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      Department of Finance Research

      Abstract Report 2020

Robust Estimation of Conditional Risk Measures for Crude Oil and Natural Gas Futures Prices in the Presence of Outliers

In this study, we employ statistical procedures to identify outliers in the prices for all crude oil and natural gas futures contracts traded on the. Empirical results for crude oil and natural gas futures contracts show that handling outliers when performing parametric estimation of the data generating process can have a large impact on the estimation of various risk metrics including value at risk, expected shortfall, and probability of outperforming a benchmark. Our research demonstrates that it is crucial to manage outliers to decrease bias of the data generating process.
Sponsors: Oklahoma State University, Texas State University

PI/PDs: Betty Simkins, Joe Byers

Texas State University: Ivilina Popova

 

The Influence of Major News Events in Causing Outliers for Crude Oil and Natural Gas Commodity Futures Prices

The main goal is to improve our understanding of the impact of major news events in causing outliers in commodity futures prices that focus on crude oil and natural gas futures contracts.  Natural gas futures can have up to 120 risk factors based on each open contract and these risk factors are driven by different news events.  This research identifies outliers in the prices for all crude oil and natural gas futures contracts traded on the CME over the period of 2003 to 2017, and analyzes what specific types of news events can cause different types of price impacts.

Sponsors: Oklahoma State University, Texas State University

PI/PDs: Betty Simkins, Joe Byers

Texas State University: Ivilina Popova

 

Digital Average Price Options (DAPO)

We present an analytical solution for Digital Average Price Options (DAPO). This is an extension of digital options to incorporate average price or Asian price characteristics. We build on work by Zhang (1998), Turnbull and Wakeman (1991), and Haug (2004). We utilize numerical difference methods to calculate the Greeks based on the derived closed-form solution. These options can be used to manage risk or generate income. These products can effectively manager tail risk exposures with one transaction for an energy company who is exposed to multiple types of tail risk, which otherwise would require insuring each event with separate transactions.

Sponsor: Oklahoma State University

PI/Pd: Joe W. Byers

 

How to Bring Rigorous Risk Management to Classroom and Research Projects: Implementing Document Control, Disaster Recovery, and Security Standards for the Academic.

All teachers struggle with security, version control, and disaster recovery of their classroom, research, and administrative documents. The paper will demonstrate that utilizing techniques and technology from FOSS one can protect their documents and intellectual property. The paper show how to version control documents in the cloud, providing disaster recovery at all times, and access from anywhere one has access to the internet. We further demonstrate the security provided by these methods to protect intellectual property and fraud in our virtual age.

Sponsor: Oklahoma State University

PI/Pd: Joe W. Byers

 

Online Exams, an Algorithm for Randomizing Questions to Mitigate the Risk of Fraud.

We provide a proof of concept for algorithms that will mitigate the risk of fraud for online Multiple choice exams with significant probabilities. The algorithm is implement in an open source software Ruby. This algorithm will take standard multiple choice and randomize the questions as different multiple choice and true/false questions that include negative variants of the questions. One simple question with four options including an all of the above will generate questions in terms of four factorial.

Sponsor: Oklahoma State University

PI/Pd: Joe W. Byers

 

Constraints and Boundary Conditions for Real Option Valuation and Risk Management of Commodity Storage using constrained optimization.

This paper extends Byers (2005) and Byers (2006) with further insights on monetizing the a Real Options Commodity Assets with flow constraints. The paper shows how the real asset can be fully hedged using standard liquid derivatives that are openly traded. We effectively build a "box" around the value of the asset. This paper overcomes other valuation and risk management techniques that rely on stochastic modeling and implementing derivatives that do not trade in the market, so all valuation contains bias and error from parameters estimations.

Sponsor: Oklahoma State University

PI/Pd: Joe W. Byers

 

Volatility Persistence or Price Outliers, a Tail of Two Methods?

Volatility persistence is related to the duration of shocks to volatility. These are events that cause a shift in the standard deviation of an asset's returns that decay over time. The duration can be short, medium, long. An alternative explanation is how outliers impact asset returns through the mean of the return process, not the volatility. This will have not volatility persistence for all outlier types but one, the innovative outlier (IO). This paper will investigate the impact of controlling for mean shocks (Outliers) to and the asset return process with respect to past volatility persistence patterns.

Sponsor: Oklahoma State University

PI/Pd: Joe W. Byers

 

Round and Charm Number Pricing of Real Estate

Researchers of stock data have found that prices tend to clump around “round” numbers and more transactions take place on specific digits and, before decimalization, “even eighths.”  Real estate list prices commonly use “charm pricing.”  Allen and Dare (2004, 2006) found that transaction prices of charm listed properties brought more in actual price when compared to equivalent properties without charm listing, thus indicating a possible signaling from seller to buyer.  We extend the investigation of charm pricing by analyzing actual prices for real estate.  We find in the majority of transactions, round numbers, fives and zeros, dominate final transaction prices.
Sponsor: Oklahoma State University
PI/PDs: William Dare
Florida Gulf Coast University: Marcus T. Allen

 

Sports Gambling as an Asset Class

The Supreme Court recently stuck down the Professional and Amateur Sports Protection Act,   creating the possibility of legal sports gambling in the US.  The difference between sports and casino gambling is that in sports gambling; the odds of winning are determined by the individuals; those betting, taking the bets, and all involved. We offer a gambling market efficiency test that evaluates betting strategy returns with the risk return tradeoff; specifically, the S&P 500.  This incorporates the well-known Kelly criterion to reexamine the well-documented bias of NFL games with the tests indicating much less of an inefficiency than previously reported. 

