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Abstract:
From 1997 to March 2000, as technology stocks rose more than five-fold, institutions were responsible for approximately 64 percent of new technology stock purchases with the remaining 36 percent attributable to individuals directly or through mutual fund flows. Among institutions, hedge funds were the most aggressive investors, but independent investment advisors and mutual funds (net of flows) actively invested the most capital in the technology sector. The technology stock reversal in March 2000 was accompanied by a broad sell-off from institutional investors but accelerated buying by individuals, particularly discount brokerage clients. In the cross-section, institutions strongly moved with and chased daily and weekly stock returns, even on the days and weeks with no news. Overall, our evidence is most consistent with the bubble model of Abreu and Brunnermeier (2003) where rational arbitrageurs fail to trade against bubbles until a coordinated selling effort occurs.

Stock Market Bubbles, Institutional Trading, Individual Trading

Abstract:
We examine whether momentum profits globally can be explained by macroeconomic risk and address in part whether momentum returns are consistent with risk-based explanations. Profits to momentum strategies only weakly co-move among 40 countries, whether within regions or across continents. Internationally, momentum profits bear basically no statistically or economically significant relation to the Chen, Roll, and Ross (1986) macroeconomic factors. Performance of a forecasting model based on lagged instrumental variables also indicates that there is no measurable relation between macroeconomic risk and momentum either abroad or in the U.S. Globally, momentum profits are large and statistically reliable in periods of both negative and positive economic growth; these momentum profits reverse over one- to five-year horizons, an action inconsistent with current risk-based explanations.

Momentum, Business Cycle, Portfolio Risk

Abstract:
We examine whether momentum profits globally can be explained by macroeconomic risk and address in part whether momentum returns are consistent with risk-based explanations. Profits to momentum strategies only weakly co-move among 40 countries, whether within regions or across continents. Internationally, momentum profits bear basically no statistically or economically significant relation to the Chen, Roll, and Ross (1986) macroeconomic factors. Performance of a forecasting model based on lagged instrumental variables also indicates that there is no measurable relation between macroeconomic risk and momentum either abroad or in the U.S. Globally, momentum profits are large and statistically reliable in periods of both negative and positive economic growth; these momentum profits reverse over one- to five-year horizons, an action inconsistent with current risk-based explanations.

Momentum, Business Cycle, Portfolio Risk

Abstract:
Using data from 56 markets, we find that short-term reversal, post-earnings drift, and momentum strategies earn similar profits in emerging and developed markets. Portfolio-level variance ratios and market delay measures show greater deviations from efficiency in developed markets and firm-level variance ratios are similar across emerging and developed markets. Conceptually, we show that efficiency tests can yield misleading inferences because they do not control for the information environment. Our evidence corrects misperceptions that emerging markets feature larger trading profits and higher return autocorrelation, highlights crucial limitations of weak and semi-strong form efficiency measures, and points to the importance of measuring informational aspects of efficiency.

market efficiency, information efficiency, synchronicity, international finance, earnings announcements, emerging markets

Abstract:
This paper re-examines the extent to which gains to international diversification are due to differences in industrial structure across countries. Recent papers by Roll (1992) and Heston and Rouwenhorst (1994) investigate this issue and find conflicting evidence. Using a new database, the Dow Jones World Stock Index, with coverage in 25 countries and over 66 industry classifications, we are able to decompose comprehensively both country and industrial sources of variation. We confirm the previous finding that little of the variation in country index returns can be explained by their industrial composition. We also uncover differences in the proportion of variation in industry index returns that is captured by country and industry factors. The implications for global diversification strategies are discussed.

Abstract:
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.

