EconSouth (First Quarter 2003)
Research Notes and News highlights recently published research as well as other news from the Federal Reserve Bank of Atlanta. For complete text of summarized articles and publications, see the Atlanta Fed’s World Wide Web site at www.frbatlanta.org/publ.cfm.
An introduction to direct investment plans
Direct investment plans (commonly known as DRIPs) let investors bypass traditional investment channels and avoid problems such as high transactions costs and the relatively large dollar amounts necessary to purchase certain assets. While no one expects these plans to answer all of the modern investor’s needs, DRIPs probably appeal to the buy-and-hold clientele seeking the lowest possible transactions costs.
In a recent article Ramon P. DeGennaro provides a primer on DRIPs, describing how the financial services industry has evolved to meet the needs of the small investor. The author identifies the remaining limitations on this sort of investment, noting that mutual funds continue to offer convenience and unmatched diversification for small accounts. He then presents reasons why companies might offer DRIPs. For example, companies that face regulatory scrutiny may want a broad, stable ownership base. Such shareholders also tend to vote with management, offering potential as a takeover defense. Finally, a broad ownership base provides opportunities for cross-selling.
The article also identifies empirical differences between companies that offer DRIPs and those that do not. The analysis shows that large companies, more mature companies and companies in industries that are subject to relatively high levels of regulation are more likely to offer the plans.
Finally, the discussion speculates about the future of direct investments. One obvious tool for DRIP investors is the Internet. Broker-run DRIPs provide another evolutionary direction.
Geomagnetic storms and international stock markets
Explaining movements in daily stock prices is one of the most difficult tasks in modern finance. A recent working paper contributes to the existing literature by documenting the impact of geomagnetic storms on international stock market returns.
A large body of psychological research has shown that geomagnetic storms have a profound effect on people’s moods, and, in turn, people’s moods have been found to be related to human behavior, judgments and decisions about risk. An important finding of this literature is that people often attribute their feelings and emotions to the wrong source, leading to incorrect judgments. Specifically, people affected by geomagnetic storms may be more inclined to sell stocks on stormy days because they incorrectly attribute their bad mood to negative economic prospects rather than bad environmental conditions. Misattribution of mood and pessimistic choices can translate into a relatively higher demand for riskless assets, causing the price of risky assets to fall or to rise less quickly than they otherwise would.
Authors Anna Krivelyova and Cesare Robotti find strong empirical support in favor of a geomagnetic-storm effect in stock returns after controlling for market seasonals and other environmental and behavioral factors. Unusually high levels of geomagnetic activity have a negative and statistically significant effect on the following week’s stock returns for nine out of 10 countries and 12 out of 13 indices in the authors’ sample. The paper also provides evidence of substantially higher returns around the world during periods of quiet geomagnetic activity. The effect appears to be relevant from an economic point of view.
Section 529 plans: A good choice?
Changes in the U.S. tax code have brought Section 529 plans to the forefront of investment vehicles for college savings. Not surprisingly, the number of investors using Section 529 plans and the amounts invested in them have grown rapidly; about $25 billion flowed into such plans in 2002, and that figure is expected to balloon to $200 billion by 2007. But are these plans a wise choice?
Previous research concluded that the prespecified asset allocations used by many Section 529 college savings plans can make them poor options for most investors compared to some other investments. According to a working paper by Ramon P. DeGennaro, even if the earlier finding was accurate at one time, it is true now only for a much smaller number of savers and for reasons other than those previously asserted. The earlier work could mislead investors and tend to deflect attention from investment options and strategies that would benefit many college savers.
DeGennaro’s paper explores the important distinction between the decision to allocate funds to a Section 529 plan and the decision to allocate funds within the plan. Investors can widen their range of investment alternatives by selecting plans outside of their states of residence. Such choices can eliminate the potential problems that previous research has identified while retaining the tax advantages of college savings plans.
Recent tax law changes have magnified the importance of Section 529 plans, and their appeal is now much greater. For most investors, the plans are fully tax-exempt at the federal level, and investment limits are typically much larger. Investors saving for college must understand the implications of their choice of investment vehicle and of their portfolio choices.
Atlanta Fed sponsors conference on monetary policy and learning
Learning is central to monetary policy: The monetary authorities learn about the economy as they try to achieve their goals, the public learns about policymakers’ objectives, and its learning, in turn, changes the way monetary policy works. Yet the topic of learning and monetary policy has until recently been overlooked in academic and policy circles. A new strand of the literature in macroeconomics is changing this state of affairs. To offer a perspective on this issue, the Federal Reserve Bank of Atlanta sponsored the conference Monetary Policy and Learning in March 2003 and brought together some of the main contributors to the literature.
The conference featured presentations followed by commentary and an open-floor discussion of the paper and related issues. Topics discussed included adaptive learning and the use of forecasts in monetary policy, monetary policy mistakes and the evolution of inflation expectations, and learning and adaptation in hyperinflation. For more information about the conference agenda and links to the papers presented, visit the bank’s Web site at www.frbatlanta.org and go to News and Events.