Celebrating Success: Professor Darren Duxbury

Congratulations to Darren on the recent acceptance of the paper,‘Capital Gains Overhang with a Dynamic Reference Point’,  to the world leading journal, Management Science.

Further information about the Paper:

‘Capital Gains Overhang with a Dynamic Reference Point.’ (with C. Riley and B. Summers).  Forthcoming Management Science.

Abstract:

Financial models incorporating a reference point, such as the Capital Gains Overhang (CGO) model, typically assume it is fixed at the purchase price. Combining experimental and market data, this paper examines whether such models can be improved by incorporating reference point adjustment. Using real stock prices over horizons from 6-months to 5-years, experimental evidence demonstrates that a number of salient points in the prior share price path are key determinants of the reference point, in addition to the purchase price. Market data testing is then undertaken using the CGO model. We show that composite CGO variables, created using a mix of salient points with weights determined in the experiment, have greater predictive power than the traditional CGO variable in both cross-sectional US equity return analysis and when analyzing the performance of double-sorted portfolios. In addition, future trading volume is more sensitive to changes in the composite CGO variables than to the traditional CGO, further emphasizing the importance of adjusting reference points.

Summary:

In the paper we show that investors’ reference prices are not fixed at the purchase price of a stock, but instead adjust in response to stock price movements.  Using parameters derived in an experimental setting, we show that the predictive ability of financial models, specifically the Capital Gains Overhang (CGO) model, can be improved when incorporating dynamic reference points.  Results are supported under cross-sectional US equity return analysis and when analyzing the performance of double-sorted portfolios.  In addition, future trading volume is more sensitive to CGOs incorporating dynamic reference points than static reference points based on purchase price alone.