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The Efficient Market Theory and Evidence: Implications for Active Investment Management
Abstract
The Efficient Market Hypothesis (EMH) asserts that, at all times, the price of a security reflects all available information about its fundamental value. The implication of the EMH for investors is that, to the extent that speculative trading is costly, speculation must be a loser’s game. Hence, under the EMH, a passive strategy is bound eventually to beat a strategy that uses active management, where active management is characterized as trading that seeks to exploit mispriced assets relative to a risk-adjusted benchmark. The EMH has been refined over the past several decades to reflect the realism of the marketplace, including costly information, transactions costs, financing, agency costs, and other real-world frictions. The most recent expressions of the EMH thus allow a role for arbitrageurs in the market who may profit from their comparative advantages. These advantages may include specialized knowledge, lower trading costs, low management fees or agency costs, and a financing structure that allows the arbitrageur to undertake trades with long verification periods. The actions of these arbitrageurs cause liquid securities markets to be generally fairly efficient with respect to information, despite some notable anomalies.
... The latest developments in EMH allows functioning of the stock markets with lower than full information (Ang et al., 2012). In an efficient market, no investor can earn more than the market (Malkiel, 2000). ...
... Having discussed an account of theories, this research stems its roots in APT of Ross (1976) and Chen et al. (1986) that more than one factors are responsible for changes in the stock prices, and builds on the EMH of Fama (1970) and its latest developments, i.e. Ang et al. (2012) that at any time the stock prices reflect publicly available information, though not complete. ...
Purpose: This study investigates the determinants of Islamic stock returns listed on Jakarta Islamic Index (Indonesia) between 2008 and 2018.
Design/Methodology/Approach: This study uses a Quantile Bounded Auto-regressive Distributed Lag (QBARDL) model to uncover relevant relation-ships.
Findings: This study finds that the Dow Jones Islamic Market Index, gold returns, world oil prices, and exchange rates are the determinants of the Indonesia’s Islamic stock returns. However, the relationship is time varying developing intra/inter quantile bounded.
Practical Implications: Integration of the Islamic stock returns with the real economic indicators change over time. The findings have important implica-tions for the policymakers, the fund managers and the investors to anticipate consequences when considering the macroeconomic conditions before par-ticipating in the Indonesian Islamic stock market.
... Economic transformation of rural livelihoods market improvement linkages along the value chain is critical which is increases opportunities and choices of rural farmers and reduces fluctuations between household consumption and income [12]. Efficient integrated access to information and other infrastructure help reduce transaction costs thus raising incomes of the rural poor [13,19]. About 4.3% of the surveyed households were female headed with 5.9% in Bako Tibe and 1.7% in Guto Gida districts. ...
... According to the sample households reported the price of maize and tomato seed increased from time to time than other inputs due to input speculation and shortage of seed. This result implies that there is maize seed market inefficiency due to input speculation [19]. ...
The study is to describe the marketing system of inputs and outputs; identify weather there is marketing system inefficiencies and integration in inputs and outputs of maize and tomato marketing system in Bako Tibe and Guto Gida districts. From the result, there is an information gap with and among producers, Development Agents, input suppliers, traders, and consumers. The majority of the producers preferred cooperatives to sell their products. According to producers' reported disease, low price of grain, poor market linkage, shortage of chemicals and unlicensed traders were the major challenges in both maize and tomato production. Shortage of inputs, farmers reluctant to buy inputs, high competition unlicensed traders, weak government support, and shortage of storage were the main challenges in input supply while low quality with poor awareness, low supply, unlicensed traders, brokers and demand fluctuations were also major challenges in traders. Enhancing the technical knowledge and skill of farmers, Development Agents, input suppliers, and buyers need the training to provide effective enabling service to increase market efficiency among the actors. Besides, build the capacity of farmer's cooperatives in value chains of inputs and outputs, considering market-oriented extension service and improving the enabling environment in promoting competition in agribusiness marketing efficiency.
... Existing studies have shown how the majority of mutual fund managers consistently under-perform relative to their respective benchmarks (Jensen, 1968; Quigley & Sinquefield, 2000; Ang, Goetzmann &Schaefer, 2010). Mutual fund managers and investors in general, who are known to consistently beat the market, attribute their success to unique investment strategies. ...
... Existing studies have shown how the majority of mutual fund managers consistently under-perform relative to their respective benchmarks (Jensen, 1968;Quigley & Sinquefield, 2000;Ang, Goetzmann &Schaefer, 2010). Mutual fund managers and investors in general, who are known to consistently beat the market, attribute their success to unique investment strategies. ...
This study seeks to investigate herd behaviour among equity mutual fund managers and the performance of mutual funds that trade against the herd in South Africa. The behaviour of mutual funds has an effect on the stability and volatility of stock markets, the ultimate returns to the investors. The study builds upon the efficient market hypothesis, portfolio theory and behavioural finance to provide evidence of the behaviour of mutual funds in an emerging market context using the Johannesburg Stock Exchange. The Lakonishok, Shleifer and Vishney (1991) measure of herding is used to ascertain the behaviour of mutual funds over the period 2006 to 2012. Institutional investors in South Africa are susceptible to the behavioural bias of herding and this phenomenon influences the performance of their funds. Funds that trade in the opposite direction of herd funds are able to put up a superior performance over time. Superior performance, however, does not entice mutual fund investors to invest less in under-performing funds and more in funds that recently show superior performance. These findings imply that following investment waves does not culminate in superior returns in the stock market. Consequently, mutual funds that take an opposite direction to herd funds help stabilize the stock market and lessen the severity of bear markets. This study categorizes mutual funds into 'herding' and 'contrarian' and provides an insight into the performance of each category. Investors who oppose herd behaviour realize greater returns over time while stabilizing the markets at the same time.
... EMT assumed that a large number of independent, well-informed, and profitmaximizing buyers and sellers; random information production; and quick investor adjustment. A securities market should meet several requirements to be deemed efficient, including efficient [3]. Market efficiency had been categorized into three levels based on the information impounded into stock prices. ...
