JFQA Forthcoming Articles

The following papers have been accepted for publication in future issues.

Fiscal Policy, Consumption Risk, and Stock Returns: Evidence from U.S. States
Zhi Da, Mitch Warachka, and Hayong Yun

We find that the consumption risk of investors is lower in states that implement countercyclical fiscal policies. Moreover, firms whose investor base are concentrated in counter-cyclical states have lower stock returns, along with firms that relocate their headquarters to a counter-cyclical state. Therefore, counter-cyclical fiscal policies lower the consumption risk of investors and consequently their required equity return premium. This conclusion is confirmed by smaller declines in market participation during recessions in counter-cyclical states. Overall, the location of a firm’s investor base enables state-level fiscal policy to influence stock returns.

Life-Cycle Asset Allocation with Ambiguity Aversion and Learning
Kim Peijnenburg

Ambiguity and learning about the equity premium can simultaneously explain the low fraction of financial wealth allocated to stocks over the life cycle and the stock market participation puzzle. Individuals are ambiguous about the size of the equity premium and are averse to this ambiguity, resulting in lower stock allocations over the life cycle consistent with the data. As agents get older, they learn about the equity premium and increase their allocation to stocks. Furthermore, I find that ambiguity leads to underdiversification, home bias, lower Sharpe ratios, and higher savings. Similar results cannot be obtained by assuming higher risk aversion.

Do Commodities Add Economic Value in Asset Allocation? New Evidence from Time-Varying Moments
Xin Gao and Federico Nardari

We conduct a comprehensive out-of-sample assessment of the economic value-adding of commodities in multi-asset investment strategies that exploit the predictability of asset return moments. We find that predictability makes the inclusion of commodities profitable even when short-selling and high leverage are not permitted. For instance, a mean-variance (non mean-variance) investor with moderate risk aversion and leverage, rebalancing quarterly, would be willing to pay up to 108 (155) basis points per year after transaction cost for adding commodities to her stock, bond and cash portfolio. Previous research had reached mixed or even opposite conclusions, especially in an out-of-sample context.

Political Uncertainty and IPO Activity: Evidence from U.S. Gubernatorial Elections
Gonul Colak, Art Durnev, and Yiming Qian

We analyze IPO activity under political uncertainty surrounding gubernatorial elections in the U.S. There are fewer IPOs originating from a state when it is scheduled to have an election. To establish identification, we develop a neighboring-states method that uses bordering states without elections as a control group. The dampening effect of elections on IPO activity is stronger for firms with more concentrated businesses in their home states, firms that are more dependent on government contracts (particularly state contracts), and harder-to-value firms. This dampening effect is related to lower IPO offer prices (hence higher costs of capital) during election years.

Are Ratings the Worst Form of Credit Assessment Except for All the Others?
Andreas Blöchlinger and Markus Leippold

We present a prediction model to forecast corporate defaults. In a theoretical model, under incomplete information in a market with publicly traded equity, we show that our approach must outperform ratings, Altman’s Z-score, and Merton’s distance to default. We reconcile the statistical and structural approaches under a common framework, i.e., our approach nests Altman’s and Merton’s approaches as special cases. Empirically, the combined approach is indeed the most powerful predictor and the numbers of observed defaults align well with the estimated probabilities. With a new transformation method, we obtain cycle-adjusted forecasts that still outperform ratings.

Institutional Investor Expectations, Manager Performance, and Fund Flows
Howard Jones and Jose Vicente Martinez

Using survey data we analyze institutional investors’ expectations about the future performance of fund managers and the impact of those expectations on asset allocation decisions. We find that institutional investors allocate funds mainly on the basis of fund managers’ past performance and of investment consultants’ recommendations, but not because they extrapolate their expectations from these. This suggests that institutional investors base their investment decisions on the most defensible variables at their disposal, and supports the existence of agency considerations in their decision making.

High Frequency Quoting: Short-Term Volatility in Bids and Offers
Joel Hasbrouck

At subsecond horizons bids and offers in U.S. equity markets are more volatile than what would be implied by long-term fundamentals. To assess costs and consequences, the paper suggests that traders’ random delays (latencies) interact with quote volatility to generate execution price risk and relative latency costs. Analysis of the behavior of quote setters suggests that this volatility is more likely to arise from recurrent cycles of undercutting similar to the Edgeworth cycles found in product markets, rather than mixed strategies of limit order placement.

Investment Efficiency and Product Market Competition
Neal M. Stoughton, Kit Pong Wong, and Long Yi

Does more competition lead to more information production and greater investment efficiency? This question is largely unexplored in the finance literature. This paper provides both a model and a series of extensive empirical tests. The model features a two-stage Bayesian game in differentiated products market competition. We find that competition causes firms to acquire less information and investments become more inefficient relative to a first best case with the same market structure. Empirically the panel regression analysis provides strong support for the theory and shows that investment is more efficient in concentrated industries.

An Empirical Analysis of Market Segmentation on U.S. Equities Markets
Frank Hatheway, Amy Kwan, and Hui Zheng

We examine the impact of trading on markets partially exempt from National Market System requirements (‘dark venues’) on equity market quality. We find evidence consistent with the notion that dark venues rely on their special features to segregate order flow based on asymmetric information risk, which results in their transactions being less informed and contributing less to price discovery on the consolidated market. Except for the execution of large transactions and trading in small stocks, the effects of dark venue order segmentation are damaging to overall market quality. Our results have important implications for the regulation of international equity markets.

Horses for Courses: Fund Managers and Organizational Structures
Yufeng Han, Tom Noe, and Michael Rebello

We model and test the relations between the team management of mutual funds, managers’ ability, performance, and holdings. Our model predicts that team-managed funds perform better and behave more conservatively than single-manager funds. However, the effect of team-management is masked in equilibrium since high ability managers rationally self-select into single-manager funds. Consistent with the model’s prediction, we find that team-managed funds perform better and deviate less from their benchmark allocations than single-manager funds with the same characteristics. These differences are marked after we control for the endogenous self-selection of managers.

Do Short-Sellers Trade on Private Information or False Information?
Amiyatosh Purnanandam and Nejat Seyhun

We investigate whether short-sellers contribute toward informational efficiency of market prices by trading on their private information or destabilize market prices by trading on rumors and false information. We find that short-selling activities are considerably informative about future stock returns when there is a higher likelihood of private in-formation in stocks, as measured by insider-trading activities. Short-sellers also bring considerable additional information to the market that is not fully captured by contemporaneous insider trading. Overall, these results suggest that on average, short-sellers bring informational efficiency to market prices rather than destabilize them.

Equity Volatility Term Structures and the Cross Section of Option Returns
Aurelio Vasquez

The slope of the implied volatility term structure is positively related to future option returns. I rank firms based on the slope of the volatility term structure and analyze the returns for straddle portfolios. Straddle portfolios with high slopes of the volatility term structure outperform straddle portfolios with low slopes by an economically and statistically significant amount. The results are robust to different empirical setups and are not explained by traditional factors, higher-order option factors, or jump risk.

Tips from TIPS: The Informational Content of Treasury Inflation-Protected Security Prices
Stefania D’Amico, Don H. Kim, and Min Wei

Treasury Inflation-Protected Securities (TIPS) are frequently thought of as risk-free real bonds. Using no-arbitrage term structure models, we show that TIPS yields exceeded risk-free real yields by as much as 100 basis points when TIPS were first issued and up to 300 basis points during the recent financial crisis. This spread reflects predominantly the poorer liquidity of TIPS relative to nominal Treasury securities. Other factors, including the indexation lag and the embedded deflation protection in TIPS, play a much smaller role. Ignoring this spread also significantly distorts the informational content of TIPS breakeven inflation, a widely-used proxy for expected inflation.

The Anatomy of a Credit Supply Shock: Evidence from an Internal Credit Market
José María Liberti and Jason Sturgess

We investigate how financial contracting interacts with lending channel effects by tracing the anatomy of a credit supply shock using micro-level data from a multinational bank. Borrowers with stronger lending relationships, higher non-lending revenues, and those that pledge collateral, especially outside assets and real estate, experience less credit rationing. Consistent with a tightening of financing constraints post shock, borrower composition shifts toward larger and less risky firms, and loans exhibit higher collateralization rates. Our analysis highlights the value of relationships and suggests that relationship banking is a channel through which borrowers can mitigate lending channel effects.

