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
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.
Zhi Da, Mitch Warachka, and Hayong Yun
Life-Cycle Asset Allocation with Ambiguity Aversion and Learning
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
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.
Xin Gao and Federico Nardari
Political Uncertainty and IPO Activity: Evidence from U.S. Gubernatorial Elections
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.
Gonul Colak, Art Durnev, and Yiming Qian
Are Ratings the Worst Form of Credit Assessment Except for All the Others?
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.
Andreas Blöchlinger and Markus Leippold
Institutional Investor Expectations, Manager Performance, and Fund Flows
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.
Howard Jones and Jose Vicente Martinez
High Frequency Quoting: Short-Term Volatility in Bids and Offers
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
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.
Neal M. Stoughton, Kit Pong Wong, and Long Yi
An Empirical Analysis of Market Segmentation on U.S. Equities Markets
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.
Frank Hatheway, Amy Kwan, and Hui Zheng
Horses for Courses: Fund Managers and Organizational Structures
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.
Yufeng Han, Tom Noe, and Michael Rebello
Do Short-Sellers Trade on Private Information or False Information?
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.
Amiyatosh Purnanandam and Nejat Seyhun
Equity Volatility Term Structures and the Cross Section of Option Returns
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
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.
Stefania D’Amico, Don H. Kim, and Min Wei
The Anatomy of a Credit Supply Shock: Evidence from an Internal Credit Market
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.
José María Liberti and Jason Sturgess
Davids, Goliaths, and Business Cycles
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.
Jefferson Duarte and Nishad Kapadia
Risk Premium Information from Treasury Bill Yields
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
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.
Travis L. Johnson
Why Do Fund Managers Identify and Share Profitable Ideas?
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
Steven S. Crawford, Wesley R. Gray, and Andrew E. Kern
Hedge Fund Return Dependence: Model Misspecification or Liquidity Spirals?
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.
Richard Sias, H. J. Turtle, and Blerina Zykaj
To Group or Not to Group? Evidence from Mutual Fund Databases
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.
Saurin Patel and Sergei Sarkissian
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.
Jorge A. Cruz Lopez, Jeffrey H. Harris, Christophe Hurlin, and Christophe Pérignon
Entrepreneurial Litigation and Venture Capital Finance
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
Douglas Cumming, Bruce Haslem, and April Knill
Valuations in Corporate Takeovers and Financial Constraints on Private Targets
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
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.
Xin Chang, Yangyang Chen, and Leon Zolotoy
Leverage Effect, Volatility Feedback, and Self-Exciting Market Disruptions
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
Peter Carr and Liuren Wu
The Diminishing Benefits of US Cross-Listing: Economic Consequences of SEC Rule 12h-6
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.
Chinmoy Ghosh and Fan He
Investor Attrition and Fund Flows in Mutual Funds
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.
Susan E. K. Christoffersen and Haoyu Xu
Did Saving Wall Street Really Save Main Street? The Real Effects of TARP on Local Economic Conditions
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.
Allen N. Berger and Raluca A. Roman
What Explains the Difference in Leverage between Banks and Non-Banks?
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.
Tobias Berg and Jasmin Gider
Long-Term versus Short-Term Contingencies in Asset Allocation
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.
Mahmoud Botshekan and André Lucas
Time-Disaggregated Dividend-Price Ratio and Dividend Growth Predictability in Large Equity Markets
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.
Panagiotis Asimakopoulos, Stylianos Asimakopoulos, Nikolaos Kourogenis, and Emmanuel Tsiritakis
Regulatory Sanctions and Reputational Damage in Financial Markets
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.
John Armour, Colin Mayer, and Andrea Polo
Crash Risk in Currency Returns
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.
Mikhail Chernov and Jeremy Graveline
The Interpretation of Unanticipated News Arrival and Analysts’ Skill
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.
Amir Rubin, Benjamin Segal, and Dan Segal
Equilibrium Informed Trading with Relative Performance Measurement
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
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.
Stéphane Chrétien and Manel Kammoun
Stock Market Mean Reversion and Portfolio Choice over the Life Cycle
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.
Alexander Michaelides and Yuxin Zhang
Expected Business Conditions and Bond Risk Premia
This paper studies the predictability of bond risk premia by means
to future business conditions using survey forecasts from the Survey
Forecasters. We show that expected business conditions consistently
affect excess bond
returns and that the inclusion of expected business conditions in
regressions improve forecast performance relative to models using
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.
Jonas Nygaard Eriksen
DRIPs and the Dividend Pay Date Effect
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
Henk Berkman and Paul D. Koch
Payout Yields and Stock Return Predictability: How Important Is the
Measure of Cash Flow?
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
`management fee' to switch to the optimal policy.
Gregory W. Eaton and Bradley S. Paye
Gender Differences in Executives’ Access to Information
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
A. Can Inci, M. P. Narayanan, and H. Nejat Seyhun
Investment Cash Flow Sensitivity: Fact or Fiction?