Sponsor: Oklahoma State University

PI/PDs: William Dare

Florida Gulf Coast University: Marcus T. Allen

 

Measuring Institutional Trading Costs and the Implications for Finance Research: The Case of Tick Size Reductions

Abstract: We demonstrate that many widely used liquidity measures do not adequately capture institutional trading costs. Using proprietary data, we construct a price impact measure that better represents the costs faced by institutional investors. We find that price impact is not correlated with many common liquidity proxies. In addition, institutional trading costs are not dramatically impacted by decimalization, casting doubt on the widely used identification strategy that employs decimalization as an exogenous shock to liquidity, particularly institutional liquidity. Indeed, we find that conclusions from prior research are significantly altered when we measure liquidity using institutional trading data.

Sponsor: Oklahoma State University

PI/PD: Gregory Eaton

 

Measuring M&A premiums: Does the Use of Fixed Pre-Merger Event Windows Impart Bias?

Most academic studies use fixed pre-announcement event days (such as -20, -42, or -63) to measure unaffected target-firm stock prices. In this paper, we demonstrate that the use of fixed pre-announcement event days generates downward bias in measured premiums, especially for more recent samples and for transactions with long deal processes (such as target-initiated deals). We take account of this bias by hand-collecting deal initiation dates and demonstrate that using these dates results in measured premiums that give contradictory conclusions to those found in the existing literature. We also offer guidance for measuring M&A premiums if hand-collecting data is impractical.

Sponsor: Oklahoma State University

PI/PD: Gregory Eaton

 

Ambiguity Aversion and Asset Price Dynamics

We derive the equilibrium asset expected returns when there is ambiguity in asset expected returns, as well as ambiguity in asset return variances.  In our model, ambiguity risk is systematic in nature and is non-diversifiable.  Under regularity conditions, expected asset returns are linearly increasing in variance risk and ambiguity risk.  We show that a beta pricing model can be derived from the equilibrium expected return function, which contains a systematic return factor and an ambiguity portfolio return factor, where the ambiguity portfolio weights are determined within the model.  We test our model empirically and we obtain the model-implied results.

Sponsors: Oklahoma State University, Rutgers Business School

PI/PDs: Louis Piccotti

Rutgers Business School: Yangru Wu

 

A Multiscale Estimator for Pricing Errors in High-frequency Financial Market

For a Lévy process corrupted with microstructure noise, I derive the sampling distributions for the information-related and information-unrelated pricing error parameters and for the variance of latent true price returns (a noise-robust and consistent estimator of realized variance).  The test statistics converge in distribution to the standard normal distribution, while statistics for joint tests, tests for intraday seasonality, and tests for time varying parameters converge in distribution to the  distribution.  Simulation evidence verifies that test statistics display good properties.  As an empirical example, the proposed tests are taken to a sample of exchange rates, commodities, and index futures.

Sponsor: Oklahoma State University

PI/PD: Louis Piccotti

Portfolio Frequency Structure Preferences

I examine the optimal portfolio allocation for investors with risk frequency preferences.  As an implication, the portfolio opportunity set can be uniquely constructed from a set of basis frequency structures.  Factor model representations represent restrictions on the frequency structure space, which is equivalent to finding a linear combination of frequency structures that are required to price a portfolio. A portfolio’s alpha results from the frequency structure misalignment between the marginal investor and the factor model implied one.

Sponsor: Oklahoma State University

PI/PD: Louis Piccotti

 

Financial Contagion: Bank Characteristics Matter

We systematically examine how bank characteristics are related to a bank’s financial contagion exposure.  Examining capital requirements, we find evidence that while tier 1 capital requirements are negatively related to a bank’s contagion exposure, the sum of tier 1 and tier 2 capital ratios are positively related to it.  Banks with greater financial constraints are less exposed to contagion.  Geographic distance between banks is negatively related to contagion exposures and we find evidence that institutional ownership is positively related to banks’ contagion exposures.  Finally, we find that board attributes that reduce banks’ risk taking incentives negatively associate with financial contagion.

Sponsor: Oklahoma State University

PI/PDs: Louis Piccotti, Sharif Mazumder

 

Are Options Redundant? The Benefits of Synthetic Diversification

This paper examines an alternative avenue through which trading in

options can expand investors’ opportunity sets, unrelated

to private information, differing opinions, endowments, or trading

restrictions in the stock market. Investors can synthetically replicate

the return profile of optionable stocks using options for a fraction

of the cost of holding the underlying securities, which makes diversification

more cost-efficient. We find that the option to stock volume ratio

increases when stock price, idiosyncratic risk, stock illiquidity,

borrowing cost, and market risk aversion are high. In addition, institutional

holdings and option trading have a U-shaped relation.

Sponsor: Oklahoma State University

PI/PDs: Louis Piccotti, Yifan Liu

 

Portfolio Returns and Consumption Growth Covariation in the Frequency Domain, Real Economic Activity, and Expected Returns

The slope of the portfolio return and consumption growth co-spectrum contains predictive information about future real economic activity; future recession probabilities, the risk aversion coefficient, as well as future expected returns.  Commonly used economic variables do not subsume the predictive power of the co-spectrum slope and while the interest rate term spread largely fails to predict the Financial Crisis, the set of co-spectrum slopes predicts the crisis with a 75% probability.  The co-spectrum slope significantly improves the fit of long-horizon expected return models and contains more significant predictive information than the current dividend yield.

