Professional Documents
Culture Documents
Presented to,
Raza Yaqoob
M.Com (Finance)
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
In The Name of ALLAH, the Compassionate The Merciful Praise be to Allah, Lord of the world, the Compassionate the Merciful Master of the Day Judgment, You Alone We Worship, and to You Alone We Look for Help Guide Us to the Straight Path the Path of Those upon who bestowed not Those ho Have Invited Your Worth Not Those Who Have Goane a Stray?
(AL-FATIHA)
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
ACKNOWLEDGEMENT
I start my work on the assigned topic the name of ALLAH, the most Beneficent and Merciful, the Creator of the universe, Who gave me strength , ability and courage to fulfill the requirement of this thesis, I offer Darood Pak to the holy prophet Muhammad (Peace be upon him) Who showed the right path to the mankind. I am very thankful of my teacher and University Management that give me chance of research and assigned the topic which I require I chose this topic because I think may be my research help to economic situation of the world as well as Pakistan and .I would like to thank to my family and especially my parents and brother for their underlying love, prayers and encouragement. I admire my family members their determination and sacrifices at this level. It is through their encouragement and care that i have through all the steps to reach this point in life and would not have done it without them. I am highly grateful to my kind natured, dedicated, sincere and devoted supervisor Sir Osman Saeed who solves my problems during research. His worthy comments, suggestions and valuable guidance enable me in enhancing and improving my capabilities. Without his generous help and guidance it was not possible for me to complete this work. I can offer just a little acknowledgement for his very kind guidance, cooperation and great care in preparing this thesis. I am highly obliged and owe him deep thanks. And at the end I am very thankful to all the authors of various books, articles, research papers and journals. During the working I get help from so many articles and journals.
Raza Yaqoob
_____________________________________________________
The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Brief Contents
Details Acknowledgment
Page No 3
Chapter #1
Capital Market 1.1 Introduction of Capital Market 1.2 Capital Market Resources 1.3 Today Types of Capital Market 9 9 11
Chapter #2
New York Stock Exchange 2.1 Introduction 2.2 Position of NYSE in World & US Capital Market 2.3 NYSE is a Hybrid Market 2.3.1 Floor Brokers 2.3.2 Specialist 2.4 Marketplace Technology 2.5 How a Stock is Buy & Sell 2.6 NYSE Regulations 2.7 Types of Stock 2.7.1 Income stock 2.7.2 Blue Chip Stocks 2.7.3 Growth Stock 2.7.4 Cyclical Stock 2.7.5 Defensive stock 2.8 Mutual Funds 2.9 Exchange Traded Funds 2.10 Fixed Income Securities 2.11 Structured Products 2.12 Options 2.13 How to Read a Stock Table 12 12 12 13 14 14 14 15 18 18 18 18 18 19 19 19 19 19 20 20 20
Chapter #3
5
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Share Prices 3.1 What Drives Share Prices 3.2 Demand & Supply 3.3 News 3.4 Price Earning Ratio 3.5 Market Cap 3.6 EPS (Earning Per Share) 3.7 Indexes 3.8 A Companys Financial Health 3.9 Industry Information 3.10 Political Instability 3.11 War & Terror 3.12 International Relation 3.13 Economic Trends 3.14 World and National Events
22 22 25 25 26 26 26 27 27 27 28 28 28 28
Chapter #4
Insider Trading 4.1 Insider 4.2 Insider Trading US Market 4.3 American Insider Trading Law 4.4 Legal Insider Trading 4.5 Illegal Insider Trading 4.6 SEC Regulations 4.7 Liability for Insider Trading 4.8 Trading on Information in General 4.9 Security Analysis and Insider Trading 4.10 Why Follow Insiders? 4.11 Insider Qualification 4.12 One Reason to Buy 4.13 Insider Sentiment 4.14 Who Insider 4.14.1 Position 4.14.2 Historical performance 4.15 Commitment 4.15.1 Dollar Amount 29 29 30 30 30 31 31 31 31 32 32 32 33 33 33 33 34 34 6
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
4.15.2 Change in total holdings 4.16 Consensus 4.16.1 How many insiders are purchasing 4.16.2 What the overall trend has been 4.17 Summary 4.18 Effects of Insider in the Stock 4.18.1 Significant of Insider Trading 4.18.2 Identification of Insider Trading 4.18.3 SEC Disclosure Requirements 4.18.4 Potential Benefits from Insider Trading 4.18.5 Famous example of Insider Trading 4.19 The Effects of Insider Trading Regulation on Trading Timing and, Litigation Risk and Profitability 4.19.1 Hypothesis Development 4.19.2 Insider Trading Profitability 4.19.3 Conclusion
34 34 34 34 35 35 35 35 36 36 36 36 37 39 39
Chapter #5
Institutional Trading 5.1 Institutional Trading, Trading Volumes and Spread 5.2 Introduction 5.3 Effect of Institutional Trading On Securities Prices 5.4 Provide Liquidity 5.5 I.T How Affect the Individual components of the spread 5.6 Our Approach 5.7 Buying & Selling 5.8 Negative Slope 5.9 Motivation 5.10 Regression Frame Work 5.11 Components of Spread 5.11.1 Effect on Components 5.11.2 According to Some Experts 5.12 Regression Model & Data Description 5.13 Data for Institutional Trading 5.14 Regression Results of Panel Model 5.15 Conclusion 41 41 41 42 42 42 43 43 43 44 44 44 45 46 46 48 49
Chapter #6
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
NYSE Sector Indexes 6.1 Methodology Guide 6.2 Index Overview and Description 6.3 Key Feature 6.3.1 Membership Criteria 6.3.2 Base Data & Base Value 6.3.3 Calculation and Dissemination 6.3.4 Index Divisor Adjustment 6.3.5 Weighting 6.3.6 Dividend Treatment 6.4 Index Maintenance 6.5 Constituent Change 6.5.1 Additions 6.5.2 Deletion 6.6 Changes in Share out Standing 6.7 Index Divisor Adjustment 6.7.1 Formula for Divisor adjustment 6.7.2 Adjustment of Corporate Actions 6.8 Index calculation Methodology 6.8.1 Input Data 6.8.2 Input Formula 6.8.3 Computational Precision 6.8.4 Intraday Corrections 6.8.5 Index-Related Data and Divisor Corrections 6.9 Float Adjustment 6.10 First Regular Index Performance Report
50 50 50 50 51 51 51 53 53 53 54 54 54 54 55 55 57 57 58 58 58 59 59 60
Chapter #7
News Announcement 7.1 Introduction 7.2 Types of News 7.2.1 Positive News 7.3 Affect on Share Prices 7.3.1Trade Volume / Index 7.4 Demand & Supply 7.4.1 Example 7.4.2 Case 62 62 62 62 63 63 64 65 8
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Chapter #8
Efficiency 8.1 Market Efficiency 8.2 Forms of Efficiency 8.2.1 Weak form Efficiency 8.2.1.1 Tests of Weak form efficiency 8.2.1.2 Rules for the efficiency tests 8.2.2 Semi Strong Form efficiency 8.3 Technical Analysis 8.4 Behavioral Finance 8.5 NYSE Efficient Hypothesis 8.6 Efficient Market Hypothesis 8.7 Decision Negative Positive Actual Situation 8.8 Discussion 67 67 68 68 68 69 70 70 70 71 71 72
Chapter # 9
Conclusion Bibliography References 73 75 75
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Chapter # 1
Capital Market
1.1 Introduction
The financial markets are an important part of our daily lives. Making sure we are financially secure is a vital part of how our economy grows. And investing in securities is often a significant component of an investors portfolio. Owning stock means you own a slice of a public company. These companies span the global economy and form the core of our private enterprise system. They spur job creation and economic growth while creating products and providing services that improve our quality of life. When a company needs to raise money to expand, it sells stocks or bonds to the public through the financial markets. Individuals become investors in this company by purchasing those securities. More than 90 million Americans own shares of stock through individual investments or through mutual funds. And many more participate in the stock market through the investments of retirement funds, insurance companies, universities and banks. Owning stock allows investors, large and small, to share in the worlds economic growth and vitality. Central to this activity is the NYSE marketplace, where billions of dollars worth of stock change hands each day. Only the highest quality companies can choose to list their securities on the NYSE. And once they do, the NYSE plays a unique role in providing deep and liquid markets for the trading of those securities, benefiting all investors, large
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
buildings, airplanes, trains, ships, telephone lines, and other assets; to conduct research and development; and to support a host of other essential corporate activities. Much of the money comes from such major institutions as pension funds, insurance companies, banks , foundations, and colleges and universities. Increasingly, it comes from individuals as well. More than 40 percent of U.S. families owned common stock in the mid-1990s. Very few investors would be willing to buy shares in a company unless they knew they could sell them later if they needed the funds for some other purpose. The stock market and other capital markets allow investors to buy and sell stocks continuously. The markets play several other roles in the American economy as well. They are a source of income for investors. When stocks or other financial assets rise in value, investors become wealthier; often they spend some of this additional wealth, bolstering sales and promoting economic growth. Moreover, because investors buy and sell shares daily on the basis of their expectations for how profitable companies will be in the future, stock prices provide instant feedback to corporate executives about how investors judge their performance. Stock values reflect investor reactions to government policy as well. If the government adopts policies that investors believe will hurt the economy and company profits, the market declines; if investors believe policies will help the economy, the market rises. Critics have sometimes suggested that American investors focus too much on short-term profits; often, these analysts say, companies or policy-makers are discouraged from taking steps that will prove beneficial in the long run because they may require short-term adjustments that will depress stock prices. Because the market reflects the sum of millions of decisions by millions of investors, there is no good way to test this theory. In any event, Americans pride themselves on the efficiency of their stock market and other capital markets, which enable vast numbers of sellers and buyers to engage in millions of transactions each day. These markets owe their success in part to computers, but they also depend on tradition and trust the trust of one broker for another and the trust of both in the good faith of the customers they represent to deliver securities after a sale or to pay for purchases. Occasionally, this trust is abused. But during the last half century, the federal government has played an increasingly important role in ensuring honest and equitable dealing. As a result, markets have thrived as continuing sources of investment funds that keep the economy growing and as devices for letting many Americans share in the nation's wealth.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
