Presidential Address: Macrofinance and Resilience
Version of Record online: 11/11/2024 | DOI: 10.1111/jofi.13403
MARKUS K. BRUNNERMEIER
This address reviews macrofinance from the perspective of resilience. It argues for a shift in mindset, away from risk management toward resilience management. It proposes a new resilience measure, and contrasts micro‐ and macro‐resilience. It also classifies macrofinance models in first‐ (log‐linearized) and second‐generation models, and links the important themes of macrofinance to resilience.
Scope, Scale, and Concentration: The 21st‐Century Firm
Version of Record online: 11/4/2024 | DOI: 10.1111/jofi.13400
GERARD HOBERG, GORDON M. PHILLIPS
We provide evidence using firm 10‐Ks that over the past 30 years, U.S. firms have expanded their scope of operations. Increases in scope were achieved largely without increasing traditional operating segments. Scope expansion significantly increases valuation and is realized primarily through acquisitions and investment in R&D, but not through capital expenditures. Traditional concentration ratios do not capture this expansion of scope. Our findings point to a new type of firm that increases scope through related expansion, which is highly valued by the market.
Version of Record online: 10/27/2024 | DOI: 10.1111/jofi.13401
JONATHAN BROGAARD, MATTHEW C. RINGGENBERG, DOMINIK ROESCH
Although algorithmic trading now dominates financial markets, some exchanges continue to use human floor traders. On March 23, 2020 the NYSE suspended floor trading because of COVID‐19. Using a difference‐in‐differences analysis around the closure of the floor, we find that floor traders are important contributors to market quality. The suspension of floor trading leads to higher spreads and larger pricing errors for treated stocks relative to control stocks. To explore the mechanism, we exploit two partial floor reopenings that have different characteristics. Our finding suggests that in‐person human interaction facilitates the transfer of valuable information that algorithms lack.
A Multifactor Perspective on Volatility‐Managed Portfolios
Version of Record online: 10/27/2024 | DOI: 10.1111/jofi.13395
VICTOR DeMIGUEL, ALBERTO MARTÍN‐UTRERA, RAMAN UPPAL
Moreira and Muir question the existence of a strong risk‐return trade‐off by showing that investors can improve performance by reducing exposure to risk factors when their volatility is high. However, Cederburg et al. show that these strategies fail out‐of‐sample, and Barroso and Detzel show they do not survive transaction costs. We propose a conditional multifactor portfolio that outperforms its unconditional counterpart even out‐of‐sample and net of costs. Moreover, we show that factor risk prices generally decrease with market volatility. Our results demonstrate that the breakdown of the risk‐return trade‐off is more puzzling than previously thought.
Equilibrium Data Mining and Data Abundance
Version of Record online: 10/27/2024 | DOI: 10.1111/jofi.13397
JÉRÔME DUGAST, THIERRY FOUCAULT
We study theoretically how the proliferation of new data (“data abundance”) affects the allocation of capital between quantitative and nonquantitative asset managers (“data miners” and “experts”), their performance, and price informativeness. Data miners search for predictors of asset payoffs and select those with a sufficiently high precision. Data abundance raises the precision of the best predictors, but it can induce data miners to search less intensively for high‐precision signals. In this case, their performance becomes more dispersed and they receive less capital. Nevertheless, data abundance always raises price informativeness and can therefore reduce asset managers' average performance.
Equity Term Structures without Dividend Strips Data
Version of Record online: 10/24/2024 | DOI: 10.1111/jofi.13394
STEFANO GIGLIO, BRYAN KELLY, SERHIY KOZAK
We use a large cross section of equity returns to estimate a rich affine model of equity prices, dividends, returns, and their dynamics. Our model prices dividend strips of the market and equity portfolios without using strips data in the estimation. Yet model‐implied equity yields closely match yields on traded strips. Our model extends equity term‐structure data over time (to the 1970s) and across maturities, and generates term structures for various equity portfolios. The novel cross section of term structures from our model covers 45 years and includes several recessions, providing a novel set of empirical moments to discipline asset pricing models.
