Walking down Wall Street
The People in Your Neighborhood: Social Interactions and Mutual Fund Portfolios
Veronika Pool, Noah Stoffman & Scott Yonker
Journal of Finance, forthcoming
Abstract:
We find that socially connected fund managers have more similar holdings and trades. The overlap of funds whose managers reside in the same neighborhood is considerably higher than that of funds whose managers live in the same city but in different neighborhoods. These effects are larger when managers share a similar ethnic background, and are not explained by preferences. Valuable information is transmitted through these peer networks: a long-short strategy composed of stocks purchased minus sold by neighboring managers delivers positive risk-adjusted returns. Unlike prior empirical work, our tests disentangle the effects of social interactions from community effects.
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Weather-Induced Mood, Institutional Investors, and Stock Returns
William Goetzmann et al.
Review of Financial Studies, forthcoming
Abstract:
This study shows that weather-based indicators of mood impact perceptions of mispricing and trading decisions of institutional investors. Using survey and disaggregated trade data, we show that relatively cloudier days increase perceived overpricing in individual stocks and the Dow Jones Industrial Index and increase selling propensities of institutions. We introduce stock-level measures of investor mood; investor optimism positively impacts stock returns among stocks with higher arbitrage costs, and stocks experiencing similar investor mood exhibit return comovement. These findings complement existing studies on how weather impacts stock index returns and identify another channel through which it can manifest.
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Anne Jones Dorn, Daniel Dorn & Paul Sengmueller
Management Science, forthcoming
Abstract:
This paper offers evidence from three different samples consistent with investors substituting between playing the lottery and gambling in financial markets. In the United States, increases in the jackpots of the multistate lotteries Powerball and Mega Millions are associated with significant reductions in small trade participation in the stock market. California-based discount brokerage clients and German discount brokerage clients are significantly less likely to trade during weeks with larger lottery prizes in the California and German lotteries, respectively. Variation in lottery prizes affects speculative trading in more lottery-like securities such as individual stocks and options, but not trading in bonds and mutual funds. Trading that is likely associated with long-term savings motives, such as trading in retirement accounts, does not respond to lottery jackpots, either. The negative relation between trading activity and jackpots is stronger for individuals who are more likely to play the lottery.
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Impact of the Dodd-Frank Act on Credit Ratings
Valentin Dimitrov, Darius Palia & Leo Tang
Journal of Financial Economics, forthcoming
Abstract:
We analyze the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) on corporate bond ratings issued by credit rating agencies (CRAs). We find no evidence that Dodd-Frank disciplines CRAs to provide more accurate and informative credit ratings. Instead, following Dodd-Frank, CRAs issue lower ratings, give more false warnings, and issue downgrades that are less informative. These results are consistent with the reputation model of Morris (2001), and suggest that CRAs become more protective of their reputation following the passage of Dodd-Frank. Consistent with Morris (2001), we find that our results are stronger for industries with low Fitch market share, where Moody's and Standard & Poor's have stronger incentives to protect their reputation (Becker and Milbourn, 2011). Our results are not driven by business cycle effects or firm characteristics, and strengthen as the uncertainty regarding the passage of Dodd-Frank gets resolved. We conclude that increasing the legal and regulatory costs to CRAs might have an adverse effect on the quality of credit ratings.
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The potential effect of US baby-boom retirees on stock returns
Haim Kedar-Levy
North American Journal of Economics and Finance, November 2014, Pages 106–121
Abstract:
Empirical studies demonstrated that US baby boomers consumption and savings patterns have affected economic aggregates over the past decades, among them equity returns. Boomers’ retirement is expected to mitigate the demand for equities until 2050, but its impact varies with the specific population age structure along decades. This paper employs a dynamic asset pricing model with optimum consumption and portfolio rules to estimate aging effects on S&P500 returns between 1950 and 2050. Calibration for demographic and economic data between 1950 and 2005 yields model estimates that significantly explain the moving average of S&P500 returns. Further, taking into account the present value of expected demographic effects until 2050 suggests that the S&P500 was fairly priced at the heart of the financial crisis, on April 2009, but overpriced thereafter.
