The Journal of Finance

THE DEMAND FOR INTERNATIONAL RESERVES*

Published: 06/01/1970   |   DOI: 10.1111/j.1540-6261.1970.tb00543.x

Michael G. Kelly

THE PROFITABILITY OF GROWTH THROUGH MERGERS*

Published: 06/01/1968   |   DOI: 10.1111/j.1540-6261.1968.tb00835.x

Eamon M. Kelly

THE REPETITIVE BIDDING PROCESS IN MUNICIPAL BOND UNDERWRITING, A CHANCE‐CONSTRAINED PROGRAMMING APPROACH*

Published: 09/01/1974   |   DOI: 10.1111/j.1540-6261.1974.tb03112.x

James Michael Kelly

Market Expectations in the Cross‐Section of Present Values

Published: 05/13/2013   |   DOI: 10.1111/jofi.12060

BRYAN KELLY, SETH PRUITT

Returns and cash flow growth for the aggregate U.S. stock market are highly and robustly predictable. Using a single factor extracted from the cross‐section of book‐to‐market ratios, we find an out‐of‐sample return forecasting R2 of 13% at the annual frequency (0.9% monthly). We document similar out‐of‐sample predictability for returns on value, size, momentum, and industry portfolios. We present a model linking aggregate market expectations to disaggregated valuation ratios in a latent factor system. Spreads in value portfolios’ exposures to economic shocks are key to identifying predictability and are consistent with duration‐based theories of the value premium.

A Tough Act to Follow: Contrast Effects in Financial Markets

Published: 04/16/2018   |   DOI: 10.1111/jofi.12685

SAMUEL M. HARTZMARK, KELLY SHUE

A contrast effect occurs when the value of a previously observed signal inversely biases perception of the next signal. We present the first evidence that contrast effects can distort prices in sophisticated and liquid markets. Investors mistakenly perceive earnings news today as more impressive if yesterday's earnings surprise was bad and less impressive if yesterday's surprise was good. A unique advantage of our financial setting is that we can identify contrast effects as an error in perceptions rather than expectations. Finally, we show that our results cannot be explained by an alternative explanation involving information transmission from previous earnings announcements.

The Gender Gap in Housing Returns

Published: 02/07/2023   |   DOI: 10.1111/jofi.13212

PAUL GOLDSMITH‐PINKHAM, KELLY SHUE

Using detailed transactions data across the United States, we find that single women earn 1.5 percentage points lower annualized returns on housing relative to single men. Forty‐five percent of the gap is explained by transaction timing and location. The remaining gap arises from a 2% gender difference in execution prices at purchase and sale. Consistent with a negotiation channel, women list for less and experience worse negotiated discounts. The gender gap shrinks in tight markets, where negotiation is replaced by quasi‐auctions. Overall, gender differences in housing explain 30% of the gender gap in wealth accumulation for the median household.

How Do Quasi‐Random Option Grants Affect CEO Risk‐Taking?

Published: 08/01/2017   |   DOI: 10.1111/jofi.12545

KELLY SHUE, RICHARD R. TOWNSEND

We examine how an increase in stock option grants affects CEO risk‐taking. The overall net effect of option grants is theoretically ambiguous for risk‐averse CEOs. To overcome the endogeneity of option grants, we exploit institutional features of multiyear compensation plans, which generate two distinct types of variation in the timing of when large increases in new at‐the‐money options are granted. We find that, given average grant levels during our sample period, a 10% increase in new options granted leads to a 2.8% to 4.2% increase in equity volatility. This increase in risk is driven largely by increased leverage.

Can the Market Multiply and Divide? Non‐Proportional Thinking in Financial Markets

Published: 05/28/2021   |   DOI: 10.1111/jofi.13059

KELLY SHUE, RICHARD R. TOWNSEND

We hypothesize that investors partially think about stock price changes in dollar rather than percentage units, leading to more extreme return responses to news for lower‐priced stocks. Consistent with such non‐proportional thinking, we find a doubling in price is associated with a 20% to 30% decline in volatility and beta (controlling for size/liquidity). To identify a causal price effect, we show that volatility jumps following stock splits and drops following reverse splits. Lower‐priced stocks also respond more strongly to firm‐specific news. Non‐proportional thinking helps explain asset pricing patterns such as the size‐volatility/beta relation, the leverage effect puzzle, and return drift and reversals.

