Published: 04/18/2019 | DOI: 10.1111/jofi.12777
Using proprietary credit default swap (CDS) data, I investigate how capital shocks at protection sellers impact pricing in the CDS market. Seller capital shocks — measured as CDS portfolio margin payments — account for 12% of the time‐series variation in weekly spread changes, a significant amount given that standard credit factors account for 18% during my sample. In addition, seller shocks possess information for spreads that is independent of institution‐wide measures of constraints. These findings imply a high degree of market segmentation, and suggest that frictions within specialized financial institutions prevent capital from flowing into the market at shorter horizons.
Published: 04/18/2019 | DOI: 10.1111/jofi.12775
We propose a theoretical measure of income hedging demand and show that it affects asset prices. We focus on the value factor and first demonstrate that our demand estimates are correlated with the actual demands of retail and mutual fund investors. We then show that the aggregate HML demand predicts HML returns. Exploiting the state‐level variation in income risk, we demonstrate that state‐level hedging demands predict state‐level HML returns. A long‐short portfolio that exploits this hedging‐induced predictability earns an annualized risk‐adjusted return of 6%.
Published: 04/18/2019 | DOI: 10.1111/jofi.12780
In this paper, we investigate how globalization is reflected in asset prices. We use shipping costs to measure firms' exposure to globalization. Firms in low shipping cost industries carry a 7% risk premium, suggesting that their cash flows covary negatively with investors' marginal utility. We find that the premium emanates from the risk of displacement of least efficient firms triggered by import competition. These findings suggest that foreign productivity shocks are associated with times when consumption is dear for investors. We discuss conditions under which a standard model of trade with asset prices can rationalize this puzzle.
Published: 04/18/2019 | DOI: 10.1111/jofi.12778
We derive a formula for the expected return on a stock in terms of the risk‐neutral variance of the market and the stock's excess risk‐neutral variance relative to that of the average stock. These quantities can be computed from index and stock option prices; the formula has no free parameters. The theory performs well empirically both in and out of sample. Our results suggest that there is considerably more variation in expected returns, over time and across stocks, than has previously been acknowledged.
Published: 04/17/2019 | DOI: 10.1111/jofi.12779
We analyze how proxy advisors, which sell voting recommendations to shareholders, affect corporate decision‐making. If the quality of the advisor's information is low, there is overreliance on its recommendations and insufficient private information production. In contrast, if the advisor's information is precise, it may be underused because the advisor rations its recommendations to maximize profits. Overall, the advisor's presence leads to more informative voting only if its information is sufficiently precise. We evaluate several proposals on regulating proxy advisors and show that some suggested policies, such as reducing proxy advisors' market power or decreasing litigation pressure, can have negative effects.
Published: 04/17/2019 | DOI: 10.1111/jofi.12776
We document a highly significant, strongly nonlinear dependence of stock and bond returns on past equity market volatility as measured by the VIX. We propose a new estimator for the shape of the nonlinear forecasting relationship that exploits variation in the cross‐section of returns. The nonlinearities are mirror images for stocks and bonds, revealing flight‐to‐safety: expected returns increase for stocks when volatility increases from moderate to high levels while they decline for Treasuries. These findings provide support for dynamic asset pricing theories in which the price of risk is a nonlinear function of market volatility.
Published: 03/30/2019 | DOI: 10.1111/jofi.12773
Although the aggregate capital share of U.S. firms has increased, capital share at the firm‐level has decreased. This divergence is due to mega‐firms that produce a larger output share without a proportionate increase in labor compensation. We develop a model in which firms insure workers against firm‐specific shocks, with more productive firms allocating more rents to shareholders while less productive firms endogenously exit. Increasing firm‐level risk delays exit and increases the measure of mega‐firms, raising (lowering) the aggregate (average) capital share. An increase in the level of rents magnifies this effect. We present evidence that supports this mechanism.
Published: 03/30/2019 | DOI: 10.1111/jofi.12772
A single macroeconomic factor based on growth in the capital share of aggregate income exhibits significant explanatory power for expected returns across a range of equity characteristic portfolios and non‐equity asset classes, with risk price estimates that are of the same sign and similar in magnitude. Positive exposure to capital share risk earns a positive risk premium, commensurate with recent asset pricing models in which redistributive shocks shift the share of income between the wealthy, who finance consumption primarily out of asset ownership, and workers, who finance consumption primarily out of wages and salaries.