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Volume 68: Issue 3 (June 2013)

Reverse Survivorship Bias

Pages: 789-813  |  Published: 5/2013  |  DOI: 10.1111/jofi.12030  |  Cited by: 49


Mutual funds often disappear following poor performance. When this poor performance is partly attributable to negative idiosyncratic shocks, funds' estimated alphas understate their true alphas. This paper estimates a structural model to correct for this bias. Although most funds still have negative alphas, they are not nearly as low as those suggested by the fund‐by‐fund regressions. Approximately 12% of funds have net four‐factor model alphas greater than 2% per year. All studies that run fund‐by‐fund regressions to draw inferences about the prevalence of skill among mutual fund managers are subject to reverse survivorship bias.

The Evolution of a Financial Crisis: Collapse of the Asset‐Backed Commercial Paper Market

Pages: 815-848  |  Published: 5/2013  |  DOI: 10.1111/jofi.12023  |  Cited by: 258


This paper documents “runs” on asset‐backed commercial paper (ABCP) programs in 2007. We find that one‐third of programs experienced a run within weeks of the onset of the ABCP crisis and that runs, as well as yields and maturities for new issues, were related to program‐level and macro‐financial risks. These findings are consistent with the asymmetric information framework used to explain banking panics, have implications for commercial paper investors’ degree of risk intolerance, and inform empirical predictions of recent papers on dynamic coordination failures.

Equilibrium Subprime Lending

Pages: 849-879  |  Published: 5/2013  |  DOI: 10.1111/jofi.12022  |  Cited by: 9


This paper develops an equilibrium model of a subprime mortgage market. Our goal is to offer a benchmark with which the recent subprime boom and bust can be compared. The model is tractable and delivers plausible orders of magnitude for borrowing capacities, as well as default and trading intensities. We offer simple explanations for several phenomena in the subprime market, such as the prevalence of teaser rates and the clustering of defaults. In our model, both nondiversifiable and diversifiable income risks reduce debt capacities. Thus, debt capacities need not be higher when a larger fraction of income risk is diversifiable.

Access to Collateral and Corporate Debt Structure: Evidence from a Natural Experiment

Pages: 881-928  |  Published: 5/2013  |  DOI: 10.1111/jofi.12020  |  Cited by: 362


We investigate how firms respond to strengthening of creditor rights by examining their financial decisions following a securitization reform in India. We find that the reform led to a reduction in secured debt, total debt, debt maturity, and asset growth, and an increase in liquidity hoarding by firms. Moreover, the effects are more pronounced for firms that have a higher proportion of tangible assets because these firms are more affected by the secured transactions law. These results suggest that strengthening of creditor rights introduces a liquidation bias and documents how firms alter their debt structures to contract around it.

Value and Momentum Everywhere

Pages: 929-985  |  Published: 5/2013  |  DOI: 10.1111/jofi.12021  |  Cited by: 1701


We find consistent value and momentum return premia across eight diverse markets and asset classes, and a strong common factor structure among their returns. Value and momentum returns correlate more strongly across asset classes than passive exposures to the asset classes, but value and momentum are negatively correlated with each other, both within and across asset classes. Our results indicate the presence of common global risks that we characterize with a three‐factor model. Global funding liquidity risk is a partial source of these patterns, which are identifiable only when examining value and momentum jointly across markets. Our findings present a challenge to existing behavioral, institutional, and rational asset pricing theories that largely focus on U.S. equities.

Can Time‐Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility?

Pages: 987-1035  |  Published: 5/2013  |  DOI: 10.1111/jofi.12018  |  Cited by: 642


Why is the equity premium so high, and why are stocks so volatile? Why are stock returns in excess of government bill rates predictable? This paper proposes an answer to these questions based on a time‐varying probability of a consumption disaster. In the model, aggregate consumption follows a normal distribution with low volatility most of the time, but with some probability of a consumption realization far out in the left tail. The possibility of this poor outcome substantially increases the equity premium, while time‐variation in the probability of this outcome drives high stock market volatility and excess return predictability.

