The Journal of Finance

Diagnostic Expectations and Stock Returns

Published: 07/06/2019   |   DOI: 10.1111/jofi.12833

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.

Why Do Foreign Firms Leave U.S. Equity Markets?

Published: 07/15/2010   |   DOI: 10.1111/j.1540-6261.2010.01577.x

CRAIG DOIDGE, G. ANDREW KAROLYI, RENÉ M. STULZ

Foreign firms terminate their Securities and Exchange Commission registration in the aftermath of the Sarbanes–Oxley Act (SOX) because they no longer require outside funds to finance growth opportunities. Deregistering firms’ insiders benefit from greater discretion to consume private benefits without having to raise higher cost funds. Foreign firms with more agency problems have worse stock‐price reactions to the adoption of Rule 12h‐6 in 2007, which made deregistration easier, than those firms more adversely affected by the compliance costs of SOX. Stock‐price reactions to deregistration announcements are negative, but less so under Rule 12h‐6, and more so for firms that raise fewer funds externally.

Risk Overhang and Loan Portfolio Decisions: Small Business Loan Supply before and during the Financial Crisis

Published: 09/04/2015   |   DOI: 10.1111/jofi.12356

ROBERT DEYOUNG, ANNE GRON, GӦKHAN TORNA, ANDREW WINTON

We estimate a structural model of bank portfolio lending and find that the typical U.S. community bank reduced its business lending during the global financial crisis. The decline in business credit was driven by increased risk overhang effects (consistent with a reduction in the liquidity of assets held on bank balance sheets) and by reduced loan supply elasticities suggestive of credit rationing (consistent with an increase in lender risk aversion). Nevertheless, we identify a group of strategically focused relationship banks that made and maintained higher levels of business loans during the crisis.

Agency Problems and Dividend Policies around the World

Published: 03/31/2007   |   DOI: 10.1111/0022-1082.00199

Rafael La Porta, Florencio Lopez‐de‐Silanes, Andrei Shleifer, Robert W. Vishny

This paper outlines and tests two agency models of dividends. According to the “outcome model,” dividends are paid because minority shareholders pressure corporate insiders to disgorge cash. According to the “substitute model,” insiders interested in issuing equity in the future pay dividends to establish a reputation for decent treatment of minority shareholders. The first model predicts that stronger minority shareholder rights should be associated with higher dividend payouts; the second model predicts the opposite. Tests on a cross section of 4,000 companies from 33 countries with different levels of minority shareholder rights support the outcome agency model of dividends.

Market Structure and Transaction Costs of Index CDSs

Published: 06/01/2020   |   DOI: 10.1111/jofi.12953

PIERRE COLLIN‐DUFRESNE, BENJAMIN JUNGE, ANDERS B. TROLLE

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

Carry Trades and Global Foreign Exchange Volatility

Published: 03/27/2012   |   DOI: 10.1111/j.1540-6261.2012.01728.x

LUKAS MENKHOFF, LUCIO SARNO, MAIK SCHMELING, ANDREAS SCHRIMPF

We investigate the relation between global foreign exchange (FX) volatility risk and the cross section of excess returns arising from popular strategies that borrow in low interest rate currencies and invest in high interest rate currencies, so‐called “carry trades.” We find that high interest rate currencies are negatively related to innovations in global FX volatility, and thus deliver low returns in times of unexpected high volatility, when low interest rate currencies provide a hedge by yielding positive returns. Furthermore, we show that volatility risk dominates liquidity risk and our volatility risk proxy also performs well for pricing returns of other portfolios.

Positive Feedback Investment Strategies and Destabilizing Rational Speculation

Published: 06/01/1990   |   DOI: 10.1111/j.1540-6261.1990.tb03695.x

J. BRADFORD DE LONG, ANDREI SHLEIFER, LAWRENCE H. SUMMERS, ROBERT J. WALDMANN

Analyses of rational speculation usually presume that it dampens fluctuations caused by “noise” traders. This is not necessarily the case if noise traders follow positive‐feedback strategies—buy when prices rise and sell when prices fall. It may pay to jump on the bandwagon and purchase ahead of noise demand. If rational speculators' early buying triggers positive‐feedback trading, then an increase in the number of forward‐looking speculators can increase volatility about fundamentals. This model is consistent with a number of empirical observations about the correlation of asset returns, the overreaction of prices to news, price bubbles, and expectations.

