Blue horseshoe doesn't love
When Transparency Improves, Must Prices Reflect Fundamentals Better?
Snehal Banerjee, Jesse Davis & Naveen Gondhi
Review of Financial Studies, June 2018, Pages 2377–2414
Abstract:
No. In the presence of speculative opportunities, investors can learn about both asset fundamentals and the beliefs of other traders. We show that this learning exhibits complementarity: learning more along one dimension increases the value of learning about the other. As a result, regulatory changes may be counterproductive. First, increasing transparency (i.e., making fundamental information cheaper to acquire) can make prices less informative when investors respond by learning relatively more about others. Second, public disclosures discourage private learning about fundamentals, while encouraging information acquisition about others. Accordingly, disclosing more fundamental information can decrease overall informational efficiency by decreasing price informativeness.
The Volcker Rule and corporate bond market making in times of stress
Jack Bao, Maureen O’Hara & Xing (Alex) Zhou
Journal of Financial Economics, forthcoming
Abstract:
Focusing on downgrades as stress events that drive the selling of corporate bonds, we show that the illiquidity of stressed bonds has increased after the Volcker Rule. Dealers regulated by the rule have curtailed their market-making activities and non-Volcker-affected dealers have not offset the decreased activities of Volcker-affected dealers. Furthermore, even Volcker-affected dealers that are not constrained by Basel III and Comprehensive Capital Analysis and Review regulations change their behavior, inconsistent with the effects being driven by these other regulations. Because Volcker-affected dealers have been the main liquidity providers, bonds have become less liquid during times of stress due to the Volcker Rule.
Rankings and Risk‐Taking in the Finance Industry
Michael Kirchler, Florian Lindner & Utz Weitzel
Journal of Finance, forthcoming
Abstract:
Rankings are omnipresent in the finance industry, yet the literature is silent on how they impact financial professionals' behavior. Using lab‐in‐the‐field experiments with 657 professionals and lab experiments with 432 students, we investigate how rank incentives affect investment decisions. We find that both rank and tournament incentives increase risk‐taking among underperforming professionals, while only tournament incentives affect students. This rank effect is robust to the experimental frame (investment frame versus abstract frame), to payoff consequences (own return versus family return), to social identity priming (private identity versus professional identity), and to professionals' gender (no gender differences among professionals).
Do Better Informed Investors Always Do Better? A Buyback Puzzle
Glenn Boyle & Gerald Ward
Economic Inquiry, forthcoming
Abstract:
We explore the value of private investment information using data from a singular source: auctions of yearling racehorses. Horse breeders possess superior information about their own horses and have strong financial incentives to buy the best of these back at auction. However, those they repurchase subsequently perform significantly worse on average, earning 30% less at the racetrack than horses purchased by outsiders. Moreover, this underperformance is concentrated in male horses, despite these being purchased exclusively for racing purposes. These puzzling findings cannot be explained by differences in horse risk or breeder abilities, or by nonfinancial objectives, or by behavioral or selection biases.
Mood Betas and Seasonalities in Stock Returns
David Hirshleifer, Danling Jiang & Yuting Meng
NBER Working Paper, June 2018
Abstract:
Existing research has documented cross-sectional seasonality of stock returns — the periodic outperformance of certain stocks relative to others during the same calendar month, weekday, or pre-holiday periods. A model in which stocks differ in their sensitivities to investor mood explains these effects and implies new sets of seasonal patterns. We find that relative performance across stocks during past high or low mood months and weekdays tends to recur in future periods with congruent mood, and to reverse in periods with non-congruent mood. Stocks with higher sensitivities to aggregate mood swings — higher mood betas — earn higher expected returns during future high mood periods and lower expected returns during future low mood periods, including those induced by Daylight Saving Time changes, weather conditions and anticipation of major holidays.
Is Bitcoin Really Un-Tethered?
John Griffin & Amin Shams
University of Texas Working Paper, June 2018
Abstract:
This paper investigates whether Tether, a digital currency pegged to U.S. dollars, influences Bitcoin and other cryptocurrency prices during the recent boom. Using algorithms to analyze the blockchain data, we find that purchases with Tether are timed following market downturns and result in sizable increases in Bitcoin prices. Less than 1% of hours with such heavy Tether transactions are associated with 50% of the meteoric rise in Bitcoin and 64% of other top cryptocurrencies. The flow clusters below round prices, induces asymmetric autocorrelations in Bitcoin, and suggests incomplete Tether backing before month-ends. These patterns cannot be explained by investor demand proxies but are most consistent with the supply-based hypothesis where Tether is used to provide price support and manipulate cryptocurrency prices.
Sophisticated Investors and Market Efficiency: Evidence from a Natural Experiment
Yong Chen, Bryan Kelly & Wei Wu
NBER Working Paper, April 2018
Abstract:
We study how sophisticated investors, when faced with changes in information environment, adjust their information acquisition and trading behavior, and how these changes in turn affect market efficiency. We find that, after exogenous reductions of analyst coverage due to closures of brokerage firms, hedge funds scale up information acquisition. They trade more aggressively and earn higher abnormal returns on the affected stocks. Moreover, the participation of hedge fund significantly mitigates the impairment of market efficiency caused by coverage reductions. Our results show a substitution effect between sophisticated investors and public information providers in facilitating market efficiency in a causal framework.
