THE FLORIDA STATE UNIVERSITY COLLEGE OF BUSINESS MARKET EFFICIENCY AND MARKET ANOMALIES: THREE ESSAYS INVESTIGATING THE OPINIONS AND BEHAVIOR OF FINANCE PROFESSORS BOTH AS RESEARCHERS AND AS INVESTORS By COLBRIN (COLBY) A. WRIGHT A Dissertation submitted to the Department of Finance in partial fulfillment of the requirements for the degree of Doctor of Philosophy Degree Awarded: Summer Semester, 2007 UMI Number: 3282678 3282678 2007 Copyright 2007 by Wright, Colbrin A. UMI Microform Copyright All rights reserved. This microform edition is protected against unauthorized copying under Title 17, United States Code. ProQuest Information and Learning Company 300 North Zeeb Road P.O. Box 1346 Ann Arbor, MI 48106-1346 All rights reserved. by ProQuest Information and Learning Company. The members of the Committee approve the dissertation of Colbrin A. Wright defended on May 22, 2007. _____________________________ David Peterson Professor Directing Dissertation _____________________________ Michael Brady Outside Committee Member _____________________________ Gary Benesh Committee Member _____________________________ James Doran Committee Member Approved: _________________________________ William Christiansen, Chair, Department of Finance _________________________________ Caryn L. Beck-Dudley, Dean, College of Business The Office of Graduate Studies has verified and approved the above named committee members. ii To my wonderful wife, Misty, whose unremunerated and oft-times unrecognized work as a mother is both unequivocally more challenging and infinitely more important than any of my professional accomplishments. Thanks for being my rock when the winds and rains have beat upon me. iii ACKNOWLEDGEMENTS No great work in life is ever accomplished alone. While readily acknowledging that my dissertation is no “great work,” I would like to gratefully acknowledge the many individuals who have improved the quality of this dissertation and influenced me along the way. First, thanks to my dissertation chair, Dr. David Peterson, who was mercilessly forced to read literally hundreds of pages of my writing. His questions, candor, direction, and suggestions have been invaluable. He, more than anyone else, has taught me how to be a researcher. Also, I sincerely thank each of the other members of my dissertation committee. Dr. Gary Benesh provided the voice of reason and experience. His candid feedback on the survey instrument and on the volume of work I initially proposed proved invaluable and prophetic. Dr. Mike Brady has been my brightly burning torch in an otherwise dark room as I constructed, distributed, and analyzed the responses to the survey. Dr. James Doran became my reason to keep working. On the days of frustration and disappointment, which accompany all dissertations, he was the optimistic cheerleader and demanding coach pushing me to keep going. His suggestions tremendously improved the quality of the work. I also want to thank Dr. Bill Christiansen whose instruction, mentoring, advice, and friendship have meant more to me than he will ever know. In addition to those mentioned above, I wish to thank the following individuals for their insightful suggestions, questions, and interest in my work: Prithviraj Banerjee, Jim Brau, Ronnie Clayton, Dean Diavatopolous, Michael Ehrhardt, Campbell Harvey, Matthew Spiegel, Tom Noe, Jeff Rockwell, Brian Tarrant, seminar participants at Central Michigan University, all respondents to my survey (especially those who provided feedback), and the entire finance faculty at Florida State University. Dave Horowitz, Tim Munyon, and Andrew Wilson provided much appreciated guidance in executing the structural equation modeling testing in the dissertation. Also, surveyZ and Qualtrics.com saved me countless hours of work by generously allowing me to use their survey software free of charge. Jean Heck graciously gave me access to his database that also greatly expedited the completion of the dissertation. Lastly, I thank Misty Wright for her expert assistance in collecting the data for this study. All errors in this dissertation are mine. iv TABLE OF CONTENTS LIST OF TABLES vi LIST OF FIGURES vii ABSTRACT viii INTRODUCTION AND MOTIVATION 1 How Efficient Do We Think Us Stock Markets Are And Does It Really Matter? 3 What Really Matters When Buying and Selling Stock? 5 So You Discovered an Anomaly…Gonna Publish It? 6 Outline of Dissertation 9 HOW EFFICIENT DO WE THINK US STOCK MARKETS ARE AND DOES IT REALLY MATTER? 10 Introduction 10 Background 11 Subjects, Surveys, and Response Rate 13 How Efficient are US Markets? 19 Assessing Views of Market Efficiency Based on Investing Objectives 23 Does Market Efficiency Even Matter? 24 Conclusion 35 WHAT REALLY MATTERS WHEN BUYING AND SELLING STOCKS? 