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Investor Sentiment and Return Comovements: Evidence from Stock Splits and Headquarters Changes
Abstract
This paper examines whether the trading activities of retail and institutional investors cause comovements in stock returns. Using stock splits and headquarters changes events and a variety of trading-based measures, we show directly that retail investors generate excess comovements in stock returns. Specifically, around stock splits, retail trading correlations decrease with stocks in the pre-split price range and increase with the post-split price range. Further, shifts in retail trading correlation influence return comovement changes around stock splits. In the cross-section, excess return comovements among low-priced stocks are amplified when retail trades are more correlated. We find similar patterns among local stocks and when firms change their corporate headquarters. These comovement patterns are stronger when uncertainty is high and behavioral biases are amplified. In contrast to retail trading, institutional trading attenuates return comovements.
... Barberis and Shleifer (2003) posit that limited cognitive ability induces investors' selective information processing; that is, instead of processing information of thousands of different stocks, investors first divide them into separate groups and then allocate their investment funds based on this grouping. These style-based investments have evidently caused the returns of stocks to comove together (e.g., Barberis et al., 2005;Greenwood, 2008;Boyer, 2011, Kumar et al., 2013Hameed and Xie, 2019). We examine LGBT-induced comovements in the second part of our paper. ...
... Pirinsky and Wang (2006) report excess return comovements among stocks of firms headquartered in the same geographic location. Green and Hwang (2009), and Kumar et al. (2013) show that stocks within a similar price range comove together while Kumar (2009) The remainder of the paper is organized as follows. Section 2 presents data and sample selection. ...
Investors are attentive to lesbian, gay, bisexual, and transgender (LGBT) topic and a firm's adoption of LGBT-supportive policy. Using a sample of new LGBT adopters from KLD database, we show that mutual funds with a strong (weak) preference for LGBT stocks increase (decrease) their holdings in new LGBT adopters and receive more (less) capital flows when investor sentiment toward LGBT is high. We also find significant evidence that LGBT-induced trading activities lead to comovements in stock returns and share turnover. Specifically, LGBT adopters experience an increase (decrease) in return comovement with a portfolio of existing (non-) LGBT stocks. Our additional analyses based on an alternative sample from the Human Rights Campaign yield consistent results and suggest that investors consider not only the presence or lack of LGBT-supportive policy in a firm but also its LGBT performance when they make trading decisions. This research makes an important contribution to our limited understanding of the LGBT policy effect on investors, a key group of the firm's stakeholders.
... For example, Barberis et al. (2005), Greenwood (2008), and Boyer (2011) find that stocks included in an index apparently constitute a category for investment, and this index inclusion results in an increase in return covariance with stocks in the index. Excess comovement in return is also found among stocks of firms headquartered in the same geographic location (Pirinsky and Wang, 2006), stocks within a similar price range (Green and Hwang, 2009;Kumar et al., 2013), stocks with listed options (Agyei-Ampomah and Mazouz, 2011), stocks that use the same lead underwriter during their IPOs (Grullon et al., 2014), stocks in industries of retail investor demand (Jame and Tong, 2014), and stocks with similar size or book-to-market ratios (Kumar, 2009). Hameed and Xie (2019) find that firms initiating dividend payments begin to comove more with the portfolio of dividend-paying stocks and less with the portfolio of non-dividend paying stocks. ...
... Kumar (2009) finds that firm size and market-to-book (M/B) ratio drive stock return comovements among firms with the same style. Green and Hwang (2009) and Kumar et al. (2013) find evidence of price-based excess return comovements. Hence, we estimate excess comovements for our sample firms based on size, M/B, and price separately. ...
Leverage-initiating stocks experience an increase in return comovement with leveraged stocks and a decrease in return comovement with zero-leverage stocks in the year after the leverage initiation event. Conversely, stocks that fully deleverage comove more with their new peers of zero-leverage stocks and less with their old peers of leveraged stocks. These findings are robust after controlling for common factors and firm characteristics and using various time series and events as exogenous shocks to corporate leverage decisions. Our findings can be explained by investor clienteles for financial leverage and are not driven by omitted variables and other characteristic-induced comovements.
... It is well-known that investors prefer domestic stocks to foreign stocks in international portfolio selections (French & Poterba, 1991); and among domestic stocks, they favor firms close to them and invest disproportionally more in stocks of local firms (Coval & Moskowitz, 1999. This phenomenon, so called home (local) bias, is ubiquitous not only among individual investors (Benartzi, 2001;Huberman, 2001;Ivkovic & Weisbenner, 2005;Kumar & Lee, 2006;Kumar, Page, & Spalt, 2013;Nofsinger & Varma, 2012;Seasholes & Zhu, 2010) but also among institutional investors (Coval & Moskowitz, 1999. The studies in community or neighborhood effect also show that an individual is more likely to invest in the stock market when a higher fraction of individuals in the local community are stock investors (Brown, Ivkovic, Smith, & Weisbenner, 2008;Hong, Kubik, & Stein, 2004). ...
... The growing literature indicates that investors classify equity securities into categories and allocate funds into these categories based on their past returns and relative performance (Barberis and Shleifer, 2003;Barberis, Shleifer, & Wurgler, 2005;Kumar et al., 2013;Vijh, 1994). Barberis and Shleifer (2003) indicate that style investing generates common factors in the returns of the same asset style even these common factors are unrelated to cash flows and fundamentals. ...
We investigate how the geographic distance between firms' headquarters affects their stock price comovement. Our results show that a firm's stock return has stronger comovement with the returns of nearby firms than with those of distant firms. Being in the same state and/or in the same industry strengthens the return comovement, but does not substitute for the negative effect of geographic distance on price comovement. Firms of similar share price and size also show stronger return comovement, but these factors do not mitigate the negative distance impact. Consistent with investor home bias and neighborhood effect literature, our results suggest that investors' preference for local stocks and their interactions lead to correlated trading in local stocks and therefore stronger local price comovement.
