Big Days in the Market

Kevin Lewis

June 29, 2020

Inside the Mind of a Stock Market Crash
Stefano Giglio et al.
NBER Working Paper, May 2020


We analyze how investor expectations about economic growth and stock returns changed during the February-March 2020 stock market crash induced by the COVID-19 pandemic, as well as during the subsequent partial stock market recovery. We surveyed retail investors who are clients of Vanguard at three points in time: (i) on February 11-12, around the all-time stock market high, (ii) on March 11-12, after the stock market had collapsed by over 20%, and (iii) on April 16-17, after the market had rallied 25% from its lowest point. Following the crash, the average investor turned more pessimistic about the short-run performance of both the stock market and the real economy. Investors also perceived higher probabilities of both further extreme stock market declines and large declines in short-run real economic activity. In contrast, investor expectations about long-run (10-year) economic and stock market outcomes remained largely unchanged, and, if anything, improved. Disagreement among investors about economic and stock market outcomes also increased substantially following the stock market crash, with the disagreement persisting through the partial market recovery. Those respondents who were the most optimistic in February saw the largest decline in expectations, and sold the most equity. Those respondents who were the most pessimistic in February largely left their portfolios unchanged during and after the crash.

How Financial News Affects Prosocial Behavior
Polly Kang, David Daniels & Maurice Schweitzer
University of Pennsylvania Working Paper, April 2020


A fundamental puzzle in the social and natural sciences is why humans, in contrast to other animals, routinely help strangers at substantial personal cost. Scholars assert that humans’ hyper-prosociality can be explained by the “warm glow” prosocial actors derive from helping others, and predict that people with greater resources will help more. We challenge these assertions. Many prosocial behaviors involving feedback, like volunteering, are actually warm glow gambles: first, prosocial actors invest affective resources trying to help others; then, positive feedback (e.g., feedback suggesting “success”) boosts affective resources but negative feedback (e.g., feedback suggesting “failure”) diminishes affective resources. We theorize that either negative affect shocks (by depleting affective resources) or positive affect shocks (by triggering risk aversion) can decrease people’s likelihood of taking warm glow gambles. We test this by studying the influence of a complex human institution, the stock market, which broadcasts negative affect shocks when the market falls (suggesting bad financial news) and positive affect shocks when it rises (suggesting good financial news). Analyzing a unique, massive five-year dataset of nearly 3 million text messages sent by volunteer crisis counselors, we show that significantly fewer people volunteer when stock returns are either extremely negative or extremely positive; prosocial behavior peaks on “normal” days when returns approach zero. Further supporting our theory, these effects are moderated by the level of positive affect in volunteers’ geographical areas. Our findings contradict existing theories and lay beliefs. Ironically, an institution designed for economic efficiency broadcasts signals that profoundly influence humans’ hyper-prosocial behavior.

Financial Distancing: How Venture Capital Follows the Economy Down and Curtails Innovation
Sabrina Howell et al.
NBER Working Paper, May 2020


Although late-stage venture capital (VC) activity did not change dramatically in the first two months after the COVID-19 pandemic reached the U.S., early-stage VC activity declined by 38%. The particular sensitivity of early-stage VC investment to market conditions — which we show to be common across recessions spanning four decades from 1976 to 2017 — raises questions about the pro-cyclicality of VC and its implications for innovation, especially in light of the common narrative that VC is relatively insulated from public markets. We find that the implications for innovation are not benign: innovation conducted by VC-backed firms in recessions is less highly cited, less original, less general, and less closely related to fundamental science. These effects are more pronounced for startups financed by early-stage venture funds. Given the important role that VC plays in financing breakthrough innovations in the economy, our findings have implications for the broader discussion on the nature of innovation across business cycles

Does Floor Trading Matter?
Jonathan Brogaard, Matthew Ringgenberg & Dominik Rösch
University of Utah Working Paper, June 2020


While algorithmic trading now dominates financial markets, some exchanges continue to use human floor traders. On March 23, 2020 the NYSE suspended floor trading because of COVID-19. Using a difference-in-differences analysis, we find that floor traders are important contributors to market quality, even in the age of algorithmic trading. The suspension of floor trading leads to higher effective spreads, volatility, and pricing errors. Moreover, consistent with theoretical predictions about automation, the effects are strongest during the opening and closing auctions when complexity is highest. Our findings suggest that human floor traders improve market quality.

Where the Heart Is: Information Production and the Home Bias
Jess Cornaggia, Kimberly Cornaggia & Ryan Israelsen
Management Science, forthcoming


This paper tests whether home bias exists among information producers. We find that credit analysts are more generous when rating issuers from their home states compared with (a) benchmark analysts from outside the state and (b) their own standards for rating issuers from other states. This home analyst effect strengthens around key rating certifications (AAA and investment grade), reduces credit spreads, and expands affected issuers’ debt capacity. We conduct several tests to address the possibility that the observed home analyst effect reflects a selection effect based on informational advantages and conclude that it instead reflects a home bias.

