The Journal of Finance

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.

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: 189

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

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: 249

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.

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: 245

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.

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.

Trading and Returns under Periodic Market Closures

Published: 2/2000,  Volume: 55,  Issue: 1  |  DOI: 10.1111/0022-1082.00207  |  Cited by: 144

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.

Speculative Betas

Published: 9/14/2016,  Volume: 71,  Issue: 5  |  DOI: 10.1111/jofi.12431  |  Cited by: 252

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.

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: 3202

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.

Analyzing the Analysts: Career Concerns and Biased Earnings Forecasts

Published: 2/2003,  Volume: 58,  Issue: 1  |  DOI: 10.1111/1540-6261.00526  |  Cited by: 1138

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: 687

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.

Asset Float and Speculative Bubbles

Published: 5/16/2006,  Volume: 61,  Issue: 3  |  DOI: 10.1111/j.1540-6261.2006.00867.x  |  Cited by: 366

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.

Are Overconfident CEOs Better Innovators?

Published: 7/19/2012,  Volume: 67,  Issue: 4  |  DOI: 10.1111/j.1540-6261.2012.01753.x  |  Cited by: 1671

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.

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.

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.

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: 437

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: 2092

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 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: 336

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.

Social Interaction and Stock‐Market Participation

Published: 2/2004,  Volume: 59,  Issue: 1  |  DOI: 10.1111/j.1540-6261.2004.00629.x  |  Cited by: 1477

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.

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: 805

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.

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: 1432

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.

Limited Risk Sharing and International Equity Returns

Published: 12/16/2020,  Volume: 76,  Issue: 2  |  DOI: 10.1111/jofi.12994  |  Cited by: 6

SHAOJUN ZHANG

Limited stock market participation can potentially explain the disconnect between international asset prices and macro quantities. An incomplete markets model in which risk sharing for stockholders is high generates highly correlated equity returns and relatively smooth exchange rates. Risk sharing for nonstockholders is limited because of their nonparticipation in stock markets and borrowing constraints, reducing the aggregate consumption correlation and the correlation between aggregate consumption differentials and exchange rates. Financial integration widens the disconnect by benefiting stockholders but hurting nonstockholders. Survey data indicate that international risk sharing for stockholders is better than that for nonstockholders, consistent with the predictions.

The Value Premium

Published: 2/2005,  Volume: 60,  Issue: 1  |  DOI: 10.1111/j.1540-6261.2005.00725.x  |  Cited by: 1119

LU ZHANG

The value anomaly arises naturally in the neoclassical framework with rational expectations. Costly reversibility and countercyclical price of risk cause assets in place to be harder to reduce, and hence are riskier than growth options especially in bad times when the price of risk is high. By linking risk and expected returns to economic primitives, such as tastes and technology, my model generates many empirical regularities in the cross‐section of returns; it also yields an array of new refutable hypotheses providing fresh directions for future empirical research.

Carbon Returns across the Globe

Published: 10/21/2024,  Volume: 80,  Issue: 1  |  DOI: 10.1111/jofi.13402  |  Cited by: 185

SHAOJUN ZHANG

The pricing of carbon transition risk is central to the debate on climate‐aware investments. Emissions are tightly linked to sales and are available to investors only with significant lags. The positive carbon return, or brown‐minus‐green return differential, documented in previous studies arises from forward‐looking firm performance information contained in emissions rather than a risk premium in ex ante expected returns. After accounting for the data release lag, carbon returns turn negative in the United States and insignificant globally. Developed markets experience lower carbon returns due to intense climate concern shocks, while countries with stringent climate policies exhibit higher carbon returns.