To work effectively, markets require the free flow of information. Without it, investors cannot keep abreast of developments or gauge, to the best of their ability, the true value of stocks. Numerous sources of information enable investors to follow the fortunes of the market daily, hourly, or even minute-by-minute. Companies are required by law to issue quarterly earnings reports, more elaborate annual reports, and proxy statements to tell stockholders how they are doing. In addition, investors can read the market pages of daily newspapers to find out the price at which particular stocks were traded during the previous trading session. They can review a variety of indexes that measure the overall pace of market activity; the most notable of these is the Dow Jones Industrial Average (DJIA), which tracks 30 prominent stocks. Investors also can turn to magazines and newsletters devoted to analyzing particular stocks and markets. Certain cable television programs provide a constant flow of news about movements in stock prices. And now, investors can use the Internet to get up-to-the-minute information about individual stocks and even to arrange stock transactions and small.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Chapter # 2
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
transfers from other markets or as non-U.S. companies cross-listing at exchanges worldwide Listed companies pay both initial listing fees and annual fees. In return, their stock is bought and sold on the NYSE or NYSE Arca, following rules set by the Securities and Exchange Commission (SEC), a U.S. federal government agency, and NYSE Regulation Inc. S M, the independent NYSE Group subsidiary that regulates the NYSE and NYSE Arca markets. This publication focuses on the NYSE, the worlds premier equities marketplace. In addition to having the highest overall listing standards of any securities marketplace in the world, the NYSE is among the worlds most well-recognized brand names. For 214 years, the NYSE has facilitated national and global capital formation and symbolized the strength and vitality of the U.S. securities markets. Issuers that list with the NYSE benefit from association with this brand name while gaining access to the worlds largest, most liquid market for the trading of their securities. When companies first list on the NYSE, the companys top officials are often invited to ring the opening BellSM on the NYSE Trading Floor. Ringing the Bell, which signals the start and close of the trading day, is part of the NYSEs rich heritage and signifies the opportunities the financial markets provide
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
2.3.1 Floor Brokers Brokers represent public orders to buy or sell shares and work to get their customers the best price. Brokers participate both in person and electronically on the Trading Floor and have advanced tools to assist them in handling trades on behalf of their clients. Two main types of floor brokers work on the Trading Floor: house brokers and independent brokers. House brokers are employed by brokerage firms that hold accounts for public investors. These market professionals buy and sell securities as an agent for their customers. The majority of independent brokers are direct access brokers who deal with institutional investors at low commission rates. 2.3.2 Specialists
Each stock listed on the NYSE is allocated to a specialist, a market professional who acts as the contact point between brokers with orders to buy shares and brokers with orders to sell shares. Specialists act as auctioneers in the specific stocks they are designated to trade at a designated location, called a trading post. All buying and selling of a given stock occurs at that location. Specialists use enhanced technology to bring buyers and sellers together, improve prices, and serve as a point of accountability for the smooth functioning of the market. The Hybrid Market automates much of what specialists do, helping them become much more efficient.
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
7. At the specialist workstation both orders are represented as auction market orders in order to have the opportunity for price improvement. The specialist who handles XYZ makes sure the transactions are executed fairly and in an orderly manner. 8. After the transaction is executed, the specialists workstation sends notice to the firms originating the orders and to the consolidated tape so that a written record is made of every transaction 9. The transaction is reported by computer and appears on the consolidated tape displays across the country and around the world. 10. The transaction is processed electronically, crediting Toms brokerage firm and debiting the account of Dianes brokerage firm. Toms broker calls him and tells him at what price he bought 300 shares of XYZ. In a couple of days, Tom receives a written confirmation in the mail. Diane receives confirmation from her brokerage firm electronically on her computer within seconds. These confirmations describe the trade, its terms and conditions, and the exact amount to be paid or received. 11. Tom settles his account within 11a. Dianes trade is also settled in three business days after the three business days. Her account will be transaction by submitting credited with the proceeds of the sale of payment to his brokerage firm for stock, minus any applicable the 300 shares of XYZ, plus any commissions. Tom settles his account 17
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
applicable commissions.
within three business days after the transaction by submitting payment to his brokerage firm for the 300 shares of XYZ, plus any applicable commissions.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
growth stocks are riskier than other types of stocks but also offer more appreciation potential. 2.7.4 Cyclical Stocks are issued by companies that are affected by general economic trends. The prices of these stocks tend to go down during recessionary periods and increase during economic booms. Examples of cyclical stock companies include automobile, heavy machinery and home building. 2.7.5 Defensive Stocks are the opposite of cyclical stocks. Defensive stocks issued by companies producing staples such as food, beverages, drugs and insurance typically maintain their value during recessionary periods.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
amounts at a specified coupon, or interest rate, with a set maturity date at which time the obligation must be repaid. Many debt issues may be redeemed, or called, by the issuer prior to the maturity date if specified in the issues indenture. The NYSE operates the largest centralized bond market of any U.S. securities exchange. It offers investors a broad selection of bonds: corporate (including convertibles), agency and government bonds. The majority of NYSE bond volume is in corporate debt issues. NYSE bonds trade through the Exchange's Automated Bond System (ABS), a screen-based system used by NYSE member firm subscribers. ABS reports real-time quotes and trades to market data vendors.
2.12 Options
An option is a contract to buy or sell a specific financial product, which is called the options underlying instrument or underlying interest. For equity options, the underlying instrument is a stock, ETF or similar product. The contract itself is very precise. It establishes a specific price, called the strike price, at which the contract may be exercised. And it has an expiration date. When an option expires, it no longer has value and no longer exists. Options are most frequently used to remove market risk in owning or trading in an individual security or market segment
52-weeks Hi/Lo:
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
The highest and lowest prices paid for Future Comm. stock during the past year. The numbers used to be expressed in fractions but now all prices have been converted to decimals so they can be read as dollars and cents. In this case, the stocks price has been between $80.06 and $132.94 per share over the past year. Knowing the past years high and low can help an investor evaluate a stocks current price. Stock: The name of the company. Sym: The stocks trading symbol. To avoid confusion and simplify the order process, every stock that is traded on a securities market is assigned a symbol. Some newspapers do not provide the stocks trading symbol but instead provide an abbreviation of the companys name. Many financial websites let you type in a companys name and quickly find out its symbol. Div: Short for dividend. For each share of stock owned, a Future Comm. shareholder should receive 56 cents from the companys annual profits. Payment is usually made on a quarterly basis. Not all companies pay dividends all the time. The companys board of directors decides whether a dividend will be paid and its amount. When companies are just starting out they usually do not pay a dividend because if they are making a profit they are reinvesting it back into the company to accelerate growth. Yld: The yield, or the rate of return, on a stockholders investment. It is figured by dividing the annual dividend by the current price of the stock. Future Comm. Stockholders earn 0.6% of todays stock price from dividends. PE: Short for price/earnings ratio. The price of a share of stock divided by the companys earnings per share for the last year. Vol 100s: The total amount of stock traded during the previous day. On that day, 10,092,700 shares of Future Comm. stock changed hands. The number does not include odd lots, which are sales of less than 100 shares. Close: The last price paid for this stock at the end of the previous day was $96.47. Net Chg: The last price on the previous day, $96.47, was 12 cents less than the last price on the preceding day.
