Findings

Pro tip

Kevin Lewis

August 29, 2016

Can information be locked up? Informed trading ahead of macro-news announcements

Gennaro Bernile, Jianfeng Hu & Yuehua Tang

Journal of Financial Economics, September 2016, Pages 496-520

Abstract:
Government agencies routinely allow pre-release access to information to accredited news agencies under embargo agreements. Using high-frequency data, we find evidence consistent with informed trading during embargoes of Federal Open Market Committee (FOMC) scheduled announcements. The E-mini Standard & Poor's 500 futures' abnormal order imbalances are in the direction of subsequent policy surprises and contain information that predicts the market reaction to the policy announcements. The estimated informed trades' profits are arguably large. Notably, we find no evidence of informed trading prior to the start of FOMC news embargoes or during lockups ahead of nonfarm payroll, US Producer Price Index, and gross domestic product data releases.

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Family Descent as a Signal of Managerial Quality: Evidence from Mutual Funds

Oleg Chuprinin & Denis Sosyura

NBER Working Paper, August 2016

Abstract:
We study the relation between mutual fund managers' family backgrounds and their professional performance. Using hand-collected data from individual Census records on the wealth and income of managers' parents, we find that managers from poor families deliver higher alphas than managers from rich families. This result is robust to alternative measures of fund performance, such as benchmark-adjusted return and value extracted from capital markets. We argue that managers born poor face higher entry barriers into asset management, and only the most skilled succeed. Consistent with this view, managers born rich are more likely to be promoted, while those born poor are promoted only if they outperform. Overall, we establish the first link between family descent of investment professionals and their ability to create value.

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Low Interest Rates and Risk Taking: Evidence from Individual Investment Decisions

Chen Lian, Yueran Ma & Carmen Wang

Harvard Working Paper, June 2016

Abstract:
In recent years, many central banks have set benchmark interest rates to historic lows. In this paper, we provide evidence that individual investors "reach for yield", that is, have a greater appetite for risk taking in such low interest rate environment. We first document this phenomenon in a simple investment experiment, where investment risks and risk premia are held constant. We find significantly higher allocations to risky assets in the low rate condition, among MTurks as well as HBS MBAs. This reaching for yield behavior is unrelated to institutional frictions, and cannot be easily explained by conventional portfolio choice theory. We then propose and provide evidence for two sets of explanations related to people's preferences and psychology. We also present complementary evidence using historical data on individual investors' portfolio allocations and household investment flows.

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Political Sentiment and Predictable Returns

Jawad Addoum & Alok Kumar

Review of Financial Studies, forthcoming

Abstract:
This study shows that shifts in political climate influence stock prices. As the party in power changes, there are systematic changes in the industry-level composition of investor portfolios, which weaken arbitrage forces and generate predictable patterns in industry returns. A trading strategy that attempts to exploit demand-based return predictability generates an annualized risk-adjusted performance of 6% during the 1939 to 2011 period. This evidence of predictability spans 17%-27% of the market and is stronger during periods of political transition. Our demand-based predictability pattern is distinct from cash flow-based predictability identified in the recent literature.

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The Societal Benefit of a Financial Transaction Tax

Aleksander Berentsen, Samuel Huber & Alessandro Marchesiani

European Economic Review, October 2016, Pages 303-323

Abstract:
We provide a novel justification for a financial transaction tax for economies where agents face stochastic consumption opportunities. A financial transaction tax makes it more costly for agents to readjust their portfolios of liquid and illiquid assets in response to liquidity shocks, which increase both the demand for and the price of liquid assets. The higher price improves liquidity insurance and welfare for other market participants. We calibrate the model to U.S. data and find that the optimal financial transaction tax is 1.6 percent and that it reduces the volume of financial trading by 17 percent.

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How Rigged Are Stock Markets?: Evidence From Microsecond Timestamps

Robert Bartlett & Justin McCrary

NBER Working Paper, August 2016

Abstract:
We use new timestamp data from the two Securities Information Processors (SIPs) to examine SIP reporting latencies for quote and trade reports. Reporting latencies average 1.13 milliseconds for quotes and 22.84 milliseconds for trades. Despite these latencies, liquidity-taking orders gain on average $0.0002 per share when priced at the SIP-reported national best bid or offer (NBBO) rather than the NBBO calculated using exchanges' direct data feeds. Trading surrounding SIP-priced trades shows little evidence that fast traders initiate these liquidity-taking orders to pick-off stale quotes. These findings contradict claims that fast traders systematically exploit traders who transact at the SIP NBBO.

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Public reaction to stock market volatility: Evidence from the ATUS

Patrick Payne, Christopher Browning & Charlene Kalenkoski

Applied Economics Letters, Fall 2016, Pages 1197-1200

Abstract:
How does the public react to changes in the stock market? We know from the existing body of research that sentiment can predict future stock-market movements. However, do market movements affect sentiment? This article addresses these questions by testing whether market movements precede changes in the emotional well-being of the general public. Using Granger causality analysis, we compare how market movements affect public well-being during periods of increased (2010) and decreased (2012) volatility. The results show that 30-day-lagged returns are associated positively and significantly with the public's emotional well-being, and that this effect is stronger during periods of increased volatility. The results also show that this effect may persist for up to 120 days.

