Performance characteristic of moving average trading rules in the Finnish stock market

The thesis examines the profitability of DMAC trading rules in the Finnish stock market over the 1996-2012 period. It contributes to the existing technical analysis literature by comparing for the first time the performance of DMAC strategies based on individual stock trading portfolios to the performance of index trading strategies based on the trading on the index (OMX Helsinki 25) that consists of the same stocks. Besides, the market frictions including transaction costs and taxes are taken into account, and the results are reported from both institutional and individual investor’s perspective. Performance characteristic of DMAC rules are evaluated by simulating 19,900 different trading strategies in total for two non- overlapping 8-year sub-periods, and decomposing the full-sample-period performance of DMAC trading strategies into distinct bullish- and bearish-period performances. The results show that the best DMAC rules have predictive power on future price trends, and these rules are able to outperform buy-and-hold strategy. Although the performance of the DMAC strategies is highly dependent on the combination of moving average lengths, the best DMAC rules of the first sub-period have also performed well during the latter sub-period in the case of individual stock trading strategies. According to the results, the outperformance of DMAC trading rules over buy-and-hold strategy is mostly attributed to their superiority during the bearish periods, and particularly, during stock market crashes.

Interdependence of Emerging Eastern European stock markets

One of the main developments in the global economy during the past decades has been the growth of emerging economies. Projections for their long-term growth, changes in the investment climate, corporate transparency and demography point to an increasing role for these emerging economies in the global economy. Today, emerging economies are usually considered as financial markets offering opportunities for high returns, good risk diversification and improved return-to-risk ratios. However, researchers have noted that these advantages may be in decline because of the increasing market integration. Nevertheless, it is likely that certain financial markets and specific sectors will remain partially segmented and somewhat insulated from the global economy for the year to come. This doctoral dissertation investigates several stock markets in Emerging Eastern Europe (EEE), including the ones in Russia, Poland, Hungary, the Czech Republic, Bulgaria and Slovenia. The objective is to analyze the returns and financial risks in these emerging markets from international investor’s point of view. This study also examines the segmentation/integration of these financial markets and the possibilities to diversify and hedge financial risk. The dissertation is divided into two parts. The first includes a review of the theoretical background for the articles and a review of the literature on EEE stock markets. It includes an overview of the methodology and research design applied in the analysis and a summary of articles from the second part of this dissertation and their main findings. The second part consists of four research publications. This work contributes to studies on emerging stock markets in four ways. First, it adds to the body of research on the pricing of risk, providing new empirical evidence about partial stock market segmentation in EEE. The results suggest that the aggregate emerging market risk is a relevant driver for stock market returns and that this market risk can be used to price financial instruments and forecast their performance. Second, it contributes to the empirical research on the integration of stock markets, asset prices and exchange rates by identifying the relationships between these markets through volatility and asset pricing. The results show that certain sectors of stock markets in EEE are not as integrated as others. For example, the Polish consumer goods sector, the Hungarian telecommunications sector, and the Czech financial sector are somewhat isolated from their counterparts elsewhere in Europe. Nevertheless, an analysis of the impact of EU accession in 2004 on stock markets suggests that most of the EEE markets are becoming increasingly integrated with the global markets. Third, this thesis complements the scientific literature in the field of shock and volatility spillovers by examining the mechanism of spillover distribution among the EU and EEE countries. The results illustrate that spillovers in emerging markets are mostly from a foreign exchange to the stock markets. Moreover, the results show that the effects of external shocks on stock markets have increased after the enlargement of the EU in 2004. Finally, this study is unique because it analyzes the effects of foreign macroeconomic news on geographically closely related countries. The results suggest that the effects of macroeconomic announcements on volatility are significant and have effect that varies across markets and their sectors. Moreover, the results show that the foreign macroeconomic news releases, somewhat surprisingly, have a greater effect on the EEE markets than the local macroeconomic news. This dissertation has a number of implications for the industry and for practitioners. It analyses financial risk associated with investing in Emerging Eastern Europe. Investors may use this information to construct and optimize investment portfolios. Moreover, this dissertation provides insights for investors and portfolio managers considering asset allocation to protect value or obtain higher returns. The results have also implications for asset pricing and portfolio selection in light of macroeconomic news releases.

