Knowledge that Transforms

Dilip Madan, Haluk Unal, A Two-Factor Hazard Rate Model for Pricing Risky Debt and the Term Structure of Credit Spreads, The Journal of Financial and Quantitative Analysis, Vol. 35, No. 1 (Mar., 2000), pp. 43-65

This study examines the Morningstar rating system as a predictor of mutual fund performance for U.S. domestic equit funds. We also compare the predictive abilities of the Morningstar rating system with those of alternative predictors. The results indicate findings that are robust across different samples, ages and styles of funds, and performance measures. First, low ratings from Morningstar generally indicate relatively poor future performance. Second, there is little statistical evidence that Morningstar's highest-rated funds outperform the next-to-highest and median-rated funds. Third, Morningstar ratings, at best, do only slightly better than the alternative predictors in forecasting future fund performance.

We investigate the long-run return performance of non-U.S. firms that raise equity capital in U.S. markets. Overall, between 1982 and 1996, our sample of 333 global equity offerings with U.S. depositary receipt (ADR) tranches from 35 countries in Asia, Latin America, and Europe under-perform local market benchmarks of comparable firms by 8%–15% over the three years following issuance. We show that differences in long-run returns are related to the scope and magnitude of investment barriers that induce segmentation of capital markets around the world. While companies from markets with significant investment barriers for foreigners that issue equity on major U.S. exchanges outperform their benchmarks, those from segmented markets that issue equity in the U.S. by way of Rule 144A private placements significantly under-perform. We also show that inter-market competition for order flow in the post-issuance period affects long-run return performance. Post-issuance buy-and-hold abnormal returns are most significantly and positively related to the offering's ability to generate a larger share of U.S. trading volume.

examining the reasonableness and accuracy of investment advice. Topics such as earnings estimates, security analysts recommendations, and recommendations for selecting mutual funds have been studied extensively. However, almost no attention has been paid to examining advice about the asset allocation decision (the allocation of funds across broad classes of assets). This is surprising because the asset allocation decision has been recognized as a major determinant of return and risk and because of this, advice on the optional allocation decision is provided by most brokerage firms and investment advisors Given the importance of the asset allocation decision we anticipate that the rationality of asset allocation advice will be extensively examined. The purpose of the article is two fold. First, we will examine modern portfolio theory to see what we can learn about the general characteristics of advice that are necessary for consistency with theory. Second, we will examine the advice of some specific investment advisors to see if their advice is consistent with rational behavior. We proceed in three steps. We first review some of the basic tenets of MPT, discuss alternative formulations of the problem, and examine which formulation is appropriate and

Jarl G. Kallberg, Crocker L. Liu, Charles Trzcinka, The Value Added from Investment Managers: An Examination of Funds of REITs, The Journal of Financial and Quantitative Analysis, Vol. 35, No. 3 (Sep., 2000), pp. 387-408

This study examines the stock market forecasts and portfolio allocation decisions of small individual investors, based on survey data for 1987-1994. When investors are bullish, they increase their equity holdings; when investors are bearish, they decrease equity holdings. The surveyed investors are unable to time the stock market successfully. However, the shifts in their portfolios reflect past market movements and are consistent with positive feedback trading. I. Introduction There can be no doubt that, over short horizons, stock price changes are highly unpredictable. Nevertheless, many individuals discover seeming in past prices and trade based on the expectation that the trends will persist. De Long, Shleifer, Summers, and Waldmann (1990) call these investors positive feedback traders.

This study directly tests the ability of several competing methods to identify market buy and sell orders using intra-day quote and trade prices, and identifies factors that affect the accuracy of the methods. Lee and Ready's (1991) algorithm performs about the same as the tick test, but the performance of both methods is worse than expected. The results show that the use of either algorithm to classify trades can lead to significantly biased estimates of effective spreads and signed volume, but the tick test provides better estimates of effective spreads and signed volume than Lee and Ready's method. I. Introduction The use of intra-day prices in empirical studies of securities markets is increasingly common and studies frequently require trades be identified as buyer or seller initiated. Unfortunately, most data sets do not identify trade direction. Methods have, however, been proposed that allow trade direction to be inferred from adjacent prices and quotes. The accuracy of these methods and the implica? tions for microstructure research are still unresolved issues in large part because trade direction is unobservable in most financial data sets. This study directly tests the ability of several competing methods to iden? tify market buy and sell orders using intra-day quote and trade prices. The tests are conducted using the TORQ database, a unique data set the New York Stock Exchange makes available to researchers that contains information on trades, quotes, and orders. Using the tick tests and Lee and Ready's (LR hereafter) (1991) method to classify trades as buys or sells, and comparing the results to the direction of the actual orders, I directly test the accuracy of the classification algorithms. The tests also identify the factors that affect the accuracy of the clas? sification methods. Additional tests demonstrate that using these algorithms can lead to biased inferences in two of their most common applications: estimating effective spreads and signed volume trading. Test results also show that the tick

This paper addresses the bias associated with parametric measurement of timing skill based on monthly timer returns when timers can make daily timing decisions. Simulations suggest that the classic Henriksson-Merton parametric measure of timing skill is weak and biased downward when applied to the monthly returns of a daily timer. The paper proposes an adjustment that mitigates this problem without the need to collect daily timer returns. Four tests of timing skill, carried out on a sample of 558 mutual funds, show that very few funds exhibit statistically significant timing skill. More encompassing, the adjusted-FF3 test (based on the specification that incorporates both the proposed adjustment and the Fama-French three-factor model) is the least biased measure of timing skill among the four—it provides for a sharper inference regarding timing skill and helps mitigate biases associated with the choice of investment style.

Vihang R. Errunza, Darius P. Miller, Market Segmentation and the Cost of Capital in International Equity Markets, The Journal of Financial and Quantitative Analysis, Vol. 35, No. 4 (Dec., 2000), pp. 577-600

We present large sample evidence on the performance of domestic and U.S. (foreign) bid? der firms acquiring Canadian targets. Domestic bidders earn significantly positive average announcement period abnormal returns, while U.S. bidder returns are indistinguishable from zero. Measures of pre- and post-acquisition abnormal accounting performance are also consistent with a superior domestic bidder performance. Domestic bidder announce? ment returns are, on average, greatest for offers involving stock payment and for the bid? ders with the smallest equity size relative to the target. Neither direct foreign investment controls, horizontal product market relationships, nor acquisition propensities explain why domestic bidders outperform their U.S. competitors.