Buy or sell

Kevin Lewis

August 05, 2019

Easy, breezy, risky: Lay investors fail to diversify because correlated assets feel more fluent and less risky
Yann Cornil, David Hardisty & Yakov Bart
Organizational Behavior and Human Decision Processes, July 2019, Pages 103-117

Why do people fail to diversify risk in their investment portfolios? We study how lay investors (people with low financial literacy) invest in financial assets whose past or expected returns are provided. Although investing in assets with negatively correlated returns reduces portfolio risk (i.e., reduces portfolio fluctuations), we find that lay investors instead prefer investing in assets with positively correlated returns, which results in less diversified and riskier investment portfolios than intended. Using a mixed-method approach, we find that lay investors rely on a lay perception of portfolio risk: assets with positively correlated returns feel more fluent (more familiar, simple, and predictable), and thus are erroneously perceived as less risky. We find that lay investors succeed in forming diversified, lower-risk portfolios when they are provided with aggregate portfolio returns, or when — paradoxically — they are encouraged to take more risk.

Hedge Fund Hold'em
Yan Lu, Sandra Mortal & Sugata Ray
University of Alabama Working Paper, May 2019

We find that hedge fund managers who do well in poker tournaments have significantly better fund performance. This effect is stronger for tournaments with more entrants, larger buy-ins, larger cash prizes and for managers who win multiple tournaments, suggesting poker skills are correlated with fund management skills. Investors appear cognizant of this as after a manager wins a poker tournament, net flows to the manager’s fund increase significantly. These increases are concentrated in cases where there is media coverage of the manager’s poker playing, when the tournament win is bigger, and for more prominent tournaments (e.g. the World Series of Poker). Along with higher net flows, fund alpha also decreases significantly following the tournament win, especially in cases where net inflows are highest, suggesting decreasing returns to scale erode the informativeness of the poker win signal. Given this, hedge fund investors would be better off investing in an otherwise similar manager without poker tournament success.

Bitcoin Dilemma: Is Popularity Destroying Value?
Thomas Kim
Finance Research Letters, forthcoming

I measure the amount of congestion in the Bitcoin network by the time to execute a trade and find that congestion is harming Bitcoin's ability to function as a method of trade. The average time to execute a Bitcoin transaction increased from 30 minutes in 2016 to 413 minutes in 2018. I find that the congestion is associated with higher transaction fees and reduced volume. The congestion is also creating a distortion in Bitcoin price. The relationship between congestion and price is strongest during the business hours of East Asia.

Regulations and Brain Drain: Evidence from Wall Street Star Analysts’ Career Choices
Yuyan Guan et al.
Management Science, forthcoming

The Global Settlement, along with related regulations in the early 2000s, prohibits the use of investment banking revenue to fund equity research and compensate equity analysts. We find that all-star analysts from investment banks are more likely to exit the profession or move to the buy side after the regulations. The departed star analysts’ earnings revisions and stock recommendations are more informative than those of the remaining analysts who followed the same companies. To the extent that star analysts are superior to their nonstar counterparts in terms of research ability and ability to inform the market, the exit of star analysts represents a brain drain in the sell-side equity research industry. These results are consistent with the view that the regulations introduced to protect equity investors have unintended adverse effects on the investors due to a brain drain in investment banks.

Long-Term Firm Growth: An Empirical Analysis of US Manufacturers 1959-2015
Giovanni Dosi et al.
Harvard Working Paper, May 2019

Firm growth is an essential feature of market economies, shaping together macroeconomic performance and the evolution of industry structures. As a potential indicator of organizational “fitness” within a competitive environment, firm growth is also a central concern to both the practice and theory of business strategy. Despite both its theoretical and practical importance, though, growth remains a poorly understood property of firms. While previous studies have documented the highly skewed nature of firm growth rates, we know far less about the persistence of growth rates over long-periods of time. For instance, do “fast growers” tend to maintain their relative growth rates advantages over long-periods or is superior growth a transitory phenomenon? Is, as predicted by evolutionary and capability based theories of the firm, the process of firm growth path-dependent or is it more akin to a random walk? The answers to these questions are central to building a robust theory of firm growth. This paper attempts to address this gap in our empirical knowledge of firm growth using a dataset that spans 50 years, which allows the abandonment of the assumption, common to all incumbent studies, that the stochastic paths of all firms stem from the same generating process. These exploratory results indicate that growth rate persistence is there and may be even substantial for some firms, but it is rare. We also study the links between the micro-properties of firm growth within sectors and the patterns of aggregate growth of these same sectors. Indeed, we find circumstantial but widespread evidence that heterogeneity across firms correlates with industry dynamism.

Entrepreneurial Uncertainty and Expert Evaluation: An Empirical Analysis
Erin Scott, Pian Shu & Roman Lubynsky
Management Science, forthcoming

This paper empirically examines the evaluations of 537 ventures in high-growth industries performed by 251 experienced entrepreneurs, investors, and executives. These experts evaluated ventures by reading succinct summaries of the ventures without meeting the founding teams, and their evaluations were not disclosed to the entrepreneurs. We find that experts can differentiate among early-stage ventures on grounds of quality beyond the explicit venture and entrepreneur characteristics contained in the written summaries. They can only do so effectively, however, for ventures in the hardware, energy, life sciences, and medical devices sectors; they cannot do so for ventures in the consumer products, consumer web and mobile, and enterprise software sectors. Our results highlight sector-specific heterogeneity in the information needed to effectively screen ventures, a finding that has implications for the design of optimal investment strategies.

