The Journal of Finance

Diagnostic Expectations and Credit Cycles

Published: 1/26/2018,  Volume: 73,  Issue: 1  |  DOI: 10.1111/jofi.12586  |  Cited by: 499

PEDRO BORDALO, NICOLA GENNAIOLI, ANDREI SHLEIFER

We present a model of credit cycles arising from diagnostic expectations—a belief formation mechanism based on Kahneman and Tversky's representativeness heuristic. Diagnostic expectations overweight future outcomes that become more likely in light of incoming data. The expectations formation rule is forward looking and depends on the underlying stochastic process, and thus is immune to the Lucas critique. Diagnostic expectations reconcile extrapolation and neglect of risk in a unified framework. In our model, credit spreads are excessively volatile, overreact to news, and are subject to predictable reversals. These dynamics can account for several features of credit cycles and macroeconomic volatility.

Diagnostic Expectations and Stock Returns

Published: 7/23/2019,  Volume: 74,  Issue: 6  |  DOI: 10.1111/jofi.12833  |  Cited by: 351

PEDRO BORDALO, NICOLA GENNAIOLI, RAFAEL LA PORTA, ANDREI SHLEIFER

We revisit La Porta's finding that returns on stocks with the most optimistic analyst long‐term earnings growth forecasts are lower than those on stocks with the most pessimistic forecasts. We document the joint dynamics of fundamentals, expectations, and returns of these portfolios, and explain the facts using a model of belief formation based on the representativeness heuristic. Analysts forecast fundamentals from observed earnings growth, but overreact to news by exaggerating the probability of states that have become more likely. We find support for the model's predictions. A quantitative estimation of the model accounts for the key patterns in the data.

Asset Management within Commercial Banking Groups: International Evidence

Published: 7/24/2018,  Volume: 73,  Issue: 5  |  DOI: 10.1111/jofi.12702  |  Cited by: 93

MIGUEL A. FERREIRA, PEDRO MATOS, PEDRO PIRES

We study the performance of equity mutual funds run by asset management divisions of commercial banking groups using a worldwide sample. We show that bank‐affiliated funds underperform unaffiliated funds by 92 basis points per year. Consistent with conflicts of interest, the underperformance is more pronounced among those affiliated funds that overweight the stock of the bank's lending clients to a great extent. Divestitures of asset management divisions by banking groups support a causal interpretation of the results. Our findings suggest that affiliated fund managers support their lending divisions’ operations to reduce career concerns at the expense of fund investors.

The Presidential Puzzle: Political Cycles and the Stock Market

Published: 9/11/2003,  Volume: 58,  Issue: 5  |  DOI: 10.1111/1540-6261.00590  |  Cited by: 452

Pedro Santa‐Clara, Rossen Valkanov

AbstractThe excess return in the stock market is higher under Democratic than Republican presidencies: 9 percent for the value‐weighted and 16 percent for the equal‐weighted portfolio. The difference comes from higher real stock returns and lower real interest rates, is statistically significant, and is robust in subsamples. The difference in returns is not explained by business‐cycle variables related to expected returns, and is not concentrated around election dates. There is no difference in the riskiness of the stock market across presidencies that could justify a risk premium. The difference in returns through the political cycle is therefore a puzzle.

Idiosyncratic Risk Matters!

Published: 5/6/2003,  Volume: 58,  Issue: 3  |  DOI: 10.1111/1540-6261.00555  |  Cited by: 845

Amit Goyal, Pedro Santa‐Clara

AbstractThis paper takes a new look at the predictability of stock market returns with risk measures. We find a significant positive relation between average stock variance (largely idiosyncratic) and the return on the market. In contrast, the variance of the market has no forecasting power for the market return. These relations persist after we control for macroeconomic variables known to forecast the stock market. The evidence is consistent with models of time‐varying risk premia based on background risk and investor heterogeneity. Alternatively, our findings can be justified by the option value of equity in the capital structure of the firms.

Dynamic Portfolio Selection by Augmenting the Asset Space

Published: 9/19/2006,  Volume: 61,  Issue: 5  |  DOI: 10.1111/j.1540-6261.2006.01055.x  |  Cited by: 178

MICHAEL W. BRANDT, PEDRO SANTA‐CLARA

We present a novel approach to dynamic portfolio selection that is as easy to implement as the static Markowitz paradigm. We expand the set of assets to include mechanically managed portfolios and optimize statically in this extended asset space. We consider “conditional” portfolios, which invest in each asset an amount proportional to conditioning variables, and “timing” portfolios, which invest in each asset for a single period and in the risk‐free asset for all other periods. The static choice of these managed portfolios represents a dynamic strategy that closely approximates the optimal dynamic strategy for horizons up to 5 years.

