The Journal of Finance

Optimal Consumption and Investment with Transaction Costs and Multiple Risky Assets

Published: 2/2004,  Volume: 59,  Issue: 1  |  DOI: 10.1111/j.1540-6261.2004.00634.x  |  Cited by: 248

Hong Liu

We consider the optimal intertemporal consumption and investment policy of a constant absolute risk aversion (CARA) investor who faces fixed and proportional transaction costs when trading multiple risky assets. We show that when asset returns are uncorrelated, the optimal investment policy is to keep the dollar amount invested in each risky asset between two constant levels and upon reaching either of these thresholds, to trade to the corresponding optimal targets. An extensive analysis suggests that transaction cost is an important factor in affecting trading volume and that it can significantly diminish the importance of stock return predictability as reported in the literature.

Rational Inattention and Portfolio Selection

Published: 8/2007,  Volume: 62,  Issue: 4  |  DOI: 10.1111/j.1540-6261.2007.01263.x  |  Cited by: 130

LIXIN HUANG, HONG LIU

Costly information acquisition makes it rational for investors to obtain important economic news with only limited frequency or limited accuracy. We show that this rational inattention to important news may make investors over‐ or underinvest. In addition, the optimal trading strategy is “myopic” with respect to future news frequency and accuracy. We find that the optimal news frequency is nonmonotonic in news accuracy and investment horizon. Furthermore, when both news frequency and news accuracy are endogenized, an investor with a higher risk aversion or a longer investment horizon chooses less frequent but more accurate periodic news updates.

Liquidity Premia and Transaction Costs

Published: 9/4/2007,  Volume: 62,  Issue: 5  |  DOI: 10.1111/j.1540-6261.2007.01277.x  |  Cited by: 139

BONG‐GYU JANG, HYENG KEUN KOO, HONG LIU, MARK LOEWENSTEIN

Standard literature concludes that transaction costs only have a second‐order effect on liquidity premia. We show that this conclusion depends crucially on the assumption of a constant investment opportunity set. In a regime‐switching model in which the investment opportunity set varies over time, we explicitly characterize the optimal consumption and investment strategy. In contrast to the standard literature, we find that transaction costs can have a first‐order effect on liquidity premia. However, with reasonably calibrated parameters, the presence of transaction costs still cannot fully explain the equity premium puzzle.

Government Credit, a Double‐Edged Sword: Evidence from the China Development Bank

Published: 11/7/2017,  Volume: 73,  Issue: 1  |  DOI: 10.1111/jofi.12585  |  Cited by: 186

HONG RU

Using proprietary data from the China Development Bank (CDB), this paper examines the effects of government credit on firm activities. Tracing the effects of government credit across different levels of the supply chain, I find that CDB industrial loans to state‐owned enterprises (SOEs) crowd out private firms in the same industry but crowd in private firms in downstream industries. On average, a $1 increase in CDB SOE loans leads to a $0.20 decrease in private firms' assets. Moreover, CDB infrastructure loans crowd in private firms. I use exogenous timing of municipal politicians' turnover as an instrument for CDB credit flows.

A Model of Returns and Trading in Futures Markets

Published: 4/2000,  Volume: 55,  Issue: 2  |  DOI: 10.1111/0022-1082.00233  |  Cited by: 41

Harrison Hong

This paper develops an equilibrium model of a competitive futures market in which investors trade to hedge positions and to speculate on their private information. Equilibrium return and trading patterns are examined. (1) In markets where the information asymmetry among investors is small, the return volatility of a futures contract decreases with time‐to‐maturity (i.e., the Samuelson effect holds). (2) However, in markets where the information asymmetry among investors is large, the Samuelson effect need not hold. (3) Additionally, the model generates rich time‐to‐maturity patterns in open interest and spot price volatility that are consistent with empirical findings.

INFLATION AND THE MARKET VALUE OF THE FIRM: THEORY AND TESTS

Published: 9/1977,  Volume: 32,  Issue: 4  |  DOI: 10.1111/j.1540-6261.1977.tb03307.x  |  Cited by: 29

Hai Hong

Financial Distress and the Cross‐section of Equity Returns

Published: 5/23/2011,  Volume: 66,  Issue: 3  |  DOI: 10.1111/j.1540-6261.2011.01652.x  |  Cited by: 244

LORENZO GARLAPPI, HONG YAN

We explicitly consider financial leverage in a simple equity valuation model and study the cross‐sectional implications of potential shareholder recovery upon resolution of financial distress. Our model is capable of simultaneously explaining lower returns for financially distressed stocks, stronger book‐to‐market effects for firms with high default likelihood, and the concentration of momentum profits among low credit quality firms. The model further predicts (i) a hump‐shaped relationship between value premium and default probability, and (ii) stronger momentum profits for nearly distressed firms with significant prospects for shareholder recovery. Our empirical analysis strongly confirms these novel predictions.

