure and preemptive preannouncement on the slope of the regression of returns on earnings surprise—the earnings response coefficient (ERC). When firms do not manage earnings, additional disclosure has no effect, and the ERC is proportional to price/permanent earnings ratio. If they manage earnings by attempting to inflate them, the response to (100% credible) negative earnings surprise is stronger than the response to (less than 100% credible) positive surprise. To avert litigation, firms that manage earnings adopt a partial voluntary disclosure strategy—either public revelation of good news and withholding bad news, or public revelation of bad news and withholding good news. Voluntary disclosure affects ERC on positive earnings surprise only, depending on what the firm reveals: the good- news revealing ERC (GRC) is higher than the bad-news revealing ERC (BRC), because good news enhances the credibility of the positive earnings surprise, even though the market discounts good news. Furthermore, preemptive pre-announcements improve ERC accuracy by narrowing the scope of earnings management.

Observable Consequences of Trading Structure Differences: On the Use of Variance Ratios in Microstructure Studies

This paper examines the variance ratio tests in studies of transitory volatility and concludes that the variance ratio is an appropriate test of trading structure differences only under certain assumptions regarding the evolution of underlying stock prices and the autocorrelation structure of returns. This result raises caution as to the interpretation of results bases upon the 24-hour variance ratio methodologies in studies of transitory volatility and trading structure effects. A numerical example indicates that errors in inferences can be severe.

On the Tension between Full Revelation and Earnings Management: A Reconsiderastion of the Revelation Principle

We challenge the popular view that because of the revelation principle, the research on earnings management must be restricted only to situations in which a truth-telling, fully revealing equilibrium/i> does not exist. After presenting and discussing the revelation principle, we state conditions under which truth-telling equilibria may be dominated by equilibria wherein the message (such as earnings) is managed. The optimal message in an undominated equilibrium may involve either partial suppression of information (omission of some data) or aggregation (summarization of data).

Unfair 'Fair Value' in an Opaque Credit Default Swap Market: How Marking-to-Market Pushed the International Credit Crunch

Mark-to-market accounting, as required by FAS No. 157, has been implicated as a contributor to the financial meltdown caused by the housing crisis and the consequent write-down of securities backed by mortgages (MBS) and collateralized debt obligations (CDO). In this paper, we investigate the effects of mark-to-market accounting write-downs by financial institutions on equity returns, trading volume, and CDS premiums and whether the write-downs induced contagion effects on similar institutions without write-downs. Specifically, we examine whether equity returns and CDS premiums of the similar institutions responded significantly to write downs by peer firms. We find that firms that write down assets to their exit values in accordance with FAS No. 157 not only experience significant abnormal negative returns and a spike in the premiums of CDS written on their obligations – indicating higher default probability – but that similar firms without write downs exhibit a sympathetic and significant negative abnormal returns as well at the same time as the write-down firms. This is clear evidence of contagion effects induced by FAS No. 157 mark-to-market accounting. The analysis shows significant cross-sectional determinants of both equity abnormal returns and CDS premiums to generally include the measurement levels under FAS 157, liquidity, the amount of the write-down and rating changes.

When an Executive Departs: An Informational Content Story

Information about an executives decisions at his/her former employer can have a significant impact on the stock returns of his/her current employer, even after the job change occurs. In this article, we analyze transfers of information, which, we argue, reflect executive decision‐making ability as executives change jobs. We examine information about restructurings and write‐downs at the new employer emerging after the executive has left an employer that indicates the executive is of lower ability than investors had expected at the time of the hiring. Our results show that such signals are associated with significant negative returns to the current employers shares, particularly for within‐industry job changes. We distinguish between restructurings at firms with and without departing executives and find that following an executives departure, firms that had executives depart experience negative market reactions. Le depart dun cadre superieur : une question de contenu en informations Les informations relatives aux decisions prises par un cadre superieur dans le cadre de ses fonctions aupres de son employeur precedent peuvent avoir une incidence marquee sur le rendement des actions de son employeur actuel, meme apres le changement de fonctions. Les auteurs analysent les transferts dinformations qui, selon eux, refletent les aptitudes decisionnelles strategiques des cadres superieurs lorsque ceux‐ci changent de fonctions. Ils se penchent sur les informations relatives aux restructurations et aux reductions de valeur operees par le nouvel employeur qui font surface une fois que le cadre superieur a quitte un employeur et selon lesquelles les aptitudes dudit cadre sont inferieures aux attentes des investisseurs au moment de lembauche. Les resultats de l’etude revelent que ces indicateurs sont associes a des rendements negatifs importants des actions de lemployeur actuel, en particulier dans le cas de changements de fonctions a linterieur dun meme secteur dactivite. Les auteurs etablissent la distinction entre les restructurations selon que les societes en cause affichent ou non des departs de cadres superieurs, et ils constatent qu’a la suite du depart de cadres superieurs, les societes concernees connaissent des reactions negatives du marche.

Advances in Quantitative Analysis of Finance and Accounting:Essays in Microstructure in Honor of David K Whitcomb

NewsProfessor Cheng-Few Lee ranks #1 based on his publications in the 26 core finance journals, and #163 based on publications in the 7 leading finance journals (Source: Most Prolific Authors in the Finance Literature: 1959–2008 by Jean L Heck and Philip L Cooley (Saint Josephs University and Trinity University).Market microstructure is the study of how markets operate and how transaction dynamics can affect security price formation and behavior. The impact of microstructure on all areas of finance has been increasingly apparent. Empirical microstructure has opened the door for improved transaction cost measurement, volatility dynamics and even asymmetric information measures, among others. Thus, this field is an important building block towards understanding todays financial markets. One of the pioneers in the field of market microstructure is David K Whitcomb, who retired from Rutgers University in 1999 after 25 years of service. David generously funded the David K Whitcomb Center for Research in Financial Services, located at Rutgers University. The Center organized a conference at Rutgers in his honor. This conference showcased papers and research conducted by the leading luminaries in the field of microstructure and drew a broad and illustrious audience of academicians, practitioners and former students, all who came to pay tribute to David K Whitcomb. Most of the papers in this volume were presented at that conference and the contributions to this volume are a lasting bookmark in microstructure. The coverage of topics on this volume is broad, ranging from the theoretical to empirical, and covering various issues from market architecture to liquidity and volatility.