This study explores the factors affecting the market price of Nepalese commercial banks over the period from 2017/18 to 2021/22 AD. Utilizing bivariate correlation and regression models, data sourced from the annual reports and official publications of eight NEPSE-listed banks underwent comprehensive analysis facilitated by MS-Excel and SPSS. The results unveil a significant positive correlation between earnings per share (EPS) and price-earnings ratio (P/E ratio), indicating that as EPS increases, so does the P/E ratio, and consequently, the market price. However, the impact of book value and dividend per share on market prices was found to be negligible, suggesting that these factors exert minimal influence on market valuations. The primary inference drawn from the findings underscores the dominance of price-earnings ratio and earnings per share as pivotal determinants of share prices within Nepalese commercial banks. This indicates that investors place substantial emphasis on these metrics when evaluating the investment potential of Nepalese Original Research Article Pandey et al.; Asian J. Econ. Busin. 172 commercial banks. These findings provide valuable insights for investors, financial analysts, and policymakers, offering a clearer understanding of the market dynamics and the key drivers of share prices within the Nepalese banking sector. Moreover, they underscore the importance of considering EPS and P/E ratio when making investment decisions in Nepalese commercial banks.
... Hence, in order to estimate the true value of a security, the best approach would be to perform an evaluation using its current market price(s). According to Ang et al. (2011), the efficient market hypothesis simply states that the price of a security embodies and portrays all available information about its fundamental value or worth at every point in time. EMH asserts that investors only make use of available and accessible information to trade assets in the financial markets in order to maximize wealth. ...
This study examined the performance of Unit Trust Schemes in Nigeria. This study utilized the weekly net assets value (NAV) data of the existing types of Unit Trust Schemes in the assessment of the variability of the performance of the funds over time, for the period of 2016 to 2020. The data utilized was sourced from secondary sources and was retrieved from an online database maintained by the Securities and Exchange Commission (SEC) of Nigeria. This study covered the seven (7) types of funds recognized for operation in the country namely: Equity-Based Fund, Money Market Fund, Bond Fund, Fixed Income Fund, Real Estate Fund, Mixed Fund, and Ethical Fund. Descriptive statistics, Regression analysis, and the Chow Breakpoint test were used in this study. The results showed that the weekly performance of the UTS sector of the Nigerian economy. The results of this study indicated the existence of a positive relationship between the portfolio of the market and the existing unit trust schemes, and that their performance has not been persistent over the course of the years. By implication, this means that a positive performance by the funds would result in a positive performance of the market portfolio. All other things being equal, the high volatility of the funds was attributed to the inconsistency of the returns of the existing funds. This study recommends that this work should be reproduced at the ECOWAS and/or Sub-Saharan African levels.
... By the mid-1970s there was such strong theoretical and empirical evidence supporting the Efficient Market Hypothesis that it seemed a proved theory. However, there has recently been an emergence of counterarguments refuting the hypothesis [5]. ...
This paper’s objective is to demystify the world of investing, first by showing and exposing the results the greatest money managers in the Wall Street have obtained over the last years compared to the performance of their benchmark indexes. Index investing represents a passive investment strategy of holding hundreds of stocks instead of the active management approach used by these experts. After exposing said results, a theoretical framework will be presented that explains why money managers have such a difficult time outperforming their benchmark indexes. Later on, a back-test experiment will be presented and thoroughly explained showing five different hypothetical investment scenarios over several 20-year periods with the attempt to quantify the potential benefit of perfectly timing the market and compare it to the cost of waiting for a better time to invest. The results find shows that the cost of waiting is much greater that the potential benefit of perfectly timing the market and the best alternative would be to invest available cash immediately regardless of market or economic outlook.
... While this finding is academically meaningful and has implications on portfolio management, it does not indicate how an investor can generate profits in case where the market is found to be inefficient. For instance, Ang et al. (2011) concur on the refinement of the EMH over recent years to reflect real market imperfections (e.g., trading costs related to transaction, information and liquidity as well as financing and agency cost) and argue that the evidence of inefficient markets must allow arbitrageurs to make trading profits from their comparative advantages (e.g., specialized knowledge, technical know-how and trading rules, and lower trading costs). Therefore, it is clear from a practical perspective that a more solid approach is required because investors and portfolio managers, among others, look for explicit instructions and methods to exploit the violation of the weak-form efficiency stated by the earlier academic studies. ...
The Vietnamese stock market provides an interesting and enriching test field for the application of trading expert systems as its economy is opening up, has high growth rate and may offer risk diversification opportunities. This paper examines the question of whether this frontier emerging market offers possibilities for statistical arbitrage through a financial expert system. Based on a sample of the most liquid stocks in the VN30 benchmark index, our results indicate that the index itself and some of its components offer moderate opportunities for statistical arbitrage even after considering transaction costs. It is also found that the purely momentum-based models already work satisfactorily for specific stocks, while the long-short strategies do not work more robustly than the long-only strategies. Overall, our findings hint into the direction of some exploitable inefficiencies, but the magnitude of the tradable volume is such that only comparatively small amounts can be traded.
... Investment has a meaning as a commitment to a number of funds or other resources that are made or consumed now to obtain greater profits in the future (Tandelilin, 2010). There are two types of investments, namely investments in the form of financial assets and real assets (Fransiskus, 2016) Efficiency Theory Market is a theory that explains that at any time the price of a security reflects all information about its fundamental value (Andrew Ang, et al., 2011). So, this market efficiency theory explains the relationship between market reaction and available information, so that it affects the movement of stock prices or the value of a security. ...
... Several empirical studies tested the EMH in different asset classes with mixed results. For a detailed and comprehensive literature review on the efficient market hypothesis, the reader can refer to Ang et al. 3 ; Degutis and Novickyte 39 ; Lim and Brooks 70 ; T ‚ it ‚an 99 ; Yen and Lee. 107 Lo 71 extends the EMH to better explain the time-varying nature of efficiency found in several asset classes. ...
This paper aims to investigate how Machine Learning (ML) techniques perform in the prediction of cryptocurrency prices. We answer if Support Vector Machines (SVM) and Artificial Neural Networks (ANN) based strategies can generate abnormal risk-adjusted returns when applied to Bitcoin, the largest decentralized digital currency in terms of market capitalization. Findings indicate that traders are able to earn conservative returns on the risk adjusted basis, even accounting for transaction costs, when using SVM. Furthermore, the study suggests that ANN can explore short run informational inefficiencies to generate abnormal profits, being able to beat even buy-and-hold during strong bull trends. Keywords: Bitcoins, Machine learning (ML), Artificial neural network (ANN), Support vector machine regression (SVM), JEL Code: G11, G15, G17
... During this period, the theory of market efficiency remained in the shadow of the theory of rational expectation and the capital valuation model. To some extent, the theoretical logic of EMH, articulated by Regnault (1863), Cowles (1937), Fama (1965), Samuelson (1965) and Mandelbort (1963) provides convincing and useful means to develop price models of assets so it has become intellectual paradigm for generations of scientists (Ang et al., 2011). ...