Carbon Returns across the Globe
Version of Record online: 10/21/2024 | DOI: 10.1111/jofi.13402
SHAOJUN ZHANG
The pricing of carbon transition risk is central to the debate on climate‐aware investments. Emissions are tightly linked to sales and are available to investors only with significant lags. The positive carbon return, or brown‐minus‐green return differential, documented in previous studies arises from forward‐looking firm performance information contained in emissions rather than a risk premium in ex ante expected returns. After accounting for the data release lag, carbon returns turn negative in the United States and insignificant globally. Developed markets experience lower carbon returns due to intense climate concern shocks, while countries with stringent climate policies exhibit higher carbon returns.
Mortgage Lock‐In, Mobility, and Labor Reallocation
Version of Record online: 10/20/2024 | DOI: 10.1111/jofi.13398
JULIA FONSECA, LU LIU
We study the impact of rising mortgage rates on mobility and labor reallocation. Using individual‐level credit record data and variation in the timing of mortgage origination, we show that a 1 percentage point decline in the difference between mortgage rates locked in at origination and current rates reduces moving by 9% overall and 16% between 2022 and 2024, and this relationship is asymmetric. Mortgage lock‐in also dampens flows in and out of self‐employment and the responsiveness to shocks to nearby employment opportunities that require moving, measured as wage growth within a 50‐ to 150‐mile ring and instrumented with a shift‐share instrument.
Bonds versus Equities: Information for Investment
Version of Record online: 10/20/2024 | DOI: 10.1111/jofi.13396
HUIFENG CHANG, ADRIEN D'AVERNAS, ANDREA L. EISFELDT
We provide a simple model of investment by a firm funded with debt and equity and empirical evidence to demonstrate that, once we control for the debt overhang problem with credit spreads, asset volatility is an unambiguously positive signal for investment, while equity volatility sends a mixed signal: Elevated volatility raises the option value of equity and increases investment for financially sound firms, but exacerbates debt overhang and decreases investment for firms close to default. Our study provides a simple unified understanding of the structural and empirical relationships between investment, credit spreads, equity versus asset volatility, leverage, and Tobin's q$q$.
Financial Sophistication and Consumer Spending
Version of Record online: 10/17/2024 | DOI: 10.1111/jofi.13393
ADAM TEJS JØRRING
Using detailed account‐level data, this paper explores how financial sophistication affects consumers' spending responses to changes in income. I document that, controlling for liquidity, financially unsophisticated consumers display significant spending responses to predictable decreases in their disposable income. Furthermore, they have lower savings rates, fewer liquid savings, and higher debt‐to‐income ratios, leaving them more exposed to income shocks. Robustness tests, supported by anecdotal survey evidence, indicate that these results are driven by some consumers' lack of financial sophistication and their consequent failure to understand their financial contracts, rather than by random idiosyncratic shocks, rational liquidity management, or optimal inattention.
Time‐Consistent Individuals, Time‐Inconsistent Households
Version of Record online: 10/16/2024 | DOI: 10.1111/jofi.13392
ANDREW HERTZBERG
I present a model of consumption and savings for a multiperson household in which members are imperfectly altruistic, derive utility from both private and shared public goods, and share wealth. I show that, despite having standard exponential time preferences, the household is time‐inconsistent: Members save too little and overspend on private consumption goods. The household remains time‐inconsistent even when members save separately, because the possibility of voluntary transfers or joint contribution to the public good preserves the dynamic commons problem. The household will choose to share wealth when the risk‐sharing benefits outweigh the utility cost of overconsumption.
Liquidity Transformation and Fragility in the U.S. Banking Sector
Version of Record online: 10/13/2024 | DOI: 10.1111/jofi.13390
QI CHEN, ITAY GOLDSTEIN, ZEQIONG HUANG, RAHUL VASHISHTHA
Liquidity transformation, a key role of banks, is thought to increase fragility, as uninsured depositors face an incentive to withdraw money before others (a so‐called panic run). Despite much theoretical work, however, there is little empirical evidence establishing this mechanism. In this paper, we provide the first large‐scale evidence of this mechanism. Banks that engage in more liquidity transformation exhibit higher fragility, as captured by stronger sensitivities of uninsured deposit flows to bank performance and greater levels of uninsured deposit outflows when performance is poor. We also explore the effects of deposit insurance and systemic risk.