Davids, Goliaths, and Business Cycles
Jefferson Duarte and Nishad Kapadia

We show that a simple, intuitive variable, GVD (Goliath versus David) reflects time-variation in discount rates related to changes in aggregate business conditions. GVD is the annual change in the weight of the largest 250 firms in the aggregate stock market, and is motivated by research that shows that small firms are more severely impacted than large firms by economic shocks due to differences in access to external finance. We find that GVD is the best single predictor of market returns out-of-sample among traditional predictors, predicting quarterly market returns with an out-of-sample R2 of 6:3% in the 1976–2011 evaluation period.

Risk Premium Information from Treasury Bill Yields
Jaehoon Lee

This paper finds that short-maturity Treasury-bill yields have unique information about risk premiums that is not spanned by long-maturity Treasury-bond yields. I estimate two components of risk premiums: one is for long-term and the other is for short-term. The long-term component steepens the slope of yield curves and has forecastability horizon of longer than one year. In contrast, the short-term component affects Treasury-bill yields but almost invisible from Treasury bonds, has forecastability horizon of less than one quarter, and is related to bond liquidity premiums.

Risk Premia and the VIX Term Structure
Travis L. Johnson

The shape of the VIX term structure conveys information about the price of variance risk rather than expected changes in the VIX, a rejection of the expectations hypothesis. A single principal component, Slope, summarizes nearly all this information, predicting the excess returns of synthetic S&P 500 variance swaps, VIX futures, and S&P 500 straddles for all maturities and to the exclusion of the rest of the term structure. Slope’s predictability is incremental to other proxies for the conditional variance risk premia, economically significant, and inconsistent with standard asset pricing models.

Why Do Fund Managers Identify and Share Profitable Ideas?
Steven S. Crawford, Wesley R. Gray, and Andrew E. Kern

We study data from an organization in which fund managers privately share and discuss detailed investment recommendations. Buy recommendations generate positive abnormal returns, and sell recommendations result in negative abnormal returns. In the context of these results, we explore an important economic question: Why do skilled investors share profitable ideas with others? Evidence suggests that the managers in our sample share to receive feedback on their ideas and to attract additional arbitrageur capital to the securities they recommend in order to correct mispricings.

Hedge Fund Return Dependence: Model Misspecification or Liquidity Spirals?
Richard Sias, H. J. Turtle, and Blerina Zykaj

We test whether model misspecification or liquidity spirals primarily explain the observed excess dependence in filtered (for economic fundamentals) hedge fund index returns and the links between volatility, liquidity shocks, and hedge fund return clustering. Evidence supports the model misspecification hypothesis: (i) hedge fund filtered return clustering is symmetric, (ii) filtered short bias fund returns exhibit negative dependence with filtered returns for other hedge fund types, (iii) negative liquidity shocks are associated with clustering in both tails and market volatility subsumes the role of negative liquidity shocks, and (iv) these same patterns appear in size-sorted equity portfolios.

To Group or Not to Group? Evidence from Mutual Fund Databases
Saurin Patel and Sergei Sarkissian

Despite the overwhelming trend in mutual funds towards team management, empirical studies find no performance benefits for this phenomenon. We show it is caused by large discrepancies in reported managerial structures in CRSP and Morningstar Principia datasets versus SEC records, resulting in up to 50 bps underestimation of the team impact on fund returns. Using more accurate Morningstar Direct data, we find that team-managed funds outperform single-managed funds across various performance metrics. The relation between team size and fund performance is nonlinear. Also, team-managed funds take no more risk than single-managed funds. Overall, team management benefits the fund industry performance.

Jorge A. Cruz Lopez, Jeffrey H. Harris, Christophe Hurlin, and Christophe Pérignon

We present CoMargin, a new methodology to estimate collateral requirements in derivatives central counterparties (CCPs). CoMargin depends on both the tail risk of a given market participant and its interdependence with other participants. Our approach internalizes trading externalities and enhances the stability of CCPs, thus, reducing systemic risk concerns. We assess our methodology using proprietary data from the Canadian Derivatives Clearing Corporation that include daily observations of the actual trading positions of all of its members from 2003 to 2011. We show that CoMargin outperforms existing margining systems by stabilizing the probability and minimizing the shortfall of simultaneous margin-exceeding losses.

Entrepreneurial Litigation and Venture Capital Finance
Douglas Cumming, Bruce Haslem, and April Knill

This paper empirically examines the interaction between entrepreneurial plaintiff firm litigation and venture capital (VC). The data indicate that, relative to non-plaintiffs, firms that litigate prior to [after] obtaining VC (1) receive financing from less [more] reputable venture capitalists (VCs), (2) are subject to greater [similar] oversight by VCs, (3) receive less [more] VC funding, (4) are more likely to exit through an initial public offering than through an acquisition, and (5) when litigation occurs after VC financing, they are also less likely to be liquidated. The results are robust to different specifications, methodologies, and endogeneity checks.

Valuations in Corporate Takeovers and Financial Constraints on Private Targets
Daniel Greene

I examine acquisitions of private firms by public acquirers to better understand the effects of financial constraints on the division of economic gains in takeovers. Empirical tests exploit interstate bank branching deregulation, which relaxes financial constraints on private firms and can strengthen their bargaining position in an acquisition. Using a proxy for the degree to which targets depend on acquirers for financing, I find that private targets depend less on acquirers as a result of interstate bank branching deregulation. Relaxing financial constraints on private targets leads to an increase in target valuation multiples and a decrease in acquirer wealth gains.

Stock Liquidity and Stock Price Crash Risk
Xin Chang, Yangyang Chen, and Leon Zolotoy

We find that stock liquidity increases stock price crash risk. To identify the causal effect, we use the decimalization of stock trading as an exogenous shock to liquidity. This effect is increasing in a firm’s ownership by transient investors and non-blockholders. Liquid firms have a higher likelihood of future bad earnings news releases, which are accompanied by greater selling by transient investors, but not blockholders. Our results suggest that liquidity induces managers to withhold bad news, fearing that its disclosure will lead to selling by transient investors. Eventually, accumulated bad news is released all at once, causing a crash.

Leverage Effect, Volatility Feedback, and Self-Exciting Market Disruptions
Peter Carr and Liuren Wu

Equity index volatility variation and its interaction with the index return can come from three distinct channels. First, index volatility increases with the market’s aggregate financial leverage. Second, positive shocks to systematic risk increase the cost of capital and reduce the valuation of future cash flows, generating a negative correlation between the index return and its volatility, regardless of financial leverage. Finally, large negative market disruptions show self-exciting behaviors. This paper proposes a model that incorporates all three channels and examines their relative contribution to index option pricing, as well as to stock option pricing for different types of companies.

The Diminishing Benefits of US Cross-Listing: Economic Consequences of SEC Rule 12h-6
Chinmoy Ghosh and Fan He

On March 21, 2007, SEC passed Rule 12h-6 to make it easier for cross-listed firms to deregister from the U.S. market and escape its regulatory costs. Using difference-in-difference tests, we find that, on average, Rule 12h-6’s passage induced an increase in voting premium, a decline in equity raising, and a decline in cross-listing premium. These effects are observed for exchangelisted firms, and for firms from countries with weak investor protection. We conclude that while cross-listed firms are still valued at a significant premium over non-cross-listed firms, the rule decreased the value of commitment to the U.S. regulatory system.

Investor Attrition and Fund Flows in Mutual Funds
Susan E. K. Christoffersen and Haoyu Xu

We explore the properties of equity mutual funds that experience a loss of assets after poor performance. We document that both inflows and outflows are less sensitive to performance because performance-sensitive investors leave or decide not to invest after bad performance. Consistent with the idea that attrition measures the sorting of performance-sensitive investors, we find that attrition has less of an impact on the fund’s flow-performance sensitivity for institutional funds where there is less dispersion in investor performance-sensitivity. Also attrition has no effect on the flow-performance sensitivity when attrition arises after good performance or investors invest for non-performance reasons.

Did Saving Wall Street Really Save Main Street? The Real Effects of TARP on Local Economic Conditions
Allen N. Berger and Raluca A. Roman

We investigate whether saving Wall Street through the Troubled Assets Relief Program (TARP) really saved Main Street during the recent financial crisis. Our difference-in-difference analysis suggests that TARP statistically and economically significantly increased net job creation and net hiring establishments and decreased business and personal bankruptcies. The results are robust, including accounting for endogeneity. The main mechanisms driving the results appear to be increases in commercial real estate lending and off-balance sheet real estate guarantees. These results suggest that saving Wall Street via TARP may have helped save Main Street, complementing the TARP literature and contributing to the cost-benefit debate.