Monetary Policy Spillovers through Invoicing Currencies

Published: 8/17/2021,  Volume: 77,  Issue: 1  |  DOI: 10.1111/jofi.13071  |  Cited by: 34

TONY ZHANG

This paper explores the role of trade invoicing currencies in the international spillover of monetary policy. Using high‐frequency measures of Federal Reserve monetary policy shocks, I show that exchange rates, interest rates, and equity returns in countries with a larger share of dollar‐invoiced imports systematically respond more to U.S. monetary policy. I document similar transmission effects from European Central Bank (ECB) monetary policy shocks to countries with euro‐invoiced imports. I rationalize these findings within a New Keynesian framework. As a result of these spillovers, domestic monetary policy should be less effective in countries with traded goods invoiced in foreign currencies.

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.

Tracking Retail Investor Activity

Published: 5/14/2021,  Volume: 76,  Issue: 5  |  DOI: 10.1111/jofi.13033  |  Cited by: 575

EKKEHART BOEHMER, CHARLES M. JONES, XIAOYAN ZHANG, XINRAN ZHANG

We provide an easy method to identify marketable retail purchases and sales using recent, publicly available U.S. equity transactions data. Individual stocks with net buying by retail investors outperform stocks with negative imbalances by approximately 10 bps over the following week. Less than half of the predictive power of marketable retail order imbalance is attributable to order flow persistence, while the rest cannot be explained by contrarian trading (proxy for liquidity provision) or public news sentiment. There is suggestive, but only suggestive, evidence that retail marketable orders might contain firm‐level information that is not yet incorporated into prices.

Labor‐Technology Substitution: Implications for Asset Pricing

Published: 3/27/2019,  Volume: 74,  Issue: 4  |  DOI: 10.1111/jofi.12766  |  Cited by: 107

MIAO BEN ZHANG

This paper studies the asset pricing implications of a firm's opportunities to replace routine‐task labor with automation. I develop a model in which firms optimally undertake such replacement when their productivity is low. Hence, firms with routine‐task labor maintain a replacement option that hedges their value against unfavorable macroeconomic shocks and lowers their expected returns. Using establishment‐level occupational data, I construct a measure of firms' share of routine‐task labor. Compared to their industry peers, firms with a higher share of routine‐task labor (i) invest more in machines and reduce more routine‐task labor during economic downturns, and (ii) have lower expected stock returns.

Information Uncertainty and Stock Returns

Published: 1/20/2006,  Volume: 61,  Issue: 1  |  DOI: 10.1111/j.1540-6261.2006.00831.x  |  Cited by: 1561

X. FRANK ZHANG

There is substantial evidence of short‐term stock price continuation, which the prior literature often attributes to investor behavioral biases such as underreaction to new information. This paper investigates the role of information uncertainty in price continuation anomalies and cross‐sectional variations in stock returns. If short‐term price continuation is due to investor behavioral biases, we should observe greater price drift when there is greater information uncertainty. As a result, greater information uncertainty should produce relatively higher expected returns following good news and relatively lower expected returns following bad news. My evidence supports this hypothesis.

Endogenous Borrowing Constraints With Incomplete Markets

Published: 12/1997,  Volume: 52,  Issue: 5  |  DOI: 10.1111/j.1540-6261.1997.tb02758.x  |  Cited by: 62

HAROLD H. ZHANG

This article develops ways to endogenize the borrowing constraints used in a class of computable incomplete markets models. We allow the constraints to depend on an investor's characteristics such as time preference, risk aversion, and income streams. The proposed constraint can be interpreted as a borrowing limit within which an investor has no incentive to default. Using a numerical algorithm, we find that for an array of structural parameters, the endogenous borrowing constraints can be much less stringent than the ad hoc borrowing constraints adopted by the existing studies.

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.

Credit Contagion from Counterparty Risk

Published: 9/28/2009,  Volume: 64,  Issue: 5  |  DOI: 10.1111/j.1540-6261.2009.01494.x  |  Cited by: 383

PHILIPPE JORION, GAIYAN ZHANG

Standard credit risk models cannot explain the observed clustering of default, sometimes described as “credit contagion.” This paper provides the first empirical analysis of credit contagion via direct counterparty effects. We find that bankruptcy announcements cause negative abnormal equity returns and increases in CDS spreads for creditors. In addition, creditors with large exposures are more likely to suffer from financial distress later. This suggests that counterparty risk is a potential additional channel of credit contagion. Indeed, the fear of counterparty defaults among financial institutions explains the sudden worsening of the credit crisis after the Lehman bankruptcy in September 2008.