The Cross Section of MBS Returns

Published: 06/15/2021   |   DOI: 10.1111/jofi.13055

PETER DIEP, ANDREA L. EISFELDT, SCOTT RICHARDSON

We present a simple, linear asset pricing model of the cross section of Mortgage‐Backed Security (MBS) returns. MBS earn risk premia as compensation for their exposure to prepayment risk. We measure prepayment risk and estimate risk loadings using prepayment forecasts versus realizations. Estimated loadings on prepayment risk decrease monotonically in securities' coupons relative to the par coupon, consistent with the predicted effect of prepayment on bond value. Prepayment risk appears to be priced by specialized MBS investors. The price of prepayment risk changes sign over time with the sign of a representative MBS investor's exposure to prepayment shocks.

Good News for Value Stocks: Further Evidence on Market Efficiency

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb04825.x

RAFAEL LA PORTA, JOSEF LAKONISHOK, ANDREI SHLEIFER, ROBERT VISHNY

This article examines the hypothesis that the superior return to so‐called value stocks is the result of expectational errors made by investors. We study stock price reactions around earnings announcements for value and glamour stocks over a 5‐year period after portfolio formation. The announcement returns suggest that a significant portion of the return difference between value and glamour stocks is attributable to earnings surprises that are systematically more positive for value stocks. The evidence is inconsistent with a risk‐based explanation for the return differential.

Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading

Published: 09/04/2015   |   DOI: 10.1111/jofi.12357

ANDREW ELLUL, CHOTIBHAK JOTIKASTHIRA, CHRISTIAN T. LUNDBLAD, YIHUI WANG

Accounting rules, through their interactions with capital regulations, affect financial institutions’ trading behavior. The insurance industry provides a laboratory to explore these interactions: life insurers have greater flexibility than property and casualty insurers to hold speculative‐grade assets at historical cost, and the degree to which life insurers recognize market values differs across U.S. states. During the financial crisis, insurers facing a lesser degree of market value recognition are less likely to sell downgraded asset‐backed securities. To improve their capital positions, these insurers disproportionately resort to gains trading, selectively selling otherwise unrelated bonds with high unrealized gains, transmitting shocks across markets.

Government Ownership of Banks

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00422

Rafael La Porta, Florencio Lopez‐De‐Silanes, Andrei Shleifer

We assemble data on government ownership of banks around the world. The data show that such ownership is large and pervasive, and higher in countries with low levels of per capita income, backward financial systems, interventionist and inefficient governments, and poor protection of property rights. Higher government ownership of banks in 1970 is associated with slower subsequent financial development and lower growth of per capita income and productivity. This evidence supports “political” theories of the effects of government ownership of firms.

The Effect of Three Mile Island on Utility Bond Risk Premia: A Note

Published: 03/01/1986   |   DOI: 10.1111/j.1540-6261.1986.tb04504.x

W. BRIAN BARRETT, ANDREA J. HEUSON, ROBERT W. KOLB

Changes in Interstate Banking Laws: The Impact on Shareholder Wealth

Published: 12/01/1990   |   DOI: 10.1111/j.1540-6261.1990.tb03735.x

HAROLD A. BLACK, M. ANDREW FIELDS, ROBERT L. SCHWEITZER

This study examines the impact on shareholder wealth of changes in interstate banking laws. The research demonstrates that changes in state statutes which allow interstate banking have a positive impact on the stock prices of regional banking organizations and a negative impact on the stock prices of money center banks. Interstate banking statutes initially exclude those states in which the money center banks are headquartered. The findings provide evidence that, by excluding money center banks from expansion across state lines, the competition from the regional banks may have an adverse competitive effect on the money center banks.

