Alpha and beta

Kevin Lewis

June 12, 2017

Political climate, optimism, and investment decisions
Yosef Bonaparte, Alok Kumar & Jeremy Page
Journal of Financial Markets, forthcoming


We show that people's optimism towards financial markets and the macroeconomy is dynamically influenced by their political affiliation and the current political climate. Individuals become more optimistic and perceive markets to be less risky and more undervalued when their preferred party is in power. Accordingly, investors increase allocations to risky assets and exhibit a stronger preference for high market beta, small-cap, and value stocks, and a weaker preference for local stocks. The differences in optimism and portfolio choice across political regimes are not explained by shifts in economic conditions or differential response to economic conditions by Democrat and Republican investors.

Hidden vs. known gender effects in experimental asset markets
Catherine Eckel & Sascha Füllbrunn
Economics Letters, July 2017, Pages 7–9


Eckel and Füllbrunn (2015) report a striking gender effect in experimental asset markets: Markets with only men produce substantial price bubbles while markets with only women sometimes produce negative bubbles. A possible explanation might be that common expectations about the behavior of men and women in a market drive the bubble formation. If we take away these common expectations, male/female differences might be reduced. Hence, we reran this experiment hiding the single-sex composition of the markets. We find no significant difference between all-male and all-female markets, providing evidence that common expectations play a role in bubble formation.

Trump Tweets and the Efficient Market Hypothesis
Jeffery Born, David Hobson Myers & William Clark
Northeastern University Working Paper, May 2017


In a Semi-Strong Form (SSF) Efficient Market, asset prices should respond quickly and completely to the public release of new information. In the period from his election on 11/8/16 and his swearing in ceremony on 1/20/17, President-elect Trump posted numerous statements (‘tweets’) on his Twitter messaging service account that identified ten publicly traded firms. In the absence of new information, the Efficient Market Hypothesis (EMH) predicts that these announcements should have little or no price impact on the common stocks of these firms. Using standard event study methods, we find that positive (negative) content tweets elicited positive (negative) abnormal returns on the event date and virtually all of this effect is from the opening stock price to the close. Within five trading days, the CARs are no longer statistically significant. President-elect Trump’s tweets were associated with increases in trading volume and Google Search activity. Taken as a whole, the price and trading volume response, combined with Google Search activity is consistent with hypothesis that it was small/noise traders who were acting on President-elect Trump’s tweets and that their impacts were transitory.

Moral Hazard in Active Asset Management
David Brown & Shaun William Davies
Journal of Financial Economics, forthcoming


We consider a model of active asset management in which mutual fund managers exert unobservable effort to earn excess returns. Investors allocate capital to actively managed funds and passively managed products. In equilibrium, investors are indifferent between investing an additional dollar with an active manager or with a passively managed product. As passively managed products become more attractive to investors, active managers’ revenues from portfolio-management services fall, reducing their effort incentives. More-severe decreasing-returns-to-scale are also associated with reduced incentives and increased moral hazard. Performance-based fees and holdings-based data are all unlikely to mitigate moral hazard.

Unusual News Flow and the Cross Section of Stock Returns
Turan Bali et al.
Management Science, forthcoming


We document that stocks that experience sudden increases in idiosyncratic volatility underperform otherwise similar stocks in the future, and we propose that this phenomenon can be explained by the Miller conjecture [Miller E (1977) Risk, uncertainty, and divergence of opinion. J. Finance 32(4):1151–1168]. We show that volatility shocks can be traced to unusual firm-level news flow, which temporarily increases the level of investor disagreement about the firm value. At the same time, volatility shocks pose a barrier to short selling, preventing pessimistic investors from expressing their views. In the presence of divergent opinions and short-selling constraints, prices initially reflect optimistic views but adjust downward in the future as investors’ opinions converge.

Managers' Self-Inclusive Language in Conference Calls: Multi-Method Evidence
Zhenhua Chen & Serena Loftus
Tulane University Working Paper, March 2017


We investigate whether a subtle, but common, element of managers’ language, self-inclusive language (SIL), influences investors’ reactions to earnings conference calls. SIL is language that explicitly includes the speaker, and includes first-person singular and plural pronouns. We predict that investors react positively to managers’ SIL regardless of firm performance because SIL increases investors’ impression that managers can influence firm outcomes. To isolate the ceteris paribus effect of SIL on investors’ reactions, we use an experiment where we vary SIL and firm performance. Results of the experiment suggest that investors react more favorably to disclosures containing SIL than disclosures without SIL regardless of firm performance, consistent with our prediction. In a supplemental experiment, we find evidence suggesting that investors may be unaware of the effect of SIL. We also use the archival method to analyze over 50,000 earnings conference call transcripts, and find that market reactions to SIL are consistent with our experiment results. Taken together, our findings contribute to a growing literature on the influence of managers’ language choices on investors by offering multi-method evidence of the impact of a subtle and easily-overlooked component of managers’ language on investors’ judgments and decisions.

A New Era of Voluntary Disclosure? Empirical Evidence on the Informativeness of Rank-and-File Employees' Business Outlook
Jeffrey Hales, James Moon & Laura Swenson
Georgia Tech Working Paper, March 2017


With the advent of social media, individual public opinions about firms can be more easily accessed and aggregated, and recent research suggests that various platforms, such as Twitter, Seeking Alpha, and Estimize, provide information relevant in predicting future firm disclosures. Rather than focusing on the general public’s opinion, we examine a public platform designed to convey insider information online at Glassdoor, where employees voluntarily share their opinions on a number of issues, including the company’s near-term business outlook. Using a sample of approximately 150,000 employee reviews, we extract both employees’ explicit assessments of outlook and a measure of their latent outlook derived from factor analysis. We then examine whether the opinions employees share on social media relate to future corporate disclosures. In particular, we find evidence that employee opinions are useful in predicting income statement information, earnings surprises, management forecast news, and the likelihood and magnitude of goodwill impairments. While voluntary disclosures about firm performance have traditionally come from firms’ executives, our evidence suggests that rank-and-file employees are chipping away at upper-level management’s exclusive control over that channel.

