Beyond Random Assignment: Credible Inference and Extrapolation in Dynamic Economies
Published: 11/16/2019 | DOI: 10.1111/jofi.12862
CHRISTOPHER A. HENNESSY, ILYA A. STREBULAEV
We derive analytical relationships between shock responses and theory‐implied causal effects (comparative statics) in dynamic settings with linear profits and linear‐quadratic stock accumulation costs. For permanent profitability shocks, responses can have incorrect signs, undershoot, or overshoot depending on the size and sign of realized changes. For profitability shocks that are i.i.d., uniformly distributed, binary, or unanticipated and temporary, there is attenuation bias, which exceeds 50% under plausible parameterizations. We derive a novel sufficient condition for profitability shock responses to equal causal effects: martingale profitability. We establish a battery of sufficient conditions for correct sign estimation, including stochastic monotonicity. Simple extrapolation/error correction formulae are presented.
Relationship Trading in OTC Markets
Published: 11/15/2019 | DOI: 10.1111/jofi.12864
TERRENCE HENDERSHOTT, DAN LI, DMITRY LIVDAN, NORMAN SCHÜRHOFF
We examine the network of trading relationships between insurers and dealers in the over‐the‐counter corporate bond market. Regulatory data show that one‐third of insurers use a single dealer, while other insurers have large dealer networks. Execution prices are nonmonotone in network size, initially declining with more dealers but increasing once networks exceed 20 dealers. A model of decentralized trade in which insurers trade off the benefits of repeat business and faster execution quantitatively fits the distribution of insurers' network size and explains the price–network size relationship. Counterfactual analysis shows that regulations to unbundle trade and nontrade services can decrease welfare.
Informed Trading and Intertemporal Substitution
Published: 11/13/2019 | DOI: 10.1111/jofi.12857
YIZHOU XIAO
I examine the possibility of information‐based trading in a multiperiod consumption setting. I develop a necessary and sufficient condition for trade to occur. Intertemporal substitution introduces a desire to correlate current consumption with future aggregate shocks. When agents have heterogeneous time‐inseparable preferences, information differentially affects relative preferences for current and future consumption, making information‐based trading mutually acceptable. The no‐trade result continues to hold if there is no aggregate shock, or if agents have either homogeneous or time‐separable preferences.
Measuring Innovation and Product Differentiation: Evidence from Mutual Funds
Published: 11/12/2019 | DOI: 10.1111/jofi.12853
LEONARD KOSTOVETSKY, JEROLD B. WARNER
We study innovation and product differentiation using a uniqueness measure based on textual analysis of prospectuses. We find that small and start‐up families have higher start rates than larger families, and their products are more unique. Unique strategies attract more inflows in the first three years, and investors respond more to text‐based uniqueness than other measures such as holdings or returns uniqueness. For established funds, word uniqueness has weak negative power for explaining returns, so investors in competitive equilibrium do not sacrifice much performance to get specialized products. Uniqueness attenuates the flow‐performance relation, reducing the risk of investor outflows.
Trading Against the Random Expiration of Private Information: A Natural Experiment
Published: 11/12/2019 | DOI: 10.1111/jofi.12844
MOHAMMADREZA BOLANDNAZAR, ROBERT J. JACKSON, WEI JIANG, JOSHUA MITTS
For years, the Securities and Exchange Commission (SEC) accidentally distributed securities disclosures to some investors before the public. We exploit 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.
Robust Inference for Consumption‐Based Asset Pricing
Published: 11/12/2019 | DOI: 10.1111/jofi.12855
FRANK KLEIBERGEN, ZHAOGUO ZHAN
The reliability of traditional asset pricing tests depends on: (i) the correlations between asset returns and factors; (ii) the time series sample size T compared to the number of assets N. For macro‐risk factors, like consumption growth, (i) and (ii) are often such that traditional tests cannot be trusted. We extend the Gibbons‐Ross‐Shanken statistic to test identification of risk premia and construct their 95% confidence sets. These sets are wide or unbounded when T and N are close, but show that average returns are not fully spanned by betas when T exceeds N considerably. Our findings indicate when meaningful empirical inference is feasible.
