Timothy T. Simin

The alpha factor asset pricing model: A parable

Recent empirical studies use the returns of attribute-sorted portfolios of common stocks as if they represent risk factors in an asset pricing model. If the attributes are chosen following an empirically observed relation to the cross-section of stock returns, such portfolios will appear to be useful risk factors, even when the attributes are completely unrelated to risk. We illustrate this result using a parable and argue that the moral of the story is important in practice. ( 1999 Elsevier Science B.V. All rights reserved. JEL classification: C5; G12

The Poor Predictive Performance of Asset Pricing Models

This paper examines time-series forecast errors of expected returns from conditional and unconditional asset pricing models for portfolio and individual firm equity returns. A new result that increases predictive precision concerning model specification and forecasting is introduced. Conditional versions of the models generally produce higher mean squared errors than unconditional versions for step ahead prediction. This holds for individual firm data when the instruments are firm specific. Mean square forecast error decompositions indicate that the asset pricing models produce relatively unbiased predictions, but the variance is severe enough to ruin the step ahead predictive ability beyond that of a constant benchmark.

The market reaction to federal reserve policy action from 1989 to 1992

Abstract An examination of the market reaction to Federal Reserve policy easings from 1989 to 1992 suggests that these actions were mostly unexpected and were not viewed to be persistent. Changes in the intended trading range for the federal funds rate had their greatest impact on the near-term outlook, but those effects diminished as the investing horizon lengthened. By this interpretation, any change in longer-term interest rates was mostly owed to the consequences of lower near-term rates, not to any substantial revision to the longer-run outlook. Most significantly, the range of reaction was remarkably wide across all markets.

Is There a Contemporaneous Relation Between Exchange Rates and Stock Prices? Evidence from Decisions to Allow the Mexican Peso and Thai Baht to Float

This paper estimates short horizon exchange rate sensitivity with an event study methodology. We look at stock price reactions to very large, unexpected exchange rate changes: the decisions to allow the Mexican peso and Thai baht to float. For both events, we find evidence of a statistically and economically significant contemporaneous relation. Our findings are consistent with the premise that the inability of much of the prior research to observe a contemporaneous relation between exchange rates and company value is due to methodological issues.

Managing the Balance Sheet with Leases

We document significantly increased reliance on off-balance-sheet (OBS) lease financing that is inconsistent with economic theory. Specifically, the increase is greatest among non-distressed firms characterized by growth options and high R&D but without obvious tax incentives. We explore alternative incentives and find that (1) OBS leasing enables firms to manage debt covenants limiting debt or capital expenditures, (2) excess OBS leasing is diminished by scrutiny of institutional investors, and (3) firms investigated by the SEC or DOJ for financial misrepresentation exhibit high levels of excess OBS leasing. Overall, we conclude that firms use OBS leases to expand their debt capacity while preserving conservative balance sheets.

Return Predictability Under the Alternative

Long-horizon predictability is not a myth. We propose a new analytical standard error for predictive regressions that does not impose the null hypothesis that returns are unpredictable and exhibits substantial power gains relative to popular tests. Deriving the covariance matrix under the alternative hypothesis produces two new terms capturing the volatility of shocks to the regressor and their correlation with shocks to the prediction equation. Empirically, we show that failure to detect long-horizon predictability comes from lower power in tests derived under the null hypothesis. For many predictors, giving the alternative a chance allows short-run predictability to survive at long-horizons.

Spurious Regression and Data Mining in Conditional Asset Pricing Models

Stock returns are not highly autocorrelated, but there exists a spurious regression bias in predictive regressions for stock returns similar to the classic studies of Yule (Journal of the Royal Statistical Society 89, 1–64, 1926) and Granger and Newbold (Journal of Econometrics 4, 111–120, 1974). Data mining for predictor variables reinforces spurious regression bias because more highly persistent series are more likely to be selected as predictors. In asset pricing regression models with conditional alphas and betas, the biases occur only in the estimates of conditional alphas. However, when time-varying alphas are suppressed and only time-varying betas are considered, the betas become biased. The analysis shows that the significance of many standard predictors of stock returns and time-varying alphas in the literature is often overstated.

Estimating the Exchange Rate Exposure of US Multinational Firms: Evidence from an Event Study Methodology

This paper provides new evidence on the issue of whether or not there is a contemporaneous relation between the dollar and firm value as measured with stock returns. Prior studies have failed to find any short-term relation between the value of the dollar and the stock price reactions of U.S. multinational firms. Using a different methodology than previous studies, we find a significant average negative drop in stock price across 430 firms on the day that Thailand devalued the bhat, initiating Asia’s financial crisis. We also show that this measure of exposure is related to both firm size and several proxies for intensity of foreign and Asian operations.

The Decline of Informed Trading in the Equity and Options Markets

Reliable excess returns from active portfolio management derive from informed trading. This article investigates the information content of informed trading in the equity market and the options market. The authors find that informed equity trading and options trading are positively correlated in the time series but virtually uncorrelated cross sectionally. Portfolio-level and stock-level analyses provide robust evidence that the cross-sectional return predictive power of informed trading in each market is distinct. Time-series analyses indicate that aggregate informed options trading is useful for predicting market returns but that the amount of informed trading has declined significantly in more recent years. The time-series patterns of both informed trading measures coincide closely with the decline in equity hedge fund excess returns.

The Value of Uninformative Credit Ratings

We test the hypothesis that financial institutions and other regulated institutional investors benefit from relatively uninformative credit ratings. Using credit ratings without regulatory implications as a benchmark, we show that Moody’s certifies riskier bonds as investment grade. This arbitrary line affects regulated investors’ reserve requirements. We argue that Moody’s certification of marginal bonds allows regulated investors to mitigate the regulatory costs associated with yield chasing. This evidence supports an efficient market explanation – mitigating the costs of regulatory compliance – for the well-documented evidence that Moody’s credit ratings are less informative than those produced by smaller rating agencies.