The Flash Crash: High‐Frequency Trading in an Electronic Market

Published: 01/25/2017   |   DOI: 10.1111/jofi.12498

ANDREI KIRILENKO, ALBERT S. KYLE, MEHRDAD SAMADI, TUGKAN TUZUN

We study intraday market intermediation in an electronic market before and during a period of large and temporary selling pressure. On May 6, 2010, U.S. financial markets experienced a systemic intraday event—the Flash Crash—where a large automated selling program was rapidly executed in the E‐mini S&P 500 stock index futures market. Using audit trail transaction‐level data for the E‐mini on May 6 and the previous three days, we find that the trading pattern of the most active nondesignated intraday intermediaries (classified as High‐Frequency Traders) did not change when prices fell during the Flash Crash.

Reinforcement Learning and Savings Behavior

Published: 11/25/2009   |   DOI: 10.1111/j.1540-6261.2009.01509.x

JAMES J. CHOI, DAVID LAIBSON, BRIGITTE C. MADRIAN, ANDREW METRICK

We show that individual investors over‐extrapolate from their personal experience when making savings decisions. Investors who experience particularly rewarding outcomes from 401(k) saving—a high average and/or low variance return—increase their 401(k) savings rate more than investors who have less rewarding experiences. This finding is not driven by aggregate time‐series shocks, income effects, rational learning about investing skill, investor fixed effects, or time‐varying investor‐level heterogeneity that is correlated with portfolio allocations to stock, bond, and cash asset classes. We discuss implications for the equity premium puzzle and interventions aimed at improving household financial outcomes.

Tax‐Induced Trading: The Effect of the 1986 Tax Reform Act on Stock Market Activity

Published: 06/01/1989   |   DOI: 10.1111/j.1540-6261.1989.tb05060.x

PAUL J. BOLSTER, LAWRENCE B. LINDSEY, ANDREW MITRUSI

The end of favorable tax treatment for long‐term capital gains caused investors to reassess traditional tax‐induced trading strategies. This study compares trading behavior in December 1986 and January 1987 with previous years. Our results indicate that these tax code changes had a powerful effect on trading behavior. Relative trading volume was considerably higher in December 1986 for long‐term winners but not significantly lower for long‐term losers. Results also indicate altered trading patterns based on short‐term gains in December 1986 and for long‐term winners in January 1987.

Summing Up

Published: 06/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb04744.x

Navin Chopra, Charles M. C. Lee, Andrei Shleifer, Richard H. Thaler

Investor Protection and Corporate Valuation

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00457

Rafael Porta, Florencio Lopez‐De‐Silanes, Andrei Shleifer, Robert Vishny

We present a model of the effects of legal protection of minority shareholders and of cash‐flow ownership by a controlling shareholder on the valuation of firms. We then test this model using a sample of 539 large firms from 27 wealthy economies. Consistent with the model, we find evidence of higher valuation of firms in countries with better protection of minority shareholders and in firms with higher cash‐flow ownership by the controlling shareholder.

Legal Determinants of External Finance

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb02727.x

RAFAEL PORTA, FLORENCIO LOPEZ‐DE‐SILANES, ANDREI SHLEIFER, ROBERT W. VISHNY

Using a sample of 49 countries, we show that countries with poorer investor protections, measured by both the character of legal rules and the quality of law enforcement, have smaller and narrower capital markets. These findings apply to both equity and debt markets. In particular, French civil law countries have both the weakest investor protections and the least developed capital markets, especially as compared to common law countries.

An Empirical Comparison of Alternative Models of the Short‐Term Interest Rate

Published: 07/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb04011.x

K. C. CHAN, G. ANDREW KAROLYI, FRANCIS A. LONGSTAFF, ANTHONY B. SANDERS

We estimate and compare a variety of continuous‐time models of the short‐term riskless rate using the Generalized Method of Moments. We find that the most successful models in capturing the dynamics of the short‐term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate. A number of well‐known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility. We show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk.