Knowledge that Transforms

This investigation of the cross-section of mutual fund equity holdings for the years 1991 and 1992 shows that mutual funds have a significant preference towards stocks with high visibility and low transaction costs, and are averse to stocks with low idiosyncratic volatility. These findings are relevant to theories concerning investor recognition, a potential agency problem in mutual funds, tests of trend-following and herd behavior by mutual funds, and corporate finance.

The current trend toward corporate focus reverses the diversification trend of the late 1960s and early 1970s. This article examines the value of diversification when many corporations started to diversify. The author finds no evidence that diversified companies were valued at a premium over single segment firms during the 1960s and 1970s. On the contrary, there was a large diversification discount during the 1960s but this discount declined to zero during the 1970s. Insider ownership was negatively related to diversification during the 1960s but, when the diversification discount declined, firms with high insider ownership were the first to diversify.

This article investigates whether differences in information‐based trading can explain observed differences in spreads for active and infrequently traded stocks. Using a new empirical technique, we estimate the risk of information‐based trading for a sample of New York Stock Exchange (NYSE) listed stocks. We use the information in trade data to determine how frequently new information occurs, the composition of trading when it does, and the depth of the market for different volume‐decile stocks. Our most important empirical result is that the probability of information‐based trading is lower for high volume stocks. Using regressions, we provide evidence of the economic importance of information‐based trading on spreads.

Previous work shows that average returns on common stocks are related to firm characteristics like size, earnings/price, cash flow/price, book-to-market equity, past sales growth, long-term past return, and short-term past return. Because these patterns in average returns apparently are not explained by the capital asset pricing model, (CAPM), they are called anomalies. The authors find that, except for the continuation of short-term returns, the anomalies largely disappear in a three-factor model. Their results are consistent with rational intertemporal CAPM or arbitrage pricing theory asset pricing but the authors also consider irrational pricing and data problems as possible explanations.

The authors test the hypothesis that, when their compensation is linked to relative performance, managers of investment portfolios likely to end up as 'losers' will manipulate fund risk differently than those managing portfolios likely to be 'winners.' An empirical investigation of the performance of 334 growth-oriented mutual funds during 1976 to 1991 demonstrates that mid-year losers tend to increase fund volatility in the latter part of an annual assessment period to a greater extent than mid-year winners. Furthermore, the authors show that this effect became stronger as industry growth and investor awareness of fund performance increased over time.

Kothari, Shanken, and Sloan (1995) claim that betas from annual returns produce a stronger positive relation between beta and average return than betas from monthly returns. They also contend that the relation between average return and book-to-market equity (BE/ME) is seriously exaggerated by survivor bias. We argue that survivor bias does not explain the relation between BE/ME and average return. We also show that annual and monthly betas produce the same inferences about the beta premium. Our main point on the beta premium is, however, more basic. It cannot save the Capital asset pricing model (CAPM), given the evidence that beta alone cannot explain expected return.

Sample evidence about the predictability of monthly stock returns is considered from the perspective of a risk-averse Bayesian investor who must allocate funds between stocks and cash. The investor uses the sample evidence to update prior beliefs about the parameters in a regression of stock returns on a set of predictive variables. The regression relation can seem weak when described by usual statistical measures but the current values of the predictive variables can exert a substantial influence on the investor's portfolio decision, even when the investor's prior beliefs are weighted against predictability.

We document a directional asymmetry in the small stock concurrent and lagged response to large stock movements. When returns on large stocks are negative, the concurrent beta for small stocks is high, but the lagged beta is insignificant. When returns on large stocks are positive, small stocks have small concurrent betas and very significant lagged betas. That is, the cross-autocorrelation puzzle documented by Lo and MacKinlay (199Oa) is associated with a slow response by some small stocks to good, but not to bad, common news. Time series portfolio tests and cross-sectional tests of the delay for individual securities suggest that existing explanations of the cross-autocorrelation puzzle based on data mismeasurement, minor market imperfections, or time-varying risk premiums fail to capture the directional asymmetry in the data.

This article develops a new framework for measuring financial and real economic linkages between countries. Using U.S. and U.K. data from 1957 to 1989, the authors find closer financial linkages after the Bretton Woods currency arrangement was abandoned and Britain suspended exchange controls. In a pairwise application to fifteen countries over a shorter period, they also find that news about future dividend growth is more highly correlated between countries than contemporaneous output measures. This suggests that there are lags in the international transmission of economic shocks and that contemporaneous output correlation may understate the magnitude of integration.