Material Information
Eye in the sky: Private satellites and government macro data
Abhiroop Mukherjee, George Panayotov & Janghoon Shon
Journal of Financial Economics, forthcoming
Abstract:
We develop an approach to identify whether recent technological advancements -- such as the rise of commercial satellite-based macro estimates -- can provide an alternative to government data. We measure the extent to which satellite estimates affect the value of a government macro announcement using its asset price impact. Our identification relies on cloud cover, which prevents satellites from observing economic activity at a few key hubs. Applying our approach, we find that some satellite estimates are now so effective that markets are no longer surprised by government announcements. Our results point to a future in which the resolution of macro uncertainty is smoother and governments have less control over macro information.
The Voice of Monetary Policy
Yuriy Gorodnichenko, Tho Pham & Oleksandr Talavera
NBER Working Paper, March 2021
Abstract:
We develop a deep learning model to detect emotions embedded in press conferences after the meetings of the Federal Open Market Committee and examine the influence of the detected emotions on financial markets. We find that, after controlling for the Fed’s actions and the sentiment in policy texts, positive tone in the voices of Fed Chairs leads to statistically significant and economically large increases in share prices. In other words, how policy messages are communicated can move the stock market. In contrast, the bond market appears to take few vocal cues from the Chairs. Our results provide implications for improving the effectiveness of central bank communications.
Asset prices, midterm elections, and political uncertainty
Kam Fong Chan & Terry Marsh
Journal of Financial Economics, forthcoming
Abstract:
This study attests to the important role of US midterm elections in asset pricing, even more important than presidential elections. In months following the midterms, equity premiums, mutual fund flows, and real investment growth rates are significantly higher and Treasury premiums are lower. This is consistent with theoretical models relating higher asset prices to lower future discount rates when post-election political uncertainty decreases. The results are robust to different measures of uncertainty. Also, market betas relate positively to the cross section of average returns in post-midterm months, but the relation is flat in other months.
Do People Understand the Benefit of Diversification?
Nicholas Reinholtz, Philip Fernbach & Bart de Langhe
Management Science, forthcoming
Abstract:
Diversification — investing in imperfectly correlated assets — reduces volatility without sacrificing expected returns. Although the expected return of a diversified portfolio is the weighted average return of its constituent parts, the variance of the portfolio is less than the weighted average variance of its constituent parts. Our results suggest that very few people have correct statistical intuitions about the effects of diversification. The average person in our data sees no benefit of diversification in terms of reducing portfolio volatility. Many people, especially those low in financial literacy, believe diversification actually increases the volatility of a portfolio. These people seem to believe that the unpredictability of individual assets compounds when aggregated together. Additionally, most people believe diversification increases the expected return of a portfolio. Many of these people correctly link diversification with the concept of risk reduction but seem to understand risk reduction to mean greater returns on average. We show that these beliefs can lead people to construct investment portfolios that mismatch investors’ risk preferences. Furthermore, these beliefs may help explain why many investors are underdiversified.
Corporate Twitter use and cost of equity capital
Mohamed Al Guindy
Journal of Corporate Finance, forthcoming
Abstract:
This paper investigates whether firms that communicate information on social media have a lower cost of equity capital. Using a hand-collected dataset comprising the full universe of all firms listed on the NYSE, AMEX and NASDAQ since the inception of Twitter, I show that firms that use Twitter have a lower cost of equity capital. Furthermore, firms that face the greatest information asymmetries; namely, smaller companies, companies with few analyst followings, and companies with the least institutional holdings, benefit particularly from tweeting financial information. For identification, I employ a difference-in-difference analysis based on the staggered adoption of Twitter, and a propensity score match (PSM) of tweeting and non-tweeting firms.