Sponsor: Oklahoma State University

PI/PD: Louis Piccotti

 

Information shares in a two-tier FX market

Using several measures of information share, we examine price discovery across the inter-dealer and dealer-customer market tiers in the currencies market. In the spot market, the information share of the inter-dealer tier is higher than that of the dealer-customer one for non-financial sector trades and is lower than the dealer-customer tier for foreign investors’ sell trades. In the forward market, the dealer-customer tier generally has the greater information share at the dealer’s buy side. Our results indicate the market where customers’ trades are the most informative and demonstrate how exogenous events affect price discovery across markets and market tiers.

Sponsors: Oklahoma State University, Bank of Israel

PI/PDs: Louis Piccotti

Bank of Israel: Ben Z. Schreiber

 

Strategic Trade when Securitized Portfolio Values are Unknown

I examine the effect that securitization has on the market quality of the underlying asset, as well as focus on the market quality of the derivative asset. In a market comprised of liquidity traders, an informed trader, and an arbitrageur, with securitization, the underlying portfolio has improved liquidity, the trading intensity of the informed trader is increased, and the informed trader's expected profit is increased.  The combination of the underlying portfolio and derivative portfolio prices can fully reveal the unknown liquidation value of the underlying portfolio.  The derivative price can also be fully revealing about the unknown tracking error.

Sponsor: Oklahoma State University

PI/PD: Louis Piccotti

 

Differential Risk Premiums and the UIP Puzzle

We re-specify the uncovered interest rate parity (UIP) conditions by inverting the market price of risk formula.  Our empirical model provides new insights, which show that violations to UIP stems from the existence of a risk premium in exchange rates and from observed market return differentials being a noisy statistic of the markets' expected return differentials in our re-specified model.  Using an integrated macro-microstructure framework for expected market return differentials improves our model fit and the validity of UIP.

Sponsors: Oklahoma State University, University at Albany, SUNY, Bank of Israel

PI/PDs: Louis Piccotti

University at Albany, SUNY: Rita Biswas

Bank of Israel: Ben Z. Schreiber

 

Informed Trading Surrounding Data Breaches in Options Markets

We explore whether there is informed trading, which takes advantage of data breach events. By analyzing transactions in the options market, we find two distinct informed trading patterns that begin approximately three months and nine months prior to corporate data-breach announcements, which are supported by evidence of higher trading volume and open interest for put options, a higher put-to-call volume ratio, a higher put-to-call open interest ratio, and lower spreads prior to data-breach announcements. We further examine stock reactions following data-breach announcements and find significantly negative CARs of -0.35% within one day. Cross-sectional analysis provides evidence that options trading activity have predictive power for stock returns.

Sponsor: Oklahoma State University

PI/PDs: Louis Piccotti, Emily Wang

 

Covariance Matrix Jumps in High-Frequency Financial Markets

In this paper, we examine jumps and co-jumps in the covariance matrix for high-frequency financial markets.  We formulate the jump test as a two-step estimator, which allows us to identify jumps in both asset prices and the covariance matrix through time.  We provide simulation results of our estimator’s performance and we provide an empirical example with exchange rates.

Sponsor: Oklahoma State University

PI/PDs: Louis Piccotti, Yuri Hupka

 

Bond Market Structure and Volatility

We examine price volatility in a bond market using the variance ratio concept. The variance ratio methodology has been used to study the price volatility of equity markets extensively. To our knowledge, our article is the first to study the price volatility in a bond market. We find that the open-to-open return volatility is on average higher than the close-to-close return volatility. This implies that the market mechanism at open affects the price volatility of the bond market.

Sponsors: Oklahoma State University, Georgia College

PI/PDs: Louis Piccotti

Georgia College: Isarin Durongkadej

 

Option Pricing in the Presence of Pricing Errors in the Underlying

In this paper, I examine how option prices need to be adjusted when the underlying asset has microstructure noise.  A closed-form solution is attained, which modifies the BSM option pricing model.  Near-to-maturity options are the most mispriced, while Far-to-maturity options continue to be relatively fairly priced in the BSM model.

Sponsor: Oklahoma State University

PI/PD: Louis Piccotti

 

Cash Holdings and CEO Risk Incentive Compensation: Effect of CEO Risk Aversion

We examine the risk incentive effect of CEO compensation (Vega) on firm cash holdings and how this relationship is moderated by managerial risk aversion.   We find that Vega is positively related to cash holdings and that this relationship is enhanced for firms with greater managerial risk aversion.  We conclude that managers appropriately respond to risk incentives by taking on riskier projects but increase cash holdings to reduce their undiversified risk to the firm as a consequence of greater risk incentive compensation.

Sponsors: Oklahoma State University, Penn State University-Behrend

PI/PDs: Ramesh P. Rao

Penn State University-Behrend: Harry Feng

 

Debt Diversification and Financial Constraints

This study examines the impact of debt diversification on the external financing constraints of US firms. We argue that firms are motivated to diversify their debt sources in order to decrease their financial constraints.  Using the well-established measure of cash flow sensitivity of cash to assess the degree of financial constraint, we find that debt diversification indeed has a negative impact on the financial constraints faced by firms. This result is robust across multiple methods of classifying firms based on their inherent degree of financial constraint including firm age, dividend payout, and growth opportunity.

Sponsors: State of Oklahoma, Indiana University of Pennsylvania, IMT-Nagpur

PI/PDs: Ramesh P. Rao

Indiana University of Pennsylvania: Namrata Saikia

IMT-Nagpur: Nemiraja Jadiyappa

 

The Positive Externalities of Leveraged Buyouts

We show that private equity-sponsored going-private announcements can evoke positive externality effects on their industry peers. It is well-established that “active” ownership of private equity (PE) houses increases competitiveness of target firms by improving their operational strategies and corporate governance. We argue that private equity-sponsored going-private announcements should also impact their industry peers as a result of increased takeover threat and competitive pressure felt by the peers.  Industry peers mitigate the increased takeover threat and competitive pressure by significantly improving their operational efficiency, engaging in long-term innovation and enhancing their corporate governance.