Modeling Corporate Bond Returns

Published: 04/24/2023   |   DOI: 10.1111/jofi.13233

BRYAN KELLY, DIOGO PALHARES, SETH PRUITT

We propose a conditional factor model for corporate bond returns with five factors and time‐varying factor loadings. We have three main empirical findings. First, our factor model excels in describing the risks and returns of corporate bonds, improving over previously proposed models in the literature by a large margin. Second, our model recommends a systematic bond investment portfolio whose high out‐of‐sample Sharpe ratio suggests that the credit risk premium is notably larger than previously estimated. Third, we find closer integration between debt and equity markets than found in prior literature.

The Virtue of Complexity in Return Prediction

Published: 12/08/2023   |   DOI: 10.1111/jofi.13298

BRYAN KELLY, SEMYON MALAMUD, KANGYING ZHOU

Much of the extant literature predicts market returns with “simple” models that use only a few parameters. Contrary to conventional wisdom, we theoretically prove that simple models severely understate return predictability compared to “complex” models in which the number of parameters exceeds the number of observations. We empirically document the virtue of complexity in U.S. equity market return prediction. Our findings establish the rationale for modeling expected returns through machine learning.

The Price of Political Uncertainty: Theory and Evidence from the Option Market

Published: 03/01/2016   |   DOI: 10.1111/jofi.12406

BRYAN KELLY, ĽUBOŠ PÁSTOR, PIETRO VERONESI

We empirically analyze the pricing of political uncertainty, guided by a theoretical model of government policy choice. To isolate political uncertainty, we exploit its variation around national elections and global summits. We find that political uncertainty is priced in the equity option market as predicted by theory. Options whose lives span political events tend to be more expensive. Such options provide valuable protection against the price, variance, and tail risks associated with political events. This protection is more valuable in a weaker economy and amid higher political uncertainty. The effects of political uncertainty spill over across countries.

(Re‐)Imag(in)ing Price Trends

Published: 08/02/2023   |   DOI: 10.1111/jofi.13268

JINGWEN JIANG, BRYAN KELLY, DACHENG XIU

We reconsider trend‐based predictability by employing flexible learning methods to identify price patterns that are highly predictive of returns, as opposed to testing predefined patterns like momentum or reversal. Our predictor data are stock‐level price charts, allowing us to extract the most predictive price patterns using machine learning image analysis techniques. These patterns differ significantly from commonly analyzed trend signals, yield more accurate return predictions, enable more profitable investment strategies, and demonstrate robustness across specifications. Remarkably, they exhibit context independence, as short‐term patterns perform well on longer time scales, and patterns learned from U.S. stocks prove effective in international markets.

Variance and Lower Partial Moment Measures of Systematic Risk: Some Analytical and Empirical Results

Published: 06/01/1982   |   DOI: 10.1111/j.1540-6261.1982.tb02227.x

KELLY PRICE, BARBARA PRICE, TIMOTHY J. NANTELL

As a measure of systematic risk, the lower partial moment measure requires fewer restrictive assumptions than does the variance measure. However, the latter enjoys far wider usage than the former, perhaps because of its familiarity and the fact that two measures of systematic risk are equivalent when return distributions are normal. This paper shows analytically that there are systematic differences in the two risk measures when return distributions are lognormal. Results of empirical tests show that there are indeed systematic differences in measured values of the two risk measures for securities with above average and with below average systematic risk.

Principal Portfolios

Published: 12/14/2022   |   DOI: 10.1111/jofi.13199

BRYAN KELLY, SEMYON MALAMUD, LASSE HEJE PEDERSEN

We propose a new asset pricing framework in which all securities' signals predict each individual return. While the literature focuses on securities' own‐signal predictability, assuming equal strength across securities, our framework includes cross‐predictability—leading to three main results. First, we derive the optimal strategy in closed form. It consists of eigenvectors of a “prediction matrix,” which we call “principal portfolios.” Second, we decompose the problem into alpha and beta, yielding optimal strategies with, respectively, zero and positive factor exposure. Third, we provide a new test of asset pricing models. Empirically, principal portfolios deliver significant out‐of‐sample alphas to standard factors in several data sets.