What Explains the Difference in Leverage between Banks and Non-Banks?
Tobias Berg and Jasmin Gider

Banks have much more leverage than non-banks. This paper uses a joint sample of banks and non-banks between 1965 and 2013 to analyze the determinants of this leverage difference. We find that one single factor—asset risk—is able to explain up to 90% of this difference. Banks' assets consist of a diversified portfolio of non-bank debt. Therefore, banks have a much lower asset risk than non-banks. Since asset risk is a major determinant of capital structure choice, this single factor is able to explain a large fraction of the difference between bank and non-bank leverage.

Long-Term versus Short-Term Contingencies in Asset Allocation
Mahmoud Botshekan and André Lucas

We investigate whether long-term and short-term components of typical conditioning variables in asset pricing studies, such as the dividend yield or yield spread, have different implications for optimal asset allocation. We argue that short-term components relate mostly to momentum, and long-term components relate mostly to mean reversion effects, respectively. Therefore, they may have a different information content for investors with different horizons. We obtain improvements in terms of out-of-sample Sharpe ratios and expected utilities for decomposed state variables that directly reflect stock market related information, such as the dividend yield and stock market trend.

Time-Disaggregated Dividend-Price Ratio and Dividend Growth Predictability in Large Equity Markets
Panagiotis Asimakopoulos, Stylianos Asimakopoulos, Nikolaos Kourogenis, and Emmanuel Tsiritakis

We consistently show that in large equity markets, the dividend-price ratio is significantly related with the growth of future dividends. In order to uncover this relationship, we use monthly dividends and a mixed data sampling technique which allows us to cope with within-year seasonality. Our approach avoids the use of overlapping observations, and at the same time reduces the implications of the impact of price volatility on the dividend-price ratio. An empirical analysis using market level data from U.S., U.K., Canada and Japan strongly supports the dividend growth predictability hypothesis, suggesting that time-aggregation of dividends eliminates significant information.

Regulatory Sanctions and Reputational Damage in Financial Markets
John Armour, Colin Mayer, and Andrea Polo

We study the impact of the enforcement of financial regulation by the U.K.’s regulatory authorities on the market price of penalized firms. Existing studies rely on analyses of multiple events that may distort the measurement of reputational losses. In the United Kingdom, the entire enforcement process involves only one public announcement and is accompanied by complete information on legal penalties. We find that reputational losses are nearly nine times the size of fines, and are associated with misconduct harming customers or investors, but not third parties.

Crash Risk in Currency Returns
Mikhail Chernov and Jeremy Graveline

We develop an empirical model of bilateral exchange rates. It includes normal shocks with stochastic variance and jumps in an exchange rate and in its variance. The probability of a jump in an exchange rate corresponding to depreciation (appreciation) of the US dollar is increasing in the domestic (foreign) interest rate. The probability of a jump in variance is increasing in the variance only. Jumps in exchange rates are associated with announcements, jumps in variance are not. On average, jumps account for 25% of total currency risk. The dollar carry index retains these features. Options suggest that jump risk is priced.

The Interpretation of Unanticipated News Arrival and Analysts’ Skill
Amir Rubin, Benjamin Segal, and Dan Segal

Analysts’ functions are divided into discovery and interpretation roles, but separating between the two is non-trivial. We conjecture that analysts’ interpretation skill can be gauged by their forecast revisions following material unanticipated news—in particular following non-earnings 8-K reports, which arrive at the market unexpectedly. We establish that unanticipated 8-Ks are informative for analysts, and find that analysts who are more likely to revise their forecasts following unanticipated 8-Ks provide more timely and accurate forecasts. We document a positive association between analysts’ tendency to react to unanticipated 8-Ks and market reaction to their recommendation changes, suggesting investors prefer these analysts’ opinions.

Equilibrium Informed Trading with Relative Performance Measurement
Zhigang Qiu

This paper analyzes the informative trading of professional money managers within a rational expectations equilibrium model in which managers care about their performance relative to their peer group. We find that the existence of uninformed managers causes informed managers with relative performance concerns to trade less informatively, engendering less informative prices. When managers are differentially informed, they need to forecast the average performance based on private signals and each manager may place more weight on the private signal if the signal provides good information about the average performance. The price aggregates those signals and thus becomes more informative.

Mutual Fund Performance Evaluation and Best Clienteles
Stéphane Chrétien and Manel Kammoun

This paper investigates investor disagreement and clientele effects in performance evaluation by developing a measure that considers the best potential clienteles of mutual funds. In an incomplete market under law-of-one-price and no-good-deal conditions, we obtain an upper bound on admissible performance measures that identifies the most favorable alpha. Empirically, we find that a reasonable investor disagreement leads to generally positive performance for the best clienteles. Performance disagreement by investors can be significant enough to change the average evaluation of mutual funds from negative to positive, depending on the clienteles.

Stock Market Mean Reversion and Portfolio Choice over the Life Cycle
Alexander Michaelides and Yuxin Zhang

We solve for optimal consumption and portfolio choice in a life-cycle model with short-sales and borrowing constraints, undiversifiable labor income risk and a predictable, time-varying, equity premium and show that the investor pursues aggressive market timing strategies. Importantly, in the presence of stock market predictability, the model suggests that the conventional financial advice of reducing stock market exposure as retirement approaches is correct on average, but ignoring changing market information can lead to substantial welfare losses. Therefore, enhanced target-date funds (ETDFs) that condition on expected equity premia increase welfare relative to target-date funds (TDFs). Out-of-sample analysis supports these conclusions.

Expected Business Conditions and Bond Risk Premia
Jonas Nygaard Eriksen

This paper studies the predictability of bond risk premia by means of expectations to future business conditions using survey forecasts from the Survey of Professional Forecasters. We show that expected business conditions consistently affect excess bond returns and that the inclusion of expected business conditions in standard predictive regressions improve forecast performance relative to models using information derived from the current term structure or macroeconomic variables. The results are confirmed in a real-time out-of-sample exercise, where the predictive accuracy of the models is evaluated both statistically and from the perspective of a mean-variance investor that trades in the bond market.

DRIPs and the Dividend Pay Date Effect
Henk Berkman and Paul D. Koch

On the day that dividends are paid we find a significant positive mean abnormal return that is completely reversed over the following days. This dividend pay date effect has strengthened since the 1970s, and is consistent with the temporary price pressure hypothesis. The pay date effect is concentrated among stocks with dividend reinvestment plans (DRIPs), and is larger for stocks with a higher dividend yield, greater DRIP participation, and greater limits to arbitrage. Over time, profits from a trading strategy that exploits this behavior are positively related to the dividend yield and spread, and negatively associated with aggregate liquidity.

Payout Yields and Stock Return Predictability: How Important Is the Measure of Cash Flow?
Gregory W. Eaton and Bradley S. Paye

We compare the stock return forecasting performance of alternative payout yields. The net payout yield produces more accurate forecasts relative to alternatives, including the traditional dividend yield. This remains true even after excluding several years during the Great Depression when issuance was unusually high. The measure of cash flow used to form the yield matters economically. Long-term investors' hedging demand for stock is considerably reduced when net payout, rather than dividends, serves as the cash flow measure. An agent relying on an incorrect payout measure is willing to pay an economically significant `management fee' to switch to the optimal policy.

Gender Differences in Executives’ Access to Information
A. Can Inci, M. P. Narayanan, and H. Nejat Seyhun

We provide novel evidence on gender differences in insider trading behavior and profitability of senior corporate executives. On average, both female and male executives make positive profits from insider trading. Males, however, earn significantly more than females in equivalent positions and also trade more than females. These gender differences disappear when we limit the sample to firms in which female trading is relatively high. Collectively these results suggest that female executives have a disadvantage relative to males in access to inside information even if they have equal formal status and informal networks may play an important role attenuating this disadvantage.

Investment Cash Flow Sensitivity: Fact or Fiction?
Şenay Ağca and Abon Mozumdar

We examine whether internal funds matter for investment when the measurement error in q is addressed. By carefully employing methodologies that tackle the measurement error in q, we show that cash flow is a significant determinant of investment. We also find that an analyst forecast based q measure is not superior to a stock market based one. We further propose an approach that uses two alternative proxies of q as instruments for addressing measurement error. Our evidence indicates that instrumental variables type GMM estimators yield empirically well specified models.

