UNIVERSITY OF ROCHESTER William E. Simon Graduate School of Business Administration FIN 532 Advanced Topics in Capital Markets Home work Assignment #4 Due: May 24, 2012 The point of this assignment is 1) to make sure that you don t get out of this class without knowing how to download and organize the basic CRSP and Compustat data; 2) to get you looking at real data before you actually have to produce a paper; and 3) to basically lower the bar to doing empirical work by giving you a starter library of code that can be modified and expanded in the future to suit your needs. The assignment will consequently be a lot more work, but a lot more valuable, to those early in the program. If you have your own code and are comfortable with your way of doing things, there s no need to use mine. The assignment: Please replicate some know result from the literature on the cross section of expected stock returns (see below for a list of possible topics but please feel free to choose a result that is not on the list). Please adhere to the following guidelines: Be skeptical! o There are at least a couple topics on the list where I think the data only provide very weak support (at best) for the authors claims. Please go beyond what was done in the literature in some dimension. I want you to (try to) replicate the basic empirical facts not replicate the paper. o How persistent are the strategy s abnormal returns (does the signal predicting returns only have highly transitory power)? o Is the result there outside the really small stocks? Almost everything is much stronger in the small caps. o Sub-sample (or out-of-sample) results? o Is it stronger in industries, or across industries? You do not need to do all of these. Please just pick some further dimension to explore that you think is particularly relevant to your topic (and it doesn t have to be one of those listed above). As data checks along the way my code looks at some very basic results (e.g., value and momentum). If you choose one of these topics, then I ll expect you to do more above and beyond the basic results. If you already have experience with these data, the please pick something you haven t looked at before.
2 o I ll also expect you to be a little more ambitious in your analysis. You don t need to write a paper. Turn in a few tables showing the basic results and the additional dimension you investigate. Include a brief summary (few paragraphs) summarizing what you found, and in what ways it s both consistent and inconsistent with the prominent literature. o Be concise! I do not want to see the results of every test you ran. It is as important to figure out what not to include as what to include Early in your career writing papers you ll have a hard time leaving out any table that has anything mildly interesting (they re your babies) but if a table isn t central to your story, then drop it! If you don t have your own code, I have posted a zip file ( Matlab_Package ). It has detailed instructions, and corresponding code, that will walk you through getting and organizing the data. Start with the word files CRSP data exercise and Compustat data exercise. Some topic suggestions The following topics are simply meant as possibilities (they are relatively easy, and can be done with the data from the exercises), and are no means meant to be exhaustive. Please feel free to pick a topic that does not appear on this list. Topic: Performance of the CAPM / Betting Against Beta Data Issues: Requires rolling estimates of stock betas the Make_betas script in the project folder helps with that. 1. Fischer Black, Michael Jensen, and Myron Scholes, The Capital Asset Pricing Model: Some Empirical Tests, Studies in the Theory of Capital Markets, Praeger Publishers Inc., 1972 (and easily available online). 2. Andrea Frazzini and Lasse Pedersen, Betting Against Beta, working paper, 2010. Topic: Value and Long Run Reversals 1. Werner De Bondt and Richard Thaler, Does the Stock Market Overreact? Journal of Finance, 1985. 2. Eugene Fama and Kenneth French, Common Risk Factors in the Returns of Stocks and Bonds, Journal of Financial Economics, 1993.