This research examines calendar anomalies (day-of-the-week effect) on stock exchanges in the region. The main objective of the study is to examine the effect of days of the week on stock exchanges in the region in the period from 2008 to 2014, and whether there are differences in relation to the effects that occur during the crisis period from 2008 to 2011 and postcrisis period from 2012 to 2014. The subsample of the analysis shows different results due to an increase in the maturity of the capital market, the financial crisis, accession to the European Union and other important events for the financial markets in the region. The purpose of this paper is to determine whether the relationships between the average stock returns in emerging markets are the same or different across different days of the week. The study includes a quantitative analysis of the yield of stock exchange indices on a certain day that uses daily data from 01.01.2008 to 31.12.2014 for capital markets in Bosnia and Herzegovina, Bulgaria, Montenegro, Croatia, Macedonia, Romania and Serbia. The results of the study indicate the effect of the days of the week on all observed stock markets in the region, except for the stock market in Bulgaria. Obtained panel results support earlier studies conducted on emerging markets and provide evidence of stock market inefficiency.
... It is also expected that the risk-return profile of Islamic and conventional products (i.e., stocks) is different because of the unique characteristics of Islamic stocks such as ethical investing, ratio screening, low tolerance towards interest based leverage and limit to the intensively structured financial 2 Before the latest developments of the EMH concept, the individual investors may not be able to obtain the optimal benefits as a result of high information costs, transactions costs, agency costs and other real-world frictions. However, the most recent expressions of the EMH thus allow a role for individual investors in the market who may profit from their comparative advantages including specialized knowledge, lower trading costs, low agency costs or management fees and a financing structure (Ang, et al. 2011). ...
In this paper, we examine the comparative efficiency of 12 Islamic and conventional stock markets counterparts using multifractal de-trended fluctuation analysis (MF-DFA). The full sample results indicate that developed markets are relatively more efficient, followed by the BRICS’ stock markets. The comparative efficiency analysis shows that almost all the Islamic stock markets excluding Russia, Jordan and Pakistan are more efficient than their conventional counterparts. Implying that Islamic stock markets are new, however the peculiar nature, shari’ah compliant laws and good governance and disclosure mechanisms make them more efficient. Further, our results indicate that the Islamic stock markets’ adjustment to speculative activity is, in fact, higher than their conventional counterparts. The findings of the study may help regulators and policy makers to reduce economic distortions through more effective resource allocation.
... For instance, any portfolio optimization involving factor-mimicking portfolios has to deal with the estimation of their expected returns, variances, and correlations. 33 In particular, Ang et al, (2010) show how performance evaluation and active asset allocation change when multiple style portfolios are considered. Investors and practitioners should also be interested in managing the risks embedded in their portfolios. ...
This paper studies the predictive performance of multivariate models at forecasting the (excess) returns of portfolios mimicking the Market, Size, Value, Momentum, and Low Volatility factors isolated in asset pricing research. We evaluate the accuracy of the point forecasts of a number of linear and regime-switching models in recursive, out-of-sample forecasting experiments. We assess the accuracy of the models using several measures of unbiasedness and predictive accuracy, and using Diebold and Mariano’s approach to test whether differences in expected losses from all possible pairs of forecast models are statistically significant. We fail to find evidence that complex statistical models are uniformly more accurate than a naïve constant expected return model for factor-mimicking portfolio (excess) returns. However, we show that it is possible to build simple portfolio strategies that profit from the higher out-of-sample predictive accuracy of forecasting models with Markov switching in conditional mean coefficients. These results appear to be independent of the forecasting horizon and robust to changes in the loss function that captures the investors’ objectives.
... 8 See the classical works by Chen, Roll, and Ross [1986], Fama and French [1989], and Schwert [1990] on macroeconomic risk factors driving asset returns. See Cochrane [2005] and Ang, Goetzmann, and Schaefer [2011] for overviews of the recent literature and empirical evidence. 9 For the purist, we are admittedly abusing the language of "alpha." ...
Despite the large literature on the importance of asset allocation as a primary determinant of portfolio performance, the definition of asset allocation “alpha” remains a poorly defined concept. In this paper, we show that a portfolio’s total alpha can be decomposed into alpha from asset allocation and manager selection. The asset allocation alpha can then be further attributed to value-add from (1) taking additional risk exposure relative to the policy portfolio, (2) exploiting the relative value differential between assets with similar risk exposures and (3) timing the cyclicality in risk premia.
Analyzing the overwhelming number of options available in the cryptocurrency market through technical analysis becomes unfeasible, whether expert investor or not. Similarly, challenging is the application of fundamental analysis in such markets. To address these complexities, this paper proposes a novel method to assist investors in navigating the overwhelming array of cryptocurrency options by employing a ‘buy-and-sell’ strategy. The approach incorporates a dynamic daily ranking system generated through LSTM neural network predictions and a dynamic linguistic decision-making model (DLDM). Simulated on a dataset of 68 cryptocurrencies observed from March to May 2018, the method surpasses state-of-the-art returns by over 300% when considering combinations of Day Profitability, Day Variability, and one of Open, Close, Low, or High attributes. Furthermore, by using a unitary constant as the third attribute, it achieves even higher returns, outperforming the state-of-the-art by more than 1700%. Comparatively, the proposed method easily outshines alternative strategies such as random selection, Bitcoin buy-and-hold, and equitable investment in all cryptocurrencies, which yielded returns of 3%, -34%, and 54%, respectively. The integration of LSTM predictions and DLDM showcases a potent tool for making informed decisions in the dynamic cryptocurrency market, especially crucial given the multitude of investment options and prevalence of non-expert investors. This paper presents a powerful approach to cryptocurrency investment, leveraging LSTM predictions and dynamic linguistic decision-making to provide investors with a competitive edge. The method's superior performance against published strategies showcases its potential for effectively tackling the complexities in cryptocurrency market, benefiting investors, despite experienced or not.
Capital markets provide an important channel in financing the real economy, allocating risk, supporting economic growth and sustaining financial stability. Nonetheless, these objectives cannot be achieved in a vacuum but can only be aspired to when capital markets are allowed to operate effectively. This dissertation highlights the importance of an appropriate legal and regulatory framework which is key to enable capital markets to effectively intermediate capital and contribute to investor confidence.
