Financial markets

Are returns to investors in stocks in new industries high? Looking at Microsoft or Dell, one would naturally think so. But then it doesn’t take long to recall all the software and hardware firms that never returned a dime in dividends and are long gone. The dot-com boom and subsequent bust makes it all the more interesting.

Cora Barnart and I wrote a paper to answer the question: “Are Stocks in New Industries Like Lottery Tickets?” The short answer is “No.” That led to a significant revision of the paper. (Asking a question and finding out the answer is “no” does not necessarily make for a publishable paper.)

Returns to Investors in Stock in New Industries” is an improved version of that paper with additional historical data. We find that investors received positive returns, sometime spectacular ones.

All that said, on average an investor generally would be better off with a diversified portfolio of stocks in the overall market given the risk. A portfolio of stocks in a new industry does not compensate for the riskiness of the portfolio. So much for sector funds, at least as an entire portfolio. This paper is forthcoming in Economic Inquiry.

Interestingly, that is not true for investors in firms before they have marketable stock. John Cochrane looked at returns to venture and capital and estimated expected returns of about 59 percent. Ray DeGennaro and I estimate an expected return of about 70 percent for angel investors in firms in our paper “Expected Returns to Stock Investments by Angel Investors in Groups”. These angel investors in firms are similar to the angels bankrolling plays in movies. Angel investors provide funds to firms at very early stages. Seventy percent is not a bad expected return. It should be added that most investments never pay back the original investment, but some pay off handsomely.

I also have been interested in futures markets for a long time, although I only recently have a paper on those markets.

My good friend Al Ballinger got me interested in crude oil futures and their effect on the cash market. Crude oil futures were introduced into a cash market which had prices posted by refiners. In every other case of which we are aware, the cash market was an auction market when a futures market was introduced. (The sole possible exception is onion futures, which subsequently were outlawed.) This paper was largely done before he passed away.

Ann Gillette, Al and I ran some experiments to generate related data. The current version of the paper is “Trading Institutions and Price Discovery: The Cash and Futures Markets for Crude Oil.” Ann ran additional experiments and I hope we will be revising the paper shortly.