Asset Pricing across Asset Classes: The Impacts of Fines and Flows

285 Pages·2017·3.57 MB·English

Henley Business School
The University Of Reading
ICMA Centre

Asset Pricing across Asset Classes:
The Impacts of Fines and Flows

Thesis submitted in partial fulfilment of the requirements for the
degree of Doctor of Philosophy

By
Rupini Deepa Rajagopalan

June 2017
Declaration of Original Authorship
I confirm that this is my own work and the use of all material from other sources has
been properly and fully acknowledged.

Rupini Deepa Rajagopalan
Reading, June 2017

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Abstract
This thesis consists of four empirical studies that examine two types of
information, using a unique set of fines and fund flow data, on a multi–asset setting.
The first study finds underperformance of between 29 and 57 basis points per month
measured as Carhart model alphas on long-term stock returns of firms after
announcements of monetary fines. Additionally, environmental fines are perceived by
investors to be more of a concern while social, governance and also long-term aspects
matter somewhat less. In the second study, I extend the research on fines by examining
the inter-link between equities and bonds using short selling ratios and bond returns.
Analysis using a fixed-income model shows that high short selling in the context of
fines induces negative underperformances in bond returns. In addition, the
underperformances are more profound for portfolios with longer remaining years to
maturity and in crisis periods. The third study examines short-term reaction of Credit
Default Swaps (CDS) spread changes and stock returns to fines. I find the CDS market
is able to anticipate illegality news. Both markets react very differently to fines in
different legal stages, industries and also by type of fine. Environmental issues are also
a key concern in both CDS and stock markets and they also react more to higher fines
per market cap. These empirical studies show that information about fines are valuable
for investors as on average companies with illegalities underperform relevant
benchmarks in the short and long-term. The fourth study involves fund flows on a
global scale in Exchange Traded Funds (ETFs). I use panel data models and find that
the explanatory power of ETF fund flows are similar to macro-economic variables in
explaining indices returns. I also find investors could use ETF fund flows as
information to understand market movements especially globally.
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Acknowledgements
First of all, I would like to thank my supervisor and mentor, Dr. Andreas
Hoepner, who has provided me with the outmost support and has believed in me from
the start of my Masters until now. He has allowed me to be a part of his growing
network in the Responsible Investment (RI) community and provided me with the
opportunity to meet and work with many important and influential people in this area.
My valuable discussions with him on not only my PhD dissertation but also on day-to-
day life issues gave me the courage and determination to complete this journey. I am
very glad that I not only gained a mentor but also a good friend.
I would like to thank my closest friends Tiffany, Gaini, Eunice, Dr. Muholan
and Jai who cheered me up and provided me with so much of moral support. Besides
that, I would also like to thank all my fellow PhD students at the ICMA Centre
(ICMAC) and academic staff including Professor Adrian Bell, Professor Chris Brooks,
Dr. Alfonso Dufour, Dr. Simone Varotto, Dr. Ioannis Oikonomou and Dr. Miriam
Marra who provided me with additional guidance on my PhD along the way. I would
also like to extend my gratitude to the administrative staff, especially Leanne Ley, who
helped me in organizing many of the RI events at ICMAC. I also have to thank all the
participants at the ERIIC conference in Hamburg and UNPRI conference in New York
for their comments on the papers in this thesis. I also thank all of the PhD students
under Dr. Andreas Hoepner’s guidance for their feedback and thoughts on my research.
This PhD would not have been possible without my family. My father, Dr. K
Rajagopalan and most importantly my beloved mother, Professor Dr. Jayati Roy who I
admire for her strength and who I look up to as a strong women figure in my life. She
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always told me to think positive and to take life as a challenge. I would also want to
thank my sister, Hema Raj Trukenbrod who since the day I was born always told me
“To reach for the stars”. With our 14-year age gap, she has always loved and protected
me more than a sister and has given me all the support I needed. The encouragement
and love from my brother in law Geoff and my two nieces, Naia and Sloane have also
made my PhD journey a better one. This thesis is also in remembrance to my deceased
grandmother, Renuka Roy, whose love and kindness will always be remembered.
However, the person who gave me the most strength is my husband and my best
friend, Ralf Sobottka. He has always been by my side making sure I could finish this
PhD journey. He has always been encouraging and has reminded me that the finish line
is near and that I am capable of much more. He has supported me not only morally but
has also made sure I am comfortable living in Germany to finish writing up my thesis.
All our discussions on my PhD topic have encouraged me to think deeper. His love and
support knows no boundaries. Without him, this PhD would not have been possible.