This thesis reviews the current situation of the local capital markets and their respective challenges, particularly those prevailing due to a somewhat rigid regulatory framework (based on EU Regulation and Directives, together with other locally-enacted legislative acts and rules), its size (which impacts liquidity and limits the value of the new issues coming to market) and the high proportion of unsophisticated retail investors. The author makes a number of suggestions for potential reform in the local capital markets with a view of making it effective for the local economy. These include, primarily, adopting an approach to EU legislation which does not go beyond the minimum requirements (unless this is beneficial to the economy) and develop capital markets that are less onerous and more cost-effective for small and medium sized companies in Malta.
Other measures such as the introduction of market makers and the openness to foreign investors could also contribute to an improved effectiveness of the local capital markets. At the same time, Malta also needs to work towards improving financial literacy, by not only improving the knowledge of existing investors but to also enlighten future generations.
Whilst the author appreciates the development of Malta's capital markets since their inception in 1990, further efforts are required to continue improving the local capital markets in order to truly achieve a level of effectiveness that will benefit the economy at large as well as issuers and investors alike.
We establish, under both theoretical conditions and empirical application, the separate roles of (1) market asset class exposure through index funds; (2) style factor exposure, such as exposure to value, momentum, and quality, which have traditionally delivered higher and differentiated returns than market index exposure; and (3) pure alpha-seeking sources of return in excess of index and factor returns. A new methodology determines optimal allocations of index, factors, and alpha-seeking funds by imposing priors on the information ratios of factors and alpha strategies. We expect in many cases, prior standard deviations for factor funds will be smaller than those for alpha strategies, whereas prior means for alpha strategies may be larger than those for factor funds.
Founded in 2014, MRC diffuses knowledge in monetary theory, history, policy and institutions, associating empirical researches, developing new statistical measurements, estimating quantitative models of economic behavior, assessing the economic effects of monetary policies, and projecting the effects from the work of alternative monetary organisations. The MRC is а nonprofit economic research unit within the department of UNWE. Main accent on the 4 th Annual Conference was the place and importance of the Balkan countries in the European Union. Researchers and professionals from more than 7 countries took part.
We start this paper by presenting compelling evidence of short-term momentum in the excess returns on the S&P Composite stock price index. For the first time ever, we assume that the excess returns follow an autoregressive process of order p, AR(p), and evaluate the parameters of this process. Armed with a fairly accurate knowledge of the momentum generating process, we continue this paper by providing a number of important theoretical implications. First, we present analytical results on the profitability of long-only and long-short time-series momentum (TSMOM) strategies. Our results suggest that the long-only TSMOM strategy is profitable, while the long-short one is not. We find that over multiple periods the risk profile of the long-only TSMOM strategy resembles the risk profile of a portfolio insurance strategy. We estimate the power of the statistical test for superiority of the TSMOM strategy and find that the power is much below the acceptable level. Consequently, any empirical study tends not to reject the null hypothesis of no profitability of TSMOM strategy. Finally, we evaluate the precision of identification of the optimal number of lags in the TSMOM rule using a standard back-testing methodology and find that this precision is extremely poor. However, we demonstrate that the performance of the TSMOM rule is robust to the choice of the number of lags.
We describe the narrative framework called modern portfolio theory, including mean-variance optimization, the capital asset pricing model, arbitrage pricing theory, and the efficient markets hypothesis, that serves as a foundation for asset allocation and performance attribution in the investment management industry. We evaluate its key assumptions and implications. We then examine the financial and social objectives of universal asset owners and their methods of achieving those goals. In practice, sustainable portfolio choice requires a consideration of a far wider set of systemic risk factors than is dreamt of in modern portfolio theory, solutions to the principal-agent problem in financial intermediation and investor efforts at addressing collective action problems.
Factor portfolios with value, size, momentum, profitability, and low volatility stocks have historically exhibited high returns after adjusting for market risk. As the weights of these portfolios increase in the stochastic discount factor, the excess returns of these factor strategies should decrease. We compare weights of these factor portfolios in the efficient set relative to which there are no factor risk premiums with market capitalization weights.
In the financial turmoil of 2008, U.S. firms reported debt-ratios that differed from the debt-ratios calculated from balance sheets. The problem is that investors bought common stock expecting initial investment return and lost money when companies delisted. The purpose of this quantitative study was to determine sample securities pricing with the application of synthetic assets and debt accrued. Addressed in the research questions was whether those securities were (a) underpriced compared with return-on-assets (ROA), (b) overpriced compared with ROA, (c) a debt-ratio higher than 60% and also overpriced, (d) underpriced with a synthetic asset added, or (e) related by relative pricing to variant pricing and market capitalization. The study’s base theory was Pan’s efficient market hypothesis (EMH) of security price prediction of market prices versus model prices. The data from the financial statements of 16 publicly traded U.S. electric utility companies were analyzed via correlations and multiple regression analyses to determine securities pricing and suitability. The findings from the analyses of the sample’s variables of market price, book value, market-to-book, and study constructed variables from those variable data were statistically significant. The alternate hypotheses were accepted for all 5 research questions since the analytical operationalization of the hypothetical constructs led to significant relationships. Results suggest that the use of more pricing determinants in securities evaluation may lead to investors losing less money and earning the expected returns for a more efficient capital market, leading to a stronger economy and macroeconomic stability.
The Norwegian Government Pension Fund Global was recently ranked the largest fund on the planet. It is also highly rated for its professional, low-cost, transparent, and socially responsible approach to asset management. Investment professionals increasingly refer to Norway as a model for managing financial assets. We present and evaluate the strategies followed by the Fund, review long-term performance, and describe how it responded to the financial crisis. We conclude with some lessons that investors can draw from Norway’s approach to asset management, contrasting the Norway Model with the Yale Model.
For any given research area, one cannot tell how many studies have been conducted but never reported. The extreme view of the "file drawer problem" is that journals are filled with the 5% of the studies that show Type I errors, while the file drawers are filled with the 95% of the studies that show nonsignificant results. Quantitative procedures for computing the tolerance for filed and future null results are reported and illustrated, and the implications are discussed. (15 ref) (PsycINFO Database Record (c) 2012 APA, all rights reserved)
To determine whether the investment decisions of institutional plan sponsors contribute to their asset values, this study used a dataset of 80,000 yearly observations of institutional investment product assets, accounts, and returns for 1984−2007. Results show that plan sponsors may not be acting in their stakeholders’ best interests when they make rebalancing or reallocation decisions. Investment products that receive contributions subsequently underperform products experiencing withdrawals over one, three, and five years. For investment decisions among equity, fixed-income, and balanced products, most of the underperformance can be attributed to product selection. Tests suggest that these results are not attributable to survivorship or other biases. Much like individual investors who switch mutual funds at the wrong time, institutional investors do not appear to create value from their investment decisions.