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The university of Lahore, City Campus.
Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Chapter # 3
Share Prices
3.1 What Drives Share Prices
Theres truth to the old Wall Street adage that says a stock is worth what somebody is willing to pay for it. In essence, thats because the price of a stock is determined by buyers and sellers. As they weigh information about the company, the economy and their own investment goals, investors decide whether they are willing to pay more or less for a stock. Like any other commodity, in the stock market, share prices are also dependent on so many factors. So, it is hard to point out just one or two factors that affect the price of the stocks. There are still some factors that are that directly influence the share prices.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
The downward sloping line is the demand curve, while the upward sloping line is the supply curve. The demand curve indicates that if the price were $10, the demand would be zero. However, if the price dropped to $8, the demand would increase to 4 units. Similarly, if the price were to drop to $2, the demand would be for 16 units. The supply curve indicates how much producers will supply at a given price. If the price were zero, no one would produce anything. As the price increases, more producers would come forward. At a price of $5, there would be 5 units produced by various suppliers. At a price of $10, the suppliers would produce 10 units. The intersection of the supply curve and the demand curve, shown by (P*, Q*), is the market clearing condition. In this example, the market clearing price is P*= 6.67 and the market clearing quantity is Q*=6.67. At the price of $6.67, various producers supply a total of 6.67 units, and various consumers demand the same quantity.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
By now, the attentive reader may have noted a quirk specific to the analysis of demand and supply. In the analysis, it is the price that is first set (i.e., it is the independent variable) and the quantity is the result of the analysis (i.e., the dependent variable). However, on a Demand and Supply graph, the quantity is shown on the horizontal axis and the price on the vertical axis. This reverses the norm for charting, in which the horizontal axis represents the independent variable and the vertical axis the dependent variable. Excel sticks to the norm and expects that in a two-column XY Scatter chart, the first column is the independent variable to be shown on the horizontal (x) axis. In our analysis, we put the price -- the independent variable -- in the first column, but then plot it on the vertical axis. The easiest way to handle this 'difference in expectations' is with an extra column as shown on the right. Note that column D is a copy of column A. It is possible to plot the data without use of the extra column but it requires a little extra work.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Scatter Chart
Once price data set is duplicated in column D, plot columns C and D in a XY Scatter chart as shown on the right.
3.3 News
News is undoubtedly a huge factor when it comes to stock price. Positive news about a company can increase buying interest in the market while a negative press release can ruin the prospect of a stock. Having said that, you must always remember that often times, despite amazingly good news, a stock can show least movement. It is the overall performance of the company that matters more than news. It is always wise to take a wait and watch policy in a volatile market or when there is mixed reaction about a particular stock.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
stocks in the market to get the market cap of a company and that is the worth of the company.
3.7 Indexes
When you hear on the news that stock prices or the market was up, reporters are generally referring to an index. A stock index is a specific group of stocks, and whether its value is up or down reflects the combined price movements of the stocks in the index. The stock market reports its moves through a variety of indexes, because no single index can tell investors everything they need to know. Widely cited indexes include the Dow Jones Industrial Average, which tracks the stock prices of 30 key blue chip1 companies; the S&P 500, which tracks the stock prices of 500 large U.S. companies; and the NYSE Composite Index, which tracks the prices of all the common stocks listed on the New York Stock Exchange
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Supply and demand explains why individual stock prices fluctuate. But how do investors decide whether it is a good idea to buy or sell a particular stock at a given price? First, they need to consider the financial health of the company whose stock they are considering buying or selling. If it looks like a company is going to lose money perhaps the company just announced poor earnings then its stock has less value. Investors will pay more for a company with a history of earning strong profits and consistently paying healthy dividends.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Chapter # 4
Insider Trading
It is the trading of a corporation's stock or other securities (e.g. bonds or stock options) by individuals with potential access to non-public information about the company. In most countries, trading by corporate insiders such as officers, key employees, directors, and large shareholders may be legal, if this trading is done in a way that does not take advantage of non-public information. However, the term is frequently used to refer to a practice in which an insider or a related party trades based on material non-public information obtained during the performance of the insider's duties at the corporation, or otherwise in breach of a fiduciary duty or other relationship of trust and confidence or where the non-public information was misappropriated from the company.
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be based on material non-public information, some investors believe corporate insiders nonetheless may have better insights into the health of a corporation (broadly speaking) and that their trades otherwise convey important information (e.g., about the pending retirement of an important officer selling shares, greater commitment to the corporation by officers purchasing shares, etc.)
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
Insider trading, or similar practices, are also regulated by the SEC under its rules on takeovers and tender offers under the Williams Act
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
the mosaic theory. This information may include non-material nonpublic information as well as material public information, which may increase in value when properly compiled and documented. In May 2007, a bill entitled the "Stop Trading on Congressional Knowledge Act, or STOCK Act" was introduced that would hold congressional and federal employees liable for stock trades they made using information they gained through their jobs and also regulate analysts or "Political Intelligence" firms that research government activities. The bill has not passed
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2.They think that their company is undervalued and they believe that with time the market will correct by increasing the stock price.
4.14 Who
When researching insider activity at a company, first look to see who is doing the purchasing. Not all insiders are created equal, and identifying the best insiders to follow will help you prioritize the companies to investigate further. When evaluating a purchaser, take a look at their: 4.14.1 Position While all insiders are well-qualified to evaluate a company's future prospects, take a close look at purchases made by top executives (e.g. CEO, COO, CFO, etc.). These C-Level officers have the most comprehensive insight into a company and are the company's most skilled and experienced businesspeople. Members of the board of directors and other corporate officers (Vice Presidents, etc.) also have deep insight into a company's operations.
4.14.2
Historical performance
Look also at how insiders have performed with their past purchases. Some insiders are better than others at identifying and taking advantage of situations where the market has temporarily undervalued their company. An insider who has done well on a number of past purchases is a good bet to perform well on a recent purchase as well.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
4.15 Commitment
When investors are more confident in a company, they're willing to commit larger amounts of money to it. When evaluating an insider's commitment to their company, take a look at: 4.15.1 Dollar Amount When insiders are more confident of their company's future prospects, they invest more so that they can make more. Disregard small or regular purchases that can be attributed to retirement plan contributions or participation in an employee stock purchase program, and are not indicative of bullish behavior.
4.15.2
For those insiders who are not multi-millionaires, even a relatively small purchase can significantly increase their personal holdings. This significant increase in holdings signals a strong confidence in the company and the insider's correspondingly bullish outlook.
4.16 Consensus
While any purchase by an insider is a vote of confidence in that company's future, you should also look to see what other insiders at that company have been doing to see if there is a consensus of opinion forming. If multiple insiders are showing bullish signs, you can be more confident in that company's future. When evaluating consensus within a company, take a look at:
4.16.1
When two or more insiders are purchasing at the same time, it shows that a consensus of opinion has formed in the company regarding its future prospects. This reduces the chance that any one insider has misinterpreted data and increases the likelihood that the stock price will raise.
4.16.2
As a group, insiders sell their own stock far more often than they buy it. This is in no small part due to the fact that they have a large part of their compensation in the form of options and/or grants, and this selling is in essence cashing part of their 35
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paycheck. However, if insiders are selling less than they historically have, this may send a signal a change in sentiment about the company's future prospects.