... According to Tzioumis' research, the main reason why companies implement equity incentives is to attract and retain good employees [3]. Spalt points out that such incentives can also help maintain employee loyalty, which in turn reduces employee turnover [4]. Through empirical research, Shen and Wang found that with the increase of agent equity, the agent's status as a shareholder makes its goals tend to be consistent with the goals of the owner of the enterprise, so it can alleviate the principal-agent contradiction and reduce the agency cost [5]. ...
As a matter of fact, regarding as an effective way to attract and retain talents, equity incentives were first implemented by high-tech enterprises in the United States. The purpose of this study is to deeply explore the implementation effect of the company's equity incentive plan. With this in mind, this paper takes Youyou Food Company as a case for analysis. By comparing the situation before and after the implementation of the equity incentive plan of Youyou Food Company, the effect of its equity incentive in three aspects (i.e., profitability, development ability and debt repayment ability) was analyzed. According to the analysis, the effect of Youyou Food's implementation of equity incentives did not reach the expected rate of return, which may be due to the economic downturn in the general environment eating up the benefits of equity incentives. At the same time, the problems as well as suggestions are proposed based on the analysis.
... , 주식분할에 따른 저가주와의 동조화 현상이나 기업의 지리적 위치에 따른 수익률 동조화는 주로 개인투자자의 선호에 의해 발생한다는 결과를 보여주고 있다 (Kumar and Lee, 2006;Kumar et al., 2013;Jun and Choe, 2013 ...
This article examines the impact of additions or deletions to the ESG index on stock return comovement in the Korean stock market over a 10-year period from 2010 to 2019, using eight ESG indices. Our results show that firms added to the ESG index experience an increased beta, both in the short- and long-term, while deleted stocks from the ESG index show significant decreases in beta. The return comovement following ESG index changes identifies not only the initial ESG index but also the new ESG index launched in 2015. However, comovement to the ESG index inclusion is more pronounced with the initial ESG index. Moreover, we find that comovement largely accounts for the trading behavior of individual investors and is partially related to foreign investors’ trading. Our findings are consistent with previous evidence on comovement with changes in major market index constituents and suggest that ESG index revision by considering non-financial factors also induces stock return comovement. These results can be explained by the investor sentiment-based views.
... Eun, Wang, and Xiao (2015) show that culture affects the correlation between investors' trading activity, which leads to higher (lower) stock-price comovement in culturally tight (loose) and collectivistic (individualistic) countries. Pindyck and Rotemberg (1993), Kumar and Lee (2006), Chordia, Goyal, andTong (2011), Kumar, Page, andSpalt (2013), and Antón and Polk (2014), among others, provide evidence on the link between stock comovement and demand from institutional and retail investors. Raffestin (2017) finds that bonds that change rating classes start comoving more with the bonds in the new class. ...
We develop a dynamic model of corporate investment and financing, in which shocks to the value of collateralizable assets generate variation in firms’ debt capacity. We show that the degree of similarity among firms’ financial flexibility forecasts cross-sectional variation in return correlation. We test the implications of the model with firm-level data in two empirical analyses using i) an instrumental variable approach based on shocks to the value of collateralizable corporate assets and ii) the outbreak of the COVID-19 crisis as an event study. We find that firms in the same percentile of the cross-sectional distribution of financial flexibility have 62% higher correlation in stock-return residuals than firms 50 percentiles apart.
... In the search for a better understanding of the possible causes of asset prices not matching their fundamental value, the information uncertainty has taken a relevant position (Jiang et al., 2005). Along these lines, several authors have documented that uncertainty regarding social, political or economic conditions has a great influence on the sentiment of investors (Knight, 1921;Price and Tewksbury, 1997;Shiller, 2005;Beugelsdijk and Frijns, 2010;Kumar et al., 2012). ...
Purpose
This paper aims to evaluate the influence of economic policy uncertainty (EPU) on the momentum effect, analysing its influence depending on the economic cycle and in different quantiles.
Design/methodology/approach
To determine the influence of EPU in the momentum effect taking into account the economic cycle and the level of the quantile, linear regression and quantile regression have been applied for the period from 2 January 1985 to 30 April 2019 for the US stock market.
Findings
It is shown that an increased feeling of insecurity associated with EPU reduces the momentum effect, especially in times of recession. Distinguishing by quantiles, an asymmetry in the impact of EPU in the momentum effect is discovered, finding that EPU reduces (increases) the profits of momentum strategies in the lowest (highest) quantiles. In the highest quantiles, an investor can obtain higher extraordinary returns with this strategy. For example, in the highest quantile, a one-point increase in the EPU levels would have increased the daily profitability by 12.7 basis points. These findings have important implications for investors and policymakers.
Originality/value
To the best of the authors’ knowledge, this is the first paper that evaluates the influence of EPU on the momentum effect by conducting an analysis based on the economic cycle and different quantiles, demonstrating how these factors are relevant in the influence of this uncertainty in the momentum anomaly.
... 6 In the US: Loughran (2008) document that urban IPOs are 45.9% while rural IPOs are 7.5% (period 1990-2002); Nielsson and Wójcik (2016) show urban IPOs are 23.7% and rural IPOs are 13.1% (period 1986-2014); in Nielsson and Wójcik (2016)'s time period that covers Loughran (2008)'s time period (1990)(1991)(1992)(1993)(1994)(1995)(1996)(1997)(1998)(1999)(2000)(2001)(2002), urban IPOs First, we contribute to the literature emphasizing the importance of the firm's geographic location in corporate finance. 7 In the majority of this literature, the firm's location matters because investors have a strong preference for geographic proximate existing stocks, which in turn affects market values (see also, Hong et al., 2008;Kumar et al., 2012) and corporate policies (e.g., Becker et al., 2011). We add to this literature by showing that investors have a similar, much stronger preference for the new local equity that will be issued by the local going public private firms. ...
