In this paper, using the Conrad and Kaul's methodology we test for the overreaction hypothesis – which maintains that stock prices systematically overshoot and therefore their reversal can be predicted from past performance — in seven industrialized countries. Consistent with the findings of Conrad and Kaul, we see no evidence of overreaction in the US. However, returns to long-term contrarian strategies in other countries seem to be generally significant. Moreover, we find that in the majority of the countries, while returns to arbitrage portfolios based on price are higher than those based on size, the latter generally outperform the winner–loser arbitrage portfolios.

In a recent critique of the ‘market discipline’ literature in banking, Gorton and Santomero [ Journal of Money, Credit and Banking 22 (1990) 119–128] emphasize the need for adopting a rigorous valuation model in order to test for the existence of market discipline. They employ a standard version of the contingent claims pricing model in which firm-value risk is the only source of uncertainty. In this paper we extend their model by also incorporating interest rate uncertainty. The results reported here demonstrate the complex interaction effects arising from the joint uncertainties of firm risk and interest rate risk. No simple monotonie relationship exists with respect to interest rate uncertainty. The analysis presented in this paper is also applicable to a much wider class of debt-valuation problems and is not restricted to a specific question of banking policy.

This paper examines the cross-sectional relation between idiosyncratic volatility and expected stock returns. The results indicate that i) the data frequency used to estimate idiosyncratic volatility, ii) the weighting scheme used to compute average portfolio returns, iii) the breakpoints utilized to sort stocks into quintile portfolios, and iv) using a screen for size, price, and liquidity play critical roles in determining the existence and significance of a relation between idiosyncratic risk and the cross section of expected returns. Portfoliolevel analyses based on two different measures of idiosyncratic volatility (estimated using daily and monthly data), three weighting schemes (value-weighted, equal-weighted, inverse volatility-weighted), three breakpoints (CRSP, NYSE, equal market share), and two different samples (NYSE/AMEX/NASDAQ and NYSE) indicate that no robustly significant relation exists between idiosyncratic volatility and expected returns.

This paper determines whether the world market risk, country-specific total risk, and country-specific idiosyncratic risk are priced in an international capital asset pricing model (ICAPM). Portfolio-level analyses, country-level cross-sectional regressions, stacked time-series, and pooled panel regressions indicate that the world market risk is not, but country-specific total and idiosyncratic risks are significantly priced in an ICAPM framework with partial integration. This result is robust to different methods for estimating risk measures, different investment horizons, and after controlling for the countries’ aggregate dividend yield, earnings-to-price ratios, inflation risk, exchange rate uncertainties, aggregate volatility risk, and past return characteristics. The main findings turn out to be insensitive to the choice of one-factor vs. multifactor models used to estimate systematic and idiosyncratic risk measures.

We introduce a new hybrid measure of stock return tail covariance risk, motivated by the underdiversified portfolio holdings of individual investors, and investigate its cross-sectional predictive power. Our key innovation is that this covariance is measured across the left tail states of the individual stock return distribution, and not across those of the market return as in standard systematic risk measures. We document a positive and significant relation between hybrid tail covariance risk (H-TCR) and expected stock returns, with an annualized premium of 9%, in contrast to the insignificant or negative results for purely stock-specific or systematic tail risk measures.

Using intraday trades and quotes data, we study the stock options market before, during, and after the market events of May 6, 2010. Focusing on the S&P 500 and S&P 100 stock options, we explore if the options market provided any discernible signals that forewarned the extreme volatility on that day and whether the recovery was fast and without a permanent impact. We find that the options market reacted to the volatility- rather than predicting it, and almost all of the variables are indistinguishable from their previous levels in the next few trading days. Intraday empirical analysis suggests that most of the impact was over within a few hours from the peak of market volatility.

Motivated by existing evidence of the salience theory (ST) effect in the United States, we investigate its importance in 49 countries over the past three decades. Initial results suggest a negative relationship between the ST measure and future returns. The underperformance of low ST stocks is the strongest in countries with high idiosyncratic risk. However, the salience effect has three vital limitations. First, a substantial part of the anomaly can be attributed to the short-term return reversal. Second, it is priced primarily among microcaps. Third, the premium is realized predominantly following severe down markets and volatility spikes. Outside of microcaps and extreme market conditions, the salience effect does not exist.

Motivated by existing evidence of a preference among investors for assets with lottery-like payoffs and that many investors are poorly diversified, we investigate the significance of extreme positive returns in the cross-sectional pricing of stocks. Portfolio-level analyses and firm-level cross-sectional regressions indicate a negative and significant relation between the maximum daily return over the past one month (MAX) and expected stock returns. Average raw and risk-adjusted return differences between stocks in the lowest and highest MAX deciles exceed 1% per month. These results are robust to controls for size, book-to-market, momentum, short-term reversals, liquidity, and skewness. Of particular interest, including MAX reverses the puzzling negative relation between returns and idiosyncratic volatility recently shown in Ang et al., 2006, Ang et al., 2009.

We hypothesize that local economic discomfort influences investors’ risk aversion, leading to cross-sectional variation in risk premia in segmented equity markets. To test this assertion, we employ the misery index (MI)—which aggregates both unemployment and inflation rates—as a gauge of macroeconomic welfare. Using six decades of data from 69 markets, we demonstrate that economic discomfort reliably predicts cross-sectional stock returns. A quartile of countries with the highest MI outperforms those with the lowest by 0.74% per month. The effect prevails in markets where prices are set locally and gradually declines over time as markets become more integrated.