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Applied Economics Letters

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Further evidence from ex-dividend days

a b
Rakesh Bali & Jack C. Francis
a
Risk Return Consulting , 10 Ferncliff Road, Scarsdale, NY, 10583, USA
b
Department of Economics and Finance , Zicklin School of Business, Baruch College, City
University of New York, One Bernard Baruch Way , New York, NY, 10010, USA
Published online: 28 Jun 2011.

To cite this article: Rakesh Bali & Jack C. Francis (2012) Further evidence from ex-dividend days, Applied Economics Letters,
19:6, 537-540, DOI: 10.1080/13504851.2011.587763

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 Applied Economics Letters, 2012, 19, 537540

Further evidence from ex-dividend

days
Rakesh Balia,* and Jack C. Francisb
a
Risk Return Consulting, 10 Ferncliff Road, Scarsdale, NY 10583, USA
b
Department of Economics and Finance, Zicklin School of Business,
Baruch College, City University of New York, One Bernard Baruch Way,
New York, NY 10010, USA
Downloaded by [The University of British Columbia] at 19:00 29 October 2014

We tested how dividend pricing is impacted by the reduction in capital gains

tax rate to 20% (May 1997) and the move to trading in 6.25 (June 1997).
Price behaviour does not support tax clienteles but is consistent with
transaction costs-based explanation. Raw returns, for all groups, are
within or close to weak no-arbitrage bounds and are unchanged around
these events. We find that taxes may impact investor behaviour but they do
not impact marginal dividend pricing.

Keywords: ex-day; tax clienteles; transaction costs; price discreteness; bid-

ask prices

JEL Classification: G12; G35

I. Introduction June 1997 events. They support the transaction costs

Elton and Gruber (1970) claim that tax clienteles exist.
Kalay (1982) argues that short-term, tax-neutral tra-
ders (arbitrageurs) would arbitrage away any tax
premium.
Bali and Hite (1998) propose the discreteness model
which can explain the clientele effects. Naranjo et al.
(2000) support the Bali and Hite model. Bali (2003a, b)
augment the model by incorporating bid-ask spreads
and provide supporting empirical evidence.
Jakob and Ma (2007) find support for the transac-
tion costs hypothesis for both small and large divi-
dends but do find clientele effects for large dividends.
Rantapuska (2008) studies the Finnish market and
finds that transaction costs, beta, idiosyncratic risk
and dividend yield influence ex-day price behaviour.
Whitworth and Rao (2010) find that for high (low)
yields the relative price decline on ex-day is associated
with the corporate (personal) tax rates. They do not
model transaction costs but support tax clienteles. Bali
and Francis (forthcoming) document a decline in trad-
ing volume for high yields subsequent to the May and
hypothesis.
If tax clienteles exist then subsequent to reduction
in capital gains tax rate a lower premium on capital
losses should be observed, that is, ex-day return would
increase following the act. Further, this effect should be
most prominent for stocks held by high tax bracket
investors, that is, low-yield stocks.
The change in tick size has implications for inves-
tors costs of trading and on the strategic behaviour of
the arbitrageur impacting market liquidity. This sug-
gests that the distribution of ex-day returns should
change subsequent to the events if transaction costs
change.
The raw returns for high- and low-yield stocks are
not significantly different subsequent to these events
and do not support the claims in Graham et al. (2003)
and Jakob and Ma (2004). The volatility of ex-day
returns increases in the post-event period consistent
with a decline in liquidity and market quality.
This article is organized as follows: Section II details
the model and Section III presents the analysis.
Section IV concludes.

*Corresponding author. E-mail: rb@caa.columbia.edu

Applied Economics Letters ISSN 13504851 print/ISSN 14664291 online # 2012 Taylor & Francis 537
http://www.informaworld.com
DOI: 10.1080/13504851.2011.587763
 538
II. The Model
The proportional price drop (ex-day price drop, P,
divided by cum price, P) is as follows (Bali, 2003a):
P D 
qc  qx :spr b: l: e 1
P P P (0.13). This implies that overall the arbitrageurs are
where spr is the relative spread, qc (qx) is the probabil-
ity that the closing transaction price on the cum (ex)
day is the ask price and  = D D.
If investors tend to sell cum and buy ex due to
dividend aversion, then qc , qx, that is, a negative
intercept in Equation 1. The liquidity providers then
inventory the dividend overnight. If dividend capturing
Downloaded by [The University of British Columbia] at 19:00 29 October 2014
investors (e.g. corporations) trade due to regulatory
reasons, they may buy cum and sell ex which leads to
qc . qx and implies a positive intercept in Equation 1.
The liquidity providers are then short the stock
overnight.
We estimate the following regression:
P D D
a aev :DUMev b: bev : :DUMev not significantly different from 1 (1.05) and l is
P P P
 