46 Introduction 46 Background 47 Surveys in Finance Literature 52 Survey Subjects, Description, and Distribution 53 Results 56 Conclusion 67 SO YOU DISCOVERED AN ANOMALY…GONNA PUBLISH IT? 84 Introduction 84 The Theory and Assumptions 86 Model Implications 92 Analysis of Empirical Implications – Data and Methods 94 Analysis of Empirical Implications – Results 101 Conclusion and Discussion 110 CONCLUSION 125 APPENDIX 127 REFERENCES 138 BIOGRAPHICAL SKETCH 144 v LIST OF TABLES 1. Summary Statistics 37 2. Opinions About Market Efficiency by Rank 38 3. Market Efficiency Specialists’ Opinions About Market Efficiency 39 4. Respondents’ Propensities to Actively Invest by Rank 40 5. Respondents’ Propensities to Actively Invest by Specialty 41 6. The Congruence of Respondents’ Opinions and Investment Objectives 42 7. Respondents’ Investment Objectives as a Function of Their Opinions and Confidence 43 8. Explaining Investment Objectives – Ordered Probit Analysis 44 9. Summary Statistics Reproduced 69 10. Relative Importance of 14 Groups of Variables 70 11. Relative Importance of 43 Individual Variables 71 12. Investment Experience by Rank 74 13. Respondents Who Have No Experience 75 14. Investment Experience by Gender 76 15. Ordered Probit Analysis of Investment Experience 77 16. What Matters to Active Investors 78 17. What Groups of Variables Matter to Active Investors 80 18. What Matters to Active Traders 81 19. Anomalies and Authors 112 20. Differences in Means and Medians: Anomaly vs. Matched Authors 113 21. Singe-Variable Probit Analyses 115 22. Full Specification Probit Analyses 116 23. Multicollinearity Mitigated Probit Analyses 119 24. Preliminary Regression Analyses 120 25. Multicollinearity Mitigated Regression Analyses 121 26. Principal Components 123 27. Principal Components Regression Analyses 124 vi LIST OF FIGURES I. Structural Equation Modeling Path Diagram 45 II. Holdings of Active Investors 82 vii ABSTRACT I study the topics of market efficiency and anomalies to market efficiency by focusing on finance professors in their joint roles as both researchers and market participants. I ask three main research questions: (1) how efficient do finance professors believe US stock markets are and does their opinion of market efficiency influence their investing behavior, (2) what really matters to finance professors when they buy and sell stocks, and (3) why do finance professors publish market anomalies? Related to the first question, I discover that finance professors agree that US stock markets are weak form efficient but not strong form efficient. However, there is much disagreement about the semi-strong form efficiency of US stock markets. Their investing behavior, though, suggests that finance professors accept markets as semi-strong form efficient; twice as many finance professors passively invest than actively invest. Surprisingly, their opinion about market efficiency has very little to do with their investing behavior. Instead, their investing behavior seems primarily driven by their confidence in their own abilities to beat the market, regardless of how efficient they perceive US stock markets to be. Related to the second question, I present three main findings. First, traditional valuation techniques and asset-pricing models commonly used in research and taught in the classroom are universally unimportant to finance professors when they buy and sell stocks. Second, the most important information to finance professors when considering stock purchases and sales are firm characteristics (PE ratio and market capitalization) and momentum related information (the stock’s return over the past six to 12 months and 52- week high and low). Third, finance professors have less real-world investing experience than one might expect – the median professor has bought an individual stock between 10 and 19 times, and 14.5% have never done so. Related to the third question, I find that finance professors are, in fact, acting rationally when they publish market anomalies. The theory I develop suggests it is rational for researchers to publish market anomalies if they have relatively few previous publications or have lesser reputations. Accordingly, the theory implies that the likelihood of publishing an anomaly and the profitability of published anomalies should be inversely related to the authors’ previous publications and reputation. These viii implications are empirically corroborated providing evidence for the theory and supporting the notion that researchers are behaving rationally when they publish. Sadly, this also suggests that it is very likely that profitable anomalies have been discovered but not published so that the discoverer can exploit the anomaly, which provides indirect evidence of market inefficiency. ix [...]