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Capital Gains Overhang with a Dynamic Reference Point

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posted on 2019-05-20, 09:30 authored by Christopher Riley, Barbara Summers, Darren Duxbury
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 by using the CGO model. We show that composite CGO variables, created by 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 U.S. 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.

History

Citation

Management Science, 2020, 66 (10), pp. 4359-4919, iii-iv

Author affiliation

/Organisation/COLLEGE OF SOCIAL SCIENCES, ARTS AND HUMANITIES/School of Business

Version

  • VoR (Version of Record)

Published in

Management Science

Volume

66

Issue

10

Pagination

4359-4919

Publisher

INFORMS (Institute for Operations Research and Management Sciences)

issn

0025-1909

Acceptance date

2019-05-09

Copyright date

2019

Available date

2020-02-05

Notes

The file associated with this record is under embargo until publication, in accordance with the publisher's self-archiving policy. The full text may be available through the publisher links provided above.

Language

en

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