Favoritism in Mutual Fund Families? Evidence on Strategic Cross‐Fund Subsidization

Published: 1/20/2006,  Volume: 61,  Issue: 1  |  DOI: 10.1111/j.1540-6261.2006.00830.x  |  Cited by: 448

JOSÉ‐MIGUEL GASPAR, MASSIMO MASSA, PEDRO MATOS

We investigate whether mutual fund families strategically transfer performance across member funds to favor those more likely to increase overall family profits. We find that “high family value” funds (i.e., high fees or high past performers) overperform at the expense of “low value” funds. Such a performance gap is above the one existing between similar funds not affiliated with the same family. Better allocations of underpriced initial public offering deals and opposite trades across member funds partly explain why high value funds overperform. Our findings highlight how the family organization prevalent in the mutual fund industry generates distortions in delegated asset management.

Implications of Keeping‐Up‐with‐the‐Joneses Behavior for the Equilibrium Cross Section of Stock Returns: International Evidence

Published: 11/25/2009,  Volume: 64,  Issue: 6  |  DOI: 10.1111/j.1540-6261.2009.01515.x  |  Cited by: 41

JUAN‐PEDRO GÓMEZ, RICHARD PRIESTLEY, FERNANDO ZAPATERO

This paper tests the cross‐sectional implications of “keeping‐up‐with‐the‐Joneses” (KUJ) preferences in an international setting. When agents have KUJ preferences, in the presence of undiversifiable nonfinancial wealth, both world and domestic risk (the idiosyncratic component of domestic wealth) are priced, and the equilibrium price of risk of the domestic factor is negative. We use labor income as a proxy for domestic wealth and find empirical support for these predictions. In terms of explaining the cross‐section of stock returns and the size of the pricing errors, the model performs better than alternative international asset pricing models.

Portfolio Manager Compensation in the U.S. Mutual Fund Industry

Published: 1/17/2019,  Volume: 74,  Issue: 2  |  DOI: 10.1111/jofi.12749  |  Cited by: 197

LINLIN MA, YUEHUA TANG, JUAN‐PEDRO GÓMEZ

We study compensation contracts of individual portfolio managers using hand‐collected data of over 4,500 U.S. mutual funds. Variations in the compensation structures are broadly consistent with an optimal contracting equilibrium. The likelihood of explicit performance‐based incentives is positively correlated with the intensity of agency conflicts, as proxied by the advisor's clientele dispersion, its affiliations in the financial industry, and its ownership structure. Investor sophistication and the threat of dismissal in outsourced funds serve as substitutes for explicit performance‐based incentives. Finally, we find little evidence of differences in future performance associated with any particular compensation arrangement.

The Role of Institutional Investors in Voting: Evidence from the Securities Lending Market: Erratum

Published: 11/12/2015,  Volume: 70,  Issue: 6  |  DOI: 10.1111/jofi.12360  |  Cited by: 3

REENA AGGARWAL, PEDRO A. C. SAFFI, JASON STURGESS

The Role of Institutional Investors in Voting: Evidence from the Securities Lending Market

Published: 9/3/2015,  Volume: 70,  Issue: 5  |  DOI: 10.1111/jofi.12284  |  Cited by: 165

REENA AGGARWAL, PEDRO A. C. SAFFI, JASON STURGESS

This paper investigates voting preferences of institutional investors using the unique setting of the securities lending market. Investors restrict lendable supply and/or recall loaned shares prior to the proxy record date to exercise voting rights. Recall is higher for investors with greater incentives to monitor, for firms with poor performance or weak governance, and for proposals where returns to governance are likely higher. At the subsequent vote, recall is associated with less support for management and more support for shareholder proposals. Our results indicate that institutions value their vote and use the proxy process to affect corporate governance.

The Relative Valuation of Caps and Swaptions: Theory and Empirical Evidence

Published: 12/2001,  Volume: 56,  Issue: 6  |  DOI: 10.1111/0022-1082.00399  |  Cited by: 129

Francis A. Longstaff, Pedro Santa‐Clara, Eduardo S. Schwartz

Although traded as distinct products, caps and swaptions are linked by no‐arbitrage relations through the correlation structure of interest rates. Using a string market model, we solve for the correlation matrix implied by swaptions and examine the relative valuation of caps and swaptions. We find that swaption prices are generated by four factors and that implied correlations are lower than historical correlations. Long‐dated swaptions appear mispriced and there were major pricing distortions during the 1998 hedge‐fund crisis. Cap prices periodically deviate significantly from the no‐arbitrage values implied by the swaptions market.