Bid Resistance by Takeover Targets: Managerial Bargaining or Bad Faith?
Thomas W. Bates and David A. Becher

This paper examines management’s motives for rejecting takeover bids and the associated shareholder wealth effects. We develop several measures of initial bid quality and find a significant negative correlation between contested offers and bid quality. The likelihood of higher follow-on offers decreases in bid quality and is greater when targets have classified boards and CEOs have significant personal wealth tied to the transaction. Moreover, CEOs who fail to close high quality offers experience a significant rate of forced turnover. Overall, the results support a price improvement motive for contested bids.

Dynamic Portfolio Choice with Linear Rebalancing Rules
Ciamac C. Moallemi and Mehmet Sağlam

We consider a broad class of dynamic portfolio optimization problems that allow for complex models of return predictability, transaction costs, trading constraints, and risk considerations. Determining an optimal policy in this general setting is almost always intractable. We propose a class of linear rebalancing rules and describe an efficient computational procedure to optimize with this class. We illustrate this method in the context of portfolio execution and show that it achieves near optimal performance. We consider another numerical example involving dynamic trading with mean–variance preferences and demonstrate that our method can result in economically large benefits.

Liquidity Constraints and Credit Card Delinquency: Evidence from Raising Minimum Payments
Philippe d'Astous and Stephen H. Shore

We use credit card data to estimate the impact of increasing minimum payments on delinquency, payments, spending, and write-offs. Our identification strategy exploits an unusual institutional feature: borrowers can use their account to make purchases with both revolving loans (on which minimum payments increased) and term loans (on which there was no change). Payment increases by delinquent borrowers are insufficient to match increasing minimums, resulting in lower cure rates and an increase in write-offs. Affected borrowers migrate away from these accounts by decreasing charges and increasing payments, consequently lowering the interest earned by the bank.

Fortune Favors the Bold
Costanza Meneghetti and Ryan Williams

We investigate whether incentives to join the Fortune 500 affect corporate decisions. Firms closer to the cutoff appear to take actions to join the list by engaging in more M&A activity, bidding for larger targets, and paying higher takeover premia. Further, the relation is stronger for firms with more-entrenched CEOs and the stock market reaction to bids is worse when bidders are close to Fortune’s cutoff. A 1994 methodological change by Fortune acts as an exogenous shock for identification. Our results suggest that firms try to increase revenues to join the Fortune 500 but that such actions adversely affect shareholders.

Hedge Funds: The Good, the Bad, and the Lucky
Yong Chen, Michael Cliff, and Haibei Zhao

We develop an estimation approach based on a modified EM algorithm and a mixture of Normal distributions associated with skill groups to assess performance in hedge funds. By allowing luck to affect both skilled and unskilled funds, we estimate the number of skill groups, the fraction of funds from each group, and the mean and variability of skill within each group. For each individual fund, we propose a performance measure combining the fund’s estimated alpha with the crosssectional distribution of fund skill. In out-of-sample tests, an investment strategy using our performance measure outperforms those using estimated alpha and t-statistic.

CEO Turnover-Performance Sensitivities in Private Firms
Huasheng Gao, Jarrad Harford, and Kai Li

We compare CEO turnover in public and large private firms. Public firms have higher turnover rates and exhibit greater turnover-performance sensitivities than private firms. Controlling for preturnover performance, performance improvements are greater for private firms than for public firms. We investigate whether these differences are due to differences in quality of accounting information, the CEO candidate pool, CEO power, board structure, ownership structure, investor horizon, or some unobservable differences between public and private firms. One factor contributing to public firms’ higher turnover rates and greater turnover-performance sensitivities appears to be investor myopia.

New Evidence on Mutual Fund Performance: A Comparison of Alternative Bootstrap Methods
David Blake, Tristan Caulfield, Christos Ioannidis, and Ian Tonks

We compare two bootstrap methods for assessing mutual fund performance. Kosowski, Timmermann, Wermers and White (2006) produces narrow confidence intervals due to pooling over time, while Fama and French (2010) produces wider confidence intervals because it preserves the cross-correlation of fund returns. We then show that the average UK equity mutual fund manager is unable to deliver outperformance net of fees under either bootstrap. Gross of fees, 95% of fund managers on the basis of the first bootstrap and all fund managers on the basis of the second bootstrap fail to outperform the luck distribution of gross returns.

Social Capital and Debt Contracting: Evidence from Bank Loans and Public Bonds
Iftekhar Hasan, Chun-Keung (Stan) Hoi, Qiang Wu, and Hao Zhang

We find that firms headquartered in US counties with higher levels of social capital incur lower bank loan spreads. This finding is robust to using organ donation as an alternative social-capital measure and incremental to the effects of religiosity, corporate social responsibility, and tax avoidance. We identify the causal relation using companies with a social-capital changing headquarter relocation. We also find that high-social-capital firms face loosened nonprice loan terms, incur lower at-issue bond spreads, and prefer bonds over loans. We conclude that debt holders perceive social capital as providing environmental pressure constraining opportunistic firm behaviors in debt contracting.

Individual Investors’ Dividend Taxes and Corporate Payout Policies
Oliver Zhen Li, Hang Liu, Chenkai Ni, and Kangtao Ye

The 2012 Dividend Tax Reform in China ties individual investors’ dividend tax rates to the length of their share holding period. We find that firms facing a reduction (increase) in their individual investors’ dividend tax rates are more (less) likely to increase dividend payout. Such an effect is concentrated in firms where incentives of controlling shareholders and minority shareholders are aligned. Further, investors respond to this tax law change by reducing trading activities before the cum-dividend day, and successfully lower their dividend tax penalty. Overall, our evidence enhances the notion that individual investors’ tax profiles shape firms’ payout policies.

A Multivariate Model of Strategic Asset Allocation with Longevity Risk
Emilio Bisetti, Carlo A. Favero, Giacomo Nocera, and Claudio Tebaldi

Population-wide increase in life expectancy is a source of aggregate risk. Longevity-linked securities are a natural instrument to reallocate it. This paper extends the standard Campbell and Viceira (2005) strategic asset allocation model by including a longevity-linked investment possibility. Model estimation, based on prices for standardized annuities publicly offered by United States insurance companies, shows that aggregate shocks to survival probabilities are predictors for long-term returns of the longevity-linked securities, and reveals an unexpected predictability pattern. Valuation of longevity risk premium confirms that longevity-linked securities o er inexpensive funding opportunities to asset managers.

Banks’ Internal Capital Markets and Deposit Rates
Itzhak Ben-David, Ajay Palvia, and Chester Spatt

A common view is that deposit rates are determined primarily by supply: depositors require higher deposit rates from risky banks (market discipline). An alternative perspective is market discipline is limited and that internal demand for funding by banks determines rates. Using branch-level deposit rate data, we find little evidence for market discipline as rates are similar across bank capitalization levels. In contrast, banks’ loan growth has a causal effect on deposit rates: e.g., branches’ deposit rates are correlated with loan growth in other states in which their bank has some presence, suggesting internal capital markets help reallocate the bank’s funding.

Institutional Investment Constraints and Stock Prices
Jie Cao, Bing Han, and Qinghai Wang

We test the hypothesis that investment constraints in delegated portfolio management may distort demand for stocks, leading to price underreaction to news and stock return predictability. We find that institutions tend not to buy more of a stock with good news that they already overweight; they are reluctant to sell a stock with bad news that they already underweight. Stocks with good news overweighted by institutions subsequently outperform signi cantly stocks with bad news underweighted by institutions. The impact of institutional investment constraints shed new lights on asset pricing anomalies such as stock price momentum and post earnings announcement drift.

CEO Tournaments: A Cross-Country Analysis of Causes, Cultural Influences and Consequences
Natasha Burns, Kristina Minnick, and Laura Starks

Using a cross-country sample, we examine the CEO tournament structure (measured alternatively as the ratio and the difference of pay between the CEO and other top executives within a firm). We find the tournament structure to vary systematically with firm and country cultural characteristics. In particular, firm size and the cultural values of Power distance, Fair income differences and Competition are significantly associated with variations in tournament structures. We also establish support for the primary implication of tournament theory in that tournament structure tends to be positively related to firm value, even after controlling for endogeneity.

How Do Frictions Affect Corporate Investment? A Structural Approach
M. Cecilia Bustamante

This paper provides a structural approach to test investment equations based on the log-likelihood function of a non-linear investment rule. The analysis integrates the predictions of the q-theory for the commonly studied active region of investment, and provides new inferences on how real and financing frictions affect the probability that a firm invests. Our empirical findings are consistent with the macro-finance literature suggesting that q-theory models with non-convex investment frictions better explain the data. We also find that both real and financing costs of investment are related to the capital intensity of the industry in which firms operate.