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
4.19 The Effects of Insider Trading Regulation on Trade Timing, Litigation Risk, and Profitability
The working on Insider Trading show how firms and insiders respond to changes in insider trade-related litigation risk by analyzing the effects of changes in insider trade regulation on firm-level litigation risk and on insiders trade distribution before and after earnings announcements. Prior literature documents that insiders modify trade patterns when faced with increased litigation risk.1 However, there is little evidence of the net effect of insider trade regulation on total firm-level litigation risk when considering the changes in trading patterns documented in prior research. This study utilizes a simultaneous equations approach to directly examine 37
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both (1) the association between increased insider trade regulation and changes in observed insider trade patterns and (2) the association between changes in observed insider trade patterns and total firm litigation risk. By examining these two associations we develop a better sense of the true impact of insider trade regulation on firms risk environment. There is still uncertainty regarding the degree to which insider trade regulation has an effect on insider trade behavior. For example, Seyhun (1992) finds that insiders reduce timely trade before major firm events such as earnings and takeover announcements; however, he does not find a decrease in abnormal insider trade profits or volume associated with passage of two regulatory Acts that materially increase penalties for illegal trade.2 We find evidence that increased insider trade regulation is associated with shifts in insider trade activity from periods that precede earnings announcements to periods that follow earnings announcements. This is consistent with prior evidence that insiders appear to avoid trade before 4.19.1 Hypothesis development This study focuses on determining the degree to which litigation risk affects insider trade patterns and the degree to which insiders trade patterns affect litigation risk. Prior research has generally focused only on the former question, thereby leaving open the question of how the endogenous nature of insider trade regulation impacts firms. Because insider trade regulation generally increases insiders trade-related litigation costs, prior research hypothesizes that insiders profits and timely trade volume are negatively associated with increased regulation or enforcement. We present similar hypotheses regarding insiders trades surrounding earnings announcements because these announcements are the most common source of price-relevant news for most firms. Also, as previously noted, there is survey evidence (e.g., BCL; Jeng, 1999) suggesting firms often limit their insiders ability to trade before earnings announcements. Specifically, we hypothesize that:
H1A: Insiders trade more volume after earnings announcements relative to volume before earnings announcements. 38
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H1B: The proportion of insiders trade volume after earnings announcements relative to before earnings announcements is positively associated with the passage of regulatory acts that increase illegal insider trade-related penalties. Firms at risk of shareholder lawsuits are especially sensitive to revelations of insiders trading on price-relevant information. Johnson et al. (2006) show that abnormal insider selling correlates with the initiation and outcomes of shareholder lawsuits. Similarly, Griffin and Grandest (2002) show that firms sued by shareholders exhibit higher insider selling than control firms. It is possible that firms that face higher litigation risk will enforce more stringent restrictions on insiders trade activity before material news events like earnings announcements. It is also possible that insiders at firms that face higher litigation risk infer higher trade-related litigation costs associated with trades executed before material news events like earnings announcements. In either case, we hypothesize that: H2A: The proportion of insiders trade volume after earnings announcements relative to before earnings announcements is positively associated with a firms expected level of litigation risk. Since insider trade activity is a key component of firm level litigation risk (Johnson et al., 2006), presumably less timely trade should be associated with lower overall firm-level litigation risk. If firms restrict insiders trades or if insiders simply choose to trade less before material news events like earnings announcements, this should, in turn, reduce the likelihood that the firm will face litigation costs. Specifically, we hypothesize that: H2B: Firm-level litigation risk is negatively associated with the proportion of insiders trade volume after earnings announcements relative to before earnings announcements. Our final hypothesis investigates the economic effects of insider-trading legislation. Similar to Seyhun (1992), we investigate whether insider profits have declined after increases in regulation. Seyhun (1992) does not find evidence of a reduction in insiders trade profitability associated with the increased penalties from either ITSA or ITSFEA . H3A: Active (passive) profits from insiders trades are negatively (positively) associated with the passage of regulatory acts that increase illegal insider trade-related penalties. 39
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H3B: Active profits from insiders trades are negatively associated with the response of firms and insiders to the passage of regulatory acts that increase illegal insider trade-related penalties. 4.19.2 Insider-Trading Profitability Our final set of results concern changes in the profitability of insider trading over time. If changes in regulation and litigation risk have prompted insiders to trade during times of low litigation risk (or prompted firms to better monitor insiders trade activity), we would expect to see reductions in the ability of insiders to exploit their private information. We test this proposition by examining changes (postITSA and post-ITSFEA) in abnormal returns to insider-trading events. We measure changes in profitability by regressing firms monthly excess returns on risk factors and indicator variables that capture mean profit shifts across insider-trading event 4.19.3 Conclusion This study examines how insider trades are affected by increases in insider-trading regulation. We find that insider-trading legislation is positively associated with the tendency of insiders to trade after, relative to before, earnings announcements. This is consistent with firms and insiders adopting self-imposed limits on trading during times of high information asymmetry when the penalties for trading on private information increase. Examining the simultaneous relation between litigation risk and insider timing, we find some evidence of a positive association between increased litigation risk and insiders trade volume after, relative to before, earnings announcements, consistent with insiders seeking to avoid litigation risk or with firms increasing restrictions on insiders trade. Our results also suggest that increased trade after, relative to before, earnings announcements, is negatively associated with firms overall litigation risk (as measured by the incidence of shareholder lawsuits). Regarding insiders trade strategies, the evidence suggests that insiders passive profits (earned when insiders delay trades until after the revelation of price-relevant information such as selling after good news) are positively associated with the passage of the Insider Trading and Securities Fraud Enforcement Act of 1988. The documented increase in passive trading seems a rational response to the regulation since passive strategies are much less likely to trigger insider-trading violations. Evidence also suggests, however, that insiders active profits (earned when insiders trade prior to the revelation of price-relevant information such as selling before bad news) are positively associated with the passage of ITSFEA. However, examining 40
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subsets of firms defined by whether they respond to ITSFEA by moving trading after earnings announcements, we provide some evidence that responding firms have lower increases in abnormal profits to insider trading than non-responding firms. Thus, ITSFEA appears to have some effects on the ability of insiders to exploit their private information. Our results provide evidence regarding the economic impact of insider-trading regulation, specifically documenting that regulation appears endogenously associated with insider-trading patterns and with overall litigation risk. Our results also confirm that there does not appear to be evidence of overall insider trading profit declines for trades that execute after increased trade regulation enactment; rather the key factor affecting trading profits is the firms apparent response to the legislation in moving trading after earnings announcements. Thus, in this case, private enforcement of public regulation appears necessary for the regulation to affect firms and insiders.
Chapter # 5
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Institutional Trading
5.1 Institutional trading, Trading Volume, and Spread
The effect of institutional trading on the bid-ask Spread is of interest to regulators and market makers. It is often argued that Greater institutional participation results in increased volatility in the market. On the other hand, some argue that greater liquidity trading by institutions reduces spread. There is no direct empirical evidence and little theoretical knowledge to suggest a Convincing relation between institutional trading and spread. , we present some evidence on the nature and effect of institutional trading on spreads and share Prices. We argue that Institutional trading is not completely information driven; part of it is liquidity trading in nature. We find evidence that information induced institutional trading increases the adverse selection component. However, large volume (liquidity) trading reduces the order processing costs. We find the net effect of institutional trading on spread is consistently negative. Moreover, institutional buys have differential information from sells. Institutional trades per se reduce spreads, but only sells increase the adverse selection component. Both effective and relative spreads impound the differential nature of institutional buys and sells.
5.2 Introduction
Some of the significant determinants of spread found in the literature are order size, number of trades, competition in the dealers market, ownership structure, and the native characteristics of a stock e.g., price, and volatility. Trading rules and mechanics of trading that proxy for information flow are also found to affect the spread. There is very little empirical evidence on institutional trading and spread and their interrelationship. Keim and Madhavan (1997) find execution costs for institutional trades are different between listed and NASDAQ stocks.
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The role of institutional trading in the determination of spread is interesting since it is often argued (casually) that increased institutional participation in the U.S. equity Market during the past decade has led to an increase in the volatility, and has widened the Bid-ask spread in the equity market.
5.5 How Institutional Trading Affects the Individual Components of the Spread
In these analyses, we investigate if institutional trading has any information content beyond what has been documented as a size or volume effect. In a multivariate, panel regression framework, we determine if there exists a relation between bid-ask spread and institutional trading after adjusting for size and price effects. Most studies on the Determinants of spread focus on the supply side of dealership market i.e., competition in The dealer market, and use a cross sectional regression approach.