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Table of Contents
DECLARATION OF ORIGINAL AUTHORSHIP .................................................... I
ABSTRACT .................................................................................................................... II
ACKNOWLEDGEMENTS ........................................................................................ III
TABLE OF CONTENTS .............................................................................................. V
LIST OF TABLES ....................................................................................................... IX
LIST OF FIGURES .................................................................................................... XII
LIST OF ABBREVIATIONS .................................................................................. XIII
1. INTRODUCTION ................................................................................................... 1
1.1 Motivation for the Thesis .................................................................................... 1
1.2 Intended Original Contributions of the Thesis ................................................. 8
1.3 Outline of the Thesis .......................................................................................... 10
2. CORPORATE LEGAL RESPONSIBILITY AND STOCK RETURNS ......... 17
2.1 Introduction ........................................................................................................ 17
2.2 Literature Review and Hypothesis Development ........................................... 21
2.2.1 Corporate Legal Responsibility ........................................................................ 21
2.2.2 Illegalities and Firm Value ............................................................................... 24
2.2.3 Hypotheses Development................................................................................. 27
2.3 Data and Methodology ...................................................................................... 33
2.3.1 Data Sample ..................................................................................................... 33
2.3.2 EFFAS’ Criteria ............................................................................................... 34
2.3.3 Data Preparation ............................................................................................... 35
2.3.4 Portfolio Creation ............................................................................................. 36
2.3.5 Empirical Model and Benchmark Creation ...................................................... 39
2.4 Empirical Results and Analysis ........................................................................ 42
2.4.1 Impact of Overall (All industries) Results ....................................................... 42
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2.4.2 Impact of Fines per Firm Size Results ............................................................. 43
2.4.3 Impact of Individual Legal Stages ................................................................... 44
2.4.4 Impact of Individual Industry Results .............................................................. 48
2.4.5 Impact of ESG plus LT Results ....................................................................... 55
2.4.6 Impact of ESG plus LT per Industry Results ................................................... 61
2.5 Additional Analyses ........................................................................................... 66
2.5.1 Value Weighted Results ................................................................................... 66
2.5.2 Effect of Value of Fines on Short Interest ....................................................... 76
2.6 Summary ............................................................................................................. 80
3. INTER-MARKET LINK OF ILLEGALITY: MEASURING THE EFFECT
OF SHORT SELLING IN THE CONTEXT OF FINES ON FIXED INCOME .... 83
3.1 Introduction ........................................................................................................ 83
3.2 Literature Review .............................................................................................. 88
3.2.1 Short Selling and Equity Performances ........................................................... 88
3.2.2 Different Information Effects on Asset Classes (Equity and Bond) ................ 89
3.2.3 Related Research .............................................................................................. 91
3.2.4 Bonds and Socially Responsible Investment (SRI) ......................................... 93
3.2.5 Conceptual background and Hypotheses Development ................................... 94
3.3 Data and Methodology ...................................................................................... 99
3.3.1 Data of Illegal Violations ................................................................................. 99
3.3.2 Data Preparation ............................................................................................... 99
3.3.3 Data Construction ........................................................................................... 102
3.3.4 Bond Methodology......................................................................................... 103
3.4 Descriptive Statistics ........................................................................................ 106
3.5 Empirical Results ............................................................................................. 107
3.5.1 Bond Returns on Overall Portfolios ............................................................... 107
3.5.2 Bond Returns in Crisis and Non-Crisis Periods ............................................. 112
3.5.3 Bond Returns according to Remaining Years to Maturity ............................. 116
3.6 Robustness Test ................................................................................................ 120
3.6.1 Different Benchmark Index ............................................................................ 120
3.6.2 Value Weighted .............................................................................................. 122
3.6.3 Liquidity Measure .......................................................................................... 126
3.6.4 Additional Analysis ........................................................................................ 128
3.7 Summary ........................................................................................................... 132
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4. A COMPARATIVE EVENT STUDY: THE IMPACT OF FINES ON
CREDIT DEFAULT SWAPS AND STOCKS ......................................................... 135
4.1 Introduction ...................................................................................................... 135
4.2 Literature Review and Hypotheses Development ......................................... 141
4.2.1 Related literature of the impact of announcements/news on CDS spreads .... 141
4.2.2 Related literature on the relationship between CDS and other asset classes . 144
4.2.3 Hypotheses Development............................................................................... 145
4.3 Data and Methodology .................................................................................... 151
4.3.1 Credit default swap spreads and illegality data .............................................. 151
4.3.2 Event Study Methodology.............................................................................. 152
4.4 Empirical Results: Analyzing CDS spread changes and stock market
returns .......................................................................................................................... 156
4.4.1 Overall Market reaction and by CDS maturity level ..................................... 156
4.4.2 Market reaction by fines per market cap ........................................................ 162
4.4.3 Market reaction by stages of legal process .................................................... 165
4.4.4 Market reaction by industry ........................................................................... 169
4.4.5 Market reaction by ESG plus LT ................................................................... 176
4.5 Limitations ........................................................................................................ 182
4.6 Summary ........................................................................................................... 183
5. ETF FUND FLOWS AND INDEX RETURNS: A GLOBAL MULTI ASSET
CLASS ANALYSIS .................................................................................................... 186
5.1 Introduction ...................................................................................................... 186
5.2 Related Literature and Research Question Development ............................ 192
5.2.1 Literature on ETFs and Performances ............................................................ 192
5.2.2 Literature on Asset Allocation and Variability .............................................. 195
5.2.3 Literature on Price Movement and Macro-economic Variables .................... 197
5.2.4 Research Question Development ................................................................... 199
5.3 Data and Methodology .................................................................................... 200
5.4 Empirical Results ............................................................................................. 205
5.4.1 Descriptive and Correlation Analysis ............................................................ 205
5.4.2 Regression Analysis ....................................................................................... 209
5.4.3 Effects of Index Returns on Macroeconomic Variables and ETF Fund Flows
209
5.4.4 Effects of ETF Fund Flows on the movements of Index Returns .................. 213
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5.5 Summary ........................................................................................................... 216
6. CONCLUSION .................................................................................................... 218
6.1 Summary of the findings of the thesis ............................................................ 218
6.2 Suggestion for future research ........................................................................ 224
7. REFERENCES .................................................................................................... 227
8. APPENDIX .......................................................................................................... 245
8.1 Appendix to Chapter 1 .................................................................................... 245
8.2 Appendix to Chapter 2 .................................................................................... 246
8.3 Appendix to Chapter 3 .................................................................................... 254
8.4 Appendix to Chapter 4 .................................................................................... 261
8.5 Appendix to Chapter 5 .................................................................................... 266

