Value at risk
Quantifying the semantics of search behavior before stock market moves
Chester Curme et al.
Proceedings of the National Academy of Sciences, 12 August 2014, Pages 11600-11605
Abstract:
Technology is becoming deeply interwoven into the fabric of society. The Internet has become a central source of information for many people when making day-to-day decisions. Here, we present a method to mine the vast data Internet users create when searching for information online, to identify topics of interest before stock market moves. In an analysis of historic data from 2004 until 2012, we draw on records from the search engine Google and online encyclopedia Wikipedia as well as judgments from the service Amazon Mechanical Turk. We find evidence of links between Internet searches relating to politics or business and subsequent stock market moves. In particular, we find that an increase in search volume for these topics tends to precede stock market falls. We suggest that extensions of these analyses could offer insight into large-scale information flow before a range of real-world events.
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Private Equity and Industry Performance
Shai Bernstein et al.
Stanford Working Paper, June 2014
Abstract:
The growth of the private equity industry has spurred concerns about its potential impact on the economy. This analysis looks across nations and industries to assess the impact of private equity on industry performance. We find that industries where private equity funds have invested in the past five years have grown more quickly in terms of productivity and employment, and these industries appear to be less exposed to aggregate shocks. Robustness tests suggest that the results are not driven by reverse causality. These patterns are not driven solely by common law nations such as the United Kingdom and United States, but also hold in Continental Europe.
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Tim Lohse, Razvan Pascalau & Christian Thomann
Journal of Economic Behavior & Organization, October 2014, Pages 197-212
Abstract:
We empirically investigate whether increases in the U.S. Securities and Exchange Commission's (SEC) budget have an effect on firms' compliance behavior with securities market rules. Our study uses a dataset on the SEC's resources and its enforcement actions over a period beginning shortly after the Second World War and ending in 2010. We find that increases in the SEC's resources both improve compliance and lead to an increased activity level of the SEC. The higher level of compliance is reflected by a decrease in the numbers of enforcement cases. The increased activity level is reflected by a surge in the number of investigations conducted by the SEC.
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Did going public impair Moody's credit ratings?
Simi Kedia, Shivaram Rajgopal & Xing Zhou
Journal of Financial Economics, forthcoming
Abstract:
We investigate a prominent allegation in congressional hearings that Moody's loosened its rating standards to chase revenue after it went public in 2000. Consistent with this allegation, Moody's ratings for both corporate bonds and structured finance products are significantly more favorable to issuers, relative to S&P's, after Moody's IPO. Moreover, Moody's ratings are more favorable for clients subject to greater conflict of interest. There is little evidence that Moody's higher ratings, post-IPO, are more informative, measured as expected default frequencies (EDFs) or as the probability of default. Our findings inform the debate on whether financial gatekeepers should be publicly traded.
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Capitalizing on Capitol Hill: Informed Trading by Hedge Fund Managers
Meng Gao & Jiekun Huang
University of Illinois Working Paper, July 2014
Abstract:
This paper examines the hypothesis that hedge fund managers gain an informational advantage in securities trading through their connections with lobbyists. Using datasets on the long-equity holdings and lobbyist connections of hedge funds from 1998 to 2012, we show that hedge funds outperform by 63 to 87 basis points per month on their political holdings when they are connected to lobbyists. Furthermore, the political outperformance of connected funds decreased significantly after the STOCK Act was signed into law. Our study provides evidence on the transmission of private political information in the financial markets and on the value of such information to financial market participants.
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Irrational exuberance and neural crash warning signals during endogenous experimental market bubbles
Alec Smith et al.
Proceedings of the National Academy of Sciences, 22 July 2014, Pages 10503-10508
Abstract:
Groups of humans routinely misassign value to complex future events, especially in settings involving the exchange of resources. If properly structured, experimental markets can act as excellent probes of human group-level valuation mechanisms during pathological overvaluations - price bubbles. The connection between the behavioral and neural underpinnings of such phenomena has been absent, in part due to a lack of enabling technology. We used a multisubject functional MRI paradigm to measure neural activity in human subjects participating in experimental asset markets in which endogenous price bubbles formed and crashed. Although many ideas exist about how and why such bubbles may form and how to identify them, our experiment provided a window on the connection between neural responses and behavioral acts (buying and selling) that created the bubbles. We show that aggregate neural activity in the nucleus accumbens (NAcc) tracks the price bubble and that NAcc activity aggregated within a market predicts future price changes and crashes. Furthermore, the lowest-earning subjects express a stronger tendency to buy as a function of measured NAcc activity. Conversely, we report a signal in the anterior insular cortex in the highest earners that precedes the impending price peak, is associated with a higher propensity to sell in high earners, and that may represent a neural early warning signal in these subjects. Such markets could be a model system to understand neural and behavior mechanisms in other settings where emergent group-level activity exhibits mistaken belief or valuation.