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Further we decompose the spread into order processing and adverse selection components and investigate how those components vary with changes in trading volume, net order flow (buy vs. sell), and institutional trading. We assume contemporaneous correlation between the disturbances and use an SUR (Seemingly Unrelated Regression) Analysis to find the significant determinants of the adverse selection and the order processing components of the spread for our sample firms. We use a unique data set (TORQ) that identifies institutional trading. Prior studies proxy institutional participation by using measures based on trade size that is subject to measurement error. Our results show that institutional trading proportion is inversely related to both effective and relative spreads.
5.9 Motivation
Relation between Spread and Institutional trading An economist identifies four classes of variables, namely, Activity Risk Information competition As determinants of spread, existing literature find trade size, number of trades, ownership structure, and extent of market power in the dealership market to be the key determinants of bid-ask 44
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Dealer market competition represents the supply side of the market for liquidity services5. On the other hand, trade size, ownership structure, and frequency of trading measure the activity in securities markets and represent the demand side of the market for liquidity services. Prior research suggests an inverse relationship between spread and trading activity measured by order size, and number of trades institutions trade large sizes, and also trade frequently. Thus institutional trading will induce low spread. However, trading activity also contributes to both information and risk associated with a security7. Provides evidence that large trades contain more information than small trades and cause spreads to widen. Linefeed evidence of an increasing (although not continuously), nonlinear relation between spread and trade size report.
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5.11.2 According some Experts (References) Sias (1996) reports positive correlation between institutional activity and market Volatility; Cohen et al (1987) suggest that institutions trade frequently because of their low order processing costs. We conjecture that if institutional trading is a mix of information and liquidity trading then the information effect should increase the adverse selection component and the liquidity effect should decrease the order processing costs. We also recognize that while gross volume is important for the determination of order processing cost, trade direction or net volume (buy volume - sell volume), is important in the determination of adverse selection costs. We therefore include log (buy/sell) as a variable in the regression model for the adverse selection component we determine through a set of simultaneous equations how institutional trading affects the order processing and the adverse selection components of the spread after controlling for number of trades, volume, and trade direction. The simultaneous equations approach uses the cross correlation between the two regression equations to improve the estimates. Further we determine how the asymmetric information content and the liquidity motive in institutional buys and institutional sells affect the adverse selection (information) component of the spread. Stated in alternate form, our hypotheses are: H2a. The adverse-selection component should increase with institutional trading, and the order-processing component should decrease with institutional trading. H2b. Institutional buys should have a differential effect on the adverse selection component of the spread from institutional sells.
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We use a multivariate, panel (time series cross sectional) regression framework to investigate the effect of institutional trading on the bid-ask spread. We use a unique data set (TORQ) that allows us to identify the order origination for a trade as institutional or otherwise. Most studies on the determinants of spread use pooled OLS estimates of the parameters of a regression model. OLS estimates ignore the covariance structure of the error term both across firms and over time. We assume disturbances are both serially and contemporaneously correlated. Specifically, we assume an AR (1) process with contemporaneous correlation for the disturbance term. In our model for the spread, the serial correlation may be due to lagged spread or lagged values of the independent variables or their interactions. .
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Orders initiated by institutions for each day. We compute the effective spread for each Trade defined as twice the absolute value of the difference between trade price and the Prevailing mid-quote. The mean effective spread is the average of effective spreads across all trades in a day. To determine the mean proportion of trades by institutions in that firm, we calculate, for each day, the proportion of trades by institutions on the buy and sell side. Besides proportion of institutional trading, there are three other independent variables in the panel regression. The number of trades variable is computed as the number of trades each day divided by the average number of trades for the firm over the sample period. Thus this is a measure of abnormal trading in each day. Trading above (below) mean would give this variable a value higher (lower) than one. The trading volume variable is computed by dividing the daily share volume for the firm by the average daily share volume over the sample period. Therefore, this variable also has values above (below) one when trading volume is higher (lower) than the average daily share volume. The price variable is the closing price of the stock. In Table 1, we present means of the computed statistics of the variables used in the panel regression. We first compute the relevant statistics for the sample firms over the sample period and then compute the means of those statistics. Thus we report the means of the cross sections of firm means, medians, and standard deviations. The interim mean (median) spread is .126 (.12) that is about an eighth. The inter-firm mean standard deviation is quite low at .02. The largest spread in our sample is .514, approximately one-half, and the lowest .019 or approximately onesixty-fourth. The inter-firm mean (and median) institutional trading in our sample is around 30%. Although institutions generally trade on a regular basis, in some trading days there is no institutional trading. Of the 3,213 (51 63) firm trading days covered in our sample there were 10 firm-days when there was no institutional trading, and one firm-day when all the trading was initiated by institutions. There is also sufficient variability in the number of trades and volume. The low trading (volume) in our sample was 9% (3%) of average daily trades (volume). The high trading (volume) was 392% (1235%) of average daily volume. In Table 2, we present Pearson correlations for variables in the regression. Panel A presents pooled correlations computed from 3,213 observations. In Panel B, we present the means of correlations computed in time series for each firm.
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the proportion n of institutional trades. All four variables are significant in determining effective spread. The significant coefficients show that effective spread increases as trading (number of trade) and price increase and decreases as trading volume and institutional trading increase. The coefficient for institutional proportion is negative (-.0111) and significant at less than 1% level. Thus an increase in institutional proportion reduces the spread. The R2 for this model is 22%. However, for a similar model with relative spread (1-RS) as the dependent variable, number of trades fails to be a significant determinant of spread. All other variables, namely average trading volume (-.0137), price (-.028), and institutional proportion (-.024) remain significant at less than 1% level, and the R2 for the model is 90%. The change in the effect of price on relative spread (decreasing in price) from that on effective spread (increasing in price) is expected since relative spread is computed as effective spread over mid quote. This change in the effect of price on effective and relative spreads is consistent across all the four models. For our second model, we introduce two dummy variables for high and medium institutional proportions. The high (medium) institutional proportion variable has a value of 1 when the level of institutional trading is in the top (middle) 33% percentile, and zero otherwise. The coefficients of the dummy variables are both positive and significant in the regression. The high dummy has a larger coefficient (.0016) than the medium dummy variable (.0007). Taken in conjunction with the significant negative (-0.0153) coefficient of the institutional proportion variable, this suggests that the negative slope of the institutional proportion variable flattens out at higher levels of institutional trading. This conjecture is confirmed with model 3. In model 3, the institutional proportion variable is replaced by three variables high, medium and low proportion. The high (medium, low) proportion variable has the same value as institutional proportion if institutional trading proportion is in the top (middle, bottom) 33 percentile, and zero otherwise. The coefficients of all three variables are negative and significant in the regression, but while the coefficient for low proportion is -.0144, that for the high proportion is significantly (14%) less at -.0122. We interpret these results as follows. On average, there may be a mean positive effect on institutional trading embodied in the positive intercept. However, when there is an increase in institutional trading within a level, the spread declines, but the rate of decrease is lower at higher levels of institutional proportion. Between low and medium levels, the rate of decrease is similar indicating these are perhaps two discrete levels of institutional proportions. Finally, for our fourth model, we break up the institutional proportion into institutional buy and institutional sell to test for a difference in their effect on the spread. Zero results from the fourth model show that spread reduces as institutional trading increases, be it buy or sell. The coefficients for buy and sell are significantly negative for both effective spread and relative spread. 49
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These results support our hypotheses. We show (H1) that institutional trading is a significant variable in the determination of both effective and relative spreads. We also show that this relation has a downward slope that gradually flattens out. Finally, we show that institutional trading per se drives the relation between spread and institutional trading, and not the direction of institutional trade - buy or sell. Model, we estimate the system of equations with institutional buys and sells in place of total institutional proportion. We find that institutional sells are positive and significant (at 8% level) in determining the adverse component. Buys are insignificant in the adverse selection equation.