Utility Tokens as a Commitment to Competition
Version of Record online: 10/10/2024 | DOI: 10.1111/jofi.13389
ITAY GOLDSTEIN, DEEKSHA GUPTA, RUSLAN SVERCHKOV
We show that utility tokens can limit the rent‐seeking activities of two‐sided platforms with market power while preserving efficiency gains due to network effects. We model platforms where buyers and sellers can meet to exchange services. Tokens serve as the sole medium of exchange on a platform and can be traded in a secondary market. Tokenizing a platform commits a firm to give up monopolistic rents associated with the control of the platform, leading to long‐run competitive prices. We show how the threat of entrants can incentivize developers to tokenize and discuss cases where regulation is needed to enforce tokenization.
Putting the Price in Asset Pricing
Version of Record online: 10/9/2024 | DOI: 10.1111/jofi.13391
THUMMIM CHO, CHRISTOPHER POLK
We propose a novel way to estimate a portfolio's abnormal price, the percentage gap between price and the present value of dividends computed with a chosen asset pricing model. Our method, based on a novel identity, resembles the time‐series estimator of abnormal returns, avoids the issues in alternative approaches, and clarifies the role of risk and mispricing in long‐horizon returns. We apply our techniques to study the cross‐section of price levels relative to the capital asset pricing model (CAPM) and find that a single characteristic, adjusted value, provides a parsimonious model of CAPM‐implied abnormal price.
The Working Capital Credit Multiplier
Version of Record online: 8/27/2024 | DOI: 10.1111/jofi.13385
HEITOR ALMEIDA, DANIEL CARVALHO, TAEHYUN KIM
We provide novel evidence that funding frictions can limit firms’ short‐term investments in receivables and inventories, reducing their production capacity. We propose a credit multiplier driven by these considerations and empirically isolate its importance by comparing how a similar firm responds to shocks differently when these shocks are initiated in their most profitable quarter (“main quarter”). We implement this test using recurring and unpredictable shocks (e.g., oil shocks) and provide extensive evidence supporting our identification strategy. Our results suggest that funding constraints and credit multiplier effects are significant for smaller firms that heavily rely on financing from suppliers.
Treasury Bill Shortages and the Pricing of Short‐Term Assets
Version of Record online: 8/26/2024 | DOI: 10.1111/jofi.13376
ADRIEN D'AVERNAS, QUENTIN VANDEWEYER
We propose a model of post‐Great Financial Crisis (GFC) money markets and monetary policy implementation. In our framework, capital regulation may deter banks from intermediating liquidity derived from holding reserves to shadow banks. Consequently, money markets can be segmented, and the scarcity of Treasury bills available to shadow banks is the main driver of short‐term spreads. In this regime, open market operations have an inverse effect on net liquidity provision when swapping ample reserves for scarce T‐bills or repos. Our model quantitatively accounts for post‐2010 time series for repo rates, T‐bill yields, and the Fed's reverse repo facility usage.
Currency Management by International Fixed‐Income Mutual Funds
Version of Record online: 8/25/2024 | DOI: 10.1111/jofi.13381
CLEMENS SIALM, QIFEI ZHU
Investments in international fixed‐income securities are exposed to significant currency risks. We collect novel data on currency derivatives used by U.S. international fixed‐income funds. We document that while 90% of funds use currency forwards, they hedge, on average, only 18% of their currency exposure. Funds' currency forward positions differ substantially based on risk management demands related to portfolio currency exposure, return‐enhancement motives such as currency momentum and carry trade, and strategic considerations related to past performance and fund clientele. Funds that hedge their currency risk exhibit lower return variability, but do not generate inferior abnormal returns.
Lying to Speak the Truth: Selective Manipulation and Improved Information Transmission
Version of Record online: 8/19/2024 | DOI: 10.1111/jofi.13375
PAUL POVEL, GÜNTER STROBL
We analyze a principal‐agent model in which an effort‐averse agent can manipulate a publicly observable performance report. The principal cannot observe the agent's cost of effort, her effort choice, and whether she manipulated the report. An optimal contract links compensation to the realized output and the (possibly manipulated) report. Manipulation can be beneficial to the principal because it can make the report more informative about the agent's effort choice, thereby reducing the agent's information rent. This is achieved through a contract that incentivizes the agent to selectively engage in manipulation based on her effort choice.