We provide new evidence that local investors are peculiarly biased towards local IPO stocks. Taking the well-known investor preference for local stocks a step further, we contribute by showing that local IPOs boost stock market participation far more intensely than local listed firms. Interestingly, the effect is driven by individuals born and raised in the region, having zero effect for those who have moved to the area. Consistent with underwriters significantly under-estimating the local investors’ demand in local IPOs, the probability of a private firm to go public, the IPO underpricing and the cross-sectional volatility of IPO initial returns, increase in remote firms where the local investors’ demand in local IPOs is particularly high. Overall, our results suggest that local investors are crucial for the IPO decision.
... attribute the comovement in retail investors trades to sentiment, that is the false believe to have special information about future stock prices(De Long, Shleifer, Summers, & Waldmann, 1990). Several other studies confirmed this finding (e.g.Barber, Odean, & Zhu, 2009;Frijns, Verschoor, & Zwinkels, 2017;Green & Hwang, 2009;Kumar, Page, & Spalt, 2012.Green and Hwang (2009), for instance, find that similarly priced stocks correlated and that after a stock-split the return correlation with low-priced (high-priced) stocks increases (decreases). These changes in comovement cannot be explained by fundamentals and are more pronounced during periods of high investor sentiment. ...
Considerable theoretical and empirical evidence links price comovements with the behavior of retail investors. Nevertheless, when predicting stock return correlations, research has focused on the leverage effect. We propose a new model of realized covariances that allows exogenous predictors to influence the correlation dynamics while ensuring the predicted matrices' positive definiteness. Using this model, we provide evidence for the predictive power of sentiment and attention measures obtained from social media and web-search query data for the correlations of 35 Dow Jones stocks. At the one-day forecasting horizon, these findings are confirmed by value-at-risk forecasts.
... Share prices are difficult to predict since prices always reflect relevant information according to the efficient market hypothesis (Fama, 1965(Fama, , 1991(Fama, , 1998. However, this viewpoint is challenged by the overreaction hypothesis (Debondt & Thaler, 1985, 1987, which supposes that (i) investors may overreact to the available and private information released owing to excessive self-confidence (Chuang & Lee, 2006;Daniel, Hirshleifer, & Subrahmanyam, 1998), (ii) herd behaviors result in chasing rising or falling prices (Chalmers, Kaul, & Phillips, 2013;Mendel & Shleifer, 2012), and (iii) investors' sentiments and behavioral pscyhology have an impact on price movements (Da, Engelberg, & Gao, 2015;Dergiades, 2012;Huang et al., 2014;Huang & Ni, 2017;Kumar, Page, & Spalt, 2013). ...
Journal: Financial Innovation (SSCI)
We observe that the sharp movement in exchange rates including USDX, GBP/USD, and USD/CNY might result in stock market fluctuation due to investors’ sentiments aroused. To our knowledge, we argue that the subsequent performance of trading stocks right after the sharp movement in exchange rates seems seldom explored in the relevant studies, which may contribute to the existing literature. By employing the constituent stocks of DJ 30, FTSE 100, and SSE 50 as our targets due to these markets regarded as representative stock markets in the world, we then reveal that the share prices are more volatile after diverse sharp movements in Chinese Yuan, even though Chinese Yuan is less volatile due to Chinese Yuan likely managed by the authority; whereas, share prices would rise no matter what sharp depreciation or sharp appreciation occurs in US Dollar and British Pound rather impressive for investors.
... Specifically, Goetzmann, Kim, Kumar, and Wang (2015) construct a weather-induced mood index for institutional investors and explore how mood affects the trading behaviors of these investors in the stock market. However, individual investors are more likely to be the ideal unit to examine this mood effect because they are more irrational than institutional investors (Kumar, Page, & Spalt, 2013). In this respect, Schmittmann, Pirschel, Meyer, and Hackethal (2015) provide empirical evidence that weather conditions affect individuals' moods and, in turn, their trading activities and risk tolerance. ...
We construct a firm-level index for measuring the mood of individual investors induced by air pollution in the Chinese stock market. In a setting where individual investors dominate the stock market, we examine how the individual investor mood affects stock pricing. We find that the investor mood only affects individual investors’ trading behaviors, thereby validating the individual investor mood indices. Further, a pessimistic individual investor mood decreases liquidity and volatility, eventually causing a decline in stock returns. The mispricing caused by the individual investor mood cannot be eliminated by using risk-factor models, thereby implying the limited efficiency of the Chinese stock market.
... Theoretically and empirically, much research focuses on the importance of investor trading behaviour on stock returns, such as the relation between investor trading behaviour and return comovements (Kumar & Lee, 2006;Kumar, Page, & Spalt, 2013;Yang & Zhou, 2015), investor trading behaviour, and risk (Han & Kumar, 2013). Here, we classify trades as buyers or sellers according to the Lee and Ready (1991) algorithm: If a trade is executed at a price above (below) the quote midpoint, it is classified as a buy (sell). ...
This paper sheds new light on the relation between investor trading behaviour and crash risk to examine how investors react to stocks with lottery features in Chinese Stock Market. We find that investor trading behaviour has a greater impact on stocks with higher crash risk, which implies that investors overreact to stocks with higher stock price crash risk. Furthermore, investor trading behaviour has strongest effects on stocks with highest crash risk and highest idiosyncratic risk and has weakest effects on stocks with lowest crash risk and lowest idiosyncratic risk, which indicates that investors gamble lottery‐like stocks with high crash risk and high idiosyncratic risk. Collectively, these results support a role for investor trading behaviour in the formation of stock returns.
... Peng, Xiong, and Bollerslev (2007) found that the return correlations rose with the arrival of macroeconomic news but fell significantly in the days following the news. Kumar and Lee (2006) found that systematic retail trading explained the return comovements for stocks with high retail concentration, while Kumar, Page, and Spalt (2013) found that retail investors generated excess comovements in stock returns surrounding stock-split and corporateheadquarter-change events. Tang and Xiong (2012) reported that the high exposure to common shocks for commodities and other asset classes was influenced more by investor sentiment than by macroeconomic fundamentals. ...
