We review extensive evidence about how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource misallocation. We argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market participants. However, individuals as political participants remain subject to the biases and self-interest they exhibit in private settings. Indeed, correcting contemporaneous market pricing errors is probably not government’s relative advantage. Government and private planners should establish rules ex ante to improve choices and efficiency, including disclosure, reporting, advertising, and default-option-setting regulations. Especially

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Abstract. Sloan (1996) and a number of subsequent studies present evidence that a trading strategy based on publicly available accounting accruals earns abnormal returns of approximately 10 % in the year following its initiation. This empirical regularity has been named the ‘accrual anomaly’. In this paper I investigate the accrual anomaly along two dimensions. First, I evaluate whether the accrual anomaly is related to other anomalies documented in the finance literature. Second, I investigate whether different methods for calculating long-term abnormal returns have an effect on the returns to the accrual strategy. My results indicate that both mergers and divestitures have an effect on the returns generated by the accrual strategy. After excluding observations associated with either mergers or divestitures, there is a decrease of about 25 % in the strategy’s returns. Second, different calculation methods for benchmark portfolio returns do not have a material effect on the returns of the accrual strategy. Third, when book-tomarket is added to size as a second control for normal returns, returns to the accrual strategy decrease by approximately 20%. Fourth, the accrual strategy’s returns are much larger in a sample of Nasdaq firms. Overall, I conclude that the accrual anomaly is sensitive to the series of tests conducted in this study, although a substantial portion of it remains unexplained. I would like to thank the members of my dissertation committee: Bill Schwert, Jerry Warner, Ross Watts (chair) and Jerry Zimmerman for their valuable comments and suggestions. I also benefited greatly from the insights of

This paper aims to survey selected recent papers presenting new evidence on an age-old question in financial economics: “Are stock market returns predictable?”. The hypothesis that equity returns are predictable (specifically at long horizons) has been called a “new fact in finance ” by Cochrane (1999). Thus, stock market predictability is now taken almost as a feature of the data. However, there is less consensus on what drives this predictability. It may reflect time-varying risk premiums, it may reflect irrational behavior on the part of market participants, or it may simply notpresentinthedata—astatisticalfluke due to poor statistical inference. It is this last possibility that seems to gain increasing credibility considering the long list of authors criticizing the statistical methodologies in the predictability literature. The results of these studies typically show that findings against the constant expected excess return hypothesis based on standard statistical inference can appear much more significant than they really are. Of course, the strength and usefulness of these critical results are still hotly debated — consistently evaluating their significance is thus no easy task. Still, they raise questions about the implications of these findings for the way academics and practitioners use financial theory. In particular, the implications for the asset management industry (and dynamic asset allocation strategies) may be serious.

National Taiwan University This paper provides a risk-based explanation for the leverage anomalies. Following Daniel and Titman’s (1997) methodology, we show that the characteristic-based explanations for the book-leverage and the market-leverage anomalies are both rejected by Ferguson and Shockley’s (2003) leverage-based three-factor model, which receives stronger support for the period before 1980. With independent samples from six other non-U.S. G7 countries, we obtain robust results which support the superiority of Ferguson and Shockley’s (2003) three-factor model in explaining the leverage anomalies. Further evidence shows that leverage premia are reduced, or even eliminated after returns are adjusted by Ferguson and Shockley’s factors. JEL Classification: G10; G12; G32.

A market is said to be efficient with respect to an information set if the price ‘fully reflects ’ that information set, i.e. if the price would be unaffected by revealing the information set to all market participants. The efficient market hypothesis (EMH) asserts that financial markets are efficient. On the one hand, the definitional ‘fully ’ is an exacting requirement, suggesting that no real market could ever be efficient, implying that the EMH is almost certainly false. On the other hand, economics is a social science, and a hypothesis that is asymptotically true puts the EMH in contention for one of the strongest hypotheses in the whole of the social sciences. Strictly speaking the EMH is false, but in spirit is profoundly true. Besides, science concerns seeking the best hypothesis, and until a flawed hypothesis is replaced by a better hypothesis, criticism is of limited value. Starting in the 16th century, this note gives a chronological review of the notable literature relating to the EMH. History of the Efficient Market Hypothesis