l: lev : :DUMev e 2 ^ (-0.26 for both groups) indicates reduced value
P P
where a is the intercept term from Equation 1; b and l
are coefficients on the dividend pricing and discreteness
terms, respectively; DUMev = 1 in the post-event per-
iod and 0 otherwise; and aev, bev and lev measure the
respective changes caused by the events. The error term
follows a Generalized Autoregressive Conditional
Heteroscedasticity (GARCH (1,1)) process which is
tested for change in the post-event period. Specifically,
ht b0 b1  e2t1 b2  ht1 b3  DUMev 3 The DurbinWatson statistics indicate positive
where ht is the conditional variance and b indicates
standard GARCH (1,1) terms and the dummy term.
The null hypothesis states that the slope coefficients
of the terms with the event dummy (aev, bev and lev)
should equal 0 in Equation 2. Any significance is only
necessary but not sufficient condition for rejecting the
no-arbitrage conditions.
We test fairly weak arbitrage conditions and utilize
the observable discreteness in dividends alone and
compute bounds assuming the price drop equals the
tick multiple just below the dividend (D) and D plus 1
tick, that is,
DR  RW  DR 4 per cent. For high yields the mean raw return is
where RW is the ex-day raw return.
R. Bali and J. C. Francis
III. Analysis
Bali (2003a) provides the data selection procedure.
Table 1 reports the results of regression equations
(23). For the full sample the intercept is significantly
negative (-0.25) and increases in the post-event period
long the stocks from cum to ex and there is a tendency
for more sales in the post-event period. The coefficient
^ is significantly larger than 1 (1.14) and falls in the
b
post-event period b ^ 0:15 consistent with
ev
decline in dividend capture post-event. The estimate
^l is positively significant (0.63) and is unchanged in
the post-event period.
Other estimates are consistent with the model.
Both high and low yields indicate selling cum and
buying ex with significant intercepts (-0.33 and
-0.20, respectively). They are higher in the post-
event period consistent with more sales. The magni-
tude of the intercept is smaller for low yields con-
sistent with them having lower relative spreads. For
^ is significantly larger than 1 (1.20) and
high yields b
^l is significantly positive (0.57). For low yields b ^ is
^
positively significant (0.65). Negatively significant
b ev
placed on dividend post-event.
The GARCH terms are significant for the full sam-
ple and for the two yield groups. The coefficient on the
dummy term in the variance equation is positively
significant for all groups. The error variance is signifi-
cantly higher post-event consistent with a decline in
market quality. GARCH (2,2) did not converge.
These results complement the conclusions in Bali and
Francis (forthcoming), who show a post-event decline
in volume for high yields.
autocorrelation for all groups. The Chow tests do
not detect a structural break post-event for any
group. To test for the effects of outliers we form a
subsample by omitting bottom and top 1% of obser-
vations with extreme (D P) values. The dividend
pricing estimates are unaffected but for high yields the
GARCH term assumes more prominence at the
expense of ARCH terms.
Figure 1(a) and (b) provides the time-series varia-
tion in monthly raw returns along with the discrete-
ness bounds for high and low yields over the period
1994 to 2000. For the whole period and for both
groups RWs are generally constrained by the weak
no-arbitrage bounds. Overall, for the full sample,
the mean raw return is 0.22 (bounds -0.21 and 0.15)
0.12 (bounds -0.33 and 0.28) per cent. For low
yields the mean raw return is 0.24 (bounds -0.18 and
 Downloaded by [The University of British Columbia] at 19:00 29 October 2014