Trading and Returns under Periodic Market Closures

Published: 2/2000,  Volume: 55,  Issue: 1  |  DOI: 10.1111/0022-1082.00207  |  Cited by: 143

Harrison Hong, Jiang Wang

This paper studies how market closures affect investors' trading policies and the resulting return‐generating process. It shows that closures generate rich patterns of time variation in trading and returns, including those consistent with empirical findings: (1) U‐shaped patterns in the mean and volatility of returns over trading periods, (2) higher trading activity around the close and open, (3) more volatile open‐to‐open returns than close‐to‐close returns, (4) higher returns over trading periods than over nontrading periods, (5) more volatile returns over trading periods than over nontrading periods. It also shows that closures can make prices more informative about future payoffs.

A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets

Published: 12/1999,  Volume: 54,  Issue: 6  |  DOI: 10.1111/0022-1082.00184  |  Cited by: 3197

Harrison Hong, Jeremy C. Stein

We model a market populated by two groups of boundedly rational agents: “newswatchers” and “momentum traders.” Each newswatcher observes some private information, but fails to extract other newswatchers' information from prices. If information diffuses gradually across the population, prices underreact in the short run. The underreaction means that the momentum traders can profit by trend‐chasing. However, if they can only implement simple (i.e., univariate) strategies, their attempts at arbitrage must inevitably lead to overreaction at long horizons. In addition to providing a unified account of under‐ and overreactions, the model generates several other distinctive implications.

Speculative Betas

Published: 9/14/2016,  Volume: 71,  Issue: 5  |  DOI: 10.1111/jofi.12431  |  Cited by: 250

HARRISON HONG, DAVID A. SRAER

The risk and return trade‐off, the cornerstone of modern asset pricing theory, is often of the wrong sign. Our explanation is that high‐beta assets are prone to speculative overpricing. When investors disagree about the stock market's prospects, high‐beta assets are more sensitive to this aggregate disagreement, experience greater divergence of opinion about their payoffs, and are overpriced due to short‐sales constraints. When aggregate disagreement is low, the Security Market Line is upward‐sloping due to risk‐sharing. When it is high, expected returns can actually decrease with beta. We confirm our theory using a measure of disagreement about stock market earnings.

Analyzing the Analysts: Career Concerns and Biased Earnings Forecasts

Published: 2/2003,  Volume: 58,  Issue: 1  |  DOI: 10.1111/1540-6261.00526  |  Cited by: 1137

Harrison Hong, Jeffrey D. Kubik

We examine security analysts' career concerns by relating their earnings forecasts to job separations. Relatively accurate forecasters are more likely to experience favorable career outcomes like moving up to a high‐status brokerage house. Controlling for accuracy, analysts who are optimistic relative to the consensus are more likely to experience favorable job separations. For analysts who cover stocks underwritten by their houses, job separations depend less on accuracy and more on optimism. Job separations were less sensitive to accuracy and more sensitive to optimism during the recent stock market mania. Brokerage houses apparently reward optimistic analysts who promote stocks.

Creditor Rights, Enforcement, and Bank Loans

Published: 3/13/2009,  Volume: 64,  Issue: 2  |  DOI: 10.1111/j.1540-6261.2009.01450.x  |  Cited by: 686

KEE‐HONG BAE, VIDHAN K. GOYAL

We examine whether differences in legal protection affect the size, maturity, and interest rate spread on loans to borrowers in 48 countries. Results show that banks respond to poor enforceability of contracts by reducing loan amounts, shortening loan maturities, and increasing loan spreads. These effects are both statistically significant and economically large. While stronger creditor rights reduce spreads, they do not seem to matter for loan size and maturity. Overall, we show that variation in enforceability of contracts matters a great deal more to how loans are structured and how they are priced.

The Economics of Hedge Fund Startups: Theory and Empirical Evidence

Published: 3/5/2021,  Volume: 76,  Issue: 3  |  DOI: 10.1111/jofi.13009  |  Cited by: 19

CHARLES CAO, GRANT FARNSWORTH, HONG ZHANG

This paper examines how market frictions influence the managerial incentives and organizational structure of new hedge funds. We develop a stylized model in which new managers search for accredited investors and have stronger incentives to acquire managerial skill when encountering low investor demand. Fund families endogenously arise to mitigate frictions and weaken the performance incentives of affiliated new funds. Empirically, based on a TASS‐HFR‐BarclayHedge merged database, we find that ex ante identified cold inceptions facing low investor demand outperform existing hedge funds and hot inceptions facing high demand and that cold stand‐alone inceptions outperform all types of family‐affiliated inceptions.

