Kevin Lewis

December 13, 2017

Stock Trades of SEC Employees
Shivaram Rajgopal & Roger White
Journal of Law and Economics, forthcoming

We examine the profitability of stock trades executed by SEC employees. Subject to the considerable constraints of the data (no portfolio information, occupational details, or individual identifiers and inability to determine actual profitability of trades), we find that a hedge portfolio mimicking such trades earns a positive abnormal return of about 8.5% per year in U.S. stocks, driven primarily by negative abnormal future returns on sell transactions. The SEC claims that this result stems in part from employees being forced to sell stocks in a firm when they are assigned to secret investigations. We question whether this policy is reasonable.

Do Journalists Help Investors Analyze Firms' Earnings News?
Nicholas Guest
MIT Working Paper, November 2017

I examine whether the market’s reaction to firms’ earnings news varies with analysis (or editorial content) produced by financial journalists. A series of natural experiments at The Wall Street Journal (WSJ) shows that WSJ articles increase trading volume and improve price discovery at earnings announcements. The effects are stronger when an article contains more original analysis and less content reproduced from the firm’s press release. This evidence refines inferences from prior studies that find media dissemination, but not analysis, makes the market’s earnings response more efficient. Instead, my paper suggests media analysis also enhances investors’ trading decisions by improving their understanding of the implications of firms’ earnings news. In other words, journalists’ analysis efforts provide value to readers, which helps explain the continued production of costly earnings-related analysis amid increasing pressure from low-cost information sources.

What a Difference a (Birth) Month Makes: The Relative Age Effect and Fund Manager Performance
John (Jianqiu) Bai et al.
Northeastern University Working Paper, November 2017

Many US states have a single cutoff date for school entry, meaning that some children are older than others when they begin kindergarten. We document that this variation in birth months is associated with differences in adult labor market outcomes in the mutual fund industry. Relatively older managers (i.e. those born just after the cutoff) make better stock selections and their funds outperform their younger peers’ funds by 0.48% per annum. This difference is linked to increased confidence. Survey respondents judge relatively older managers as appearing more confident in photographs, and these managers display more confident behavior: making larger bets, window-dressing their holdings less, and securing more fund flows conditional on performance.

The Deterrent Effect of the Securities and Exchange Commission’s Enforcement Intensity on Illegal Insider Trading: Evidence from Run-up before News Events
Diane Del Guercio, Elizabeth Odders-White & Mark Ready
Journal of Law and Economics, May 2017, Pages 269-307

We examine whether public enforcement of US insider-trading laws affects price discovery. Examining insider-trading civil cases filed by the Securities and Exchange Commission (SEC) from 2003 to 2011, we find that the price impact on insider-trading days is much smaller than the effect documented for the 1980s, consistent with increased fear of prosecution. Moreover, we find that preannouncement anticipatory run-up in comprehensive samples of takeover bids and earnings announcements is negatively related to resource-based measures of public enforcement intensity, which suggests that aggressive SEC enforcement deters illegal activity. In addition, we find that quoted bid-ask spreads are negatively related to the SEC’s enforcement intensity, which suggests that greater enforcement improves liquidity. Moreover, the negative and significant relation between run-up and the SEC’s enforcement intensity persists after controlling for quoted spreads.

Political Uncertainty and IPO Activity: Evidence from U.S. Gubernatorial Elections
Gönül Çolak, Art Durnev & Yiming Qian
Journal of Financial and Quantitative Analysis, forthcoming

We analyze initial public offering (IPO) activity under political uncertainty surrounding gubernatorial elections in the United States. There are fewer IPOs originating from a state when it is scheduled to have an election. To establish identification, we develop a neighboring-states method that uses bordering states without elections as a control group. The dampening effect of elections on IPO activity is stronger for firms with more concentrated businesses in their home states, firms that are more dependent on government contracts (particularly state contracts), and harder-to-value firms. This dampening effect is related to lower IPO offer prices (hence, higher costs of capital) during election years.

Examining the Examiners: SEC Effectiveness in Identifying Financial Reporting Errors
Matthew Kubic
Duke University Working Paper, October 2017

I examine the effectiveness of the SEC Division of Corporate Finance (DCF) comment letter process. In a sample of 17,624 financial statement reviews covering 2005 to 2014, the DCF identifies an error that results in a restatement in 6.3% of cases, and in 7.0% of cases fails to identify an error that results in a restatement. I use the ratio of errors identified (1,114 or 6.3%) to total errors (2,342 or 13.3%) as a measure of effectiveness (47.6%). The DCF is more (less) likely to detect severe errors and errors related to long-term assets and financial statement presentation (income taxes). Enforcement intensity increases the likelihood of detecting an error, while errors are more likely to be missed during periods of above average workload. The economic reward to a DCF examiner for identifying an error is less than $1,000 per error and individual examiners differ in their ability to detect errors.