Performance of active portfolio management and the effect of stock market trend

Purpose of the study is to evaluate performance of active portfolio management and the effect of stock market trend on the performance. Theory of efficient markets states that market prices reflect all available information and that all investors share a common view of future price developments. This view gives little room for the success of active management, but the theory has been disputed – at least the level of efficiency. Behavioral finance has developed theories that identify irrational behavior patterns of investors. For example, investment decisions are not made independent of past market developments. These findings give reason to believe that also the performance of active portfolio management may depend on market developments. Performance of 16 Finnish equity funds is evaluated during the period of 2005 to 2011. In addition two sub periods are constructed, a bull market period and a bear market period. The sub periods are created by joining together the two bull market phases and the two bear market phases of the whole period. This allows for the comparison of the two different market states. Performance of the funds is measured with risk-adjusted performance by Modigliani and Modigliani (1997), abnormal return over the CAPM by Jensen (1968), and market timing by Henriksson and Merton (1981). The results suggested that in average the funds are not able to outperform the market portfolio. However, the underperformance was found to be lower than the management fees in average which suggests that portfolio managers are able to do successful investment decisions to some extent. The study revealed substantial dependence on the market trend for all of the measures. The risk-adjusted performance measure suggested that in bear markets active portfolio managers in average are able to beat the market portfolio but not in bull markets. Jensen´s alpha and the market timing model also showed striking differences between the two market states. The results of these two measures were, however, somewhat problematic and reliable conclusions about the performance could not be drawn.

Financial Slack and Bidding Firms’ Takeover Announcement Stock Returns – an Event Study

Despite the fact that the literature on mergers and acquisitions is extensive, relatively little effort has been made to examine the relationship between the acquiring firms’ financial slack and short-term post-takeover announcement abnormal stock returns. In this study, the case is made that the financial slack of a firm is not only an outcome of past business and financing activities but it also may affect the quality of acquisition decisions. We will hypothesize that the level of financial slack in a firm is negatively associated with the abnormal returns following acquisition announcements because slack reduces managerial discipline over the use of corporate funds and also because it may give rise to managerial self-serving behavior. In this study, financial slack is measured in terms of three financial statements ratios: leverage ratio, cash and equivalents to total assets ratio and free cash flow to total assets ratio. The data used in this paper is collected from two main sources. A list comprising 90 European acquisition announcements is retrieved from Thomson One Banker database. The stock price data and financial statements information for the respective firms is collected using Datastream. Our empirical analysis is two-fold. First, we conduct a two-sample t-test where we find that the most slack-rich firms experience lower abnormal returns than the most slack-poor firms in the event window [-1, +1], significant at 5% risk level. Second, we perform a cross sectional regression for sample firms using three financial statements ratios to explain cumulative abnormal returns (CAR). We find that leverage shows a statistically significant positive relationship with cumulative abnormal returns in event window [-1; +1] (significance 5%). Moreover, cash to total assets ratio showed a weak negative relationship with CAR (significant at 10%) in event window [-1; +1]. We conclude that our hypothesis for the inverse relationship between slack and abnormal returns receives empirical support. Based on the results of the event study we get empirical support for the hypothesis that the capital markets expect the acquisitions undertaken by slack-rich firms to more likely be driven by managerial self-serving behavior and hubris than do those undertaken by slackpoor firms, signaling possible agency problems and behavioral biases.

The Impact of European Macroeconomic News Announcements on CIVETS Stock Markets

The purpose of this research is to investigate how CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa) stock markets are integrated with Europe as measured by the impact of euro area (EA) scheduled macroeconomic news announcements, which are related to macroeconomic indicators that are commonly used to indicate the direction of the economy. Macroeconomic announcements used in this study can be divided into four categories; (1) prices, (2) real economy, (3) money supply and (4) business climate and consumer confidence. The data set consists of daily market data from CIVETS and scheduled macroeconomic announcements from the EA for the years 2007-2012. The econometric model used in this research is Exponential Generalized Autoregressive Conditional Heteroscedasticity (EGARCH). Empirical results show diverse impacts of macroeconomic news releases and surprises for different categories of news supporting the perception of heterogeneity among CIVETS. The analyses revealed that in general EA macroeconomic news releases and surprises affect stock market volatility in CIVETS and only in some cases asset pricing. In conclusion, all CIVETS stock markets reacted to the incoming EA macroeconomic news suggesting market integration to some extent. Thus, EA should be considered as a possible risk factor when investing in CIVETS.