Asset Float and Speculative Bubbles

Published: 5/16/2006,  Volume: 61,  Issue: 3  |  DOI: 10.1111/j.1540-6261.2006.00867.x  |  Cited by: 365

HARRISON HONG, JOSÉ SCHEINKMAN, WEI XIONG

We model the relationship between asset float (tradeable shares) and speculative bubbles. Investors with heterogeneous beliefs and short‐sales constraints trade a stock with limited float because of insider lockups. A bubble arises as price overweighs optimists' beliefs and investors anticipate the option to resell to those with even higher valuations. The bubble's size depends on float as investors anticipate an increase in float with lockup expirations and speculate over the degree of insider selling. Consistent with the internet experience, the bubble, turnover, and volatility decrease with float and prices drop on the lockup expiration date.

Simple Forecasts and Paradigm Shifts

Published: 5/8/2007,  Volume: 62,  Issue: 3  |  DOI: 10.1111/j.1540-6261.2007.01234.x  |  Cited by: 119

HARRISON HONG, JEREMY C. STEIN, JIALIN YU

We study the asset pricing implications of learning in an environment in which the true model of the world is a multivariate one, but agents update only over the class of simple univariate models. Thus, if a particular simple model does a poor job of forecasting over a period of time, it is discarded in favor of an alternative simple model. The theory yields a number of distinctive predictions for stock returns, generating forecastable variation in the magnitude of the value‐glamour return differential, in volatility, and in the skewness of returns. We validate several of these predictions empirically.

Earnings Management and the Long‐Run Market Performance of Initial Public Offerings

Published: 12/1998,  Volume: 53,  Issue: 6  |  DOI: 10.1111/0022-1082.00079  |  Cited by: 1663

Siew Hong Teoh, Ivo Welch, T.J. Wong

Issuers of initial public offerings (IPOs) can report earnings in excess of cash flows by taking positive accruals. This paper provides evidence that issuers with unusually high accruals in the IPO year experience poor stock return performance in the three years thereafter. IPO issuers in the most “aggressive” quartile of earnings managers have a three‐year aftermarket stock return of approximately 20 percent less than IPO issuers in the most “conservative” quartile. They also issue about 20 percent fewer seasoned equity offerings. These differences are statistically and economically significant in a variety of specifications.

Are Overconfident CEOs Better Innovators?

Published: 7/19/2012,  Volume: 67,  Issue: 4  |  DOI: 10.1111/j.1540-6261.2012.01753.x  |  Cited by: 1668

DAVID HIRSHLEIFER, ANGIE LOW, SIEW HONG TEOH

Previous empirical work on adverse consequences of CEO overconfidence raises the question of why firms hire overconfident managers. Theoretical research suggests a reason: overconfidence can benefit shareholders by increasing investment in risky projects. Using options‐ and press‐based proxies for CEO overconfidence, we find that over the 1993–2003 period, firms with overconfident CEOs have greater return volatility, invest more in innovation, obtain more patents and patent citations, and achieve greater innovative success for given research and development expenditures. However, overconfident managers achieve greater innovation only in innovative industries. Our findings suggest that overconfidence helps CEOs exploit innovative growth opportunities.

Participation Costs and the Sensitivity of Fund Flows to Past Performance

Published: 5/8/2007,  Volume: 62,  Issue: 3  |  DOI: 10.1111/j.1540-6261.2007.01236.x  |  Cited by: 436

JENNIFER HUANG, KELSEY D. WEI, HONG YAN

We present a simple rational model to highlight the effect of investors' participation costs on the response of mutual fund flows to past fund performance. By incorporating participation costs into a model in which investors learn about managers' ability from past returns, we show that mutual funds with lower participation costs have a higher flow sensitivity to medium performance and a lower flow sensitivity to high performance than their higher‐cost peers. Using various fund characteristics as proxies for the reduction in participation costs, we provide empirical evidence supporting the model's implications for the asymmetric flow‐performance relationship.

Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies

Published: 2/2000,  Volume: 55,  Issue: 1  |  DOI: 10.1111/0022-1082.00206  |  Cited by: 2086

Harrison Hong, Terence Lim, Jeremy C. Stein

Various theories have been proposed to explain momentum in stock returns. We test the gradual‐information‐diffusion model of Hong and Stein (1999) and establish three key results. First, once one moves past the very smallest stocks, the profitability of momentum strategies declines sharply with firm size. Second, holding size fixed, momentum strategies work better among stocks with low analyst coverage. Finally, the effect of analyst coverage is greater for stocks that are past losers than for past winners. These findings are consistent with the hypothesis that firm‐specific information, especially negative information, diffuses only gradually across the investing public.

