Three anomalies in finance

Abstract

This thesis is dedicated to the study of the broad subject of market anomalies.  Within this framework, three specific finance problems are investigated in depth, namely: 1 – An event study focusing on the FTSE100 index changes which evidence structural change over time in this well known anomaly; 2 – The investigation of interim and final companies’ results announcements as sources of extreme events in the company lifetime.  3 – The pricing of options and the effect of the underlying asset expected return on their valuation. 

The first part studies the effect of UK companies being promoted or relegated from the FTSE100 index to the FTSE250 on the share price.  The data sample consists of all the index promotions since the constitution of the index in 1984 until November 2004.  It is split into four characteristic time periods of the lifetime of the FTSE100 index (1984-1989; 1990-1994; 1995-1999; 2000-2004) in an attempt to observe alterations in investor behaviour to index changes along time, and how these relate to the prevailing explanations in the academic literature.  I find evidence for structural changes over time in the share behaviour upon promotion/relegation to the FTSE100 index.  These findings show support for price-pressure hypothesis and permanent share price change depending on the time-window and time period under study.  For index promotions, the results support mainly a permanent share price increase, which is not related to an increased traded volume and therefore is likely to be information-related.  For relegations, support for a permanent share price decrease is weak and we find evidence for price-pressure within shorter time-windows that is associated with larger average daily traded volumes.

The second part of the thesis investigates companies’ interim and final results announcements as possible sources of extreme events in the company return distribution.  We find that on these dates even though there is no evident share return pattern either with evidence of an abnormal return on the event date or cumulative abnormal returns before or after the event, there is strong evidence of higher dispersion of the abnormal returns on the event date.

The third and fourth parts investigate the effect of the underlying asset return on the valuation of options.  We first examine the problem theoretically by obtaining a closed form expression that relates the expected value of the call option with the Black-Scholes value.  We then provide, in part four, empirical evidence of the effect of historical returns on the Black-Scholes implied volatilities (IVs).  We show that our expression for the expected value of the call option can explain the empirical observations that show a strong relation between past returns and IVs.  We conclude that the market uses underlying asset expectations to price options, which should not occur under the Black-Scholes conditions.

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