The Anchoring Bias of Investors and the 52-Week High Momentum Strategy in the OMX Helsinki Stock Exchange: Psychological Approach to Market Efficiency

The behavioural finance literature expects systematic and significant deviations from efficiency to persist in securities markets due to behavioural and cognitive biases of investors. These behavioural models attempt to explain the coexistence of intermediate-term momentum and long-term reversals in stock returns based on the systematic violations of rational behaviour of investors. The study investigates the anchoring bias of investors and the profitability of the 52-week momentum strategy (GH henceforward). The relatively highly volatile OMX Helsinki stock exchange is a suitable market for examining the momentum effect, since international investors tend to realise their positions first from the furthest security markets by the time of market turbulence. Empirical data is collected from Thomson Reuters Datastream and the OMX Nordic website. The objective of the study is to provide a throughout research by formulating a self-financing GH momentum portfolio. First, the seasonality of the strategy is examined by taking the January effect into account and researching abnormal returns in long-term. The results indicate that the GH strategy is subject to significantly negative revenues in January, but the strategy is not prone to reversals in long-term. Then the predictive proxies of momentum returns are investigated in terms of acquisition prices and 52-week high statistics as anchors. The results show that the acquisition prices do not have explanatory power over the GH strategy’s abnormal returns. Finally, the efficacy of the GH strategy is examined after taking transaction costs into account, finding that the robust abnormal returns remain statistically significant despite the transaction costs. As a conclusion, the relative distance between a stock’s current price and its 52-week high statistic explains the profits of momentum investing to a high degree. The results indicate that intermediateterm momentum and long-term reversals are separate phenomena. This presents a challenge to current behavioural theories, which model these aspects of stock returns as subsequent components of how securities markets respond to relevant information.

Finnish stock market reaction to quarterly earnings announcements

This thesis examines the stock market reactions to quarterly earnings announcements. The study covers the OMX Helsinki 25 index companies for the years 2007–2010. The stock market response to quarterly earnings announcements is tested by employing the event study –methodology and daily stock returns of Finnish listed companies. The thesis provides evidence that stock prices react to earnings announcements that exceed or fall below analyst forecasts. The most liquid stocks earn higher returns around positive earnings news than less traded stocks, which supports the evidence from previous studies. This thesis finds evidence for the authorization to sell stocks short reducing the post–earnings announcement drift induced by negative earnings news. In addition, the market’s reaction to earnings announcements seems to quicken during economic turmoil.

Market integration, return and volatility dynamics; empirical evidence from African stock markets

Frontier and Emerging economies have implemented policies with the objective of liberalizing their equity markets. Equity market liberalization opens the domestic equity market to foreign investors and as well paves the way for domestic investors to invest in foreign equity securities. Among other things, equity market liberalization results in diversification benefits. Moreover, equity market liberalization leads to low cost of equity capital resulting from the lower rate of return by investors. Additionally, foreign and local investors share any potential risks. Liberalized equity markets also become liquid considering that there are more investors to trade. Equity market liberalization results in financial integration which explains the movement of two markets. In crisis period, increased volatility and co-movement between two markets may result in what is termed contagion effects. In Africa, major moves toward financial liberalization generally started in the late 1980s with South Africa as the pioneer. Over the years, researchers have studied the impact of financial liberalization on Africa’s economic development with diverse results; some being positive, others negative and still others being mixed. The objective of this study is to establish whether African stock-markets are integrated into the United States (US) and World market. Furthermore, the study helps to see if there are international linkages between the Africa, US and the world markets. A Bivariate- VAR- GARCH- BEKK model is employed in the study. In the study, the effect of thin trading is removed through series of econometric data purification. This is because thin trading, also known as non-trading or inconsistency of trading, is a main feature of African markets and may trigger inconsistency and biased results. The study confirmed the widely established results that the South Africa and Egypt stock markets are highly integrated with the US and World market. Interestingly, the study adds to knowledge in this research area by establishing the fact that Kenya is very integrated with the US and World markets and that it receives and exports past innovations as well as shocks to and from the US and World market.