The Real Determinants of Asset Sales

Published: 9/10/2008,  Volume: 63,  Issue: 5  |  DOI: 10.1111/j.1540-6261.2008.01396.x  |  Cited by: 85

LIU YANG

I develop a dynamic structural model in which a firm makes rational decisions to buy or sell assets in the presence of productivity shocks. By identifying equilibrium asset prices, the model also examines the aggregate asset sales activity over the business cycle. It shows that changes in productivity, rather than productivity levels, affect decisions: Firms with rising productivity buy assets and firms with falling productivity downsize (“rising buys falling”). As such, industries in which firms have less persistent and more volatile productivity experience greater asset reallocation. Using plant‐level data from Longitudinal Research Database (LRD), I find strong support for the model's predictions.

A Model of Systemic Bank Runs

Published: 3/21/2023,  Volume: 78,  Issue: 2  |  DOI: 10.1111/jofi.13213  |  Cited by: 26

XUEWEN LIU

We develop a tractable model of systemic bank runs. The market‐based banking system features a two‐layer structure: banks with heterogeneous fundamentals face potential runs by their creditors while they trade short‐term funding in the asset (interbank) market in response to creditor withdrawals. The possibility of a run on a particular bank depends on its assets' interim liquidation value, and this value depends endogenously in turn on the status of other banks in the asset market. The within‐bank coordination problem among creditors and the cross‐bank price externality feed into each other. A small shock can be amplified into a systemic crisis.

The Real and Financial Implications of Corporate Hedging

Published: 9/21/2011,  Volume: 66,  Issue: 5  |  DOI: 10.1111/j.1540-6261.2011.01683.x  |  Cited by: 335

MURILLO CAMPELLO, CHEN LIN, YUE MA, HONG ZOU

We study the implications of hedging for corporate financing and investment. We do so using an extensive, hand‐collected data set on corporate hedging activities. Hedging can lower the odds of negative realizations, thereby reducing the expected costs of financial distress. In theory, this should ease a firm's access to credit. Using a tax‐based instrumental variable approach, we show that hedgers pay lower interest spreads and are less likely to have capital expenditure restrictions in their loan agreements. These favorable financing terms, in turn, allow hedgers to invest more. Our tests characterize two exact channels—cost of borrowing and investment restrictions—through which hedging affects corporate outcomes. The analysis shows that hedging has a first‐order effect on firm financing and investment, and provides new insights into how hedging affects corporate value. More broadly, our study contributes novel evidence on the real consequences of financial contracting.

Thy Neighbor's Portfolio: Word‐of‐Mouth Effects in the Holdings and Trades of Money Managers

Published: 11/10/2005,  Volume: 60,  Issue: 6  |  DOI: 10.1111/j.1540-6261.2005.00817.x  |  Cited by: 802

HARRISON HONG, JEFFREY D. KUBIK, JEREMY C. STEIN

A mutual fund manager is more likely to buy (or sell) a particular stock in any quarter if other managers in the same city are buying (or selling) that same stock. This pattern shows up even when the fund manager and the stock in question are located far apart, so it is distinct from anything having to do with local preference. The evidence can be interpreted in terms of an epidemic model in which investors spread information about stocks to one another by word of mouth.

Social Interaction and Stock‐Market Participation

Published: 2/2004,  Volume: 59,  Issue: 1  |  DOI: 10.1111/j.1540-6261.2004.00629.x  |  Cited by: 1475

Harrison Hong, Jeffrey D. Kubik, Jeremy C. Stein

We propose that stock‐market participation is influenced by social interaction. In our model, any given “social” investor finds the market more attractive when more of his peers participate. We test this theory using data from the Health and Retirement Study, and find that social households—those who interact with their neighbors, or attend church—are substantially more likely to invest in the market than non‐social households, controlling for wealth, race, education, and risk tolerance. Moreover, consistent with a peer‐effects story, the impact of sociability is stronger in states where stock‐market participation rates are higher.

Yesterday's Heroes: Compensation and Risk at Financial Firms

Published: 3/12/2015,  Volume: 70,  Issue: 2  |  DOI: 10.1111/jofi.12225  |  Cited by: 235

ING‐HAW CHENG, HARRISON HONG, JOSÉ A. SCHEINKMAN

Many believe that compensation, misaligned from shareholders’ value due to managerial entrenchment, caused financial firms to take risks before the financial crisis of 2008. We argue that, even in a classical principal‐agent setting without entrenchment and with exogenous firm risk, riskier firms may offer higher total pay as compensation for the extra risk in equity stakes borne by risk‐averse managers. Using long lags of stock price risk to capture exogenous firm risk, we confirm our conjecture and show that riskier firms are also more productive and more likely to be held by institutional investors, who are most able to influence compensation.

