EX- DAY PRICE BEHAVIOR AND LIQUIDITY: EVIDENCE FROM AN EMERGING MARKET FREE OF MICROSTRUCTURE IMPEDIMENTS

DANIEL DUPUIS

Assistant-Professor, Department of Finance, School of Business Administration, American University of Sharjah, Sharjah, United Arab Emirates, P.O. Box 26666 E-mail: [email protected].

Abstract - This paper investigates the effect of liquidity on the ex-dividend day price premium. It is well documented that prices drop less than the dividend amount on the ex-day; this market inefficiency is attributed to the tax-induced clientele effect and various structural frictions. I show that, even in a tax-free market where the usual microstructure impediments are limited or absent, abnormal returns persist. Imodify the illiquidity ratio to account for the restriction in the public free float and find that liquidity is statistically significant in the determination of the ex-dividend day price anomaly. A 1% reduction in illiquidity yields a 0.1% increase in unrealized abnormal returns.

Keywords - Abnormal return; ; microstructure; emerging markets; liquidity; mispricing. JEL Classifications - G12, G14, G15, G35.

I. INTRODUCTION or capital gains and the base is relatively homogenous with retail traders dominating the field. In a perfect frictionless economy, the price of a This is in stark contrast with mature markets like the should fall by the exact value of the dividend on the U.S. where institutions run the roost and the fiscal day shareholders can no longer claim a right to the burden is prominent. As with any study based in said dividend. The rationale is quite simple; since the emerging economies, there are disadvantages; the payout amount no longer belongs to the firm, its sample size is limited, the market is relatively aggregate value must be subtracted from the unknown to the academic community and its company’s equity and the stock price adjust particularities may not be duplicated in some or many downwards accordingly. It is well documented in the developed countries - but I feel it provides a unique, literature that the reality differs; there is “money left quasi-laboratory setting to conduct research in an on the table” as prices drop less than the expected environment isolated from most of the documented dividend. Many empirical and theoretical ex-day price behavior effects. studiesattemptto explain this phenomenon with mixed results. Earlier papers (e.g. Elton and Gruber, 1970; This study provides five main contributions to the Kalay, 1982, Booth and Johnston, 1984;Hietala, literature. First, I offer evidence supporting the notion 1990; Michaely, 1996; etc.) hold the differential in that the generally accepted structural frictions and tax tax preference accountable for the price inefficiency effects are absent in the UAE markets. Second, I as some may show a predilection for exploit this near-Walrasianeconomic state to show dividends over capital gains or vice-versa (the that, even in the absence of microstructure clientele effect). Others (e.g. Bali and Hite, 1998; impediments, the ex-day price-drop remains Frank and Jagannathan, 1998; Jakob and Ma, 2006; significantly less than the dividend and etc.) focus on the presence of structural frictions in unrealized abnormal returns persist. Consistent with the equity markets; price discreteness, tick size, bid- the literature on other tax-free markets, I find a mean ask bounce, limit order imbalance and transaction adjusted price-drop ratio of 3.21% for an average costs all belong to this category. Results vary across of 5.22% and an ex-day abnormal the spectrum of research but one constant remains; in return of 1.69%. The implication is that other a taxable market, it is problematic to separate the undocumented factors could be responsible for the clientele effect from other frictions and conclusions price premium.Third, I argue that liquidity is an issue drawn within this framework may be tainted by the in the Emirati market and may play a role in the loss joint interaction of two or more variables. of ex-day price efficiency. Fourth, I modify the turnover-adjusted illiquidity ratio to incorporate the In this paper, I investigate the factors that may hinder potentially restrictive effect of lowpublic free float on the theorized stock price-drop surrounding cash liquidity.Finally, using portfolio sorting, regression dividend events and the associated abnormal returns. analysis and the redefined measure of fluidity, I show The capital markets of the United Arab Emirates offer that illiquidity, dividend-yield magnitude, traded a near-perfect setting to conduct this research. The volume and, to a lesser extent, brokerage fees play an computerized stock exchanges of the UAE operate important role in the determination of ex-day under modern rules, there are no taxes on dividends abnormal returns in a market free of the usual

Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 10 Ex-Dividend Day Price Behavior and Liquidity: Evidence from an Emerging Market Free of Microstructure Impediments frictions. My results indicate that a 1% increase in claim 76%of the but these illiquidity reduces abnormal returns by 0.1%. The investors have little incentive to trade, accounting for remainder of this paper is organized as follows. a mere 14.6% of the volume (2007) to a maximum of Section two introduces the characteristics proper to 28.4% (first quarter of 2016). This behavioral the capital markets in the United Arab Emirates and characteristic may go a way in explaining the details the effect of the various microstructure complete lack of ex-day volume for almost half of the frictions, as found in the literature, on the ex-dividend dividend events identified in this study. Professionals day price behavior in the context of the peculiar UAE have a taste for risk while retail investors shun it market. Section three describes my sample and data (Florentsen and Rydqvist, 2002). Gonzalez et al. while section four presents my hypotheses, empirical (2016) study the link between ownership methodology and results. Section five concludes the concentration and dividend yield to show that large paper. shareholders encourage higher yields. There is documented evidence that dividend yields are II.UAE MARKET CHARACTERISTICS AND positively correlated with abnormal returns so I MICROSTRUCTURE FRICTIONS expect that high institutional ownership, paired with low trading interest can have an effect on liquidity 2.1. The United Arab Emirates market and ex-day premiums. Furthermore, the mean free The United Arab Emirates is a fast-growing middle- float for the DFM exchange oscillates around the eastern sovereign nation and a member of the Gulf 60% level, indicating that 40% of the shares are not Cooperation Council (GCC). While it is still available to trade. Since there are few corporate considered an emerging market, the UAE has adopted entities to act as institutional investors and no local most of the stringent market practices that mutual funds or ETFs (exchange traded funds) characterize its western counterparts; increased available for purchase, the government is a transparency, market surveillance, sophisticated substantial stockholder and acts as a passive investor, computerized platforms, etc. Part of its success is due providing a potential explanation for the low or nil to the willingness to rapidly embrace reforms and volume for many and the lack of interest in enact change. Originally an oil-based economy, the dividend-yield capture. Market-maker presence is UAE has, in the past few decades, endeavored to minimal with only seven stocks (incidentally, the diversify into tourism, heavy/light industry and real most liquid) actively managed out of total sample of estate, with relative success. The country’s stock fifty seven.Overall, the UAE markets support the exchanges include the Dubai Financial Markets, trading activity of a relatively homogeneous group established in March 2000, the Abu Dhabi exchange composed mostly of local retail investors2 andthe (November 2000) and Nasdaq Dubai (September peculiarity of this investor base may have a material 2005). All of the nation’s exchanges support an impact on ex-dividend day price behavior. order-driven computerized trading system under the supervision of the Securities and Commodities Market operations on the DFM, ADX and Nasdaq Authority. There are no taxes on dividends or capital Dubai are processed using the standard order-book gains for individuals and corporations located in method, with investors placing orders through special free zones, making for one of the simplest tax brokers who complete the trade on the exchange. The codes in the world. processing time for completing a trade is T+2 (three days) and the record date usually precedes the ex-date During the period under study (April 2007- May by the same number of days, discounting weekend 2016), the UAE did not allow sales and no holidays which are held on Friday and Saturday in the derivatives (options or futures) are offered to trade. GCC countries. Listed firms distribute cash or stock The first equity futures contracts have recently been dividends on a yearly basis following the traditional introduced on Nasdaq Dubai (September 2016) and pattern; the board of directors proposes, and final cover seven stocks but fall outside of the date range approval belongs to stockholders during the annual of this paper. The DFM supports the equity listing of general meeting. Investors usually agree with the 60 firms, the ADX 67 companies and the Nasdaq board’s recommendation with the exception of the Dubai accounts for 10. The total market capitalization 2008 period where eight planned dividend payout for our sample periodranges from a high of AED 507 events were voted down. This outcome is not billion (2007) to a low of AED 180 billion (2011). surprising since the board meeting generally took Stock ownership in the UAE is characterized by a place before the market crash and the general meeting strong domestic bias; local entities (Emiratis) own in its aftermath. more than 80% of the available shareswith GCC nationals (ex-UAE) and residents of other Arab countries far behind at 15%, leaving other foreign 2 1 Al-Hiluet al. (2016) study the behavior of investors in the UAE holdings 5% of the capital stock . Institutional owners market and find that Emirati traders depend on familiarity and personal information channels to make decision while exhibiting overconfidence and home bias; all characteristics 1Source: Dubai Financial Markets investor relations. associated with noise traders.

Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 11 Ex-Dividend Day Price Behavior and Liquidity: Evidence from an Emerging Market Free of Microstructure Impediments 2.2. Market frictions and structural impediments that price discretion is a dubious candidate in the The main goal of this paper is to identify the frictions search for a solution to the ex-day premium puzzle that may hinder the theorized stock price-drop while Kadapakkam and Martinez (2005) propose that surrounding cash dividend events. The literature on price decimalization limits the impact of tick size. ex-day price behavior identifies a number of Similarly, Al-Yahyaeeet al. (2013)also argue that in a microstructure impediments however, due to the market characterized by large dividend/tick ratios, particular nature of the Emirati market, some or all of price discreteness sheds its significance in assessing these frictions may be absent. In this section, rely I ex-day returns4. To illustrate, the pricing grid in the review the documented structural hindrance factors UAE moves in0.1 fils (AED50.001) increments. The and ascertain their pertinence to firms listed on the mean dividend in our sample is AED 0.22 or 220 UAE stock exchanges. times the tick size. With an average ex-day opening price of 6.04 AED, the tick/price ratio is 0.000166. 2.2.1 Clientele effect For price discreteness to retain its significance the ex- A sizable portion of the literature on ex-day abnormal effect would need to be of similar magnitude but my returns focuses on the difference in tax treatment results indicate a price-drop ratio of at least 200 times between capital gains and dividends. Contingent on the tick/price value. Based on this summary analysis, their taxable status, investors may show a preference I follow in the footsteps of Asimakopouloset al. between selling on the cum-day or collecting the (2015) and Al-Yahyaeeet al. (2008) anddeduce that dividend. Multiple studies conclude that the tax effect tick size is not a factor in explaining ex-day is difficult to separate from other structural frictions, premiums in the UAE markets. casting a shadow on the significance of many ex-day price-drop puzzle solutions (ex: Hess, 1982; Kalay, 2.2.3 Bid-ask bounce and limit order imbalance 1982; Bali et al,1998; Boyd and Jagannathan, 1994; Frank and Jagannathan (1998) introduce a etc.). Fortunately, the UAE markets provide an microstructure model where noise traders are advantageous research setting as there are no taxes on indifferent to the state of the dividend and trade for income, capital gains or dividends for individual other unknown reasons. As this group is mostly investors. Corporations can (and do!) take advantage composed of retail investors, noise traders use market of special tax-free zones(for example, the Dubai orders which are filled at the “worst” market price, International Financial Center) thereby delineating i.e. at the ask price for a purchase and the bid price the confounding clientele effect from other for a sale. Alternatively, market makers and microstructure impediments. While a complete institutional investors tend to display more patience review of the literature on the tax-induced price and sophistication, thus using limit orders when premium effect is beyond the scope of this article, the trading. They would therefore take the opposite complete absence of such tax friction is sufficient to to noise traders in the market order-book and determine that the clientele effect is absent in the benefit from a better order fill. As retail investors price behavior of stocks traded on the DFM, ADX may find it cumbersome to collect and reinvest the and Nasdaq Dubaiexchanges. dividends, they tend to trade on the close of the cum- day. The final outcome is that noise traders sell on the 2.2.2 Price discreteness and tick size cum-day at the bid price and purchase at the ask price Tick size can create a potential positive bias in on ex-day, introducing a distortion equivalent to half abnormal ex-day returns and numerous studies of the spread at the closing of the cum-day and the document the phenomenon. As stock prices fluctuate same at the opening on ex-day, thus affecting exclusively by tick increments, if the dividend is a abnormal returns. To solve this dilemma, Frank and fraction of the minimum tick then the price drop on Jaggannathan (1998) propose the use of the mid-point ex-day will be rounded off to the nearest integer and between bid and ask prices as anchor points. This may not reflect the full amount of the dividend3. model performs well in explaining ex-day premiums Payout frequency tends to exacerbate the problem as if the dividend is relatively close in size to the bid-ask quarterly dividends are smaller in size than the yearly spread as the gap between both trading prices creates equivalent. Even if the dividend amount is a large a band of uncertainty. The mean bid-ask spread for discrete multiple of the minimum tick size, Bali and our sample is 0.083 dirhams (8.3 fils) with an average Hite (1998) show that the return anomaly may persist dividend of 0.22 AED. These values indicate that the if the ex-effect is below one tick as traders cannot dividend is much larger than the spread and the benefit from the fractional increment and the stock impact of the bid-ask bounce may be negligible. price remains above its expected value. However, Asimakopoulos et al. (2015) study the ex-day price they point out that the clientele-induced tax effect adjustment for the Greek market which is somewhat may skew their findings. Graham et al. (2003) study the 2001 NYSE reduction in tick size and conclude 4Al-Yahyaee (2013) shows that a market-regulated negative change in tick sizeresults in lower ex-day abnormal returns. 5AED is the abbreviation for the dirham, the legal currency in the 3While studying the clientele effect, Boyd and Jagannathan (1994) UAE with a fixed exchange rate of 3.67 AED/USD. Each dirham note that this is often the case for US markets. can be subdivided in 100 fils.

Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 12 Ex-Dividend Day Price Behavior and Liquidity: Evidence from an Emerging Market Free of Microstructure Impediments similar to that of the UAE (tax free, limited market while higher trading levels increase the same through making, etc.). They argue that ex-day price drops on higher efficiency. Earlier studies (Lakinishok and the Athens cannot be attributed bid- Vermaelen, 1986; Kalay, 1982)demonstrate that ask spreads and market makers because of the latter’s abnormal ex-dividend price levels (akin to a lower minimal presence in the market6. Of the 199 dividend price-drop ratio) are positively associated with events in our final sample, only 23 (11.5%) occur dividend yields and transaction costs while unusually under the influence of a . Furthermore, high trading volumes relate to increasing dividend market makers are restricted in their actions; DFM yields but lower trading fees7.Recent studies, rules state that a market maker can provide liquidity focusing on tax-free markets, dispel the existence of a if “the number of trading days on the security is less short-term trading effect. Al-Yahyaeeet al. (2008) than 50 percent of the total number of trading days" show an actual reduction in abnormal volume around over six months” and “the number of transactions ex-day in the Omani market8 and conclude that ex- executed on the security (over six months) are less day behavior is not affected by short-term trading. than 150 transactions, while the number of shares Dasilas (2009) and Asimakopouloset al. (2015) traded in that period should be less than 500,000 disagree as they find a dividend-induced volume shares.”Hu and Tseng (2006) show that small effect in the Greek market. Isakssonet al. (2013) investors (retail) prefer low-priced stock and choose introduce the somewhat perplexing alternativethat to sell cum-dividend or buy on the ex-day while price and volume anomalies may bemarket- institutions prefer short-term arbitrage.For the bid-ask dependent. Using the same analytical method across bounce theory to hold, professional traders are four countries, they find evidence of abnormal returns required to fill the noise traders’ market orders.As and volumes in the Tokyo and London Exchanges but discussed in section 2.1, the UAE markets are none in the New York and Shanghai markets9. characterized by low market maker involvement and Perhaps the conflicting conclusions are the result of limited institutional trading. It is thus highly unlikely the difference in the array of statistical tools that these professional traders generate enough employed in the studies (portfolio sorting, event volume to overtake retail investors. Dubofski (1992) studies, regressions, etc.) or, as indirectly implied by develops a model where he links abnormal ex-day Isaksson, et al. (2013),the outcome of market-specific returns to NYSE regulation 118. This rule states that characteristics. Regardless, short-term trading limit buy orders active on ex-day are systematically remains the domain of institutional investors and reduced by the dividend. Jakob and Ma (2006) find market makers, both of which are in short supply in that automated limit order adjustments sway ex-day the Emirati stock exchanges. I thus surmise that, for prices for low dividend stocks (less than or equal to the UAE market, short-term trading and transaction one tick) thus decoupling the price drop ratio from costs may not constitute a satisfactory explanation to ex-day yields. To my knowledge, no such rules exists the ex-day premium price puzzle. Of all theprice- in the UAE;all of the localexchanges offer a pre- drop impediments identified in the literature (tax market system that allows investors to input bid/ask differential between dividends and capital gains, price trades prior to market opening thus any price discreteness and tick size, bid-ask bounce, limit order adjustment on ex-day reflects the traders’ opinion of imbalanceand transaction costs), none appear to have the value of the shares. This brief qualitative analysis a material impact on the ex-day price drop in the provides factual information leading to the conclusion UAE exchanges. The rest of this paper is devoted to that, for the UAE markets, the bid-ask bounce and an investigation into the potential persistence of limit order imbalance microstructure impediments are abnormal returns despite the favorable particularities not likely to act as frictions in the ex-day price of the Emirati market. puzzle. III. SAMPLE AND DATA 2.2.4 Transaction costs and short-term trading In a framework of risk neutrality, the price drop ratio This study targets the universe of UAE stocks paying from cum- to ex-date should equal 1. Traders would cash dividends from April 2007 to May 2016 (10 naturally sell the stock on ex-day until the arbitrage years). All of the stocks traded on the three UAE opportunity disappears. Transaction costs inhibit this capital markets (DFM, ADX and NASDAQ Dubai) relationship by creating a drag on the seller’s profit, are included in initial sample. In accordance with the leaving a portion of the dividend as a component of literature, the final listis trimmed to include stocks the ex-day price. The concepts of trading fees and that meet the following conditions: (1) the firm paid a abnormal ex-day volume (a measure of trading activity) are intertwined and impact market prices 7Since the studies take place in taxable markets, the results may be differently; greater fees reduce the price-drop ratio influenced by the presence of the clientele effect. 8 Note that the capital markets of Oman are very similar to that of the UAE 6In their 2008 paper on ex-dividend day behavior, Al-Yahyaeeet al. 9 The authors point out that their analysis may suffer from offer a dissenting opinion and conduct a test of the bid-ask bounce sampling bias as they exclusively study blue-chip stocks and the theory to show that using mid-prices eliminates the ex-day period under consideration includes the 2007-2008 economic abnormal returns. crisis.

Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 13 Ex-Dividend Day Price Behavior and Liquidity: Evidence from an Emerging Market Free of Microstructure Impediments regular cash dividend, (2) the data for price, volume, stock price will decrease by the exact value of the float, outstanding shares, etc. is publicly available and payout amount on ex-day opening.External market continuous (no trading halts) for the window [-240, - influences can play a role in the calculation of 41] days around the ex-day, (3) there are no splits, specific stock ex-day returns and the choice of stock dividends or rights issue on the ex-day, (4) measurement variable can have a considerable there are positive trading volumes on cum and ex- impact.If closing prices for both the cum- and ex-day dividend days and finally, (5) there is no material are used to compute the various ratios then discrepancy between the dataset, the exchange’s Pexpartially reflects market movements during the ex- and/or company’s records. Rule (4) offers the day and must be scaled accordingly, likewise if the opportunity for an interesting reflection; it concerns opening price is used on cum-day. For the theoretical data points where there is no volume, hence no price relationship to hold (RPR=1), one should use the change on ex-dividend day. Careless direct data closing value on cum-day and the opening price on analysis would yield a null pricedrop since the ex-dividend day to measure the raw price ratio. reported closing price on cum-day is equivalent to Following Graham et al. (2003) and Cloydet al. that of the open and close on ex-day but no trading (2004), equation (2) is rewritten as follows: took place so there is no actualprice, return or volume available. In fact, the data is undefined for these RPR = , , (3) observations. I am thus forced to eliminate themfrom whereD is the dividend paid,P is the closing price the final sample but their existence provides an cum,cl on cum-day and P is the opening price on ex-day. insight into the nature of the UAE markets with ex,op Furthermore, the change in price from cum- to ex-day regards to liquidity. The shares are listed to trade, but can also be influenced by overnight market no one seems interested in doing so. The zero-volume movements. Should a material event occur after observations represent a material 47.8% of all data markets close, the RPR will be skewed by external points and appear to indicate that there is a strong forces during the pre-market order-accumulation liquidity issue with the United Arab Emirates period on the ex-dividend day10. I thus rewrite markets. Unfortunately, all measures of liquidity (bid- equation (3) to reflect this precision and add a ask spread, Amihud (2002)’s ratio, etc.) are also subscript to the variables; “cl” for closing price, “op” undefined and any empirical analysis including these for opening and “ov” for overnight.The overnight observations is difficult if not impossible. market return (R ) represents the difference m,ov between the closing and opening values of the market The dividend amounts, ex-date and type (cash, stock, index. This market-adjusted price ratio (MAPR) thus special, etc.), opening and closing prices, historical removes exogenous influences and can be computed daily , number of outstanding shares and as follows11: daily volumes are obtained from Thomson Reuters , Zawya.I manually verify all dividend events against , MAPR = , (4) exchange records, company announcements and Bloomberg data; in case of material disagreement Where rm,ov is the overnight market index return.As (ex-date, dividend amount or type, etc.), the with the RPR, the theoretical value of MAPR is also observation is struck from the dataset. The final equal to 1 but it offers a more accurate estimation.I sample includes 199 dividend events from 57 firms. thus formulate my first hypothesis as follows: Table 1provides the descriptive statistics for the dataset. : In a market free ofmicrostructure frictions, the ex-day raw and market-adjusted price ratios are equal IV. METHODOLOGY, HYPOTHESIS TESTING to 1. AND RESULTS Table 2 describes the results for both price ratios for 4.1 Price premium ratios my sample of 199 observations. The significance Early studies on ex-day behavior include Elton and levels reported are the result of testing the null Gruber (1970) who develop an arbitrage model and hypothesis that RPR and MAPR are different from show that, ceteris paribus, the price of a dividend the theoretical value of 1. These tests are conducted paying stock should decrease by the amount of the using a two-sample t-test with unequal variances dividend (D) from the cum-date (P ) to the ex-date cum (Pex): 10All of the UAE exchanges (DFM, ADX and NASDAQ Dubai) P = P + D (1) offer a pre- and post- market order accumulation mechanism where Equation (1) can be rearranged to obtain the raw price bids and asks are collected but no trades are settled. Order ratio (RPR), a measure of the price differential scaled cancellation is allowed until the last five minutes prior to the by the dividend: opening and closing times. 11I also test the two market-adjusted alternatives (open-open and RPR = (2) close-close) to find that the results are not statistically different In the absence of taxes and other market frictions, the from the close-open adjusted for overnight market movements. For parsimony, these results are not tabulated but are available from the theoretical value of the raw price-drop ratio is 1; the author upon request.

Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 14 Ex-Dividend Day Price Behavior and Liquidity: Evidence from an Emerging Market Free of Microstructure Impediments where the premium ratios are paired with a unit From Table 2, rows 3 and 4, the mean (median) raw vector. In particular, I find that the mean (median) and adjusted price-drop ratios are practically identical raw and market-adjusted premiums are almost at 3.22% (3.21%) for RPDR and 3.04% (3.04%) for quantitatively equivalent at 0.6581 (0.7500) for the MAPDR, indicating the absence of overnight market RPR and 0.6554 (0.7142) for the MAPR. Both tests shocks (the basis for adjustments) between cum- and are significant at the 99% level with t-statistics of - ex-days. Both results are strongly significant (99% 5.10 and -5.11 respectively. I thus conclude that the level) with t-statistics of -5.08 and -5.11. With this ex-dividend day price premium in the UAE is less summary analysis, I reject the null that the price-drop that the theorized value of 1. These results conforms ratios are equivalent to the dividend yield and support closely to the literature on tax-free markets as Al- the existing opinion in the literature stating that there Yahyaeeet al. (2008) report an a mean price ratio of is “money left on the table” on ex-dividend days. My 0.6460 for the Omani market, Asimakopouloset al. results show a slightly higher raw price-drop ratio (2015) show 0.6223 for the Greek market and Frank than Asimakopouloset al. (2015) at 2.09% for the and Jagannathan (1998) indicate a slightly lower Greek market and Frank and Jagannathan (1998) at value at 0.4324 for Hong Kong. 0.17% for Hong Kong but this explained by the fact that the dividend-yield for my sample is also higher at 4.2 Price-drop ratios 5.22% compared to 3.16% and 2.51% respectively. Price premium methods are intuitive and somewhat attractive but many authors (Eadeset al., 1984; 4.3 Ex-dividend day abnormal returns. Lakonishok and Vermaelen, 1986; Barclay, 1987; While both the adjusted-price and drop ratios are Michaely, 1991;, Boyd and Jagganathan, 1994;Bell informative in assessing the ex-dividend behavior of and Jenkinson, 2002)submit that the RPR and MAPR stock values, abnormal returns provide a direct and suffer from heteroskedasticity since the ratiosare intuitive measure of the impact of the friction on ex- scaled by the payout amount, thus introducing day prices. If the price decreases by the full dividend excessive weight on low-dividend observations.They amount, theory dictates that the abnormal return suggest that the raw price-drop ratio (RPDR) should be zero. I compute the adjusted ex-day provides a better measure of ex-day behavior. The abnormal return AR as follows: , RPDR is similar to the price differential from , , equation (2) but, instead of the dividend D, the AR = − E(R,) (7) , denominator is the cum-pricePcum,cl:

Where e(Ri,t) is the expected return of the dividend- , RPDR = , = (5) paying stock for the one-day period “t” corresponding , , Adjusting for exogenous market price movements, to the ex-day and the other variables as previously we compute the market-adjusted price-drop defined.Following the literature (Graham et al., 2003; ratio(MAPDR) as follows: Lianoet al., 2003; Cloydet al., 2004; Al-Yahyaeeet al., 2008), I select the CAPMas the market model: , , , MAPDR = (6) ER, = α, + R, + β,ER, − R, + ε, , (8) With all variables as previously described. In the absence of market frictions, the expected drop on the E(Rm,t) is proxied bythe daily returns of the respective ex-day open is equivalent to the dividend amount market (DFM, ADX or NASDAQ Dubai) therefore both the raw and market-adjusted price-drop wherestockiis traded during the ex-day t. Since the ratios take on a theoretical value equal to the dividend UAE does not issue treasury bills, the accepted yield(D/P ).I thus formulate the second hypothesis cum,cl practice is to use the overnight inter-bank repo rate as as follows: the risk-free rate and I obtain this data from the Central Bank of the United Arab Emirates. The : In a market free of microstructure impediments, annualRf,tobservation is scaled to match the daily the ex-day raw and adjusted price-drop ratios are frequency of the dataset. Following Dasilas (2009), I equal to the dividend yield. estimate the model parameters using daily returns within the [-240, -41] window relative to the event Table 2 presents the results for the price-drop ratios. and formulate the third hypothesis as follows: The significance levels reported are the result of testing the null hypothesis that the vectors RPDR and : In a market free of microstructure impediments, MAPDR are different from the theoretical dividend- the ex-day abnormal return is equal to zero. yield target. These tests are conducted using a two- Table 2 row 5 reports the results for the abnormal sample t-test with unequal variances where the price- returns. I am testing the null hypothesis that the ex- drop ratios are paired with a vector composed of the day AR is different from zero. This analysis is corresponding dividend yields. There are 199 completed using a two-sample t-test with unequal observations in the sample.

Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 15 Ex-Dividend Day Price Behavior and Liquidity: Evidence from an Emerging Market Free of Microstructure Impediments variances where the abnormal return is paired with a measure is biased by market capitalization as shares null vector. The sample contains 199 observations. with a smaller dollar-denominated volume will [Please insert table 2 about here.] The mean systematically appear less liquid for an equivalent (median) ex-day abnormal return is 1.69% (0.68%) turnover. This concern is also reflected in a study by with a t-statistic of 4.83 indicating that AR is Florakiset al. (2011) who propose that Amihud’s ratio statistically greater (at the 99% level) than zero. This should be adjusted by the daily stock turnover defined finding ranks in the middle of the range as reported in as the volume of stock traded divided by the number other studies targeting similar markets; 1.18% forAl- of . Asimakopouloset al. (2015) Yahyaee et al. (2008),4.45% forAsimakopouloset al. further refer to this latest measure as the “turnover- (2015) andDasilas (2009) at 0.8%. Contrary to theory, adjusted illiquidity ratio” (TIlliqi,,t): it appears that abnormal ex-day returns in the United |,| TIlliq, = (10) Arab Emirates are positive and significant despite the , absence of most, if not all, price-drop inhibiting with , factors. TR, = (11) ,

4.4 Liquidity, public free-float and abnormal where |R | is the daily return (open to close) of stock returns i,t i on day t,TR is the turnover ratio,Vol is the daily Results thus far show that ex-day abnormal returns i,t i,t trading volume for stock i and Outstanding is the persist even ina tax-free country with little or no i,t number of outstanding shares for firmi at time t . microstructure impediments. To better understand the Florakiset al. (2011) also show that Tilliq captures ex-dividend price behavior in the Emirati markets, I two distinct dimensions of liquidity, namely trading focus on an alternative explanation factor. As cost and frequency. Unfortunately, this measure of discussed insection 3, close to half of the dividend liquidity may be considered imprecise in markets events in my initial sample (before attrition) with relatively concentrated ownership.The turnover displayed a nil volume around the ex-day. No volume ratio TR is computed as a portion of the number of implies no trading – the full amount of the dividend is i,t outstanding shares but,for closely-held firms, a left on the table. Further investigation into the substantial fraction of this outstanding stock is not universe of UAE stocks (dividend paying or not) available to trade. The illiquidity ratio as previously reveals that there is little if any volume or price defined may fail to capture the effect of the restriction movement for a sizable portion of the listed firms in trading potential. I thus propose a modified within the DFM and ADX exchanges – 58 out of 127 illiquidity ratio where the number of outstanding stocks display a mode of zero daily trading volume. shares is replaced by the more accurate public free Institutional ownership stands at a mean of 76% but float and dub this measure the “free-float illiquidity only contribute to 21% of the trading volume and the ratio” or “FIlliq ”: mean free float for my sample is somewhat low at i,t |,| 62.8%. As with many GCC markets, the UAE is FIlliq, = (11) , characterized by large holdings in the hands of with family, governmental and/or institutional entities that , FTR, = (12) do not participate actively in the markets. Although , these shares are not restricted in the legal sense of the term, they do not trade, resulting in a large number of where |Ri,t| is the daily return (open to close) of stock stocks with zero turnover. Liquidity thus appears to i on day t, FTRi,tis the free-float turnover ratio, 12 be an issue in the Emirati equity markets . Since the Voli,tis the daily trading volume for stock i and Free- number of shares available to trade is limited for floati,t is the public free-float for firm i.The economic corporations controlled by relatively few owners, the interpretation of FIlliqi,t is analogous to price reaction level of investor participation should impact returns. of the stock to a one-percent change of turnover rate. Quantifying liquidity remains an issue. Amihud The instinctive understanding is that, for an (2002) proposes a measure of illiquidity based equivalent daily return and volume, stocks with a on a combination of returns and volumes: lower free-float level will display a higher turnover |,| rate; the denominator from equation (11) increases Illiq, = (9) , and FIlliqi,t shrinks accordingly. Hence, ceteris paribus, a lower free-float would imply a reduced whereilliqi,,tis Amihud’s (2002) measure of liquidity, illiquidity ratio. This reasoning may appear |Ri,t| is the daily return (open to close) of stock i on counterintuitive but the reality hinges on the interplay day t, and Voli,tis the dollar-based trading volume for between the price impact and liquidity. While the same stock. Cochrane (2005) argues that this isolating one termand keeping the others constant provides a theoretical overview, the empirical 12Lischewski and Voronkova (2012) use a number of various evidence shows that all three variables (return, measures to show that liquidity is an important factor in the volume and turnover rate) are affected by the quantity determination of returns in the Polish market, another emerging of stock available to trade and no conclusion can be economy.

Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 16 Ex-Dividend Day Price Behavior and Liquidity: Evidence from an Emerging Market Free of Microstructure Impediments drawn by isolating a single term. As Florakiset al. paired with a null vector, MAPR with a unit vector (2011) highlight, it is the compounded effect of all and MAPDR with the respective Divyld values. the variables that matters for asset pricing, not each [Please insert table 3 about here.] feature in isolation and selective intuition may lead to erroneous conclusions. In practice, turnover-based I compare sub-sample OBS1, with the highest ratios such as FIlliqandTIlliqcould be reflected upon illiquidity ratio, to the bottom quintile OBS5 as liquidityin contrast with illiquidity measures. containing the observations with the lowest value for There is a fundamental difference between the results FIlliq.The results for the complete sample are of the return-effect of illiquidity obtained using reported at the top of the table for ease of Illiqi,,t(the Amihud ratio) and TIlliqi,,t (orFIlliqi,t ). The comparison.The D/P ratio increases across the five general consensus is that, as Amihud’s volume-based subsamples, from high to low illiquidity, indicating illiquidity ratio increases, returns also increase. The that events with subdued illiquidity are associated opposite conclusion is reached when using the with a superior dividend yield.The cross-sectional turnover-based ratio; returns decrease asFIlliqi,t volume of shares traded on ex-day does not follow a rises.Amihud (2002) advances that expected monotonic or linear pattern but a rather convex path illiquidity is positively linked to excess ex-ante with a depressed value at both ends of the illiquidity returns while unexpected illiquidity has a negative spectrum and a maximum in the transition. This result effect on contemporaneous returns. From equation is consistent with the notion that the free-float (7), the ex-dividend abnormal return is composed of turnover illiquidity ratio is independent of size bias two parts. The first term constitutes the actual but and further strengthens the decision to use FIlliq for unrealized potential return of the stock from which the present study as opposed to the widely used ex-ante return E(Ri,t), the second part, is deducted. Amihud ratio. Both the mean market-adjusted price Following Amihud’s reasoning, if contemporaneous and price-drop ratios appear to increase with (ex-ante) returns decrease (increase) with illiquidity, illiquidity although the former is not statistically the resulting impact on AR should be that of a significant across most of the samples. The mean negative relationship; the first component decreases abnormal return increases from 0.61% (high with illiquidity while the second, which is subtracted, illiquidity) to 2.20% (low illiquidity), leading to the increases with FIlliqi,t. The results from Florakiset al. conclusion that AR is negatively related to illiquidity. (2011) support this interpretation: “…stocks with low The median values also reflect this relationship. The RtoTR13 values yield significantly higher post- mean abnormal return for the top (illiquid) quintile is ranking returns as compared to stocks with high weakly (at the 90% level) different from the RtoTR values…” (p. 3349).I thus propose that theoretical null while that of OBS5 is strongly abnormal returns are negatively related to the float- significant. My results are inconsistent with that adjusted turnover illiquidity measure and formulate ofAsimakopouloset al. (2015) who find the the fourth hypothesis: oppositeeffect. Their analysis is based on a single test using a similar portfolio-sorting technique withTIlliq : The ex-dividend day abnormal return is as a measure of illiquidity and I fail to reconcile the negatively related tothe illiquidityratio of a stock as incompatible conclusions. Furthermore, their results proxied by FIlliqi,t. do not support Florakiset al. (2011) as the latter predicts that a decrease in returns is associated with The empirical tests of this hypothesis follow an increase in the turnover illiquidity ratio.

4.4.1 Portfolio sorting method Perhaps the solution lies in one of the inherent The purpose of this test is to verify if abnormal weaknesses of the portfoliosorts method; the returns are reduced by anincreasing free-float difficulty in isolating the effect of each variable. The turnover illiquidity measure. The sample under study dividend yield plays an important role in the contains all of the dividend events in the UAE market determination of AR; ex-day yields are positively meeting the five requirements from section (3). I sort related to ex-day price ratios and abnormal returns14 the data by the free-float illiquidity ratio, from and our results reflect this association.Among other highest to lowest, and separate the sample in five studies, Boyd and Jagannathan(1994) develop a equal-size quintiles of roughly forty observations. model to show theoretically and empirically that Table 3 describes the results. The significance levels different ranges of dividend yields correspond to reported are the result of testing the null hypothesis varying equilibrium prices; thus the D/P ratio has a that the subject variable is different from its material impact on ex-day prices as well as returns theoretical value. These tests are conducted using a and this relationship is not a linear but a convex two-sample t-test with unequal variances; AR is function.As the dividend/price ratiofor my sample increases from OBS1 to OBS5, it is impossible to

14 See Grammatikos (1989), Michaely (1991), Frank and 13Florakis et al.’s return-to-turnover rate (RtoTR) value is the Jagannathan (1998) and Asimakopouloset al. (2015) for a detailed equivalent of TIlliq (equation 10). explanation.

Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 17 Ex-Dividend Day Price Behavior and Liquidity: Evidence from an Emerging Market Free of Microstructure Impediments extricate the liquidity effect from the dividend-yield day, I add the control variable Voli,tto equation effect thus casting a potential shadow on the results (13)15.The regression model is as follows: obtained. In their liquidity analysis, Asimakopouloset al. (2015) do not report the D/P ratio for their five AR, = β + βDivyld,+ βTRcost, + βRisk, + sub-samples (table 6, p. 10) and it is therefore pure βlogVol, + βlogFIlliq, + ε,(13) conjecture to assign the source of the conflicting outcome to the dividend-yield effect. Where: ARi,t is the abnormal return as estimated in 4.4.2 Regression analysis. section 4.3. Since the conclusion reached with the portfolio Divyldi,t is the dividend yield for stock i on cum-day t sorting method may be tainted by the influence of as reported in section 3. variables exogenous to the return-liquidity TRcostit is the proxy for transaction cost estimated relationship, I use regression analysis as a robustness as1/Pcum,cl. test.The purpose of this testis to determineRiski,t the is the standard deviation of the residuals from CAPM influence of lower liquidity, as proxied by the model (8) scaled by the market risk and estimated as ε m previously-described free-float illiquidity ratio σ ,i,t/ σ i,. (FIlliqi,t), on ex-day abnormal returns. Multiple logVoli,t is the log transformation of the trading studies on ex-dividend day price behavior document volume on ex-day t. the various control variables considered necessary for logFIlliqi,t is the proxy for as this analysis. Karpoff and Walking (1988) document described in section 4.4. that stocks with a higher dividend yield attract more trading interest as the arbitrage benefits are greater. The F-statistic of 33.65 is significant (p-value = The rationale for adding the dividend yield to the list 0.0000). As expected, the coefficient of the dividend of independent variables is discussed in the previous yield regressor is positive (0.8772) and highly section. Suffice to say that, according to the literature, significant (p-value = 0.0000), confirming the results it is one of the more important regressors.Trading from section 4.4.1, as well as those reported in the cost also induces a drag on ex-day unrealized returns. literature namely that ex-day abnormal returns Kalay (1982) argues that, although stock prices increase with Divyldi,t. A 1% increase in the yield is should drop by the dividend amount, price arbitrage associated with a 0.87% rise in AR. As surmised in by short-term investors is subdued by the fees they section 2.2.4, the transaction cost does not appear to must disburse to complete the trade. Following in the hinder arbitrage activity that would reduce the price- footsteps of Bhardwaj and Brooks (1992), Dhaliwal drop ratio and increase abnormal returns. The and Li (2006), and Asimakopouloset al. (2015), I use coefficient for TRcostit is negative (-0.0177) and the inverse of the closing price on cum-day (1/Pcum,cl) signifies that a decrease in abnormal ex-day return is as an independent variable to measure frictions due to associated with higher fees but the significance level the brokerage cost (TRcostit). Investors that trade on is somewhat weak with a p-value of 0.03. Risk does the ex-dividend day opening also face the additional not seem to be a material factor in the determination risk that the expected drop in price remains of ex-dividend day price behavior as is not unrealized. Heath and Jarrow (1988) postulate that significant (p-value = 0.71). In accordance with this constraint may hinder arbitrage.Michaely and previous research, volume appears to play an Vila (1996), Al-Yahyaee et al. (2008) and important role; at -0.0162, displays a t-statistic of - Asimakopouloset al. (2015) measure this risk as the 4.54. A 1% rise in logVoli,t leads to an AR decrease standard deviation of the of the residuals from their of 1.62%. Higher ex-day volume is a gauge of chosen market model scaled by the market risk. I thus arbitrage activity, increasing the price-drop ratio thus ε compute σ i,tfor the CAPM model (equation 8) depressing abnormal returns. At -0.0099, the estimate normalized by the standard deviation of the market m for , the coefficient of the proxy for illiquidity returns σ i,t to obtain the control variable Riski,t= ε m logFIlliqi,t, is highly significant with a p-value of (σ ,i,t/ σ i,t). The estimation of these parameters is 0.00. The economic interpretation is that, for a 1% completed using the same [-240, -41] window as with increase in illiquidity, AR decreases by 0.1%. As the CAPM model. Finally,Lakonishok and discussed in the previous section, thisoutcome Vermaelen (1986), Michaely et al. (1996), Al- conforms to the expectations posited by Florakiset al. Yahyaeeet al. (2008) and Asimakopouloset al. (2015) (2011) but disagrees with the conclusion reachedby observe that trading volumes and/or turnover around Asimakopouloset al. (2015) with regards to liquidity. the ex-day are evidence of short-term arbitrage and Since both the portfolio sorting test and the regression may impact unrealized abnormal returns although analysis deliver the same results, I thus surmise that their results differ. Al-Yahyaeeet al. (2008) find a liquidity has a significant effect on ex-dividend day significant drop in volume on the ex-day while Asimakopouloset al. (2015) report positive abnormal 15 volumes. To account for the potential (negative or The variables Voli,tand FIlliqi,t display positive skewness of the positive) friction due to trading volume on the ex- residuals and are subject to outliers, I thus use the log transformation to normalize the distribution.

Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 18 Ex-Dividend Day Price Behavior and Liquidity: Evidence from an Emerging Market Free of Microstructure Impediments stock price behavior and that abnormal returns are investigate the impact of liquidity on the ex-dividend negatively related to the float-adjusted turnover day price behavior and introduce a modification to illiquidity ratio FIlliqi,t. the illiquidity turnoverratio (as devised by Florakiset al., 2011) to create the “float-adjusted turnover CONCLUSION illiquidity ratio”, a metric that normalizes liquidity by the public free float instead of the traditional number This paper investigates the ex-dividend day price of outstanding shares. To my knowledge, this is the premiums and abnormal returns in a tax-free setting first time that the public free float is used in a unencumbered by the structural impediments that are derivative of the Amihud (2002) ratio to quantify commonly blamed for dividend-related price liquidity. inefficiencies. It contributes to the literature by providing a new insight into the potential causes for Using this new variable, a portfolio sorting method the persistence of unrealized abnormal returns. I and regression analysis as a test of robustness, I find select the equity market of the United Arab Emirates that illiquidity has a statistically significant impact on for this study primarily because of its fiscal ex-day price efficiency; an increase of 1% in environment; there are no taxes on dividends or illiquidity is associated with a 0.1% reduction in capital gains thus completely eliminating the clientele abnormal returns. The coefficients for the dividend effect as one possible explanation for the less-than- yield (positive) and trading volume (negative) are expected price drop on ex-day. The Emirati market’s also significant at the 99% level while that of the composition is also relatively homogenous; the transaction cost (negative) is weaker with a p-value of trading activity is dominated by retail investors with 0.03. Risk does not appear to be an important factor institutions holding a sizable portion of the capital in the determination of the ex-day price premium. I stock (76%) but exhibiting a low participation rate in thus conclude that liquidity (or lack thereof) plays an the daily turnover (16-28%). Market-maker important role in the behavior of ex-day prices. The involvement is very limited; only seven stocks in our capital markets in the United Arab Emirates provide a sample (out of a total of fifty seven) fall under their unique study environment. Further inquiries into the influence and the market rules severely restrict their nature of the investor base could shed light on the ability to move prices. This characteristic suggests peculiar lackluster of ex- volume that that the ex-day price behavior in the UAE market is afflict many dividend-paying stocks, even if the probably not be attributable to inefficiencies presence of potential profits in the form of unrealized originating from thebid-ask bounce, limit order abnormal returns. Perhaps a domestic bias, the wealth imbalance, short-term trading or transaction cost effect or other behavioral attributes may provide since all require the active involvement of answers and further research is required. professionals and institutional traders. Price discreteness can also be ruled out; the Emirati REFERENCES exchanges use a decimal quoting system with a tick size of AED 0.001 and the mean dividend/tick for my [1] Al-Hitu, K., Azad, A.S.M.S., Chazi, A. and Khallaf, A. 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Proceedings of 90th The IRES International Conference, Manila, Philippines, 28th-29th November, 2017 20