IB9520 Research Methodology – Individual Assignment: Empirical Project
UNIVERSITY OF WARWICK
The objective of the project is to help students to learn how to gather, clean, analyse and present data; formulate
a hypothesis; interpret results; and gain other transferable skills for their dissertations. An important aspect of this
exercise is the economic interpretation of results and their discussion in the context of the strengths and
weaknesses of the tests themselves. The quality of the interpretation is as important as the empirical analysis and
the results. Please keep in mind that this task is all open-ended: there is no guarantee that you end up having
similar empirical results compared to what have been documented previously. As long as you are certain about
your analysis, there is no point wasting time replicating the existing results. Just proceed with your findings and
try to interpret them by relating them to the concepts covered in class.
There are three research topics provided and you must choose ONLY ONE topic to write a report.
You must stick to the following guidelines:
1. Word count: the report should not exceed the word limit of 1,500 (excluding figures, tables, and
references). This is a strict limit and the module leader may deduct marks if you have exceeded the
word limit.
2. Format: the report should have the proper format of academic research paper by including abstract,
introduction, literature review, methodology, results, conclusion, and references.
3. Computer code: you do not need to include the code you have compiled.
4. Figures and tables: it is recommended to convert figures & tables into images when you include in
your report. Figures and tables must be reported in a proper way entailing the title and descriptions.
5. Marking criteria: Marks based on overall quality of the report for the following four aspects:
a) Comprehension: ability to have a solid grasp of literature and methodologies
b) Analysis: ability to apply the proper empirical methods and produce the accurate results
c) Critical Evaluation: ability to reflect and appraise on the results
d) Academic Writing: ability to present ideas and arguments fluent and well
6. Mark distribution: 70+ (Distinction), 60+ (Merit), 50+ (Pass), <50 (Fail)
7. Submission: only a report in pdf formats
8. E-mail queries: only queries for clarification will be addressed. As this assignment is fairly open-
ended, much is up to students’ discretion.
Topic 1. Momentum Effect
Background: a growing body of literature documents evidence of stock return predictability based on
a variety of firm-specific variables. Among these anomalies, the price momentum effect is probably the
most difficult to explain within the context of the traditional risk-based asset pricing paradigm. In an
influential paper, DeBondt and Thaler (1985) document that past losers over three- to five-year periods
outperform past winners over the subsequent three to five years. Jegadeesh and Titman (1993)
document that U.S. stocks that perform the best (worst) over a three- to 12-month period tend to
continue to perform well (poorly) over the subsequent three to 12 months. In a follow-up study,
Jegadeesh and Titman (2001) show that momentum strategies remained profitable in the nineties; a
period subsequent to the sample period in Jegadeesh and Titman (1993).
Research Objective: examine whether the momentum effect in stock returns still exists, discuss the
potential source of momentum profits, and evaluate whether it is a market anomaly.
Data: stock returns of 50 firms (of your choice) in the U.S. from the CRSP for the period of January
2010 to December 2020.
Empirical Methodology: asset pricing methodology (portfolio sorting, Fama-MacBeth regression)
Reference:
DeBondt WFM, Thaler RH. 1985. Does the stock market overreact? J. Finance 40:793–805
Jegadeesh, N., and S. Titman, 1993. Returns to buying winners and selling losers: Implications for stock
market efficiency. The Journal of finance 48:65-91.
Jegadeesh, N., and S. Titman, 2001. Profitability of momentum strategies: An evaluation of alternative
explanations. The Journal of finance 56:699-720.
Jegadeesh, N., and S. Titman, 2011. Momentum. Annual Review of Financial Economics 3:493-509.
Korajczyk, Robert A., and Ronnie Sadka. "Are momentum profits robust to trading costs?" The Journal
of Finance 59.3 (2004): 1039-1082.
Topic 2. Post Earning Announcement Drift (PEAD)
Background: no other single event has been found to explain more of the cross-sectional variation in
stock returns than the earnings announcement. Earnings announcements are the primary mechanism
through which public companies provide periodic financial performance updates to investors. It is
therefore not surprising that a considerable body of academic research examines the relation between
stock prices and earnings. In particular, PEAD refers to the phenomenon of abnormal stock returns’
tendency to be positive (negative) in the months following good (bad) news earnings announcements.
Ball and Brown (1968) initially documented this phenomenon using annual earnings announcements.
Foster, Olsen & Shevlin (1984) replicate Ball & Brown’s results using quarterly earnings
announcements. Bernard and Thomas (1989) examine a variety of explanations and conclude that it is
a delayed response to new information. They find no support for the competing hypothesis that it is due
to omitted risk premia.
Research Objective: examine whether the PEAD is still an observable phenomenon, discuss the
potential explanations, and evaluate whether it is a violation of market efficiency.
Data: Stock returns and accounting information of 50 firms (of your choice) in the US from the CRSP
and COMPUSTAT for the period of January 2010 to December 2020.
Empirical Methodology: event study methodology
Reference:
Ball, R., and P. Brown, 1968. An empirical evaluation of accounting income numbers. Journal of
accounting research 6:159-177.
Bernard, V. L., and J. K. Thomas, 1989. Post-earnings-announcement drift: delayed price response or
risk premium? Journal of Accounting Research 27:1-36.
Dechow, P. M., R. G. Sloan, and J. Zha, 2014. Stock Prices and Earnings: A History of Research.
Annual Review of Financial Economics 6:343-363.
Foster G, Olsen C, Shevlin T. 1984. Earnings releases, anomalies, and the behavior of security
returns. The Accounting Review 59:574–603
Rendleman Jr, R. J., C. P. Jones, and H. A. Latane, 1982. Empirical anomalies based on unexpected
earnings and the importance of risk adjustments. Journal of Financial economics 10:269-287.
Topic 3. Cross-Sectional Determinants of Capital Structure
Background: how do firms choose their capital structure? It is a fundamental question in financial
economics and indeed, this question is at the heart of the "capital structure puzzle" put forward by Myers
(1984). Much of the research since the seminal work of Modigliani & Miller (1958) has focused on
testing the implications of two traditional views of capital structure: the static trade-off model, in which
firms form a leverage target that optimally balances various costs (e.g., financial distress costs,
stockholder-bondholder agency conflicts) and benefits (e.g., tax savings, mitigated manager-
shareholder agency costs) of debt, and the pecking order of Myers & Majluf (1984), in which firms
follow a financing hierarchy designed to minimize adverse selection costs of security issuance.
Research Objective: explain the heterogeneity in observed capital structures across firms by
identifying determinants and associating them with firm leverage. In particular, discuss/illustrate the
importance of firm fixed effects.
Data: accounting information of 50 firms (of your choice) in the US from the COMPUSTAT for the
period of January 2010 to December 2020.
Empirical Methodology: panel data methodologies
Reference:
Graham, J. R., and M. T. Leary, 2011. A Review of Empirical Capital Structure Research and Directions
for the Future. Annual Review of Financial Economics, 3: 309-345.
Lemmon, M. L., M. R. Roberts, and J. F. Zender, 2008. Back to the beginning: persistence and the
cross‐section of corporate capital structure. The Journal of Finance 63:1575-1608.
Modigliani F, and Miller M. 1958. The cost of capital, corporation finance and the theory of investment.
The American Economic Review 48:261–97.
Myers S. 1984. The capital structure puzzle. J. Finance 39:575–92
Myers S, and Majluf N. 1984. Corporate financing and investment decisions when firms have
information that investors do not have. Journal of Financial Economics 13:187–221.