Vinay T. Datar

Liquidity and stock returns: An alternative test

Abstract This paper provides an alternative test of Amihud and Mendelsons (1986, Journal of Financial Economics, 8, 31–35) model using the turnover rate (number of shares traded as a fraction of the number of shares outstanding) as a proxy for liquidity. The evidence suggests that liquidity plays a significant role in explaining the cross-sectional variation in stock returns. This effect persists after controlling for the well known determinants of stock returns like the firm-size, book-to-market ratio and the firm beta. Unlike Eleswarapu and Reinganum (1993, Journal of Financial Economics, 34, 373–386), this paper finds that the liquidity effect is not restricted to the month of January alone and is prevalent throughout the year. The evidence supports Amihud and Mendelsons (1986) notion of liquidity premium and establishes its role in the overall cross section of stock returns.

Price clustering in foreign exchange spot markets

Abstract This paper documents the existence of price clustering in the foreign exchange spot market for the German mark, the Japanese yen, the United Kingdom pound, the French franc, the Italian lira, and the Swedish krona. The U.S. dollar exchange rate indicative quotes for these currencies tend to exhibit clustering around right-most digits that end in either a “zero” or a “five.” The tendency for exchange rates to cluster has increased with increases in trading volume and volatility. Moreover, the tendency for exchange rates to cluster differs across currencies.

Impact of liquidity on premia/discounts in closed-end funds

Abstract This paper examines the impact of market liquidity on the premia/discounts in closed-end funds. The central conjecture is that premia (discounts) are observed when claims issued by the fund are more (less) liquid than the underlying assets. The empirical results strongly support the liquidity conjecture: funds with higher liquidity, as measured by proxies for trading activity, have higher premia (or lower discounts) than funds with lower liquidity. This relationship is observed in equity funds as well as in bond funds. Further, the results are robust to various assumptions about model parameters and error structures. Overall, the liquidity hypothesis is supported in our data and may offer a richer description of the premia/discount phenomenon in conjunction with existing hypotheses.

The relevance of value‐at‐risk disclosures: evidence from the LTCM crisis

Purpose – Previous studies have established that the failure of the hedge fund, long-term capital management (LTCM), was associated with significant negative abnormal returns for many US banks, especially around September 2, 1998, when LTCM announced its failure. This study attempts to examine whether bank value-at-risk (VaR) disclosures were used by investors to assess the potential trading loss that a bank could suffer at that time. Design/methodology/approach – This study examines whether there was any association between disclosed VaR and the magnitude of abnormal returns and trading volume surrounding the announcement date. Findings – The results indicate that there was no such association which suggests that investors did not use the VaR information to assess the potential trading losses of exposed banks. Banks that formed part of the LTCM bailout consortium and those with larger amounts of notional derivatives faced the largest negative reaction at the time of the failure announcement. Originality/value – VaR disclosures are costly to prepare and complex to interpret. The study finds no benefits of VaR disclosures to bank investors.

Deep underpricing of China's IPOs: sources and implications

The empirical findings of this paper suggest that IPOs in the Chinese stock market were deliberately, substantially underpriced by the issuers rather than overpriced by the aftermarket. We propose that the Chinese government has deliberately underpriced the IPOs primarily to create a viable capital market without any particular regard to maximisation of issue proceeds (or minimisation of underpricing). The implications of these findings for Chinese policy makers and local as well as foreign investors are significant. The high level of underpricing leads to a wealth transfer but it can be rationalised as an investment in building a capital market infrastructure. There is evidence suggesting that the issuer prefers to keep the offer price low regardless of the offer size; presumably this makes the issues accessible to a wider clientele and thereby makes the wealth transfer more equitable. The combination of a high level of underpricing and a small offer price makes the IPOs widely desirable and also widely affordable; this makes the potential wealth transfer equitable and also facilitates a wide dispersion of ownership that may be essential for a huge emerging capital market such as that of China.

Bid–ask bias in cumulated returns: an analytical approach

Several studies in Finance and Accounting literature have measured security returns subsequent to some economic events over long-horizons by cumulating the returns over time. It is well known that when single period returns are cumulated over long-horizons, the bid-ask error in the measured returns could be very high. One way of estimating the bid-ask error is by simulation. This paper offers an alternative to the simulation approach and provides a closed form expression for the bid-ask error in cumulated returns. Our analytical approach has two main advantages over the traditional simulation method: first it quantifies the bias precisely and second, it is computationally simpler by several orders of magnitude.

Value Effect and Macroeconomic Risk

The authors study the extent to which macroeconomic risk (i.e., the innovations in macroeconomic variables) drives the positive cross-sectional relationship between future stock returns and relative firm value, using such measures as the book-to-market ratio and earnings-to-price ratio. The authors provide evidence that value stocks are riskier than growth stocks. They show that value stocks have higher risk loadings than growth stocks on the growth rate of industrial production, the term premium, and the default premium. They also find that the risk loadings and risk premiums account for more than half of the average return spreads between value and growth portfolios. The evidence suggests that risk plays an important role in explaining the value effect, which has implications for value and growth investment.