1. 1 Stock Price Synchronicity and Analyst Coverage in Emerging Markets and R 2 Around the World: New Theory and Tests Discussion by Campbell R. Harvey Duke University and NBER 4 th Annual Conference on Emerging Markets Finance March 9-11, 2005 University of Virginia

2. 2 The Common Theme Both papers study how stocks in international markets move together (synchronicity) Both papers study how stocks in international markets move together (synchronicity) Both use R 2 (stock return regressed on market return) as measure of synchronicity Both use R 2 (stock return regressed on market return) as measure of synchronicity (market-wide info) (market-wide info) R 2 ~ ------------------------------------------------- (market-wide info + firm-specific info) (market-wide info + firm-specific info) 4 th Annual Conference on Emerging Markets Finance

3. 3 Roll (1988) Roll (1988) –U.S. stocks have low R 2 Campbell, Lettau, Malkiel, Xu (2001) Campbell, Lettau, Malkiel, Xu (2001) –R 2 decreasing over time for U.S. stocks Morck, Yeung, Yu (2000) Morck, Yeung, Yu (2000) –Higher R 2 in emerging markets than developed markets Piotroski, Roulstone (2004) Piotroski, Roulstone (2004) –Different market participants’ info generating activities and their effect on R 2. Security analysts do not have an advantage over insiders or institutional investors The Research Setting 4 th Annual Conference on Emerging Markets Finance

4. 4 Jin, Myers (JM) Jin, Myers (JM) –Explain differences in R 2 across countries Chan, Hameed (CH) Chan, Hameed (CH) –Explain differences in R 2 across firms The Differences 4 th Annual Conference on Emerging Markets Finance

5. 5 Both study role of information in explaining differences in R 2 Both study role of information in explaining differences in R 2 JM: link R 2 with opaqueness JM: link R 2 with opaqueness CH: link R 2 with analyst activity CH: link R 2 with analyst activity * * * * * * The Differences 4 th Annual Conference on Emerging Markets Finance

6. 6 Model first predicts R 2 increases with opaqueness Model first predicts R 2 increases with opaqueness Why? Why? –Insiders know more firm-specific info than outsiders (info asymmetry) –Insiders bear part of firm-specific risk on behalf of outsiders –Outsiders face relatively more market-wide risk Jin-Myers Model 4 th Annual Conference on Emerging Markets Finance

7. 7 Model second predicts that crash frequency increases with opaqueness Model second predicts that crash frequency increases with opaqueness Why? Why? –Insiders can only absorb so much firm- specific bad news Jin-Myers Model 4 th Annual Conference on Emerging Markets Finance

8. 8 JM proxy opaqueness by JM proxy opaqueness by –Disclosure (Transparency International) –Number of auditors per 100,000 –Diversity (dispersion of analysts forecasts) In emerging markets, driven by In emerging markets, driven by –Weak disclosure regulation –Little voluntary disclosure –Financial development –Interconnecting companies Opaqueness 4 th Annual Conference on Emerging Markets Finance

9. 9 CH asks: CH asks: –Do analysts generate market-wide info or firm-specific info? Prediction for R 2 : Prediction for R 2 : –If analysts generate relatively more market- wide info => R 2 increases with analyst coverage –If analysts generate relatively more firm- specific info => R 2 decreases with analyst coverage Chan-Hameed Model 4 th Annual Conference on Emerging Markets Finance

10. 10 Findings support predictions: Findings support predictions: –R 2 increases with opaqueness –Crash frequency increases with opaqueness (insiders exercise abandonment option if conditions get really bad) Jin-Myers Results 4 th Annual Conference on Emerging Markets Finance

11. 11 Provides alternative interpretation to Morck, Yeung, Yu (2000) Provides alternative interpretation to Morck, Yeung, Yu (2000) –MMY argue property rights protection explains differences in R 2 across countries (weak property rights discourage informed trading and therefore prevent firm- specific information from getting into prices) JM: Opaqueness measures has more explanatory power than property rights measures JM: Opaqueness measures has more explanatory power than property rights measures JM study effect of opaqueness on higher moments of stock markets JM study effect of opaqueness on higher moments of stock markets Find positive effect of kurtosis on R 2 – invite explanations Find positive effect of kurtosis on R 2 – invite explanations Jin-Myers Contribution 4 th Annual Conference on Emerging Markets Finance

12. 12 Findings: Findings: –More analyst coverage increases R 2 –Supports hypothesis that analysts generate relatively more market-wide info Chan-Hameed Results 4 th Annual Conference on Emerging Markets Finance

13. 13 Study interaction between analyst coverage and R 2 in emerging markets Study interaction between analyst coverage and R 2 in emerging markets Shows that Piostroski, Roulstone (2004) results for U.S. hold in emerging markets Shows that Piostroski, Roulstone (2004) results for U.S. hold in emerging markets Tests show that analysts generate market- wide info in emerging markets Tests show that analysts generate market- wide info in emerging markets Chan-Hameed Contribution 4 th Annual Conference on Emerging Markets Finance

