For Whom the Bell Tolls

Kevin Lewis

August 17, 2021

Failing to forecast rare events
Philip Bond & James Dow
Journal of Financial Economics, forthcoming


Do more talented traders prefer to bet on and against rare events or common events? Bets on rare events include out of the money options. Bets against rare events include the carry trade and investment grade bonds. In a model where traders specialize, equilibrium pricing reflects trading ability: A market with more skilled traders has a larger bid ask spread. We show that lower skill traders bet on and against rare events, while higher skill traders bet on and against frequent events, leading to higher bid-ask spreads in common event assets, and reducing financial markets' ability to predict rare events.

Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors
Klakow Akepanidtaworn et al.
NBER Working Paper, July 2021


Are market experts prone to heuristics, and if so, do they transfer across closely related domains -- buying and selling? We investigate this question using a unique dataset of institutional investors with portfolios averaging $573 million. A striking finding emerges: while there is clear evidence of skill in buying, selling decisions underperform substantially -- even relative to random selling strategies. This holds despite the similarity between the two decisions in frequency, substance and consequences for performance. Evidence suggests that an asymmetric allocation of cognitive resources such as attention can explain the discrepancy: we document a systematic, costly heuristic process when selling but not when buying.

Does Interaction on Social Media Increase or Moderate Extremeness?
Devin Shanthikumar, Qiao Annie Wang & Shijia Wu
University of California Working Paper, June 2021


Using comment streams on Seeking Alpha articles, we examine whether interacting on social media increases or moderates the extremeness of investors' opinions. Unlike some findings from political science that show social media increases extremeness of opinions, we find that interaction on Seeking Alpha moderates extremeness. Comments become less extreme over the sequence of comments for a given article, as well as within individual comment sub-threads, and over a single user's comments for a given article. Extremeness reduction is stronger when the article itself is more moderate, and when more users are self-identified (i.e., not anonymous). Results also suggest that the extremeness reduction triggered by Seeking Alpha interaction has capital market implications. Differences of opinion captured by stock-based measures, abnormal volume and turnover, decrease significantly after the release of Seeking Alpha articles with comments. Our results provide the first evidence of the effect of social media interaction on the updating of individuals' opinions.

The Double-Edged Sword of Global Integration: Robustness, Fragility & Contagion in the International Firm Network
Everett Grant & Julieta Yung
Journal of Applied Econometrics, forthcoming


Increased global integration of firm, production, and financial networks has the potential to benefit growth but also amplify the transmission of crises. We test whether higher global connectedness is associated with robust (beneficial) or fragile (harmful) behavior using networks derived from firm equity returns across all industries (1991-2016). More globally connected firms are less likely to be in distress, with higher profit, revenue and equity price growth; however, they are more exposed to direct contagion from distressed neighboring firms. Our analysis reveals the centrality of finance, increased globalization, and greater potential for crises to spread globally when they do occur.

The Active World of Passive Investing
David Easley et al.
Review of Finance, forthcoming


We investigate the new reality of exchange-traded funds (ETFs). We show that most ETFs are active investments in form (designed to generate alpha) or function (serve as building blocks of active portfolios). We define a new activeness index to capture these dimensions, finding that the cross-section of ETFs is now increasingly characterized by highly active investment vehicles. Active-in-form ETFs have positive flow-performance sensitivity, charge the highest fees among ETFs, and have high within-portfolio turnover. Active-in-function ETFs have more concentrated holdings, less within-portfolio turnover, but higher turnover in the secondary market. We show how more active ETFs are gaining market share over less active ETFs, leading to competitive fee pressure both within the ETF space and across the investment management industry. We suggest that the growing activeness of ETFs may assuage concerns about ETFs harming price discovery.

Do we become more cautious for others when large amounts of money are at stake?
Eleonore Batteux, Eamonn Ferguson & Richard Tunney
Experimental Psychology, June 2021, Pages 32-40


A considerable proportion of financial decisions are made by agents acting on behalf of other people. Although people are more cautious for others when making medical decisions, this does not seem to be the case for economic decisions. However, studies with large amounts of money are particularly absent from the literature, which precludes a clear comparison to studies in the medical domain. To address this gap, we investigated the effect of outcome magnitude in two experiments where participants made choices between safe and risky options. Decision-makers were not more cautious for others over large amounts. In fact, risk-taking was accentuated for large amounts in the gain domain. We did not find self-other differences in the loss domain for either outcome magnitude. This suggests that the caution observed in medical decisions does not replicate in financial decisions with large amounts, or at least not in the same way. These results echo the concerns that have been raised about excessive risk-taking by financial agents.

