A Tale of Two Premiums: The Role of Hedgers and Speculators in Commodity Futures Markets
Published: 10/12/2019 | DOI: 10.1111/jofi.12845
WENJIN KANG, K. GEERT ROUWENHORST, KE TANG
This paper studies the dynamic interaction between the net positions of traders and risk premiums in commodity futures markets. Short‐term position changes are driven mainly by the liquidity demands of noncommercial traders, while long‐term variation is driven primarily by the hedging demands of commercial traders. These two components influence expected futures returns with opposite signs. The gains from providing liquidity by commercials largely offset the premium they pay for obtaining price insurance.
Tax‐Efficient Asset Management: Evidence from Equity Mutual Funds
Published: 10/10/2019 | DOI: 10.1111/jofi.12843
CLEMENS SIALM, HANJIANG ZHANG
We investigate the relation between tax burdens and mutual fund performance from both a theoretical and an empirical perspective. The theoretical model introduces heterogeneous tax clienteles in an environment with decreasing returns to scale and shows that the equilibrium performance of mutual funds depends on the size of the tax clienteles. Our empirical results show that the performance of U.S. equity mutual funds is related to their tax burdens. We find that tax‐efficient funds exhibit not only superior after‐tax performance, but also superior before‐tax performance due to lower trading costs, favorable style exposures, and better selectivity.
The Market for Conflicted Advice
Published: 10/10/2019 | DOI: 10.1111/jofi.12848
BRIANA CHANG, MARTIN SZYDLOWSKI
We present a model of the market for advice in which advisers have conflicts of interest and compete for heterogeneous customers through information provision. The competitive equilibrium features information dispersion and partial disclosure. While conflicted fees lead to distorted information, they are irrelevant for customers' welfare: banning conflicted fees improves only the information quality, not customers' welfare. Instead, financial literacy education for the least informed customers can improve all customers' welfare, because of a spillover effect. Furthermore, customers who trade through advisers realize lower average returns, which rationalizes empirical findings.
Does Borrowing from Banks Cost More than Borrowing from the Market?
Published: 10/9/2019 | DOI: 10.1111/jofi.12849
MICHAEL SCHWERT
This paper investigates the pricing of bank loans relative to capital market debt. The analysis uses a novel sample of loans matched with bond spreads from the same firm on the same date. After accounting for seniority, lenders earn a large premium relative to the bond‐implied credit spread. In a sample of secured term loans to noninvestment‐grade firms, the average premium is 140 to 170 bps or about half of the all‐in‐drawn spread. This is the first direct evidence of firms' willingness to pay for bank credit and raises questions about the nature of competition in the loan market.
Published: 10/9/2019 | DOI: 10.1111/jofi.12846
KEVIN ARETZ, MURILLO CAMPELLO, MARIA‐TERESA MARCHICA
France's Ordonnance 2006‐346 repudiated the notion of possessory ownership in the Napoleonic Code, easing the pledge of physical assets in a country where credit was highly concentrated. A differences‐test strategy shows that firms operating newly pledgeable assets significantly increased their borrowing following the reform. Small, young, and financially constrained businesses benefitted the most, observing improved credit access and real‐side outcomes. Start‐ups emerged with higher “at‐inception” leverage, located farther from large cities, with more assets‐in‐place than before. Their exit and bankruptcy rates declined. Spatial analyses show that the reform reached firms in rural areas, reducing credit access inequality across France's countryside.
Trading Against the Random Expiration of Private Information: A Natural Experiment
Published: 10/9/2019 | DOI: 10.1111/jofi.12844
MOHAMMADREZA BOLANDNAZAR, ROBERT J. JACKSON, WEI JIANG, JOSHUA MITTS
For years, the SEC accidentally distributed securities disclosures to some investors before the public. We expolit this setting, which is unique because the delay until public disclosure was exogenous and the private information window was well defined, to study informed trading with a random stopping time. Trading intensity and the pace at which prices incorporate information decrease with the expected delay until public release, but the relation between trading intensity and time elapsed varies with traders' learning process. Noise trading and relative information advantage play similar roles as in standard microstructure theories assuming a fixed time window.