The coordinated trading of weather-sensitive investors drives stock returns and links the return correlations with weather variables. In this study, I test whether the correlations in the Stock Exchange of Thailand can be explained by Bangkok’s weather variables. Using the daily data from September 3, 2002, to December 29, 2017, I find that the correlation of the returns on the Stock Exchange of Thailand 50 and the Market for Alternative Investment index portfolios has a significant relationship with Bangkok’s weather. The significant variables are a subset of those variables that drive return volatility.
... Share prices are difficult to predict since prices always reflect relevant information according to the efficient market hypothesis (Fama, 1965(Fama, , 1991(Fama, , 1998. However, this viewpoint is challenged by the overreaction hypothesis (Debondt & Thaler, 1985, 1987, which supposes that (i) investors may overreact to the available and private information released owing to excessive self-confidence (Chuang & Lee, 2006;Daniel, Hirshleifer, & Subrahmanyam, 1998), (ii) herd behaviors result in chasing rising or falling prices (Chalmers, Kaul, & Phillips, 2013;Mendel & Shleifer, 2012), and (iii) investors' sentiments and behavioral pscyhology have an impact on price movements (Da, Engelberg, & Gao, 2015;Dergiades, 2012;Huang et al., 2014;Huang & Ni, 2017;Kumar, Page, & Spalt, 2013). ...
We argue that the sharp movement in exchange rates may result in stock market fluctuation due to investors’ sentiments stimulated. To our knowledge, we document that the performance of trading stocks as the sharp currency movement occurred seems unexplored in the relevant literature, which might contribute to the existing literature. By using the constituent stocks of SSE 50 and TW 50 as our samples owing to comparing these two economies in Asia, we reveal that share prices would either drop substantially as the sharp depreciation or enhanced considerably as the sharp appreciation in Chinese Yuan (CNY) far different from that share prices move slightly as the sharp movement in New Taiwan Dollar (TWD), even though CNY likely managed by the authority is much less volatile than TWD. We argue that our results would be beneficial for investors in trading these constituent stocks as the occurrence of the sharp currency movement.
... Finally, firm location matters because proximity facilitates information and sentiment transmission, which in turn, have significant impact on economic activities and outcomes (e.g., Antia et al., 2013;Brown et al., 2008;Hong et al., 2004;Infante and Piazza, 2014;John et al., 2011;Kedia and Rajgopal, 2009). As a consequence, market prices have a geographic component (e.g., Baschieri et al., 2015;Gao et al., 2008;García and Norli, 2012;Hong et al., 2008;Korniotis and Kumar, 2013;Kumar et al., 2012;Pirinsky and Wang, 2006). In the literature, local factors specific to the firm geographic location are variables that affect corporate market value and policies. ...
... Chelley-Steeley et al. [11] find that illiquidity shocks have an impact on stock market return comovement. The results in Kumar et al. [32] support the view that correlated retail trading generates comovements in stock returns. Using data from forty markets over 10 years, Claessens and Yafeh [13] find that when added to a major index, firms experience an increase in comovement between their firm and the rest of the index. ...
Stock return comovement analysis is important to financial analysts, decision makers, and academic researchers, in many financial implications, such as, portfolio management, style investing, and market risk detecting. This paper examines firms' social media, in par-ticular, microblogging metrics' role on analyzing stock return comovement. Social media allows firms to proactively connect with public users, customers, suppliers, and other business partners. It also provides us a large-scale and free data set to automatically and quickly uncover firms' social media metrics' influence on financial outcomes. Most prior studies of social media metrics focused on overall firm metrics and their predictability on stock returns. However, the role of firms proactive activities has been omitted. This paper filled this gap by using cross-sectional data from the US and China to investigate on how firm-specific social media metrics make an impact to the stock return comovement. The results show starting with the four-digit Global Industry Classification Standard (GICS) system, the stock groups that are divided by firms' effect microblogging metrics, have a higher comovement than six-digit GICS groups.
Considering the behavior anomaly under both rising and falling market conditions, this paper aims to address whether the investor trading behavior is sensitive to a different quantile of stock return dispersions by using quantile regression model. Results show that investor trading behavior has significant impacts on different quantiles of stock return dispersions, and reveal the smile slope of investor trading behavior effect which is stronger at the extreme quantile distributions than the median distribution. Moreover, results evidence that the investor trading behavior effect with optimistic investor sentiment should be stronger than the investor trading behavior effect with pessimistic investor sentiment. Finally, this paper sheds light on the anchoring effect of investor trading behavior, and demonstrates that the anchor of investor trading behavior has a positive and significant impact on stock returns. These patterns hold when accounting for stock specific characteristics, various factors and market conditions.
We investigate changes in US market sentiment using structural break analysis over a period of five decades. We show that investor sentiment was trending and nonstationary from 1965 to 2001, a period associated with numerous crashes. Since 2001, sentiment has been substantially more mean reverting, implying the diminished effect of noise investors and their associated mispricing. We illustrate how these changes in sentiment persistence affect equity anomalies and assess the predictive power of sentiment on short‐run returns when regime changes are considered. Our findings suggest that the presence of sentiment‐driven investors and their market impact is significantly time‐variant.
We define areas with strong geographic ties to powerful politicians as politically vibrant and show that they are characterized by greater value‐relevant information generation and symptomatic of equity market segmentation. Political vibrancy entails greater levels of local bias and local comovement and has two important return predictability implications. First, it enhances local institutions’ informational advantages; their trades’ ability to forecast local stock returns exceeds that of nonlocal institutions. Second, in support of the view that information diffuses slowly into prices, stock returns of firms from politically vibrant areas predict returns of similar firms in other areas.