Quantifying the High-Frequency Trading "Arms Race"
Matteo Aquilina, Eric Budish & Peter O'Neill
NBER Working Paper, July 2021


We use stock exchange message data to quantify the negative aspect of high-frequency trading, known as "latency arbitrage." The key difference between message data and widely-familiar limit order book data is that message data contain attempts to trade or cancel that fail. This allows the researcher to observe both winners and losers in a race, whereas in limit order book data you cannot see the losers, so you cannot directly see the races. We find that latency-arbitrage races are very frequent (about one per minute per symbol for FTSE 100 stocks), extremely fast (the modal race lasts 5-10 millionths of a second), and account for a remarkably large portion of overall trading volume (about 20%). Race participation is concentrated, with the top 6 firms accounting for over 80% of all race wins and losses. The average race is worth just a small amount (about half a price tick), but because of the large volumes the stakes add up. Our main estimates suggest that races constitute roughly one-third of price impact and the effective spread (key microstructure measures of the cost of liquidity), that latency arbitrage imposes a roughly 0.5 basis point tax on trading, that market designs that eliminate latency arbitrage would reduce the market's cost of liquidity by 17%, and that the total sums at stake are on the order of $5 billion per year in global equity markets alone.

Venture capital contracts
Michael Ewens, Alexander Gorbenko & Arthur Korteweg
Journal of Financial Economics, forthcoming


We estimate the impact of venture capital (VC) contract terms on startup outcomes and the split of value between the entrepreneur and investor, accounting for endogenous selection via a novel dynamic search-and-matching model. The estimation uses a new, large data set of first financing rounds of startup companies. Consistent with efficient contracting theories, there is an optimal equity split between agents, which maximizes the probability of success. However, venture capitalists (VCs) use their bargaining power to receive more investor-friendly terms compared to the contract that maximizes startup values. Better VCs still benefit the startup and the entrepreneur due to their positive value creation. Counterfactuals show that reducing search frictions shifts the bargaining power to VCs and benefits them at the expense of entrepreneurs. The results show that the selection of agents into deals is a first-order factor to take into account in studies of contracting.

Obfuscation in Mutual Funds
Ed deHaan et al.
Journal of Accounting and Economics, forthcoming


Mutual funds hold 32% of the U.S. equity market and comprise 58% of retirement savings, yet retail investors consistently make poor choices when selecting funds. Theory suggests poor choices are partially due to fund managers creating unnecessarily complex disclosures and fee structures to keep investors uninformed and obfuscate poor performance. An empirical challenge in investigating this "strategic obfuscation" theory is isolating manipulated complexity from complexity arising from inherent differences across funds. We examine obfuscation among S&P 500 index funds, which have largely the same regulations, risks, and gross returns but charge widely different fees. Using bespoke measures of complexity designed for mutual funds, we find evidence consistent with funds attempting to obfuscate high fees. This study improves our understanding of why investors make poor mutual fund choices and how price dispersion persists among homogeneous index funds. We also discuss insights for mutual fund regulation and academic literature on corporate disclosures.

Persuading Investors: A Video-Based Study
Allen Hu & Song Ma
NBER Working Paper, July 2021


Persuasive communication functions not only through content but also delivery, e.g., facial expression, tone of voice, and diction. This paper examines the persuasiveness of delivery in start-up pitches. Using machine learning (ML) algorithms to process full pitch videos, we quantify persuasion in visual, vocal, and verbal dimensions. Positive (i.e., passionate, warm) pitches increase funding probability. Yet conditional on funding, high-positivity startups underperform. Women are more heavily judged on delivery when evaluating single-gender teams, but they are neglected when co-pitching with men in mixed-gender teams. Using an experiment, we show persuasion delivery works mainly through leading investors to form inaccurate beliefs.

Asset pricing on earnings announcement days
Kam Fong Chan & Terry Marsh
Journal of Financial Economics, forthcoming


Market betas have a strong and positive relation with average stock returns on a handful of days every year. Such unique days, defined as leading earnings announcement days (LEADs), are times when an aggregate of influential S&P 500 firms disclose quarterly earnings news early in the earnings season. The positive return-to-beta relation holds for various test portfolios, individual stocks, and Treasuries; and is robust to different data frequencies and testing procedures. On days other than LEADs, the beta-return relation is flat. We conclude that waves of early earnings announcements by large firms clustered on LEADs significantly influence asset pricing.


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