Table 1. Regression analysis for the full sample, high- and low-yield groups of NYSE taxable cash dividends around the moves to reduction in capital gains tax rate from 28% to
20% and to trading in 6.25 (dividends . 12.5)
Panel A: Pricing dynamics

a aev b bev l lev R2

Full sample
Estimate -0.25a 0.13a 1.14b -0.15a 0.63a 0.15 0.18
SE 0.03 0.04 0.02 0.03 0.07 0.21
High-yield group
Estimate -0.33a 0.49a 1.20b -0.26a 0.57a -0.11 0.17
SE 0.12 0.15 0.04 0.05 0.12 0.26
Low-yield group
Further evidence from ex-dividend days

Estimate -0.20a 0.17a 1.05 -0.26a 0.65a 0.39 0.04

SE 0.04 0.06 0.05 0.08 0.11 0.37
D D  
Notes: P
P a aev :DUMev b: P bev : P :DUMev l: P lev : P :DUMev e
where P is the price drop, P the cum price, D equals the tick multiple just short of the dividend amount,  = (DD), DUMev is a dummy variable equal to 1 over the period 24
June 1997 to 6 May 2000 and 0 over the period 24 June 1994 to 6 May 1997. NYSE, New York Stock Exchange.
a
Denotes significant difference from 0 at the 5% level.
b
Denotes significant difference from 1 at the 5% level (for b only).
Panel B: Error term parameters

b0 b1 b2 b3

Full sample
Estimate 0.004a 0.005a 0.993a 0.003a
SE 0.001 0.000 0.000 0.000
High-yield group
Estimate 0.956a 0.031a 0.550a 0.583a
SE 0.286 0.009 0.130 0.178
Low-yield group
Estimate 0.007a 0.007a 0.990a 0.005a
SE 0.001 0.001 0.001 0.001

Notes: The error term is modelled as ht b0 b1  e2t1 b2  ht1 b3  DUMev where ht is the conditional variance.
a
Denotes significant difference from 0 at the 5% level.
539
 540 R. Bali and J. C. Francis
(a) fall by about one-half in the second period. Gene-
1.5 rally, the raw returns are within trading costs for
both yield groups in the two periods. For neither
1.0 group are returns statistically different across the
two periods (tst = 0.9 and 1.6 for high and low
Returns (%)

0.5 yields, respectively).

0.0

0.5 IV. Conclusions

1.0 We utilize the framework in Bali (2003a) and study the

Jan-94

Feb-95

Mar-96

Apr-97

May-98

Jun-99

Jul-00
events analysed by Bali and Francis (forthcoming).
We find that taxes may affect investor behaviour but
Month
our results do not support the contention that tax
(b)
Downloaded by [The University of British Columbia] at 19:00 29 October 2014

1.5 clienteles exist. We confirm that transaction costs-

based models are capable of explaining the data well
1.0 and find that generally raw returns satisfy weak no-
arbitrage bounds and are statistically equal in the pre-
Returns (%)

0.5 and post-event periods.

0.0

0.5
References
Bali, R. (2003a) Variation in ex day dividend pricing: Myth
1.0 or reality?, Journal of Economics and Finance, 27,
190210.
Jan-94

Feb-95

Mar-96

Apr-97

May-98

Jun-99

Jul-00

Bali, R. (2003b) Seasonality in ex dividend day returns,

Month
Fig. 1. Monthly raw returns and discreteness bounds for the
(a) high-yield and (b) low-yield groups around the reduction in
capital gains tax rate from 28% to 20% and the move to
trading in 6.25 (1 January 1994 to 31 December 2000)
Notes: The solid line represents the mean ex-day raw return
estimated for each month. Events are sorted into yield quin-
tiles each calendar year. The top quintile is considered as
high yield while the bottom four are together treated as low
yield. The broken line at the top in each figure is computed
assuming each price drop equals next lower tick multiple
adjacent to the dividend (D). The bottom broken line
assumes that the price drop equals D plus one tick. The
number of observations over the period 1994 to 2000 is
4222 (16 897) for the high (low)-yield group.
0.12) per cent. Due to lower prices for high-yield
stocks, the bounds are twice as wide.
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and 0.35%, respectively. In the period 1 July 1997
to 31 December 2000, the corresponding estimates
equal 0.14, -0.24 and 0.21. For low yields the cor-
responding values are 0.22%, -0.24% and 0.16% in
the first period and 0.26, -0.11 and 0.08 in the
second period. Since the discreteness effect is a
function of the tick size, the discreteness bounds
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