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Abstract:
The tendency of some investors to hold on to their losing stocks, driven by prospect theory and mental accounting, creates a spread between a stock's fundamental value and its equilibrium price, as well as price underreaction to information. Spread convergence, arising from the random evolution of fundamental values and updating of reference prices, generates predictable equilibrium prices that will be interpreted as possessing momentum. Cross-sectional empirical tests are consistent with the model. A variable proxying for aggregate unrealized capital gains appears to be the key variable that generates the profitability of a momentum strategy. Past returns have no predictability for the cross-section of returns once this variable is controlled for.

prospect theory, mental accounting, disposition effect, momentum

Abstract:
We use an iterative relocation algorithm to identify factors in common stock returns. The benefit of the approach is that factors are portfolios of assets with non-negative weights. As a result, they are readily interpreted in terms of their characteristics of the underlying securities. The positive portfolio factors have comparatively high explanatory power in sample and out-of-sample. We find evidence of a size factor and factors identified with certain industries. Factors extracted from the mutual fund universe perform marginally better than factors from the universe of equities.

Abstract:
We use an iterative relocation algorithm to identify factors in common stock returns. The benefit of the approach is that factors are portfolios of assets with non-negative weights. As a result, they are readily interpretable in terms of the characteristics of the underlying securities. The positive portfolio factors have comparatively high explanatory power in sample and out of sample. We find evidence of a size factor and factors identified with certain industries. Factors extracted from the mutual fund universe perform marginally better than factors from the universe of equities.

Abstract:
A unique data set allows us to monitor the buys, sells, and holds of individuals and institutions in the Finnish stock market on a daily basis. With this data set, we employ Logit regressions to identify the determinants of buying and selling activity over a two-year period. We find evidence that investors are reluctant to realize losses, that they engage in tax-loss selling activity, and that past returns and historical price patterns, such as being at a monthly high or low, affect trading. There also is modest evidence that life cycle trading plays a role in the pattern of buys and sells.

Abstract:
This paper argues that liquidity differences between government securities and short term Eurodollar borrowings account for interest rate swap spreads. It then models the convenience of liquidity as a linear function of two mean-reverting state variables and values it. The interest rate swap spread for a swap of particular maturity is the annuitized equivalent of this value. It has a closed form solution: a simple integral. Special cases examined include the Vasicek (1977) and Cox-Ingersoll-Ross (1985) one-factor term structure models. Numerical values for the parameters in both special cases illustrate that many realistic "swap spread term structures" can be replicated. Model parameters are estimated using weekly data on the "term structure of swap spreads" from several countries. The model fits the data well.

Abstract:
This paper parsimoniously characterizes how past returns affect the cross-section of expected returns. Using Fama-MacBeth regressions, it shows that the momentum and reversals associated with past returns over various horizons are strongly affected by a turn-of-the-year seasonal that differs for winners and losers, depending on both the tax environment and the month of the year, and differs by exchange listing. The analysis also uncovers a consistent winners effect - high fractions of positive return months tend to increase expected returns. Out-of-sample evidence suggests that the documented relation between past returns and expected returns cannot entirely be due to data snooping biases.

Abstract:
Multihorizon temporal relationships between stock returns are complex due to confounding sources of return premia, microstructure effects, and changes in the relationship over various horizons. We find the relation to be further complicated by the sign and consistency of the past return that also varies, somewhat sensibly, with the season and the tax environment. Accounting for these additional effects using a parsimonious technical trading rule generates surprisingly large abnormal returns, despite controlling for microstructure effects, transaction costs, and date-snooping biases. The documented variation in profits across stock characteristics, season, and tax environment appears inconsistent with existing theory, but may point to future explanations for the relation between past and expected returns.

Abstract:
This paper documents that investors are more likely to hold, buy and sell the stocks of Finnish firms that are located close to the investor, that communicate in the investor's native tongue, and that have chief executives of the same cultural background. These distance, language and cultural biases are less prevalent among the most investment-savvy institutions than they are among both households and less savvy institutions. Regression analysis indicates (1) that the marginal effect of distance is less for firms that are more nationally known, and for distances that exceed one hundred kilometers and (2) more sophisticated individuals exhibit less distance bias.

Abstract:
This study presents evidence which indicates that stock prices, on average, react positively to stock dividend and stock split announcements that are uncontaminated by other contemporaneous firm-specific announcements. In addition, it documents significantly positive excess returns on and around the ex-dates of stock dividends and splits. Both announcement and ex-date returns were found to be larger for stock dividends than for stock splits. While the announcement returns cannot be explained by forecasts of imminent increases in cash dividends, the paper offers several signaling based explanations for them. These are consistent with a cross-sectional analysis of the announcement period returns.