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Does the Tail Wag the Dog?: The Effect of Credit Default Swaps on Credit Risk
Marti Subrahmanyam, Dragon Yongjun Tang & Sarah Qian Wang
Review of Financial Studies, forthcoming
Abstract:
We use credit default swaps (CDS) trading data to demonstrate that the credit risk of reference firms, reflected in rating downgrades and bankruptcies, increases significantly upon the inception of CDS trading, a finding that is robust after controlling for the endogeneity of CDS trading. Additionally, distressed firms are more likely to file for bankruptcy if they are linked to CDS trading. Furthermore, firms with more "no restructuring" contracts than other types of CDS contracts (i.e., contracts that include restructuring) are more adversely affected by CDS trading, and the number of creditors increases after CDS trading begins, exacerbating creditor coordination failure in the resolution of financial distress.
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Access to management and the informativeness of analyst research
Clifton Green et al.
Journal of Financial Economics, forthcoming
Abstract:
We examine whether access to management at broker-hosted investor conferences leads to more informative research by analysts. We find analyst recommendation changes have larger immediate price impacts when the analyst's firm has a conference-hosting relation with the company. The effect increases with hosting frequency and is strongest in the days following the conference. Conference-hosting brokers also issue more informative, accurate, and timely earnings forecasts than non-hosts. Our findings suggest that access to management remains an important source of analysts' informational advantage in the post-Regulation Fair Disclosure world.
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The behavioral basis of sell-side analysts' herding
Robert Durand, Manapon Limkriangkrai & Lucia Fung
Journal of Contemporary Accounting & Economics, forthcoming
Abstract:
Sell-side analysts move away from the prevailing consensus as their confidence increases. As their confidence falls, they herd towards the prevailing consensus. Confidence and the associated propensity to move away from the herd, increases as firms become more difficult to analyze. This behavior is consistent with such analysts having lower meta-cognitive skills.
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Nicola Gennaioli, Andrei Shleifer & Robert Vishny
Journal of Finance, forthcoming
Abstract:
We present a new model of investors delegating portfolio management to professionals based on trust. Trust in the manager reduces an investor's perception of the riskiness of a given investment, and allows managers to charge fees. Money managers compete for investor funds by setting fees, but because of trust fees do not fall to costs. In equilibrium, fees are higher for assets with higher expected return, managers on average underperform the market net of fees, but investors nevertheless prefer to hire managers to investing on their own. When investors hold biased expectations, trust causes managers to pander to investor beliefs.
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Private Equity Premium Puzzle Revisited
Katya Kartashova
American Economic Review, forthcoming
Abstract:
This paper revisits the results of Moskowitz and Vissing-Jorgensen (2002) on returns to entrepreneurial investments in the United States. Following the authors' methodology and new data from the Survey of Consumer Finances (SCF), I find that the "private equity premium puzzle" does not survive the period of high public equity returns in the 1990s. The difference between private and public equity returns is positive and large period-by-period between 1999 and 2007. Whereas in the economy-wide downturn of the Great Recession, public and private equities performances are substantially closer. I validate these results in the aggregate data going back to 1960s.
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Pengfei Ye
Journal of Financial and Quantitative Analysis, February 2014, Pages 221-248
Abstract:
This paper examines whether one of the most important participants in the takeover market, the institutional investors of target companies, suffers from the disposition effect and, if so, how this selling bias influences the takeover outcomes. I report robust evidence that target institutional investors are reluctant to realize losses. This bias further allows their sunk cost to affect both the takeover price and the deal success. My results are explained by neither the undervalued targets nor the 52-week-high price effect. They are most pronounced among targets whose investors have a strong propensity to hold on to loser stocks.