Houses as ATMs? Mortgage Refinancing and Macroeconomic Uncertainty
Published: 10/8/2019 | DOI: 10.1111/jofi.12842
HUI CHEN, MICHAEL MICHAUX, NIKOLAI ROUSSANOV
Mortgage refinancing activity associated with extraction of home equity contains a strongly countercyclical component consistent with household demand for liquidity. We estimate a structural model of liquidity management featuring countercyclical idiosyncratic labor income uncertainty, long‐ and short‐term mortgages, and realistic borrowing constraints. We empirically evaluate its predictions for households' choices of leverage, liquid assets, and mortgage refinancing using micro‐level data. Taking the observed historical paths of house prices, aggregate income, and interest rates as given, the model accounts for many salient features in the evolution of balance sheets and consumption in the cross section of households over 2001 to 2012.
Thinking about Prices versus Thinking about Returns in Financial Markets
Published: 9/3/2019 | DOI: 10.1111/jofi.12835
MARKUS GLASER, ZWETELINA ILIEWA, MARTIN WEBER
Prices and returns are alternative ways to present information and to elicit expectations in financial markets. But do investors think of prices and returns in the same way? We present three studies in which subjects differ in the level of expertise, amount of information, and type of incentive scheme. The results are consistent across all studies: asking subjects to forecast returns as opposed to prices results in higher expectations, whereas showing them return charts rather than price charts results in lower expectations. Experience is not a useful remedy but cognitive reflection mitigates the impact of format changes.
Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows
Published: 8/29/2019 | DOI: 10.1111/jofi.12841
SAMUEL M. HARTZMARK, ABIGAIL B. SUSSMAN
Examining a shock to the salience of the sustainability of the U.S. mutual fund market, we present causal evidence that investors marketwide value sustainability: being categorized as low sustainability resulted in net outflows of more than $12 billion while being categorized as high sustainability led to net inflows of more than $24 billion. Experimental evidence suggests that sustainability is viewed as positively predicting future performance, but we do not find evidence that high‐sustainability funds outperform low‐sustainability funds. The evidence is consistent with positive affect influencing expectations of sustainable fund performance and nonpecuniary motives influencing investment decisions.
A Dynamic Model of Characteristic‐Based Return Predictability
Published: 8/28/2019 | DOI: 10.1111/jofi.12839
AYDOĞAN ALTI, SHERIDAN TITMAN
We present a dynamic model that links characteristic‐based return predictability to systematic factors that determine the evolution of firm fundamentals. In the model, an economy‐wide disruption process reallocates profits from existing businesses to new projects and thus generates a source of systematic risk for portfolios of firms sorted on value, profitability, and asset growth. If investors are overconfident about their ability to evaluate the disruption climate, these characteristic‐sorted portfolios exhibit persistent mispricing. The model generates predictions about the conditional predictability of characteristic‐sorted portfolio returns and illustrates how return persistence increases the likelihood of observing characteristic‐based anomalies.
Brokers and Order Flow Leakage: Evidence from Fire Sales
Published: 8/28/2019 | DOI: 10.1111/jofi.12840
ANDREA BARBON, MARCO DI MAGGIO, FRANCESCO FRANZONI, AUGUSTIN LANDIER
Using trade‐level data, we study whether brokers play a role in spreading order flow information in the stock market. We focus on large portfolio liquidations that result in temporary price drops, and identify the brokers who intermediate these trades. These brokers’ clients are more likely to predate on the liquidating funds than to provide liquidity. Predation leads to profits of about 25 basis points over 10 days and increases the liquidation costs of the distressed fund by 40%. This evidence suggests a role of information leakage in exacerbating fire sales.