Does SEC Form 8-K Provide Information Necessary or Useful for the Protection of Investors?
Azi Ben-Rephael et al.
Indiana University Working Paper, March 2017


The extant literature shows that, for many SEC 8-K filings, there is a significant market reaction on the date of the event for which the 8-K is filed, on the days between the event date and the filing date, and on the filing date. The question we address is: who pays attention and trades on these days – institutional investors, retail investors, or both? And, in turn, who benefits from the information that is contained in the 8-K? We show that there is significant abnormal attention paid by institutional investors on both the filing date and the event date, more so on the event day; but there is no obvious pattern of abnormal attention from retail investors on either of these dates. Moreover, most price discovery occurs during the pre-filing period when institutional investors are paying attention; suggesting that the 8-K filing has little informational benefit, particularly to retail investors. More importantly, the 8-K filings appear to have the undesirable consequence of attracting retail attention and price pressure on the filing date and this price change eventually reverts. We show that institutional investors appear to trade against retail investors, profiting from providing liquidity. In short, our analyses question the effectiveness of the Form 8-K in protecting the interests of retail investors.

Hole in the Wall: Informed Short Selling Ahead of Private Placements
Henk Berkman, Michael McKenzie & Patrick Verwijmeren
Review of Finance, May 2017, Pages 1047-1091


Companies planning a private placement typically gauge the interest of potential buyers before the offering is publicly announced. Regulators are concerned with this practice, called wall-crossing, as it might invite insider trading, especially when the potential investors are hedge funds. We examine privately placed common stock and convertible offerings and find evidence of widespread pre-announcement short selling. We show that pre-announcement short sellers are able to predict announcement day returns. The effects are especially strong when hedge funds are involved and when the number of buyers is high. We also observe pre-announcement trading in the options market.

Squaring Venture Capital Valuations with Reality
Will Gornall & Ilya Strebulaev
Stanford Working Paper, April 2017


We develop a financial model to estimate the fair value of venture capital-backed companies and of each type of security these companies issue. Our model uses the most recent financing round price and the terms of that financing to infer the value of each of their shares. Using data from legal filings, we show that the average highly-valued venture capital-backed company reports a valuation 51% above its fair value, with common shares overvalued by 62%. In our sample of unicorns – companies with reported valuation above $1 billion – almost one half (53 out of 116) lose their unicorn status when their valuation is recalculated and 13 companies are overvalued by more than 100%. Overvaluation arises because the reported valuations assume all of a company’s shares have the same price as the most recently issued shares. In practice, these most recently issued shares almost always have better cash flow rights than the previously issued shares, so equating their prices significantly inflates valuations. Specifically, we find 53% of unicorns have given their most recent investors either a return guarantees in IPO (15%), the ability to block IPOs that do not return most of their investment (20%), seniority over all other investors (31%), or other important terms.

Skin or Skim? Inside Investment and Hedge Fund Performance
Arpit Gupta & Kunal Sachdeva
NYU Working Paper, June 2017


Using a comprehensive and survivor-bias free dataset of U.S. hedge funds, we document the role that inside investment plays in managerial compensation and fund performance. We find that funds with greater investment by insiders outperform funds with less "skin in the game" on a factor-adjusted basis; exhibit greater return persistence; and feature lower fund flow-performance sensitivities. These results suggest that managers earn outsize rents by operating trading strategies further from their capacity constraints when managing their own money. Our findings have implications for optimal portfolio allocations of institutional investors and models of delegated asset management.

What Motivates Buy-Side Analysts to Share Recommendations Online?
Steven Crawford et al.
Management Science, forthcoming


We examine why buy-side analysts share investment ideas on, a private social networking website designed to facilitate interaction and information sharing among buy-side professionals. We explore labor market motivations for information sharing and document that analysts with strong incentives to build a reputation (i.e., those who did not attend a top 10 university and those employed at small funds) are significantly more likely to share recommendations. Our findings indicate that analysts who share ideas are more likely to change jobs and that the likelihood of employment change is positively related to the ratings provided by peers. We also document that analyst recommendations generate significant returns when they are posted on SumZero and that prices drift in the direction of the recommendation. Long-window returns are particularly strong for contrarian buy recommendations and for most sell recommendations. Overall, we show that buy-side analysts share valuable private information in an online social network and that this can be an effective reputation-building and job-seeking tool.

Deception and Reception: The Behavior of Information Providers and Users
Roman Sheremeta & Timothy Shields
Journal of Economic Behavior & Organization, May 2017, Pages 445–456


We investigate the behavior of information providers (underwriters) and users (investors) in a controlled laboratory experiment where underwriters have incentives to deceive and investors have incentives to avoid deception. Participants play simultaneously as underwriters and investors in one-shot information transmission games. The results of our experiment show a significant proportion of both deceptive and non-deceptive underwriters. Despite the presence of deceptive underwriters, investors are receptive to underwriters’ reports, gleaning information content, albeit overly optimistic. Within our sample, deception by underwriters and reception by investors are the most profitable strategies. Moreover, participants who send deceptive reports to investors, but at the same time are receptive to reports of underwriters, earn the highest payoffs. These results call into question the characterization of duped investors being irrational.

to your National Affairs subscriber account.

Already a subscriber? Activate your account.


Unlimited access to intelligent essays on the nation’s affairs.

Subscribe to National Affairs.