Forthcoming Articles

The Mismatch Between Mutual Fund Scale and Skill

Published: 6/4/2020  |  DOI: 10.1111/jofi.12950


I demonstrate that skill and scale are mismatched among actively managed equity mutual funds. Many mutual fund investors confuse the effects of fund exposures to common systematic factors with managerial skill when allocating capital among funds. Active mutual funds with positive factor‐related past returns thus accumulate assets to the point that they significantly underperform. I also show that the negative aggregate benchmark‐adjusted performance of active equity mutual funds is driven mainly by these oversized funds.

Cash Flow News and Stock Price Dynamics

Published: 6/4/2020  |  DOI: 10.1111/jofi.12901


We develop a new approach to modeling dynamics in cash flows extracted from daily firm‐level dividend announcements. We decompose daily cash flow news into a persistent component, jumps, and temporary shocks. Empirically, we find that the persistent cash flow component is a highly significant predictor of future growth in dividends and consumption. Using a log‐linearized present value model, we show that news about the persistent dividend growth component predicts stock returns consistent with asset pricing constraints implied by this model. News about the daily dividend growth process also helps explain concurrent return volatility and the probability of jumps in stock returns.

The Employment Effects of Faster Payment: Evidence from the Federal Quickpay Reform

Published: 6/2/2020  |  DOI: 10.1111/jofi.12955


We study the impact of Quickpay, a reform that permanently accelerated payments to small business contractors of the U.S. government. We find a strong direct effect of the reform on employment growth at the firm level. However, we document substantial crowding out of non‐treated firms' employment within local labor markets. While the overall net employment effect is positive, it is close to zero in tight labor markets. Our results highlight an important channel for alleviating financing constraints in small firms, but emphasize the general‐equilibrium effects of large‐scale interventions, which can lead to lower aggregate outcomes depending on labor market conditions.

No Job, No Money, No Refi: Frictions to Refinancing in a Recession

Published: 6//2020  |  DOI: 10.1111/jofi.12952


We study how employment documentation requirements and out‐of‐pocket closing costs constrain mortgage refinancing. These frictions, which bind most severely during recessions, may significantly inhibit monetary policy pass‐through. To study their effects on refinancing, we exploit an FHA policy change that excluded unemployed borrowers from refinancing and increased others' out‐of‐pocket costs substantially. These changes dramatically reduced refinancing rates, particularly among the likely unemployed and those facing new out‐of‐pocket costs. Our results imply that unemployed and liquidity‐constrained borrowers have a high latent demand for refinancing. Cyclical variation in these factors may therefore affect both the aggregate and distributional consequences of monetary policy.

Market Structure and Transaction Costs of Index CDSs

Published: 6//2020  |  DOI: 10.1111/jofi.12953


Despite regulatory efforts to promote all‐to‐all trading, the post‐Dodd‐Frank index CDS market remains two‐tiered. Transaction costs are higher for dealer‐to‐client than interdealer trades, but the difference is explained by the higher, largely permanent, price impact of client trades. Most interdealer trades are liquidity motivated and executed via low‐cost, low‐immediacy trading protocols. Dealer‐to‐client trades are nonanonymous; they almost always improve upon contemporaneous executable interdealer quotes, and dealers appear to price discriminate based on the perceived price impact of trades. Our results suggest that the market structure is a consequence of the characteristics of client trades: relatively infrequent, large, and differentially informed.

Bad Credit, No Problem? Credit and Labor Market Consequences of Bad Credit Reports

Published: 6//2020  |  DOI: 10.1111/jofi.12954


We study the financial and labor market impacts of bad credit reports. Using difference‐in‐differences variation from the staggered removal of bankruptcy flags, we show that bankruptcy flag removal leads to economically large increases in credit limits and borrowing. Using administrative tax records linked to personal bankruptcy records, we estimate economically small effects of flag removal on employment and earnings outcomes. We rationalize these contrasting results by showing that, conditional on basic observables, “hidden” bankruptcy flags are strongly correlated with adverse credit market outcomes but have no predictive power for measures of job performance.

The Causal Effect of Limits to Arbitrage on Asset Pricing Anomalies

Published: 5/29/2020  |  DOI: 10.1111/jofi.12947


We examine the causal effect of limits to arbitrage on 11 well‐known asset pricing anomalies using the pilot program of Regulation SHO, which relaxed short‐sale constraints for a quasi‐random set of pilot stocks, as a natural experiment. We find that the anomalies became weaker on portfolios constructed with pilot stocks during the pilot period. The pilot program reduced the combined anomaly long–short portfolio returns by 72 basis points per month, a difference that survives risk adjustment with standard factor models. The effect comes only from the short legs of the anomaly portfolios.

