Growing volatile
The time cost of information in financial markets
Chad Kendall
Journal of Economic Theory, July 2018, Pages 118-157
Abstract:
I model a financial market in which traders acquire private information through time-consuming research. A time cost of information arises due to competition – through the expected adverse price movements due to others' trades – causing traders to rush to trade on weak information. This cost monotonically increases with asset value uncertainty, so that, exactly opposite to the result under the standard modeling assumption of a monetary cost of information, traders acquire the least information when this uncertainty is largest. The model makes several novel testable predictions regarding volume and order imbalances, some of which have existing empirical support.
Technological Revolutions and the Three Great Slumps: A Medium-Run Analysis
Dan Cao & Jean-Paul L’Huillier
Journal of Monetary Economics, forthcoming
Abstract:
The Great Recession, the Great Depression, and the Japanese slump of the 1990s were all preceded by periods of major technological innovation, which happened about 10 years before the start of the decline in economic activity. We estimate a model with noisy news. Beliefs about long-run income adjust with an important delay to permanent shifts in productivity. The estimation tells a common and simple story for the observed dynamics of productivity and consumption on a 20 to 25 year window. Our analysis highlights the advantages of a look at this data from the point of view of the medium run.
How Does the Stock Market Absorb Shocks?
Murray Frank & Ali Sanati
Journal of Financial Economics, forthcoming
Abstract:
Using a comprehensive set of news stories, we find a stark difference in market responses to positive and negative price shocks accompanied by new information. When there is a news story about a firm, positive price shocks are followed by reversal, while negative ones result in drift. This is interpreted as the stock market overreaction to good news and underreaction to bad news. These seemingly contradictory results can be explained in a single framework, considering the interaction of retail investors with attention bias, and arbitrageurs with short-run capital constraints. Consistent with this hypothesis, we find that both patterns are stronger when the attention bias is stronger, and when the arbitrage capital is scarce.
How Do Personal Real Estate Transactions Affect Productivity and Risk Taking? Evidence From Professional Asset Managers
David Ling, Yan Lu & Sugata Ray
Real Estate Economics, forthcoming
Abstract:
Housing decisions require intensive attention from households. However, the existing housing literature has not examined the potential connection between costly and time-consuming real estate purchases and the behavior and work productivity of individuals involved in the housing search and acquisition process. In addition, micro evidence on the link between home purchase decisions and the investment/risk choices of households is limited and inconclusive. Our study fills these gaps in the literature by examining the real estate acquisitions of professional asset managers. Overall, we find evidence that major purchases, such as real estate acquisitions, lead to distractions, as evidenced by reduced performance, less active trading, and increased susceptibility to behavioral biases such as the disposition effect. We also find evidence that managers tend to increase the riskiness of their professional portfolios after real estate purchases. This increase in risk is concentrated in cases of purchases of investment properties and purchases using extensive leverage, suggesting consistent risk-taking appetites across personal and professional portfolios. These findings suggest that housing transactions may shed light on the decision making, risk taking, and work productivity of a broad set of homeowners, such as asset managers, corporate executives, and even rank and file employees.
Informed Trading and Cybersecurity Breaches
Joshua Mitts & Eric Talley
Columbia University Working Paper, February 2018
Abstract:
Cybersecurity has become a significant concern in corporate and commercial settings, and for good reason: a threatened or realized cybersecurity breach can materially affect firm value for capital investors. This paper explores whether market arbitrageurs appear systematically to exploit advance knowledge of such vulnerabilities. We make use of a novel data set tracking cybersecurity breach announcements among public companies to study trading patterns in the derivatives market preceding the announcement of a breach. Using a matched sample of unaffected control firms, we find significant trading abnormalities for hacked targets, measured in terms of both open interest and volume. Our results are robust to several alternative matching techniques, as well as to both cross-sectional and longitudinal identification strategies. All told, our findings appear strongly consistent with the proposition that arbitrageurs can and do obtain early notice of impending breach disclosures, and that they are able to profit from such information. Normatively, we argue that the efficiency implications of cybersecurity trading are distinct — and generally more concerning — than those posed by garden-variety information trading within securities markets. Notwithstanding these idiosyncratic concerns, however, both securities fraud and computer fraud in their current form appear poorly adapted to address such concerns, and both would require nontrivial re-imagining to meet the challenge (even approximately).
Revolving Rating Analysts and Ratings of Mortgage-Backed and Asset-Backed Securities: Evidence from LinkedIn
John Jiang, Isabel Wang & Philip Wang
Management Science, forthcoming
Abstract:
This study examines whether revolving rating analysts who transition from major rating agencies to issuers are associated with any rating inflation in the issuers’ mortgage-backed securities (MBS) or asset-backed securities (ABS). Using professional profiles posted on LinkedIn to identify revolving rating analysts with structured finance rating experience, we find that the more the issuers employ such analysts, the more likely that ratings of issuers’ MBS and ABS new issuances are inflated compared with otherwise similarly rated securities. Additional analyses show that the impact of revolving rating analysts is more pronounced in complex deals and when the revolving analysts are more senior, indicating that rating expertise in structured finance may play a role in MBS and ABS rating inflation. Finally, we find that at least for AAA-rated MBS and ABS, investors fail to see through the rating inflation associated with revolving rating analysts.
Do Short Sellers Trade on Private Information or False Information?
Amiyatosh Purnanandam & Nejat Seyhun
Journal of Financial and Quantitative Analysis, forthcoming
Abstract:
We investigate whether short sellers contribute toward the informational efficiency of market prices by trading on their private information or destabilize market prices by trading on rumors and false information. We find that short-selling activities are considerably informative about future stock returns when there is a higher likelihood of private information in stocks, as measured by insider-trading activities. Short sellers also bring considerable additional information to the market that is not fully captured by contemporaneous insider trading. Overall, these results suggest that on average, short sellers bring informational efficiency to market prices rather than destabilize them.