Sponsors: State of Oklahoma, Penn State University-Behrend

PI/PDs: Ramesh P. Rao

Penn State University-Behrend: Harry Feng

 

Secondary Market Frictions and Real Firm Activity

We show that secondary market structure and trading activity impacts the cost of issuing new debt. Firms with existing illiquid debt are less likely to issue new debt within a given year, and, when they do, face higher borrowing costs. Using the staggered implementation of TRACE and a regression discontinuity design we also show that improvements in market design and transparency subsequently lowers the cost of debt. Additionally, our results indicate that liquidity and price discovery affect firms’ decisions related to capital structure and investment. Overall, the results provide understanding of the connection between the secondary market and real economy.

Sponsors: Oklahoma State University, University of Tennessee, University of Alabama, Burmingham

PI/PDs: Ryan Davis

University of Tennessee: David Maslar

University of Alabama, Burmingham: Brian Roseman

 

One Stone Kills Two Birds: The Effects of a Tick Size Increase on Equity and Option Liquidity

We examine the impact of the 2016 U.S. SEC Tick Size Pilot Program on liquidity in both the equity and options markets. We find that an increase in the tick size from one-cent to five-cents degrades stock liquidity for treatment stocks constrained by the minimum price variation, relative to control stocks. However, for the subset of treatment stocks with an active option series, the deterioration in stock liquidity is mitigated. We also find an unfavorable liquidity spillover effect from the underlying stock market to the options market, which seems to be driven by a shift in information-based trading from equities to options.

Sponsors: Oklahoma State University, Utah State University

PI/PDs: Brian Roseman, Danjue Shang

Utah State University: Todd Griffith, Danjue Shang

 

Passive Informed Trading Around Earnings Announcements

Using a sample of NASDAQ firms, we investigate informed trading in the limit order book prior to earnings announcements. Consistent with recent limit order theory, and in contrast to classic adverse selection models, we show that liquidity improves during periods of asymmetric information, which is attributed to the liquidity supply of informed traders. For earnings announcements with high absolute returns, we find that the quoted spread is low, bid and ask depth is highly correlated, the implied cost to trade is low, and the information-share of the limit order book is high, relative to earnings announcements with low absolute returns.

Sponsors: Oklahoma State University, University of Texas, El Paso

PI/PDs: Brian Roseman

University of Texas, El Paso: Jim Upson

 

Economics of Distributed Power Generation via Gasification of Biomass and Municipal Solid Waste

This study investigates the economics of power generation through gasification of biomass and MSW using a 60-kW downdraft gasifier, developed at Oklahoma State University. Effects of feedstock cost, electricity selling price, feed-in-tariff, tipping fee, tax rate, and the output power are evaluated using major financial parameters.  Results show that the 60-kW downdraft gasification power system offers a PP of 7.7 years, while generating an IRR, MIRR, and NPV of 10.9%, 7.7%, and $84,550, respectively. Results from a sensitivity analysis indicate that the feed in tariff, has the greatest positive impact on the project’s NPV.

Sponsors: Oklahoma State University, National Institute of Technology Bandung, Indonesia 

PI/PDs: Betty Simkins, Ajay Kumar, Raymond L. Huhnke

National Institute of Technology Bandung, Indonesia: Natarianto Indrawan

 

Energy Realities and U.S. Energy Policy

This study discusses six energy realities and the implications for U.S. energy policy:

1) We are not running out of fossil fuels. All energy sources should be promoted and not punished. 2) Energy transitions are generally slow and historically have taken up to a century. 3) Energy is all about thermodynamics and financial economics. 4) Renewable energy sources help but they are just part of the solution. 5) We need to focus on what the science and economics of energy and not let politics impact our judgement. 6) The public is misinformed about energy. Energy education is a must. 

Sponsor: Oklahoma State University

PI/PD: Betty Simkins 

 

Real Options Evaluation and Decision-Making in Petroleum Exploration and Production

This study establishes a risk-neutral binomial lattice method to apply real options theory to valuation and decision-making in the petroleum exploration and production (E&P) industry under uncertain oil prices. The research is applied to the switching time from primary to water flooding oil recovery. The established real options evaluation framework enhances the valuation and decision-making for petroleum E&P industry including when to switch from one enhanced oil recovery method to another and when to switch from conventional to unconventional hydrocarbon production.

Sponsors: Oklahoma State University, University of Texas

PI/PDs: Betty Simkins, Liying Xu

University of Texas at Austin: Kamy Sephrnoori, Jim S. Dyer

 

Cyber Threat Risk and Firm Governance and Risk Implications

This research explores cyber threat attacks on firms in the U.S. and the firms’ responses to improve cyber risk oversight by the board of directors.  Other risk implications are explored.

Sponsors: Oklahoma State University, University of New Mexico

PI/PDs: Betty Simkins

Oklahoma State University: Heng (Emily) Wang

University of New Mexico: Subbu Iyer

 

The Influence of Major News Events in Causing Outliers for Crude Oil and Natural Gas Commodity Futures Prices

The main goal of this research is to improve our understanding of the impact of major news events in causing outliers in commodity futures prices.  Research to date has been sparse.  On any given day, natural gas futures can have up to 120 risk factors based on each open contract and these risk factors are driven by different news events.  This research studies news around when the major outliers occur, and analyzes what specific types of news events can cause different types of price impacts (outliers) in futures prices.