Presidential Address: Social Transmission Bias in Economics and Finance

Published: 5/27/2020  |  DOI: 10.1111/jofi.12906


I discuss a new intellectual paradigm, social economics and finance—the study of the social processes that shape economic thinking and behavior. This emerging field recognizes that people observe and talk to each other. A key, underexploited building block of social economics and finance is social transmission bias: systematic directional shift in signals or ideas induced by social transactions. I use five “fables” (models) to illustrate the novelty and scope of the transmission bias approach, and offer several emergent themes. For example, social transmission bias compounds recursively, which can help explain booms, bubbles, return anomalies, and swings in economic sentiment.

Informational Frictions and the Credit Crunch

Published: 5/26/2020  |  DOI: 10.1111/jofi.12900


In this paper, I estimate the magnitude of an informational friction limiting credit reallocation to firms during the 2007 to 2009 financial crisis. Because lenders rely on private information when deciding which relationship to end, borrowers looking for a new lender are adversely selected. I show how to separately identify private information from information common to all lenders but unobservable to the econometrician by using bank shocks within a discrete choice model of relationships. Quantitatively, these informational frictions appear to be too small to explain the credit crunch in the U.S. syndicated corporate loan market.

Declining Labor and Capital Shares

Published: 5/26/2020  |  DOI: 10.1111/jofi.12909


This paper presents direct measures of capital costs, equal to the product of the required rate of return on capital and the value of the capital stock. The capital share, equal to the ratio of capital costs and gross value added, does not offset the decline in the labor share. Instead, a large increase in the share of pure profits offsets declines in the shares of both labor and capital. Industry data show that increases in concentration are associated with declines in the labor share.

The Banking View of Bond Risk Premia

Published: 5/20/2020  |  DOI: 10.1111/jofi.12949


Banks' balance‐sheet exposure to fluctuations in interest rates strongly forecasts excess Treasury bond returns. This result is consistent with optimal risk management, a banking counterpart to the household Euler equation. In equilibrium, the bond risk premium compensates banks for bearing fluctuations in interest rates. When banks' exposure to interest rate risk increases, the price of this risk simultaneously rises. We present a collection of empirical observations that support this view, but also discuss several challenges to this interpretation.

A Macrofinance View of U.S. Sovereign CDS Premiums

Published: 5/20/2020  |  DOI: 10.1111/jofi.12948


Premiums on U.S. sovereign credit default swaps (CDS) have risen to persistently elevated levels since the financial crisis. We examine whether these premiums reflect the probability of a fiscal default – a state in which a balanced budget can no longer be restored by raising taxes or eroding the real value of debt by increasing inflation. We develop an equilibrium macrofinance model in which the fiscal and monetary policy stances jointly endogenously determine nominal debt, taxes, inflation, and growth. We show that the CDS premiums reflect the endogenous risk‐adjusted probabilities of fiscal default. The calibrated model is consistent with elevated levels of CDS premiums but leaves dynamic implications quantitatively unresolved.

False (and Missed) Discoveries in Financial Economics

Published: 5/19/2020  |  DOI: 10.1111/jofi.12951


Multiple testing plagues many important questions in finance such as fund and factor selection. We propose a new way to calibrate both Type I and Type II errors. Next, using a double‐bootstrap method, we establish a t‐statistic hurdle that is associated with a specific false discovery rate (e.g., 5%). We also establish a hurdle that is associated with a certain acceptable ratio of misses to false discoveries (Type II error scaled by Type I error), which effectively allows for differential costs of the two types of mistakes. Evaluating current methods, we find that they lack power to detect outperforming managers.

Price and Probability: Decomposing the Takeover Effects of Anti‐Takeover Provisions

Published: 5/12/2020  |  DOI: 10.1111/jofi.12908


We study the effects of anti‐takeover provisions (ATPs) on the takeover probability, the takeover premium, and target selection. Voting to remove an ATP increases both the takeover probability and the takeover premium, that is, there is no evidence of a trade‐off between premiums and takeover probabilities. We provide causal estimates based on shareholder proposals to remove ATPs and address the endogenous selection of targets through bounding techniques. The positive premium effect in less protected firms is driven by better bidder‐target matching and merger synergies.

Understanding Systematic Risk: A High‐Frequency Approach

Published: 5/8/2020  |  DOI: 10.1111/jofi.12898


Based on a novel high‐frequency data set for a large number of firms, I estimate the time‐varying latent continuous and jump factors that explain individual stock returns. The factors are estimated using principal component analysis applied to a local volatility and jump covariance matrix. I find four stable continuous systematic factors, which can be well approximated by a market, oil, finance, and electricity portfolio, while there is only one stable jump market factor. The exposure of stocks to these risk factors and their explained variation is time‐varying. The four continuous factors carry an intraday risk premium that reverses overnight.

Low‐Risk Anomalies?