Limit Orders, Depth, and Volatility: Evidence from the Stock Exchange of Hong Kong

Published: 4/2001,  Volume: 56,  Issue: 2  |  DOI: 10.1111/0022-1082.00345  |  Cited by: 228

Hee‐Joon Ahn, Kee‐Hong Bae, Kalok Chan

We investigate the role of limit orders in the liquidity provision in a pure order‐driven market. Results show that market depth rises subsequent to an increase in transitory volatility, and transitory volatility declines subsequent to an increase in market depth. We also examine how transitory volatility affects the mix between limit orders and market orders. When transitory volatility arises from the ask (bid) side, investors will submit more limit sell (buy) orders than market sell (buy) orders. This result is consistent with the existence of limit‐order traders who enter the market and place orders when liquidity is needed.

Driven to Distraction: Extraneous Events and Underreaction to Earnings News

Published: 9/28/2009,  Volume: 64,  Issue: 5  |  DOI: 10.1111/j.1540-6261.2009.01501.x  |  Cited by: 1430

DAVID HIRSHLEIFER, SONYA SEONGYEON LIM, SIEW HONG TEOH

Recent studies propose that limited investor attention causes market underreactions. This paper directly tests this explanation by measuring the information load faced by investors. The investor distraction hypothesis holds that extraneous news inhibits market reactions to relevant news. We find that the immediate price and volume reaction to a firm's earnings surprise is much weaker, and post‐announcement drift much stronger, when a greater number of same‐day earnings announcements are made by other firms. We evaluate the economic importance of distraction effects through a trading strategy, which yields substantial alphas. Industry‐unrelated news and large earnings surprises have a stronger distracting effect.

Tunneling or Value Added? Evidence from Mergers by Korean Business Groups

Published: 12/2002,  Volume: 57,  Issue: 6  |  DOI: 10.1111/1540-6261.00510  |  Cited by: 939

Kee‐Hong Bae, Jun‐Koo Kang, Jin‐Mo Kim

We examine whether firms belonging to Korean business groups (chaebols) benefit from acquisitions they make or whether such acquisitions provide a way for controlling shareholders to increase their wealth by increasing the value of other group firms (tunneling). We find that when a chaebol‐affiliated firm makes an acquisition, its stock price on average falls. While minority shareholders of a chaebol‐affiliated firm making an acquisition lose, the controlling shareholder of that firm on average benefits because the acquisition enhances the value of other firms in the group. This evidence is consistent with the tunneling hypothesis.

Does Investor Misvaluation Drive the Takeover Market?

Published: 3/9/2006,  Volume: 61,  Issue: 2  |  DOI: 10.1111/j.1540-6261.2006.00853.x  |  Cited by: 733

MING DONG, DAVID HIRSHLEIFER, SCOTT RICHARDSON, SIEW HONG TEOH

This paper uses pre‐offer market valuations to evaluate the misvaluation and Q theories of takeovers. Bidder and target valuations (price‐to‐book, or price‐to‐residual‐income‐model‐value) are related to means of payment, mode of acquisition, premia, target hostility, offer success, and bidder and target announcement‐period returns. The evidence is broadly consistent with both hypotheses. The evidence for the Q hypothesis is stronger in the pre‐1990 period than in the 1990–2000 period, whereas the evidence for the misvaluation hypothesis is stronger in the 1990–2000 period than in the pre‐1990 period.

Outsourcing Mutual Fund Management: Firm Boundaries, Incentives, and Performance

Published: 3/7/2013,  Volume: 68,  Issue: 2  |  DOI: 10.1111/jofi.12006  |  Cited by: 142

JOSEPH CHEN, HARRISON HONG, WENXI JIANG, JEFFREY D. KUBIK

We investigate the effects of managerial outsourcing on the performance and incentives of mutual funds. Fund families outsource the management of a large fraction of their funds to advisory firms. These funds underperform those run internally by about 52 basis points per year. After instrumenting for a fund's outsourcing status, the estimated underperformance is three times larger. We hypothesize that contractual externalities due to firm boundaries make it difficult to extract performance from an outsourced relationship. Consistent with this view, outsourced funds face higher powered incentives; they are more likely to be closed after poor performance and excessive risk‐taking.

Long‐Run Risk: Is It There?

Published: 4/14/2022,  Volume: 77,  Issue: 3  |  DOI: 10.1111/jofi.13126  |  Cited by: 46

YUKUN LIU, BEN MATTHIES

This paper documents the existence of a persistent component in consumption growth. We take a novel approach using news coverage to capture investor concern about economic growth prospects. We provide evidence that consumption growth is highly predictable over long horizons—our measure explains between 23% and 38% of cumulative future consumption growth at the five‐year horizon and beyond. Furthermore, we show a strong connection between this predictability and asset prices. Innovations to our measure price 51 standard portfolios in the cross section and our one‐factor model outperforms many benchmark macro‐ and return‐based multifactor models.