The Use of Data Envelopment Analysis as Equity Portfolio Selection Criterion in the Finnish Stock Market

This thesis examines the application of data envelopment analysis as an equity portfolio selection criterion in the Finnish stock market during period 2001-2011. A sample of publicly traded firms in the Helsinki Stock Exchange is examined in this thesis. The sample covers the majority of the publicly traded firms in the Helsinki Stock Exchange. Data envelopment analysis is used to determine the efficiency of firms using a set of input and output financial parameters. The set of financial parameters consist of asset utilization, liquidity, capital structure, growth, valuation and profitability measures. The firms are divided into artificial industry categories, because of the industry-specific nature of the input and output parameters. Comparable portfolios are formed inside the industry category according to the efficiency scores given by the DEA and the performance of the portfolios is evaluated with several measures. The empirical evidence of this thesis suggests that with certain limitations, data envelopment analysis can successfully be used as portfolio selection criterion in the Finnish stock market when the portfolios are rebalanced at annual frequency according to the efficiency scores given by the data envelopment analysis. However, when the portfolios were rebalanced every two or three years, the results are mixed and inconclusive.

Risk-return trade-off and autocorrelation

A trade-off between return and risk plays a central role in financial economics. The intertemporal capital asset pricing model (ICAPM) proposed by Merton (1973) provides a neoclassical theory for expected returns on risky assets. The model assumes that risk-averse investors (seeking to maximize their expected utility of lifetime consumption) demand compensation for bearing systematic market risk and the risk of unfavorable shifts in the investment opportunity set. Although the ICAPM postulates a positive relation between the conditional expected market return and its conditional variance, the empirical evidence on the sign of the risk-return trade-off is conflicting. In contrast, autocorrelation in stock returns is one of the most consistent and robust findings in empirical finance. While autocorrelation is often interpreted as a violation of market efficiency, it can also reflect factors such as market microstructure or time-varying risk premia. This doctoral thesis investigates a relation between the mixed risk-return trade-off results and autocorrelation in stock returns. The results suggest that, in the case of the US stock market, the relative contribution of the risk-return trade-off and autocorrelation in explaining the aggregate return fluctuates with volatility. This effect is then shown to be even more pronounced in the case of emerging stock markets. During high-volatility periods, expected returns can be described using rational (intertemporal) investors acting to maximize their expected utility. During lowvolatility periods, market-wide persistence in returns increases, leading to a failure of traditional equilibrium-model descriptions for expected returns. Consistent with this finding, traditional models yield conflicting evidence concerning the sign of the risk-return trade-off. The changing relevance of the risk-return trade-off and autocorrelation can be explained by heterogeneous agents or, more generally, by the inadequacy of the neoclassical view on asset pricing with unboundedly rational investors and perfect market efficiency. In the latter case, the empirical results imply that the neoclassical view is valid only under certain market conditions. This offers an economic explanation as to why it has been so difficult to detect a positive tradeoff between the conditional mean and variance of the aggregate stock return. The results highlight the importance, especially in the case of emerging stock markets, of noting both the risk-return trade-off and autocorrelation in applications that require estimates for expected returns.

Stock Price Reactions on M&A, Dividends and Game Releases. Evidence from Gaming Industry.

A rapidly growing gaming industry, which specializes on PC, console, online and other games, attracts attention of investors and analysts, who try to understand what drives changes of the gaming industry companies’ stock prices. This master thesis shows the evidence that, besides long-established types of events (M&A and dividend payments), the companies’ stock price changes depend on industry-specific events. I analyzed specific for gaming industry events - game releases with respect to its subdivisions: new games-sequels, games ratings and subdivision according to a developer of a game (self-developed by publisher or outsourced). The master thesis analyzes stock prices of 55 companies from gaming industry from all over the world. The research period covers 5 year, spreading from April 2008 to April 2013. Executed with an event study method, results of the research show that all the analyzed events types have significant influence on the stock prices of the gaming industry companies. The current master thesis suggests that acquisitions in the industry affect positively bidders’ and targets’ stock prices. Mergers events cause positive stock price reactions as well. But dividends payments and game releases events influence negatively on the stock prices. Game releases’ effect is up to -2.2% of cumulative average abnormal return (CAAR) drop during the first ten days after the game releases. Having researched different kinds of events and identified the direction of their impact, the current paper can be of high value for investors, seeking profits in the gaming industry, and other interested parties.