Sponsors: Oklahoma State University, Texas State University

PI/PDs: Betty Simkins, Joe Byers

Texas State University: Ivilina Popova

 

Does Risk Management Add Value? An Update

This study reviews the literature on corporate risk management by nonfinancial firms and provides a review of the findings to date.  The study discusses the theories and methodologies used and provides suggestions for future research in this area.

Sponsors: Oklahoma State University, University of Oklahoma

PI/PDs: Betty Simkins

University of Oklahoma: Chitru Fernando

 

Susser Petroleum Partners, LP: IPO of a Master Limited Partnership

This case study investigates the 2012 IPO by Susser Holdings to create the first master limited partnership (MLP) in the fuel distribution business.  The case study explores the rationale for the MLP and investigates the valuation of this unique transaction.

Sponsors: Oklahoma State University, University of Texas, Austin, University of Virginia

PI/PDs: Betty Simkins

University of Virginia: Susan Chaplinsky

University of Texas Austin: Sheridan Titman

 

Determinants of NCAA Football Head Coaches’ Salaries

This study examines National Collegiate Athletic Association (NCAA) Football Bowl Subdivision (FBS) head football coach’s contracts to investigate the determinants of both maximum compensation and guaranteed compensation.  The results show that maximum compensation is positively related to both the performance of a university’s football program and the head football coach. 

Sponsors: State of Oklahoma, Valparaiso University, Georgia Tech University

PI/PDs: Betty Simkins

Valparaiso University: Phillip Humphrey

Georgia Tech: Jacqueline Garner

 

Investor Attention and the Neutrality of Corporate Social Responsibility

In this study we investigate the effect of ESG (Environmental, Social and Governance) factors and investor attention on the higher moments of a firm’s stock returns. Our preliminary results show that minimizing exposure to "concern" factors lowers a firm’s exposure to crash risk.

Sponsors: State of Oklahoma, Texas State University

PI/PDs: Betty Simkins

Texas State University: Ivilina Popova

 

 Public Information and Stale Limit Orders: The Evidence

In a specialist market public information shocks may generate a sequence of transactions at stale prices, as nimble floor traders pick off obsolete limit orders. We design a test for the importance of public information in price formation around this fact. We find that removing all potentially stale limit order trades from the transactions record has no significant effect on a statistic that links price change to transactions. We use the bootstrap to calibrate this result and demonstrate that public information shocks account for a small portion of stock return variances.

Sponsors: Oklahoma State University, University of Arizona

PI/PDs: Qin Wang

University of Arizona: Chris Lamoureux

 

Second and Higher Moments of Fundamentals: A Literature Review

This literature review outlines the recent progress in fundamental second and higher moments research. We survey the moments' existence, formation, and financial market and macroeconomic implications. Research shows that time-varying volatility and non-Gaussian shocks exist throughout all measures of fundamentals at both the micro and macro levels. Additionally, the granular network among firms helps explain the origin of fundamental second and higher moments. Empirical evidence shows that the moments have strong predictive power on asset prices and macroeconomic variables. We also highlight several areas where more research is needed to better understand the moments.

Sponsors: Oklahoma State University, Central University of Finance and Economics, Texas State University

PI/PDs: Betty Simkins, Qin Emma Wang

Central University of Finance and Economics: Yuecheng Jia

Texas State University: Ivilina Popova

 

Stock Market Return Predictability: Evidence from A Decomposition of Dividend Yield

The existing marginally significant evidence for the one-year stock market return predictability by the dividend yield is the result of an error-in-variable problem. A decomposition shows that the trend and innovation components of dividend yield correspond to the expected future long-term and one-year returns, respectively. Robust in-sample and out-of-sample evidence is documented that the innovation provides superior next-year return predictability than the dividend yield, while the trend captures the long-run predictability of dividend yield. The findings are consistent with a time-varying and predictable term structure of expected stock returns.

Sponsor:  Oklahoma State University

PI/PD:  Shu Yan

 

Information Spillovers and Predictable Currency Returns: An Analysis via Machine Learning

This paper employs the post-Least Absolute Shrinkage and Selection Operator (post-LASSO) to forecast 1-month-ahead currency return using all other currencies' lagged forward discounts as candidate predictors. The trading strategy of buying (selling) quintile currency portfolios of high (low) post-LASSO forecasts yields a monthly excess return of 1.05% for the 48-currency sample. The results do not change even after controlling for various predictors. The predictive power of the post-LASSO comes from two sources. First, it identifies the origin currencies of information spillovers, which are sparse and time-varying. Second, it incorporates cross-sectional variations in currencies' predictive relations with the origin currencies.

Sponsors:  Oklahoma State University, Rutgers University, Central University of Finance and Economics, China

PI/PDs:  Shu Yan

Rutgers University: Yangru Wu

Central University of Finance and Economics: Yuecheng Jia

 

Implicit Government Bailout Guarantee and Short Selling of Financial Stocks

This paper documents significant evidence that implicit government bailout guarantees render financial stocks less likely to be heavily shorted than otherwise similar non-financial stocks. The impact is more pronounced for financial firms that are large, distressed, in the TARP, having cheap puts, in the banking and broker--dealer sectors, during periods of high financial risk, or after 2008. When short sellers heavily short a financial stock, they earn significantly higher profits than shorting a similar non-financial stock. We show that implicit government bailout guarantees lead to more informed trading and higher information efficiency in heavily-shorted financial stocks.