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Presidential Elections and the Market Pricing of Future Earnings
Michael Drake, Michael Mayberry & Jaron Wilde
BYU Working Paper, October 2014
Abstract:
We examine whether presidential elections influence the market pricing of future earnings. We predict that uncertainty surrounding presidential election outcomes, and the associated policy changes that impact future firm operations, reduces the extent to which current prices reflect information about future earnings. We estimate future earnings response coefficients (FERCs) for the years 1981-2009, a period that covers seven presidential elections, and find that FERCs are significantly lower (by approximately 7.2 percent) during presidential election years compared to other years. Additional analyses using pseudo election years, ex-ante polls and ex-post margins of victory, and cross-sectional firm characteristics confirm that the lower FERCs during election years are related to political election uncertainty. We also investigate potential explanations for the lower FERCs during election years and find that it is related to increased forecasting uncertainty, and not to changes in discount rates or noise trading. Overall, we contribute to the literature by providing the first empirical evidence on whether and how political election uncertainty influences the pricing of future earnings.
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The Worst, the Best, Ignoring All the Rest: The Rank Effect and Trading Behavior
Samuel Hartzmark
Review of Financial Studies, forthcoming
Abstract:
I document a new stylized fact about how investors trade assets: individuals are more likely to sell the extreme winning and extreme losing positions in their portfolio (“the rank effect”). This effect is not driven by firm-specific information, holding period or the level of returns itself, but is associated with the salience of extreme portfolio positions. The rank effect is exhibited by both retail traders and mutual fund managers. The effect indicates that trades in a given stock depend on how the stock compares to other positions in an investor's portfolio.
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Dhammika Dharmapala & Vikramaditya Khanna
University of Chicago Working Paper, August 2014
Abstract:
The effect of mandatory securities regulation on firm value has been a longstanding concern across law, economics and finance. In 2012, Congress enacted the Jumpstart Our Business Startups (“JOBS”) Act, relaxing disclosure and compliance obligations for a new category of firms known as “emerging growth companies” (EGCs) that satisfied certain criteria (such as having less than $1 billion of annual revenue). The JOBS Act’s definition of an EGC involved a limited degree of retroactivity, extending its application to firms that conducted initial public offerings (IPOs) between December 8, 2011 and April 5, 2012 (the day the bill became law). The December 8 cutoff date was publicly known prior to the JOBS bill’s key legislative events, notably those of March 15, 2012, when Senate consideration began and the Senate Majority Leader expressed strong support for the bill. We analyze market reactions for EGCs that conducted IPOs after the cutoff date, relative to a control group of otherwise similar firms that conducted IPOs in the months preceding the cutoff date. We find positive and statistically significant abnormal returns for EGCs around March 15, relative to the control firms. This suggests that the value to investors of the disclosure and compliance obligations relaxed under the JOBS Act is outweighed by the associated compliance costs. The baseline results imply a positive abnormal return of between 3% and 4%, and the implied increase in firm value is at least $20 million for an EGC with the median market value in our sample.
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Markus Brunnermeier & Martin Oehmke
Review of Finance, October 2014, Pages 2153-2195
Abstract:
Financial institutions may be vulnerable to predatory short selling. When the stock of a financial institution is shorted aggressively, leverage constraints imposed by short-term creditors can force the institution to liquidate long-term investments at fire sale prices. For financial institutions that are sufficiently close to their leverage constraints, predatory short-selling equilibria coexist with no-liquidation equilibria (the vulnerability region) or may even be the unique equilibrium outcome (the doomed region). Increased coordination among short sellers expands the doomed region, where liquidation is the unique equilibrium. Our model provides a potential justification for temporary restrictions on short selling of vulnerable institutions and can be used to assess recent empirical evidence on short-sale bans.
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Cheol Eun, Lingling Wang & Steven Xiao
Journal of Financial Economics, forthcoming
Abstract:
Consistent with predictions from the psychology literature, we find that stock prices co-move more (less) in culturally tight (loose) and collectivistic (individualistic) countries. Culture influences stock price synchronicity by affecting correlations in investors' trading activities and a country's information environment. Both market-wide and firm-specific variations are lower in tighter cultures. Individualism is mostly associated with higher firm-specific variations. Trade and financial openness weakens the effect of domestic culture on stock price comovements. These results hold for various robustness checks. Our study suggests that culture is an important omitted variable in the literature that investigates cross-country differences in stock price comovements.