Stock splits, stock dividends, signalling, announcement effects, ex-date effects

Abstract:
An individual’s IQ stanine, measured early in adult life, is monotonically related to his stock market participation decision later in life. The high correlation between IQ and participation, which exists even among the 10% most affluent individuals, controls for wealth, income, and other demographic and occupational information. Supplemental data from siblings are used with both an instrumental variables approach and paired difference regressions to show that our results apply to both females and males, and that omitted familial and non-familial variables cannot account for our findings. IQ also is related to diversification. High IQ investors are more likely to hold mutual funds and larger numbers of stocks, other things equal.

Intelligence, household finance, stock market participation

Abstract:
An analysis of trades in the Finnish stock market around the turn of the year shows that Finnish investors tend to realize losses more than gains towards the end of December. They also buy back the same stocks they recently sold, with a repurchase rate that depends on the size of the capital loss and how close the sale is to the end of December. The resulting net buying pressure from these 'wash sale' repurchases is greater for stocks with small market capitalizations and has a calendar pattern that is similar to that of stock returns.

Abstract:
An analysis of Finnish investors' stock trades shows that they realize losses more than gains towards the end of December. Moreover, they repurchase the same stocks recently sold. The repurchase rate depends on loss magnitude, firm size, and how late in the year the sale takes place. This trading pattern generates net tax-loss buying pressure that is negative prior to the turn of the year and positive afterwards. Cross-sectional regressions indicate that stock returns around the turn of the year, particularly for small firms, are related to net tax-loss buying pressure but not to firm size per se.

Abstract:
This study analyzes the automobile purchase behavior of all residents of two Finnish provinces over several years. It finds that a consumer's purchases are strongly influenced by the purchases of his neighbors, particularly purchases in the recent past and by neighbors who are geographically most proximate. There is little evidence that emotional biases, like envy or an urge to conform, lie behind the interpersonal influence in automobile consumption. The most reasonable alternative explanation for these findings is some form of information sharing among neighbors.

Abstract:
This study analyzes the automobile purchase behavior of all residents of two Finnish provinces over several years. It finds that a consumer's purchases are strongly influenced by the purchases of his neighbors, particularly purchases in the recent past and by neighbors who are geographically most proximate. There is little evidence that emotional biases, like envy or an urge to conform, lie behind the interpersonal influence in automobile consumption. The most reasonable alternative explanation for these findings is some form of information sharing among neighbors.

Abstract:
This paper studies the valuation of assets with debt tax shields when debt policy is a general time-dependent function of the asset's unlevered cash flows, value, and history. In a continuous-time setting, it shows that the value of a project's debt tax shield satisfies a partial differential equation, which simplifies to an easily solved ordinary differential equation for most plausible debt policies. A large class of cases exhibits closed-form solutions for the value of a levered asset, the value of its tax shield, and the appropriate tax-adjusted cost of capital for discounting unlevered cash flows.

Abstract:
This paper studies the valuation of assets with debt tax shields when debt policy is a general time-dependent function of the asset's unlevered cash flows, value, and history. In a continuous-time setting, it shows that the value of a project's debt tax shield satisfies a partial differential equation, which simplifies to an easily solved ordinary differential equation for most plausible debt policies. A large class of cases exhibits closed-form solutions for the value of a levered asset, the value of its tax shield, and the appropriate tax-adjusted cost of capital for discounting unlevered cash flows.

debt policy, corporate taxes, discount rates, weighted cost of capital

Abstract:
A security design model shows that multinational firms needing to finance their operations should issue different securities to investors in different countries in order to aggregate their disparate information about domestic and foreign cash flows. However, if the firm becomes bankrupt, investors may face uncertain costs of reorganizing assets in a foreign country and thus may value foreign assets at their average value. This penalizes superior firms with low reorganization costs. Such firms minimize the adverse selection penalty by designing securities that allocate all the cash flow in bankruptcy to investors for which the adverse selection costs are the smallest given the exchange rate. We show that this sharing rule can be implemented with currency swaps because these instruments allow the priorities of claims in bankruptcy to switch depending on the exchange rate.

Abstract:
This study analyzes whether high IQ investors exhibit superior investment performance. It combines equity return, trade, and limit order book data with two decades of scores from an intelligence test administered to nearly every Finnish male of draft age. Controlling for wealth, trading frequency, age, and determinants of the cross-section of stock returns on each day, we find that high IQ investors exhibit superior stock-picking skills, particularly for purchases, and superior trade execution for both purchases and sales.

