Top

Review of Quantitative Finance and Accounting

Published in:

01-01-2014 | Original Research

Do dividend initiations signal a reduction in risk? Evidence from the option market

Authors: Jeffrey S. Jones, Jenny Gu, Pu Liu

Published in: Review of Quantitative Finance and Accounting | Issue 1/2014

Activate our intelligent search to find suitable subject content or patents.

search-config

AI-assisted search

Off

Abstract

We investigate whether dividends convey information about the risk of a company by examining the reaction of implied volatility in the option market to the announcement of a dividend initiation. Implied volatility decreases after the announcement and the magnitude of the decline in volatility is positively related to both the magnitude of cumulative abnormal returns (CAR) in the equity markets and the size of the dividend. Additionally, firms with weaker (stronger) corporate governance experience larger (smaller) declines in implied volatility. Cross sectional analysis shows that a one-standard deviation decline in measures of risk increases the 2-day CAR by 74–137 basis points. Our results suggest that dividend initiations signal declining firm risk.

previous article Corporate cash holdings and political connections

next article Uncovering a positive risk-return relation: the role of implied volatility index

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

See Black (1976) for detailed descriptions of the puzzle.

A partial list of studies that examine the first order effect of dividend changes include Aharony and Swary (1980), Asquith and Mullins (1986), Bernartzi et al. (1997), Cheng et al. (2007), Fehrs et al. (1988), Ghosh and Woolridge (1988), Healy and Palepu (1988), Lacina and Zhang (2008), Michaely et al. (1995), Nissim and Ziv (2001), and Van Eaton (1999).

Docking and Koch (2005) focus on market volatility instead of the risk of a firm. Specifically, they find the announcement of a dividend decrease elicits a significant decrease in stock price when market returns have been up and volatile, while the announcement of a dividend increase causes a significant increase in stock price when market returns have been down and volatile.

Acker (1999) examines changes in implied standard deviations surrounding dividend announcements in the United Kingdom, but the dividend paying process in the UK. is substantially different from that in the US. Jayaraman and Shastri (1993) examine volatility changes around the announcement of special dividends compared to ordinary dividends, but the sample is quite small and methodological flaws exist since they average estimates of volatility over time. These studies are not particularly relevant or comparable to this study.

Special dividends (third digit of CRSP distribution code is “7”) are generally nonrecurring and are excluded from this study, as prior research (e.g. Brickley 1983) has demonstrated less information content associated with special dividends.

This data was purchased from Delta Neutral in early 2006. We elected not to extend the sample period by purchasing additional data for more recent years due to the onset of the financial crisis in 2007.

Currently no closed-form solution exists to explicitly solve for implied volatility using the Black–Scholes model, so iterative processes are used.

As used here, "matching" means the put option must have the same strike price and term to expiration as the call option.

We also used the CRSP equal-weighted index in the analyses and the use of equal-weighted index produces results similar to those using value-weighted index.

We also considered adding GIM INDEX as a control variable. The coefficient for GIM INDEX was negative, suggesting that weaker governance reduces the CAR. However, this variable was not statistically significant in any of the regressions, so we did not include it in the presented results.

Acker D (1999) Stock return volatility and dividend announcements. Rev Quant Financ Acc 12(3):221–242CrossRef

Aharony J, Swary I (1980) Quarterly dividend and earnings announcements and stockholders’ returns: an empirical analysis. J Financ 35(1):1–12CrossRef

Asquith P, Mullins DW Jr (1986) Signaling with dividends, stock repurchases, and equity issues. Financ Manag 15(3):27–44CrossRef

Bernartzi S, Michaely R, Thaler R (1997) Do dividend changes signal the future or the past? J Financ 52(3):1007–1034CrossRef

Black F (1976) The dividend puzzle. J Portf Manag 2(2):72–77CrossRef

Black F, Scholes M (1973) The pricing of options and corporate liabilities. J Polit Econ 81(3):637–654CrossRef

Brickley J (1983) Shareholder wealth, information signaling, and the specially designated dividend: an empirical study. J Financ Econ 12(2):187–209CrossRef

Charest G (1978) Dividend information, stock returns and market efficiency II. J Financ Econ 6(2–3):297–330CrossRef

Cheng L, Fung H, Leung T (2007) Information effect of dividends: evidence from the Hong Kong market. Rev Quant Financ Acc 28(1):23–54CrossRef

Docking D, Koch P (2005) Sensitivity of investor reaction to market direction and volatility: dividend change announcements. J Financ Res 28(1):21–40CrossRef

