Essays on Stock Market Reactions to New Information

A functioning stock market is an essential component of a competitive economy, since it provides a mechanism for allocating the economy’s capital stock. In an ideal situation, the stock market will steer capital in a manner that maximizes the total utility of the economy. As prices of traded stocks depend on and vary with information available to investors, it is apparent that information plays a crucial role in a functioning stock market. However, even though information indisputably matters, several issues regarding how stock markets process and react to new information still remain unanswered. The purpose of this thesis is to explore the link between new information and stock market reactions. The first essay utilizes new methodological tools in order to investigate the average reaction of investors to new financial statement information. The second essay explores the behavior of different types of investors when new financial statement information is disclosed to the market. The third essay looks into the interrelation between investor size, behavior and overconfidence. The fourth essay approaches the puzzle of negative skewness in stock returns from an altogether different angle than previous studies. The first essay presents evidence of the second derivatives of some financial statement signals containing more information than the first derivatives. Further, empirical evidence also indicates that some of the investigated signals proxy risk while others contain information priced with a delay. The second essay documents different categories of investors demonstrating systematical differences in their behavior when new financial statement information arrives to the market. In addition, a theoretical model building on differences in investor overconfidence is put forward in order to explain the observed behavior. The third essay shows that investor size describes investor behavior very well. This finding is predicted by the model proposed in the second essay, and hence strengthens the model. The behavioral differences between investors of different size furthermore have significant economic implications. Finally, the fourth essay finds strong evidence of management news disclosure practices causing negative skewness in stock returns.

Finnish Short-Term Stock Returns

Functioning capital markets are a crucial part of a competitive economy since they provide the mechanisms to allocate resources. In order to be well functioning a capital market has to be efficient. Market efficiency is defined as a market where prices at any time fully reflect all available information. Basically, this means that abnormal returns cannot be predicted since they are dependent on future, presently unknown, information. The debate of market efficiency has been going on for several decades. Most academics today would probably agree that financial markets are reasonably efficient since virtually nobody has been able to achieve continuous abnormal positive returns. However, it is clear that a set of return anomalies exists, although they are apparently to small to enable substantial economic profit. Moreover, these anomalies can often be attributed to market design. The motivation for this work is to expand the knowledge of short-term trading patterns and to offer some explanations for these patterns. In the first essay the return pattern during the day is examined. On average stock prices move during two time periods of the day, namely, immediately after the opening and around the formal close of the market. Since stock prices, on average, move upwards these abnormal returns are generally positive and cause the distinct U-shape of intraday returns. In the second essay the results in the first essay are examined further. The return pattern around the former close is shown to partly be the result of manipulative action by market participants. In the third essay the focus is shifted towards trading patterns of the underlying stocks on days when index options and index futures on the stocks expire. Generally no expiration day effect was found. However, some indication of an expiration day effect was found when a large amount of open in- or at-the-money contracts existed. Also, the effects were likelier to be found for shares with high index-weight but fairly low trading volume. Last, in the forth essay the attention is turned to the behaviour of different tax clienteles around the dividend ex-day. Two groups of investors showed abnormal trading behaviour. Domestic non-financial investors, especially domestic companies, showed a dividend capturing behaviour, i.e. buying cum-dividend and selling ex-dividend shares. The opposite behaviour was found for foreign investors and domestic financial institutions. The effect was more notable for high yield, high volume stocks.

Intraday Dynamics of International Equity Markets

The increased availability of high frequency data sets have led to important new insights in understanding of financial markets. The use of high frequency data is interesting and persuasive, since it can reveal new information that cannot be seen in lower data aggregation. This dissertation explores some of the many important issues connected with the use, analysis and application of high frequency data. These include the effects of intraday seasonal, the behaviour of time varying volatility, the information content of various market data, and the issue of inter market linkages utilizing high frequency 5 minute observations from major European and the U.S stock indices, namely DAX30 of Germany, CAC40 of France, SMI of Switzerland, FTSE100 of the UK and SP500 of the U.S. The first essay in the dissertation shows that there are remarkable similarities in the intraday behaviour of conditional volatility across European equity markets. Moreover, the U.S macroeconomic news announcements have significant cross border effect on both, European equity returns and volatilities. The second essay reports substantial intraday return and volatility linkages across European stock indices of the UK and Germany. This relationship appears virtually unchanged by the presence or absence of the U.S stock market. However, the return correlation among the U.K and German markets rises significantly following the U.S stock market opening, which could largely be described as a contemporaneous effect. The third essay sheds light on market microstructure issues in which traders and market makers learn from watching market data, and it is this learning process that leads to price adjustments. This study concludes that trading volume plays an important role in explaining international return and volatility transmissions. The examination concerning asymmetry reveals that the impact of the positive volume changes is larger on foreign stock market volatility than the negative changes. The fourth and the final essay documents number of regularities in the pattern of intraday return volatility, trading volume and bid-ask spreads. This study also reports a contemporaneous and positive relationship between the intraday return volatility, bid ask spread and unexpected trading volume. These results verify the role of trading volume and bid ask quotes as proxies for information arrival in producing contemporaneous and subsequent intraday return volatility. Moreover, asymmetric effect of trading volume on conditional volatility is also confirmed. Overall, this dissertation explores the role of information in explaining the intraday return and volatility dynamics in international stock markets. The process through which the information is incorporated in stock prices is central to all information-based models. The intraday data facilitates the investigation that how information gets incorporated into security prices as a result of the trading behavior of informed and uninformed traders. Thus high frequency data appears critical in enhancing our understanding of intraday behavior of various stock markets’ variables as it has important implications for market participants, regulators and academic researchers.