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This study examines the market responses and return comovement between real estate and financial stocks around the reclassification of real estate firms from the financial sector to a standalone new real estate sector. We find that real estate stocks experience positive abnormal returns at the announcement of new sector creation, and attract more investor attention after the announcement. In addition, the comovement between real estate and financial stocks decreases dramatically after the new sector creation. These findings demonstrate the market impact of new real estate sector creation and provide important implications for real estate investors, portfolio managers, and policy makers.
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We introduce a new indicator of relative liquidity, equivalent volume (EV), based on the amount of a stock traded indirectly through its inclusion in ETFs. We hypothesize that the EV of an ETF component stock is related to its comovement with other component stocks through the relative liquidity channel under trading caused by arbitrage. Using daily ETF holdings and several comovement estimators, we find that a one-unit increase in daily equivalent volume is associated with increase in comovement ranging from 1.1% to 27.6%. Our findings contribute to the literature on trading volume, liquidity and comovement by relating arbitrage-induced trading pressure to the underlying stock comovement.
A distinctive trend in the capital markets over the past two decades is the rise in equity ownership of passive financial institutions. We propose that this rise has a negative effect on price informativeness. By not trading around firm-specific news, passive investors reduce the firm-specific component of total volatility and increase stock correlations. Consistent with this hypothesis, we find that the growth in passive institutional ownership is robustly associated with the growth in market model R2s of individual stocks since the early 1990s. Additionally, we find a negative relation between passive ownership and earnings predictability, an informativeness proxy.
This study shows that exchange-traded fund (ETF) misvaluation – based on return differentials between ETFs and their net asset values (NAV) – comove excessively across ETFs. Excess comovements are positive (negative) and significant across ETFs in similar (distant) investment styles. Further tests based on return reversals suggest that misvaluation stems primarily from the ETF, rather than the NAV price. Excess comovements are greater for funds with high commonality in demand shocks and attractive liquidity characteristics. These findings are consistent with the idea that the high liquidity of ETFs attracts a clientele of short-horizon noise traders with correlated demand for investment styles.
This paper examines how the trading activities of different investor types are related to common return and liquidity movements. Using a unique dataset, we decompose the daily return and liquidity of individual stocks into price impact components attributable to trades of institutional investors and retail investors. We then investigate the variation of each component relative to market-wide return and liquidity. We show that institutional trades contribute more than retail trades to liquidity commonality. However, retail trades contribute more strongly to return co-movement. The incremental contribution of retail trades to the co-variability of stock returns is more pronounced for firms with high information asymmetry.
We present a dynamic model that expresses how traders use historical price patterns and recent trends and the weights they assign to each information set when predicting future market behavior. We show that although traders initially have more faith in the validity of information about historical events, in light of recent price changes, they gradually shift their reliance to more current market trends as they realize that the prices they are witnessing do not follow the historical patterns. As soon as the price trend changes again, however, traders’ confidence in the information contained in historical events is restored, and they consequently rely less on the more current price changes. We estimate the model using experimental data and explain the role of the model parameters.
This study shows that weather-based indicators of mood impact perceptions of mispricing and trading decisions of institutional investors. Using survey and disaggregated trade data, we show that relatively cloudier days increase perceived overpricing in individual stocks and the Dow Jones Industrial Index, and increase selling propensities of institutions. We introduce stock-level measures of investor mood; investor pessimism negatively impacts stock returns, mostly amongst stocks with higher arbitrage costs, and stocks experiencing similar changes in weather-induced mood exhibit return comovement. These findings complement existing studies on how weather impacts stock index returns, and identify another channel through which it can manifest.
This study investigates whether stock price performance contains a sizeable component that emanates from local sports sentiment. We measure sports sentiment by the performance of sports teams from the four major professional sports leagues (NFL, MLB, NBA, and NHL) that are based nearby firms’ headquarters. We find that concurrent stock returns and sports performances associated with the same locality are highly correlated. Consistent with the notion that mispricing is indeed caused by sports sentiment, we also determine that sentiment is related to a subsequent gradual return reversal, which occurs over the following three year period. In addition, we confirm that local comovement is more pronounced in the presence of sports sentiment in support of the notion that local stock preference of relatively less sophisticated retail investors can be driven by factors that are not information-based. Finally, we devise investment strategies based on recent past observations of sports sentiment and find that they generate sizable abnormal returns, especially in cases of firms located in areas where fan base support appears to be stronger.
Does the retail clientele matter for option returns? By delta-hedging options and trading straddles, thus allowing a focus on volatility, this paper empirically shows that a higher retail trading proportion (RTP) is related to lower option returns. Long-short portfolios involving options on low and high RTP stocks generate significantly positive abnormal returns. The results suggest that retail investors speculate and pay a lottery premium on the expected future volatility, resulting in more expensive options with higher implied volatilities. This systematic deviation of option-implied volatility from realized volatility suggests retail clientele as a behavioral-based driving force of volatility risk premium.
We theoretically develop and empirically test a model in which investor overconfidence produces overpricing of high idiosyncratic volatility stocks in the presence of binding short-sale constraints. The theory predicts that, upon mitigation of short-sale constraints, high volatility stocks will experience both more short sales and more negative market reaction than those with low idiosyncratic volatility. We test these model predictions using three natural experiments: IPO lockup expirations, option introductions, and the 2008 short-sale ban on financial firms. Consistent with our model's predictions, we show that when short-sale constraints are relaxed, event stocks with high idiosyncratic volatility tend to experience greater price reductions, as well as larger increases in trading volume and short interest, than low idiosyncratic volatility stocks. These results hold when we benchmark event stocks with non-event stocks with comparable idiosyncratic volatility. Overall, our findings suggest that binding short-sale constraints contribute to idiosyncratic volatility overpricing.
