RADFORD – The work of three professors from the Radford University College of Business and Economics was recently featured in two prominent financial journals.

Finance professor Axel Grossmann’s article, “ADR Mispricing: Do Costly Arbitrage and Consumer Sentiment Explain the Price Deviation?” was recently published in the Journal of International Financial Markets, Institutions and Money. The article examines the difference between the price of American depository receipts (ADR) and the price of its underlying asset. According to Grossmann, an ADR “represents ownership in the shares of a foreign company trading on U.S. financial markets. Essentially, ADRs enable U.S. investors to buy shares in foreign companies without undertaking cross-border transactions.”

“I sought to determine the extent to which discounts and premiums on ADRs can be explained by the transaction costs and holding costs of arbitrage [the simultaneous purchase and selling of an asset in order to profit from the price difference] as well as consumer sentiment in the U.S. and consumer sentiment in the foreign market,” said Grossmann.

He found that ADRs with a higher transaction cost and lower dividend payments are more likely to exhibit a higher price gap. While Grossmann hypothesized that a higher U.S. sentiment would lead to a higher premium, he found the opposite: the more optimistic U.S. consumers, the lower the premium. The study shows that this puzzling result can be explained by the fact that both the price of the ADR and the price of the underlying asset are driven more by U.S. sentiment than the consumer sentiment in the ADR’s home country.

The article took nearly three years to complete and was co-authored with Teofilo Ozuna and Marc W. Simpson from the University of Texas-Pan American. The piece examined 74 ADRs from nine countries between 1996 and 2003.

“Long Term Buy-and-Hold Versus Monthly Rebalancing” was the lead article in a recent edition of the Journal of Applied Financial Research. Written by finance professors Steve Beach and Clarence Rose, the piece compared buy-and-hold investments to monthly portfolio rebalancing over 1-, 5-, 10- and 20-year investment horizons. In order to produce the article, Rose and Beach undertook an extensive review of investment literature and statistical analysis of stock market performance, examining returns from the U.S. financial markets from 1926 until 2004.

“We wanted to contribute to the growing literature on ‘Life Cycle’ investing, in which most practitioners argue that investors should carry a lower-risk investment portfolio as they get older,” explained Beach. “The phrase ‘buy-and-hold’ is often mistakenly applied when the decisions are based on analyses that assume regular rebalancing of the portfolio. We wanted to give some insight to investors regarding this issue.”

The term “buy-and-hold” refers to the purchase of investments with strong fundamentals and good growth potential. After the acquisition, investors sit back and wait to see how their investment performs, a choice described by Chase.com as an effective way to ride out the stock market’s short-term fluctuations. Portfolio rebalancing refers to a restoration of a portfolio to its original mix of stocks, bonds and cash. Because of the natural cycle of the stock market, investments that perform well will begin to take up more of an investor’s portfolio, while investments that perform poorly will take up less. This process will inevitably move the investor away from their ideal asset allocation and expose that person to more risk than is acceptable.

According to Beach, he and Rose found that “buy-and-hold generally results in greater risk than a monthly rebalancing strategy, but that the risk was usually accompanied by higher returns. As a result, the best buy-and-hold portfolios contained a lower proportion in stocks, helping to mitigate the risk. As the investment horizon shortens, or you could say ‘as the investor ages,’ both strategies benefit from lower risk allocations. This final result supports the common advice given to individual investors to move more money into bonds, a historically lower risk investment than stocks, as they progress to the retirement years.”

“The results of this article provide investors and financial planners with additional tools for managing investment portfolios,” added Rose.