Ideological Misfit? Political Affiliation and Employee Departure in the Private-Equity Industry
Sekou Bermiss & Rory McDonald
Academy of Management Journal, forthcoming
Abstract:
Though organizations are increasingly active participants in the political realm, little research has investigated how an organization's heightened focus on political ideology impacts employees. We address this gap by exploring how an individual's political ideological misfit with an organization's prevailing ideology impacts departure. By tracking the movements of over 40,000 investment professionals in the US private equity industry over ten years, we investigate the consequences of the ideological misfit that arises when individuals' political ideologies diverge substantially from the prevailing ideology of their firms. We hypothesize that ideological misfit increases the likelihood of departure, though the effects vary with liberal/conservative ideological orientation. Polynomial regression analyses reveal that the fit relationship between individual and organizational political ideology deviates from the idealized congruence relationship that underlies prevailing theory. Specifically, we find that departure is more likely for employees experiencing conservative misfit (a personal ideology more conservative than the firm's) versus liberal misfit (a personal ideology more liberal than the firm's). Conservatives are more likely to depart than liberals regardless of fit, and departing misfits tend to join new organizations that are closer to their own ideology.
Inside Insider Trading
Marcin Kacperczyk & Emiliano Pagnotta
Imperial College London Working Paper, March 2018
Abstract:
How do insider traders act on private information? Despite the breadth of the theoretical literature analyzing this issue, direct evidence of insiders’ behavior is scarce as private information sets and corresponding trades are almost never observable. We address this identification challenge by utilizing a unique hand-collected sample of insider trading cases prosecuted by the U.S. Securities Exchange Commission (SEC). We find evidence that insider traders strategically time when to trade after receiving tips about firm fundamentals. They also seek to minimize their price impact by splitting their trades, as in Kyle’s model, and manage their trades’ size according to prevailing liquidity conditions. The value and type of information, not only its sign, both play a crucial role in designing trading strategies. Individual characteristics, such as investing expertise and age, also play an essential role. By exploiting the adoption of the SEC Whistleblower Reward Program, we find evidence that insider traders (i) react to higher enforcement risk by waiting to trade and splitting their trades further, and (ii) concentrate on information of higher value. Thus, insider trading enforcement may hamper stock price informativeness.
The Investment Value of Fund Managers’ Experience outside the Financial Sector
Gjergji Cici et al.
Review of Financial Studies, forthcoming
Abstract:
Human capital acquired while working in other industries before joining fund management provides fund managers with an information advantage. Fund managers exploit this advantage by overweighting their experience industries and by picking outperforming stocks from these industries. These managers’ superior information is impounded into stock prices slowly, suggesting that their information is unique and takes a while to be discovered by the markets. Families exploit their manager’s industry-specific human capital by broadly employing their investment ideas in other funds. The investment value of industry experience is unaffected by whether or not the manager with such experience is in a team.
A Long‐Run Performance Perspective on the Technology Bubble
Maximilian Franke & Gunter Löffler
Financial Review, May 2018, Pages 379-412
Abstract:
The events surrounding the stock price peak of March 2000 are commonly interpreted as the bursting of a technology or Internet bubble, with some researchers pointing out that the pattern could also arise in fundamental models. We inform the debate by studying the long‐run performance of Internet and technology stocks from March 2000 onward. Using calendar‐time regressions, we do not find conclusive evidence of negative abnormal returns. The results are consistent with a new interpretation of the events; namely, the price drop of the early 2000s was not warranted in light of future cash flows and risk.
Do Associate Analysts Matter?
Menghai Gao, Yuan Ji & Oded Rozenbaum
George Washington University Working Paper, March 2018
Abstract:
Sell-side equity analysts often work in hierarchical teams. Lead analysts manage a team of associate and junior analysts, who take part in the team’s tasks. We examine the relative contribution of lead analysts and associate analysts to the team’s performance. We find that associate analyst fixed effects explain 17.6 percent more of the variation in forecast accuracy than lead analyst fixed effects do. In contrast, we find that lead analyst fixed effects explain 3 times more of the variation in forecast timeliness and 10.7 percent more of the variation in forecast bias than associate analyst fixed effects do. These results suggest that the decision to issue a forecast is at the discretion of the lead analyst and that lead analysts have a greater influence on forecast bias. In cross-sectional tests, we find that less experienced lead analysts explain more of the variation in forecast accuracy, timeliness, and bias compared to more experienced lead analysts. We also find that lead analysts explain more of the variation in the forecast accuracy, timeliness, and bias of the first forecast in the quarter compared to the revised forecasts. These results suggest that experienced lead analysts are less involved in EPS forecasting and that lead analysts are more involved when more information processing is required. Lastly, we find that the length of the collaboration of the lead analyst and the associate analyst improves forecast accuracy and timeliness but does not affect forecast bias. Overall, our study documents the significant role of associate analysts in forecasting.
Trust Busting: The Effect of Fraud on Investor Behavior
Umit Gurun, Noah Stoffman & Scott Yonker
Review of Financial Studies, April 2018, Pages 1341–1376
Abstract:
We study the importance of trust in the investment advisory industry by exploiting the geographic dispersion of victims of the Madoff Ponzi scheme. Residents of communities that were exposed to the fraud subsequently withdrew assets from investment advisers and increased deposits at banks. Additionally, exposed advisers were more likely to close. Advisers who provided services that can build trust, such as financial planning advice, experienced fewer withdrawals. Our evidence suggests that the trust shock was transmitted through social networks. Taken together, our results show that trust plays a critical role in the financial intermediation industry.