Alternative Information Sources and the Information Content of Bank Loans

Published: 9/1993,  Volume: 48,  Issue: 4  |  DOI: 10.1111/j.1540-6261.1993.tb04765.x  |  Cited by: 151

RONALD BEST, HANG ZHANG

This paper examines the information content of bank loan agreements. We differentiate borrowers according to financial analysts' percentage earnings forecast errors and most recent forecast revisions. The empirical results suggest that banks rely on other indicators as initial screening devices to determine where to best deploy their evaluation and monitoring efforts. If these other indicators are reliable and signal‐improving prospects, banks do little further investigation. However, if the indicators are noisy and signal‐declining prospects, banks have incentives to expend resources to investigate the borrowers, resulting in the production of valuable information.

Tax‐Efficient Asset Management: Evidence from Equity Mutual Funds

Published: 11/12/2019,  Volume: 75,  Issue: 2  |  DOI: 10.1111/jofi.12843  |  Cited by: 43

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.

Trading Activity and Price Volatility in the Municipal Bond Market

Published: 3/25/2004,  Volume: 59,  Issue: 2  |  DOI: 10.1111/j.1540-6261.2004.00652.x  |  Cited by: 100

Chris Downing, Frank Zhang

Utilizing a comprehensive database of transactions in municipal bonds, we investigate the volume–volatility relation in the municipal bond market. We find a positive relation between the number of transactions and a bond's price volatility. In contrast to previous studies, we find a negative relation between average deal size and price volatility. These results are found to be robust throughout the sample. Our results are inconsistent with current theoretical models of the volume–volatility relation. These inconsistencies may arise because current models fail to account for the effects of overall market liquidity on the costs of large transactions.

Two‐Pass Tests of Asset Pricing Models with Useless Factors

Published: 2/1999,  Volume: 54,  Issue: 1  |  DOI: 10.1111/0022-1082.00102  |  Cited by: 238

Raymond Kan, Chu Zhang

In this paper we investigate the properties of the standard two‐pass methodology of testing beta pricing models with misspecified factors. In a setting where a factor is useless, defined as being independent of all the asset returns, we provide theoretical results and simulation evidence that the second‐pass cross‐sectional regression tends to find the beta risk of the useless factor priced more often than it should. More surprisingly, this misspecification bias exacerbates when the number of time series observations increases. Possible ways of detecting useless factors are also examined.

Local Risk, Local Factors, and Asset Prices

Published: 1/12/2017,  Volume: 72,  Issue: 1  |  DOI: 10.1111/jofi.12465  |  Cited by: 118

SELALE TUZEL, MIAO BEN ZHANG

Firm location affects firm risk through local factor prices. We find more procyclical factor prices such as wages and real estate prices in areas with more cyclical economies, namely, high “local beta” areas. While procyclical wages provide a natural hedge against aggregate shocks and reduce firm risk, procyclical prices of real estate, which are part of firm assets, increase firm risk. We confirm that firms located in higher local beta areas have lower industry‐adjusted returns and conditional betas, and show that the effect is stronger among firms with low real estate holdings. A production‐based equilibrium model explains these empirical findings.

Economic Stimulus at the Expense of Routine‐Task Jobs

Published: 10/4/2021,  Volume: 76,  Issue: 6  |  DOI: 10.1111/jofi.13080  |  Cited by: 55

SELALE TUZEL, MIAO BEN ZHANG

Do investment tax incentives improve job prospects for workers? We explore states' adoption of a major federal tax incentive that accelerates the depreciation of equipment investments for eligible firms but not for ineligible ones. Analyzing massive establishment‐level data sets on occupational employment and computer investment, we find that when states expand investment incentives, eligible firms immediately increase their equipment and skilled employees; whereas they reduce routine‐task employees after a delay of up to two years. These opposing effects constitute an overall insignificant effect on the firms' total employment and shed light on the nuances of job creation through investment incentives.