Since hedge funds specify significant lock-up periods, we investigate persistence in the performance of hedge funds using a multi-period framework in which the likelihood of observing persistence by chance is lower than in the traditional two-period framework. Under the null hypothesis of no manager skill (no persistence), the theoretical distribution of observing wins or losses follows a binormial distribution. We test this hypothesis using the traditional two-period framework and compare the findings with the results obtained using our multi-period framework. We examine whether persistence is sensitive to the length of return measurement intervals by using quarterly, half-yearly and yearly returns. We find maximum persistence at the quarterly horizon indicating that presistence among hedge fund managers is short term in nature.
Deviations from put-call parity contain information about future stock returns. Using the difference in implied volatility between pairs of call and put options to measure these deviations, we find that stocks with relatively expensive calls outperform stocks with relatively expensive puts by 50 basis points per week. We find both positive abnormal performance in stocks with relatively expensive calls and negative abnormal performance in stocks with relatively expensive puts, which cannot be explained by short sale constraints. Rebate rates from the stock lending market directly confirm that our findings are not driven by stocks that are hard to borrow. The degree of predictability is larger when option liquidity is high and stock liquidity low, while there is little predictability when the opposite is true. Controlling for size, option prices are more likely to deviate from strict put-call parity when underlying stocks face more information risk. The degree of predictability decreases over the sample period. Our results are consistent with mispricing during the earlier years of the study, with a gradual reduction of the mispricing over time.
Previous work on U.K. pension funds found only slight evidence of fund manager persistence but survivorship bias in the construction of these data samples may have disguised true persistence. Using a large sample of pension funds over the period 198397 in which there is less survivorship bias, we find strong evidence of persistence in abnormal returns generated by fund managers over 1-year time horizons but weaker evidence over longer horizons. Even when an allowance is made for momentum in stock returns, we find pension-fund managers exhibit performance persistence.
Since September, 1976, stocks newly included into the Standard and Poor's 500 Index have earned a significant positive abnormal return at the announcement of the inclusion. This return does not disappear for at least ten days after the inclusion. The returns are positively related to measures of buying by index funds, consistent with the hypothesis that demand curves for stocks slope down. The returns are not related to S & P's bond ratings, which is inconsistent with a plausible version of the hypothesis that inclusion is a certification of the quality of the stock.
The power of dividend yields to forecast stock returns, measured by regression R2, increases with the return horizon. We offer a two-part explanation. (1) High autocorrelation causes the variance of expected returns to grow faster than the return horizon. (2) The growth of the variance of unexpected returns with the return horizon is attenuated by a discount-rate effect - shocks to expected returns generate opposite shocks to current prices. We estimate that, on average, the future price increases implied by higher expected returns are just offset by the decline in the current price. Thus, time-varying expected returns generate ‘temporary’ components of prices.
When estimating risk and return of infrequently traded assets, a bias arises due to heteroscedasticity and sample selection. We present a Bayesian model to resolve these problems, and estimate the model using data with VCs' investments in entrepreneurial companies. Correcting for the bias, we find that the intercept of the market model is significantly lower, and both systematic and idiosyncratic risks are significantly higher, than suggested by standard methods. The results are robust across specifications, and the estimates of the selection equation provide new insights into determinants of refinancing decisions for these companies. We present a new empirical model of the risk and return of infrequently traded assets and apply it to investments in entrepreneurial companies by venture capital (VC) investors. A
In this paper we investigate the role of the asset allocation decision in the performance of college and university endowment funds. Our analysis is based on a unique dataset detailing the investment practice and performance of these investors from 1984 to 2005. Despite their ability to implement relatively unrestricted investment strategies, and despite a wide heterogeneity in the asset allocation weights deployed, we find that the university endowments in our sample hold remarkably similar levels of asset allocation (or "passive") risk. We argue that this self-imposed passive risk budget is ultimately hurting the performance of endowments that are less committed to active management. We also document that the average endowment seems to have under-utilized its active management abilities in favor of a more passively oriented portfolio.
Does limited attention among investors affect stock returns? We compare the response to earnings announcements on Friday, when investor inattention is more likely, to the response on other weekdays. If inattention influences stock prices, we should observe less immediate response and more drift for Friday announcements. Indeed, Friday announcements have a 15% lower immediate response and a 70% higher delayed response. A portfolio investing in differential Friday drift earns substantial abnormal returns. In addition, trading volume is 8% lower around Friday announcements. These findings support explanations of post-earnings announcement drift based on underreaction to information caused by limited attention. Copyright (c) 2009 the American Finance Association.
We conduct an analysis of the risk and return characteristics of a number of widely used fixed-income arbitrage strategies.
We find that the strategies requiring more “intellectual capital” to implement tend to produce significant alphas after controlling
for bond and equity market risk factors. These positive alphas remain significant even after taking into account typical hedge
fund fees. In contrast with other hedge fund strategies, many of the fixed-income arbitrage strategies produce positively
skewed returns. These results suggest that there may be more economic substance to fixed-income arbitrage than simply “picking
up nickels in front of a steamroller.”
Abstract This paper studies the risk in fixed-income hedge fund styles. Principal component analysis is applied to groups of fixed-income hedge funds to extract common,sources of risk and return. These common sources of risk are related to market risk factors, such as changes in interest rate spreads and options on interest rate spreads. We call these assetbased style factors (“ABS”). The paper finds that fixed-income hedge funds tend to be exposed to a common,ABS factor: credit spreads. Hedge fund strategies came under intense scrutiny in the wake of the stressful market events surrounding the collapse of Long-Term Capital Management,(LTCM). Several studies have been sponsored by regulatory agencies of financial markets: the President’s Working Group on Financial Markets [1999], and Bank for International Settlements [1999a, b, and c]. In addition to the macro question as to whether hedge funds have a destabilizing influence on markets, these studies directed much of their attention to a particular type of strategy used by fixed-income hedge funds: Convergence Trading. Just what are the risk characteristics that caught the attention of financial regulators and how do they differ from other hedge fund strategies? Understanding hedge fund risk is a non-trivial task. Information on hedge funds is hard to come by. As private investment vehicles, hedge funds ,are exempt from the
This paper investigates whether stock prices reflect information about future earnings contained in the accrual and cash flow components of current earnings. The extent to which current earnings performance persists into the future is shown to depend on the relative magnitudes of the cash and accrual components of current earnings. However, stock prices are found to act as if investors "fixate" on earnings, failing to fully reflect information in the accrual and cash flow components of current earnings until it impacts future earnings.