Rent Extraction with Securities Plus Cash

Published: 4/6/2021,  Volume: 76,  Issue: 4  |  DOI: 10.1111/jofi.13018  |  Cited by: 26

TINGJUN LIU, DAN BERNHARDT

In our target‐initiated theory of takeovers, a target approaches potential acquirers that privately know their standalone values and merger synergies, where higher synergy acquirers tend to have larger standalone values. Despite their information disadvantage, targets can extract all surplus when synergies and standalone values are concavely related by offering payment choices that are combinations of cash and equity. Targets exploit the reluctance of high‐valuation acquirers to cede equity claims, inducing them to bid more cash. When synergies and standalone values are not concavely related, sellers can gain by combining cash with securities that are more information sensitive than equities.

Dividend Dynamics, Learning, and Expected Stock Index Returns

Published: 12/4/2018,  Volume: 74,  Issue: 1  |  DOI: 10.1111/jofi.12731  |  Cited by: 42

RAVI JAGANNATHAN, BINYING LIU

We present a latent variable model of dividends that predicts, out‐of‐sample, 39.5% to 41.3% of the variation in annual dividend growth rates between 1975 and 2016. Further, when learning about dividend dynamics is incorporated into a long‐run risks model, the model predicts, out‐of‐sample, 25.3% to 27.1% of the variation in annual stock index returns over the same time horizon, with learning contributing approximately half of the predictability in returns. These findings support the view that investors' aversion to long‐run risks and their learning about these risks are important in determining stock index prices and expected returns.

How to Discount Cashflows with Time‐Varying Expected Returns

Published: 12/2004,  Volume: 59,  Issue: 6  |  DOI: 10.1111/j.1540-6261.2004.00715.x  |  Cited by: 117

ANDREW ANG, JUN LIU

While many studies document that the market risk premium is predictable and that betas are not constant, the dividend discount model ignores time‐varying risk premiums and betas. We develop a model to consistently value cashflows with changing risk‐free rates, predictable risk premiums, and conditional betas in the context of a conditional CAPM. Practical valuation is accomplished with an analytic term structure of discount rates, with different discount rates applied to expected cashflows at different horizons. Using constant discount rates can produce large misvaluations, which, in portfolio data, are mostly driven at short horizons by market risk premiums and at long horizons by time variation in risk‐free rates and factor loadings.

Mortgage Lock‐In, Mobility, and Labor Reallocation

Published: 10/20/2024,  Volume: 79,  Issue: 6  |  DOI: 10.1111/jofi.13398  |  Cited by: 27

JULIA FONSECA, LU LIU

We study the impact of rising mortgage rates on mobility and labor reallocation. Using individual‐level credit record data and variation in the timing of mortgage origination, we show that a 1 percentage point decline in the difference between mortgage rates locked in at origination and current rates reduces moving by 9% overall and 16% between 2022 and 2024, and this relationship is asymmetric. Mortgage lock‐in also dampens flows in and out of self‐employment and the responsiveness to shocks to nearby employment opportunities that require moving, measured as wage growth within a 50‐ to 150‐mile ring and instrumented with a shift‐share instrument.

Robust Measures of Earnings Surprises

Published: 1/15/2019,  Volume: 74,  Issue: 2  |  DOI: 10.1111/jofi.12746  |  Cited by: 41

CHIN‐HAN CHIANG, WEI DAI, JIANQING FAN, HARRISON HONG, JUN TU

Event studies of market efficiency measure earnings surprises using the consensus error ( CE ), given as actual earnings minus the average professional forecast. If a subset of forecasts can be biased, the ideal but difficult to estimate parameter‐dependent alternative to CE is a nonlinear filter of individual errors that adjusts for bias. We show that CE is a poor parameter‐free approximation of this ideal measure. The fraction of misses on the same side ( FOM ), which discards the magnitude of misses, offers a far better approximation. FOM performs particularly well against CE in predicting the returns of U.S. stocks, where bias is potentially large.

False (and Missed) Discoveries in Financial Economics

Published: 6/16/2020,  Volume: 75,  Issue: 5  |  DOI: 10.1111/jofi.12951  |  Cited by: 105

CAMPBELL R. HARVEY, YAN LIU

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.

