Three Essays on International Finance and International Capital Markets by Qiaoqiao Zhu A dissertation submitted in partial fulfillment of the requirements for the degree of Doctor of Philosophy (Economics) in The University of Michigan 2009 Doctoral Committee: Professor Linda L Tesar, Chair Professor Kathryn Mary Dominguez Assistant Professor Paolo Pasquariello Assistant Professor Zhichao Yuan The difficulty lies not in the new ideas but in escaping from the old ones. - John Maynard Keynes, 1935 c Qiaoqiao Zhu 2009 All Rights Reserved To Mom and Dad Who know unconditional love ii ACKNOWLEDGEMENTS I would like to express my gratitude to all those who made this dissertation pos- sible. I am deeply indebted to my advisor, Prof. Linda Tesar, whose guidance and encouragement helped me in the writing of this thesis.
Her willingness to listen, thought-provoking input, and her rigorousness are essential to the fruition of this dissertation. I am also grateful to my other committee members for all their help, support, interest, and valuable discussions. I want to thank Prof. Kathryn Dominguez for all the useful discussions.
It was working as a research assistant for her and Prof. Tesar that first allured me into the field of complicated, yet exciting, international finance. I am especially obliged to Prof. Paolo Pasquariello and Prof.
Kathy Yuan, whose comments helped to shape my research. I would like to thank Prof. Lu Zheng, who is now at UC Irvine. I learned a great deal about empirical finance through working with her.
Two of the chapters are coau- thored with Prof. Lu and members of my committee. Chapter III is coauthored with Paolo Pasquariello and Kathy Yuan, and was presented at the 2007 AFA meetings. Chapter IV is coauthored with Kathy Yuan and Lu Zheng, and is published as a leading article in The Journal of Empirical Finance 13(1), 1-23, 2006.
My thanks also go to my professors at Fudan University, Prof. Min Hua and Prof. The spirit of persistence they inspired in me has translated into the Michigan affirmation - those who stay will be champions. Life is full of cliches, but iii this one is worth repeating: Never give up.
I wish to thank my beloved Fang for her love and support through difficult times. She was of great help in the finishing stage of this dissertation. Finally, I would like to give my special thanks to my parents and my brother, whose patient love and trust enabled me to complete this work. iv TABLE OF CONTENTS DEDICATION.
iii LIST OF FIGURES. vii LIST OF TABLES. viii LIST OF ABBREVIATIONS. The Home Stigma: Adverse Selection in ADRs and the Home Capital Market Environment .2 Home Capital Market Environment .1 Average Quoted Spreads .2 A Time-Varying Measure of Information Environment 30 2.3 Fama-Macbeth Statistical Method .4 Effective Spreads and Adverse Selection Component of Spreads .5 Alternative Information Measure .6 Is the Home Country Institution Risk Priced?.
Is There Timing Ability in Currency Markets? Evidence from ADR Issuances .2 Currency and Equity Returns .3 Timing Ability in Exchange Rate Markets .1 Event Study Analysis .3 Market Timing: Crises and Integration .4 Who Times the Exchange Rate Market?. Are Investors Moonstruck? Lunar Phases and Stock Returns 129 4.1 Lunar Effect on the Global Portfolios. Small Capitalization Stocks .4 Trading Volume and Market Volatility .6 The Lunar Effect and Other Calendar Anomalies .7 Additional Robustness Checks .8 30-Day Cycle Effect. 171 vi LIST OF FIGURES Figure 2.1 Home Market Information Transparency Measures .1 Cumulative Abnormal Exchange Rate Returns Around ADR Issues 121 3.2 Cumulative Abnormal Exchange Rate Returns Around ADR Issues: Regional Groups .3 Cumulative Abnormal Exchange Rate Returns Around ADR Issues: Financial Crises .4 Cumulative Abnormal Exchange Rate Returns Around ADR Issues: Market Integration .5 Cumulative Abnormal Exchange Rate Returns around ADR Issues: Firm and Issue Size .6 Cumulative Abnormal Exchange Rate Returns around ADR Issues: Tobin’s q .7 Cumulative Abnormal Exchange Rate Returns Around ADR Issues: Industries .8 Cumulative Abnormal Exchange Rate Returns around ADR Issues: Underwriters .1 Average Daily Logarithmic Stock Returns of the Global Portfolio .2 Average Daily Logarithmic Return of the Global Portfolio by Lunar Dates .3 Distribution of Macro-announcement Days .4 Distribution of Full Moon Days on Days of a Week .5 30-Day Cycles and Stock Returns.
