Contents of Volume 4, Number 1

Special Issue: Behavioural Finance: Theory and Evidence (Guest Editor: Prof. Richard Fairchild)

June 2008

Behavioural Corporate Finance: Existing Research and Future Directions

R. Fairchild

Abstract: Behavioural corporate finance (BCF) examines the effects of managerial and investor psychological biases on a firm’s corporate finance decisions (such as investment appraisal and capital structure). In contrast to the well-developed research in behavioural finance (which examines the effects of investors’ biases on the behaviour of the financial markets), the emerging research in BCF is relatively young. In this paper, we review the existing research to date in BCF, and suggest areas for future development.

The Role of Trust and Risk in Predicting Individuals’ Savings Allocation Behaviour  

P. Cox

Abstract: Modern portfolio theory (MPT) argues that individuals diversify at the investment and product provider level. Regarding the former, MPT offers a widely accepted model, but regarding the latter it does not. This study uses existing theory on the behavioural relationship between trust and risk to propose that individuals’ choice of financial service provider for the allocation of their savings is influenced by trust. The study focuses on the savings allocations within one UK financial service provider that is considered to be highly trusted, and compares the levels of risk-free and risky savings of this provider with the UK industry as a whole, to ask the question of how dissimilar its savings allocations are compared to the overall industry. The originality of the study is the application of behavioural aspects to predict individuals’ choice of product provider in their retail savings. The study confirms the predicted relationship, and finds that trust significantly influences risky financial decisions. The results support behavioural finance findings that consumers value information that is non-numeric and personal. In terms of practice, the findings indicate that a provider not perceived as highly trusted may have difficulty selling risk-based products on which higher fees are earned.  

The Short and Long Term Performance of Initial Public Offerings in the Cyprus Stock Exchange

D. Gounopoulos, Ch. Nounis, P. Stylianides

Abstract: This study examines the price performance of initial public offerings (IPOs) in the Cyprus Stock Exchange during the period 1999-2002. It investigates the difference between the IPOs listing price and their equilibrium market price through studying a sample of 75 new listed companies.  Specifically, it examines the differences between the listing price of IPOs and their equilibrium market prices at the end of the first day, sixth, twelfth, twenty-fourth and thirty-sixth month. From the derived results it is evident that Cypriot IPOs have large positive initial returns, especially on the end of the first trading day. Long term results, not taking into account the first day returns, are much lower and in many cases even negative. Both these trends are in agreement with the outcomes of international empirical studies. The first day underpricing phenomenon forces to search for possible factors, which may have caused it. Different variables, used in similar international studies were used to do so. Our research shows that positive initial returns, amongst other factors, may have been affected by increase in the General Index of the Stock Exchange between the last day of public offerings’ period and the first trading day (time lag), the reputation of the companies underwriters, the firms issue size and the companies history.  It is also evident that our sample was affected by the extraordinary stock exchange conditions that prevailed during the specified period, which is examined. The intriguing Cyprus Stock Exchange behaviour is further examined by looking into its investment, parallel and alternative primary markets.

Stock Market Returns Through the Bull-bear Cycle

H.J. Wells, D.E. Ayling, L. Hodgkinson

Abstract: This paper examines the distribution of stock market trends within different phases of  bull-bear cycles using a bootstrap methodology to measure the extent to which empirical distributions of returns differ from those expected to be observed in randomly occurring trends.  Data from the world’s six largest stock markets, by capitalisation, from 1987 to 2004 are used to examine bull-bear cycles broken down into quarterly bull and quarterly bear phases.  The paper then considers whether behavioural explanations can explain why trends may differ, in a systematic way, from random trends. Key findings are i) that mean amplitudes and durations of bull trends tend to be larger than for bear trends; ii) that mean returns throughout the cycle are asymmetric with the largest changes at turning points; iii) that the final quarter of bear trends are characterised by extreme steepness; and iv) that there is a positive relation between absolute mean returns and market volatility; but concludes that the only behavioural explanation consistent with the findings is loss aversion.  Loss aversion would produce asymmetries across bull and bear markets and therefore may have a role to play in generating the patterns observed in stock market returns through the bull/bear cycle. Asymmetric volatility has been previously observed during market crashes but the results of the paper suggest that, rather than being a feature of extreme market corrections, such volatility may be a feature of bull-bear trends in general, particularly for the final stages of bear trends.

Asset Prices and Multiple Reference Points

Marcello Basili, Roberto Renò, Carlo Zappia

Abstract: This paper introduces multiple reference points in the traditional consumption-based asset pricing model of Lucas (1978). Following Barberis et al. (2001), we assume that an investor derives utility both from consumption and from changes (gains and losses) in the value of her financial wealth with respect to the initial endowment of a risky asset. We build upon Basili et al. (2005) and represent the investor's loss aversion over changes with respect to a set of reference points, instead of a single one, showing that this improves the descriptive ability of the cumulative prospect theory approach proposed by Barberis et al. (2001).