Published: 11/12/2019 | DOI: 10.1111/jofi.12847
DAVID BERGER, NICHOLAS TURNER, ERIC ZWICK
We study temporary fiscal stimulus designed to support distressed housing markets by inducing demand from buyers in the private market. Using difference‐in‐differences and regression kink research designs, we find that the First‐Time Homebuyer Credit increased home sales by 490,000 (9.8%), median home prices by $2,400 (1.1%) per standard deviation increase in program exposure, and the transition rate into homeownership by 53%. The policy response did not reverse immediately. Instead, demand comes from several years in the future: induced buyers were three years younger in 2009 than typical first‐time buyers. The program's market‐stabilizing benefits likely exceeded its direct stimulus effects.
A Tale of Two Premiums: The Role of Hedgers and Speculators in Commodity Futures Markets
Published: 11/12/2019 | 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.
The Insurance Is the Lemon: Failing to Index Contracts
Published: 11/12/2019 | DOI: 10.1111/jofi.12856
BARNEY HARTMAN‐GLASER, BENJAMIN HÉBERT
We model the widespread failure of contracts to share risk using available indices. A borrower and lender can share risk by conditioning repayments on an index. The lender has private information about the ability of this index to measure the true state that the borrower would like to hedge. The lender is risk‐averse and thus requires a premium to insure the borrower. The borrower, however, might be paying something for nothing if the index is a poor measure of the true state. We provide sufficient conditions for this effect to cause the borrower to choose a nonindexed contract instead.
Tax‐Efficient Asset Management: Evidence from Equity Mutual Funds
Published: 11/12/2019 | 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: 11/8/2019 | 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. Although 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.
Houses as ATMs: Mortgage Refinancing and Macroeconomic Uncertainty
Published: 11/7/2019 | 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 microlevel 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.
Why Don't We Agree? Evidence from a Social Network of Investors
Published: 11/7/2019 | DOI: 10.1111/jofi.12852
J. ANTHONY COOKSON, MARINA NIESSNER
We study sources of investor disagreement using sentiment of investors from a social media investing platform, combined with information on the users' investment approaches (e.g., technical, fundamental). We examine how much of overall disagreement is driven by different information sets versus differential interpretation of information by studying disagreement within and across investment approaches. Overall disagreement is evenly split between both sources of disagreement, but within‐group disagreement is more tightly related to trading volume than cross‐group disagreement. Although both sources of disagreement are important, our findings suggest that information differences are more important for trading than differences across market approaches.
Does Borrowing from Banks Cost More than Borrowing from the Market?
Published: 10/30/2019 | 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.
The Impact of Salience on Investor Behavior: Evidence from a Natural Experiment
Published: 10/21/2019 | DOI: 10.1111/jofi.12851
CARY FRYDMAN, BAOLIAN WANG
We test whether the display of information causally affects investor behavior in a high‐stakes trading environment. Using investor‐level brokerage data from China and a natural experiment, we estimate the impact of a shock that increased the salience of a stock's purchase price but did not change the investor's information set. We employ a difference‐in‐differences approach and find that the salience shock causally increased the disposition effect by 17%. We use microdata to document substantial heterogeneity across investors in the treatment effect. A previously documented trading pattern, the “rank effect,” explains heterogeneity in the change in the disposition effect.
On Comparing Asset Pricing Models
Published: 10/20/2019 | DOI: 10.1111/jofi.12854
SIDDHARTHA CHIB, XIAMING ZENG, LINGXIAO ZHAO
Revisiting the framework of Barillas and Shanken (2018), BS henceforth, we show that the Bayesian marginal likelihood‐based model comparison method in that paper is unsound: the priors on the nuisance parameters across models must satisfy a change of variable property for densities that is violated by the Jeffreys priors used in the BS method. Extensive simulation exercises confirm that the BS method performs unsatisfactorily. We derive a new class of improper priors on the nuisance parameters, starting from a single improper prior, which leads to valid marginal likelihoods and model comparisons. The performance of our marginal likelihoods is significantly better, allowing for reliable Bayesian work on which factors are risk factors in asset pricing models.
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.
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.
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.