Intelligence, household finance, trading performance

Abstract:
Prior experimental and empirical research documents that many investors have a lower propensity to sell those stocks on which they have a capital loss. This behavioral phenomenon, known as "the disposition effect," has implications for equilibrium prices. We investigate the temporal pattern of stock prices in an equilibrium that aggregates the demand functions of both rational and disposition investors. The disposition effect creates a spread between a stock's fundamental value - the stock price that would exist in the absence of a disposition effect - and its market price. Even when a stock's fundamental value follows a random walk, and thus is unpredictable, its equilibrium price will tend to underreact to information. Spread convergence, arising from the random evolution of fundamental values, generates predictable equilibrium prices. This convergence implies that stocks with large past price runups and stocks on which most investors experienced capital gains have higher expected returns that those that have experienced large declines and capital losses. The profitability of a momentum strategy, which makes use of this spread, depends on the path of past stock prices. Cross-sectional empirical tests of the model find that stocks with large aggregate unrealized capital gains tend to have higher expected returns than stocks with large aggregate unrealized capital losses and that this capital gains "overhang" appears to be the key variable that generates the profitability of a momentum strategy. When this capital gains variable is used as a regressor along with past returns and volume to predict future returns, the momentum effect disappears.

Abstract:
This study analyzes the fees of mutual funds and the choices of mutual fund investors. Using a comprehensive dataset on males in two Finnish provinces, we find that the fees of funds selected by high IQ investors are not significantly lower than the fees of funds selected by low IQ investors. This conclusion controls for a variety of fund and individual attributes that explain mutual fund fees and mutual fund choices. This suggests that fees are set competitively in the fund industry.

Abstract:
This study analyzes the role that two psychological attributes - sensation seeking and overconfidence - play in the tendency of investors to trade stocks. Equity trading data are combined with data from an investor's tax filings, driving record, and psychological profile. We use the data to construct measures of overconfidence and sensation seeking tendencies. Controlling for a host of variables, including wealth, income, age, number of stocks owned, marital status, and occupation, we find that overconfident investors and those investors most prone to sensation seeking trade more frequently.

Abstract:
This study analyzes the automobile purchase behavior of all residents of two Finnish provinces over several years. Using a comprehensive dataset with location coordinates at the individual consumer level, it finds that the purchases of neighbors, particularly in the recent past and by those who are geographically most proximate, influence a consumer's purchases of automobiles. There is little evidence that emotional biases, like envy, account for the observed social influence on consumption.

Social influennce, consumption, network effects, automobiles

Abstract:
This study analyzes the automobile purchase behavior of all residents of two Finnish provinces over several years. Using a comprehensive dataset with location coordinates at the individual consumer level, it finds that the purchases of neighbors, particularly in the recent past and by those who are geographically most proximate, influence a consumer's purchases of automobiles. There is little evidence that emotional biases, like envy, account for the observed social influence on consumption.

Social influennce, consumption, network effects, automobiles

Abstract:
Multihorizon temporal relationships between stock returns are complex due to confounding sources of return premia, microstructure effects, and changes in the relationship over various horizons. We find the relation to be further complicated by the sign and consistency of the past return that also varies, somewhat sensibly, with the season and the tax environment. Accounting for these additional effects using a parsimonious technical trading rule generates surprisingly large abnormal returns, despite controlling for microstructure effects, transaction costs, and data-snooping biases. The documented variation in profits across stock characteristics, season, and tax environment appear inconsistent with existing theory, but may point to future explanations for the relation between past and expected returns.

Abstract:
A model of security design based on the principle of information aggregation and alignment is used to show that (i) firms needing to finance their operations should issue different securities to different groups of investors in order to aggregate their disparate information and (ii) each security should be highly correlated (closely aligned) with the private information signal of the investor to whom it is marketed. This alignment reduces the adverse selection penalty paid by a firm with superior information. Adverse selection costs are often contingent on ex post publicly observable and contractible state variables such as exchange rates. In such cases, debt contracts are dominated by currency swaps. Moreover, optimal securities are derivative contracts that are contingent on state variables that influence adverse selection costs. This is because the netting of cash flows in these derivative contracts, in effect, alters the state-by-state seniority of different claims in a desirable way.

