Volume 1, Number 3, 2000 Abstracts
© Copyright Erlbaum 2000
EDITORIAL COMMENTARY
The Old Psychology Behind "New Metrics" Cash Flow Is King? Cognitive Errors by Investors
Todd Houge
Tim Loughran
When investors fixate on current earnings, they commit a cognitive error and fail to fully value the information contained in accruals and cash flows. Extending the accrual anomaly documented by Sloan [1996], we identify significant excess returns from a cash flow-based trading strategy. The market consistently underestimates the transitory nature of accruals and the long-term persistence of cash flows. We find that the accrual anomaly derives from the poor performance of high accrual firms, which are more likely to manage earnings. Combining the accrual and cash flow information also reveals that investors misvalue the quality of earnings. Contrary to Fama [1998], these anomalies are robust to the three-factor model with equally or value-weighted portfolio returns.
Home Bias in International Stock Return Expectations
Michael Kilka
Martin Weber
Despite the advantages of international portfolio diversification, actual equity portfolio holdings reveal a strong bias towards domestic stocks. One hypothesis is that this bias can be explained by stock return expectations expressed in probability judgments. To test that hypothesis and to analyze the underlying effects that might cause distortions in investorsÕ expectations, we conducted a cross country study in Germany and the U.S. comparing participantsÕ judgments about an identical set of German and U.S. stocks.
The New Economy Creed: A Case of Thought Contagion
G. Glenn Baigent
William Acar
This paper looks at recent market-related events and the contention, gradually gaining credence in business circles, that we have entered an age of a New Economy. According to the New Economy view, the present upswing in the stock market will, at least in the U.S., last over the long run. This is an important issue on which hinge many important public and private decisions. Yet only special interest groups investigate it.
We attempt to take a dispassionate look at the New Economy thesis, so as to provide an explanation for some of the strange phenomena associated with this decade’s fixation on the stock market and financial rationality. We analyse the paradox of the belief in a one-way swing of the economic pendulum in terms of market fundamentals as well as investor sentiment, or potential irrationality. Our analysis confirms the early insights of Keynes and more recent views of Black. We conclude by formulating a few caveats for the true believers of this emerging "New Economy creed" as well as for its cynical detractors.
Market Efficiency or Behavioral Finance: The Nature of the Debate
George M. Frankfurter
Elton G. McGoun
Academic finance (also known as financial economics) espouses a methodology that has been largely discredited (or, at the very least, challenged) in all other disciplines, not to mention the philosophy of science itself. And this methodology is so ingrained that it is rarely even addressed, let alone seriously debated. The term behavioral finance, which ought to be applied to a different, more experimental methodological approach to finance, is instead applied to a set of papers that make slightly different assumptions in their mathematics/statistics without even using different methods.
Risk Aversion and the Investment Horizon: A New Perspective on the Time Diversification Debate
Sanjiv Jaggia
Satish Thosar
Investment managers generally subscribe to the principle of time diversification. This implies that a larger portion of the portfolio should be devoted to risky assets as the investment horizon increases. In contrast, academics have shown that for investors with utility functions characterized by constant relative risk aversion, the optimal asset-allocation strategy is independent of the investment horizon. The relative risk aversion in these studies is assumed to be constant both with respect to wealth as well as investment horizon. We suggest a utility function that explicitly captures the notion that individuals are more risk tolerant when the investment horizon is long, thereby validating the intuitively appealing time diversification argument.
