Forthcoming Articles

Operating Leverage, Profitability, and Capital Structure

Zhiyao Chen, Jarrad Harford, and Avraham Kamara

Operating leverage increases profitability and reduces optimal financial leverage. Thus, operating leverage generates a negative relation between profitability and financial leverage that is thought to be inconsistent with the trade-off theory, but is commonly observed in the data. We demonstrate the effect of operating leverage on firms’ profitability and financial leverage, as well as on the empirical relation between profitability and financial leverage, by using China’s entry into the World Trade Organization in 2001 and its effect on the capital-labor ratio of US firms.

Factor Structure in Commodity Futures Return and Volatility

Peter Christoffersen, Asger Lunde, and Kasper V. Olesen

We uncover stylized facts of commodity futures’ price and volatility dynamics in the post-financialization period and find a factor structure in daily commodity volatility that is much stronger than the factor structure in returns. The common factor in commodity volatility relates to stock market volatility as well as to the business cycle. Model-free realized commodity betas with the stock market were high during 2008–2010, but have since returned to the pre-crisis level, close to zero. While commodity markets appear segmented from the equity market when considering only returns, commodity volatility indicates a nontrivial degree of market integration.

Tail Risk and the Cross-Section of Mutual Fund Expected Returns

Nikolaos Karagiannis and Konstantinos Tolikas

We test for the presence of a tail risk premium in the cross-section of mutual fund returns and find that the top tail risk quintile of funds outperforms the bottom by 4.4% per annum. This premium is not simply a reward for market risk, nor do commonly used risk factors offer an adequate explanation. Our findings hold across double-sorted portfolios formed on tail risk and a number of fund characteristics. We also find that funds susceptible to tail risk tend to be small, young, have high management fees, and have managers who do not risk their own capital.

Heterogeneity of Beliefs and Trade in Experimental Asset Markets

Tim A. Carle, Yaron Lahav, Tibor Neugebauer, and Charles N. Noussair

We investigate the relationship between traders’ expectations and market outcomes with experimental asset market data. The data show that those who have high price expectations buy more frequently and submit higher bids, and those who hold low price expectations sell more frequently and submit lower bids. Traders who have more accurate expectations achieve greater earnings. Simulations using only belief data reproduce the pricing patterns observed in the market well, indicating that the heterogeneity of expectations is a key to explaining market activity.

Getting Paid to Hedge: Why Don’t Investors Pay a Premium to Hedge Downturns?

Nishad Kapadia, Barbara Ostdiek, James P. Weston, and Morad Zekhnini

Stocks that hedge sustained market downturns should have low expected returns, but they do not. We use ex ante firm characteristics and covariances to construct a tradable Safe Minus Risky (SMR) portfolio that hedges market downturns out-of-sample. Although downturns (peaks to troughs in market index levels at the business cycle frequency) predict significant declines in GDP growth, SMR has significant positive average returns and four factor alphas (both around 0.8% per month). Risk-based models do not explain SMR’s returns, but mispricing does. Risky stocks are overpriced when sentiment is high, resulting in subsequent returns of −0.9% per month.

Union Concessions following Asset Sales and Takeovers

Erik Lie and Tingting Que

We document that the likelihood of asset sales increases with union presence and union wages. Furthermore, acquiring firms gain significant concessions from the incumbent union following asset sales. Finally, the anticipation of union concessions helps explain the excess stock returns around asset sale announcements. We find no comparable effects for takeovers. We conclude that asset sales, but not takeovers, are partially motivated by the potential to extract concessions from unions.

Coskewness Risk Decomposition, Covariation Risk, and Intertemporal Asset Pricing

Petko S. Kalev, Konark Saxena, and Leon Zolotoy

We develop an intertemporal asset pricing model where cash flow news, discount rate news, and their second moments are priced by the market. This model generalizes the market return decomposition framework, showing that intertemporal considerations imply a decomposition of squared market returns (coskewness risk). Our model accounts for 68% of the return variation across size-, book-to-market-, momentum-, investment-, and profitability-sorted portfolios for a modem U.S. sample period. Further, our findings highlight the importance of covariation risk, that is, the risk of simultaneous unfavorable shocks to cash flows and discount rates, in understanding equity risk premia.

Investor Protection and the Long-Run Performance of Activism

Pouyan Foroughi, Namho Kang, Gideon Ozik, and Ronnie Sadka

Using a parsimonious measure of investor protection constructed from fund organizational characteristics, this paper documents that companies targeted by activists with better investor protection structures outperform those targeted by poor-investor-protection activists by roughly 10% per year. The outperformance is observed only for active targets for which 13Ds are filed, but not for passive 13G investments, indicating that the effect is not explained by a superior target selection ability. The evidence suggests that funds with better investor protection achieve increased profitability and valuation ratio of their targets by reducing agency costs, improving corporate governance, and collaborating with other large institutional investors.

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