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The Price of Street Friends: Social Networks, Informed Trading, and Shareholder Costs

Jie Cai, Ralph Walkling & Ke Yang

Journal of Financial and Quantitative Analysis, June 2016, Pages 801-837

Abstract:
Recent studies suggest the transfer of privileged information via social ties but do not explicitly examine the cost of these ties to shareholders. We document a significant positive relation between stock transaction costs and a company's social ties to the investment community. Social ties based on education and leisure activities, stronger ties, and ties to individuals responsible for trading have greater effects. Using investment connection deaths as natural experiments, we document that exogenous severance of ties reduces trading costs and trading activities by connected parties. Our evidence illustrates an important and previously undocumented consequence of social ties.

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Measuring Institutional Investors' Skill from Their Investments in Private Equity

Daniel Cavagnaro et al.

NBER Working Paper, August 2016

Abstract:
Using a large sample of institutional investors' private equity investments in venture and buyout funds, we estimate the extent to which investors' skill affects returns from private equity investments. We first consider whether investors have differential skill by comparing the distribution of investors' returns relative to the bootstrapped distribution that would occur if funds were randomly distributed across investors. We find that the variance of actual performance is higher than the bootstrapped distribution, suggesting that higher and lower skilled investors consistently outperform and underperform. We then use a Bayesian approach developed by Korteweg and Sorensen (2015) to estimate the incremental effect of skill on performance. The results imply that a one standard deviation increase in skill leads to about a three percentage point increase in returns, suggesting that variation in institutional investors' skill is an important driver of their returns.

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Property crime, earnings variability, and the cost of capital

James Brushwood et al.

Journal of Corporate Finance, October 2016, Pages 142-173

Abstract:
We show that firms located in states where property crime is more prevalent have more uncertain earnings and higher financing costs. Specifically, firms located in states with higher property crime rates have more volatile and less persistent earnings as well as lower quality analysts' earnings forecasts. Firms located in states with higher property crime rates also have a higher cost of equity and debt capital. These results are robust to accounting for econometric and endogeneity concerns in various ways. Overall, our results suggest that a potentially large and overlooked cost of crime is a higher cost of capital.

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What's a name worth? The impact of a likeable stock ticker symbol on firm value

Xuejing Xing, Randy Anderson & Yan Hu

Journal of Financial Markets, forthcoming

Abstract:
We investigate the impact of the likeability and pronounceability of stock ticker symbols on firm value. Using a unique, comprehensive dataset with hand-collected ratings of ticker symbols, we find that higher likeability of ticker symbols leads to higher Tobin's Q. The pronounceability of ticker symbols has a similar but weaker effect. Further evidence suggests that the effect is possibly due to the impact of ticker symbols on stock liquidity or mispricing or both.

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Analyst Promotions within Credit Rating Agencies: Accuracy or Bias?

Darren Kisgen, Matthew Osborn & Jonathan Reuter

NBER Working Paper, August 2016

Abstract:
We examine whether credit rating agencies reward accurate or biased analysts. Using data collected from Moody's corporate debt credit reports, we find that Moody's is more likely to promote analysts who are accurate, but less likely to promote analysts who downgrade frequently. Combined, analysts who are accurate but not overly negative are approximately twice as likely to get promoted. Further, analysts whose rating changes are more informative to the market are more likely to get promoted, unless their ratings changes cause large negative market reactions. Moody's balances a desire for accuracy with a desire to cater to its corporate clients.

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Peer Pressure: Social Interaction and the Disposition Effect

Rawley Heimer

Review of Financial Studies, forthcoming

Abstract:
Social interaction contributes to some traders' disposition effect. New data from an investment-specific social network linked to individual-level trading records builds evidence of this connection. To credibly estimate causal peer effects, I exploit the staggered entry of retail brokerages into partnerships with the social trading web platform and compare trader activity before and after exposure to these new social conditions. Access to the social network nearly doubles the magnitude of a trader's disposition effect. Traders connected in the network develop correlated levels of the disposition effect, a finding that can be replicated using workhorse data from a large discount brokerage.

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Do Private Equity Funds Manipulate Reported Returns?

Gregory Brown, Oleg Gredil & Steven Kaplan

NBER Working Paper, August 2016

Abstract:
Private equity funds hold assets that are hard to value. Managers may have an incentive to distort reported valuations if these are used by investors to decide on commitments to subsequent funds managed by the same firm. Using a large dataset of buyout and venture funds, we test for the presence of reported return manipulation. We find evidence that some under-performing managers boost reported returns during times when fundraising takes place. However, those managers are unlikely to raise a next fund, suggesting that investors see through much of the manipulation. In contrast, we find that top-performing funds likely understate their valuations.

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The Activities of Buy-Side Analysts and the Determinants of Their Stock Recommendations

Lawrence Brown et al.

Journal of Accounting and Economics, August 2016, Pages 139-156

Abstract:
We survey 344 buy-side analysts from 181 investment firms and conduct 16 detailed follow-up interviews to gain insights into the activities of buy-side analysts, including the determinants of their compensation, the inputs to their stock recommendations, their beliefs about financial reporting quality, and the role of sell-side analysts in buy-side research. One important finding is that 10-K or 10-Q reports are more useful than quarterly conference calls and management earnings guidance for determining buy-side analysts' stock recommendations. Our results also suggest that sell-side analysts add value by providing buy-side analysts with in-depth industry knowledge and access to company management.


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