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List of Tables
Table 1.1 Overview of the Thesis on the Main Empirical Chapters ............................... 15
Table 2.1 Overall portfolio (All Industries) results of CAPM,Fama-French and Carhart
........................................................................................................................................ 45
Table 2.2 Portfolio results of CAPM,Fama-French and Carhart regressions with created
benchmarks for the fines per market cap (0 to 20th percentile) ................................... 46
Table 2.3 Portfolio results of CAPM,Fama-French and Carhart regressions with created
benchmarks for the fines per market cap (80th to 100th percentile) ............................. 47
Table 2.4 Finance, Insurance and Real Estate portfolio results of CAPM, Fama-French
and Carhart regressions ................................................................................................... 50
Table 2.5 Manufacturing portfolio results of CAPM,Fama-French and Carhart
regressions ...................................................................................................................... 51
Table 2.7 Services portfolio results of CAPM,Fama-French and Carhart regressions ... 53
Table 2.9 Environment portfolio results of CAPM,Fama-French and Carhart
regressions with created benchmarks ............................................................................. 57
Table 2.10 Social portfolio results of CAPM,Fama-French and Carhart regressions with
created benchmarks ......................................................................................................... 58
Table 2.11 Governance portfolio results of CAPM,Fama-French and Carhart
regressions with created benchmarks ............................................................................. 59
Table 2.12 Long-Term portfolio results of CAPM,Fama-French and Carhart regressions
with created benchmarks ................................................................................................ 60
Table 2.13 Environment portfolio results (individual industries) of CAPM,Fama-
French and Carhart regressions with created benchmarks .............................................. 63
Table 2.14 Social portfolio results (individual industries) of CAPM,Fama-French and
Carhart regressions with created benchmarks ................................................................ 64
Table 2.15 Governance portfolio results (individual industries) of CAPM,Fama-French
and Carhart regressions with created benchmarks .......................................................... 65
Table 2.16 Value Weighted (Company level) results of CAPM,Fama-French and
Carhart regressions with created benchmarks ................................................................ 69
Table 2.17 Value Weighted (Company level) results of CAPM,Fama-French and
Carhart regressions with created benchmarks ................................................................ 70
Table 2.19 Value Weighted (Company level) results of CAPM,Fama-French and
Carhart regressions with created benchmarks ................................................................ 72
Table 2.20 Value Weighted (Company level) results of CAPM,Fama-French and
Carhart regressions with created benchmarks ................................................................ 73
Table 2.21 Value Weighted (Company level) results of CAPM,Fama-French and
Carhart regressions with created benchmarks ................................................................ 74
Table 2.23 The Effect of Value of Fines on Short Selling ............................................. 79
Table 3.1 Descriptive Statistics .................................................................................... 107
Table 3.2 Equal Weighted Results based on Barclays US Index Benchmark (Full
Sample Period) .............................................................................................................. 110
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