The Macroprudential Role of Stock Markets
Kyriakos Chousakos, Gary Gorton & Guillermo Ordoñez
NBER Working Paper, May 2020


A financial crisis is an event of sudden information acquisition about the collateral backing short-term debt in credit markets. When investors see a financial crisis coming, however, they react by more intensively acquiring information about firms in stock markets, revealing those that are weaker, which as a consequence end up cut off from credit. This cleansing effect of stock markets’ information on credit markets’ composition discourage information acquisition about the collateral of the firms remaining in credit markets, slowing down credit growth and potentially preventing a crisis. Production of information in stock markets, then, acts as a macroprudential tool in the economy.

Asset Pricing: A Tale of Night and Day
Terrence Hendershott, Dmitry Livdan & Dominik Rösch
Journal of Financial Economics, forthcoming


The capital asset pricing model (CAPM) performs poorly overall, as market risk (beta) is weakly related to 24-hour returns. This is because stock prices behave very differently with respect to their sensitivity to beta when markets are open for trading versus when they are closed. Stock returns are positively related to beta overnight, whereas returns are negatively related to beta during the trading day. These day-night relations hold for beta-sorted portfolios and individual stocks in the US and internationally as well as for industry and book-to-market portfolios and cash flow and discount rate beta-sorted portfolios. In addition to the change in slope of returns with respect to beta, the implied risk-free rate differs significantly between night and day. Consistent with this, returns on US Treasury futures differ significantly between night and day.

Are Online Job Postings Informative to Investors?
Elizabeth Gutiérrez et al.
Management Science, forthcoming


Human capital is a key factor in value creation in the modern corporation. Yet the disclosure of investment in human capital is scant. We propose that a company’s online job postings are disclosures made outside of the investor-relations channel that contain forward-looking information that could be informative to investors about future growth. We find that changes in the number of job postings are positively associated with changes in future performance and that this relation is stronger when postings likely represent growth rather than replacement. Consistent with job postings providing new information to the market, investors react positively to changes in the number of job postings. The market reaction to postings is stronger when firms are likely to be hiring for growth rather than replacement and for firms with low labor intensity (and therefore high marginal productivity of labor).

IQ from IP: Simplifying Search in Portfolio Choice
Huaizhi Chen et al.
Journal of Financial Economics, forthcoming


Using a novel database that tracks web traffic on the Security Exchange Commission's EDGAR server between 2004 and 2015, we show that institutional investors gather information on a very particular subset of firms and insiders, and their surveillance is very persistent over time. This tracking behavior has powerful implications for their portfolio choice and its information content. An institution that downloaded an insider trading filing by a given firm last quarter increases its likelihood of downloading an insider trading filing on the same firm by more than 41.3 percentage points this quarter. Moreover, the average tracked stock that an institution buys generates annualized alphas of over 12% relative to the purchase of an average non tracked stock. We find that institutional managers tend to track top executives and to share educational and locational commonalities with the specific insiders they choose to follow. Collectively, our results suggest that the information in tracked trades is important for fundamental firm value and is only revealed following the information-rich dual trading by insiders and linked institutions.

First Impression Bias: Evidence from Analyst Forecasts
David Hirshleifer et al.
Review of Finance, forthcoming


We present evidence of first impression bias among finance professionals in the field. Equity analysts’ forecasts, target prices, and recommendations suffer from first impression bias. If a firm performs particularly well (poorly) in the year before an analyst follows it, that analyst tends to issue optimistic (pessimistic) evaluations. Consistent with negativity bias, we find that negative first impressions have a stronger effect than positive ones. The market adjusts for analyst first impression bias with a lag. Finally, our findings contribute to the literature on experience effects. Finally, we show that a set of professionals in the field, equity analysts, apply U-shaped weights to their sequence of past experiences, with greater weight on first experiences and recent experiences than on intermediate ones.

Gambling activity and stock price volatility: A cross-country analysis
Benjamin Blau & Ryan Whitby
Journal of Behavioral and Experimental Finance, forthcoming


Shiller (2000) contends that gambling activity might promote risk-taking by individuals in other areas, such as firm decision making or in financial markets. In this study, we test the hypothesis that favorable attitudes towards gambling impact country-level stock price volatility. Using American Depositary Receipts (ADRs) to control for differing market structures, we find that countries with more gaming institutions, higher gambling losses per adult, and legalized online gambling have less stable stock prices. These results are robust to different measures of volatility and controls for both firm-specific characteristics and macroeconomic conditions. These findings support the idea that a country’s culture toward gambling might generate greater levels of volatility in the country’s financial markets.

Insider trading patterns
Lee Biggerstaff, David Cicero & Babajide Wintoki
Journal of Corporate Finance, forthcoming


We revisit the information content of stock trading by corporate insiders with an expectation that opportunistic insiders will spread their trades over longer periods of time when they have a longer-lived informational advantage, and trade in a short window of time when their advantage is fleeting. Controlling for the duration of insiders' trading strategies, we find robust new evidence that both insiders' sales and purchases predict abnormal stock returns. In addition, we provide evidence that insiders attempt to preserve their informational advantages and increase their trading profits by disclosing their trades after the market has closed. When insiders report their trades after business hours, they are more likely to engage in longer series of trades, they trade more shares overall, and their trades are associated with larger abnormal returns. Finally, we show how accounting for these trading patterns sharpens screens for corporate insiders who trade on information.


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