Visual Finance: The Pervasive Effects of Red on Investor Behavior
William Bazley, Henrik Cronqvist & Milica Mormann
Management Science, forthcoming
Abstract:
The visual communication of financial information is commonplace and involves numerous facets, including the use of color. At the same time, perception of color influences behavior. Through eight experiments, we show that using red color to represent financial data impacts individuals’ risk preferences, expectations of future stock returns, and trading decisions. The effects are not present in colorblind individuals and are muted in China, where red represents prosperity. Other colors, including yellow and blue, do not generate the same effects. Overall, we demonstrate that simple perceptual processes influence complex investor behavior, which is important given society’s increasing reliance on visual communication.
Income inequality and the volatility of stock prices
Benjamin Blau, Todd Griffith & Ryan Whitby
Applied Economics, forthcoming
Abstract:
We examine the link between income inequality and the price volatility of American Depository Receipts (ADRs). Using a large sample of ADRs across 37 countries, we find that income inequality is negatively associated with ADR volatility. To draw stronger causal inferences, we use the implementation of the French ‘Millionaire Tax’ as a negative shock to the perceived level of income inequality in France. In difference-in-difference tests, we find that volatility for French ADRs vis-à-vis non-French ADRs increased by at least 4.85 percentage points after the tax change. Therefore, instead of creating political and social uncertainty, income inequality has a stabilizing influence on the volatility of stock prices, which we argue is a result of higher-skilled human capital.
Internet searching and stock price crash risk: Evidence from a quasi-natural experiment
Yongxin Xu, Yuhao Xuan & Gaoping Zheng
Journal of Financial Economics, forthcoming
Abstract:
In 2010, Google unexpectedly withdrew its searching business from China, reducing investors’ ability to find information online. The stock price crash risk for firms searched for more via Google before its withdrawal subsequently increases by 19%, suggesting that Internet searching facilitates investors’ information processing. The sensitivity of stock returns to negative Internet posts also rises by 36%. The increase in crash risk is more pronounced when firms are more likely to hide adverse information and when information intermediaries are less effective in assisting investors’ information processing. In addition, liquidity (price delay) decreases (increases) after Google's withdrawal.
Brain Activity Foreshadows Stock Price Dynamics
Mirre Stallen, Nicholas Borg & Brian Knutson
Journal of Neuroscience, 7 April 2021, Pages 3266-3274
Abstract:
Successful investing is challenging since stock prices are difficult to consistently forecast. Recent neuroimaging evidence suggests, however, that activity in brain regions associated with anticipatory affect may not only predict individual choice, but also forecast aggregate behavior out-of-sample. Thus, in two experiments, we specifically tested whether anticipatory affective brain activity in healthy humans could forecast aggregate changes in stock prices. Using functional magnetic resonance imaging, we found in a first experiment (n = 34, 6 females; 140 trials/subject) that nucleus accumbens activity forecast stock price direction, whereas anterior insula (AIns) activity forecast stock price inflections. In a second preregistered replication experiment (n = 39, 7 females) that included different subjects and stocks, AIns activity still forecast stock price inflections. Importantly, AIns activity forecast stock price movement even when choice behavior and conventional stock indicators did not (e.g., previous stock price movements), and classifier analysis indicated that forecasts based on brain activity should generalize to other markets. By demonstrating that AIns activity might serve as a leading indicator of stock price inflections, these findings imply that neural activity associated with anticipatory affect may extend to forecasting aggregate choice in dynamic and competitive environments such as stock markets.
Sleep Disruption and Investor Processing of Earnings News: Evidence from Daylight Saving Time Advances
Tyler Kleppe et al.
