Author's School

Olin Business School

Author's Department/Program

Business Administration

Language

English (en)

Date of Award

1-1-2012

Degree Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Chair and Committee

Ohad Kadan

Abstract

My dissertation studies several topics related to the anomalous behavior of stock returns in the time series and cross section. It includes three parts. The first part investigates the relation between leverage and stock returns. First, we provide the first empirical evidence that this relation is masked by maturity: stocks with higher short-maturity debt earn significantly higher returns, but stocks with higher long-maturity debt earn lower returns. The opposite directions separated by maturity help explain why the relation between leverage and returns has been mixed. We further show that the positive short-maturity return spread is significant, persistent, and not explained by well-known risk factors: such as size or book to market). Second, we also provide the first theoretical model to explain the relation between maturity-related leverage and stock returns by endogenizing debt maturity; Firms optimally choose the maturity of their debt by trading off the cost of long term maturity with its financial risk on equity. Firms with lower credit quality find it more expensive to borrow long term, so they optimally have debt with shorter maturity. In equilibrium, firms with higher short-term debt or lower long-term debt are riskier firms and earn higher expected returns. We show that the empirical evidence we uncover can be consistent with theoretical predictions. In the second part; my co-authors, Long Chen, Ohad Kadan and I demonstrate an inconsistency of the momentum and reversal effects in explaining stock return dynamics. We argue that a two-way sorting based on long-term and recent performance can accommodate the two effects by distinguishing between fresh and stale winners and losers. Building on this idea, we propose a 'fresh momentum' strategy which invests in fresh winners and fresh losers only. This strategy generates a fresh momentum profit of 5.1\% per year even after controlling for the Carhart four-factor model: including momentum). To explain the phenomenon, we argue that investors mistakenly respond to shocks to firm fundamentals as if they are going to continue in the long run, and these mistakes are exacerbated for fresh momentum stocks, presumably generating the abnormally large returns over the short run. This hypothesis is strongly supported by evidence from earnings shocks, analyst forecast revisions, and post-earnings announcement returns. In the third part, my co-author, Long Chen and I provide one of the first papers to document extensive stock return anomalies at the industry level. We find smaller industries, industries with lower investment and industries with lower inventory changes have bigger average industry returns. Value industries have lower industry returns in contrast to higher average returns of value firms. These anomalies are robust to even controlling for known: firm-level sorted) risk factors. We further explore the relation between these anomalies and business cycles. We find consistent business cycle dynamics with the return spreads associated with these anomalies.

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Permanent URL: http://dx.doi.org/10.7936/K7HX19QQ

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