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Market Mispricing

Paper Session

Friday, Jan. 5, 2018 8:00 AM - 10:00 AM

Loews Philadelphia, Commonwealth Hall A2
Hosted By: American Finance Association
  • Chair: Jianfeng Yu, Tsinghua University

Hidden in Plain Sight: Equity Price Discovery With Informed Private Debt

Jawad Addoum
,
Cornell University
Justin Murfin
,
Yale University

Abstract

This paper examines how private information is (or is not) transmitted via prices across markets for related claims on firm cash flows. We show that equity markets fail to account for value relevant non-public information enjoyed by syndicated loan participants and reflected in publicly posted loan prices. A strategy that buys the equities of firms whose debt has recently appreciated and sells the equities of firms whose loans have recently depreciated earns as much as 1.4 to 2.2% alpha per month. The strategy returns are unaffected when focusing on loan returns that are publicly reported in the Wall Street Journal. However, when we condition on the subsample of equities held by mutual funds which also trade in syndicated loans, returns to the strategy are eliminated.

Competition and Momentum Profits

Gerard Hoberg
,
University of Southern California
Nitin Kumar
,
Indian School of Business
Nagpurnanand R. Prabhala
,
University of Maryland

Abstract

Fama and French (2008) point out that momentum is the premier anomaly confronting the finance profession. We develop a measure of buy-side competition for momentum investing and show that it explains abnormal momentum returns. Momentum is profitable when buy-side competition for exploiting momentum is low, including in the post-2000 sample. Momentum generates monthly alpha of more than 130 basis points, when competition is low, but does not yield significant alpha when competition is high.

ETF Arbitrage and Return Predictability

David Brown
,
University of Arizona
Shaun Davies
,
University of Colorado-Boulder
Matthew Ringgenberg
,
University of Utah

Abstract

Many finance models assume the existence of noise traders who push asset prices away from fundamental values. Yet empirically, these “animal spirits” are challenging to observe because fundamental values are inherently unobservable. We examine a novel database of trades by ETF authorized participants who specifically trade to correct violations of the law of one price. These trades allow us to measure arbitrage activity. We show that noise traders do not cancel each other out and arbitrage activity is associated with predictable price distortions. Our analysis indicates that noise traders exert a non-fundamental impact on market outcomes even when arbitrageurs are active. Thus, noise traders are not simply noise, they impact prices.

A Tug of War: Overnight Versus Intraday Expected Returns

Dong Lou
,
London School of Economics
Christopher Polk
,
London School of Economics
Spyros Skouras
,
Athens University of Economics and Business

Abstract

We provide new evidence about the cross-section of average stock returns through a careful examination of exactly when expected returns occur. Momentum and short-term reversal profits accrue entirely overnight while profits to all other trading strategies studied occur entirely intraday. In fact, for many of these anomalies, their overnight/intraday returns are larger than close-to-close returns as there is a partially-offsetting intraday/overnight premium of the opposite sign. We postulate that our findings are potentially consistent with a clientele explanation. We first document strong overnight and intraday return continuation, as well as cross-period reversal effects, all lasting for years. Using this novel overnight/intraday clientele lens, we argue that a relatively large difference between overnight and intraday returns reveals the extent to which investor clienteles are engaged in a "tug of war" over the direction of the strategy in question. All else equal, if the current tug of war is more contentious, the side betting to take advantage of the close-to-close pattern is more likely to be constrained and thus are more likely to leave part of the abnormal returns unexploited. Indeed, a one-standard-deviation increase in a strategy's smoothed overnight-intraday return spread forecasts a close-to-close strategy return in the following month that is 1% higher.
Discussant(s)
Xing Huang
,
Michigan State University
Kent Daniel
,
Columbia University
Itzhak Ben-David
,
Ohio State University and NBER
Joseph Engelberg
,
University of California-San Diego
JEL Classifications
  • G1 - General Financial Markets