Asymmetric information in finance: four empirical essays
Creators: name: CICIRETTI, ROCCO
Publisher: name: Università degli Studi di Roma "Tor Vergata"
Year: 2005
Subjects: subject: earning forecast bias;September 11asymmetric information; rational expectation;delta credit spread; heterogeneous agents; bubble burst;
subject: G12; Asset pricing
subject: G24; Investment banking
subject: earning forecast bias
subject: September 11asymmetric information
subject: rational expectation
subject: delta credit spread
subject: heterogeneous agents
subject: bubble burst

description: 17. ciclo
description: This research work is composed by four articles on finance issues. The overall research is driven by a common view in which financial markets microstructure is characterized by the hypothesis of the presence and interaction of heterogeneous agents with asymmetric information. Large part of the literature adopts this view by focusing on the interaction between a group of more informed (rational) (Grossman 1976) and a group of less informed traders (noise, liquidity and near rational) (Grossman-Stiglitz 1980, Verrecchia 1982). In markets where agents have heterogeneous information set, prices do not incorporate all the relevant information, and agents need to buy part of the information not incorporated into prices to decide their (buy/sell) position (Lang, Litzenberger and Madrigal 1992). In this context professional forecasts can be used as information for uninformed agents’ choice and the first idea of the research was to analyze the forecast accuracy of analysts’ across years and release dates. More in detail, the first paper is a comparative analysis of the earning forecast bias for two homogeneous samples of US and EUROZONE stocks which have been in the two indexes for all period considered. The results show that the bias of the EUROZONE stocks is significantly higher in absolute value for almost any year and distance from the release date, even though US stocks are significantly more optimistically valued between 1997 and 2000. The cross-sectional dispersion of estimates is also lower in the US. We find evidence of convergence in both markets with the bias becoming progressively lower across years. Firm size, number and standard deviation of forecasts are also found to affect significantly the bias in the same direction in both markets. In the second paper the analysis is focused on firm specific and aggregate shocks that generate reassessment of investors and analysts expectations on earnings forecasts and on the fundamental value of equities. In this paper I evaluate the effects of this combined reaction on the implied equity risk premium extracted from a standard two-stage dividend discount (DD) model. If investors and analysts revisions coincide, and in absence of measurement errors in the DD formula, the observed shocks should not have any significant impact on prices and Implied Equity Risk Premium (IEPR). On the contrary, in an analysis based on data for all S&amp;P 500 COMPOSITE INDEX constituents from 1990 to 2003, it is possible to observe substantial overreaction of investors to both downward and upward firm specific forecast revisions, plus overreaction to changes in GDP and to the announcements of the Consumer and Business Confidence indicator. It is also possible to see that positive overreaction to upward earning forecast revisions and GDP changes falls after the stock bubble burst, while overreaction to upward forecast revision and to announcements of the Consumer Confidence Index looses significance after the 9/11 terrorist attack. These findings are broadly consistent with the hypothesis of reduced participation of uninformed (noise) traders to financial markets after these two shocks. In the third one the analysis is on the relationship between the risk of holding a stock and the risk of holding a corporate bond on a large sample of option adjusted delta credit spreads (DCSs), disaggregated by rating, industry and maturity. The results show that the implied equity risk premium significantly and positively affects the IG corporate bond risk premium (proxied by DCSs). The nexus reveals that a common risk tolerance (perception of risk) component affects both bond and equity markets. This risk tolerance component is highly sensitive to economic (financial scandalsand crises) and political (September 11, Iraqi and Afghani wars) shocks and its impact on DCSs is not captured by traditional DCSs determinants such as stock market performance and volatility, institutional investors and consumers confidence and interest rate levels. The last article shows how stylized fact characterizing aggregate price evolution can be recovered from the propagation of a perturbation from the micro to the macro scale. An empirical analysis of financial markets has shown number of stylized facts such as heavy tails or volatility bursts which are difficult to explain in terms of evolution of fundamental economic variables. Indeed the non-Gaussian, non-stable character of empirical distributions, such as excess demand or stock returns, demonstrate the weakness of any independent agent approach to model the real market. Starting from the existing literature on the characterization of the behavior of random economies with many interacting agents, we identify a set of microeconomic interaction rules which could help to explain the macroeconomic observed market behavior. Following the work of Bornholdt and extending the Brock and Durlauf work, we will consider interacting agents whose payoff exhibit both a strategic complementarity with their nearest neighbors actions and an eventual global substitutability with the global market state. In this setup we reconstruct a price process related to the imbalance between buyers and sellers. Finally we investigate how the frustration resulting from the tendency of local imitation, with an additional coupling with the average state of the system reproduces main observed stylized facts of real financial markets. We show how in this framework even the largest crash may emerge as a natural intrinsic metastable dynamics of the system induced by a collective phenomena such as crowd effects or herd behavior.