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
Şenay Ağca and Abon Mozumdar
Bid Resistance by Takeover Targets: Managerial Bargaining or Bad
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.
Thomas W. Bates and David A. Becher
Dynamic Portfolio Choice with Linear Rebalancing Rules
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
We consider another numerical example involving dynamic trading with
preferences and demonstrate that our method can result in
economically large benefits.
Ciamac C. Moallemi and Mehmet Sağlam
Liquidity Constraints and Credit Card Delinquency: Evidence from
Raising Minimum Payments
We use credit card data to estimate the impact of increasing minimum
delinquency, payments, spending, and write-offs. Our identification
an unusual institutional feature: borrowers can use their account to
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
and increasing payments, consequently lowering the interest earned
by the bank.
Philippe d'Astous and Stephen H. Shore
Fortune Favors the Bold
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.
Costanza Meneghetti and Ryan Williams
Hedge Funds: The Good, the Bad, and the Lucky
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.
Yong Chen, Michael Cliff, and Haibei Zhao
CEO Turnover-Performance Sensitivities in Private Firms
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
appears to be investor myopia.
Huasheng Gao, Jarrad Harford, and Kai Li
New Evidence on Mutual Fund Performance: A Comparison of Alternative
We compare two bootstrap methods for assessing mutual fund
Timmermann, Wermers and White (2006) produces narrow confidence
intervals due to
pooling over time, while Fama and French (2010) produces wider
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.
David Blake, Tristan Caulfield, Christos Ioannidis, and Ian Tonks
Social Capital and Debt Contracting: Evidence from Bank Loans and
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
nonprice loan terms, incur lower at-issue bond spreads, and prefer
bonds over loans. We
conclude that debt holders perceive social capital as providing
constraining opportunistic firm behaviors in debt contracting.
Iftekhar Hasan, Chun-Keung (Stan) Hoi, Qiang Wu, and Hao Zhang
Individual Investors’ Dividend Taxes and Corporate Payout Policies
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
Oliver Zhen Li, Hang Liu, Chenkai Ni, and Kangtao Ye
A Multivariate Model of Strategic Asset Allocation with Longevity
Population-wide increase in life expectancy is a source of aggregate
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 oer inexpensive funding
opportunities to asset managers.
Emilio Bisetti, Carlo A. Favero, Giacomo Nocera, and Claudio Tebaldi
Banks’ Internal Capital Markets and Deposit Rates
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.
Itzhak Ben-David, Ajay Palvia, and Chester Spatt
Institutional Investment Constraints and Stock Prices
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 signicantly 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
Jie Cao, Bing Han, and Qinghai Wang
CEO Tournaments: A Cross-Country Analysis of Causes, Cultural
Influences and Consequences
Using a cross-country sample, we examine the CEO tournament
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
Natasha Burns, Kristina Minnick, and Laura Starks
How Do Frictions Affect Corporate Investment? A Structural Approach
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
M. Cecilia Bustamante
Why Do Short Sellers Like Qualitative News?
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.
Bastian von Beschwitz, Oleg Chuprinin, and Massimo Massa
Annual Report Readability, Tone Ambiguity, and the Cost of Borrowing
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
information disclosure but also bear the increased cost of external
Mine Ertugrul, Jin Lei, Jiaping Qiu, and Chi Wan
The Effect of Labor Unions on CEO Compensation
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
Second, we find that CEO compensation is curbed before union
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.
Qianqian Huang, Feng Jiang, Erik Lie, and Tingting Que
The Timing and Source of Long-Run Returns Following Repurchases
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
Leonce Bargeron, Alice Bonaime, and Shawn Thomas
Upper Bounds on Return Predictability
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.
Dashan Huang and Guofu Zhou
Should Indirect Brokerage Fees Be Capped? Lessons from Mutual Fund Marketing and Distribution Expenses
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.
Natalie Y. Oh, Jerry T. Parwada, and Kian M. E. Tan
Gender and Board Activeness: The Role of a Critical Mass
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
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.
Constantinos Antoniou, Glenn W. Harrison, Morten I. Lau, and Daniel Read
Common Macro Factors and Currency Premia
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.
Ilias Filippou and Mark P. Taylor
Stapled Financing, Value Certification, and Lending Efficiency
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.
Hadiye Aslan and Praveen Kumar
Informed Trading Around Stock Split Announcements: Evidence from the Option Market
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.
Philip Gharghori, Edwin D. Maberly, and Annette Nguyen
Model Uncertainty and Exchange Rate Forecasting
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.
Roy Kouwenberg, Agnieszka Markiewicz, Ralph Verhoeks, and Remco C. J. Zwinkels
Short-Term Reversals: The Effects of Past Returns and Institutional Exits
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.
Si Cheng, Allaudeen Hameed, Avanidhar Subrahmanyam, and Sheridan Titman
What Drives the Commonality between Credit Default Swap Spread Changes?
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
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.