G11, G23

Abstract:
We provide the first comprehensive examination of hedge funds' long-equity positions and the performance of these stock holdings. Compared to mutual funds, hedge funds have higher turnover, weights further away from the market portfolio, prefer smaller opaque securities, and their trading moves slightly in front of mutual funds. However, despite their active trading nature, aggregate hedge fund trading and holdings are not beneficial in predicting the cross-section of future stock returns, indicating that on average hedge fund long-equity positions are not informed. Decomposing returns into three components, we find some weak statistical evidence on a value-weighted basis that hedge funds are better at stock picking (1.32 percent per year) than mutual funds, but this result is driven by tech stock holdings in 1999 and 2000 and becomes statistically insignificant if looking at equal-weighted performance or with price-to-sales benchmarks. The sector timing ability and average style choices of hedge funds are no better than that of mutual funds. Additionally, we fail to find differential ability between hedge funds. Overall, our study raises serious questions about the proficiency of hedge fund managers.

Hedge Fund Holdings, Performance evaluation, Performance persistence

Abstract:
This paper examines whether country-specific or global versions of Fama and French's three-factor model better explain time-series variation in international stock returns. Regressions for portfolios and individual stocks indicate that domestic factor models explain much more time-series variation in returns and generally have lower pricing errors than does the world factor model. In addition, decomposing the world factors into domestic and foreign components demonstrates that the addition of foreign factors to domestic models leads to less accurate in- and out-of-sample pricing. Practical applications of the three-factor model, such as cost-of-capital calculations and performance evaluation, are best performed on a country-specific basis.

cost of capital, Fama and French model, asset pricing model

Abstract:
This paper examines whether country-specific or global versions of Fama and French's three-factor model better explain time-series variation in international stock returns. Regressions for portfolios and individual stocks indicate that domestic factor models explain much more time-series variation in returns and generally have lower pricing errors than does the world factor model. In addition, decomposing the world factors into domestic and foreign components demonstrates that the addition of foreign factors to domestic models leads to less accurate in- and out-of-sample pricing. Practical applications of the three-factor model, such as cost-of-capital calculations and performance evaluation, are best performed on a country-specific basis.

Abstract:
We provide practical perspectives on momentum investing in stocks internationally. First, momentum is generally more profitable on the long side than on the short side, making it accessible to a broad range of institutional capital. Second, both price and earnings momentum profits are significant globally. Third, internationally, earnings momentum is distinct from price momentum, and using price and earnings momentum in conjunction produces larger economic profits. Fourth, momentum profits have weaker co-movements across markets than market indices. Interestingly, while market correlations are much higher in down markets than in up markets, momentum correlations are low in both market conditions. Fifth, momentum strategies do not differ appreciably in profitability between up and down markets, which means timing is less important to momentum traders. Finally, momentum strategies are not riskless-historically there have often occurred periods of several months where they have netted low or negative returns. Altogether, these findings suggest that momentum is useful in international portfolio management, but its implementation should be thoughtfully considered.

Momentum, Portfolio Management

Abstract:
Previous literature finds mixed empirical support for a relation between exchange rate exposure and its theoretical determinants and that exposure is of negligible economic importance. To re-examine the nature and the economic significance of the exchange rate to firm value relation, we construct an international database of over 17,000 non-financial firms from 18 countries. We find that firms' foreign activity is broadly and significantly related to exchange rate exposure and that after controlling for this activity, large firms are more sensitive to currency movements than small firms. Using a portfolio approach to investigate the economic importance of these effects, we find that firms with high international sales outperform those with no international sales during periods of large currency depreciations by 0.72 percent per month, whereas they underperform by 1.10 percent per month during periods of large currency appreciations. Exchange rate movements have an economically significant impact on firm value in ways that are consistent with theory.

Abstract:
Using a unique data set of Nasdaq 100 stocks, we study the daily and intradaily trading patterns of individuals and institutions. Stocks in the top return performance decile are bought in net by institutions (and sold in net by individuals) on the following day 65.2 percent of the time as compared to only 41.3 percent of the time in the bottom performance decile. At the daily and intradaily frequency, vector autoregression analysis indicates that institutional buying (and individual selling) activity strongly follows returns. On a daily basis we find no evidence that institutional trading activity predicts future price movements. Intradaily evidence of this activity is extremely small and short-lived as compared to the effect of momentum investing. Daily and intradaily momentum investing are primarily responsible for the contemporaneous relationship between returns and changes in institutional ownership found at longer intervals.

