Empirical Asset Pricing

International Investment

A number of countries has delayed the opening of their capital markets to international investment because of reservations about the impact of foreign speculators on both expected returns and market volatility. The authors propose a cross-sectional time-series model that attempts to assess the impact of market liberalizations, in the form of the offering of depositary receipts, country funds and other financial instruments, in an extranational market, on the cost of capital and market volatility in emerging equity markets. They also examine the impact of capital market liberalizations on the correlation of emerging equity market returns and the world market return. Their empirical approach is designed to control for other economic events, which might confound the impact of foreign speculators on local equity markets. Whatever the empirical specification, the cost of capital always decreases after a capital market liberalization, with the effect varying between 5 and 90 basis points, depending on the specification. There is little impact on volatility. While correlation with world markets increases after liberalizations, it is unlikely that this higher correlation will impact global investors looking to diversify their international portfolios.

Analysts Forecasts and Market Reaction

Using a large database of analysts’ target prices issued over the period 1997–1999, the authors examine short-term market reactions to target price revisions and long-term comovement of target and stock prices. They find a significant market reaction to the information contained in analysts’ target prices, both unconditionally and conditional on contemporaneously issued stock recommendation and earnings forecast revisions. Using a cointegration approach, they analyze the long-term behavior of market and target prices. They find that, on average, the one-year-ahead target price is 28 percent higher than the current market price.

The Impact of Hedge Funds Strategies on Asset Prices

Hedge funds often employ opportunistic trading strategies on a leveraged basis. It is natural to find their footprints in most major market events. A “small bet” by large hedge funds can be a sizeable transaction that can impact a market. This study estimates hedge fund exposures during a number of major market events. In some episodes, hedge funds had significant exposures and were in a position to exert substantial market impact. In other episodes, hedge fund exposures were insignificant, either in absolute terms or relative to other market participants. In all cases, the authors found no evidence of hedge funds using positive feedback trading strategies. There was also little evidence that hedge funds systematically caused market prices to deviate from economic fundamentals.