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Does Media Coverage of Stocks Affect Mutual Funds' Trading and Performance?
Lily Fang, Joel Peress & Lu Zheng
Review of Financial Studies, forthcoming
Abstract:
We study the relation between mutual fund trades and mass media coverage of stocks. We find that funds exhibit persistent differences in their propensity to buy media-covered stocks. Moreover, this propensity is negatively related to their future performance. Funds in the highest propensity decile underperform funds in the lowest propensity decile by 1.1% to 2.8% per year. These results do not extend to fund sells, likely because of funds' inability to sell short. Overall, the findings suggest that professional investors are subject to limited attention.
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Counterparty Risk and the Establishment of the New York Stock Exchange Clearinghouse
Asaf Bernstein, Eric Hughson & Marc Weidenmier
NBER Working Paper, September 2014
Abstract:
Heightened counterparty risk during the recent financial crisis has raised questions about the role clearinghouses play in global financial stability. Empirical identification of the effect of centralized clearing on counterparty risk is challenging because of the co-incidence of macro-economic turbulence and the introduction of clearinghouses. We overcome these concerns by examining a novel historical experiment, the establishment of a clearinghouse on the New York Stock Exchange (NYSE) in 1892. During this period the largest NYSE stocks were also listed on the Consolidated Stock Exchange (CSE), which already had a clearinghouse. Using identical securities on the CSE as a control, we find that the introduction of clearing reduced annualized volatility of NYSE returns by 90-173bps and increased asset values. Prior to clearing, shocks to overnight lending rates reduced the value of stocks on the NYSE, relative to identical stocks on the CSE, but this was no longer true after the establishment of clearing. We also show that at least ½ of the average reduction in counterparty risk on the NYSE is driven by a reduction in contagion risk – the risk of a cascade of broker defaults. Our results indicate that clearing can cause a significant improvement in market stability and value through a reduction in network contagion and counterparty risk.
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Are Stars’ Opinions Worth More? The Relation Between Analyst Reputation and Recommendation Values
Lily Fang & Ayako Yasuda
Journal of Financial Services Research, December 2014, Pages 235-269
Abstract:
Using 1994–2009 data, we find that All-American (AA) analysts’ buy and sell portfolio alphas significantly exceed those of non-AAs by up to 0.6 % per month after risk-adjustments for investors with advance access to analyst recommendations. For investors without such access, top-rank AAs still earn significantly higher (by 0.3 %) monthly alphas in buy recommendations than others. AAs’ superior performance exists before (as well as after) they are elected, is not explained by market overreactions to stars, and is not significantly eroded after Reg-FD. Election to top-AA ranks predicts future performance in buy recommendations above and beyond other previously observable analyst characteristics. Institutional investors actively evaluate analysts and update the AA roster accordingly. Collectively, these results suggest that skill differences among analysts exist and AA election reflects institutional investors’ ability to evaluate and benefit from elected analysts’ superior skills. Other investors’ opportunity to profit from the stars’ opinions exists, but is limited due to their timing disadvantage.
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Can Analysts Predict Rallies Better Than Crashes?
Ivan Medovikov
Finance Research Letters, forthcoming
Abstract:
We use the copula approach to study the structure of dependence between sell-side analysts’ consensus recommendations and subsequent security returns, with a focus on asymmetric tail dependence. We match monthly vintages of I/B/E/S recommendations for the period January to December 2011 with excess security returns during six months following recommendation issue. Using a mixed Gaussian-symmetrized Joe-Clayton copula model we find evidence to suggest that analysts can identify stocks that will substantially outperform, but not underperform relative to the market, and that their predictive ability is conditional on recommendation changes.
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Alexander Hillert, Heiko Jacobs & Sebastian Müller
Review of Financial Studies, forthcoming
Abstract:
Relying on 2.2 million articles from forty-five national and local U.S. newspapers between 1989 and 2010, we find that firms particularly covered by the media exhibit, ceteris paribus, significantly stronger momentum. The effect depends on article tone, reverses in the long run, is more pronounced for stocks with high uncertainty, and is stronger in states with high investor individualism. Our findings suggest that media coverage can exacerbate investor biases, leading return predictability to be strongest for firms in the spotlight of public attention. These results collectively lend credibility to an overreaction-based explanation for the momentum effect.
