Determinants of stock prices : Evidence from the Automotive Industry

Contrary to previous academic inquiries of stock price determination assessing the explanatory power of a distinct category of variables, this paper explores a comprehensive array of potential determinants of four automotive manufacturers’ (Ford, Honda, Toyota and Tesla) share price. Using OLS regressions on daily panel data, spanning from January 2007 to December 2017, we investigate the effect of three macroeconomic variables : interest rates, inflation and the U.S. Dollar/Euro exchange rate and three microeconomic factors namely, firms’ P/E ratio, Tobin’s Q and Board size, on stock prices. Our ultimate contribution is the investigation of 13 major vehicle recall announcements on Ford Motor’ stock price using a dummy variable approach which contrasts with the event study methodology mostly followed in the literature. Results point toward a high significance of these factors to explain variations in share price, except for the OLS investigation of major recall announcements which proves to be not significant. Notwithstanding low external validity, we deem the analysis to provide valuable insights to actors in the automotive industry, shareholders and prospective investors. I/ INTRODUCTION For CEOs, shareholders and prospective investors of publicly listed corporations, it is primordial to utilize econometric models to understand the origins of stock price variations in order to sharpen their decision-making and enhance their investment performance. For this reason, relying on OLS regression of the Carhart Four-Factor Model depicting stock prices movements as a function of four risk factors, we test the impact of three macroeconomic variables, then consider the impact of three microeconomic variables and ultimately, we investigate the effect of 13 major vehicle recall announcements on share prices, for four prominent automobile manufacturers from January 2007 to December 2017. Thus, this paper answers the following question : What are the determinants of share prices in the automotive industry ? Through the analysis briefly described above, we aim to provide CEOs of the four manufacturers scrutinized, shareholders and prospective investors in the automotive industry with supplemental insights of the factors at the origin of stock price shifts in order to enhance their overall decision-making skills, and raise their awareness of the intricacy of stock price dynamics as an increasing number of factors appears to explain price fluctuations. The paper bridges the gaps in the existing literature by combining the investigation of the impact of macroeconomic, microeconomic variables and recall announcements on the firms’ stock price using the most recent daily panel data available. In this respect, we believe that the joint investigation provides a broader picture of potential determinants and the high frequency of the observations raises the degree of accuracy of the research outcome in contrast to earlier works. In the remaining of this thesis, we synthesize the existing literature addressing stock price determination. We pursue with a description of the empirical strategy that we employ further in the paper and continue with the presentation of the results. The ultimate section discusses the fundamental results as well as limitations of the research strategy. Ultimately, we conclude the thesis with suggestions for further research. II/ The Evolution of Asset-Pricing Models The unpredictable character inherent to financial markets and their underlying instruments has historically puzzled many economists which has led to extensive theoretical and empirical research intended to shed some light on the factors driving fluctuations in stock prices. In this section, we synthesize the academic literature relevant to our research question and examine how stock price determination has evolved over the course of time. 2.1. Macroeconomic, Institutional Variables and Stock Prices As Ho and Iyke (2017) identify, financial literature addressing the evaluation of stock prices determinants can be decomposed into two main approaches : on the one hand, a comprehensive body of academic literature investigates the contribution of macroeconomic factors to fluctuation of stock prices. In this vein, Asprem (1989) explores the significance of key macroeconomic instruments to explain stock prices in ten European countries. Using quarterly data spanning from 1968 to 1984, the author establishes a joint negative relationship between unemployment, imports, inflation and interest rates on the one hand, and stock prices on the other hand. Despite the significance of the findings, Asprem acknowledges that raising the frequency of the observations composing his dataset may enhance the strength of this relationship. Other researchers, such as Muckherjee et al. (1995) share Asprem’s findings in contrasting environments. The former, using 240 monthly observations between 1971 and 1990, extracted from the International Monetary Fund database, examines the effect of six macroeconomic variables. Muckherjee conducts a Vector Error Correction Model which enables the investigation of the cointegration degree for a set of variables, with contrasting time perspectives (shortrun and long-run) and concludes that the Japanese stock market is negatively cointegrated with exchange rates, inflation and money supply. Along similar lines, Homa and Jaffee (1971) argue that a systematic pattern of determination of stock prices occur through the money supply and interest rates in five open countries between 2004 and 2014. The main results, derived using a Random Effects model for panel regression, allowing to illustrate heterogeneity between the variables, combined with panel Vector Error Correction to determine cointegration between the variables once transformed into stationary processes, concur with the previous papers. The findings put forth a negative relationship between the variables scrutinized and an index of share prices. Thus far, it appears that there exists a general consensus that macroeconomic indicators influence stock prices, nevertheless, Ho and Iyke (2017) question macroeconomic factors as the only drivers of fluctuations and detail another source. The second approach outlined by Ho and Iyke (2017) postulates that share prices respond to the effect of institutional variables. The researchers posit that the integration of stock markets, legal framework and corporate governance constitute explanatory strands of stock prices. Along these lines, Pástor and Veronesi (2012) contend that political uncertainty, operationalized using as proxy the Policy Uncertainty Index (Baker, Bloom and Davis, 2012), raises the risk premium inherent to security price shifts, and that the phenomenon is amplified in the context of economic downturns. Their research applies a general equilibrium model which corroborates this hypothesis, using daily returns derived from the S&P 500 index, and monthly measures of economic state. Despite insightful implications, general equilibrium models rest on a set of assumptions such as perfect knowledge which hinders the external validity of the results. In the same vein, the researchers explore the joint impact of economic and politic shocks assuming that the two occurences are independent. However, it is legitimate to question this assumption by testing the independence of the two events which the paper omits. In the seminal paper Legal Determinants of External Finance, La Porta et al. (1997) prompt further evidence of the impact of institutional variables on stock prices. The authors point out that the legal framework surrounding investor protection, acts as a determinant of capital markets. Employing a sample of 49 countries, the authors identify that the development of a state’s legal environment is directly linked to the volume of its capital market. Thus far, we have argued that macroeconomic and institutional variables enable some explanations of stock prices movements. Though, economists have challenged the belief that macroeconomic and institutional factors form the exhaustive list of determinants of stock prices. In this vein, many have attempted to unravel asset-pricing puzzles by contemplating extra plausible facets. 2.2. News and Stock Prices A third body of academic literature is consistent with the extrapolation of Normative Pricing Models whereby securities are priced according to the discounted value of expected future dividend streams (Bierman and Hass, 1971). Thus, some economists have introduced the effects of heterogenous types of news on firm’s market price such as McQueen and Roley (1993). Together, they explain stock price swings to originate from adjustments in the dividend discount rate in the light of various types of news. In conformity with this view, a seminal paper from Fama et al. (1969) reaches an analogous conclusion. The analysis led by Fama and his fellow researchers scrutinizes 940 stock splits that occurred on the NYSE between 1927 and 1959. The outcome of the log-log regression on stock returns highlights that, in the context of stock splits, stock prices react to information that alter the prospects of future dividend streams. In a related vein, Cutler et al. (1988) have determined that macroeconomic news explain approximately one third of the variance experienced by share prices. Nonetheless, in an attempt to explain the remaining component of the variance of stock returns, Cutler et al. have considered the role of major political and world events. However, the findings reveal that this category of events appears to explain only to a modest extent the fraction of the variance unexplained by macroeconomic news. In order to provide further support to the hypothesis that the disclosure of new information influences stock prices, Hite and Owers (1983) consider 123 spin-offs announcements between 1963 and 1981 communicated by 116 firms. Together, they uncover abnormal favourable returns over a 1day win