Topics in Financial Economics

Just a few months of experience in economic consulting have opened my eyes further to the incredibly interesting research topics to be found in the field of Financial Economics, and have in fact contributed to adding a PhD in Finance or Financial Economics to my list of future academic interests (on top of the already-established interests in Industrial Organization and Arts Economics).

Among the ideas that interest me are the ways to make event studies to determine market efficiency a more objective and systematic process, particularly when it comes to the determination of the expected direction and magnitude of a residual based on the new and value-relevant information that arises on a particular time period (to then compare with the observed residual and determine consistency with efficiency). Ways this could be done would be generating a regression model that takes different pieces of information on a security (this would first require a study determining what pieces of information are actually value-relevant, or important to investors) that may be new on a particular day, and then output a number that would represent the expected magnitude and, of course, direction of the residual of the security’s price we would expect after regressing that price on market and industry indices. In essence, this would be a “measure of surprise” or “unexpected news” to compare observed residuals to and determine market efficiency. Indeed, this would hopefully go in the way of providing a more objective basis to determine a security’s consistency with market efficiency—as opposed to subjective and inconsistently applied measures that qualitatively take in information ex-post—particularly when there’s conflicting information on a given time period.

Along the lines of market efficiency (or in this case, inefficiency), I would also like to consider the issue of market overreactions/ knee-jerk reactions to individual pieces of macroeconomic news. In particular, there is a sense that markets are overly sensitive on a day-to-day basis to macro-related financial or economic news that may ultimately have little impact on the fundamentals of underlying companies and their future cash flows. Too often is volatility heavily impacted by macro news, causing large swings in one direction on a given day, and “corrective” movements in opposite directions on days subsequent to the news.

Leaving the issue of efficiency behind, I would consider ways to improve the accuracy of firm valuations, through the use of management-related variables that would weight calculated cash flows (and ultimately, their present values) upward or downward based on the observed relationships between management quality variables and subsequent earnings surprises or cash flow surprises. Regarding equity valuations, I would want to investigate the timing of analyst report price target and stock rating changes: do they just lag changes in prices and follow the observed price series ex-post, or do they actually play a leading role in determining the future behavior of stock prices?

And of course, I could not consider topics in financial economics without thinking as well about the financial economics of art, looking at art as an asset and how prices, investors, and markets in the financial world of art behave.