Luck versus Skill in the Cross Section of Mutual Fund Returns: Reexamining the Evidence

Published: 4/17/2022,  Volume: 77,  Issue: 3  |  DOI: 10.1111/jofi.13123  |  Cited by: 39

CAMPBELL R. HARVEY, YAN LIU

While Kosowski et al. (2006, Journal of Finance 61, 2551–2595) and Fama and French (2010, Journal of Finance 65, 1915–1947) both evaluate whether mutual funds outperform, their conclusions are very different. We reconcile their findings. We show that the Fama‐French method suffers from an undersampling problem that leads to a failure to reject the null hypothesis of zero alpha, even when some funds generate economically large risk‐adjusted returns. In contrast, Kosowski et al. substantially overreject the null hypothesis, even when all funds have a zero alpha. We present a novel bootstrapping approach that should be useful to future researchers choosing between the two approaches.

A Variance‐Ratio Test of Random Walks in Foreign Exchange Rates

Published: 6/1991,  Volume: 46,  Issue: 2  |  DOI: 10.1111/j.1540-6261.1991.tb02686.x  |  Cited by: 107

CHRISTINA Y. LIU, JIA HE

The separate variance‐ratio tests under homoscedasticity and heteroscedasticity both provide evidence rejecting the random walk hypothesis, using five pairs of weekly nominal exchange rate series over the period from August 7, 1974 to March 29, 1989. The rejections cast doubt on the random walk hypothesis in exchange rates, which has received support in the existing literature. Furthermore, since the rejections are robust to heteroscedasticity, they suggest autocorelations of weekly increments in the nominal exchange rate series, which may be consistent with the exchange rate overshooting or undershooting phenomenon.

Before an Analyst Becomes an Analyst: Does Industry Experience Matter?

Published: 3/21/2017,  Volume: 72,  Issue: 2  |  DOI: 10.1111/jofi.12466  |  Cited by: 309

DANIEL BRADLEY, SINAN GOKKAYA, XI LIU

Using hand‐collected biographical information on financial analysts from 1983 to 2011, we find that analysts making forecasts on firms in industries related to their preanalyst experience have better forecast accuracy, evoke stronger market reactions to earning revisions, and are more likely to be named Institutional Investor all‐stars. Plausibly exogenous losses of analysts with related industry experience have real financial market implications—changes in firms’ information asymmetry and price reactions are significantly larger than those of other analysts. Overall, industry expertise acquired from preanalyst work experience is valuable to analysts, consistent with the emphasis placed on their industry knowledge by institutional investors.

Private and Public Merger Waves

Published: 9/10/2013,  Volume: 68,  Issue: 5  |  DOI: 10.1111/jofi.12055  |  Cited by: 221

VOJISLAV MAKSIMOVIC, GORDON PHILLIPS, LIU YANG

We document that public firms participate more than private firms as buyers and sellers of assets in merger waves and their participation is affected more by credit spreads and aggregate market valuation. Public firm acquisitions realize higher gains in productivity, particularly for on‐the‐wave acquisitions and when the acquirer's stock is liquid and highly valued. Our results are not driven solely by public firms' better access to capital. Using productivity data from early in the firm's life, we find that better private firms subsequently select to become public. Initial size and productivity predict asset purchases and sales 10 and more years later.

Common Risk Factors in Cryptocurrency

Published: 2/24/2022,  Volume: 77,  Issue: 2  |  DOI: 10.1111/jofi.13119  |  Cited by: 564

YUKUN LIU, ALEH TSYVINSKI, XI WU

We find that three factors—cryptocurrency market, size, and momentum—capture the cross‐sectional expected cryptocurrency returns. We consider a comprehensive list of price‐ and market‐related return predictors in the stock market and construct their cryptocurrency counterparts. Ten cryptocurrency characteristics form successful long‐short strategies that generate sizable and statistically significant excess returns, and we show that all of these strategies are accounted for by the cryptocurrency three‐factor model. Lastly, we examine potential underlying mechanisms of the cryptocurrency size and momentum effects.

Institutional Investor Attention

Published: 1/16/2026,  Volume: 81,  Issue: 2  |  DOI: 10.1111/jofi.70009  |  Cited by: 6

ALAN KWAN, YUKUN LIU, BEN MATTHIES

Using data on Internet news reading, we measure fund‐level attention to both aggregate and firm‐specific news and relate it to fund portfolio allocation decisions. In the time series, we find that funds shift attention toward macroeconomic news during periods of high aggregate volatility. Those funds that exhibit stronger attention‐reallocation patterns earn higher future returns. In the cross‐section of fund portfolios, fund attention is positively related to stock holdings. Furthermore, fund attention to a stock increases the value‐add of that position to the fund's performance. This relationship is stronger using fund attention to more value‐relevant news articles.