Why Do Short Sellers Like Qualitative News?
Bastian von Beschwitz, Oleg Chuprinin, and Massimo Massa

Short sellers trade more on days with qualitative news – i.e. news containing fewer numbers. We show that this behavior is not informationally motivated but can be explained by short sellers exploiting higher liquidity on such days. We document that liquidity and noise trading increase in the presence of qualitative news enabling short sellers to better disguise their informed trades. Natural experiments support our findings. Qualitative news has a bigger effect on short sellers’ trading after a decrease in liquidity following the stock's deletion from S&P 500 and a lower effect when investor attention is distracted by the Olympic Games.

Annual Report Readability, Tone Ambiguity, and the Cost of Borrowing
Mine Ertugrul, Jin Lei, Jiaping Qiu, and Chi Wan

This paper investigates the impact of a firm’s annual report readability and ambiguous tone on its borrowing costs. We find that firms with larger 10-K file sizes and a higher proportion of uncertain and weak modal words in 10-Ks have stricter loan contract terms and greater future stock price crash risk. Our results suggest that readability and tone ambiguity of a firm’s financial disclosures are related to managerial information hoarding. Shareholders of firms with less readable and more ambiguous annual reports not only suffer from less transparent information disclosure but also bear the increased cost of external financing.

The Effect of Labor Unions on CEO Compensation
Qianqian Huang, Feng Jiang, Erik Lie, and Tingting Que

We find evidence that labor unions affect CEO compensation. First, we find that firms with strong unions pay their CEOs less. The negative effect is robust to various tests for endogeneity, including cross-sectional variations and a regression discontinuity design. Second, we find that CEO compensation is curbed before union contract negotiations, especially when the compensation is discretionary and the unions have a strong bargaining position. Third, we report that curbing CEO compensation mitigates the chance of a labor strike, thus providing a rationale for firms to pay CEOs less when facing strong unions.

The Timing and Source of Long-Run Returns Following Repurchases
Leonce Bargeron, Alice Bonaime, and Shawn Thomas

This paper investigates the timing and source of anomalous positive long-run abnormal returns following repurchase authorizations. Returns between program authorization and completion announcements are indistinguishable from zero. Abnormal returns occur only after completion announcements. Long-run returns are largely attributable to announcement returns at subsequent authorizations and takeover attempts, i.e., anomalous post-authorization returns are not persistent drifts but rather step functions. These findings have important implications for prior papers examining this most persistent and widespread anomaly. Further, our results serve to refocus the search for a rational explanation for the anomaly on subsequent repurchase announcements and takeover bids.

Upper Bounds on Return Predictability
Dashan Huang and Guofu Zhou

Can the degree of predictability found in the data be explained by existing asset pricing models? We provide two theoretical upper bounds on the R-squares of predictive regressions. Using data on the market and component portfolios, we find that the empirical R-squares are significantly greater than the theoretical upper bounds. Our results suggest that the most promising direction for future research should aim to identify new state variables that are highly correlated with stock returns, instead of seeking more elaborate stochastic discount factors.

Should Indirect Brokerage Fees Be Capped? Lessons from Mutual Fund Marketing and Distribution Expenses
Natalie Y. Oh, Jerry T. Parwada, and Kian M. E. Tan

Theory predicts that capping brokers’ compensation exacerbates the exploitation of retail investors. We show that regulated caps on mutual fund 12b-1 fees, effectively sales commissions, are associated with negative equity fund performance, but only after a structural shift toward maximum permitted levels of the fees around 2000. Past this break point, flow–performance sensitivity shifts from the middle- to the highest-performing funds, suggesting that the fee cap increases performance-chasing behavior by constraining brokers’ incentives to learn about lower-ranked funds. The policy implication is that regulators must reevaluate the efficacy of caps on brokerage fees.

Gender and Board Activeness: The Role of a Critical Mass
Miriam Schwartz-Ziv

This study analyzes detailed minutes of board meetings of business companies in which the Israeli government holds a substantial equity interest. Boards with at least three directors of each gender are found to be at least 79% more active at board meetings than those without such representation. This phenomenon is driven by women directors in particular; they are more active when a critical mass of at least three women is in attendance. Gender-balanced boards are also more likely to replace underperforming CEOs and are particularly active during periods when CEOs are being replaced.

Information Characteristics and Errors in Expectations: Experimental Evidence
Constantinos Antoniou, Glenn W. Harrison, Morten I. Lau, and Daniel Read

We design an experiment to test the hypothesis that, in violation of Bayes Rule, some people respond more forcefully to the strength of information than to its weight. We provide incentives to motivate effort, use naturally occurring information, and control for risk attitude. We find that the strength-weight bias affects expectations, but that its magnitude is significantly lower than originally reported. Controls for non-linear utility further reduce the bias. Our results suggest that incentive compatibility and controls for risk attitude considerably affect inferences on errors in expectations.

Common Macro Factors and Currency Premia
Ilias Filippou and Mark P. Taylor

We study the role of domestic and global factors on payoffs of portfolios mimicking carry, dollar carry and momentum strategies. Using factors summarizing large datasets of macroeconomic and financial variables, we find that global equity market factors are predictive for carry trade returns, while U.S. inflation and consumption variables drive dollar carry trade payoffs, momentum returns are predominantly driven by U.S. inflation factors, and global factors capture the countercyclical nature of currency premia. We also find predictability in the exchange rate component of each strategy and demonstrate strong economic value to risk-averse investors with mean-variance preferences, regardless of base currency.

Stapled Financing, Value Certification, and Lending Efficiency
Hadiye Aslan and Praveen Kumar

We examine whether financing commitments from a target firm’s financial advisor, in the form of stapled financing, provide certification of target value. Using a dataset of leveraged buyouts spanning 2002–2011, and addressing endogeneity issues, we find that stapled financing has significantly positive effects on sellers’ shareholder wealth, especially for targets suffering from greater adverse selection. Stapled financing facilitates deal financing by allowing buyers to obtain lower cost and longer maturity debt, and is positively associated with bidding intensity. Investment banks offering stapled financing appear to trade off higher expected advisory fees against loss of lending effciency ex-post.

Informed Trading Around Stock Split Announcements: Evidence from the Option Market
Philip Gharghori, Edwin D. Maberly, and Annette Nguyen

Prior research shows that splitting firms earn positive abnormal returns and that they experience an increase in stock return volatility. By examining option-implied volatility, we assess option traders’ perceptions on return and volatility changes arising from stock splits. We find that they do expect higher volatility following splits. There is only weak evidence though of option traders anticipating an abnormal increase in stock prices. We also show that our option measures can predict both stock volatility levels and changes after the announcement. However, there is little evidence that they can predict the returns of splitting firms.

Model Uncertainty and Exchange Rate Forecasting
Roy Kouwenberg, Agnieszka Markiewicz, Ralph Verhoeks, and Remco C. J. Zwinkels

Exchange rate models with uncertain and incomplete information predict that investors focus on a small set of fundamentals that changes frequently over time. We design a model selection rule that captures the current set of fundamentals that best predict the exchange rate. Out-of-sample tests show that the forecasts made by this rule significantly beat a random walk for five out of ten currencies. Further, the currency forecasts generate meaningful investment profits. We demonstrate that the strong performance of the model selection rule is driven by time-varying weights attached to a small set of fundamentals, in line with theory.

Short-Term Reversals: The Effects of Past Returns and Institutional Exits
Si Cheng, Allaudeen Hameed, Avanidhar Subrahmanyam, and Sheridan Titman

Price declines over the previous quarter lead to stronger reversals across the subsequent two months. We explain this finding based on the dual notions that liquidity provision can influence reversals, and agents that act as de facto liquidity providers may be less active in past losers. Supporting these observations, we find that active institutions participate less in losing stocks, and that the magnitude of monthly return reversals fluctuates with changes in the number of active institutional investors. Thus, we argue that fluctuations in liquidity provision with past return performance accounts for the link between return reversals and past returns.