H. Arthur Luo and Ronald J. Balvers
Unknown Unknowns: Uncertainty About Risk and Stock Returns
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.
Guido Baltussen, Sjoerd van Bekkum, and Bart van der Grient
Cash Holdings, Competition, and Innovation
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.
Evgeny Lyandres and Berardino Palazzo
Blockholder Heterogeneity, CEO Compensation, and Firm Performance
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.
Christopher P. Clifford and Laura Lindsey
Spreading the Misery? Sources of Bankruptcy Spillover in the Supply Chain
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.
Madhuparna Kolay, Michael Lemmon, and Elizabeth Tashjian
Key Human Capital
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
Ryan D. Israelsen and Scott E. Yonker
Shareholder Composition and Managerial Compensation
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.
Shinya Shinozaki, Hiroshi Moriyasu, and Konari Uchida
Optimal Option Portfolio Strategies: Deepening the Puzzle of Index Option Mispricing
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.
José Afonso Faias and Pedro Santa-Clara
To Pay or be Paid? The Impact of Taker Fees and Order Flow Inducements on Trading Costs in U.S. Options Markets
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.
Robert Battalio, Andriy Shkilko, and Robert Van Ness
Real Options, Idiosyncratic Skewness, and Diversification
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.
Luca Del Viva, Eero Kasanen, and Lenos Trigeorgis
Seasonal Asset Allocation: Evidence from Mutual Fund Flows
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
Mark J. Kamstra, Lisa A. Kramer, Maurice D. Levi, and Russ Wermers
The Strategic Behavior of Firms with Debt
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.
Jerome Reboul Anna Toldrà-Simats
Alliances and Return Predictability
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’.
Jie Cao, Tarun Chordia, and Chen Lin
Industrial Electricity Usage and Stock Returns
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.
Zhi Da, Dayong Huang, and Hayong Yun
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.
Avraham Kamara, Robert A. Korajczyk, Xiaoxia Lou, and Ronnie Sadka
Strategic Delays and Clustering in Hedge Fund Reported Returns
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.
George O. Aragon and Vikram Nanda
Anchoring Credit Default Swap Spreads to Firm Fundamentals
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.
Jennie Bai and Liuren Wu
Speculators, Prices and Market Volatility
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.
Celso Brunetti, Bahattin Büyüksahin, and Jeffrey H. Harris
The Dynamics of Performance Volatility and Firm Valuation
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.
Jianxin (Daniel) Chi and Xunhua Su
Buyers versus Sellers: Who Initiates Trades and When?
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.
Tarun Chordia, Amit Goyal, and Narasimhan Jegadeesh
Sovereign Default Risk and the US Equity Market
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
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.
Doron Avramov, Si Cheng, and Allaudeen Hameed
Creative Destruction and Asset Prices
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.
Joachim Grammig and Stephan Jank
Sentiment and the Effectiveness of Technical Analysis: Evidence from the Hedge Fund Industry
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.
David M. Smith, Na Wang, Ying Wang, and Edward J. Zychowicz
Asymmetric Information, Financial Reporting, and Open Market Share Repurchases
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.
Matthew T. Billett and Miaomiao Yu
Do Banks Issue Equity When They Are Poorly Capitalized?
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.
Valeriya Dinger and Francesco Vallascas
Initial Public Offering Allocations, Price Support, and Secondary Investors
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
Sturla Lyngnes Fjesme
Continuing Overreaction and Stock Return Predictability
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.
Suk Joon Byun, Sonya S. Lim, and Sang Hyun Yun
The Determinants and Performance Impact of Outside Board Leadership
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.
Steven Balsam, John Puthenpurackal, and Arun Upadhyay
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.
Fabian Hollstein and Marcel Prokopczuk
Does Competition Matter for Corporate Governance? The Role of Country Characteristics
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.
Jean-Claude Cosset, Hyacinthe Y. Somé, and Pascale Valéry
Urban Agglomeration and CEO Compensation
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
Bill Francis, Iftekhar Hasan, Kose John, and Maya Waisman
Labor Income, Relative Wealth Concerns, and the Cross-Section of Stock Returns
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.
Juan-Pedro Gómez, Richard Priestley, and Fernando Zapatero
Does Common Analyst Coverage Explain Excess Comovement?
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.
Ryan D. Israelsen
The Effects of Government Interventions in the Financial Sector on Banking Competition and the Evolution of Zombie Banks
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.
Cesar Calderon and Klaus Schaeck
Liquidity Risk and the Credit Crunch of 2007-2008:
Evidence from Micro-Level Data on Mortgage Loan Applications
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
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
Jonathan Lewellen and Katharina Lewellen
Ambiguity Aversion and Underdiversication
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.
Massimo Guidolin and Hening Liu
Option Valuation with Macro-Finance Variables
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
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.
Shan He and C. Wei Li
Differential Access to Price Information in Financial Markets
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.
David Easley, Maureen O'Hara, and Liyan Yang
Last updated July 25, 2016.