Corrigendum for Dividend Dynamics, Learning, and Expected Stock Index Returns

Published: 5/30/2019,  Volume: 74,  Issue: 4  |  DOI: 10.1111/jofi.12786  |  Cited by: 0

RAVI JAGANNATHAN, BINYING LIU, JIAQI ZHANG

Financial Markets, the Real Economy, and Self‐Fulfilling Uncertainties

Published: 3/27/2019,  Volume: 74,  Issue: 3  |  DOI: 10.1111/jofi.12764  |  Cited by: 65

JESS BENHABIB, XUEWEN LIU, PENGFEI WANG

We develop a model of informational interdependence between financial markets and the real economy, linking economic uncertainty to information production and aggregate economic activities in general equilibrium. The mutual learning between financial markets and the real economy creates a strategic complementarity in their information production, leading to self‐fulfilling surges in economic uncertainties. In a dynamic setting, our model characterizes self‐fulfilling uncertainty traps with two steady‐state equilibria and a two‐stage economic crisis in transitional dynamics.

Dynamic Asset Allocation with Event Risk

Published: 2/2003,  Volume: 58,  Issue: 1  |  DOI: 10.1111/1540-6261.00523  |  Cited by: 336

Jun Liu, Francis A. Longstaff, Jun Pan

Major events often trigger abrupt changes in stock prices and volatility. We study the implications of jumps in prices and volatility on investment strategies. Using the event‐risk framework of Duffie, Pan, and Singleton (2000), we provide analytical solutions to the optimal portfolio problem. Event risk dramatically affects the optimal strategy. An investor facing event risk is less willing to take leveraged or short positions. The investor acts as if some portion of his wealth may become illiquid and the optimal strategy blends both dynamic and buy‐and‐hold strategies. Jumps in prices and volatility both have important effects.

Detecting Informed Trading Risk from Undercutting Activity

Published: 6/1/2026,  Volume: 81,  Issue: 4  |  DOI: 10.1111/jofi.70047  |  Cited by: 0

YASHAR H. BARARDEHI, PETER DIXON, QIYU LIU

We introduce a simple measure of informed trading risk, , the residual to liquidity quote‐improvement‐to‐deterioration ratio times . When facing with increased informed trading risk, liquidity providers compete less to provide liquidity, reducing their undercutting activity. Reductions in undercutting leave footprints in trade and quote data that are captured by . Unlike prior measures, is easy to construct, can be computed intraday, and is orthogonal to liquidity. The measure outperforms prominent existing alternatives in reflecting the extent of information asymmetry before earnings announcements, predicting unscheduled press releases, and identifying informed trading spillovers around them.

Privacy and Team Incentives

Published: 10/15/2025,  Volume: 80,  Issue: 6  |  DOI: 10.1111/jofi.13496  |  Cited by: 0

ANDREA M. BUFFA, QING LIU, LUCY WHITE

Real‐world contracts are typically private, observed only by their direct signatories, so agents working together are vulnerable to the principal opportunistically reducing other agents' incentives. The principal can mitigate this commitment problem by giving the most skilled agent a budget and delegating authority to write other agents' contracts. This endogenous hierarchy, never optimal with public contracts, raises effort, output, and compensation but allows rent extraction. The principal prefers it when contracts are opaque enough, skill is sufficiently heterogeneous across agents, and joint output is sensitive enough to effort. Our model provides novel predictions for the structure of banking syndicates.

Underreaction to Dividend Reductions and Omissions?

Published: 4/2008,  Volume: 63,  Issue: 2  |  DOI: 10.1111/j.1540-6261.2008.01337.x  |  Cited by: 40

YI LIU, SAMUEL H. SZEWCZYK, ZAHER ZANTOUT

Using a sample of 2,337 cash dividend reduction or omission announcements over the 1927 to 1999 period, this study reports significant negative post‐announcement long‐term abnormal returns, which last 1 year only. However, this long‐term abnormal performance is driven by the post‐earnings‐announcement drift. After controlling for the earnings performance and the skewness of buy‐and‐hold abnormal returns, there is no compelling evidence of a post‐dividend‐reduction or post‐dividend‐omission price drift.

Reference‐Dependent Preferences and Sentiment‐Driven Asset Prices

Published: 8/22/2026,  Volume: ,  Issue:   |  DOI: 10.1111/jofi.70079  |  Cited by: 1

JESS BENHABIB, ZHAORUI LI, XUEWEN LIU, PENGFEI WANG

This paper studies asset pricing under expectations‐based reference‐dependent preferences in a general equilibrium framework. We show that reference‐dependent preferences can generate self‐fulfilling risk panics, producing sentiment‐driven asset price fluctuations through a feedback loop between current prices and perceived future downside risk—dynamics impossible under standard expected utility. The model helps explain empirical puzzles including (i) excess volatility, (ii) asymmetric volatility, (iii) asymmetric sentiment over the business cycle, (iv) excess asset price comovement, and (v) weak correlations between stock returns and economic fundamentals, alongside a sizable equity premium. Additional empirical evidence based on closed‐end fund discounts and quantitative analysis support the theory.