This paper presents the results of a study dealing with a number of issues regarding real estate investment. Utilizing a data set consisting of returns from two of the oldest, continuously operating commingled real estate funds (CREFs), questions relative to investment performance, inflation hedging attributes and diversification benefits are addressed. The methodology used in exploring these issues are variants of the traditional capital asset pricing model (CAPM), extended to consider uncertain inflation (CAPMUI) and an arbitrage pricing model in which real estate performance is judged relative to a more inclusive market index representing larger numbers of substitute investments. Finally, issues relative to portfolio performance are considered by constructing portfolios containing all possible combinations of real estate, stocks and bonds to assess the potential for diversification benefits and portfolio performance.
Using new, survivorship bias-free data, we examine the performance and persistence in performance of 4,617 active domestic equity institutional products managed by 1,448 investment management firms between 1991 and 2008. Controlling for the Fama–French (1993) three factors and momentum, aggregate and average estimates of alphas are statistically indistinguishable from zero. Even though there is considerable heterogeneity in performance, there is only modest evidence of persistence in three-factor models and little to none in four-factor models.
This paper analyzes 4,750 mergers from 1963 to 1998 to characterize the risk and return in risk arbitrage. Results indicate that risk arbitrage returns are positively correlated with market returns in severely depreciating markets but uncorrelated with market returns in flat and appreciating markets. This suggests that returns to risk arbitrage are similar to those obtained from selling uncovered index put options. Using a contingent claims analysis that controls for the nonlinear relationship with market returns, and after controlling for transaction costs, we find that risk arbitrage generates excess returns of four percent per year.
The value premium in U.S. stock returns is robust. The positive relation between average return and book-to-market equity is as strong for 1929 to 1963 as for the subsequent period studied in previous papers. A three-factor risk model explains the value premium better than the hypothesis that the book-to-market characteristic is compensated irrespective of risk loadings.
The aggregate portfolio of actively managed U.S. equity mutual funds is close to the market portfolio, but the high costs of active management show up intact as lower returns to investors. Bootstrap simulations suggest that few funds produce benchmark-adjusted expected returns sufficient to cover their costs. If we add back the costs in fund expense ratios, there is evidence of inferior and superior performance (nonzero true α) in the extreme tails of the cross-section of mutual fund α estimates.
This paper examines expected option returns in the context of mainstream asset-pricing theory. Under mild assumptions, expected call returns exceed those of the underlying security and increase with the strike price. Likewise, expected put returns are below the risk-free rate and increase with the strike price. S&P index option returns consistently exhibit these characteristics. Under stronger assumptions, expected option returns vary linearly with option betas. However, zero-beta, at-the-money straddle positions produce average losses of approximately three percent per week. This suggests that some additional factor, such as systematic stochastic volatility, is priced in option returns.
We present evidence supporting the hypothesis that due to investor specialization and market segmentation, value-relevant information diffuses gradually in financial markets. Using the stock market as our setting, we find that (i) stocks that are in economically related supplier and customer industries cross-predict each other's returns, (ii) the magnitude of return cross-predictability declines with the number of informed investors in the market as proxied by the level of analyst coverage and institutional ownership, and (iii) changes in the stock holdings of institutional investors mirror the model trading behavior of informed investors. Copyright (c) 2010 the American Finance Association.
By reaching a broad population of investors, mass media can alleviate informational frictions and affect security pricing even if it does not supply genuine news. We investigate this hypothesis by studying the cross-sectional relation between media coverage and expected stock returns. We find that stocks with no media coverage earn higher returns than stocks with high media coverage even after controlling for well-known risk factors. These results are more pronounced among small stocks and stocks with high individual ownership, low analyst following, and high idiosyncratic volatility. Our findings suggest that the breadth of information dissemination affects stock returns. Copyright (c) 2009 the American Finance Association.
We model demand-pressure effects on option prices. The model shows that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of the unhedgeable parts of the two options. Empirically, we identify aggregate positions of dealers and end-users using a unique dataset, and show that demand-pressure effects make a contribution to well-known option-pricing puzzles. Indeed, time-series tests show that demand helps explain the overall expensiveness and skew patterns of index options, and cross-sectional tests show that demand impacts the expensiveness of single-stock options as well. The Author 2009. 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.
The empirical relationship between earnings' yield, firm size and returns on the common stock of NYSE firms is examined in this paper. The results confirm that the common stock of high E/P firms earn, on average, higher risk-adjusted returns than the common stock of low E/P firms and that this effect is clearly significant even if experimental control is exercised over differences in firm size. On the other hand, while the common stock of small NYSE firms appear to have earned substantially higher returns than the common stock of large NYSE firms, the size effect virtually disappears when returns are controlled for differences in risk and E/P ratios. The evidence presented here indicates that the E/P effect, however, is not entirely independent of firm size and that the effect of both variables on expected returns is considerably more complicated than previously documented in the literature.
This paper investigates transitory components in stock prices. After showing that statistical tests have little power to detect persistent deviations between market prices and fundamental values, we consider whether prices are mean-reverting, using data from the United States and 17 other countries. Our point estimates imply positive autocorrelation in returns over short horizons and negative autocorrelation over longer horizons, although random-walk price behavior cannot be rejected at conventional statistical levels. Substantial movements in required returns are needed to account for these correlation patterns. Persistent, but transitory, disparities between prices and fundamental values could also explain our findings.
This paper combines the use of portfolio holdings data and conditioning information to create a new performance measure. Our conditional weight-based measure has several advantages. Using conditioning information avoids biases in weight-based measures as discussed by Grinblatt and Titman (J. Business 60 (1993)). When conditioning information is used, returns-based measures face a bias if managers can trade between observation dates. The new measures avoid this interim trading bias. We use the new measures to provide fresh insights about performance in a sample of U.S. equity pension fund managers.