Abstract:
Using a unique data set of Nasdaq 100 stocks, we study the daily and intradaily trading patterns of individuals and institutions. Stocks in the top return performance decile are bought in net by institutions (and sold in net by individuals) on the following day 65.2 percent of the time as compared to only 41.3 percent of the time in the bottom performance decile. At the daily and intradaily frequency, vector autoregression analysis indicates that institutional buying (and individual selling) activity strongly follows returns. On a daily basis we find no evidence that institutional trading activity predicts future price movements. Intradaily evidence of this activity is extremely small and short-lived as compared to the effect of momentum investing. Daily and intradaily momentum investing are primarily responsible for the contemporaneous relationship between returns and changes in institutional ownership found at longer intervals.

Abstract:
This paper examines the information embedded in both the stock and option markets prior to takeover announcements. During normal periods, buyer-seller initiated stock volume imbalances are significant predictors of next-day stock returns and option volume imbalances are uninformative. However, prior to takeover announcements, call volume imbalances are strongly positively related to next-day stock returns. Cross-sectional analysis shows that those takeover targets with the largest
pre-announcement call-imbalance increases experience the highest announcement-day returns. The largest increase in
buyer-initiated trading activity is in short-term
out-of-the-money calls that subsequently experience the largest returns. Collectively, these findings are consistent with the hypothesis that, in the presence of pending extreme informational events, the options market plays an important role in price discovery.

Abstract:
This paper investigates the dynamic relation between market-wide trading activity and returns in 46 markets. Many stock markets exhibit a strong positive relation between turnover and past returns. These findings stand up in the face of various controls for volatility, alternative definitions for turnover, differing sample periods, and are present at both the weekly and daily frequency. The relation is more statistically and economically significant in countries with restrictions on short sales, where corruption is higher, and where the allocative efficiency of the stock market is weaker. The return-volume relation is also stronger for individual investors than for institutional or foreign investors.

Abstract:
In a model that is consistent with the existence of a home bias and with foreign investors that are less informed than domestic investors, we show that unexpectedly high worldwide returns lead to net equity inflows into small countries. In addition, a small country experiences net equity inflows when its stocks earn unexpectedly high returns. We investigate these predictions using daily data on net equity flows for nine emerging market countries and find that equity flows are positively related to host country stock returns as well as market performance abroad. Both our theoretical model and our empirical analysis show that global stock return performance is an important factor in understanding equity flows.

Abstract:
Analyzing 916 CDOs issued from January 1997 to December 2007, we find that direct outputs from a rating agency model are more straightforward and accurate than actual ratings assigned to CDOs. Actual sizes of AAA rated tranches are on average 12.1% larger than implied by the rating agency model. These adjustments to the rating agency model are difficult to explain by possible determinants but exhibit a clear pattern of low model-implied AAA CDOs receiving larger adjustments. CDOs with larger adjustments experience worse subsequent performance. Moreover, prior to April 1, 2007, 91.2% of AAA rated notes only comply with the credit rating agency’s own AA default rate standard. Had the credit rating agency followed its model and default standards AAA rated tranches would on average have been rated BBB, resulting in a 20.1% lower valuation.

CDO, Credit Rating

Abstract:
In Nasdaq IPOs between 1997 and 2002, clients of the lead underwriter bought shares worth $35.36 billion on the first day of public trading but sold shares worth only $21.45 billion, leading to a net buy imbalance of $13.91 billion, or 8.79 percent of the shares issued. The strong net buying activity through the lead underwriter is driven by large trades and widely present in IPOs of various degrees of underpricing. We investigate several explanations and find no support for long-term shareholders buying to build larger positions, for clients buying because of superior execution quality, or for clientele effects. Consistent with lead underwriters extracting rents from their clients, client net buying is driven by large trades, persistent even in cold IPOs, greater for underwriters that issue multiple IPOs, coupled with relatively higher transactions costs and associated with more transient institutional ownership. Price contribution analyses show that client net buying through the lead underwriter contributes significantly to first-day price increases.

