Three Essays on Financial Economics Open Access

Wu, Yanbin (Summer 2021)

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This dissertation contains three essays on financial economics. In the first essay (“Closing Auctions: Information Content and Timeliness of Price Reaction”), we first document that closing auction volume has increased dramatically from 2010 to 2018 and currently accounts for about 11% of the total trading volume. We argue that ETF arbitrage trades significantly contribute to this growth, but these trades likely constitute less than 15% of the closing auction volume. We find that the closing auction price impact for the decile of stocks with the largest buy order imbalance is 32 basis points bigger than that for the decile with the largest sell order imbalance. About 83% of the price impact reverses over the next 3–5 days, but the remaining impact is permanent. Trading strategies that exploit these price effects and reversals are significantly profitable. In the second essay (“the Effect of Passive Investing on Initial Public Offering Stocks”), I investigate the impact of index investing on initial public offering by examining the Russell quarterly IPO additions. The findings show that stocks more likely to be included in the next quarterly additions experience bigger first-day returns, consistent with the hypothesis that underwriters do not fully incorporate the effect of potential inclusion in Russell indices on stock prices when they set the IPO prices. During quarterly addition periods, included IPOs experience significant abnormal returns that are subsequently reversed, consistent with the price pressure hypothesis. In the third essay (“Price Impact Reversal and The Illiquidity Premium,”), we find that a small subset of stocks with poor returns drives the illiquidity premium, consistent with it representing a return reversal. Stock transactions show that institutional investors sell illiquid losers, and that these stocks are subject to large transaction costs. The positive abnormal return associated with illiquid stocks stems directly from the reversal of the group of stocks with poor recent returns and downward price pressure. Our results suggest that these abnormal returns do not represent a broad premium that compensates investors for holding illiquid stocks. In fact, the mirror image group of illiquid winners shows an illiquidity discount.   

Table of Contents

Introduction 1

Closing Auctions: Information Content and Timeliness of Price Reaction 3

Introduction 3

Closing Auctions 7

Closing auctions: Key factors 9

ETF Arbitrage 9

Stock characteristics and closing auction trades 12

Earnings announcements 14

Information content of closing auction trades and timeliness of stock price reaction 15

Order imbalance trajectory 16

MOC announcement to close 17

Price changes on subsequent days 18

Earnings Announcement Days 20

Economic significance: Trading strategies 21

Trading strategy with EAD stocks 23

Price Impact: Closing auctions vs. regular trading hours 24

Conclusion 26

The Effect of Passive Investing on Initial Public Offering Stocks 41

Introduction 41

Institutional Background and Data 48

Quarterly Inclusion of IPOs into Russell U.S Indexes 48

Results 49

Passive investing and the first-day returns: all eligible IPOs 50

The price and volume effect of index inclusion 54

Price dynamics 55

Volume dynamics 57

Comovement: a difference-in-difference approach 58

Conclusion 60

Price Impact Reversal and The Illiquidity Premium 71

Introduction 71

Data 74

Empirical Analysis 77

3.1 Illiquidity and Future Stock Performance 77

3.2 Illiquidity and Past Stock Returns 79

3.2.1 Univariate Relation 79

3.2.2 Double Sort of Past Returns and Illiquidity 80

3.3 Price Pressure of Illiquidity / Return Sorts 83

3.3.1 Inferred Mutual Fund Trades 85

3.3.2 Institutional Stock Trades 87

3.3.3 Institutional Stock Transaction Costs 89

3.4 Alternative Liquidity Measures 91

4. Conclusion 95


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