Using a robust bootstrap procedure, we find that top hedge fund performance cannot be explained by luck, and hedge fund performance persists at annual horizons. Moreover, we show that Bayesian measures, which help overcome the short-sample problem inherent in hedge fund returns, lead to superior performance predictability. Sorting on Bayesian alphas, relative to OLS alphas, yields a 5.5% per year increase in the alpha of the spread between the top and bottom hedge fund deciles. Our results are robust and relevant to investors as they are neither confined to small funds, nor driven by incubation bias, backfill bias, or serial correlation.
This paper evaluates the ability of bond funds to “market time” nine common factors related to bond markets. Timing ability generates nonlinearity in fund returns as a function of common factors, but there are several non-timing-related sources of nonlinearity. Controlling for the non-timing-related nonlinearity is important. Funds’ returns are more concave than benchmark returns, and this would appear as poor timing ability in naive models. With controls, the timing coefficients appear neutral to weakly positive. Adjusting for nonlinearity, the performance of many bond funds is significantly negative on an after-cost basis, but significantly positive on a before-cost basis.
We construct optimal portfolios of equity funds by combining historical returns on funds and passive indexes with prior views about asset pricing and skill. By including both benchmark and nonbenchmark indexes, we distinguish pricing-model inaccuracy from managerial skill. Modest confidence in a pricing model helps construct portfolios with high Sharpe ratios. Investing in active mutual funds can be optimal even for investors who believe managers cannot outperform passive indexes. Optimal portfolios exclude hot-hand funds even for investors who believe momentum is priced. Our large universe of funds offers no close substitutes for the Fama-French and momentum benchmarks.
We investigate optimal portfolio choice for an investor who is skeptical about the degree to which excess returns are predictable. Skepticism is modeled as an informative prior over the R2 of the predictive regression. We find that the evidence is sufficient to convince even an investor with a highly skeptical prior to vary his portfolio on the basis of the dividend-price ratio and the yield spread. The resulting weights are less volatile and deliver superior out-of-sample performance as compared to the weights implied by an entirely model-based or data-based view.
Small firms experience large returns in January and exceptionally large returns during the first few trading days of January. The empirical tests indicate that the abnormally high returns witnessed at the very beginning of January appear to be consistent with tax-loss selling. However, tax-loss selling cannot explain the entire January seasonal effect. The small firms least likely to be sold for tax reasons (prior year ‘winners’) also exhibit large average January returns, although not unusually large returns during the first few days of January.
In this paper, we identify and document the empirical characteristics of the key drivers of convertible arbitrage as a strategy and how they impact the performance of convertible arbitrage hedge funds. We show that the returns of a buy-and-hedge strategy involving taking a long position in convertible bonds (“CBs”) while hedging the equity risk alone explains a substantial amount of these funds' return dynamics. In addition, we highlight the importance of non-price variables such as extreme market-wide events and the supply of CBs on performance. Out-of-sample tests provide corroborative evidence on our model's predictions. At a more micro level, larger funds appear to be less dependent on directional exposure to CBs and more active in shorting stocks to hedge their exposure than smaller funds. They are also more vulnerable to supply shocks in the CB market. These findings are consistent with economies of scale that large funds enjoy in accessing the stock loan market. However, the friction involved in adjusting the stock of risk capital managed by a large fund can negatively impact performance when the supply of CBs declines. Taken together, our findings are consistent with convertible arbitrageurs collectively being rewarded for playing an intermediation role of funding CB issuers whilst distributing part of the equity risk of CBs to the equity market.
This paper examines the joint time series of the S&P 500 index and near-the-money short-dated option prices with an arbitrage-free model, capturing both stochastic volatility and jumps. Jump-risk premia uncovered from the joint data respond quickly to market volatility, becoming more prominent during volatile markets. This form of jump-risk premia is important not only in reconciling the dynamics implied by the joint data, but also in explaining the volatility “smirks” of cross-sectional options data.
Correlations between U.S. stocks and the aggregate U.S. market are much greater for downside moves, especially for extreme downside moves, than for upside moves. We develop a new statistic for measuring, comparing, and testing asymmetries in conditional correlations. Conditional on the downside, correlations in the data differ from the conditional correlations implied by a normal distribution by 11.6%. We find that conditional asymmetric correlations are fundamentally different from other measures of asymmetries, such as skewness and co-skewness. We find that small stocks, value stocks, and past loser stocks have more asymmetric movements. Controlling for size, we find that stocks with lower betas exhibit greater correlation asymmetries, and we find no relationship between leverage and correlation asymmetries. Correlation asymmetries in the data reject the null hypothesis of multivariate normal distributions at daily, weekly, and monthly frequencies. However, several empirical models with greater flexibility, particularly regime-switching models, perform better at capturing correlation asymmetries.
A framework is presented for investigating the mean-variance efficiency of an unobservable portfolio based on its correlation with a proxy portfolio. A sensitivity analysis derives the highest correlation between the proxy and a portfolio that reverses the inference of a test of SHarpe-Lintner tangency. For example, the maximum correlation between the value-weighted NYSE-AMEX portfolio and a portfolio inferred tangent ranges from 0.76 to 0.48. We also test whether the correlation between the proxy and the tangent portfolio exceeds a given level. This hypothesis is often rejected for the NYSE-AMEX proxy at a correlation of 0.7.
We examine the relation between expected future volatility (options' implied volatility) and the cross-section of expected returns. A trading strategy buying stocks in the highest implied volatility quintile and shorting stocks in the lowest implied volatility quintile generates insignificant returns. A similar strategy using one-month lagged realized volatility generates significantly negative returns. To investigate the differences and interactions between alternative measures of total risk, we estimate three principal components based on realized volatility, call implied and put implied volatility. Long-short trading strategies generate significant returns only for the second and the third principal components. We find that the second principal component is related to the realized-implied volatility spread which can be viewed as a proxy for volatility risk. We find that the third principal component is related to the call-put implied volatility spread that reflects future price increase of the underlying stock.
The shape of the volatility smirk has significant cross-sectional predictive power for future equity returns. Stocks exhibiting the steepest smirks in their traded options underperform stocks with the least pronounced volatility smirks in their options by 10.9% per year on a risk-adjusted basis. This predictability persists for at least 6 months, and firms with the steepest volatility smirks are those experiencing the worst earnings shocks in the following quarter. The results are consistent with the notion that informed traders with negative news prefer to trade out-of-the-money put options, and that the equity market is slow in incorporating the information embedded in volatility smirks.