This paper shows that over time, expected market illiquidity positively affects ex ante stock excess return, suggesting that expected stock excess return partly represents an illiquidity premium. This complements the cross-sectional positive return–illiquidity relationship. Also, stock returns are negatively related over time to contemporaneous unexpected illiquidity. The illiquidity measure here is the average across stocks of the daily ratio of absolute stock return to dollar volume, which is easily obtained from daily stock data for long time series in most stock markets. Illiquidity affects more strongly small firm stocks, thus explaining time series variations in their premiums over time.
We study the trading of individual investors using transaction data and identifying buyer- or seller-initiated trades. We document four results: (1) Small trade order imbalance correlates well with order imbalance based on trades from retail brokers. (2) Individual investors herd. (3) When measured annually, small trade order imbalance forecasts future returns; stocks heavily bought underperform stocks heavily sold by 4.4 percentage points the following year. (4) Over a weekly horizon, small trade order imbalance reliably predicts returns, but in the opposite direction; stocks heavily bought one week earn strong returns the subsequent week, while stocks heavily sold earn poor returns. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.
A German broker's clients place similar speculative trades and therefore tend to be on the same side of the market in a given stock during a given day, week, month, and quarter. Aggregate liquidity effects, short sale constraints, the systematic execution of limit orders (coordinated through price movements) or the correlated trading of other investors who pick off retail limit orders do not fully explain why retail investors trade similarly. Correlated market orders lead returns, presumably due to persistent speculative price pressure. Correlated limit orders also predict subsequent returns, consistent with executed limit orders being compensated for accommodating liquidity demands.
Traditionally and understandably, the microscope of market microstructure has focused on attributes of single assets. Little theoretical attention and virtually no empirical work has been devoted to common determinants of liquidity nor to their empirical manifestation, correlated movements in liquidity. But a wider-angle lens exposes an imposing image of commonality. Quoted spreads, quoted depth, and effective spreads co-move with market- and industry-wide liquidity. After controlling for well-known individual liquidity determinants, such as volatility, volume, and price, common influences remain significant and material. Recognizing the existence of commonality is a key to uncovering some suggestive evidence that inventory risks and asymmetric information both affect intertemporal changes in liquidity.
This study examines whether local stock returns vary with local business cycles in a predictable manner. Our key conjecture is that local stock prices would decline and the average future returns would rise during local recessions as local risk aversion increases and local risk sharing abilities decline. Consistent with this conjecture, we find that U.S. state portfolios earn higher future returns when state-level unemployment rates are higher and housing collateral ratios are lower. During the 1978 to 2009 period, geography-based trading strategies that exploit this predictable pattern earn an annualized risk-adjusted performance of about five percent. This abnormal performance can be attributed to time-varying portfolio exposures to U.S. systematic risk factors and mispricing generated by coordinated local trading. Consistent with the mispricing explanation, the evidence of predictability is stronger among firms with low visibility and high local ownership. Nonlocal domestic and foreign investors arbitrage away the predictable patterns in local returns in about a year.
This paper examines the characteristics and pricing of stocks that are actively traded by speculative retail investors. We find that stocks with high "retail trading proportion" (RTP) have strong lottery features and they attract retail investors who are known to exhibit a strong propensity to gamble with stocks. High levels of RTP also reflect active trading by risk-seeking "realization utility" investors. Stocks whose trading are dominated by speculative retail investors tend to be overpriced and earn significantly negative alpha. The average return difference between the top and the bottom RTP quintiles is about -0.60% per month. This negative RTP premium is stronger among stocks that have lottery features or are located in regions in which people exhibit a stronger propensity to gamble. Collectively, these results indicate that speculative retail trading importantly affect stock prices.
We examine how commonality in liquidity varies across countries and over time in ways related to supply determinants (funding liquidity of financial intermediaries) and demand determinants (correlated trading behavior of international and institutional investors, incentives to trade individual securities, and investor sentiment) of liquidity. Commonality in liquidity is greater in countries with and during times of high market volatility (especially, large market declines), greater presence of international investors, and more correlated trading activity. Our evidence is more reliably consistent with demand-side explanations and challenges the ability of the funding liquidity hypothesis to help us understand important aspects of financial market liquidity around the world, even during the recent financial crisis.
This paper investigates a unique dataset that enables us to determine the aggregate buy and sell volume of individual investors for a large cross-section of NYSE stocks. We find that individuals trade as if they are contrarians, and that the stocks that individuals buy exhibit positive excess returns in the following month. These patterns are consistent with the idea that risk-averse individuals provide liquidity to meet institutional demand for immediacy. We further examine the relation between individual investor sentiment and short-horizon (weekly) return reversals that have been documented in the literature. Our results reveal that individual investor sentiment predicts future returns, and that the information content of investor sentiment is distinct from that of past returns or past volume. Furthermore, the trading of individuals predicts weekly returns in the post-2000 era for stocks of all sizes, while past return seems to have lost its predictive power for all but small stocks over the same time period. Lastly, we note that there is very little cross-sectional correlation of our individual sentiment measure across the stocks in our sample.
ABSTRACTI find that economically meaningless index labels cause stock returns to covary in excess of fundamentals. S&P/Barra follow a simple mechanical procedure to define their Value and Growth indices. In doing so, they reclassify some stocks from Value to Growth even after their book-to-market ratios have risen, and vice versa. Such stocks begin to covary more with the index they join and less with the index they leave. Backdated constituent data from Barra reveal no such label-related shifts in comovement during the 10 years prior to the actual introduction of the indices in 1992.
This paper offers a model in which asset prices reflect both covariance risk and misperceptions of firms' prospects, and in which arbitrageurs trade against mispricing. In equilibrium, expected returns are linearly related to both risk and mispricing measures (e.g., fundamental/price ratios). With many securities, mispricing of idiosyncratic value components diminishes but systematic mispricing does not. The theory offers untested empirical implications about volume, volatility, fundamental/price ratios, and mean returns, and is consistent with several empirical findings. These include the ability of fundamental/price ratios and market value to forecast returns, and the domination of beta by these variables in some studies.