What Drives the Commonality between Credit Default Swap Spread Changes?
Mike Anderson

This paper documents an increase in the comovement between credit default swap (CDS) spread changes during the 2007–2009 crisis and investigates the source of that increase. One possible explanation is that comovement increased because fundamental values became more correlated. However, I find that changes in fundamentals account for only 23% of the increase in covariance. The remaining increase is attributed to changes in liquidity and the market price of default risk. In contrast, counterparty risk played an insignificant role. Although both contributed, the increase in covariance was driven more by variation in exposures than factor variance-covariance.

Social Screens and Systematic Investor Boycott Risk
H. Arthur Luo and Ronald J. Balvers

We model the pricing implications of screens adopted by socially responsible investors. The model reproduces the empirically observed abnormal return to sin stock, and implies a premium for systematic investor boycott risk that affects targeted as well as non-targeted firms. The investor boycott premium is not displaced by litigation risk, measures of neglect effect, illiquidity, industry momentum or concentration. The investor boycott risk factor is useful in explaining mean returns across industries, and its premium varies with the relative wealth of socially responsible investors and the business cycle.

Unknown Unknowns: Uncertainty About Risk and Stock Returns
Guido Baltussen, Sjoerd van Bekkum, and Bart van der Grient

Stocks with high uncertainty about risk, as measured by the volatility of volatility (vol-of-vol), robustly underperform stocks with low uncertainty about risk by 8 percent per year. This vol-of-vol effect is distinct from (combinations of) at least twenty previously documented return predictors, survives many robustness checks, and holds in the U.S. and across European stock markets. We empirically explore the pricing mechanism behind the vol-of-vol effect. The evidence points towards preference-based explanations, and points away from various alternative explanations. Collectively, our results show that uncertainty about risk is highly relevant for stock prices.

Cash Holdings, Competition, and Innovation
Evgeny Lyandres and Berardino Palazzo

We demonstrate theoretically and empirically that strategic considerations are important in shaping cash policies of innovative firms. In our model, firms compete in product markets with uncertain structure using cash as a commitment device to invest in innovation. We show that firms equilibrium cash holdings are related to expected intensity of competition. The sign and magnitude of this relation depends on firms’ financial constraints. Consistent with the strategic motive for hoarding cash, we show that firms cash holdings are negatively affected by their rivals cash holding choices, more so when competition is expected to be intense.

Blockholder Heterogeneity, CEO Compensation, and Firm Performance
Christopher P. Clifford and Laura Lindsey

This paper examines heterogeneity in blockholder monitoring across investor type. We document which blockholder types (e.g., mutual funds, hedge funds) are more likely to be associated with active monitoring and show that firms targeted by such blockholders are more likely to increase the equity portion of Chief Executive Officer (CEO) pay. Further, using market-wide and exogenous shocks to liquidity to identify differences in efficacy across blockholder types, we observe greater operating performance improvements in actively monitored firms when passive monitoring is less effective, suggesting causal impact. We propose differences in compensation arrangements across blockholder types as a mechanism underlying blockholders’ heterogeneous role.

Spreading the Misery? Sources of Bankruptcy Spillover in the Supply Chain
Madhuparna Kolay, Michael Lemmon, and Elizabeth Tashjian

We document that suppliers to purely financially distressed companies that are highly likely to reorganize in bankruptcy incur little or no spillover costs. In contrast, suppliers to economically distressed firms experience large losses in market value which are linked to proxies for the cost of replacing their bankrupt customer. Suppliers experience increased SG&A expenses and lower margins in the year following their trading partner’s bankruptcy which we link to proxies for partner replacement costs. Suppliers continue to extend trade credit to firms which are healthier and where the cost of replacing the partner is higher.

Key Human Capital
Ryan D. Israelsen and Scott E. Yonker

Firms whose human capital is concentrated in a few irreplaceable employees lack diversification in their human capital stock, exposing them to key human capital risk. Using “key man life insurance" disclosures to measure this risk, we show that exposed firms are riskier. These younger, smaller, growth firms have abnormally high volatility and following announcement of key employee departures, the most exposed firms lose 8% of their value. Key employees tend to be highly educated. They are four times more likely to hold Ph.D.'s than top managers, and firms with key human capital are more innovative.

Shareholder Composition and Managerial Compensation
Shinya Shinozaki, Hiroshi Moriyasu, and Konari Uchida

Stock options are used only sparingly in Japan. Japanese firms are more likely to adopt new stock option plans when they are more (less) owned by directors and arms-length investors (stable and controlling shareholders). Those firms have significantly more independent boards and pay higher dividends surrounding the adoption year than their industry peers. These results suggest that firms adopting stock options endeavor to meet demands for good governance practice from arms-length shareholders and to follow good governance practices in other dimensions. The coexistence of arms-length, stable, and controlling shareholders generates a situation in which stock options are not widely used in Japan.

Optimal Option Portfolio Strategies: Deepening the Puzzle of Index Option Mispricing
José Afonso Faias and Pedro Santa-Clara

Traditional methods of asset allocation (such as mean-variance optimization) are not adequate for option portfolios because the distribution of returns is non-normal and the short sample of option returns available makes it difficult to estimate their distribution. We propose a method to optimize a portfolio of European options, held to maturity, with a myopic objective function that overcomes these limitations. In an out-of-sample exercise, incorporating realistic transaction costs, the portfolio strategy delivers a Sharpe ratio of 0.82 with positive skewness. This performance is mostly obtained by exploiting mispricing between options and not by loading on jump or volatility risk premia.

To Pay or be Paid? The Impact of Taker Fees and Order Flow Inducements on Trading Costs in U.S. Options Markets
Robert Battalio, Andriy Shkilko, and Robert Van Ness

Consistent with prior literature, we find that average relative effective spreads are higher on venues that pay for order flow (PFOF) than on venues utilizing the maker taker (MT) model. This relation becomes more nuanced when liquidity fees are incorporated into liquidity cost measures. For the majority of options, PFOF venues offer lower average liquidity costs net of taker fees. Net liquidity costs for the high-priced options, however, are lower on MT venues. Overall, our results suggest that the inclusion of fees and rebates can rationalize the routing of most, but not all, marketable orders to PFOF venues.

Real Options, Idiosyncratic Skewness, and Diversification
Luca Del Viva, Eero Kasanen, and Lenos Trigeorgis

We show how firm-level real options lead to idiosyncratic skewness in stock returns. We then document empirically that growth option variables are positive and significant determinants of idiosyncratic skewness. The real option impact on skewness is more significant in firms with lottery-type features, small size, high volatility, distressed, low ROA and low book-to-market. We also find that expectation on idiosyncratic skewness is associated with lower Sharpe ratios. This suggests investors are willing to sacrifice mean-variance portfolio efficiency for greater skewness deriving from real options. Further, financial flexibility has a positive incremental impact enhancing the beneficial role of asset flexibility on idiosyncratic skewness.

Seasonal Asset Allocation: Evidence from Mutual Fund Flows
Mark J. Kamstra, Lisa A. Kramer, Maurice D. Levi, and Russ Wermers

We analyze the flow of money between mutual fund categories, finding strong evidence of seasonality in investor risk aversion. Aggregate investor flow data reveal investor preference for safe mutual funds in autumn and risky funds in spring. During September alone, out flows from equity funds average $13 billion, controlling for previously documented flow determinants (e.g., capital-gain overhang). This movement of large amounts of money between fund categories is correlated with seasonality in investor risk aversion, consistent with investors preferring safer (riskier) investments in autumn (spring). We find consistent evidence in Canada, and in Australia where seasons are offset by six months

The Strategic Behavior of Firms with Debt
Jerome Reboul Anna Toldrà-Simats

We empirically study the strategic behavior of levered firms in a non-competitive and in a competitive environment. We find that regulation induces firms to increase leverage, and this reduces their ability to compete when deregulation occurs. Large and small levered firms adopt different strategies upon deregulation. Whereas more levered small firms charge higher prices to increase margins at the expense of market shares, highly-levered larger firms prey on their rivals by increasing output and reducing prices to increase their market shares. The dfference in their behavior is due to differences in their probability of bankruptcy, and their financing constraints.

Alliances and Return Predictability
Jie Cao, Tarun Chordia, and Chen Lin

Building on the growing literature on inter-firm links and limited attention, we find evidence of return predictability across alliance partners. A long-short portfolio sorted on lagged returns of strategic alliance partners provides a return of 89 basis points per month that is robust to a number of specifications. Investor inattention and limits to arbitrage may be the source of the underreaction of a firm’s returns to that of its partners’.