Sponsors:  Oklahoma State University, Central University of Finance and Economics, China, Rutgers University

PI/PDs:  Shu Yan

Central University of Finance and Economics: Yuecheng Jia

Rutgers University: Yuzhao Zhang

 

A Seesaw Effect in the Cryptocurrency Market: Understanding the Lead-Lag Effect Among Cryptocurrencies

This paper investigates the cross predictability of intraday returns across 22 major cryptocurrencies. In contrast to the well-documented positive lead-lag effect in the equity market, we document a significantly negative lead-lag effect (“seesaw effect") in the cryptocurrency market: The five largest cryptocurrencies (Bitcoin, Ripple, Ethereum, Litecoin, and EOScoin) negatively predict the returns of other coins but not vice versa. Trading strategies

that exploit the cross predictability yield highly significant profits. Further analysis suggests

that the “flight to hot large coins" and “flee from cold large coins" jointly drive the seesaw effect.

Sponsors:  Oklahoma State University, Rutgers University, Central University of Finance and Economics, China

PI/PDs:  Shu Yan

Rutgers University: Yangru Wu

Central University of Finance and Economics: Yuecheng Jia, Chenxi Yin

 

Profitability Skewness and Stock Return

This paper investigates whether profitability skewness is related to expected stock return. We document significant evidence that profitability skewness positively predicts cross-sectional stock returns, opposite to the negative relation between return skewness and stock returns. The positive return predictability is robust to alternative profitability proxies and holds up to a year. The results cannot be explained by existing risk factors and return predictors including the level of profitability and return skewness. The evidence is consistent with explanations in which profitability skewness is positively related to firm growth opportunity and future profitability. The results are also consistent with behavioral explanations.

Sponsors:  Oklahoma State University, Central University of Finance and Economics, China

PI/PDs:  Shu Yan

Central University of Finance and Economics: Yuecheng Jia

 

Skewness and Momentum

We document two opposite effects of return skewness on momentum profits. For individual stocks, momentum profits decrease with skewness while for industry portfolios, momentum profits increase with skewness. The findings cannot be explained by existing risk factors and stock characteristics. For individual stocks, the evidence is consistent with the behavioral theory of return skewness as well as the skewness preference theory. For industry portfolios, the evidence is consistent with the interpretation of portfolio skewness as a measure of asymmetric inefficiency.

Sponsors:  Oklahoma State University, Central University of Finance and Economics, China

PI/PDs:  Shu Yan

Central University of Finance and Economics, China: Yuecheng Jia

 

There is A Growth Premium: Evidence from A Decomposition of Book-to-Market Ratio

This paper proposes a time series decomposition of book-to-market ratio (BM) into a trend component and an innovation component (IBM). Under the framework of stock valuation with growth options, we demonstrate that IBM is negatively related to the change of growth options and therefore negatively related to the expected stock return. We document significant empirical evidence consistent with a growth premium as low IBM stocks earn significantly higher future returns, even after adjustment for risk factors and controlling for other predictors. Moreover, low IBM firms convert more growth options and take on higher financial leverage in the future.

Sponsors:  Oklahoma State University, Central University of Finance and Economics, China, Nankai University, China

PI/PDs:  Shu Yan

Central University of Finance and Economics, China: Yuecheng Jia

Nankai University, China: Haoxi Yang

 

Post-Crisis Regulation of Bank Trading: An Examination of the Basel Framework and Volcker Rule

In the aftermath of bank trading losses in the 2007-09 crisis, the Basel framework uses stressed

Conditional Value-at-Risk (SCVaR) to set minimum capital requirements for bank trading portfolios, whereas the Volcker rule restricts their composition in the U.S. We examine the impact of a constraint that limits SCVaR in the mean-variance model. With or without the Volcker rule, such a constraint has the benefit of reducing the standard deviation (SD) of the optimal portfolio but the costs of moving it away from the M-V frontier and increasing its SD-to-minimum capital requirement ratio.

Sponsors:  Oklahoma State University, University of Minnesota, George Washington University

PI/PDs:  Shu Yan

University of Minnesota: Gordon J. Alexander

George Washington University: Alexandre M. Baptista

 

Information Diffusion and Seasonality in Return Predictability

There is gradual information diffusion within industry in the stock market and there is also significant seasonal patterns in lead-lag relationships in stock returns. As a result, we find considerable variation in the auto-correlation coefficients of stock returns across 12 months of the year. Based on the profit decomposition of relative strength strategy, we propose to improve the conventional reversal/momentum strategy to focus only on the industries with negative/positive auto-correlations. These strategies compare considerably better with the conventional ones, providing further insights into the gradual information diffusion as a potential explanation to the reversal/momentum puzzles.

Sponsors:  Oklahoma State University, Ohio State University, University of Hong Kong

PI/PDs:  Shu Yan

Ohio State University: Kewei Hou

University of Hong Kong:  Yan Xu

 

Attention on Volatility and Options

We document a positive and persistent relation between retail investor attention, as measured by Google search volume, and future realized stock return volatility. The relation implies profitable option trading strategy of purchasing high attention delta-neutral straddles and selling low attention delta-neutral straddles; this strategy earns a significant weekly return of 2.36% and is uncorrelated with common risk factors as well as the firm level variance risk premium. Examination of option trading activities of different investor groups following increased Google search shows that retail option investors benefit most from increasing stock volatility. Our evidence strongly supports theories of noise trader risk.

