G11 - Portfolio Choice; Investment DecisionsReturn

Although the link between risk aversion and diminishing marginal utility of wealth is academically well established, theoretical discussions concerning its empirical validity remain. The presented, review-type paper aims to briefly examine theoretical roots responsible for the different views on this association in order to provide a broader perspective to alternative explanations. This latter task is assisted by comparative analysis of two recent pieces of research by Rick Falkenstein and Matthew Rabin; a duo of papers, handpicked at the author’s discretion to demonstrate the convergence of alternative ideas from different authors (and backgrounds). In support of its argumentation, the paper also presents a critical overview of the equity premium puzzle as seen through the prism of behavioural finance. The main contributions of the paper include evidence-based support for the concept of relative utility and reconfirmation of the meaningful role of behavioural finance in economics and finance.

The study tests whether realised moments of stock returns (mean, variance, skewness and kurtosis) computed from daily returns over the last month, quarter and year can predict the 1-month cross-sectional stock returns of 40 US-traded liquid stocks in the period 1986-2019. The performed univariate regression analysis confirmed a statistically significant positive effect between all the realised moments, computed over the last quarter and year, and the future 1-month cross-sectional stock returns, while the 1-month realised moments proved to be mostly insignificant. Multivariate analysis, performed with Elastic Net Regression, has confirmed that investment strategies utilising information from realised moments were able to significantly outperform a random investment in the out-sample period 2004-2019.

Asset pricing in its essence is a very controversial topic. Despite numerous research papers criticising traditional approaches, such as linear factor models, practitioners as well as academics repeatedly return to the milestone models such as the Capital Asset Pricing Model (CAPM), mainly due to their attractive simplicity. This article focuses on the risk-return relationship by comparing the power of traditional and alternative asset pricing models in explaining the cross-section of asset returns. The focus is on unconditional models, commonly used among investors and equity analysts. This paper is based on the research performed by Estrada in 2004 and it extends his approach by introducing the use of GMM. The results suggest that for Emerging markets' investors should give preference to total risk measures over systematic risk measures. Within the category of systematic risk measures, downside beta proved its superiority to traditional CAPM beta. The results can be attributed to delayed integration process, partially justified by the lower FDI and portfolio investments into Emerging markets.

This study explores the effect of the gambler's fallacy on stock returns. I hypothesize that if during a number of consecutive trading days, a stock's return is positive (negative), then due to the gambler's fallacy, at least some of the investors may believe that the stock's price "has" to subsequently fall (rise), and thus, to increase their willingness to sell (buy) the stock, resulting in negative (positive) abnormal market-adjusted stock returns. Employing a large sample of daily stock price data, I was able to document that following relatively long sequences of positive (negative) stock returns, abnormal stock returns are on average significantly negative (positive), indicating the existence of the price pressure towards the return sign reversal. Moreover, the magnitude of the effect is stronger for longer return sequences. The effect is found to be more pronounced for smaller and more volatile stocks, and is robust to other relevant company - and stock-specific factors.

In the present study, I explore interday correlations between open-to-close and opening stock returns. Employing intraday price data on all the stocks that were S&P 500 Index constituents during the period from 1993 to 2013, I find that stock returns in opening trading sessions systematically tend to be higher following days with relatively low (either negative, or lower than the same day's market) open-to-close returns. Moreover, I explicitly document the tendency of opening stock returns to be reversed (to change their sign) following previous day's open-to-close returns. This kind of price behaviour seems to contradict stock market efficiency, and may be potentially interpreted as stock price 'corrections' following their 'deviations' from the underlying values caused by noise trading during the continuous trading sessions. Based on this finding, for the sampling period, I construct two different daily-adjusted investment portfolios based on the opening trading sessions and involving a long position in the stocks on the days when their opening returns are expected to be high and a short position in the stocks on the days when their opening returns are expected to be low. Both portfolios are found to yield significantly positive returns, even after accounting for trading commissions, providing an evidence for practical applicability of the documented pattern in opening stock prices.

Capital markets appreciate stability. It means that companies reporting smooth earnings patterns tend to be priced relatively high. However, the empirical issue is whether such valuation premiums for earnings smoothness are justified. We examine the relationships between past five-year earnings smoothness and relative stock prices of companies listed on the Warsaw Stock Exchange. The empirical investigation confirmed that on the Polish market the smooth historical earnings are rewarded with valuation premiums and the erratic earnings are penalized with valuation discounts. However, stocks with smooth past earnings tend to bring sub-par future stock returns while stocks with relatively erratic earnings seem to generate above-average returns. Furthermore, the scope of past earnings smoothness does not show any discernible relationships to realized investment risk measures. Finally, companies with smooth earnings tend to report "negative earnings surprises" and relatively slow earnings growth rates in the following year. All in all, our research suggests that there is not any empirically observable justification for the valuation premiums observed in the case of stocks with smooth past earnings because such smoothness translate neither into relatively low future investment risks nor relatively fast future earnings growth.