Composite equity issuance and the cross-section of country and industry returns

ABSTRACT

Behavioural finance literature argues that stock issuance contains information on equity valuation. If so, does it predict the cross-section of both country and industry stock returns? To answer this question, we investigate data from 68 markets from 1976 to 2022. We find that composite equity issuance negatively correlates with future aggregate stock returns. An equal-weighted quintile of countries (industries) with the highest issuance underperforms those with the lowest by 0.34% (0.58%) per month. Established risk factors and other anomalies cannot subsume this cross-sectional pattern. Furthermore, the effect remains robust to many considerations. This documented issuance anomaly paves the way for an exploitable international investment strategy.

KEYWORDS:

• Composite equity issuance
• international markets
• equity anomalies
• the cross-section of stock returns
• return predictability

JEL CLASSIFICATION:

• G11
• G12
• G15

Acknowledgement

We thank the participants of the SAFA 2022 Conference for their insightful comments and suggestions. The authors have no conflicts of interest to disclose.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Replacing the earnings-to-price ratio with book-to-market ratio has no measurable impact on our overall findings.

² To avoid excessive dominance of the biggest countries in value-weighted portfolios, we follow Jensen, Kelly, and Pedersen (2022) and winsorize country market capitalizations at 80^th percentile. This aims to form more balanced yet tradeable portfolios.

³ We form the factor portfolios in the identical way as the tested portfolios (equal-weighted quintiles) in order to ensure that any abnormal returns are driven by the return predicting signal, and not by the portfolio construction. Modification in the factor weighting scheme have no qualitative impact on our results.

⁴ To ensure that any particular industry does not drive our findings, we exclude one sector (out of 11) at a time when forming industry CEI portfolios. The CEI hedge portfolio continues to generate negative and statistically significant raw and abnormal returns. These untabulated findings are available upon request.

⁵ Our self-constructed risk factors from the same universe of country or industry indices ensure apple-to-apple comparison. That is, we attempt to explain the left-hand-side portfolio returns using right-hand-side risk fac-tors constructed from the same investment asset classes, following the approach in firm-level asset pricing studies. See, for example, Fama and French (1993). As a robustness check, we calculate the abnormal returns using developed and emerging risk factors from Kenneth R. French’s website, which are constructed using international firm-level data. We consider different variations of the single-factor and multi-factor models following Fama and French (2018), and the CEI anomaly survives these risk adjustments. These results are available upon request.

Additional information

Funding

The work was supported by the National Science Center of Poland [2019/33/B/HS4/01021].