Industrial Electricity Usage and Stock Returns
Zhi Da, Dayong Huang, and Hayong Yun

The industrial electricity usage growth rate predicts future stock returns up to one year with an R-squared of 9%. High industrial electricity usage today predicts low stock returns in the future, consistent with a countercyclical risk premium. Industrial electricity usage tracks the output of the most cyclical sectors. Our findings bridge a gap between the asset pricing literature and the business cycle literature, which uses industrial electricity usage to gauge production and output in real time. Industrial electricity growth compares favorably with traditional -financial variables, and it outperforms Cooper and Priestley's (2009) output gap measure in real time.

Horizon Pricing
Avraham Kamara, Robert A. Korajczyk, Xiaoxia Lou, and Ronnie Sadka

The literature documents heterogeneity in the delay of stock-price reaction to systematic shocks, implying that asset risk depends on investment horizon. We study the pricing of risk factors across investment horizons. Value (liquidity) risk is priced over intermediate (short) horizons. Conditioning horizon-factor exposures on firm characteristics indicates that characteristics, with the exception of momentum, are not priced beyond their contribution to systematic risk. Long-horizon institutional investors overweight assets with high intermediate-horizon exposures to HML risk and high short-horizon exposures to liquidity risk. The results highlight the importance of investment horizon in determining risk premia.

Strategic Delays and Clustering in Hedge Fund Reported Returns
George O. Aragon and Vikram Nanda

We use a novel database to study timeliness of hedge-fund monthly performance disclosures. Managers engage in strategic timing: poor monthly returns are reported with delay, sometimes clustered with stronger subsequent performance, suggestive of `performance smoothing'. We posit that propensity to delay could reveal operational-risk and/or poor-managerial quality. Consistent with this, a portfolio strategy that buys (sells) funds with historically timely (untimely) reporting delivers 3% annual-style-adjusted returns. Investor flows are lower following reporting delays, though there are potential benefits to managers from delaying when performance is sufficiently poor. We conclude timely disclosure is an important consideration for hedge-fund managers and investors.

Anchoring Credit Default Swap Spreads to Firm Fundamentals
Jennie Bai and Liuren Wu

This paper examines the extent to which firm fundamentals can explain the cross-sectional variation of credit default swap (CDS) spreads. The paper constructs a fundamental CDS valuation by combining the Merton distance-to-default measure with a long list of firm fundamental characteristics. Regressing market CDS quotes against the fundamental valuation cross-sectionally generates an average R-squared of 77%. The cross-sectional explanatory power is stable over time, and robust in out-of-sample tests. Deviations between market quotes and the valuation predict significantly future market movements. The results highlight the important role of firm fundamentals in differentiating the credit quality of different firms.

Speculators, Prices and Market Volatility
Celso Brunetti, Bahattin Büyüksahin, and Jeffrey H. Harris

We employ data over 2005–2009 which uniquely identify categories of traders to test how speculators like hedge funds and swap dealers relate to volatility and price changes. Examining various sub-periods where price trends are strong, we find little evidence that speculators destabilize financial markets. To the contrary, hedge fund position changes are negatively related to volatility in corn, crude oil and natural gas futures markets. Additionally, swap dealer activity is largely unrelated to contemporaneous volatility. Our evidence is consistent with the hypothesis that hedge funds provide valuable liquidity and largely serve to stabilize futures markets.

The Dynamics of Performance Volatility and Firm Valuation
Jianxin (Daniel) Chi and Xunhua Su

We construct a model to illustrate the dynamics of cash flow volatility and firm valuation. As a firm progressively invests into its growth opportunities, its book value increases and catches up with its market value, reducing the valuation multiple (Q). Cash flow volatility (CFV) decreases due to the diversification effect of investing into more market segments. We document a positive CFV-Q association, which varies with firm size, investment opportunities, and the correlation across market segments. Empirical findings strongly support the model’s predictions and are robust to alternative explanations offered by extant studies on firm growth, volatility, and valuation.

Buyers versus Sellers: Who Initiates Trades and When?
Tarun Chordia, Amit Goyal, and Narasimhan Jegadeesh

Models that examine investor’s motivations to trade often make opposite predictions about the relation between trading decisions and past returns. We find that, in the aggregate, both buyer- and seller-initiated trades increase with past returns. The difference between buyer- and seller-initiated trades is negatively related to short horizon returns but positively related to returns over longer horizons. Tax-loss related seller-initiated trades in December and January are accompanied by increased buyer-initiated trades. Past returns significantly affect trading decisions and these findings are consistent with a number of different models of trading behavior.

Sovereign Default Risk and the US Equity Market
Alexandre Jeanneret

This paper develops an international asset-pricing model with defaultable firms and governments that demonstrates how sovereign credit risk in Europe affects US equity market prices. The risk of a sovereign debt crisis is a threat to economic growth that reduces the value of international equities and increases their volatility. The effect is strongest under adverse economic conditions, when firms are in financial distress. A structural estimation of the model shows that sovereign default risk helps explain the level and the dynamics of equity volatility in Europe and the US over the 1991-2013 period.

Time-Varying Liquidity and Momentum Profits
Doron Avramov, Si Cheng, and Allaudeen Hameed

A basic intuition is that arbitrage is easier when markets are most liquid. Surprisingly, we find that momentum profits are markedly larger in liquid market states. This finding is not explained by variation in liquidity risk, time-varying exposure to risk factors, or changes in macroeconomic condition, cross-sectional return dispersion, and investor sentiment. The predictive performance of aggregate market illiquidity for momentum profits uniformly exceed that of market return and market volatility states. While momentum strategies are unconditionally unprofitable in US, Japan, and Eurozone countries in the last decade, they are substantial following liquid market states.

Creative Destruction and Asset Prices
Joachim Grammig and Stephan Jank

We relate Schumpeter's notion of creative destruction to asset pricing, thereby offering a novel explanation of size and value premia. We argue that small-value firms must offer higher expected returns to compensate for the risk posed by serendipitous invention activity, whereas large-growth stocks provide protection against creative destruction and receive expected return discounts. A two-factor model that accounts for creative destruction risk effectively explains the cross-sectional return variation of size and book-to-market sorted portfolios. The estimated risk compensations associated with creative destruction are substantial and statistically significant, indicating their relevance for asset pricing.

Sentiment and the Effectiveness of Technical Analysis: Evidence from the Hedge Fund Industry
David M. Smith, Na Wang, Ying Wang, and Edward J. Zychowicz

This paper presents a unique test of the effectiveness of technical analysis in different sentiment environments by focusing on its usage by perhaps the most sophisticated and astute investors, namely hedge fund managers. We document that during high-sentiment periods, hedge funds using technical analysis exhibit higher performance, lower risk, and superior market-timing ability than non-users. The advantages of using technical analysis disappear or even reverse in low-sentiment periods. Our findings are consistent with the view that technical analysis is relatively more useful in high-sentiment periods with larger mispricing, which cannot be fully exploited by arbitrage activities due to short-sale impediments.

Asymmetric Information, Financial Reporting, and Open Market Share Repurchases
Matthew T. Billett and Miaomiao Yu

We explore the link between open market share repurchases (OMRs) and asymmetric information - based on financial reporting quality - and find opaque firms experience positive abnormal returns twice the magnitude of transparent firms. These significant differences remain after controlling for governance, earnings management, and firm characteristics. We document significantly positive long-run post-announcement returns for opaque firms, but not for transparent firms. We find takeover activity and premiums rise with repurchase activity by opaque firms and may explain some of the wealth effects. Our results suggest that asymmetric information plays an important role in the wealth effects around OMRs.

Do Banks Issue Equity When They Are Poorly Capitalized?
Valeriya Dinger and Francesco Vallascas

Debt overhang and moral hazard predict that poorly capitalized banks have a lower likelihood to issue equity, while the presence of regulatory and market pressures posit an opposite theoretical prediction. By using an international sample of bank Seasoned Equity Offerings (SEOs), we show that the likelihood of issuing SEOs is higher in poorly capitalized banks and that such banks prefer SEOs to alternative capitalization strategies. A series of tests exploring the variation of capital regulation and market discipline show that market mechanisms rather than capital regulation are the primary driver of the decision to issue by poorly capitalized banks.

Initial Public Offering Allocations, Price Support, and Secondary Investors
Sturla Lyngnes Fjesme

Tying Initial Public Offering (IPO) allocations to after-listing purchases of other IPO shares, as a form of price support, has generated much theoretical interest and media attention. Price support is price manipulation and can reduce secondary investor return. Obtaining data to investigate price support has in the past proven to be difficult. We document that price support is harming secondary investor return using new data from the Oslo Stock Exchange. We also show that investors who engage in price support are allocated more future oversubscribed allocations while harmed secondary investors significantly reduce their future participation in the secondary market.