Interdependence of International Stock Markets, European Government Bond Market and Gold Market

This thesis examines the interdependence of international stock markets (the USA, Europe, Japan, emerging markets, and frontier markets), European government bond market, and gold market during the 21st century. Special focus is on the dynamics of the correlations between the markets, as well as on, spillovers in mean returns and volatility. The mean return spillovers are examined on the basis of the bivariate VAR(1) model, whereas the bivariate BEKK-GARCH(1, 1) model is employed for the analysis of the volatility spillovers. In order to analyze the spillover effects in different market conditions, the full sample period from 2000 to 2013 is divided into the pre-crisis period (2000–2006) and the crisis period (2007–2013). The results indicate an increasing interdependence especially within international stock markets during the periods of financial turbulence, and are thus consistent with the existing literature. Hence, bond and gold markets provide the best diversification benefits for equity investors, particularly during the periods of market turmoil.

Insiders´ views as a predictor of stock performance : can insider trading be used to predict stock performance on the United States stock market?

This thesis studies the possibility of using information on insiders’ transactions to forecast future stock returns after the implementation of Sarbanes Oxley Act in July 2003. Insider transactions between July 2003 and August 2009 are analysed with regression tests to identify the relationships between insiders’ transactions and future stock returns. This analysis is complemented with rudimentary bootstrapping procedures to verify the robustness of the findings. The underlying assumption of the thesis is that insiders constantly receive pieces of information that indicate future performance of the company. They may not be allowed to trade on large and tangible pieces of information but they can trade on accumulation of smaller, intangible pieces of information. Based on the analysis in the thesis insiders’ profits were found not to differ from the returns from broad stock index. However, their individual transactions were found to be linked to future stock returns. The initial model was found to be unstable but some of the predictive power could be sacrificed to achieve greater stability. Even after sacrificing some predictive power the relationship was significant enough to allow external investors to achieve abnormal profits after transaction costs and taxes. The thesis does not go into great detail about timing of transactions. Delay in publishing insiders’ transactions is not taken into account in the calculations and the closed windows are not studied in detail. The potential effects of these phenomena are looked into and they do not cause great changes in the findings. Additionally the remuneration policy of an insider or a company is not taken into account even though it most likely affects the trading patterns of insiders. Even with the limitations the findings offer promising opportunities for investors to improve their investment processes by incorporating additional information from insiders’ transaction into their decisions. The findings also raise questions on how insider trading should be regulated. Insiders achieve greater returns than other investors based on superior information. On the other hand, more efficient information transfer could warrant more lenient regulation. The fact that insiders’ returns are dominated by the large investment stake they maintain all the time in their own companies also speaks for more leniency. As Sarbanes Oxley Act considerably modified the insider trading landscape, this analysis provides information that has not been available before. The thesis also constitutes a thorough analysis of insider trading phenomenon which has previously been somewhat separated into several studies.

Prediction of market switching and delisting events from OMX First North Nordic multilateral stock exchange

This thesis studies the predictability of market switching and delisting events from OMX First North Nordic multilateral stock exchange by using financial statement information and market information from 2007 to 2012. This study was conducted by using a three stage process. In first stage relevant theoretical framework and initial variable pool were constructed. Then, explanatory analysis of the initial variable pool was done in order to further limit and identify relevant variables. The explanatory analysis was conducted by using self-organizing map methodology. In the third stage, the predictive modeling was carried out with random forests and support vector machine methodologies. It was found that the explanatory analysis was able to identify relevant variables. The results indicate that the market switching and delisting events can be predicted in some extent. The empirical results also support the usability of financial statement and market information in the prediction of market switching and delisting events.