An essay on asset pricing and individual transaction behavior

Abstract

According to popular views in asset pricing, investors require higher returns for holding stocks they perceive to be more risky. However, many studies provide empirical evidence that returns are not always related to risks. These deviations are called anomalies. One of the well-documented anomalies is the new issue puzzle, where stocks of newly listed firms (IPO firms) underperform. The first two essays of my dissertation discuss why stocks of IPO firms perform poorly, and, despite their underperformances, the advantages related with going public. In my first essay, I examine whether IPO firms underperform because they are less risky. Because risk is difficult to measure, previous studies use ex post realized returns as a proxy for risk, which has been shown to deviate from investors’ perception of risk. I use a new measure of ex ante expected return, the market-implied cost of capital (ICC). With this measure, I find that investors actually expect to earn higher returns from investing in IPO firms than in similar established firms. However, investors are negatively surprised by the performances of newly listed firms. These results contradict previous arguments that IPO firms are less risky. My second essay investigates firms’ advantages in going public. I find that, by going public, large IPO firms can exert competitive pressure on their competing firms. Consequently, their competing firms experience drops in their market value, declines in their operating performances, and their default probability increases significantly. Moreover, these competing firms’ stock returns become more sensitive to macro-economic conditions and also exhibit positive risk-adjusted returns. These results suggest that investors perceive competing firms as having higher risk exposure than previously. In my third essay, I study how stock liquidity affects individual investors' preferences of holding periods. I empirically document that individual investors' holding periods are negatively related to stock liquidity, both in the United States and Finland, suggesting investors minimize their transaction costs per period. This effect is stronger for financially sophisticated investors. It help shed new lights on individual investors’ trading behavior.