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Crowdfunding, cascades and informed investors
Simon Parker
Economics Letters, forthcoming
Abstract:
Do higher proportions of (a) informed investors and (b) high-quality projects increase the number of good projects that are ultimately financed via crowdfunding? A simple model and simulation reveals the answers to both questions to be: ‘not necessarily’.
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Uncommon Value: The Characteristics and Investment Performance of Contrarian Funds
Kelsey Wei, Russ Wermers & Tong Yao
Management Science, forthcoming
Abstract:
Motivated by extant theories of herding behavior, this paper empirically identifies contrarian mutual funds as those trading most frequently against the crowd. We find that contrarian funds generate superior performance both when they trade against and with the herd, indicating that they possess superior private information. Furthermore, contrarians do not trade in a particularly correlated fashion with each other, consistent with these funds having disparate information. Our fund-level contrarian measure is largely unrelated to existing measures of fund strategy uniqueness, as both contrarian and herding funds score highly on such measures. Building on our finding of superior alphas for contrarian funds, we construct a stock-level contrarian score that reflects the aggregate stock selection information possessed by contrarian managers. This stock-level contrarian score significantly predicts stock returns after controlling for measures of stock-level herding, as well as a battery of return-predictive investment signals documented in prior studies.
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Do individual currency traders make money?
Boris Abbey & John Doukas
Journal of International Money and Finance, forthcoming
Abstract:
Using a unique online currency transactions dataset, we examine the performance, trading activity, drawdown, and timing abilities of individual currency traders. Evidence from 428 accounts during the 2004-2009 period shows that currency traders earn positive abnormal returns, even after accounting for transaction costs. Additionally, the results reveal that day traders not only trade more frequently than non-day traders, but also outperform them in terms of raw, a passive benchmark and risk-adjusted returns. Finally, sorts on trade activity, measured as the mean number of trades per day per account, and account turnover, show a positive association between performance and trade activity.
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Geetesh Bhardwaj, Gary Gorton & Geert Rouwenhorst
Review of Financial Studies, November 2014, Pages 3099-3132
Abstract:
Investors face significant barriers in evaluating the performance of investment advisors. We focus on commodity trading advisors (CTAs) and show that from 1994 to 2012, CTA excess returns to investors (i.e., net of fees) were insignificantly different from zero while gross excess returns (i.e., before fees) were 6.1%, which implies that managers captured the performance in fees. Moreover, we find that CTAs display no alpha relative to simple future strategies in the public domain. Our results have implications for all hedge fund studies in that we find the typical adjustments for biases in the hedge fund databases still leave upward bias in fund performance.
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Information Networks: Evidence from Illegal Insider Trading Tips
Kenneth Ahern
University of Southern California Working Paper, October 2014
Abstract:
This paper exploits a novel hand collected dataset to provide a comprehensive analysis of the demographics and social relationships behind illegal insider trading networks. I find that the majority of inside traders are connected through family and friendship links and a minority are connected through professional relationships. Traders cluster by age, occupation, gender, and location. Traders earn prodigious returns of about 35% over 21 days, where traders farther from the original source earn lower percentage returns, but higher dollar gains. More broadly, this paper provides some of the first evidence on information networks using direct observations of person-to-person communication.
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Raffi Indjejikian, Hai Lu & Liyan Yang
Management Science, November 2014, Pages 2762-2775
Abstract:
Empirical evidence suggests that information leakage in capital markets is common. We present a trading model to study the incentives of an informed trader (e.g., a well-informed insider) to voluntarily leak information about an asset’s value to one or more independent traders. Our model shows that, although leaking information dissipates the insider’s information advantage about the asset’s value, it enhances his information advantage about the asset’s execution price relative to other informed traders. The profit impact of these two effects are countervailing. When there are a sufficient number of other informed traders, the profit impact from enhanced information dominates. Hence, the insider has incentives to leak some of his private information. We label this rational information leakage and discuss its implications for the regulation of insider trading.