Abstract:
A puzzling phenomenon in finance is the underpricing of new issues of common stock. A signaling model, with two signals, two attributes, and a continuum of signal levels and attribute types, is developed to explain this underpricing. The model has two signals: (1) the fraction of the new issue retained by the issuer, and (2) its offering price. These convey to the investors the unobservable intrinsic value of the firm and the variance of its cash flows. In the model, an issuer has better information about future cash flows than outside investors; to overcome the asymmetric information problem, the issuer signals the firm's value by offering discounted shares and retaining some of the new shares. The model is consistent with the rationale for underpricing given by many investment professionals. The model's signaling schedule (a function of project variance and issuer's fractional holdings) reveals that the intrinsic value of the firm is positively related to the underpricing of the new issue; there is a positive relation between project variance and underpricing discount; there is a negative relation between the fractional holdings and the project variance; that fractional holdings and underpricing discount are positively related; that fractional holdings and firm value are positively related; and that firm's value and variance are positively related. Three empirical predictions and eight testable implications are articulated. Existing empirical evidence on new issues is consistent with the model's implications. Two applications are suggested: where high firm value is signaled through (1) expensive investment bankers, auditors, and advertising, and (2) high dividends. (TNM)

Signaling, Startups, Initial public offerings (IPO), Stock offerings, Underpricing, Valuation, Market value, Prices, Shareholders, Information asymmetry

Abstract:
A security design model shows that multinational firms needing to finance their operations should issue different securities to investors in different countries in order to aggregate their disparate information about domestic and foreign cash flows. However, if the firm becomes bankrupt, investors may face uncertain costs of reorganizing assets in a foreign country and thus may value foreign assets at their average value. This penalizes superior firms with low reorganization costs. Such firms minimize the adverse selection penalty by designing securities that allocate all the cash flow in bankruptcy to investors for which the adverse selection costs are the smallest given the exchange rate. We show that this sharing rule can be implemented with currency swaps because these instruments allow the priorities of claims in bankruptcy to switch depending on the exchange rate.

Abstract:
Using data from Finland, this study analyzes the extent to which past returns determine the propensity to buy and sell. It also analyzes whether these differences in past-return-based behavior and differences in investor sophistication drive the performance of various investor types. We find that foreign investors tend to be momentum investors, buying past winning stocks and selling past losers. Domestic investors, particularly households, tend to be contrarians. The distinctions in behavior are consistent across a variety of past-return intervals. The portfolios of foreign investors seem to outperform the portfolios of households, even after controlling for behavior differences.

Investor Behavior; Momentum; Performance; International Stock Returns

Abstract:
Recent research reports significant differences between Eurodollar futures and forward interest rates. In this paper, we document that the futures-forward yield difference was economically and statistically significant only in the early years of the Eurodollar futures contract. The difference has steadily diminished and in recent years has been negligible of nonexistent. The primary explanation in the literature for the observed differences between the futures and forward Eurodollar yields has been the mark-to- market feature of the futures contracts. We derive closed form solutions for the futures-forward yield difference under two popular term structure models and show that the theoretical futures-forward yield difference is indeed small. We also find that liquidity differences and default risk premia cannot explain the large differences observed in the early part of the sample period. Furthermore, we find that there was a delay in the flow of information between the spot and the futures markets during the early years of the futures contract, but we find no evidence of such a delay in the later years. Our results suggest that the differences between the futures and forward rates observed in the early part of the sample period is likely to be attributable to the mispricing of futures contracts relative to the forward rates and that the mispricing was eliminated over time.

Abstract:
We examine the investment strategies of 155 mutual funds over the 1975-84 period to determine the extent to which the funds purchased stocks based on their past returns, and to determine the relation of this behavior to their observed portfolio performance. We find that about 77% of these mutual funds were "momentum investors", buying stocks that were past winners; however, they did not systematically sell past losers. On average, these "trend-followers" realized significantly better performance than the remaining funds. We also find that the mutual funds exhibited herding behavior, and that the tendency of a fund to herd in its trades was strongly correlated with its tendency to buy past winners as well as with its portfolio performance. Consistent with the evidence on trend-following, herding into past winners was stronger than herding into past losers.

Abstract:
The role that financial innovation and the creation of derivative securities plays in financial markets is one of the most controversial issues in Finance. To provide insight into this role, we examine how market participants use one of the most successful innovations of the past decade, the Treasury STRIPS program. We find that investors use the option to create Treasury-derivative STRIPS primarily to make markets more complete, to take advantage of tax and accounting asymmetries, and to hold portfolios in their most liquid form. Although persistent arbitrage opportunities exist in the STRIPS market, we find no evidence that the option to strip and reconstitute securities is used for speculative or arbitrage-related purposes.