Continuing Overreaction and Stock Return Predictability
Suk Joon Byun, Sonya S. Lim, and Sang Hyun Yun

We study the return predictability of a measure of continuing overreaction based on the weighted average of signed volumes. We find that the strategies of buying stocks with upward continuing overreaction and selling stocks with downward continuing overreaction generate significant positive returns, and that our measure of continuing overreaction is a better predictor of future returns than past returns. The results are stronger among stocks primarily held by investors more prone to biased self-attribution. Our results provide direct support for the model of return predictability based on overconfidence and biased self-attribution.

The Determinants and Performance Impact of Outside Board Leadership
Steven Balsam, John Puthenpurackal, and Arun Upadhyay

Outside board chairs are more likely in firms that are smaller, have greater stock volatility and R&D intensity, have a lower proportion of inside directors and less institutional ownership, and when CEOs have shorter tenure and lower ownership. We also find the existence of an outside chair associated with geographical and industry norms. An outside chair is positively associated with firm performance, a finding robust to various estimation methods including event study and multivariate analyses incorporating controls for endogeneity, as well as market and accounting measures of performance. We note however, the outside chair-firm performance relationship varies with firm characteristics.

Estimating Beta
Fabian Hollstein and Marcel Prokopczuk

We conduct a comprehensive comparison of market beta estimation techniques. We study the performance of several historical, time-series model, and option implied estimators for estimating realized market beta. Thereby, we find the hybrid methodology of Buss and Vilkov (2012) to consistently outperform all other approaches. In addition, all other approaches, including fully implied and GARCH-based methods for dynamic conditional beta, are dominated by a simple beta estimate based on historical (co-) variances and a Kalman filter based approach. Our conclusions remain unchanged after performing several robustness checks.

Does Competition Matter for Corporate Governance? The Role of Country Characteristics
Jean-Claude Cosset, Hyacinthe Y. Somé, and Pascale Valéry

We investigate the role of country characteristics on the competition-governance relation. We find that competition is associated with higher ratings in corporate governance, but only in developing countries. Further, corporate governance is associated with greater firm value, but only in less competitive industries from developed countries. For developing countries, the evidence suggests that corporate governance is valuable mostly in competitive industries. Additional tests show that corporate governance increases labor productivity and cost efficiency, mostly in less competitive industries in both developed and developing countries. Furthermore in developing countries, corporate governance increases investment in capital, but primarily in competitive industries.

Urban Agglomeration and CEO Compensation
Bill Francis, Iftekhar Hasan, Kose John, and Maya Waisman

We examine the relationship between the agglomeration of firms around big cities and CEO compensation. We find a positive relationship between a firm's headquarters metropolitan size, the total and equity portion of its CEO's pay, and the quality of CEO educational attainment. We also find that CEOs gradually increase their human capital in major metropolitans and are rewarded for this upon relocation to smaller cities. Taken together, the results suggest that urban agglomeration reflects local network spillovers and faster learning of skilled individuals, for which firms are willing to pay a premium and are therefore important factors in CEO compensation.

Labor Income, Relative Wealth Concerns, and the Cross-Section of Stock Returns
Juan-Pedro Gómez, Richard Priestley, and Fernando Zapatero

The finance literature documents a relation between labor income and the cross-section of stock returns. One possible explanation for this is the hedging decisions of investors with relative wealth concerns. This implies a negative risk premium associated with stock returns correlated with local undiversifiable wealth, since investors are willing to pay more for stocks that help their hedging goals. We find evidence that is consistent with these regularities. In addition, we show that the effect varies across geographic areas depending on the size and variability of undiversifiable wealth, proxied by labor income.

Does Common Analyst Coverage Explain Excess Comovement?
Ryan D. Israelsen

This paper shows that correlated errors in news about fundamentals are an important, rational determinant of excess comovement. Individual analysts' forecast errors tend to be correlated across stocks. Using a proxy for correlated forecast errors based on analyst coverage, I find that stocks with similar sets of analysts exhibit more excess comovement, controlling for industry and other variables. Exogenous changes in commonality in analyst coverage around (1) brokerage firm mergers and (2) additions to an index lead to changes in excess comovement. This information channel explains 10% to 25% of the increase in comovement around additions to the S&P 500 index.

The Effects of Government Interventions in the Financial Sector on Banking Competition and the Evolution of Zombie Banks
Cesar Calderon and Klaus Schaeck

We investigate how government interventions such as blanket guarantees, liquidity support, recapitalizations, and nationalizations affect banking competition. This issue is critical for stability, access to finance, and economic growth. Exploiting cross-country and cross-time variation in the timing of interventions and accounting for their nonrandomness, we document that liquidity support, recapitalizations, and nationalizations trigger large increases in competition. We also find some more nuanced evidence that zombie banks’ market shares in crisis countries evolve together with interventions. A higher frequency of interventions coincides with greater zombie bank presence, and increases in competition are larger when zombie banks occupy bigger market shares.

Liquidity Risk and the Credit Crunch of 2007-2008: Evidence from Micro-Level Data on Mortgage Loan Applications
Adonis Antoniades

Recent empirical studies have shown that during the financial crisis of 2007-2008 banks that were more heavily exposed to liquidity risk contracted their supply of credit more sharply. I contribute to the identification of this effect by relying on the use of micro-level data on US mortgage loan applications, which allows me to identify liquidity risk as an important determinant of the contraction of credit in the mortgage market, but as separate from the precipitous fall in credit demand, disruptions in the securitization and subprime markets, shifts in asset risk, and changing risk-aversion among loan oficers.

Investment and Cash Flow: New Evidence
Jonathan Lewellen and Katharina Lewellen

We study the investment-cash flow sensitivities of U.S. firms from 1971–2009. Our tests extend the literature in several key ways and provide strong evidence that cash flow explains investment beyond its correlation with q. A dollar of current- and prior-year cash flow is associated with $0.32 of additional investment for firms that are the least likely to be constrained and $0.63 of additional investment for firms that are the most likely to be constrained, even after correcting for measurement error in q. Our results suggest that financing constraints and free cash flow problems are important for investment decisions.

Ambiguity Aversion and Underdiversication
Massimo Guidolin and Hening Liu

We examine asset allocation decisions under smooth ambiguity aversion when an investor has a prior degree of belief in an asset pricing model (e.g., the domestic CAPM). Different from a Bayesian approach, the investor separately relies on the conditional distribution of returns and on the posterior over parameters to make decisions, rather than on the predictive distribution of returns that integrates priors and likelihood information. We find that in the perspective of US investors, ambiguity aversion generates strong home bias in equity holdings, regardless of beliefs in the CAPM or risk aversion. Results become stronger under regime-switching investment opportunities.

Option Valuation with Macro-Finance Variables
Christian Dorion

I propose a model in which the price of an option is partly determined by macro-finance variables. In an application using an index of current business conditions, the new model outperforms existing benchmarks in fitting underlying asset returns and in pricing options. The model performs particularly well when business conditions are deteriorating. Using the recent financial crisis as an out-of-sample experiment, the new model has option-pricing errors that are 18% below those of a nested two-component volatility benchmark. Results are robust to using alternative business conditions proxies and comparing to different benchmark models.

Human Capital, Management Quality, and the Exit Decisions of Entrepreneurial Firms
Shan He and C. Wei Li

We model the employee incentive problem jointly with a firm’s exit decision. Our model predicts that firms in industries where human capital is important are more likely to go public and use high-powered stock-based compensation. We also show that the higher the management quality, the more likely a firm is to go public than to be acquired. Lifecycle-wise, a firm with high capital intensity and/or high management quality will choose to go public at a younger age.

Differential Access to Price Information in Financial Markets
David Easley, Maureen O'Hara, and Liyan Yang

Recently exchanges have been directly selling market data. We analyze how this practice affects price discovery, the cost of capital, return volatility, market liquidity, information production and trader welfare. We show that selling price data increases the cost of capital and volatility, worsens market efficiency and liquidity, and discourages the production of fundamental information relative to a world in which all traders observe prices. Generally allowing exchanges to sell price information benefits exchanges and harms liquidity traders. Overall, our results suggest that regulations on selling market data can play an important role in improving market quality and trader welfare.

Last updated July 25, 2016.