University of Kentucky Working Paper, January 2021
Abstract:
Despite extensive evidence on the effects of psychological and behavioral factors on investors’ processing of accounting information, little is known about how physiological factors affect the investor response to accounting disclosures. Research in neuroscience suggests that sleep disruptions can have profound physiological effects that impair cognition. Motivated by this evidence, we use “spring forward” Daylight Saving Time (DST) phase advances, which have been shown to inhibit cognitive function by disrupting the human sleep cycle and circadian rhythm, to examine the effect of sleep disruption on investors’ reactions to earnings news. We find consistent evidence of a muted reaction to earnings news released during the week following a DST advance. We also find that this effect is stronger when investors are more likely to be trading on earnings news. We find no evidence of a decrease in EDGAR downloads or media attention during this period, suggesting that DST advances affect investors’ information integration, rather than information acquisition. Our inferences are strengthened through a placebo test performed during the previous (i.e., pre-2007) DST phasing regime, and through alternative design choices and robustness tests. Overall, our findings suggest that sleep disruptions affect investors’ ability to integrate value-relevant earnings news into their trading decisions. Our study provides insight into the costs of sleep inadequacy, which has been declared a public health epidemic and is prevalent among professional investors, and informs ongoing policy debates regarding the abolishment of DST phasing.
Hedge funds and their prime broker analysts
Sung Gon Chung, Manoj Kulchania & Melvyn Teo
Journal of Empirical Finance, June 2021, Pages 141-158
Abstract:
Are sell-side analysts reluctant to go against the investment views of their hedge funds when these hedge funds are their prime brokerage clients? We show that prime broker analysts tend to upgrade stocks recently bought by their clients. For stocks with upgraded recommendations, post-announcement cumulative abnormal returns are significantly lower for those purchased by the prime brokerage clients. Our results are stronger with high-dollar-turnover clients who generate more trading commissions. We also find that a hedge fund with a large bet on a stock has a stronger incentive to pressure the fund’s prime brokers to issue a favorable recommendation on the stock. Results are not driven by stocks of firms with low analyst coverage or small size.
Can hedge funds benefit from corporate social responsibility investment?
Jun Duanmu et al.
Financial Review, May 2021, Pages 251-278
Abstract:
We explore the extent to which hedge funds incorporate corporate social responsibility (CSR) considerations in the development of their investment strategies. Using an asset‐weighted composite measure of CSR by fund, we examine the difference in financial performance between hedge funds with high CSR investment relative to those with low CSR investment and document no significant difference. Yet, we find that hedge funds increase their exposure to high‐CSR investments over our sample period, specifically postfinancial crisis. We find that the increases in CSR investment are associated with lower return volatilities in the future. Additionally, hedge funds with higher weighted CSR scores exhibit significantly lower risk factor loadings than funds with lower weighted CSR scores. Our results suggest that hedge funds are able to derive benefits by using CSR considerations as a form of risk mitigation in their investment policies.
Does good luck make people overconfident? Evidence from a natural experiment in the stock market
Huasheng Gao, Donghui Shi & Bin Zhao
Journal of Corporate Finance, forthcoming
Abstract:
This paper examines the changes in investors' trading behavior after winning an IPO allotment in China — a purely luck-driven event. We find that these investors subsequently become overconfident: They trade more frequently and lose more money relative to other investors. This effect is stronger when investors are inexperienced and when investors' pre-existing level of overconfidence is low. We also show that investors exhibit a stronger gambling propensity and hold more lottery-like stock after winning an IPO allotment. Our findings are not explained by wealth effects or house money effects. Overall, our evidence indicates that the experience of good luck makes people overconfident about their prospects.
Inconsistent Disclosures
Yichang Liu, Joshua Madsen & Frank Zhou
University of Minnesota Working Paper, March 2021
Abstract:
Regulations often mandate that firms disclose specific information that overlaps other sources of public information. We find that 40% of hedge fund advisers file publicly available disclosures with the SEC that contain inconsistencies regarding their regulatory histories, conflicts of interest, and risks. Inconsistencies predict lower future performance even after controlling for current and past performance. Inconsistent funds do not differ in their quarterly fund flows, flow-performance relation, ability to raise debt, ownership concentration, institutional clients, and use of a Big 4 auditor. Our evidence suggests that attention constraints limit the ability of market participants to avoid these problematic funds and highlights the need for improved disclosure regulation and investor information processing, even in markets dominated by "sophisticated" investors.