Donders M, Vorst T (1996) The impact of firm-specific news on implied volatilities. J Bank Financ 20(9):1447–1461CrossRef

Dyl E, Weigand R (1998) The information content of dividend initiations: additional evidence. Financ Manag 27(3):27–35CrossRef

Eades K, Hess P, Kim E (1985) Market rationality and dividend announcements. J Financ Econ 14(4):581–604CrossRef

Ederington L, Guan W (2002) Measuring implied volatility: is an average better? Which average? J Future Mark 22(9):811–837CrossRef

Ederington L, Lee J (1996) The creation and resolution of market uncertainty: the impact of information releases on implied volatility. J Financ Quant Anal 31(4):513–539CrossRef

Fehrs D, Benesh G, Peterson D (1988) Evidence of a relation between stock price reactions around cash dividend changes and yields. J Financ Res 11(2):111–123

Fuller K, Blau BM (2010) Signaling, free cash flow, and “nonmonotonic” dividends. Financ Rev 45(1):21–56CrossRef

Ghosh C, Woolridge JR (1988) An analysis of shareholder reaction to dividend cuts and omissions. J Financ Res 11(4):281–294

Gompers P, Ishii J, Metrick A (2003) Corporate governance and equity prices. Quart J Econ 118(1):107–155CrossRef

Grullon G, Michaely R, Swaminathan B (2002) Are dividend changes a sign of firm maturity? J Bus 75(3):387–424CrossRef

Healy P, Palepu K (1988) Earnings information conveyed by dividend initiations and omissions. J Financ Econ 21(2):149–175CrossRef

Jayaraman N, Shastri K (1993) The effects of the announcements of dividend increases on stock return volatility: evidence from the options market. J Bus Financ Acc 20(5):673–685CrossRef

Jensen M (1986) Agency costs of free cash flow, corporate finance, and takeovers. Am Econ Rev 76(2):323–329

Kalay A (1980) Signaling, information content and the reluctance to cut dividends. J Financ Quant Anal 15(4):855–869CrossRef

Kalay A, Lowenstein U (1985) Predictable events and excess returns: the case of dividend announcements. J Financ Econ 14(3):423–449CrossRef

Kim S, Rui O, Xu P (2002) Risk shift following dividend change announcement: the role of trading volume. Rev Quant Financ Acc 19(1):45–63CrossRef

Klein L, Peterson D (1988) Investor expectations of volatility increases around large stock splits as implied in call option premia. J Financ Res 11(1):71–80

Lacina M, Zhang Z (2008) Divided initiation by high-tech firms. Rev Pac Basin Financ Mark Policies 11(2):201–226CrossRef

Levy H, Yoder J (1993) The behavior of option implied standard deviations around merger and acquisitions announcements. Financ Rev 28(2):261–272CrossRef

Mayhew S (1995) Implied volatility. Financ Anal J 51(4):8–20CrossRef

Michaely R, Thaler R, Womack K (1995) Price reactions to dividend initiations and omissions: overreaction or drift? J Financ 50(2):573–608CrossRef

Nissim D, Ziv A (2001) Dividend changes and future profitability. J Financ 56(6):2111–2133CrossRef

Patell J, Wolfson M (1979) Anticipated information releases reflected in call option prices. J Acc Econ 1(2):117–140CrossRef

Patell J, Wolfson M (1981) The ex ante and ex post price effects of quarterly earnings announcements reflected in option and stock prices. J Acc Res 19(2):434–458CrossRef

Sheikh A (1989) Stock splits, volatility increases, and implied volatilities. J Financ 44(5):1361–1372CrossRef

Van Eaton R (1999) Stock price adjustment to the information in dividend changes. Rev Quant Financ Acc 12(2):113–133CrossRef

Venkatesh P (1989) The impact of dividend initiation on the information content of earnings announcements and return volatility. J Bus 62(2):175–197CrossRef

Title: Do dividend initiations signal a reduction in risk? Evidence from the option market
Authors: Jeffrey S. Jones
Jenny Gu
Pu Liu
Publication date: 01-01-2014
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 1/2014
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-012-0337-5

Springer Professional

Abstract

Please log in to get access to your license.

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Other articles of this Issue 1/2014

Dissecting and connecting the growth and accounting distortion components of accruals

Asymmetric stock price and liquidity responses to changes in the FTSE SmallCap index

Earnings management and IPO anomalies in China

Corporate cash holdings and political connections

Equivalent valuations in cash flow and accounting models

Uncovering a positive risk-return relation: the role of implied volatility index