Informed trading in the Bitcoin market
Wenjun Feng, Yiming Wang & Zhengjun Zhang
Finance Research Letters, forthcoming

Bitcoin’s price sensitivity to material events makes informed trading very profitable in this new market. We propose a novel indicator to assess the informed trades ahead of cryptocurrency-related events. Using trade-level data of USD/BTC exchange rates, we find evidence of informed trading in the Bitcoin market prior to large events: Quantiles of the order sizes of buyer-initiated (seller-initiated) orders are abnormally high before large positive (negative) events, compared to the quantiles of seller-initiated (buyer-initiated) orders. When examining the timing of the informed trades, we further notice that the informed traders prefer to build their positions two days before large positive events and one day before large negative events. The profits of informed trading in the Bitcoin market are estimated to be considerably large.

Does Algorithmic Trading Reduce Information Acquisition?
Brian Weller
Review of Financial Studies, forthcoming

I demonstrate an important tension between acquiring information and incorporating it into asset prices. As a salient case, I analyze algorithmic trading (AT), which is typically associated with improved price efficiency. Using a new measure of the information content of prices and a comprehensive panel of 54,879 stock-quarters of Securities and Exchange Commission (SEC) market data, I establish instead that the amount of information in prices decreases by 9% to 13% per standard deviation of AT activity and up to a month before scheduled disclosures. AT thus may reduce price informativeness despite its importance for translating available information into prices.

Bubbles in hybrid markets: How expectations about algorithmic trading affect human trading
Mike Farjam & Oliver Kirchkamp
Journal of Economic Behavior & Organization, forthcoming

Bubbles are omnipresent in lab experiments with asset markets. Most of these experiments are conducted in environments with only human traders. Since today's markets are substantially determined by algorithmic trading, we use a laboratory experiment to measure how human trading depends on the expected presence of algorithmic traders. We find that bubbles are clearly smaller when human traders expect algorithmic traders to be present.

Nowcasting the Local Economy: Using Yelp Data to Measure Economic Activity
Edward Glaeser, Hyunjin Kim & Michael Luca
NBER Working Paper, November 2017

Can new data sources from online platforms help to measure local economic activity? Government datasets from agencies such as the U.S. Census Bureau provide the standard measures of local economic activity at the local level. However, these statistics typically appear only after multi-year lags, and the public-facing versions are aggregated to the county or ZIP code level. In contrast, crowdsourced data from online platforms such as Yelp are often contemporaneous and geographically finer than official government statistics. In this paper, we present evidence that Yelp data can complement government surveys by measuring economic activity in close to real time, at a granular level, and at almost any geographic scale. Changes in the number of businesses and restaurants reviewed on Yelp can predict changes in the number of overall establishments and restaurants in County Business Patterns. An algorithm using contemporaneous and lagged Yelp data can explain 29.2 percent of the residual variance after accounting for lagged CBP data, in a testing sample not used to generate the algorithm. The algorithm is more accurate for denser, wealthier, and more educated ZIP codes.

All’s Well That Ends Well? On the Importance of How Returns are Achieved
Daniel Grosshans & Stefan Zeisberger
Journal of Banking & Finance, February 2018, Pages 397-410

We demonstrate that investor satisfaction and investment behavior are influenced substantially by the price path by which the final investor return is achieved. In a series of experiments, we analyze various different price paths. Investors are most satisfied if their assets first fall in value and then recover, and they are least satisfied with the opposite pattern, independent of whether the final return is positive or negative. Price paths systematically influence risk preferences, return beliefs, and ultimately trading decisions. Our results enable a much more holistic perspective on a wide range of topics in finance, such as the disposition effect, risk-taking behavior after previous gains and losses, and behavioral asset pricing.

The October 2014 United States Treasury bond flash crash and the contributory effect of mini flash crashes
Zachary Levine, Scott Hale & Luciano Floridi
PLoS ONE, November 2017

We investigate the causal uncertainty surrounding the flash crash in the U.S. Treasury bond market on October 15, 2014, and the unresolved concern that no clear link has been identified between the start of the flash crash at 9:33 and the opening of the U.S. equity market at 9:30. We consider the contributory effect of mini flash crashes in equity markets, and find that the number of equity mini flash crashes in the three-minute window between market open and the Treasury Flash Crash was 2.6 times larger than the number experienced in any other three-minute window in the prior ten weekdays. We argue that (a) this statistically significant finding suggests that mini flash crashes in equity markets both predicted and contributed to the October 2014 U.S. Treasury Bond Flash Crash, and (b) mini-flash crashes are important phenomena with negative externalities that deserve much greater scholarly attention.