Information Revelation in Decentralized Markets
Published: 8/28/2019 | DOI: 10.1111/jofi.12838
BJÖRN HAGSTRÖMER, ALBERT J. MENKVELD
How does information get revealed in decentralized markets? We test several hypotheses inspired by recent dealer‐network theory. To do so, we construct an empirical map of information revelation where two dealers are connected based on the synchronicity of their quote changes. The tests, based on the euro to Swiss franc spot rate (EUR/CHF) quote data including the 2015 crash, largely support theory: strongly connected (i.e., central) dealers are more informed. Connections are weaker when there is less to be learned. The crash serves to identify how a network forms when dealers are transitioned from no‐learning to learning, that is, from a fixed to a floating rate.
Where Is the Risk in Value? Evidence from a Market‐to‐Book Decomposition
Published: 8/27/2019 | DOI: 10.1111/jofi.12836
ANDREY GOLUBOV, THEODOSIA KONSTANTINIDI
We study the value premium using the multiples‐based market‐to‐book decomposition of Rhodes‐Kropf, Robinson, and Viswanathan (2005). The market‐to‐value component drives all of the value strategy return, while the value‐to‐book component exhibits no return predictability in either portfolio sorts or firm‐level regressions. Existing results linking market‐to‐book to operating leverage, duration, exposure to investment‐specific technology shocks, and analysts’ risk ratings derive from the unpriced value‐to‐book component. In contrast, results on expectation errors, limits to arbitrage, and certain types of cash flow risk and consumption risk exposure are due to the market‐to‐value component. Overall, our evidence casts doubt on several value premium theories.
Nonfinancial Firms as Cross‐Market Arbitrageurs
Published: 8/27/2019 | DOI: 10.1111/jofi.12837
YUERAN MA
I demonstrate that nonfinancial corporations act as cross‐market arbitrageurs in their own securities. Firms use one type of security to replace another in response to shifts in relative valuations, inducing negatively correlated financing flows in different markets. Net equity repurchases and net debt issuance both increase when expected excess returns on debt are particularly low, or when expected excess returns on equity are relatively high. Credit valuations affect equity financing as much as equity valuations do, and vice versa. Cross‐market corporate arbitrage is most prevalent among large, unconstrained firms, and helps account for aggregate financing patterns.
Words Speak Louder without Actions
Published: 8/6/2019 | DOI: 10.1111/jofi.12834
DORON LEVIT
Information and control rights are central aspects of leadership, management, and corporate governance. This paper studies a principal‐agent model that features both communication and intervention as alternative means to exert influence. The main result shows that a principal's power to intervene in an agent's decision limits the ability of the principal to effectively communicate her private information. The perverse effect of intervention on communication can harm the principal, especially when the cost of intervention is low or the underlying agency problem is severe. These novel results are applied to managerial leadership, corporate boards, private equity, and shareholder activism.
Learning from Coworkers: Peer Effects on Individual Investment Decisions
Published: 7/30/2019 | DOI: 10.1111/jofi.12830
PAIGE OUIMET, GEOFFREY TATE
Using unique data on employee stock purchase plans (ESPPs), we examine the influence of networks on investment decisions. Comparing employees within a firm during the same election window with metro area fixed effects, we find that the choices of coworkers in the firm's ESPP exert a significant influence on employees’ own decisions to participate and trade. Moreover, we find that the presence of high‐information employees magnifies the effects of peer networks. Given participation in an ESPP is value‐maximizing, our analysis suggests the potential of networks and targeted investor education to improve financial decision‐making.
Funding Liquidity without Banks: Evidence from a Shock to the Cost of Very Short‐Term Debt
Published: 7/29/2019 | DOI: 10.1111/jofi.12832
FELIPE RESTREPO, LINA CARDONA‐SOSA, PHILIP E. STRAHAN
In 2011, Colombia instituted a tax on repayment of bank loans, which increased the cost of short‐term bank credit more than long‐term credit. Firms responded by cutting short‐term loans for liquidity management purposes and increasing the use of cash and trade credit. In industries in which trade credit is more accessible (based on U.S. Compustat firms), we find substitution into accounts payable and little effect on cash and investment. Where trade credit is less available, firms increase cash and cut investment. Thus, trade credit provides an alternative source of liquidity that can insulate some firms from bank liquidity shocks.