Sponsors:  Oklahoma State University, University of Hong Kong, Rutgers University

PI/PDs:  Shu Yan

University of Hong Kong:  Yan Xu

Rutgers University: Yuzhao Zhang

 

Information Diffusion, Return Predictability, and Earnings Announcement Season

I document significant seasonal patterns in some well-known stock return predictability anomalies such as the positive short-term market return autocorrelation, lead/lag effect across stock portfolios, and short-term reversal and momentum effects for individual stocks. The evidence not only strongly supports the information diffusion hypothesis but also reveals the key role of earnings announcement seasons on how information diffuses in the market.

Sponsor:  Oklahoma State University

PI/PD:  Shu Yan

 

Dispersion in Analysts' Target Prices and Stock Returns

We propose the dispersion in analysts' target prices as a new measure of disagreement among analysts and a proxy of ex ante stock risk. Consistent with the risk hypothesis, we document a significant positive relation between the target price dispersion and future stock returns up to 24 months. The next-month return spread between the highest and lowest deciles sorted on the target price dispersion measures can be over 2%. Our findings cannot be explained by the standard risk factors and stock characteristics including the target price revision and dispersion in analysts' earnings forecasts.

Sponsors:  Oklahoma State University, Penn State University Behrend

PI/PDs:  Shu Yan, Emily (Heng) Wang

Penn State University Behrend: Hongrui Feng

 

CEO Incentive Compensation and Stock Price Momentum

We document robust evidence that CEO incentive compensation predicts stock price momentum. The profit of momentum strategy increases with pay-for-performance incentive but decreases with risk-taking incentive. The evidence is more significant for companies with older and longer tenured CEOs, during high investor sentiment periods, and cannot be explained by information uncertainty proxies such as analyst coverage. Our results are consistent with the information diffusion explanation of momentum and the findings of agency theory that incentivized CEOs tend to manipulate information by smoothing good news, concealing mildly bad news, and accelerating the disclosure of extremely bad news.

Sponsors:  Oklahoma State University, Penn State University Behrend

PI/PDs:  Shu Yan

Penn State University Behrend: Hongrui Feng

 

Local Institutional Investors and Debt Maturity

We examine the relation between the geographic proximity of a firm’s institutional investors and the maturity structure of its debt. We hypothesize and find that firms with local institutional investors have shorter maturity debt. The effect of institutional proximity on debt maturity is stronger for firms with CEO-Chair duality and before the passage of Sarbanes-Oxley Act in 2002, consistent with that firms monitored by local institutional investors choose shorter maturity debt to reduce agency costs, especially, equity agency costs. The results demonstrate the importance of local institutional investors in affecting firms’ debt maturity policy choices.

Sponsor:  Oklahoma State University

PI/PD: Jun Zhang

 

Algorithmic Trading and Firm Value

Using data from 2002 to 2013, we examine the impact of algorithmic trading on firm value. The results show that algorithmic trading generates net benefits for firm value through impacting stock liquidity, idiosyncratic volatility, and idiosyncratic skewness, and firms benefit more from algorithmic trading when algorithmic trading intensity is higher. Using the advent of auto quotation on the NYSE as an exogenous shock to algorithmic trading, we find evidence of a causal effect of algorithmic trading on firm value. The positive effects of algorithmic trading on firm value are stronger for more liquid stocks and larger firms.

Sponsors:  Oklahoma State University, Texas A&M University, University of Cincinnati

PI/PDs: Jun Zhang

Texas A&M University: Shane A. Johnson

University of Cincinnati: Brian C. Hatch

 

Social Networks and Corporate Payout Policies

This paper examines the relation between firm social network and corporate payout policies and finds that social network significantly impacts payout compositions. Firms with greater network centrality pay lower dividends, repurchase more shares, and have a lower dividend to total payout ratio. Moreover, better connected firms invest more in acquisitions and R&D and have higher stock return volatility, and firms with higher acquisition and R&D investment pay lower dividends and repurchase more shares. Overall results suggest that to accommodate more risky investments, better connected firms substitute share repurchase for dividend payment to remain financially flexible.

Sponsor:  Oklahoma State University

PI/PD: Jun Zhang

 

Inside and Outside Debt Duration

Agency theory emphasizes that the incentive alignment effect of CEO debt compensation relies on the extent to which its payoffs resemble payoffs to risky corporate debt. We examine this notion using a sample of new corporate debt issues during 2007-2012. We find that debt-biased CEO relative leverage ratio is associated with longer debt maturity only when the CEO's inside debt will be less likely to be drawn up in the near future. We show that not only does inside debt level matter, but its maturity relative to corporate debt also plays an important role in the incentive-alignment effect.

Sponsors:  Oklahoma State University, Texas A&M University, Hong Kong Polytechnic University

PI/PDs: Jun Zhang

Texas A&M University: Shane Johnson

Hong Kong Polytechnic University: Nan Yang

 

Firm Riskiness and SEO Underpricing: Evidence from a Natural Experiment 

This paper examines the impact of firm riskiness on seasoned equity offering (SEO) underpricing by exploring RegSHO pilot program as a natural experiment. Facing greater downside risk, the RegSHO pilot firms are incentivized to lower their riskiness, which mitigates negative market reactions and reduces SEO underpricing. We find that, consistent with the conjecture, the pilot firms have lower risk and experience smaller SEO underpricing. In addition, the pilot firms tend to issue more equity to take advantage of the lower equity financing cost. Overall results support that firm riskiness has important impacts on SEO underpricing.