The real effects of credit default swaps
András Danis & Andrea Gamba
Journal of Financial Economics, January 2018, Pages 51-76

We examine the effect of introducing credit default swaps (CDSs) on firm value. Our model allows for dynamic investment and financing, and bondholders can trade in the CDS market. The model incorporates both negative and positive effects of CDSs. CDS markets lead to more liquidations, but they also reduce the probability of costly debt renegotiation and reduce costly equity financing. After calibrating the model, we find that firm value increases by 2.9% on average with the introduction of a CDS market. Firms also invest more and increase leverage. The effect on firm value is strongest for small, financially constrained, and low productivity firms.

Environmental, Social, and Governance Criteria: Why Investors are Paying Attention
Ravi Jagannathan, Ashwin Ravikumar & Marco Sammon
NBER Working Paper, November 2017

We find that money managers could reduce portfolio risk by incorporating Environmental, Social, and Governance (ESG) criteria into their investment process. ESG-related issues can cause sudden regulatory changes and shifts in consumer tastes, resulting in large asset price swings which leave investors limited time to react. By incorporating ESG criteria in their investment strategy, money managers can tilt their holdings towards firms which are well prepared to deal with these changes, thereby managing exposure to these rare but potentially large risks.

How Does High-Frequency Trading Affect Low-Frequency Trading?
Kun Li, Rick Cooper & Ben Van Vliet
Journal of Behavioral Finance, forthcoming

High-frequency trading dominates trading in financial markets. How it affects the low-frequency trading, however, is still unclear. Using NASDAQ order book data, the authors investigate this question by categorizing orders as either high or low frequency, and examining several measures. They find that high-frequency trading enhances liquidity by increasing the trade frequency and quantity of low-frequency orders. High-frequency trading also reduces the waiting time of low-frequency limit orders and improves their likelihood of execution. The results indicate that high-frequency trading has a liquidity provision effect and improves the execution quality of low-frequency orders.

Venture Capital Investments and Merger and Acquisition Activity Around the World
Gordon Phillips & Alexei Zhdanov
NBER Working Paper, November 2017

We examine the relation between venture capital (VC) investments and mergers and acquisitions (M&A) activity around the world. We find evidence of a strong positive association between VC investments and lagged M&A activity, consistent with the hypothesis that an active M&A market provides viable exit opportunities for VC companies and therefore incentivizes them to engage in more deals. We also explore the effects of country-level pro-takeover legislation passed internationally (positive shocks), and US state-level antitakeover business combination laws (negative shocks), on VC activity. We find significant post-law changes in VC activity. VC activity intensifies after enactment of country-level takeover friendly legislation and decreases following passage of state antitakeover laws in the U.S.

Determinants and consequences of information processing delay: Evidence from the Thomson Reuters Institutional Brokers’ Estimate System
Ferhat Akbas et al.
Journal of Financial Economics, forthcoming

We present new evidence that highlights the role of information intermediaries in the distribution and processing of earnings estimates in capital markets. We find that the time taken to activate an analyst's earnings forecast in the Thomson Reuters Institutional Brokers’ Estimate System is related to measures of investor demand for timely information processing, processing difficulty, and limited attention. Furthermore, we find that forecast announcement returns are muted and post-announcement drift is magnified for forecasts with longer unexpected activation delay and that market inefficiency is concentrated in neglected stocks and potentially exploitable. Finally, analyzing intraday returns, we find that activations facilitate price discovery.

Short Selling and the Rounding of Analysts’ Forecasts
Hae Mi Choi
Finance Research Letters, forthcoming

This paper examines the causal effect of short selling on analyst forecast precision by exploiting a regulatory change in short-sale constraints (Regulation SHO) as a natural experiment. I find that short selling increases analysts’ rounding of forecasts, which indicates that analysts allocate less effort to gathering precise information on firms with downward price pressure. In the cross-section, the effect of short selling on analyst forecast precision is stronger for firms with more firm-specific information and firms with low levels of institutional holdings.

Why Do Individual Investors Disregard Accounting Information? The Roles of Information Awareness and Acquisition Costs
Elizabeth Blankespoor et al.
Stanford Working Paper, October 2017

Individual investors often fail to incorporate value-relevant accounting information into trading decisions, and they instead tend to underperform by trading on attention-grabbing technical trends. Many SEC regulations attempt to help individuals make better-informed trading decisions by decreasing their costs of monitoring and acquiring firms’ accounting disclosures. We examine whether information awareness and acquisition costs are responsible for individual investors’ neglect of accounting information. We do so using a unique archival setting where individual investors are presented with automated media articles that report both current earnings announcement news and recent stock returns. Although these investors have value-relevant earnings surprise information readily at hand, we find no evidence that their trades incorporate earnings news. Instead we find that they trade in response to the recent stock returns presented in the articles. Our study raises questions about the likely efficacy of regulations that aim to aid individual investors by increasing their awareness of, and access to, accounting information.


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