CEO Contracting and Antitakeover Amendments

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb01118.x

KENNETH A. BOROKHOVICH, KELLY R. BRUNARSKI, ROBERT PARRINO

This article examines incentives for adopting antitakeover charter amendments (ATAs) that are associated with compensation contracts. The evidence is consistent with the hypothesis that antitakeover measures such as ATAs help managers protect above‐market levels of compensation. Chief executive officers (CEOs) of firms that adopt ATAs receive higher salaries and more valuable option grants than CEOs at similar firms that do not adopt them. Furthermore, the magnitude of this difference increases following ATA adoption. The evidence is inconsistent with the hypothesis that ATAs facilitate the writing of efficient compensation contracts.

Is There a Replication Crisis in Finance?

Published: 05/26/2023   |   DOI: 10.1111/jofi.13249

THEIS INGERSLEV JENSEN, BRYAN KELLY, LASSE HEJE PEDERSEN

Several papers argue that financial economics faces a replication crisis because the majority of studies cannot be replicated or are the result of multiple testing of too many factors. We develop and estimate a Bayesian model of factor replication that leads to different conclusions. The majority of asset pricing factors (i) can be replicated; (ii) can be clustered into 13 themes, the majority of which are significant parts of the tangency portfolio; (iii) work out‐of‐sample in a new large data set covering 93 countries; and (iv) have evidence that is strengthened (not weakened) by the large number of observed factors.

Shaping Liquidity: On the Causal Effects of Voluntary Disclosure

Published: 05/28/2014   |   DOI: 10.1111/jofi.12180

KARTHIK BALAKRISHNAN, MARY BROOKE BILLINGS, BRYAN KELLY, ALEXANDER LJUNGQVIST

Can managers influence the liquidity of their firms’ shares? We use plausibly exogenous variation in the supply of public information to show that firms actively shape their information environments by voluntarily disclosing more information than regulations mandate and that such efforts improve liquidity. Firms respond to an exogenous loss of public information by providing more timely and informative earnings guidance. Responses appear motivated by a desire to reduce information asymmetries between retail and institutional investors. Liquidity improves as a result and in turn increases firm value. This suggests that managers can causally influence their cost of capital via voluntary disclosure.

Finance Research Productivity and Influence

Published: 12/01/1995   |   DOI: 10.1111/j.1540-6261.1995.tb05193.x

KENNETH A. BOROKHOVICH, ROBERT J. BRICKER, KELLY R. BRUNARSKI, BETTY J. SIMKINS

This study examines differences in finance research productivity and influence across 661 academic institutions over the five‐year period from 1989 through 1993. We find that 40 institutions account for over 50 percent of all articles published by 16 leading journals over the five‐year period; 66 institutions account for two‐thirds of the articles. Influence is more skewed, with as few as 20 institutions accounting for 50 percent of all citations to articles in these journals. The number of publications and publication influence increase with faculty size and academic accreditation. Prestigious business schools are associated with high publication productivity and influence.

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

Published: 02/07/2013   |   DOI: 10.1111/jofi.12028

ERIC K. KELLEY, PAUL C. TETLOCK

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

The Long‐Lasting Momentum in Weekly Returns

Published: 01/10/2008   |   DOI: 10.1111/j.1540-6261.2008.01320.x

ROBERTO C. GUTIERREZ, ERIC K. KELLEY

Reversal is the current stylized fact of weekly returns. However, we find that an opposing and long‐lasting continuation in returns follows the well‐documented brief reversal. These subsequent momentum profits are strong enough to offset the initial reversal and to produce a significant momentum effect over the full year following portfolio formation. Thus, ex post, extreme weekly returns are not too extreme. Our findings extend to weekly price movements with and without public news. In addition, there is no relation between news uncertainty and the momentum in 1‐week returns.