We document by several methods that trading in Nasdaq stocks is localized. The first evidence of localized trading is that the time zone of a company's headquarters affects intraday trading patterns in its stock. Stocks of west coast firms have lower volume early in the trading day than east coast companies and do not exhibit the steep decline in volume documented for the east coast lunch hour. Second, firms in blizzard-struck cities see a dramatic trading volume drop compared to firms in other cities. On average, about 1/3 of a normal day's trading volume is lost when a blizzard strikes. Third, trading volume drops for stocks in general during Yom Kippur, but the effect is particularly strong for cities with large Jewish populations. The finding that trading in Nasdaq stocks is geographically concentrated allows us to construct powerful alternative tests of other researchers' finding that stock returns are lower on cloudy days. We construct portfolios of Nasdaq stocks based in 25 cities. We are unable to find any evidence that cloud cover in the city of a company's headquarters affects its stock returns.
Traditionally and understandably, the microscope of market microstructure has focused on attributes of single assets. Little theoretical attention and virtually no empirical work has been devoted to common determinants of liquidity nor to their empirical manifestation, correlated movements in liquidity. But a wider-angle lens exposes an imposing image of commonality. Quoted spreads, quoted depth, and effective spreads co-move with market- and industry-wide liquidity. After controlling for well-known individual liquidity determinants, such as volatility, volume, and price, common influences remain significant and material. Recognizing the existence of commonality is a key to uncovering some suggestive evidence that inventory risks and asymmetric information both affect intertemporal changes in liquidity.
Each NYSE specialist firm provides liquidity for more than one common stock. As a result of shared capital and information among specialists within a firm, we argue that stock liquidity will co-move with the liquidity of other stocks handled by the same specialist firm, with magnitude increasing with the risk of providing liquidity. The evidence indicates that individual stock liquidity co-varies with specialist portfolio liquidity apart from information reflected by market liquidity variation. Further tests based on specialist firm size, specialist firm mergers, and market returns indicate that liquidity co-variation increases with the risk of providing liquidity.
Our paper examines the impact of geographic location on liquidity for U.S. rural- and urban-based companies. Even after adjusting for size and other factors, rural firms trade much less, are covered by fewer analysts, and are owned by fewer institutions than urban firms. Trading costs are higher for rural Nasdaq firms, and volume that can be attributed to marketwide factors is lower for rural stocks. The findings add to our understanding of the way that access to information and familiarity affect liquidity.
Similarly priced stocks move together. Stocks that undergo splits experience an increase in comovement with low-priced stocks and a decrease in their comovement with high-priced stocks. Price-based comovement is not explained by economic fundamentals, firm size, or changes in liquidity or information diffusion. The shift in comovement following splits is greater for large stocks, high-priced stocks, and when investor sentiment is high. In the full cross-section, price-based portfolios explain variation in stock-level returns after controlling for movements in the market and industry portfolios as well as portfolios based on size, book-to-market, transaction costs, and return momentum. The results suggest that investors categorize stocks based on price.
Estimates of the cost of equity for industries are imprecise. Standard errors of more than 3.0% per year are typical for both the CAPM and the three-factor model of Fama and French (1993). These large standard errors are the result of(i) uncertainty about true factor risk premiums and (ii) imp ecise estimates of the loadings of industries on the risk factors. Estimates of the cost of equity for firms and projects are surely even less precise.
This paper uses investor-level data to provide direct evidence for an intuitive but surprisingly untested proposition that investors make larger investment mistakes when valuation uncertainty is higher and stocks are more difficult to value. Using multiple measures of valuation uncertainty and multiple behavioral bias proxies, I show that individual investors exhibit stronger behavioral biases when stocks are harder to value and when market-level uncertainty is higher. I also find that informed trading intensity is higher among stocks where individual investors exhibit stronger behavioral biases. Collectively, these results indicate that uncertainty at both stock and market levels amplifies individual investors behavioral biases and that relatively better informed investors attempt to exploit those biases.
We test whether comovements of individual stock prices can be justified by economic fundamentals. This is a test of the present
value model of security valuation with the constraint that changes in discount rates depend only on changes in macroeconomic
variables. Then, stock prices of companies in unrelated lines of business should move together only in response to changes
in current or expected future macroeconomic conditions. Using a latent variable model to capture unobserved expectations,
we find excess comovement of returns. We show that this excess comovement can be explained in part by company size and degree
of institutional ownership, suggesting market segmentation.
Relative to their weights in a value-weighted index, a number of stocks in Japan's Nikkei 225 stock index are overweighted
by a factor of 10 or more. I document a strong positive relation between overweighting and the comovement of a stock with
other stocks in the Nikkei index, and a negative relationship between index overweighting and comovement with stocks outside
of the index. The cross-sectional approach resolves endogeneity problems associated with event study demonstrations of excess
comovement. A trading strategy that bets on the reversion of stock prices of overweighted stocks generates economic profits,
confirming that the observed comovement patterns are excessive, and providing further evidence that comovement of stock returns
can be a consequence of commonality in trading behavior.
This paper uses volume arising from small trades to analyze the relationship between retail investor trading behavior and the cross-section of future stock returns. The central finding is that stocks with intense sell-initiated small-trade volume, measured over the past several months, outperform stocks with intense buy-initiated small-trade volume. This return difference accrues from the first month after the portfolio formation up to two years later. Among small- and medium-sized firms, the return difference continues in the third year. The results suggest that stocks favored by retail investors subsequently experience prolonged underperformance relative to stocks out of favor with retail investors. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.
We explore the time-series relationship between investor sentiment and the small-stock premium using consumer confidence as
a measure of investor optimism. We estimate the components of consumer confidence related to economic fundamentals and investor
sentiment. After controlling for the time variation of beta, we study the time-series variation of the pricing error with
sentiment. Over the last 25 years, investor sentiment measured using consumer confidence forecasts the returns of small stocks
and stocks with low institutional ownership in a manner consistent with the predictions of models based on noise-trader sentiment.