Sponsor: Oklahoma State University

PI/PDs: Jun Zhang, Siqi Wei

 

Institutional Trading Around Corporate Fraud

We investigate whether institutional investors have information advantage by studying trading behaviors of institutional investors before revealing of corporate fraud. Compared to benchmark trading volumes, institutional investors have higher net selling volume of stocks of fraud firms several months before public revealing of corporate fraud, and the result holds only for more severe frauds leading to greater firm losses. The results suggest that institutional investors have information advantage and react early to corporate fraud before it is publicly revealed.

Sponsors: Oklahoma State University, University of Nevada-Las Vegas

PI/PDs: Jun Zhang, Qin Wang

University of Nevada-Las Vegas: D. Scott Lee

 

Is Options Trading Informed? Evidence from Credit Rating Change Announcements

This study examines the information content of options trading prior to credit rating change announcements. Pre-event informed options trading predicts cumulative abnormal returns around credit rating change announcements. The predictability of options trading is more pronounced before announcements of more severe and surprising rating changes such as downgrades, multinotch rating changes and across class rating changes. The information content of options trading is greater when the underlying stock market is less informational, when the options market is more liquid, and in the post-Reg FD period. Overall results are consistent with informed options trading prior to credit rating change announcements.

Sponsor: Oklahoma State University

PI/PD: Jun Zhang

 

Local Institutional Investors and Seasoned Equity Offerings

This paper investigates the impact of local institutional investors on firms’ seasoned equity offerings (SEOs). Equity issuers with (more) local institutional investors and higher local institutional ownership experience higher SEO announcement returns. The causal effect is established by exploiting exogenous shocks to local institutional ownership generated by reconstitutions of the Russell 1000 and 2000 indexes. The finding is more pronounced for firms with greater agency problems and robust to the correction of sample selection bias. Overall results suggest that monitoring by local institutional investors helps reducing agency problems and mitigating negative market reactions to SEOs.

Sponsor: Oklahoma State University

PI/PD: Jun Zhang

 

The Efficacy of Buying Stocks on Margin

In this paper, I explore the historical return distributions of various levered investment strategies in equities and test whether investing in stocks using broker’s call loans is more effective than investing in stocks on a cash only basis.  Using the CRSP value weighted index as well as randomly selected portfolios of stocks, I simulate investment on margin using the rules that brokers impose on investors.   sing portfolios of stocks as test assets, I find that investing in stocks on margin is also more effective than investing in stocks on cash, regardless of the policy stance of the Fed.  Other extensive tests are conducted. 

Sponsor:  Oklahoma State University

PI/PDs:  Jeffrey M. Mercer, Eric Sisneros

 

TIPS in the Rearview Mirror: A Relative Performance Comparison

Abstract: We study the ex-post performance of Treasury Inflation-Protected Securities (TIPS) relative to a maturity-matched nominal Treasury security.   We construct two performance measures, a wealth relative ratio and wealth difference, to explore the performance from the investor’s perspective.  We find that TIPS significantly outperform their maturity-matched nominal security because the actual inflation exceeds ex-ante inflation expectations.  We show that a taxable TIPS investor may realize negative net cash flows, and confirm that the unique tax treatment of TIPS does not impact the relative performance.

Sponsors:  Oklahoma State University, Texas Tech University

PI/PDs: Eric Sisneros

Texas Tech University: Joshua Fairbanks, Scott E. Hein

 

Volatility Modeling Using High Frequency Data to Identify Bitcoin Price Bubbles

The cryptocurrency Bitcoin has garnered significant interest across the globe.  At the beginning of 2017, Bitcoin, was trading in the neighborhood of $970, by December it reached $19,800.   Using high frequency trade data, we make use of a statistical test to determine if Bitcoin prices were in a financial bubble.  A bubble is confirmed if the price process is a strict local martingale, and not a true martingale.  We find that Bitcoin was in intermittently in a bubble during the years 2017 and 2018.

Sponsor: Oklahoma State University

PI/PDs:  Vijay Gautam, David Carter

Mathematics: Weiping Li

 

Non-interest Income, Bank Profitability and Risk, During the COVID-19 Pandemic

We investigate the effect of non-interest income on measures of bank performance and risk taking during the 2020 COVID-19 pandemic.  In general, higher levels of non-interest income are associated with greater profitability and lower levels of risk.  Further, changes in non-interest income are positively related to changes in performance and negatively related to changes in risk.  This suggests increases in non-interest income increase profitability, while reducing bank risk.

Sponsors: Oklahoma State University, Pennsylvania State University Behrend, Zhejiang University

PI/PDs: David Carter

Pennsylvania State University Behrend: Hongrui Feng, Sebastian Zhao

Zhejiang University: Xingjian Li

 

The Effect of the COVID-19 Pandemic on the Travel and Tourism Industry

We investigate the effect of COVID-19 related news announcements on the stock of firms in the travel and tourism industry (airlines, cruise lines, hotels, etc.).  We expect that all firms will be affected by the announcements but we test whether market participants differentiated firms by various characteristics, e.g., liquidity, debt levels, etc.

Sponsor: Oklahoma State University

PI/PDs: Eric Sisneros, Sharif Mazumder, David Carter, Betty Simkins

 

Does hedging impact stock return volatility and idiosyncratic volatility? Analysis from the airline industry

This paper investigates the impact of hedging on stock return volatility and idiosyncratic volatility (IVOL) in the airline industry. Results suggest that fuel hedging has a significant negative relationship on both stock return volatility and IVOL. However, the percentage of fuel hedged is more informative than just knowing if the airline hedges its jet fuel exposure when looking at its impact on volatility.

Sponsors: Oklahoma State University, Utah State University, St. John’s University

PI/PDs: David Carter

Utah State University: Jared Delisle

St. John’s University: Jason Berkowitz, Kavya Dasari

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