Learning from History: Volatility and Financial Crises
Jon Danielsson, Marcela Valenzuela & Ilknur Zer
Review of Financial Studies, July 2018, Pages 2774–2805
Abstract:
We study the effects of stock market volatility on risk-taking and financial crises by constructing a cross-country database spanning up to 211 years and across 60 countries. Prolonged periods of low volatility have strong in-sample and out-of-sample predictive power over the incidence of banking crises and can be used as a reliable crisis indicator, whereas volatility itself does not predict crises. Low volatility leads to excessive credit buildups and balance sheet leverage in the financial system, indicating that agents take more risk in periods of low risk, supporting the dictum that “stability is destabilizing”.
Explanations for the 2014 Oil Price Decline: Supply or Demand?
Brian Prest
Energy Economics, August 2018, Pages 63-75
Abstract:
The Brent price of crude oil declined from $112 in June 2014 to a low of $31 in January 2016 (both nominal prices), a cumulative decrease of more than 70%. Some attribute the decline to increased oil production due to the U.S. shale revolution. This paper proposes a variety of diagnostics to assess the how consistent this explanation is with the data. I find that the data are broadly inconsistent with this attribution of the decline to shale oil. Rather, the data are more consistent with a demand-side explanation of weakening global economic conditions and demand for commodities, including but not limited to oil. In summary, there is no evidence that the U.S. shale revolution played a significant role in the decline in oil prices since 2014. Rather, the evidence suggests that weakening oil demand played a much stronger role in driving the 2014 decline in oil prices.
Behavioral bias in number processing: Evidence from analysts’ expectations
Tristan Roger, Patrick Roger & Alain Schatt
Journal of Economic Behavior & Organization, May 2018, Pages 315–331
Abstract:
Research in neuropsychology shows that individuals process small and large numbers differently. Small numbers are processed on a linear scale, while large numbers are processed on a logarithmic scale. In this paper, we show that financial analysts process small prices and large prices differently. When they are optimistic (pessimistic), analysts issue more optimistic (pessimistic) target prices for small price stocks than for large price stocks. Our results are robust when controlling for the usual risk factors such as size, book-to-market, momentum, profitability and investments. They are also robust when we control for firm and analyst characteristics, or for other biases such as the 52-week high bias, the preference for lottery-type stocks and positive skewness, and the analyst tendency to round numbers. Finally, we show that analysts become more optimistic after stock splits. Overall, our results suggest that a deeply-rooted behavioral bias in number processing drives analysts’ return expectations.
Allergy onset and local investor distraction
Christos Pantzalis & Erdem Ucar
Journal of Banking & Finance, July 2018, Pages 115-129
Abstract:
We posit that investor distraction can be exogenously triggered by allergy onset's degrading effects on local investors’ health and cognitive functioning. We document that allergy onset is related to lower trading activity. We use daily pollen counts to measure the severity of allergy onset at different locations and show that stocks of firms located in areas with severe allergy problems exhibit declines in trading volume and lower stock returns. Moreover, allergy onset is associated with both a decline in investor demand for firm information, as proxied by Google search volume, and stock underreaction to earnings news. Collectively our evidence supports the notion that the association of allergy onset and stock market outcomes may be emerging through a local investor distraction channel.
Information Sharing and Spillovers: Evidence from Financial Analysts
Byoung-Hyoun Hwang, José María Liberti & Jason Sturgess
Management Science, forthcoming
Abstract:
We study how information sharing within an organization affects individual performance. We look at situations in which the same analyst, while working at the same broker, covers multiple mergers and acquisitions (M&As), in particular the acquirer prior to the M&A and the merged firm thereafter. We find that earnings forecasts for the merged firm are significantly more accurate when the analyst has a colleague (working at the same broker) covering the target prior to the M&A. This holds particularly true if acquirer analysts and target analysts reside in the same locale, if they are part of a smaller team, and if the target analyst is of higher quality. Our findings highlight the importance of information spillovers on individual performance in knowledge-based industries.
Betting Against Alpha
Alex Horenstein
University of Miami Working Paper, May 2018
Abstract:
I sort stocks on realized alphas and find that they are negatively related with future returns, future alphas, and Sharpe Ratios. These patterns emerged with the development of the CAPM in the 1960s and became more salient as the related literature expanded, especially after 1992 with the increasing popularity of the CAPM anomalies in academia and of factor investing in the private sector. I provide intuition for this counter-intuitive finding by linking it to recent theoretical and empirical work and explore some trading strategies based on it. The results suggest that wide-spread applications of academic research can stem new anomalies.
Does It Pay to Pay Attention?
Antonio Gargano & Alberto Rossi
Review of Financial Studies, forthcoming
Abstract:
We employ a novel brokerage account data set to investigate which individual investors are the most attentive, how investors allocate their attention, and the relation between investor attention and performance. Attention is positively related to investment performance, at both the portfolio return level and the individual trades level. We provide evidence that the superior performance of high-attention investors arises because they purchase attention-grabbing stocks whose positive performance persists for up to six months. Finally, we show that paying attention is particularly profitable when trading stocks with high uncertainty, but for which a lot of public information is available.