170 vii LIST OF TABLES Table 2.1 Correlation Between the Home Capital Market Environment Mea- sures .2 Summary Statistics on ADRs .3 Quoted Bid-Ask Spread and Home Capital Market Environment .4 Quoted Bid-Ask Spread and Home Market Information Transparency 47 2.5 Quoted Spread and Home Capital Market Environment: Emerging and Developed Markets .6 Quoted Spreads and Time-Varying Disclosure Measure .7 Quoted Spread and Home Capital Market Environment: Two-Stage Regression Approach .8 Effective Spread and Home Capital Market Environment .9 Adverse-Selection Component of Spreads and Home Capital Market Environment .10 C2 Adverse Selection Measure and Home Capital Market Environ- ment .11 Excess ADR Returns and Home Capital Market Environment .1 Summary Statistics on ADR Issues .2 Summary Statistics of Equity and Currency Market Returns .3 Poisson Regressions: ADRs .4 Poisson Regressions: Regional ADRs .5 Poisson Regressions: ADRs and Financial Crises .6 Poisson Regressions: ADRs and Market Integration .7 Economic Significance of Currency Market Timing Abilities .8 Poisson Regression: ADRs Across Firm and Issue Size .9 Poisson Regression: ADRs and Tobin’s q .10 Poisson Regressions: ADRs Across Industries .11 Poisson Regressions: ADRs Across Underwriters .2 Lunar phases and stock returns: the global portfolio .3 Lunar Phases and Stock Returns: Joint Tests .4 Lunar Effect and Stock Sizes .5 Lunar Phases, Trading Volumes, and Volatility .6 Lunar Phases, Stock Returns, and Macro-Variables .7 Lunar Phases, Stock Returns, and Other Calendar Anomalies .9 Lunar Phases, Stock Returns, and Varying Lunar Window Length .10 Lunar Phases, Stock Returns, and ARIMA Specifications .11 30-Day Cycles and Stock Returns. 166 ix LIST OF ABBREVIATIONS ADR American Depositary Receipt EM Emerging Market DEV Developed Market GAAP Generally Accepted Accounting Principles SEC U. Securities and Exchange Commission GDR Global Depositary Receipt CR Capital-Raising IPO Initial Public Offering IFS International Financial Statistics MSCI Morgan Stanley Capital International bps Basis Points ETF Exchange-Traded Fund ARIMA Autoregressive Integrated Moving Average x ABSTRACT Three Essays on International Finance and International Capital Markets by Qiaoqiao Zhu Chair: Linda L Tesar This dissertation consists of three essays examining informational and behavioral fric- tions in international financial and capital markets. Chapter II investigates whether characteristics of the home country capital market environment, such as informa- tion disclosure and investor rights protection, continue to affect American Depositary Receipts (ADRs) cross-listed in the U.
I find that characteristics of the home mar- kets continue to be relevant, especially for emerging market firms. Less transparent disclosure, poorer protection of investor rights and weaker legal institutions are asso- ciated with higher levels of information asymmetry. My finding suggests that cross- listing in the U. should not be viewed as a substitute for improvement in the quality of local institutions.
Chapter III addresses the question of whether it is possible to profit from timing the exchange rate markets by examining foreign firms’ decision to issue ADRs. Specifically, we test whether foreign firms consider currency market conditions in their ADR issuance decisions. We find that foreign firms tend to issue ADRs after their local currency has been abnormally strong against the U. dollar and before their local currency becomes abnormally weak.
