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Transaction costs, liquidity and expected returns at the Berlin Stock Exchange, 1892-1913

Transaction costs, liquidity and expected returns at the Berlin Stock Exchange, 1892-1913. Carsten Burhop, Universität zu Köln Sergey Gelman, ICEF, Higher School of Economics, Moscow. 1st ILFE Workshop, Moscow, September 18 , 2010. Motivation.

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Transaction costs, liquidity and expected returns at the Berlin Stock Exchange, 1892-1913

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  1. Transaction costs, liquidity and expected returns at the Berlin Stock Exchange, 1892-1913 Carsten Burhop, Universität zu Köln Sergey Gelman, ICEF, Higher School of Economics, Moscow 1st ILFE Workshop, Moscow, September 18, 2010

  2. Motivation Explore effective transaction cost determinants & effects in a ‘friendly environment’: on an early call auction stock market over a long time span

  3. Outline • Literature review • Historical background • Data & Methodology • Results • Conclusion

  4. 1. Literature Review I: liquidity & asset pricing • Amihud (2002, JFM) • Positive risk premium for expected illiquidity • Inverse relation of returns and unexpected illiquidity shocks • Eleswarapu/Reinganum (1993), Brennan and Subrahmanyam (1996) • Negative/insignificant risk premia • Bekaert et al. (2007, RFS) • Dynamic interdependence of liquidity and returns on the market level (whereby liquidity only weakly dependent); • Transaction cost adjustment + liquidity risk premium • Goyenko et al. (2009, JFE) • Effective transaction cost measures capture liquidity (incl. price impact)

  5. 1. Literature Review I: economic history • Rajan & Zingales (2003): German pre-1913 stock market development higher than US • Baltzer (2006): price differentials across stock exchanges negligible • Gelman & Burhop (2008) • weak information efficiency on a rather high level • Efficiency worsens during crises 1901, 1913 • Gehrig & Fohlin (2006) • estimate effective transaction costs for Berlin stock exchange in 1880, 1890, 1900, 1910. Find gradual decline. • find inverse relationship to size

  6. 1. Contribution • Transaction costs were on average low, but rather variable in time and cross-section • Transaction costs are inversely influenced by size and previous year returns; are higher in crises • There is a significant positive liquidity premium, which is more pronounced than market risk and size premia

  7. 2. Historical background I • Berlin Stock Exchange (BSE) was the major German stock exchange since 1870-s • Steadily increasing # of traded companies, around 1000 in 1913 • Trading 6 days per week, one price per day • Call-auction mechanism with a specialist • Presence of informed insiders possible

  8. Berlin Stock market performance Balkan war Bank run in US Leipziger Bank defaults

  9. German aggregate stock trading volume (in bln mark)

  10. 2. Historical background II • Major crises with impact on efficiency: • Bankruptcy of Leipziger Bank 1901 • Balkan war fear 1913 • Fixed relative transaction costs: • Transaction tax: 0.01% up to 04/1894; 0.02% to 10/1900 and 0.03% until the end of the sample • Broker fee: official 0.05%; private 0.025% • Provisions for intermediaries: 0.1-0.33% • Total round-trip transaction cost: 0.252-0.82% • Tick size 0.05 Mark (by stock prices of 40 Mark and above)  less than 0.125%

  11. 3. Data • Daily stock prices for 27 stocks (hand-collected fromBerliner Börsenzeitung) 1892-1913, 6692 observations per company • Industries: banking, machinery, chemicals, mining, textile, etc. • Requirement: listed during the whole period, <30% zero returns • Trading volume is available only on annual basis aggregated for all German exchanges! • Daily stock index values (from Gelman/Burhop 2008) • Annual values for market capitalization • Heterogeneous: from 0.3 bln RM to 32.8 bln RM • Dividend amounts and dates

  12. Descriptive statistics (selection)

  13. 3. Methodology I • Measure of full transaction costs (fixed costs + price impact): • LOT (1999): information-based measure

  14. 3. Methodology I • Estimate with MLE

  15. 3. Methodology I • Criticism of LOT measure • Zero returns may be due to noise trading • The measure is driven by the market return volatility • Does not incorporate other factors than market • Justification • Is the only available measure of the full transaction costs and not only spreads • Widely used in recent financial literature, e.g. Griffin et al. (2010, RFS); Lesmond (2005, JFE)

  16. 3. Methodology II: Determinants • Cross-section and Panel estimation • Dependent variable: annual effective TC (LOT measure) of a company • Regressors: • Market cap (for size) • Previous year returns • Aggregate trading volume or Time dummies

  17. 3. Methodology III: impact on asset pricing • Fama-MacBeth(1973) regression • monthly returns • factor loadings & firm characteristics • Factor: market risk (our index as proxy) • Characteristics: • Size • Daily return autocorrelation (momentum) • LOT transaction cost measure (for illiquidity)

  18. 4. Results: annual transaction costs

  19. 4. Results: annual transaction costs

  20. 4. Transaction costs BSE 1892-1913: rolling window

  21. 4. Results: time series of transaction costs • Transaction costs are low: average LOT-measure of 0.97%, • lower than for the upper decile of NYSE (1.23%) in 1963-1990 (Lesmond et al. 1999) • better than any of the emerging stock markets in 1990-s (Lesmond 2005) • But a bit above than DJIA costs of 0.6% 1970-1980 (Goyenko et al. 2009) • High variation: from 0.66% (1906) to 1.68% (1901)

  22. 4. Determinants of transaction costs: Cross-sectional results ln(MCap)

  23. 4. Determinants of transaction costs: panel

  24. 4. Determinants of transaction costs: panel

  25. 4. Determinants of transaction costs: results • Inverse relation with size • explains about 2/3 of transaction cost variation in cross-section and 23% in a panel set-up • One std increase in share of m. cap. (0.05) leads to 0.125-0.2 decrease in transaction costs • significance vanishes in FE set-up if we include past returns • Inverse relationship with previous year returns explains about 10% • One std decrease in past returns (0.126) leads to apprx 0.05 increase in LOT

  26. 4. Determinants of transaction costs: results • Transaction costs are about 0.25 percentage points higher in crises years • Transaction costs are inversely related to trade volume • One std increase in log trading volume (0.25) induces 0.05 decrease in transaction costs

  27. 4. Effects of transaction costs on asset pricing

  28. 4. Asset pricing results • We find support of Amihud (2002): • Lagged transaction costs increase expected return • Contemporaneous TC – decrease returns • CAPM doesn’t work • Size effect is absorbed by ex-ante transaction cost measure • Momentum is positive with tendency to significance

  29. 4. Asset pricing results • Different specifications of liquidity risk do not yield significant results

  30. 5. Conclusion • Transaction costs of the Berlin Stock Exchange were on average rather low as early as 1892-1913 • Size and past returns were negatively and crises were positively related to transaction costs • Illiquidity was the primary concern of investors by asset pricing, levied a positive premium

  31. Thank you for your attention

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