Chapter # 6
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6.3.2 Base Date and Base Value Each of the three NYSE Sector Indexes has a base date of December 31, 2002. The closing market value on this date was given an index value of 5,000 (December 31, 2002=5,000). 51
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6.3.3 Calculation and Dissemination Like the Consumer Price Index, each NYSE Sector Index is a Laspeyres index which measures price changes against a fixed base period quantity weight. A detailed explanation of Laspeyres's formula is provided in Section 5.2. The NYSE Sector Indexes are calculated whenever the New York Stock Exchange is open using the latest traded price on the NYSE for each company in the indexes. Following the determination of the previous day's closing index value, the Sector Index value for the current day is updated and disseminated following the opening of NYSE trading on a real-time basis beginning when the first traded price of any of the index components are received. If trading in a stock is suspended while the NYSE is open, the last traded price for that stock on the NYSE is used for all subsequent index computations until trading resumes. If trading is suspended before the opening, the stock's adjusted closing price from the previous day is used to calculate the indexes. Until a particular stock opens, its adjusted closing price from the previous day is used in the index computation. These prices are computed on both a price and total-return basis in U.S. dollars. The price index is updated on a real-time basis, while the total-return index is calculated and disseminated on an end-of-day basis. The NYSE Sector Indexes are calculated and maintained by Dow Jones Indexes. 6.3.4 Index Divisor Adjustments The market capitalizations of the NYSE Sector Indexes are affected by numerous events other than daily security price changes. At the company level, market caps are affected by share Changes caused by corporate actions such as takeovers, secondary offerings, purchase programs, rights offerings and spin-offs. Changes also result from company additions and deletions to the index. In order to insulate the members of the NYSE Sector Indexes from the effects of index component changes and corporate actions, each indexs market cap is divided by an adjustment factor called the index divisor after the close of trading on each day when there is a change in either index membership or shares outstanding for an index component. (This procedure, which links each successive weighted basket of securities in the index with the proceeding basket, is called "chaining," and the 52
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result is technically referred to as a Laspeyres chain index.) The initial index divisor was, of course, exactly 1/5000 of the indexs base market capitalization. That divisor, which was used to calculate changes in each NYSE Sector Index, gave a closing value of 5,000 on December 31, 2002. The procedure for updating the index divisor is straightforward. During the trading day, the index is computed by dividing the indexs current market capitalization (the number of a companys float shares in the index times the latest traded price, summed across all the index components) by that days divisor. If there are no corporate actions or component changes, the divisor remains unchanged for the next trading day. If there is an event resulting in a capitalization change, the indexs new adjusted base market cap is calculated after the close using the adjusted prices and adjusted share figures. Then a new divisor is calculated for use at the opening on the next trading day. The new divisor links the closing index value to the new adjusted base market cap. Conceptually, the new divisor could be calculated by solving the following simple equation: (Todays adjusted base market cap/tomorrows new divisor) = todays closing index value However, because the index values are rounded to two decimal places, this straightforward approach would quickly introduce rounding errors into the divisor adjustment process. Therefore the following formula is used, which solves for the new divisor through the ratio of the new adjusted base market cap to the current day's closing market cap: Next days new divisor = current days divisor x (adjusted base market cap for next day / current days market cap) Dividing the new divisor calculated with the above formula into today's adjusted base market cap will produce today's closing index value. Detail on the divisor calculation and the directional impact of specific corporate actions on the divisor is provided in Section 5
6.3.5 Weighting
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The NYSE Sector Indexes are weighted by float-adjusted market capitalization, rather than full market capitalization, to reflect the actual number of shares available to investors. Detail on the float-adjustment rules is provided in Section 6 6.3.6 Dividend Treatment Normal dividend payments are not taken into account in the price index, whereas they are reinvested and accounted for in the total return index. However, special dividends from non-operating income require index divisor adjustments to prevent the distributions from distorting the price index.
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Changes in the indexs market capitalization due to changes in composition, weighting, or corporate actions result in a divisor change to maintain the indexs continuity. By adjusting the divisor, the index value retains its continuity before and after the event. Corporate actions that require divisor adjustments will be implemented prior to the opening of trading on the effective date.
6.7.1 Formulae for Divisor Adjustment The following formulae will be used for divisor adjustments. (Note: No divisor adjustments are necessary for stock splits, since market capitalization does not change and the share number and share price are adjusted prior to the opening of trading on the split's ex-date.) Where: Divisor at time (t) Divisor at time (t+1) Stock prices of company i at time (t) Number of shares of company i at time (t) Add new components market capitalization and adjusted market capitalization (calculated with adjusted closing prices and shares effective at time t+1 and/or minus market capitalization of companies to be deleted (calculated with closing prices and shares at time t) Note: If the current trading price of an issue is unavailable, the previous trading sessions closing price is used. However, if the issue is affected by any corporate action that requires an adjustment, then the adjusted price is used. 6.7.2 Adjustments for Corporate Actions An index divisor may decrease () or increase () or keep constant () when corporate actions occur for a component stock. Assuming shareholders receive B new shares for every A share held for the following corporate actions: a) Cash dividend (applied for return index only) Divisor
Adjusted price = closing price - dividend announced by the company b) Special cash dividend (applied for price and return index) Divisor
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c)
Adjusted price = closing price * A / B New number of shares = old number of shares * B / A d) Rights offering Divisor Adjusted price = (closing price * A + subscription price * B) / (A + B) New number of shares = old number of shares * (A + B) / A e) Stock dividend Divisor Adjusted price = closing price * A / (A + B) new number of shares = old number of shares * (A + B) / A f)Stock dividend of a different company security Divisor Adjusted price = (closing price * A - price of the different company security * B) / A g) Return of capital and share consolidation Divisor
Adjusted price = (closing price - dividend announced by company) * A / B New number of shares = old number of shares * B / A h) Repurchase shares-self tender Divisor Adjusted price = [(price before tender * old number of shares) - (tender price * number of tendered shares)] / (old number of shares - number of tendered shares) new number of shares = old number of shares - number of tendered shares i) Spin-off Divisor Adjusted price = (closing price * A - price of spun-off shares * B) / A j) Combination stock distribution (dividend or split) and rights offering Shareholders receive B new shares from the distribution and C new shares from the rights offering for every A shares held: If rights are applicable after stock distribution (one action applicable to other) Divisor Adjusted price = [closing price * A + subscription price * C * (1 + B / A)] / [(A + B) * (1 + C / A)] New number of shares = old number of shares * [(A + B) * (1 + C / A)] / A 57
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If stock distribution is applicable after rights (one action applicable to other) Divisor Adjusted price = [closing price * A + subscription price * C] / [(A + C) * (1 + B / A)] New number of shares = old number of shares * [(A + C) * (1 + B / A)] k) Stock distribution and rights (neither action is applicable to the other) Divisor Adjusted price = [closing price * A + subscription price * C] / [A + B + C] new number of shares = old number of shares * [A + B + C]
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6.8.2 Index Formula The NYSE Sector Indexes are calculated using a Laspeyres formula. This formula is used for the calculation of the return index and the price index. The only difference is that the divisor Dt is different for the two indexes. The index is computed as follows: The above mentioned formula can be simplified as: Where: Divisor at time (t) The number of stocks in the index The closing price of stock i.e. at the base date (December 31, 2002) The number of shares of company i.e. at the base date (December 31, 2002) The price of stock i.e. at time (t) The number of shares of company i.e. at time (t) The adjustment factor for the base date market capitalization The time the index is computed Market capitalization of the index at time (t) Adjusted base date market capitalization of the index at time (t) Dividend payments are not taken into account in the price index, whereas dividend payments are reinvested in the index sample of the total return index. Any dividend larger than 10% of the equity price is considered a special cash-dividend, which requires a divisor adjustment. The adjustment protects the index from the effects of changes in index composition and the impact of corporate actions. 6.8.3 Computational Precision Index values are rounded to two decimal places and divisors are stored in a double precision floating point binary field. Any values derived by the index calculation engine from a corporate action used for the divisor adjustments and index computations are rounded to seven decimal places. 6.8.4 Data Correction Policy To maintain a high standard of data integrity, a series of procedures have been implemented to ensure accuracy, timeliness and consistency. Input prices are monitored using a variety of computerized range-check warning systems for both ticker-plant and real-time index systems. Redundant sources of market data and 59
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corporate action information are also used. Various verification and audit tasks are performed to ensure the quality of the real-time data feeds and related market data. While every effort is taken to ensure the accuracy of the information used for the index calculation, there is no guarantee that the index will be error-proof. An index error may occur due to incorrect or missing data, including trading prices, exchange rates, shares outstanding and corporate actions, due to operational errors or other reasons. 6.8.5 Intraday Corrections Reasonable efforts are employed to prevent erroneous data from affecting the index. Corrections will be made for bad prices and incorrect or missing corporate actions as soon as possible after detection. Since the index is calculated on a real-time basis, an incorrect index value tick will not be fixed retroactively. Incorrect daily high/low index values will be corrected as soon as practicable. 6.8.6 Index-Related Data and Divisor Corrections Incorrect pricing and corporate action data for individual issues in the database will be corrected upon detection. In addition, an incorrect divisor of the index, if discovered within five days of its occurrence, will always be fixed on the day it is discovered to prevent an error from being carried forward. If a divisor error is discovered more than five days after occurrence, the adjustment will depend upon how significant the error is, how far back the error occurred and the feasibility of performing the adjustment.