A Note on “Risk Reduction in Large Portfolios: Why Imposing the Wrong Constraints Helps”

Published: 7/2/2019,  Volume: 74,  Issue: 5  |  DOI: 10.1111/jofi.12824  |  Cited by: 1

RAVI JAGANNATHAN, TONGSHU MA, JIAQI ZHANG

This note corrects an error in the proof of Proposition 2 of “Risk Reduction in Large Portfolios: Why Imposing the Wrong Constraint Helps” that appeared in the Journal of Finance, August 2003.

Countercyclical Income Risk and Portfolio Choices: Evidence from Sweden

Published: 4/8/2024,  Volume: 79,  Issue: 3  |  DOI: 10.1111/jofi.13341  |  Cited by: 28

SYLVAIN CATHERINE, PAOLO SODINI, YAPEI ZHANG

Using Swedish administrative panel data, we document that workers facing higher left‐tail income risk when equity markets perform poorly have lower portfolio equity share. In line with theory, the relationship between cyclical skewness and stock holdings increases with the share of human capital in a worker's total wealth and vanishes as workers get closer to retirement. Cyclical skewness also predicts portfolio differences within pairs of identical twins. Our findings show that households hedge against correlated tail risks, an important mechanism in asset pricing and portfolio choice models.

Financially Constrained Stock Returns

Published: 7/16/2009,  Volume: 64,  Issue: 4  |  DOI: 10.1111/j.1540-6261.2009.01481.x  |  Cited by: 215

DMITRY LIVDAN, HORACIO SAPRIZA, LU ZHANG

We study the effect of financial constraints on risk and expected returns by extending the investment‐based asset pricing framework to incorporate retained earnings, debt, costly equity, and collateral constraints on debt capacity. Quantitative results show that more financially constrained firms are riskier and earn higher expected stock returns than less financially constrained firms. Intuitively, by preventing firms from financing all desired investments, collateral constraints restrict the flexibility of firms in smoothing dividend streams in the face of aggregate shocks. The inflexibility mechanism also gives rise to a convex relation between market leverage and expected stock returns.

Market Orders and Market Efficiency

Published: 3/1997,  Volume: 52,  Issue: 1  |  DOI: 10.1111/j.1540-6261.1997.tb03816.x  |  Cited by: 36

DAVID P. BROWN, ZHI MING ZHANG

This work compares a dealer market and a limit‐order book. Dealers commonly observe order flow and collect information from multiple market orders. They may be better informed than other traders, although they do not earn rents from this information. Dealers earn rents as suppliers of liquidity, and their decisions to enter or exit the market are independent of the degree of adverse selection. Introduction of a limit‐order book lowers the execution‐price risk faced by speculators and leads them to trade more aggressively on their information. Introduction of the book also lowers dealer profits, but increases the informational efficiency of prices.

Test Assets and Weak Factors

Published: 12/18/2024,  Volume: 80,  Issue: 1  |  DOI: 10.1111/jofi.13415  |  Cited by: 49

STEFANO GIGLIO, DACHENG XIU, DAKE ZHANG

We show that two important issues in empirical asset pricing—the presence of weak factors and the selection of test assets—are deeply connected. Since weak factors are those to which test assets have limited exposure, an appropriate selection of test assets can improve the strength of factors. Building on this insight, we introduce supervised principal component analysis (SPCA), a methodology that iterates supervised selection, principal‐component estimation, and factor projection. It enables risk premia estimation and factor model diagnosis even when weak factors are present and not all factors are observed. We establish SPCA's asymptotic properties and showcase its empirical applications.

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