State‐Level Business Cycles and Local Return Predictability

Pages: 1037-1096  |  Published: 5/2013  |  DOI: 10.1111/jofi.12017  |  Cited by: 163


This study examines whether local stock returns vary with local business cycles in a predictable manner. We find that U.S. state portfolios earn higher future returns when state‐level unemployment rates are higher and housing collateral ratios are lower. During the 1978 to 2009 period, geography‐based trading strategies earn annualized risk‐adjusted returns of 5%. This abnormal performance reflects time‐varying systematic risks and local‐trading induced mispricing. Consistent with the mispricing explanation, the evidence of predictability is stronger among firms with low visibility and high local ownership. Nonlocal domestic and foreign investors arbitrage away the predictable patterns in local returns in 1 year.

Do Hostile Takeovers Stifle Innovation? Evidence from Antitakeover Legislation and Corporate Patenting

Pages: 1097-1131  |  Published: 5/2013  |  DOI: 10.1111/jofi.12019  |  Cited by: 441


I examine how strong corporate governance proxied by the threat of hostile takeovers affects innovation and firm value. I find a significant decline in the number of patents and citations per patent for firms incorporated in states that pass antitakeover laws relative to firms incorporated in states that do not. Most of the impact of antitakeover laws on innovation occurs 2 or more years after they are passed, indicating a causal effect. The negative effect of antitakeover laws is mitigated by the presence of alternative governance mechanisms such as large shareholders, pension fund ownership, leverage, and product market competition.

Decentralized Investment Management: Evidence from the Pension Fund Industry

Pages: 1133-1178  |  Published: 5/2013  |  DOI: 10.1111/jofi.12024  |  Cited by: 92


Using a unique data set, we document two secular trends in the shift from centralized to decentralized pension fund management over the past few decades. First, across asset classes, sponsors replace generalist balanced managers with better‐performing specialists. Second, within asset classes, funds replace single managers with multiple competing managers following diverse strategies to reduce scale diseconomies as funds grow larger relative to capital markets. Consistent with a model of decentralized management, sponsors implement risk controls that trade off higher anticipated alphas of multiple specialists against the increased difficulty in coordinating their risk‐taking and the greater uncertainty concerning their true skills.

Financial Regulation, Financial Globalization, and the Synchronization of Economic Activity

Pages: 1179-1228  |  Published: 5/2013  |  DOI: 10.1111/jofi.12025  |  Cited by: 203


We analyze the impact of financial globalization on business cycle synchronization using a proprietary database on banks’ international exposure for industrialized countries during 1978 to 2006. Theory makes ambiguous predictions and identification has been elusive due to lack of bilateral time‐varying financial linkages data. In contrast to conventional wisdom and previous empirical studies, we identify a strong negative effect of banking integration on output synchronization, conditional on global shocks and country‐pair heterogeneity. Similarly, we show divergent economic activity due to higher integration using an exogenous de‐jure measure of integration based on financial regulations that harmonized EU markets.

How Wise Are Crowds? Insights from Retail Orders and Stock Returns

Pages: 1229-1265  |  Published: 5/2013  |  DOI: 10.1111/jofi.12028  |  Cited by: 313


We analyze the role of retail investors in stock pricing using a database uniquely suited for this purpose. The data allow us to address selection bias concerns and to separately examine aggressive (market) and passive (limit) orders. Both aggressive and passive net buying positively predict firms’ monthly stock returns with no evidence of return reversal. Only aggressive orders correctly predict firm news, including earnings surprises, suggesting they convey novel cash flow information. Only passive net buying follows negative returns, consistent with traders providing liquidity and benefiting from the reversal of transitory price movements. These actions contribute to market efficiency.

Sentiment during Recessions

Pages: 1267-1300  |  Published: 5/2013  |  DOI: 10.1111/jofi.12027  |  Cited by: 748


This paper studies the effect of sentiment on asset prices during the 20th century (1905 to 2005). As a proxy for sentiment, we use the fraction of positive and negative words in two columns of financial news from the New York Times. The main contribution of the paper is to show that, controlling for other well‐known time‐series patterns, the predictability of stock returns using news' content is concentrated in recessions. A one standard deviation shock to our news measure during recessions predicts a change in the conditional average return on the DJIA of 12 basis points over one day.


Pages: 1301-1302  |  Published: 5/2013  |  DOI: 10.1111/jofi.12033  |  Cited by: 0


Pages: 1303-1303  |  Published: 5/2013  |  DOI: 10.1111/jofi.12066  |  Cited by: 0

The Maturity Rat Race—Erratum

Pages: 1305-1305  |  Published: 5/2013  |  DOI: 10.1111/jofi.12054  |  Cited by: 0