Sentiment does not appear to forecast time-series variation in the value and momentum premiums. (JEL G10, G12, G14)
A German broker's clients place similar speculative trades and therefore tend to be on the same side of the market in a given stock during a given day, week, month, and quarter. Aggregate liquidity effects, short sale constraints, the systematic execution of limit orders (coordinated through price movements) or the correlated trading of other investors who pick off retail limit orders do not fully explain why retail investors trade similarly. Correlated market orders lead returns, presumably due to persistent speculative price pressure. Correlated limit orders also predict subsequent returns, consistent with executed limit orders being compensated for accommodating liquidity demands. Copyright 2008 by The American Finance Association.
Using a database of more than 1.85 million retail investor transactions over 1991-1996, we show that these trades are systematically correlated-that is, individuals buy (or sell) stocks in concert. Moreover, consistent with noise trader models, we find that systematic retail trading explains return comovements for stocks with high retail concentration (i.e., small-cap, value, lower institutional ownership, and lower-priced stocks), especially if these stocks are also costly to arbitrage. Macroeconomic news and analyst earnings forecast revisions do not explain these results. Collectively, our findings support a role for investor sentiment in the formation of returns. Copyright 2006 by The American Finance Association.
This paper examines the proposition that fluctuations in discounts of closed-end funds are driven by changes in individual investor sentiment. The theory implies that discounts on various funds move together, that new funds get started when seasoned funds sell at a premium or a small discount, and that discounts are correlated with prices of other securities affected by the same investor sentiment. The evidence supports these predictions. In particular, the authors find that both closed-end funds and small stocks tend to be held by individual investors, and that the discounts on closed-end funds narrow when small stocks do well. Copyright 1991 by American Finance Association.
The 2008/9 financial crisis highlighted the importance of evaluating vulnerabilities owing to interconnectedness, or Too-Connected-to-Fail risk, among financial institutions for country monitoring, financial surveillance, investment analysis and risk management purposes. This paper illustrates the use of balance sheet-based network analysis to evaluate interconnectedness risk, under extreme adverse scenarios, in banking systems in mature and emerging market countries, and between individual banks in Chile, an advanced emerging market economy.
The basic paradigm of asset pricing is in vibrant flux. The purely rational approach is being subsumed by a broader approach based upon the psychology of investors. In this approach, security expected returns are determined by both "risk" and "misvaluation". This survey sketches a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models. Copyright The American Finance Association 2001.
We document strong comovement in the stock returns of firms headquartered in the same geographic area. Moreover, stocks of companies that change their headquarters location experience a decrease in their comovement with stocks from the old location and an increase in their comovement with stocks from the new location. The local comovement of stock returns is not explained by economic fundamentals and is stronger for smaller firms with more individual investors and in regions with less financially sophisticated residents. We argue that price formation in equity markets has a significant geographic component linked to the trading patterns of local residents. Copyright 2006 by The American Finance Association.
We study how investor sentiment affects the cross-section of stock returns. We predict that a wave of investor sentiment has larger effects on securities whose valuations are highly subjective and difficult to arbitrage. Consistent with this prediction, we find that when beginning-of-period proxies for sentiment are low, subsequent returns are relatively high for small stocks, young stocks, high volatility stocks, unprofitable stocks, non-dividend-paying stocks, extreme growth stocks, and distressed stocks. When sentiment is high, on the other hand, these categories of stock earn relatively low subsequent returns. Copyright 2006 by The American Finance Association.
In a model with housing collateral, the ratio of housing wealth to human wealth shifts the conditional distribution of asset prices and consumption growth. A decrease in house prices reduces the collateral value of housing, increases household exposure to idiosyncratic risk, and increases the conditional market price of risk. Using aggregate data for the United States, we find that a decrease in the ratio of housing wealth to human wealth predicts higher returns on stocks. "Conditional" on this ratio, the covariance of returns with aggregate risk factors explains 80% of the cross-sectional variation in annual size and book-to-market portfolio returns. Copyright 2005 by The American Finance Association.
Stock price increases associated with addition to the S&P 500 Index have been interpreted as evidence that demand curves for stocks slope downward. A key premise underlying this interpretation is that Index inclusion provides no new information about companies' future prospects. We examine this premise by analyzing analysts' earnings per share (eps) forecasts around Index inclusion and by comparing postinclusion realized earnings to preinclusion forecasts. Relative to benchmark companies, companies newly added to the Index experience significant increases in eps forecasts and significant improvements in realized earnings. These results indicate that S&P Index inclusion is not an information-free event. Copyright (c) 2003 by the American Finance Association.
We propose a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrelations ("momentum"), short-run earnings "drift," but negative correlation between future returns and long-term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate financial policy. Copyright The American Finance Association 1998.
Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that traded most earned an annual return of 11.4 percent, while the market returned 17.9 percent. The average household earned an annual return of 16.4 percent, tilted its common stock investment toward high-beta, small, value stocks, and turned over 75 percent of its portfolio annually. Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth. 1 The investor's chief problem -- and even his worst enemy -- is likely to be himself. Benjamin Graham In 1996, approximately 47 percent of equity investments in the U.S. were held directly by households, 23 percent by pension funds, and 14 percent by mutual funds (Security Industry Fact Book, 1997). Financial economists have extensiv...
Comovement Journal of Financial Eco-nomics Style-related comovement: Fundamentals or labels?
- N Barberis
- A Shleifer
- J B Wurgler
Barberis, N., Shleifer, A. and Wurgler, J. (2005) Comovement, Journal of Financial Eco-nomics, 75, 283–317. rINVESTOR SENTIMENT AND RETURN COMOVEMENTS 29 Boyer, B. (2011) Style-related comovement: Fundamentals or labels?, Journal of Finance, Forthcoming, 307–332