Currency market timing is especially significant for companies who are more likely to be affected by higher xi currency exposure and emerging market companies. It is more pronounced during currency crises and after the market integration, and when the ADR issue raises cap- ital. Currency market timing is also economically significant. These findings suggest that some companies may have private information about foreign exchange market.
Chapter III examines behavioral bias in global financial markets. It investigates the relation between lunar phases and stock market returns of 48 countries. The findings indicate that stock returns are lower on the days around a full moon than on the days around a new moon. The magnitude of the return difference is 3% to 5% per annum based on analysis of global portfolios.
The return difference is not due to changes in stock market volatility or trading volumes. The lunar effect is not explained away by announcements of macroeconomic indicators, nor is it driven by major global shocks. Moreover, the lunar effect is independent of other calendar-related anomalies. xii CHAPTER I Introduction Informational frictions have always been a major issue in finance.
In our modern financial world, markets expand wider and deeper, information is flowing seemingly costlessly along our INTERNET connections. However, the information that is re- quired to evaluate financial assets is not straightforward and not equally available to all market participants. Research in the areas of home bias (e., Tesar and Werner (1995)) and international capital flows (e., Brennan and Cao (1997), Portes and Rey (2005)) all points to the evidence that information issues remain important in our increasingly integrated but still segmented global financial markets. The consequence of not fully understanding the information issues involved in our complex financial world, meanwhile, could be very severe, as the global financial crisis in 2007 and 2008 has witnessed.
Information asymmetry affects asset prices and capital allocation, ex- acerbates financial crisis and contagion, and distorts incentives in corporate financing decisions. Also, since international capital markets are segmented by different invest- ment laws and institution qualities of sovereign nations, corporate governance also plays an important role in capital allocation. Two chapters of this dissertation are related to this broad area. One chapter (Chapter II) studies the impact of the home country capital market environment on the adverse selection cost of the firms’ U.
exchange listed depositary rights, and its implications for government policies aimed at attracting global capital flows. Another 1 chapter (Chapter III) studies firms’ ability to time transactions in the currency mar- ket when raising capital internationally. In a broader sense, both chapters first try to establish evidence that certain types of information asymmetry persist in interna- tional financial markets.1 Chapter II then focuses on the implications of information asymmetry for capital allocations, while Chapter III focuses more on its implications for firms’ capital raising decisions, i., when to issue ADRs to raise capital. Behavioral bias is another reason why financial markets can be less efficient than a classical model predicts.
Research evidence suggests that investors are subject to various psychological and behavioral biases. Such biases may play a relatively more important role in international market where informational problems are more pro- nounced.2 Chapter IV investigates the lunar effect in asset prices. It presents a test of a particular behavioral hypothesis using an exogenously identifiable variable, moti- vated by psychological hypothesis. It finds global evidence of a significant correlation between stock returns and lunar phases.
Cross-listing has increasingly become an important form of raising capital abroad. Previous research on cross-listing argues that foreign firms can improve their disclo- sure and governance by cross-listing in the United States in order to bond themselves to U. The degree of effectiveness of such bonding, however, re- mains an open question. In Chapter II, we examine the cross-section of the infor- mation asymmetry surrounding ADR firms, and relate it to information disclosure quality, governance, and rule of law measures of the countries in which those firms are domiciled.
We find that less transparent disclosure, poorer protection of investor rights, and weaker legal institutions in the countries of origin are associated with higher level of adverse selection in ADRs, especially for firms from emerging markets. Methodologically, Chapter II can be viewed as a crossover study between corporate 1 In Chapter II’s case, information asymmetry of cross-listed firms in equity markets; and in Chapter III’s case, information asymmetry of exchange rate movements in currency markets., Schmeling (2009) 2 governance and market microstructure, with international cross-listing as the subject of the study.