14. 14 Does more analyst coverage lead to more informative firm-specific news or reduce firm- specific noise? Does more analyst coverage lead to more informative firm-specific news or reduce firm- specific noise? –Link firm-specific info with future fundamental news e.g. accounting variables (Durnev, Morck, Yeung, Zarowin (2001)) –Are market model residuals correlated with future accounting variables? If higher correlation with high analysts stocks, then more firm-specific information Chan-Hameed Thoughts 4 th Annual Conference on Emerging Markets Finance

15. 15 Study interaction between opaqueness and analyst activity Study interaction between opaqueness and analyst activity –Do analysts generate relatively more market-wide info for more opaque firms? –Regress R 2 on both opaqueness measure, analyst coverage and interaction term between opaqueness and analyst coverage Chan-Hameed Thoughts 4 th Annual Conference on Emerging Markets Finance

16. 16 How to reconcile JM and CH findings? How to reconcile JM and CH findings? –JM: higher earnings dispersion => increased opaqueness => increased R 2 –CH: higher earnings dispersion => more disagreement on market-wide news => reduce positive impact of analyst coverage on R 2 => decreased R 2 Reconciling the Research 4 th Annual Conference on Emerging Markets Finance

17. 17 JM measure is country-level JM measure is country-level CH measure is firm-level CH measure is firm-level Forecast dispersion depends on both opaqueness and disagreement Forecast dispersion depends on both opaqueness and disagreement Possible explanation: Possible explanation: –At country-level, opaqueness component dominates => R 2 increases –At firm-level, disagreement component dominates => R 2 decreases Reconciling the Research 4 th Annual Conference on Emerging Markets Finance

18. 18 Accounting measures Accounting measures –Earnings aggressiveness, earnings smoothing, loss avoidance (Bhattacharya, Daouk, Welker (2002)) Corporate governance measures Corporate governance measures –Business group membership (Bae, Bailey, Mao (2005)) –ICRG subcomponents ? Alternative Opaqueness 4 th Annual Conference on Emerging Markets Finance

19. 19 Analyst activity Analyst activity –Average number of analysts in market –Analysts’ advantage= average error from naïve earnings prediction model - average analysts forecast error. –Are country-level results be consistent with firm- level? Alternative Opaqueness 4 th Annual Conference on Emerging Markets Finance

20. 20 What is the effect of liberalization on the interaction among R 2, opaqueness and analyst activity? What is the effect of liberalization on the interaction among R 2, opaqueness and analyst activity? Bae, Bailey, Mao (2005) Bae, Bailey, Mao (2005) –Study effect of liberalization on info environment Interesting questions: Interesting questions: –Does liberalization affect R 2 through decreased opaqueness or increased analyst coverage? –Would increased foreign investor participation through liberalization increase R 2 because foreign investors rely more on market-wide info? Financial Liberalization 4 th Annual Conference on Emerging Markets Finance

21. 21 Possible measures of liberalization: Possible measures of liberalization: –Investibility at country-level (Bekaert,1995) [country effects will not pick this up because it changes through time] –Investibility at firm-level (Bae, Chan, Ng (2003)) used in CH not JM Financial Liberalization 4 th Annual Conference on Emerging Markets Finance

22. 22 Cross-sectional volatility (Bekaert, Harvey (1997)) Cross-sectional volatility (Bekaert, Harvey (1997)) –Higher cross-section volatility => less market-wide info –Advantage: measure is available at higher frequency than R 2 Stock return dispersion Stock return dispersion –(Solnik, Roulet (2000), De Silva, Sapra, Thorley (2001), Statman, Scheid (2004)) –Difference between average individual stock volatility and volatility of market portfolio Synchronicity 4 th Annual Conference on Emerging Markets Finance

23. 23 Results sensitive to sample (old version of paper used data back to 1989) Results sensitive to sample (old version of paper used data back to 1989) Critically important to use Scholes-Williams market model estimation in emerging market weekly data – also world factor is omitted in CH Critically important to use Scholes-Williams market model estimation in emerging market weekly data – also world factor is omitted in CH Suspicious of regressions with standardized variables on LHS and level variables on RHS Suspicious of regressions with standardized variables on LHS and level variables on RHS Not convinced of the correction for endogeneity problem Not convinced of the correction for endogeneity problem Volume is the noisiest measure in EMDB and is not a good measure of liquidity Volume is the noisiest measure in EMDB and is not a good measure of liquidity Other Issues 4 th Annual Conference on Emerging Markets Finance

24. 24 Considerable evidence that liquidity is a priced factor Considerable evidence that liquidity is a priced factor Evidence in emerging markets that local liquidity is important Evidence in emerging markets that local liquidity is important Stocks with high analysts following are likely more liquid. This explains why the high analysts sort leads the low analysts sort. Stocks with high analysts following are likely more liquid. This explains why the high analysts sort leads the low analysts sort. Liquidity 4 th Annual Conference on Emerging Markets Finance

25. 25 Interesting exercise Interesting exercise –Let the BHL liquidity measures compete with opaqueness and property rights in the JM cross-country regression –Let the BHL liquidity measures compete with the analysts measures in the firm level regression in CH Liquidity 4 th Annual Conference on Emerging Markets Finance