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Leonardo Bursztyn et al.
Econometrica, July 2014, Pages 1273-1301
Abstract:
Using a high-stakes field experiment conducted with a financial brokerage, we implement a novel design to separately identify two channels of social influence in financial decisions, both widely studied theoretically. When someone purchases an asset, his peers may also want to purchase it, both because they learn from his choice ("social learning") and because his possession of the asset directly affects others' utility of owning the same asset ("social utility"). We randomize whether one member of a peer pair who chose to purchase an asset has that choice implemented, thus randomizing his ability to possess the asset. Then, we randomize whether the second member of the pair: (i) receives no information about the first member, or (ii) is informed of the first member's desire to purchase the asset and the result of the randomization that determined possession. This allows us to estimate the effects of learning plus possession, and learning alone, relative to a (no information) control group. We find that both social learning and social utility channels have statistically and economically significant effects on investment decisions. Evidence from a follow-up survey reveals that social learning effects are greatest when the first (second) investor is financially sophisticated (financially unsophisticated); investors report updating their beliefs about asset quality after learning about their peer's revealed preference; and, they report motivations consistent with "keeping up with the Joneses" when learning about their peer's possession of the asset. These results can help shed light on the mechanisms underlying herding behavior in financial markets and peer effects in consumption and investment decisions.
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The financial performance of aircraft manufacturers during World War II: The vicissitudes of war
Stephen Ciccone & Fred Kaen
Defence and Peace Economics, forthcoming
Abstract:
Controversy has long surrounded the role and profitability of US defense contractors. From a financial perspective the question becomes whether defense contractors earn greater profits and investor returns than other companies during military conflicts. We explore this question by examining the accounting profitability and investor returns of US aircraft manufacturers before, during, and after World War II and compare them to a sample of non-defense firms. We also examine the reactions of aircraft stock prices to important political and military events of the time. We find that (1) aircraft stocks exhibited positive abnormal returns around events associated with defense buildups and outbreaks of hostile action and negative returns around events signaling an end to hostilities, (2) the company's accounting returns improved during the war but these higher accounting returns did not translate into higher stock returns for the shareholders, and (3) investors could have earned higher stock returns had they switched out of aircraft stocks after Pearl Harbor and reinvested the proceeds in the overall market.
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Bruce Carlin, Francis Longstaff & Kyle Matoba
Journal of Financial Economics, forthcoming
Abstract:
How do differences of opinion affect asset prices? Do investors earn a risk premium when disagreement arises in the market? Despite their fundamental importance, these questions are among the most controversial issues in finance. In this paper, we use a novel data set that allows us to directly measure the level of disagreement among Wall Street mortgage dealers about prepayment speeds. We examine how disagreement evolves over time and study its effects on expected returns, return volatility, and trading volume in the mortgage-backed security market. We find that increased disagreement is associated with higher expected returns, higher return volatility, and larger trading volume. These results imply that there is a positive risk premium for disagreement in asset prices. We also show that volatility in and of itself does not lead to higher trading volume. Instead, only when disagreement arises in the market is higher uncertainty associated with more trading. Finally, we are able to distinguish empirically between two competing hypotheses regarding how information in markets gets incorporated into asset prices. We find that sophisticated investors appear to update their beliefs through a rational expectations mechanism when disagreement arises.
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High-yield versus investment-grade bonds: Less risk and greater returns?
Hsi Li, Joseph McCarthy & Coleen Pantalone
Applied Financial Economics, Fall 2014, Pages 1303-1312
Abstract:
Using Bank of America/Merrill Lynch bond yield indexes, we compare the returns on investment-grade bonds to the returns on high-yield bonds over the period from January 1997 through mid-August 2011, a period marked by the collapse of the technology sector in early 2000 and the financial crisis in 2008. We compare return and risk measures under the assumption of a normal distribution with those obtained under the assumption of a stable distribution. When a normal distribution is assumed, we see a higher expected return associated with a lower SD on the high-yield bond returns relative to investment-grade bond returns. However, we also find that the returns on both high-yield bonds and investment-grade bonds exhibit stable (fat-tailed) distributions, with the fat tail more pronounced for the high-yield bond series. These results suggest that the assumption of a distribution that allows for fat tails and skewness is important for identifying the risk and return characteristics of these bond series.