Knowledge that Transforms

We observe intraday price reversals following large price changes at the opening of the S&P 500 Futures market and the HSI Futures market. We note that the magnitude of subsequent price reversals is positively related to the initial price changes, and that the price reversals are not caused by a bid–ask spread, or by panic among investors. We also note that such price reversals can be exploited to give rise to profitable opportunities after transaction costs, even though these may not be very significant. This study shows that investor overreaction may be a universal phenomenon and irrational investor behavior like overreaction may also exist among groups of sophisticated investors.

This paper examines changes in systematic risk following global equity issues by US firms. Models of market segmentation show that if international capital markets are not fully integrated and demand curves for securities are downward sloping, firms issue equity at higher prices by issuing in multiple markets compared to issuance on a single domestic market. This would imply a reduction in the firm’s cost of capital and an increase in firm value. Using a sample of global equity offers during 1986–1993, we find that US firms that issue equity abroad experience a decline in systematic risk subsequent to issuance. After controlling for size, volume, and leverage effects, we find that this decline in systematic risk is larger in magnitude for global compared to a control sample of domestic equity issues. The larger the proportion of the offer sold abroad and the larger the increase in trading volume, the bigger the decline in systematic risk. Using a two-factor global risk model we find that while firms issuing equity abroad experience a decline in the domestic component of systematic risk, the foreign component increases. Overall, however, the net effect is a decline in the cost of capital.

We use a model of mean-shifting investment technologies to study the relationship between market structure, risk taking and social welfare in lending markets. Introduction of loan market competition is shown to reduce lending rates and to generate higher investments without increasing the equilibrium bankruptcy risk of borrowers. Hence, there need not be a tradeoff between lending market competition and financial fragility. Such a tradeoff may not emerge either when banks compete by conditioning interest rates on investment volumes irrespectively of whether credit rationing takes place or not.

In accordance with studies for other markets, Swedish index returns exhibit high autocorrelation, (a) after days of above average performance of the stock market, (b) after low absolute returns, (c) when trading volume is low, and (d) following Fridays. Contrary to the non-synchronous trading and the transaction cost hypotheses, all results extend to individual stock returns. It is concluded that autocorrelation patterns are related to the trading patterns of individual investors, and not the cross-security information processing of the market. In particular, the observed autocorrelation structure corresponds to feedback trading.