The behavioral finance revolution in academic finance in the last several decades is best described as a return to a more eclectic approach to financial modeling. The earlier neo-classical finance revolution that had swept the finance profession in the 1960s and 1970s represented the overly-enthusiastic pursuit of only one model. Freed from the tyranny of just one model, financial research is now making faster progress, and that progress can be expected to show material benefits. An example of the application of both behavioral finance and neoclassical finance is discussed: the reform of Social Security and the introduction of personal accounts.

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An Examination of the Differential Impact of Regulation FD on Analysts' Forecast Accuracy

Scott Findlay, Prem G. Mathew

Regulation FD requires companies to publicly disseminate information, effectively preventing the selective pre-earnings announcement guidance to analysts common in the past. We investigate the effects of Regulation FD's reducing information disparity across analysts on their forecast accuracy. Proxies for private information, including brokerage size and analyst company-specific experience, lose their explanatory power for analysts' relative accuracy after Regulation FD. Analyst forecast accuracy declines overall, but analysts that are relatively less accurate (more accurate) before Regulation FD improve (deteriorate) after implementation. Our findings are consistent with selective guidance partially explaining variation in the forecasting accuracy of analysts before Regulation FD.

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The Impact of Inflation Measures on the Real Returns and Risk of U.S. Stocks

Charles P. Jones, Jack W. Wilson

Using different inflation measures produces economically significant differences in both the inflation record and inflation-adjusted stock returns. We introduce a more consistent measure of the monthly CPI inflation rate to better measure real returns over 1913-2004, for which the official CPI exists. We also extend the series backward to 1871 on a monthly basis, an important addition to the data series. We analyze the impact of inflation on the real standard deviation of stock returns and find that, in contrast to the results for geometric mean returns, inflation adjustments have little impact on estimates of return variability.

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Uncertain Demand, Heterogeneous Expectations, and Unintentional IPO Underpricing

Bruce K. Gouldey

Distinguishing between intentional and unintentional incentives to underprice initial public offerings (IPOs), I develop sufficient conditions for the winners’ curse postulated by Miller (1977) and implications for intertemporal changes in the magnitude of underpricing. Specifically, I show that unintentional underpricing (and occasional overpricing) of IPOs is a consequence of investors’ heterogeneous expectations of the uncertain value of a stock when the supply is constrained and the underwriter’s price discovery process only partially identifies aggregate demand. Moreover, an IPO that is oversubscribed in the premarket sale almost certainly will experience a short-term price increase in the secondary market.

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Portfolio Effects and Valuation of Weather Derivatives

Patrick L. Brockett, Mulong Wang, Chuanhou Yang, Hong Zou

In a mean-variance framework, the indifference pricing approach is adopted to value weather derivatives, taking account of portfolio effects. Our analysis shows how the magnitude of portfolio effects is related to the correlation between weather indexes and other risky assets, the correlation between weather indexes, and the payoff structures of the existing weather derivatives in an investor’s asset portfolio. We also conduct some preliminary empirical analysis. This study contributes to the weather derivatives-pricing literature by incorporating both the hedgeable and unhedgeable parts of weather risks in illustrating the portfolio effects on the indifference prices of weather derivatives.

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Inferring Public and Private Information from Trades and Quotes

Bart Frijns

We propose a new model that uses non-synchronous, ultra-high frequency data to analyze the sequential impact of trades and quotes on the price process. Private information is related to the impact of trades and public information to the impact of quotes. The model is extended to include various other factors that affect public and private information. For 20 active Nasdaq stocks, private information causes, on average, 9.43% of daily stock movements. Additionally, quotes are more informative when (1) many dealers set the best price and (2) traditional market makers rather than ECNs set the best price.

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Price Movements, Information and Liquidity in the Night Trading Market

Antoine Giannetti, Stephen J. Larson, Chun-I Lee, Jeff Madura

Night trading provides an ideal laboratory to assess the behavior of stock markets when institutional liquidity providers are less active. The evidence indicates that extreme positive (winner) and negative (loser) stock price movements during night sessions are followed by reversals the next day. The reversals are more pronounced following extreme stock price movements that are associated with less trading volume and lower liquidity. Within-the-night sample reversals are less pronounced for stocks of companies issuing earnings announcements.

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Erratum to the published version

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Variance Spillover and Skewness in Financial Asset Returns

Bob Korkie, Ranjini Sivakumar, Harry J. Turtle

Bond and stock returns have been observed in the literature to exhibit unconditional skewness and temporal persistence in conditional skewness. We demonstrate that observed persistence in conditional third central moments can be due to the spillover of conditional variance dynamics. The confounding of true skewness and a variance spillover effect is problematic for financial modeling. Using market data, we empirically demonstrate that a simple standardization approach removes the variance-induced skewness persistence. An important implication is that more parsimonious return and asset pricing models result if skewness persistence need not be modeled.

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