Abstract:
We investigate the conditions under which an equilibrium intertemporal model based on portfolio decisions of investors can explain the dynamics of high frequency equity flows. Our model shows that, when there are barriers to international investment and when the expectations of foreign investors are more extrapolative than those of domestic investors (either due to foreigners being less informed or to behavioural reasons), unexpectedly high worldwide or local stock returns lead to net euqity inflows in small countries. We investigate these predictions using daily data on net equity flows for nine emerging market countries and find that euqity flows are positively related to host country stock returns as well as market performance abroad. Both our theoretical model and out empirical analysis show that global stock return performance is an important factor in understanding equity flows.

Abstract:
We examine the extent to which stock prices respond to news around the world through the use of carefully screened earnings announcement dates and from 870,000 news articles from 56 markets. Stock prices move much more on news days than non-news days in most developed markets, but in many emerging markets there is little relation between returns and news. Cross-country differences in news reactions are best explained by measures of insider trading and technological development. Differences across markets in returns prior to takeovers are consistent with information leakage due to insider trading. Our findings should be useful to policy makers and investors in quantifying the extent of insider trading and how public news affects prices.

News, information production, earnings announcements, takeovers

Abstract:
This paper investigates the dynamic relation between market-wide trading activity and returns in 46 markets. Many stock markets exhibit a strong positive relation between turnover and past returns. These findings stand up in the face of various controls for volatility, alternative definitions for turnover, and differing sample periods, and are present at both the weekly and daily frequency. However, the magnitude of this relation varies widely across markets. Several competing explanations are examined by linking cross-country variables to the magnitude of the relation. The relation between returns and turnover is stronger in countries with restrictions on short sales and where stocks are highly cross-correlated; it is also stronger among individual investors than among foreign or institutional investors. In developed economies, turnover follows past returns more strongly in the 1980s than in the 1990s. The evidence is consistent with models of costly stock market participation in which investors infer that their participation is more advantageous following higher stock returns.

Abstract:
It is widely accepted that, for some industries, competition across countries is" economically important and that this competition is strongly affected by exchange rate changes." This paper explores the validity of this view using weekly stock return data on 320 industry pairs" in six countries from 1975 to 1997. It is found that common shocks to industries across countries" are more important than competitive shocks. Weekly exchange rate shocks explain almost" nothing of the relative performance of industries. Using returns measured over longer horizons the importance of exchange rate shocks increases slightly and the importance of common shocks" to industries increases more substantially. Both industry and exchange rate shocks are more" important for industries that produce goods traded internationally, but the importance of these" shocks is economically small for these industries as well.

Abstract:
In a model that is consistent with the existence of a home bias and with foreign investors that are less informed than domestic investors, we show that unexpectedly high worldwide returns lead to net equity inflows into small countries. In addition, a small country experiences net equity inflows when its stocks earn unexpectedly high returns. We investigate these predictions using daily data on net equity flows for nine emerging market countries and find that equity flows are positively related to host country stock returns as well as market performance abroad. Both our theoretical model and our empirical analysis show that global stock return performance is an important factor in understanding equity flows.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper examines the relationship between book-to-market equity, distress risk, and stock returns. Among firms with the highest distress risk as proxied by Ohlson's (1980) O-score, the difference in returns between high and low book-to-market securities is more than twice as large as that in other firms. This large return differential cannot be explained by the three-factor model or by differences in economic fundamentals. Consistent with mispricing arguments, firms with high distress risk exhibit the largest return reversals around earnings announcements, and the book-to-market effect is largest in small firms with low analyst coverage.

book-to-market, stock returns, distress risk

Abstract:
It is widely accepted that, for some industries, competition across countries is economically important and that this competition is strongly affected by exchange rate changes. This paper explores the validity of this view using weekly stock return data on 320 industry pairs in six countries from 1975 to 1997. It is found that common shocks to industries across countries are more important than competitive shocks. Weekly exchange rate shocks explain almost nothing of the relative performance of industries. Using returns measured over longer horizons, the importance of exchange rate shocks increases slightly and the importance of common shocks to ndustries increases more substantially. Both industry and exchange rate shocks are more important for industries that produce goods traded internationally, but the importance of these shocks is economically small for these industries as well.