Pledgeability, Industry Liquidity, and Financing Cycles
Published: 7/26/2019 | DOI: 10.1111/jofi.12831
DOUGLAS W. DIAMOND, YUNZHI HU, RAGHURAM G. RAJAN
Why do firms choose high debt when they anticipate high valuations, and underperform subsequently? We propose a theory of financing cycles where the importance of creditors’ control rights over cash flows (“pledgeability”) varies with industry liquidity. The market allows firms take on more debt when they anticipate higher future liquidity. However, both high anticipated liquidity and the resulting high debt limit their incentives to enhance pledgeability. This has prolonged adverse effects in a downturn. Because these effects are hard to contract upon, higher anticipated liquidity can also reduce a firm's current access to finance.
Diagnostic Expectations and Stock Returns
Published: 7/23/2019 | DOI: 10.1111/jofi.12833
PEDRO BORDALO, NICOLA GENNAIOLI, RAFAEL LA PORTA, ANDREI SHLEIFER
We revisit La Porta's finding that returns on stocks with the most optimistic analyst long‐term earnings growth forecasts are lower than those on stocks with the most pessimistic forecasts. We document the joint dynamics of fundamentals, expectations, and returns of these portfolios, and explain the facts using a model of belief formation based on the representativeness heuristic. Analysts forecast fundamentals from observed earnings growth, but overreact to news by exaggerating the probability of states that have become more likely. We find support for the model's predictions. A quantitative estimation of the model accounts for the key patterns in the data.
Women's Liberation as a Financial Innovation
Published: 7/19/2019 | DOI: 10.1111/jofi.12829
MOSHE HAZAN, DAVID WEISS, HOSNY ZOABI
YOLO: Mortality Beliefs and Household Finance Puzzles
Published: 7/17/2019 | DOI: 10.1111/jofi.12828
RAWLEY Z. HEIMER, KRISTIAN OVE R. MYRSETH, RAPHAEL S. SCHOENLE
We study the effect of subjective mortality beliefs on life‐cycle behavior. With new survey evidence, we document that survival is underestimated (overestimated) by the young (old). We calibrate a canonical life‐cycle model to elicited beliefs. Relative to calibrations using actuarial probabilities, the young undersave by 26%, and retirees draw down their assets 27% slower, while the model's fit to consumption data improves by 88%. Cross‐sectional regressions support the model's predictions: Distorted mortality beliefs correlate with savings behavior while controlling for risk preferences, cognitive, and socioeconomic factors. Overweighting the likelihood of rare events contributes to mortality belief distortions.
Over‐the‐Counter Market Frictions and Yield Spread Changes
Published: 7/15/2019 | DOI: 10.1111/jofi.12827
NILS FRIEWALD, FLORIAN NAGLER
We empirically study whether systematic over‐the‐counter (OTC) market frictions drive the large unexplained common factor in yield spread changes. Using transaction data on U.S. corporate bonds, we find that marketwide inventory, search, and bargaining frictions explain 23.4% of the variation in the common component. Systematic OTC frictions thus substantially improve the explanatory power of yield spread changes and account for one‐third of their total explained variation. Search and bargaining frictions combined explain more in the common dynamics of yield spread changes than inventory frictions. Our findings support the implications of leading theories of intermediation frictions in OTC markets.
Measuring Institutional Investors’ Skill at Making Private Equity Investments
Published: 6/20/2019 | DOI: 10.1111/jofi.12783
DANIEL R. CAVAGNARO, BERK A. SENSOY, YINGDI WANG, MICHAEL S. WEISBACH
Using a large sample of institutional investors’ investments in private equity funds raised between 1991 and 2011, we estimate the extent to which investors’ skill affects their returns. Bootstrap analyses show that the variance of actual performance is higher than would be expected by chance, suggesting that some investors consistently outperform. Extending the Bayesian approach of Korteweg and Sorensen, we estimate that a one‐standard‐deviation increase in skill leads to an increase in annual returns of between one and two percentage points. These results are stronger in the earlier part of the sample period and for venture funds.