Essays on the Linkages Between Financial Markets, and Risk Asymmetries (summary section only)

During the last few decades there have been far going financial market deregulation, technical development, advances in information technology, and standardization of legislation between countries. As a result, one can expect that financial markets have grown more interlinked. The proper understanding of the cross-market linkages has implications for investment and risk management, diversification, asset pricing, and regulation. The purpose of this research is to assess the degree of price, return, and volatility linkages between both geographic markets and asset categories within one country, Finland. Another purpose is to analyze risk asymmetries, i.e., the tendency of equity risk to be higher after negative events than after positive events of equal magnitude. The analysis is conducted both with respect to total risk (volatility), and systematic risk (beta). The thesis consists of an introductory part and four essays. The first essay studies to which extent international stock prices comove. The degree of comovements is low, indicating benefits from international diversification. The second essay examines the degree to which the Finnish market is linked to the “world market”. The total risk is divided into two parts, one relating to world factors, and one relating to domestic factors. The impact of world factors has increased over time. After 1993, when foreign investors were allowed to freely invest in Finnish assets, the risk level has been higher than previously. This was also the case during the economic recession in the beginning of the 1990’s. The third essay focuses on the stock, bond, and money markets in Finland. According to a trading model, the degree of volatility linkages should be strong. However, the results contradict this. The linkages are surprisingly weak, even negative. The stock market is the most independent, while the money market is affected by events on the two other markets. The fourth essay concentrates on volatility and beta asymmetries. Contrary to many international studies there are only few cases of risk asymmetries. When they occur, they tend to be driven by the market-wide component rather than the portfolio specific element.

The Relationship Between Liquidity, Trading Activity and Return - Studies of the Finnish and Swedish Stock Markets

Liquidity, or how easy an investment is to buy or sell, is becoming increasingly important for financial market participants. The objective of this dissertation is to contribute to the understanding of how liquidity affects financial markets. The first essays analyze the actions taken by underwriters immediately after listing to improve liquidity of IPO stock. To estimate the impact of underwriter activity on the pricing of the IPOs, the order book during the first weeks of trading in the IPO stock is studied. Evidence of stabilization and liquidity enhancing activities by underwriters is found. The second half of the dissertation is concerned with the daily trading of stocks where liquidity may be impacted by policy issues such as changes in taxes or exchange fees and by opening the access to the markets for foreign investors. The desirability of a transaction tax on securities trading is addressed. An increase in transaction tax is found to cause lower prices and higher volatility. In the last essay the objective is to determine if the liquidity of a security has an impact on the return investors require. The results support the notion that returns are negatively correlated to liquidity.

Short-term Price Behavior and the Effect of Foreign Investors in Finnish Equity Markets (summary section only)

As globalization and capital free movement has increased, so has interest in the effects of that global money flow, especially during financial crises. The concern has been that large global money flows will affect the pricing of small local markets by causing, in particular, overreaction. The purpose of this thesis is to contribute to the body of work concerning short-term under- and overreaction and the short-term effects of foreign investment flow in the small Finnish equity markets. This thesis also compares foreign execution return to domestic execution return. This study’s results indicate that short-term under- and overreaction occurs in domestic-buy portfolios (domestic net buying) rather than in foreign-buy portfolios. This under- and overreaction, however, is not economically meaningful after controlling for the bid-ask bounce effect. Based on this finding, one can conclude that foreign investors do not have a destabilizing effect in the short-term in the Finnish markets. Foreign activity affects short-term returns. When foreign investors are net buyers (sellers) there are positive (negative) market adjusted returns. Literature related to nationality and institutional effect leads us to expect these kind of results. These foreign flows are persistent at a 5 % to 21 % level and the persistence of foreign buy flow is higher than the foreign sell flow. Foreign daily trading execution is worse than domestic execution. Literature which quantifies foreign investors as liquidity demanders and literature related to front-running leads us to expect poorer foreign execution than domestic execution.