How Much Do Investors Trade Because of Name/Ticker Confusion?
Vadim Balashov & Andrei Nikiforov
Journal of Financial Markets, forthcoming

We conduct a search for pairs of companies with similar names/ticker symbols. Between 12% and 25% of such pairs exhibit co-movements in trading turnover, which we attribute to investor confusion. We estimate that trades made by mistake contributed to 5% of the trading turnover. The three-hour CARs for the company chosen by mistake around the time intervals with extreme returns for the paired company are 0.5%. The confusion is highest for large companies and around time intervals with high turnover. We show that when the cause of confusion disappears, the co-movement in turnover also disappears.

IT, AI and the Growth of Intangible Capital
Prasanna Tambe et al.
University of Pennsylvania Working Paper, July 2019

General purpose technologies like IT and AI typically require complementary investments in firm-specific human and organizational capital to create value for firms. However, good measures of the stock of this IT intangible capital (ITIC) have remained elusive, as has an understanding of how the accumulation of ITIC contributes to economic growth. We use a new extended firm-level panel on IT skills along with Hall’s Quantity Revelation Theorem to assess the nature and growth of ITIC over the last thirty years. We then examine implications for the current wave of AI investment. Our estimates suggest that ITIC accounted for about 25% of firms’ total assets by 2016 and that this capital is disproportionately owned by small subset of “superstar” firms. During most of the period we examine, these assets depreciated close to the same rate as R&D, but depreciation rates appear to have been accelerating with the diffusion of AI-based innovations. For the recent wave, high market values are associated with AI before they are associated with increased revenues or productivity, suggesting that investors anticipate significant future returns to AI-related intangible assets that are otherwise unmeasured.

Tiered Information Disclosure: An Empirical Analysis of the Advance Peek into the Michigan Index of Consumer Sentiment
Weishao Wu et al.
Financial Review, August 2019, Pages 541-582

This paper studies market microstructure implications of informed high‐frequency traders (HFTs) from two seconds of advance peek into the Michigan Index of Consumer Sentiment (ICS), provided by Thomson Reuters to its elite customers. Using individual stocks in the NASDAQ data set, we show how HFTs trade around ICS events. We find that liquidity demanders during two seconds of advance peek earn substantive profits, which are consistent with the notion that HFTs’ informational advantages may increase adverse selection costs for other market participants. This evidence elucidates the debate on regulatory oversight and its role in circumventing the potentially adverse effects from an advance peek into ICS.

Are Analyst Trade Ideas Valuable?
Justin Birru et al.
NBER Working Paper, July 2019

Using a novel database, we show that the stock-price impact of analyst trade ideas is at least as large as the impact of stock recommendation, target price, and earnings forecast changes, and that investors following trade ideas can earn significant abnormal returns. Trade ideas triggered by forthcoming firm catalyst events are more informative than ideas exploiting temporary mispricing. Institutional investors trade in the direction of trade ideas and commission-paying institutional clients do so earlier than non-clients. Analysts generating trade ideas are more established and are more likely to produce ideas for stocks with high dollar trading commissions in their coverage universe.

Changes in Analysts’ Stock Recommendations Following Regulatory Action Against Their Brokerage
Andrew Call, Nathan Sharp & Paul Wong
Arizona State University Working Paper, May 2019

Despite the importance of sell-side analysts in the capital markets, we know little about the effectiveness of routine monitoring of the sell-side industry. We examine the attributes of sell-side research issued by analysts before and after their brokerage is subject to regulatory sanctions. We find that after a regulatory action, analysts at sanctioned brokerages lower their stock recommendations, both in absolute terms and relative to the recommendations of other analysts following the same firms. Following a regulatory action, analysts at sanctioned brokerages are also more likely than analysts at other brokerages to downgrade a company’s stock after the receipt of unfavorable information about the firm. Importantly, we document that analysts at non-sanctioned brokerages also reduce the optimism in their stock recommendations when a peer analyst’s brokerage is sanctioned, consistent with regulatory spillovers as a result of routine regulatory monitoring. Our study provides empirical evidence that regulatory action against sell-side brokerages is associated with a reduction in sell-side analysts’ positive bias at both sanctioned and non-sanctioned brokerages.

Skin or Skim? Inside Investment and Hedge Fund Performance
Arpit Gupta & Kunal Sachdeva
NBER Working Paper, July 2019

Hedge fund managers contribute substantial personal capital, or "skin in the game," into their funds. While these allocations may better align incentives, managers may also strategically allocate their private capital in ways that negatively affect investors. We find that funds with more inside investment outperform other funds within the same family. However, this relationship is driven by managerial decisions to invest capital in their least-scalable strategies and restrict the entry of new outsider capital into these funds. Our results suggest that skin in the game may work as a rent-extraction mechanism at the expense of fund participation of outside investors.


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