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Cross ownership shares that are owned by other companies (including banks and life insurance companies); Government ownership shares that are owned by governments (central or municipal) or their agencies; Private ownership shares that are owned by individuals, families or charitable trusts and foundations; Restricted shares shares that are not allowed to be traded during a certain time period. However, a companys outstanding shares are not adjusted by institutional investors' holdings, which include, but are not limited to, the following categories: Custodian nominees; Trustee companies; Mutual funds (open-end and closed-end funds); Investment companies.
6.9.2 Threshold A companys outstanding shares are adjusted if, and only if an entity in any of the four qualified categories listed above owns 5% or more of the company. Its shares will not be adjusted if the block ownership is less than 5%. 6.9.3 Foreign Restriction The float adjustment rules also apply to foreign companies that have cross ownership of 5% or more. If a government has a foreign ownership restriction of 5% or more, the lesser of free-float shares or the portion that is available for foreign investment will be used for index calculation.
6.10 First Regular Benchmark Index Performance Report since Formation of Global Index Group
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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)
AMSTERDAM, BRUSSELS, LISBON, LONDON, NEW YORK, PARIS, Jan. 21, 2009-NYSE Euronext (NYSE Euronext: NYX) announced the 2008 performance of its benchmark indices. This report is the first regular benchmark index performance report that will be part of a regular series by NYSE Euronexts newly established Global Index Group, and utilizes the exchanges recently integrated systems and new business development initiatives. In 2008, NYSE Euronext created the Global Index Group, bringing together the US and European index specialists from NYSE Arca, NYSE Euronext and the former American Stock Exchange with a collective portfolio of over 300 benchmark indices. NYSE Euronexts Global Index Group provides design, real-time calculation and dissemination services for NYSE Euronext, third-party customized indices and Exchange Traded Products intra-day indicative values. As of December 31, 2008, NYSE Euronext had over $12 billion in assets under management linked to NYSE Euronext proprietary indices in US and European Exchange Traded Products and Structured Products. 6.10.1 Background on NYSE Euronexts Global Index Group: With a collective portfolio of over 300 benchmark indices, NYSE Euronext is a leading provider of indices. NYSE Euronext develops proprietary indices to showcase the strength of companies listed on its markets, and to provide investors and issuers with benchmarks that measure the world's leading, most liquid marketplace as well as its key segments. NYSE Euronext indices are available to be licensed as the basis for tradable products, including Exchange-Traded Funds (ETFs), to be launched in the future. In 2008, NYSE Euronext created the Global Index Group, bringing together the US and European index specialists from NYSE Arca, NYSE Euronext and the former American Stock Exchange. For more information on NYSE Euronext index services please visit:
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The university of Lahore, City Campus.
Chapter # 7
News Announcement
7.1 Introduction
In the New York Stock Exchange news are play very important role. So, the concept of news announcement in my working the Affect of news announcement on the Share prices of NYSE Trade volume /Index Demand and supply Companys worth Example: In the coming months the company will complete a huge multi billion dollar deal with Comdex. This news is already the share price has been really badly affected lately by news on oil, the dollar and US sub prime mortgage fears.
wise to take a wait and watch policy in a volatile market or when there is mixed reaction about a particular stock. CASE 1: When Iran and USA relation going to not good way and chance to war than Share prices move to downward.
7.3.1 Trade Volume / Index When news come in the country from outside of the country or when internationally bad or good news come than stock market of the move abnormally. CASE 2: When a news come that a USA bank is insolvent than world market and New York Stock Exchange index decrease suddenly. This news is really affected to the World capital market and NYSE.
late has been pretty scarce. A lot of the downward price movements could be attributed to non- company related news. 7.4.1 Example:
Demand 10 15 21 28 35 Supply 35 28 21 15 10 Demand New 10 13 17 22 28
7.4.2 CASE 3: 4 June 2008 Zetex PLC ('ZETEX') RECOMMENDED proposal for the cash acquisition OF ZETEX Scheme Court Hearing On 4 April 2008, the boards of Zetex and Diodes Incorporated ('Diodes') Announced the terms of a recommended cash offer by Diodes Holdings UK Limited (wholly owned subsidiary of Diodes), ('Bidco') of 85.45 pence per share for the Entire issued and to be issued ordinary share capital of Zetex (the
'Recommended Proposal') to be effected by way of a scheme of arrangement pursuant to section 895 of the Companies Act 2006 (the 'Scheme'). On 18 April 2008, the board of Zetex announced the posting of the scheme Document (the 'Scheme Document'), containing full details of the Recommended Proposal and the Scheme. On 12 May 2008, the Scheme was approved by the requisite majority of Scheme Shareholders at the Court Meeting and the matters ancillary thereto (including the Reduction of Capital) were similarly approved by Scheme Shareholders at the Extraordinary General Meeting. Both meetings were held on 12 May 2008. Today, the board of Zetex is pleased to announce that, at the Court hearing earlier today (the 'Scheme Court Hearing'), the Court granted an order sanctioning the Scheme to effect the Recommended Proposal. In order for the Scheme to become effective in accordance with its terms, the Court must now confirm the Reduction of Capital at the Reduction Court Hearing which is scheduled to take place on 6 June 2008. Zetex has made an application the UK Listing Authority requesting the suspension of dealings in Zetex Shares on the London Stock Exchange and cancellation of the listing of Zetex Shares on the Official List. It is anticipated that the last day of dealings in Zetex Shares will be 5 June 2008, that dealings in Zetex Shares on the London Stock Exchange's market for listed securities will be suspended with effect from 7:30 a.m. (London time) on 6 June 2008 and no transfers after such time will be registered, and that cancellation of their listing on the Official List and of their admission to trading on the London Stock Exchange will take effect at 8.00 a.m. (London time) on 9 June 2008. It is expected that the Effective Date will be 9 June 2008. A further announcement will be made by Zetex to confirm when the Scheme has become effective.
Chapter # 8
Efficiency
8.1 Market Efficiency
Market efficiency is one of the most controversial topics in finance. The simplest definition of market efficiency is that the price already reflects the available information and thus buying or selling the stock should, on average, return you only a "fair" measure of return (after transaction costs) for the associated risk. Information and competition are the underlying principles guiding market efficiency. Think of an asset price being based off of forecasts of future conditions. (Example: the future supply, demand, competition, etc.) These forecasts are made using the information available in what financial economists call information sets.
The larger the information set, the more accurate the forecasted price (information is power). Traditionally, these information sets have been classified into three categories: 1. 2. 3. Past asset price data, Information that is probably available, and Private information.
If all past information is incorporated in the price then it should be impossible to consistently beat the market using technical analysis and the like.
Prices reflect all past prices, and other security market information (such as volume data, historical rates of return, odd-lot transactions, block volume etc.) 8.2.1.1 Tests of Weak form efficiency Two main groups of tests: I. Statistical tests of independence Does return of day t correlate with day t-1,t-n? Over-short periods (1 to 4 days, even 9-16 days) Correlations are small (-.1<p<.1) and usually insignificant II. Runs tests confirm efficiency... A run is at least 2 price changes in a row of same sign (Example + + + - - +- +--- has three runs). Several studies have shown that there is serial correlation over the very short time frames. (Sort of disproving the earlier runs tests?) 8.2.1.2 Rules for the Efficiency Tests I. Filter rules on a before transaction cost basis these trading rules do appear to work, but there is no evidence that you can profitably trade on this: when transaction costs are included the profitability disappears.
Lead-lag relationships: do large stocks lead small stocks? possibly stale pricing. II.