Increasing Knowledge Focus - a Means for Entrepreneurs to Remain on a Growth Path: Essays on the Role and Nature of Knowledge Management in Finnish SMEs (summary section only)

This study explores the role and nature of knowledge management (KM) in small and medium-sized companies (SMEs). Even though the role of knowledge as a competitive advantage is commonly recognized in the SME sector, almost no attention has been paid to the managing and developing of knowledge in SMEs. This thesis consists of three different sub-studies that were reported in four individual essays. The results of the questionnaire study indicate that nearly all companies that responded to the questionnaire (N = 108) found intangible assets, i.e. knowledge resources to be their main source of competitive advantage. However, only less than a third of the companies actively deal with knowledge management. The results also indicate a significant correlation between activity in knowledge management and sustainable organic growth of the company. The interview study (N = 10) explored the context and motives of the SMEs for managing their intangible assets, and the concrete practices of knowledge management. It turned out that KM facilitated change management, clarification of the vision and new strategy formulation. All the interviewed companies were aiming at improved innovation process, new ways of doing business and attaining an increased “knowledge focus” in their business. Nearly all also aspired to grow significantly. Thus, KM provides a strategy for these SMEs to guarantee their survival and sustainability in the turbulent markets. The action research was a process to assess and develop intangible resources in three companies. The experienced benefits were the clarification of future focus and strategy, creation of a common language to discuss strategic issues within the company, as well as improved balance of different categories of intangible assets. After the process all the case companies had developed in the chosen key areas. Thus, by systematic knowledge management the implementation of new strategic orientation (knowledge focusing) was facilitated. The findings can be summarized in two main points. First, knowledge management seems to serve the purpose of change, renewal and new strategic orientation in the SMEs. It also seems to be closely related to organic growth and innovation. All of these factors can be considered dimensions of entrepreneurship. Second, the conscious development of intangible assets can increase the balance of different categories of intangible assets and the overall knowledge focusing of business. In the case companies, this in turn facilitated the path to the improved overall performance.

Information Sharing in Banking: A Collusive Device?

We show that information sharing among banks may serve as a collusive device. An informational sharing agreement is an a-priori commitment to reduce informational asymmetries between banks in future lending. Hence, information sharing tends to increase the intensity of competition in future periods and, thus, reduces the value of informational rents in current competition. We contribute to the existing literature by emphasizing that a reduction in informational rents will also reduce the intensity of competition in the current period, thereby reducing competitive pressure in current credit markets. We provide a large class of economic environments, where a ban on information sharing would be strictly welfare-enhancing.

Short-Horizon Asymmetric Mean-Reversion and Overreactions: Evidence from the Nordic Stock Markets

This paper examines the asymmetric behavior of conditional mean and variance. Short-horizon mean-reversion behavior in mean is modeled with an asymmetric nonlinear autoregressive model, and the variance is modeled with an Exponential GARCH in Mean model. The results of the empirical investigation of the Nordic stock markets indicates that negative returns revert faster to positive returns when positive returns generally persist longer. Asymmetry in both mean and variance can be seen on all included markets and are fairly similar. Volatility rises following negative returns more than following positive returns which is an indication of overreactions. Negative returns lead to increased variance and positive returns leads even to decreased variance.

Intraday Linkages across International Equity Markets

Utilizing concurrent 5-minute returns, the intraday dynamics and inter-market dependencies in international equity markets were investigated. A strong intraday cyclical autocorrelation structure in the volatility process was observed to be caused by the diurnal pattern. A major rise in contemporaneous cross correlation among European stock markets was also noticed to follow the opening of the New York Stock Exchange. Furthermore, the results indicated that the returns for UK and Germany responded to each other’s innovations, both in terms of the first and second moment dependencies. In contrast to earlier research, the US stock market did not cause significant volatility spillover to the European markets.

On the Importance of Mutual Fund Families in Emerging Markets

This study contributes to the mutual fund literature by looking at performance persistence on a fund family level, allowing for individual equity, bond and balanced funds to be included under single family umbrellas. The study is conducted on the emerging Finnish mutual fund market, an environment in which the importance of superior fund family teams is likely to be accentuated. Using both non–parametric and parametric tests we find robust evidence of performance persistence for the fund families. Persistence is particularly strong in the first half of the investigation period, which highlights the importance of fund families at early stages of market development.

Cross-Border Competence Management in Emerging Markets: Voices from China and Russia

This book is on cross-border competence management in Russia and China. Corporations are facing a number of problems and challenges in their international operations, to which there typically are no simple solutions. For instance, they need to understand and respond to cultural and institutional diversity and ascertain that their foreign units are integrated with the rest of the corporation. Throughout this report we will discuss a range of challenges confronting firms as they seek to develop their capabilities to operate internationally. Some of the challenges are clearly case specific, and although this book aims to offer research-based advice to practicing managers there is a potential danger in applying lessons from other companies to the own firm. Our hope is that our analyses of the challenges facing Finnish corporations in China and Russia reported together with extensive quotes from our interviews and insights from other recent studies will help readers draw their own conclusions as to how to deal with issues related to competence management across borders. With this book we also aspire to contribute to the academic literature by providing new insights into cross-border competence management in general and the operations of Finnish corporations in Russia and China in particular.