Anchoring: Sink or Soar

This paper investigates whether stock valuation is influenced by psychological anchoring on macroeconomic news. Investors are faced with a daunting task; creating a diversified portfolio that consistently delivers value. Monitoring financial markets and determining the influence of idiosyncratic as well as macroeconomic news is a costly exercise. The high variation of realized returns by different managed funds is a clear indication that an effective method has not yet been developed, and tasks are still prone to human decision making processes. This paper takes the stance that investors use heuristics in order to process these vast amounts of information, and be able to form portfolios. Salience has been shown to prove a pivotal role in the processing of information. With the market wide effect that macroeconomic news has, it is bound to play a salient role in news coverages. This paper takes the stance that investors anchor on the more salient macroeconomic news, thereby not correctly processing idiosyncratic news. Using cross-listed firms, with the secondary listing taking the form of an American depository receipt, macroeconomic anchoring is examined. Macroeconomic events are identified using the top 10 and bottom 10 extreme exchange rate changes (per country) over a period of 800 days. This event identification methodology is used as a proxy for events that only influence one of the two listings. The Carhart 4-factor model is used to determine the expected results, and using the realized returns abnormal returns can be calculated. The difference between the 11-day cumulative abnormal returns of the two listings is then explained using an OLS regressions, with the exchange rate, size, value, whether the firm sponsored the listing, and the origination of the firm. The findings robustly show that exchange rate shocks are not correctly integrated in prices, leading to a divergence of valuation between the two listings, and thus an arbitrage opportunity. Stock returns mimic each other, revealing investors focus on equalizing returns rather than valuations.