... conclusion: a finance professor’s opinion of the efficiency of US stock markets does not really influence whether he actively or passively invests Instead of basing their investment decisions on their perception of the general efficiency of US stock markets, 10 finance professors base their investing decisions on their confidence in their own abilities to beat the market, not the general efficiency of the markets... analysis of finance professors in their joint role both as researchers and as market participants The first two essays are based on a survey distributed to all finance professors at accredited, four-year universities and colleges in the United States In the first essay, I concentrate on the issue of market efficiency I ask finance professors five questions to assess how efficient they believe US stock markets... subject of market efficiency Unfortunately, the voluminous work on the subject has not conclusively determined the actual efficiency of US stock markets In light of the empirical disagreement on the subject, I take a unique approach to assessing the current efficiency of US stock markets I survey the experts in the field to assess their opinions on the subject Specifically, I invite all finance professors. .. half the questions on the survey but did not answer the last five I allowed these two respondents to enter the final data set Aside from these 5 Some of the websites from which email addresses were collected made it impossible to distinguish finance professors from professors of other fields, such as business law and economics Because of this, the survey was sent to and completed by some professors of. .. market efficiency and anomalies to market efficiency. ” 21 I expect those finance professors who specialize in market efficiency to be most the most informed on the subject I report the responses of this group in Table 3 The table shows the number and percentage of respondents who specialize in market efficiency who responded 1 through 7 to the five questions Finance professors who specialize in market efficiency. .. test, and ultimately refute, the notion that an investor’s decision to actively or passively invest is based on his perception of the efficiency of the market in which he is considering investing In the second essay, I ask finance professors to identify which asset-valuation techniques, asset-pricing models, market anomalies, and other information are most and least important when they invest In the. .. answer yes to the consent question, 2) s/he must be a finance professor, thus eliminating professors of law, economics, and other disciplines, 5 3) s/he must hold a Ph.D or DBA, 4) s/he must be of the rank of assistant professor, associate professor, full professor, endowed chair, or eminent scholar, and 5) s/he must answer at least one of the five questions on the last page of the survey There were two... publishing in the same journal Additionally, authors who publish anomalies have been in the field for a shorter period of time than their non-anomaly counterparts The profitability of an anomaly is inversely related to the number of publications that an author has at the time of the publication of the anomaly and the number of years the author has been in the field Moreover, the profitability of an anomaly... opportunity for productive and useful research in this area Similar to Haddad and Redman (2005), I begin by recognizing the unique positions of finance professors as researchers and participants in the arena of investing The topic of my work, however, substantially diverges from theirs My dissertation is a compilation of three essays studying the subject of market efficiency and market anomalies through an... profitability of market anomalies substantially decreases and oft-times entirely disappears once the anomaly is published (see Dimson and Marsh (1999) and Marquering, Nisser, and Valla (2006)) Given their role as market participants, finance professors could easily choose not to publish highly profitable anomalies and instead use them in their own trading It doesn’t seem economically rational for a finance professor . THE FLORIDA STATE UNIVERSITY COLLEGE OF BUSINESS MARKET EFFICIENCY AND MARKET ANOMALIES: THREE ESSAYS INVESTIGATING THE OPINIONS AND BEHAVIOR OF FINANCE PROFESSORS BOTH AS RESEARCHERS. 1 analysis of finance professors in their joint role both as researchers and as market participants. The first two essays are based on a survey distributed to all finance professors at accredited,. determine the collective opinions of finance professors on the actual efficiency of US stock markets, I come to a surprising conclusion: a finance professor’s opinion of the efficiency of US stock markets