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Author:Kokkonen, Joni. 
Title:Essays on asset pricing, portfolio choice, and investments
Published:[Helsinki] : Aalto University, School of Economics, 2011
Description:v, 168 s. : kuv. ; 25 cm.
Series:Aalto University publication series. DOCTORAL DISSERTATIONS, 1799-4934 ; 122/2011
Series no:122/2011
Year:2011  Thesis defence date: 2011-12-02
Department:Rahoituksen laitos
Index terms:behavioral finance; financing; hinnoittelu; investment; osakkeet; portfolio; pricing; rahoitus; risk; riski; shares; sijoitukset
Abstract (eng):This dissertation studies two interrelated areas of behavioral finance. The first one deals with investors' preferences and expectations, and the second one with stock market mispricing. The essays in the dissertation study applications of these broader areas to portfolio choice, cross-sectional stock returns, expectations formation, and time-varying merger activity. The first two essays examine how investors make investment decisions given their expectations and how they form these expectations. The first essay explores a model of international portfolio choice, where correlations across international stock markets depend on the state of the economy, and investors are averse to disappointing outcomes. The results show that this combination can lead to a high optimal degree of diversification during periods of market distress, but a substantial overweight in the domestic market (i.e. home bias) in the more favorable states of the economy. The model is also able to rationalize the empirically observed phenomenon of return chasing.

The second essay studies the return expectations of finance professionals in Finland and Sweden. We find that the subjects are implausibly optimistic on the relative performance of stocks over bonds. Their return and volatility expectations are not consistent with their estimates of stocks outperforming bonds. Furthermore, they are overconfident in the sense that they underestimate the risk of uncertain outcomes.

The remaining two essays focus on aspects related to stock market mispricing. In the third essay, we show that the high return associated with stocks with high book-to-market ratios (the so called value effect) is at least partly driven by stock market mispricing. Furthermore, we document that hedge funds are able to identify undervalued securities and that hedge fund flows decrease the level of relative mispricing in the stock market.

Equity market misvaluation is also one of the proposed causes of merger waves, i.e. periods with high merger activity. In the fourth essay we study the implications of these waves on deal characteristics. Our results show that periods of high merger activity are related to smaller markups, higher stock price run-ups, and a more frequent use of equity financing
Thesis defence announcement:
Portfolio diversification is profitable even in the case of correlated market crises

The doctoral dissertation comprises four separate essays. In the first two essays, Kokkonen discusses the effect that the primary choices and return expectations of investors have on investment decisions, and the formation of such expectations. The first essay investigates how correlated crisis periods on the stock markets affect the optimum diversification of an international portfolio if investors try to avoid disappointment.

According to the results, the model used will lead to broad diversification in times of crises though it may also introduce a focus on the domestic market in better times. The model also helps outline why investors tend to move over to markets where returns have been high.

Financing professionals often over-optimistic about stock returns

The second essay discusses the return expectations of professionals engaged on the financial markets in Finland and Sweden. The results suggest that professionals are over-optimistic about stocks as compared with bonds.

Estimates about how likely it is that the return from stocks will exceed that from bonds over a 10 or 20 year investment horizon are not in line with the return expectations of the instruments. The financial market crisis of 2008 did not have any appreciable impact on medium-term return expectations.

The other two essays discuss short-term mispricing on the financial markets.

The conclusion in the third essay is that the well-known ’value effect’, i.e. the relatively better historical return from stocks with high book value in relation to the market value is at least partly due to mispricing and cannot be considered compensation for higher risk. The results also indicate that hedge funds know how to select underpriced stocks. In addition, the flow of investments in funds reduces mispricing and thereby improves the efficiency of the markets.

Lively acquisition markets reduce the premiums paid

The fourth essay discusses acquisition waves, i.e. periods when there are many acquisitions. The results suggest that the premiums paid in acquisitions during waves are smaller than those paid in quieter times. Waves also lead to a rise in stock financing and a higher rise in the stock price of the acquired company before the acquisition.
Opponents:Ericsson, Jan
McGill University, Canada

Chairperson:Suominen, Matti