Thomas F. Gosnell

The intraday speed of stock price adjustment to major dividend changes: Bid−ask bounce and order flow imbalances

Abstract This paper examines the intraday stock price reaction to substantial shifts in dividend policy. The results indicate the price reaction to be slower than that previously found by Patell and Wolfson (1984) and closer to that found with earnings announcements by Woodruff and Senchack (1988). Possible order flow imbalances are examined by looking at the proximity of transaction prices to contemporaneous bid and ask quotes. While order flow imbalances are evident for bad news announcements, this is not the case for the dividend increase sample. This is interpreted as evidence that the price reaction to major dividend increases are in general anticipated. Fifteen minute holding period returns are computed to measure the movement of equilibrium prices during the announcement period. Results show a rapid adjustment of prices to positive announcements with adjustment to negative announcements taking up to 75 minutes. Finally, fifteen minute lagged bid—ask returns are calculated to determine whether an investor could respond to the announcement and earn positive returns. These results are found to be dependent on the transaction cost assumptions being made.

Purchasing power parity: Modeling and testing mean reversion

Abstract A model of mean reversion of exchange rates to purchasing power parity is developed and tested where exchange rates are assumed to follow a mean reverting elastic random walk toward a stochastic PPP rate. The model recognizes the possibility that mean reversion towards PPP may be nonlinear which allows greater flexibility in the adjustment process. Regression equations consistent with the theoretical model are derived. The model is tested using long- and short-term data for six countries. While the results are generally consistent with the findings of previous studies, evidence is presented which demonstrates that the mean reversion process is not linear for some countries.

Macroeconomic news and risk factor innovations

Purpose - The purpose of this paper is to determine if macroeconomic announcements affect the Fama-French market, size, book-to-market risk factors and momentum factor. Design/methodology/approach - Using unexpected announcements of major macroeconomic indicators, a study is made of how daily innovations of risk factors react to macroeconomic shocks. In a Flannery and Protopapadakis framework, the impact of macroeconomics surprises on the levels and volatilities of the risk factors is measured. A VAR model is employed as a robustness check. To better understand the mechanism of announcement impacts on risk factors, the relationship between the macroeconomics announcements and Fama-French size/book-to-market portfolio returns is investigated. Findings - Inflation, employment, consumption and business activities were found to affect levels and volatilities of risk factors. However, these macro variables affect risk factors differently. Inflation and non-farm payrolls decrease the market risk premium while increasing the size premium. Personal income increases the size premium while reducing the book-to-market premium. Industrial production and GDP only influence the level of the momentum factor. In this model specification, producer inflation (PPI) and personal income increase the volatility of the size premium while business inventories increase the volatility of the market premium. Originality - This papers results support the notion that different risk factors capture different economic fundamentals.

Term-Structure Factor Shifts and Economic News

For this article, daily changes in pure discount yields on U.S. risk-free securities were fit to a theoretically robust term-structure model to derive a set of orthogonal factors measuring the level, slope, and curvature of the yield curve. Changes in these factors at the release of unexpected economic news are reported. This methodology explicitly allows for commonalities in responses in the universe of spot rates, thus painting a rich picture of interest rate reactions to new information. The results have important implications for hedging volatility risk or seeking to profit from predicting volatility in bond prices. The argument that efficient markets respond quickly and completely to new information has been a cornerstone of empirical financial research for decades. Given the depth, breadth, and liquidity of the market for U.S. Treasury debt, Treasury yields react to the release of unexpected macroeconomic news in regularly scheduled announcements. Our research shows that reactions occur in a systematic way across the term structure and that an understanding of this phenomenon can enhance portfolio management strategies that are designed to hedge or profit from this predictable volatility. We studied adjustments in a set of orthogonal factors that represent shifts in the level, slope, and curvature of the term structure. The factors were estimated from daily zero-coupon yield changes and allowed for commonalities in responses across the universe of spot rates. Announcements for the following economic series were incorporated: the U.S. Consumer Price Index and Producer Price Index, nonfarm payroll, unemployment, retail sales, durable goods orders, housing starts, and industrial production. The generality of the analysis is important because it distinguished announcements that move the entire term structure in a parallel fashion from those that have incremental effects in the short range. Of the eight releases studied, the four that had the strongest systematic impact were announcements made at the beginning of each month—nonfarm payroll, industrial production, producer prices, and retail sales. Surprises in these four had a consistent, measurable impact on the term structure of zero-coupon yields that was felt equally across the entire maturity spectrum in most interest rate environments. Some announcements—most notably, nonfarm payroll—had incremental effects on the slope component as well as the level component. The underlying data were drawn from Treasury yields for 1982–2002—a long series that contains regimes of rising, falling, and neutral interest rates. This segmentation allowed us to discover that the responses to some surprises (specifically, nonfarm payroll and retail sales) occur later in the maturity structure in a falling-interest-rate environment than in a rising or neutral environment. Furthermore, in periods when the level of Treasury yields was adjusting to a new short-term equilibrium, we found that the market was sensitive to more types of announcements and that reactions to some announcements (notably, retail sales and housing starts) were significantly more pronounced. Taken as a whole, our findings indicate that traders believe increased demand from the producer sector initiates economic expansions, with a corresponding increase in the level of interest rates, whereas developments in the consumer sector sustain yield rallies. In addition, we suggest that announcement risk should be a systematic component of multifactor bond-pricing models and that it should be incorporated into trading strategies that seek to hedge against or profit from daily volatility in U.S. Treasury markets.

Speed of adjustment of the current account: an international comparison

A model of the current account using a mean-reverting Ornstein–Uhlenbeck process is developed and tested for three different measures of the current account. The results show very different adjustment patterns for the current accounts of seven large develpoed countries. This information can be very useful for further detailed analysis of behavior within these individual countries. We find that with the exception of Canada and Japan all countries have a constant long-term mean which, in most cases, was not significantly different from zero. The speed of adjustment to the mean was always between 0 and 1. France and Italy exhibited much more rapid adjustment patterns than did the other five countries.

Accrued Interest and Bond Prices

Some Academics believe that the linear pro-ration of accrued interest transferred from the buyer to the seller when a coupon bond trades between interest payment dates leads to an overstatement of the full value of the bond and imputes a bias into conventional yield to maturity algorithms. This paper provides an analytical resolution to the debate about the correct role of the accrued interest component and demonstrates that current practice reflects the actual cash flows traded between bondholders. In addition, we show that yield to maturity calculations which incorporate linearly pro-rated accrued interest is unbiased.