Trading Rules: In response to technical analysts saying blind tests (see previous section) are too rigorous, not flexible enough to catch positive returns. Caveats:
Still may be inflexible largely looking at major NYSE stocks Must make estimates of transactions costs Compared to what? BUY and HOLD strategy Results largely support EMH Filter rules may beat mkt. on before transaction cost basis. Also looked at odd-lot data, specialists data
8.2.2
Security prices reflect all public information How to test: Event studies Event Studies: Determination of event date Calculation of abnormal return (what market adjustment is needed?) Looking at either time series data of publicly avail information (earnings etc.) or cross section ally....either way EMH predicts no relationship (predictability would imply you could make money on the information and that all public information is not incorporated into the price) Most evidence suggests that market is efficient (ex takeover, dividend studies), however several studies (Watts, Ball, Latane) have suggested that it takes longer than it should to incorporate very good earnings surprises. (over 20% above expectations, the POST-announcement period gain was about 4% (over the next 26 weeks) whereas estimated transaction costs were only 2-3%...for over estimates by 40% the numbers were 5-6%)....however, does the risk ness increase? And why are there no abnormal returns for very bad earnings announcements? Short term: past returns do not help predict future returns
Longer term there is some evidence that the market MAY reverse....difficult to say (need longer periods of data) Tests usually use dividend yields, or market-book etc. Often in conjunction with macro-economic data...Low PE ratios=>higher future returns This data suggests that market may not be as efficient as earlier tests suggested, BUT there are still problems: low PE stocks have higher risk? Therefore these tests may be more of a test of CAPM than of market.
8.5 Efficient Market Hypothesis and the New York Stock Exchange
EMH software is presented in this paper. The main coefficient the software provides is the Efficiency Index, which correlates very well with Signal-to-Noise and Shannon Entropy of the historical prices, over a period of six years, of 100 stocks. Against the Efficiency Index, Auto- Correlation is more or less constant (around 0.9). Since 100 items are Representative sample size (95% confidence level and 9.66% confidence interval) for the whole NYSE, two tailed hypothesis testing revealed that 14% of the market is weak efficient, 77% semi-strong and 9% strong. So only 9% is like a completely random process. The EMH software can provide the 14% weak efficient stocks, out of 3554 registered at NYSE that can successfully be bought and sold with excess profits on basis of fundamental analysis portfolio management.
Table 1: Hypothesis testing and the definitions of the - and -errors. Fig. 1: Two distributions and the two hypotheses and the power-of-the-test, - and -errors. Decision
ACTUAL SITUATION Natural (H0 is true) NEGATIVE H0 Accepted
(Suspect EI falls in criterion)
POSITIVE H1 Accepted
(Suspect EI outside criterion)
No Error
Type I Error
NEGATIVE Manipulated (H1 is true) POSITIVE Type II Error (false positive = probability) For simplicity sake here shown is one tailed testing.
8.8 Discussion
From Graph 1 you can see that there is a good linear correlation between Signal-toNoise (SNR = /) and Efficiency Index (EI), F-Significance is within a reasonable Significance Level (< 0.05). I personally believe that SNR is the best measure of the volatility of a stock in question. If this is true EI also incorporates volatility. But there are more: EI correlates even better with the Shannon Entropy of the data distribution (Graph 3). Shannon Entropy is the best measure for the content of information in a system. Maximal Shannon Entropy means maximal information means completely random process. There is no linear regression with AutoCorrelation of the normal distribution. The line is almost parallel to the x-axis and is more some kind of constant mean value through all the data points (Graph 2). There are also other reasons, besides the good correlation of EI with SNR and Entropy, and I do not provide them because I would reveal my trade secrets, to believe that deviations from H0-hypothesis two tailed testing divide the NYSE in the weak, semi-strong and strong efficiency parts, and because 100 stocks are a representative sample it also gives the percentages of the whole Wall Street stock market. Of course I can provide the ticker symbols or the names of the individual stocks in for lets say the weak efficiency part, which could then be bought and sold with an expectation of excess profits based on fundamental analysis portfolio management, but this is not a free service. What I do in this paper is a new kind of technical analysis meant to be a part of the more general fundamental analysis.
Chapter # 9
Final Conclusion
Finally I conclude this discussion on share prices, let me remind you that there are so many other reasons behind the fall or rise of the share price. Especially there are stock specific factors that also play its part in the price of the stock. So, it is always important that you do your research well and stock trading on the basis of your research and information that you get from your broker. To get benefit from the effective consultancy service it is therefore always better from professional stock
trading companies rather than getting lured by discount brokerage advertisements that you must be coming across everyday. There are clearly a large number of factors that investors can weigh against each other to effectively use insider trading data, which may seem like a daunting task at first. Our Insider Sentiment report seeks to take the hard work out of analyzing all of the companies reporting trades and presents the most promising companies to you as determined by their insider trading activity. Investors who want to sift through the raw data themselves can also easily do so with our more general reports and our custom search functionality. This study examines how insider trades are affected by increases in insider-trading regulation. We find that insider-trading legislation is positively associated with the tendency of insiders to trade after, relative to before, earnings announcements. This is consistent with firms and insiders adopting self-imposed limits on trading during times of high information asymmetry when the penalties for trading on private information increase. Examining the simultaneous relation between litigation risk and insider timing, we find some evidence of a positive association between increased litigation risk and insiders trade volume after, relative to before, earnings announcements, consistent with insiders seeking to avoid litigation risk or with firms increasing restrictions on insiders trade. Our results also suggest that increased trade after, relative to before, earnings announcements, is negatively associated with firms overall litigation risk (as measured by the incidence of shareholder lawsuits). Regarding insiders trade strategies, the evidence suggests that insiders passive profits (earned when insiders delay trades until after the revelation of price-relevant information such as selling after good news) are positively associated with the passage of the Insider Trading and Securities Fraud Enforcement Act of 1988. The documented increase in passive trading seems a rational response to the regulation since passive strategies are much less likely to trigger insider-trading violations. Evidence also suggests, however, that insiders active profits (earned when insiders trade prior to the revelation of price-relevant information such as selling before bad news) are positively associated with the passage of ITSFEA. However, examining subsets of firms defined by whether they respond to ITSFEA by moving trading after earnings announcements, we provide some evidence that responding firms have lower increases in abnormal profits to insider trading than non-responding firms. Thus, ITSFEA appears to have some effects on the ability of insiders to exploit their private information. Our results provide evidence regarding the economic impact of insider-trading regulation, specifically documenting that regulation appears endogenously associated with insider-trading patterns and with overall litigation risk. Our results also confirm that there does not appear to be evidence of overall insider trading profit declines for trades that execute after increased trade regulation enactment;
rather the key factor affecting trading profits is the firms apparent response to the legislation in moving trading after earnings announcements. Thus, in this case, private enforcement of public regulation appears necessary for the regulation to affect firms and insiders. The role of institutional trading in the determination of spread is of interest to regulators and market makers. It is often argued that institutional investors have superior information, better processing power to assimilate the information, and greater access to markets. Institutions have low transaction costs and thus trade frequently. The increased institutional participation is often considered an attribution for the increased volatility in the U.S. equity market. However there is no empirical evidence suggesting a relation between institutional trading and spread. We present empirical evidence to suggest a non-linear inverse relation between the bid ask spread and institutional trading in the equity market. Our analysis shows that institutional trading is not just information driven a part of their trading is liquidity trading in nature. Institutional trading affects both the adverse selection and order processing components of the spread. Increased institutional trading increases the adverse selection component, while it reduces the order processing costs through large volume trading. We find the net effect of increased institutional trading to be a reduction spread. Increased institutional buys seem to reduce spreads, but sells seem to increase the adverse selection component. The market makers recognize this and accordingly adjust the effective spreads. All EMH stocks have an Auto-Correlation of around 0.9. EI of a stock incorporates the SNR and Shannon Entropy measures. EI says 14% +/- 1.3 of the NYSE stocks are marketed weak efficient, 77% +/- 7.4 is semi-strong and 9% +/- 0.86 is strong. So only 9% +/- 0.86 of the NYSE stocks are bought and sold in a completely random fashion. Stock markets must be constantly monitored with an optimized time window for historical prices because I am convinced that individual stocks can shift in efficiency category. My EMH software can provide the 14% +/- 1.3 weak efficient stocks, out of 3554 registered at NYSE that can successfully be subjected to fundamental analysis based portfolio management.
Bibliography
In my thesis work get help from many articles and journals from internet and news papers so I am very thankful to all whose help me to achieve my target. Internet Books News papers Journals
References
Some references are given below NYSE Euronexts website is main source of collecting the data which required for my work. Ms. Stewart Seyhun (1992) BCL; Jeng, 1999) Griffin and Grandest (2002) Johnson et al. (2006) Keim and Madhavan (1997) Chan and Lakonishok (1993) Sias and Starks (1997)