Published: 4/26/2020  |  DOI: 10.1111/jofi.12910


This paper shows that low‐risk anomalies in the CAPM and in traditional factor models arise when investors require compensation for coskewness risk. Empirically, we find that option‐implied ex‐ante skewness is strongly related to ex‐post residual coskewness, which allows us to construct coskewness factor mimicking portfolios. Controlling for skewness renders the alphas of betting‐against‐beta and betting‐against‐volatility insignificant. We also show that the returns of beta‐ and volatility‐sorted portfolios are driven largely by a single principal component, which in turn is explained largely by skewness.

The Value of Central Clearing

Published: 4/25/2020  |  DOI: 10.1111/jofi.12902


I study a contracting innovation that suddenly insulated traders of hedging contracts against counterparty risk: central clearing counterparties (CCPs) for derivatives. The first CCP was created in Le Havre (France) in 1882, in the coffee futures market. Using triple difference‐in‐differences estimation, I show that central clearing changed the geography of trade flows Europe‐wide, to the benefit of Le Havre. Inspecting the mechanism using trader‐level data, I find that the CCP solved both a “missing market” problem and adverse selection issues. Central clearing also facilitated entry of new traders in the market. The successful contracting innovation quickly spread to other exchanges.

Political Connections and the Informativeness of Insider Trades

Published: 4/20/2020  |  DOI: 10.1111/jofi.12899


We analyze the trading of corporate insiders at leading financial institutions during the 2007 to 2009 financial crisis. We find strong evidence of a relation between political connections and informed trading during the period in which Troubled Asset Relief Program (TARP) funds were disbursed, and that the relation is most pronounced among corporate insiders with recent direct connections. Notably, we find evidence of abnormal trading by politically connected insiders 30 days in advance of TARP infusions, and that these trades anticipate the market reaction to the infusion. Our results suggest that political connections can facilitate opportunistic behavior by corporate insiders.

Option Profit and Loss Attribution and Pricing: A New Framework

Published: 3/15/2020  |  DOI: 10.1111/jofi.12894


This paper develops a new top‐down valuation framework that links the pricing of an option investment to its daily profit and loss attribution. The framework uses the Black‐Merton‐Scholes option pricing formula to attribute the short‐term option investment risk to variation in the underlying security price and the option's implied volatility. Taking risk‐neutral expectation and demanding no dynamic arbitrage result in a pricing relation that links an option's fair implied volatility level to the underlying volatility level with corrections for the implied volatility's own expected direction of movement, its variance, and its covariance with the underlying security return.

Debt Contracting on Management

Published: 3/13/2020  |  DOI: 10.1111/jofi.12893


Change of management restrictions (CMRs) in loan contracts give lenders explicit ex ante control rights over managerial retention and selection. This paper shows that lenders use CMRs to mitigate risks arising from CEO turnover, especially those related to the loss of human capital and replacement uncertainty, thereby providing evidence that human capital risk affects debt contracting. With a CMR in place, the likelihood of CEO turnover decreases by more than half, and future firm performance improves when retention frictions are important, suggesting that lenders can influence managerial turnover, even outside of default states, and help the borrower retain talent.

Do CEOs Matter? Evidence from Hospitalization Events

Published: 3/3/2020  |  DOI: 10.1111/jofi.12897


Using variation in firms’ exposure to their CEOs resulting from hospitalization, we estimate the effect of chief executive officers (CEOs) on firm policies, holding firm‐CEO matches constant. We document three main findings. First, CEOs have a significant effect on profitability and investment. Second, CEO effects are larger for younger CEOs, in growing and family‐controlled firms, and in human‐capital‐intensive industries. Third, CEOs are unique: the hospitalization of other senior executives does not have similar effects on the performance. Overall, our findings demonstrate that CEOs are a key driver of firm performance, which suggests that CEO contingency plans are valuable.

What Matters to Individual Investors? Evidence from the Horse's Mouth

Published: 2/25/2020  |  DOI: 10.1111/jofi.12895


We survey a representative sample of U.S. individuals about how well leading academic theories describe their financial beliefs and decisions. We find substantial support for many factors hypothesized to affect portfolio equity share, particularly background risk, investment horizon, rare disasters, transactional factors, and fixed costs of stock market participation. Individuals tend to believe that past mutual fund performance is a good signal of stock‐picking skill, actively managed funds do not suffer from diseconomies of scale, value stocks are safer and do not have higher expected returns, and high‐momentum stocks are riskier and do have higher expected returns.

Bank Quality, Judicial Efficiency, and Loan Repayment Delays in Italy

Published: 2/20/2020  |  DOI: 10.1111/jofi.12896


Italian firms delay payment to banks weakened by past loan losses. Exploiting Credit Register data, we fully absorb borrower fundamentals with firm‐quarter effects. Identification therefore reflects firm choices to delay payment to some banks, depending on their health. This selective delay occurs more where legal enforcement of collateral recovery is slow. Poor enforcement encourages borrowers not to pay when the value of their bank relationship comes into doubt. Selective delays occur even by firms able to pay all lenders. Credit losses in Italy have thus been worsened by the combination of weak banks and weak legal enforcement.