The tradeoff between risk and return in equity markets is well established. This paper examines the existence of the same tradeoff in the single-family housing market. For home buyers, who constitute about two-thirds of U.S. households, the choice about how much housing and which house to buy is a joint consumption/investment decision. Does this consumption/investment link negate the risk/return tradeoff within the single-family hosuing market? Theory suggests the link still holds. This paper supplies empirical evidence in support of that theoretical result.
Compared to mutual funds, hedge funds prefer smaller, opaque value securities, and have higher turnover and more active share
bets. Decomposing returns into three components, we find that hedge funds are better than mutual funds at stock picking by
only 1.32% per year on a value-weighted basis, and this result is insignificant on an equal-weighted basis or with price-to-sales
benchmarks. Hedge funds exhibit no ability to time sectors or pick better stock styles. Surprisingly, we find only weak evidence
of differential ability between hedge funds. Overall, our study raises serious questions about the perceived superior skill
of hedge fund managers.
We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and risk-averse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles' demand for bonds affect the term structure---and constitute an additional determinant of bond prices to current and expected future short rates. At the same time, because arbitrageurs render the term structure arbitrage-free, demand effects satisfy no-arbitrage restrictions and can be quite different from the underlying shocks. We show that the preferred-habitat view of the term structure generates a rich set of implications for bond risk premia, the effects of demand shocks and of shocks to short-rate expectations, the economic role of carry trades, and the transmission of monetary policy.
This paper measures the mean, standard deviation, alpha and beta of venture capital investments, using a maximum likelihood estimate that corrects for selection bias. Since Þrms go public when they have achieved a good return, estimates that do not correct for selection bias are optimistic. The selection bias correction neatly accounts for log returns. Without a selection bias correction, I Þnd a mean log return of about 100% and a log CAPM intercept of about 90%. With the selection bias correction, I Þnd a mean log return of about 5% with a -2% intercept. However, returns are very volatile, with standard deviation near 100%. Therefore, arithmetic average returns and intercepts are much higher than geometric averages. The selection bias correction attenuates but does not eliminate high arithmetic average returns. Without a selection bias correction, I Þnd an arith- metic average return of around 700% and a CAPM alpha of nearly 500%. With the selection bias correction, I Þnd arithmetic average returns of about 57% and CAPM alpha of about 45%. Second, third, and fourth rounds of Þnancing are less risky. They have progres- sively lower volatility, and therefore lower arithmetic average returns. The betas of successive rounds also decline dramatically from near 1 for the Þrst round to near zero for fourth rounds. The maximum likelihood estimate matches many features of the data, in particular the pattern of IPO and exit as a function of project age, and the fact that return distributions are stable across horizons.
This study demonstrates the impact of systematic risk on the prices of individual equity options. The option prices are characterized
by the level and slope of implied volatility curves, and the systematic risk is measured as the proportion of systematic variance
in the total variance. Using daily option quotes on the S, and P 100 index and its 30 largest component stocks, we show that
after controlling for the underlying asset's total risk, a higher amount of systematic risk leads to a higher level of implied
volatility and a steeper slope of the implied volatility curve. Thus, systematic risk proportion can help differentiate the
price structure across individual equity options.
This paper provides an analysis of the predictable components of monthly common stock and bond portfolio return. Most of the predictability is associated with sensitivity to economic variables in a rational asset pricing model with multiple betas. The stock market risk premium is the most important for capturing predictable variation of the stock portfolios, while premiums associated with interest rate risks capture predictability of the bond returns. Time variation in the premium for beta risk is more important than changes in the betas. Copyright 1991 by University of Chicago Press.
A slowly mean-reverting component of stock prices tends to induce negative autocorrelation in returns. The autocorrelation is weak for the daily and weekly holding periods common in market efficiency tests but stronger for long-horizon returns. In tests for the 1926-85 period, large negative autocorrelations for return horizons beyond a year suggest that predictable price variation due to mean reversion accounts for large fractions of 3 to 5-year return variances. Predictable variation is estimated to be about 40 percent of 3 to 5-year return variances for portfolios of small firms. The percentage falls to around 25 percent for portfolios of large firms. Copyright 1988 by University of Chicago Press.
This study investigates whether marketwide liquidity is a state variable important for asset pricing. We find that expected stock returns are related cross-sectionally to the sensitivities of returns to fluctuations in aggregate liquidity. Our monthly liquidity measure, an average of individual-stock measures estimated with daily data, relies on the principle that order flow induces greater return reversals when liquidity is lower. From 1966 through 1999, the average return on stocks with high sensitivities to liquidity exceeds that for stocks with low sensitivities by 7.5 percent annually, adjusted for exposures to the market return as well as size, value, and momentum factors. Furthermore, a liquidity risk factor accounts for half of the profits to a momentum strategy over the same 34-year period.
We use 2 years of daily flows for three major Standard and Poor's index funds to analyze the relationship among index funds, asset prices, and volatility. We find strong contemporaneous correlation between inflows and returns, no evidence for positive feedback trading, and evidence that negative market returns may induce subsequent sales. Market volatility affects investors as dynamic risk sharing, but higher volatility does not drive investors from the market. Bullish newsletter sentiment is associated with greater inflows. We report high correlation among investor disagreement and market uncertainty and flows. Dispersion in advice and open interest correlate with lower inflows.
In textbook theory, demand curves for stocks are kept flat by riskless arbitrage between perfect substitutes. In reality, however, individual stocks do not have perfect substitutes. We develop a simple model of demand curves for stocks in which the risk inherent in arbitrage between imperfect substitutes deters risk-averse arbitrageurs from flattening demand curves. Consistent with the model, stocks without close substitutes experience higher price jumps upon inclusion into the S&P 500 Index. The results suggest that arbitrage is weaker and mispricing is likely to be more frequent and more severe among stocks without close substitutes.
This article reexamines the evidence on the ability of dividend yields to predict long-horizon stock returns. The authors use two new series beginning in 1871, a monthly series for the United States, and an annual series for the United Kingdom. Conditional on survival over the entire 122 years, dividend yields display only marginal ability to predict stock market returns in either country. The authors also argue that tests over long periods may be affected by survivorship. Simulations show that regression statistics based on a sample drawn solely from surviving markets can be seriously biased toward finding predictability. Copyright 1995 by University of Chicago Press.