Topic: Characteristics vs. Covariances 3 Data Issues: Requires rolling estimates of stock betas the Make_betas script in the project folder helps with that. 1. Daniel, Kent, and Sheridan Titman, Evidence on the characteristics of crosssectional variation in common stock returns, Journal of Finance, 1997. 2. Daniel, Kent, Mark Grinblatt, Sheridan Titman, and Russ Wermers, Measuring Mutual Fund Performance with Characteristic-Based Benchmarks, 1997. 3. James Davis, Eugene Fama, and Kenneth French, Characteristics, covariances, and average returns: 1929-1997, Journal of Finance, 2000. Topic: Basic momentum 1. Narasimhan Jegadeesh, Evidence of Predictable Behavior of Security Returns, Journal of Finance, 1990. 2. Narasimhan Jegadeesh and Sheridan Titman, Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency, Journal of Finance, 1993. Topic: Industry and style momentum 1. Tobias Moskowitz, Do industries explain momentum? Journal of Finance, 1999. 2. Cliff Asness, Burt Porter and Ross Stevens, Predicting Stock Returns Using Industry- Relative Firm Characteristics, working paper, 2000. 3. Jonathan Lewellen, Momentum and Autocorrelation in Stock Returns, Review of Financial Studies, 2002. Topic: Momentum Refinements 1. Steven Heston and Ronnie Sadka, Seasonality in the Cross-Section of Stock Returns, Journal of Financial Economics, 2008. 2. Robert Novy-Marx, Is Momentum Really Momentum? Journal of Financial Economics, 2012.
Topic: Profitability 4 1. Eugene Fama and Kenneth French, Profitability, Investment and Average Returns, Journal of Financial Economics, 2006. 2. Robert Novy-Marx, The Other Side of Value: Good Growth and the Gross Profitability Premium. working paper. 3. Long Chen, Robert Novy-Marx, and Lu Zhang, An Alternative Three-Factor Model, working paper. Topic: Post Earnings Announcement Drift Data Issues: Requires quarterly earnings announcements and announcement dates see Getting the Quarterly Data in the project folder. 1. Ray Ball and Philip Brown, An Empirical Evaluation of Accounting Income Numbers, Journal of Accounting Research, 1968. 2. Victor Bernard and Jacob Thomas, Post-Earnings-Announcement Drift: Delayed Price Response or Risk Premium? Journal of Accounting Research, 1968. Topic: The Accruals Anomaly 1. Richard Sloan, Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings? Accounting Review, 1996. 2. Patricia Dechow and Ilia Dichev, The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors, Accounting Review, 2002. Topic: Mutual Fund Performance Persistence Data Issues: Requires mutual fund return data see Getting the Mutual Fund Data in the project folder. 1. Mark Carhart, On Persistence in Mutual Fund Performance, Journal of Finance, 1997.
5 Topic: Investment Anomalies (asset growth and capital expenditures) 1. Michael Cooper, Huseyin Gulaen and Michael Schill, Asset Growth and the Cross- Section of Stock Returns, Journal of Finance, 2008. 2. Sheridan Titman, K.C. John Wei, Feixue Xie, Capital Investments and Stock Returns, Journal of Financial and Quantitative Analysis, 2004. 3. Long Chen, Robert Novy-Marx, and Lu Zhang, An Alternative Three-Factor Model, working paper. Topic: Distress anomalies (e.g., the under-performance of troubled firms) Data Issues: Uses quarterly data see Getting the Quarterly Data in the project folder. 1. John Campbell, Jens Hilscher, and Jan Szilagyi, In search of distress risk, Journal of Finance, 2008. 2. James Ohlson, Financial ratios and the probabilistic prediction of bankruptcy, Journal of Accounting Research, 1980. Topic: Equity issuance and under-performance Data Issues: Works much better with quarterly data see Getting the Quarterly Data in the project folder. 1. Tim Loughran and Jay Ritter, The New Issues Puzzle, Journal of Finance, 1995. 2. Tim Loughran and Jay Ritter, The Operating Performance of Firms Conducting Seasoned Equity Offerings, Journal of Finance, 1997. Other possibilities The Stock Market Valuation of Research and Development Expenditures (Chan, Lakonishok and Sougiannis, JF 2001) also looks at advertising. Industry Concentration and Average Stock Returns (Hou and Robinson, JF 2006). Evaluate the performance of investment strategies from the popular literature (for example, Greenblat s Little Book That Beats the Market).