Natural Liquidity
Molecular Genetics, Risk Aversion, Return Perceptions, and Stock Market Participation
Richard Sias, Laura Starks & Harry Turtle
NBER Working Paper, August 2020
Abstract:
We show that molecular variation in DNA related to cognition, personality, health, and body shape, predicts an individual’s equity market participation and risk aversion. Moreover, the molecular genetic endowments predict individuals’ return perceptions, most of which we find to be strikingly biased. The genetic endowments also strongly associate with many of the investor characteristics (e.g., trust, sociability, wealth) shown to explain heterogeneity in equity market participation. Our analysis helps elucidate why financial choices are heritable and how genetic endowments can help explain the links between financial choices, risk aversion, beliefs, and other variables known to explain stock market participation.
Do Noisy Stock Prices Impede Real Efficiency?
Steven Chong Xiao
Management Science, forthcoming
Abstract:
Using volatile and correlated liquidity shocks to investors as a source of noise trading, I show that noise in stock prices impedes real efficiency. A one-standard-deviation increase in mutual fund flow-driven volatility pressure leads to a 2.6%–4.0% decline in return on assets and a $22.6 million loss in cash flow in the subsequent two years. Noise in stock prices does not affect product market demand, but it reduces firms’ total factor productivity, profit margin, and performance in research and development and acquisitions. Further evidence suggests that noise in stock prices impedes real efficiency through three plausible channels: distorting firms’ investment decisions through misleading price signals, increasing the cost of capital, and reducing the efficacy of equity-based incentive contracts.
Can social media distort price discovery? Evidence from merger rumors
Weishi Jia et al.
Journal of Accounting and Economics, forthcoming
Abstract:
We study whether social media can play a negative information role by impeding price discovery in the presence of highly speculative rumors. We focus on merger rumors, where most do not materialize. We find that merger rumors accompanied by greater Twitter activity elicit greater immediate market reaction even though rumor-related Twitter activity is unrelated to the probability of merger realization. The price distortion associated with tweet volume persists weeks after a rumor and reverses only after eight weeks. The price distortion is more pronounced for rumors tweeted by Twitter users with greater social influence, for target firms with low institutional ownership, and for rumors that supply more details. Our evidence suggests that social media can be a rumor mill that hinders the market’s price discovery of potentially false information.
News or Noise: Mobile Internet Technology and Stock Market Activity
Nerissa Brown et al.
University of Illinois Working Paper, May 2020
Abstract:
Mobile internet devices reduce trading frictions and information search costs for investors, but also introduce attention-competing activities, such as social networking. We use exogenous nationwide and city-level outages of the Blackberry Internet Service (BIS) to investigate the effect of mobile internet technology on investors’ information-gathering vs. attention-diverting activities. We find that trading volume and trading frequency surge by about 5% on days when mobile internet systems go dark, consistent with a greater role for devices (when not dark) in diverting the limited attention of investors away from information-gathering and trading — even when they are used by presumably more sophisticated investors.
The Real Effects of Modern Information Technologies
Itay Goldstein, Shijie Yang & Luo Zuo
NBER Working Paper, July 2020
Abstract:
Modern information technologies have greatly facilitated timely dissemination of information to a broad base of investors at low costs. To examine their effects on the real economy, we exploit the staggered implementation of the EDGAR system from 1993 to 1996 as a shock to information dissemination technologies. We find that the EDGAR implementation leads to an increase in the level of corporate investment but a decrease in the investment-to-price sensitivity. We provide evidence that improved equity financing and reduced managerial learning from prices are the underlying mechanisms that explain these real effects, respectively. In addition, we show that the EDGAR implementation leads to an improvement in performance in value firms but a decline in performance in high-growth firms where learning from the market is particularly important.
Depressive Realism and Analyst Forecast Accuracy
Sima Jannati, Sarah Khalaf & Du Nguyen
University of Missouri Working Paper, July 2020
Abstract:
Whether a bad mood enhances or hinders problem-solving and financial decision making is an open question. Using the Gallup Analytics survey, we test the depressive realism hypothesis in the earnings forecasts provided by Estimize users. The depressive realism hypothesis states that mild forms of depression improve judgment tasks because of higher attention to detail and slower information processing. We find that a 1-standard-deviation increase in the segment of the U.S. population with depression leads to a 0.25% increase in future forecast accuracy, supporting the hypothesis. This influence is comparable to other determinants of Estimize users' accuracy, like the geographic proximity of users to firms, users' experience, and their professional status. Our result is robust to using an IV analysis, different measures of forecast accuracy and mood, as well as alternative explanations.
The Price Effects of Liquidity Shocks: A Study of the SEC’s Tick Size Experiment
Rui Albuquerque, Shiyun Song & Chen Yao
Journal of Financial Economics, forthcoming
Abstract:
Do stock prices of publicly listed companies respond to changes in transaction costs? Using the SEC’s pilot program that increased the tick size for approximately 1,200 randomly chosen stocks, we find a stock price decrease between 1.75% and 3.2% for small spread stocks affected by the larger tick size relative to a control group. We find that the increase in the present value of transaction costs accounts for a small percentage of the price decrease. We study channels of price variation due to changes in expected returns: information risk, investor horizon, and liquidity risk. The evidence suggests that trading frictions affect the cost of capital.
Who Is Afraid of BlackRock?
Massimo Massa, David Schumacher & Yan Wang
Review of Financial Studies, forthcoming
Abstract:
We exploit the merger between BlackRock and Barclays Global Investors to study how changes in expected ownership concentration affect the investment behavior of funds and the cross-section of stocks worldwide. We find that funds with open-end structures and large exposure to commonly held stocks begin avoiding these stocks following the merger announcement. This leads to a permanent change in the composition of institutional ownership and a negative price and liquidity impact. We confirm these results in a large sample of global asset management mergers. Our findings suggest that market participants behave strategically in response to changes in expected financial fragility.
Flying under the radar: The effects of short-sale disclosure rules on investor behavior and stock prices
Stephan Jank, Christoph Roling & Esad Smajlbegovic
Journal of Financial Economics, forthcoming
Abstract:
We study how disclosure requirements for large short positions affect investor behavior and security prices. Short positions accumulate just below the applicable disclosure threshold as certain investors never disclose any of their positions. Further tests suggest that this secrecy is part of investors’ general policy of avoiding disclosure to protect their unique, profitable investment strategies against reverse engineering by competitors. No evidence supports the notion that short sellers avoid disclosure because of potential adverse effects on securities lending fees, risk of recall, or short squeezes. Finally, the evasive behavior by short sellers in response to transparency regulations hampers price discovery.
Copy Trading
Jose Apesteguia, Jörg Oechssler & Simon Weidenholzer
Management Science, forthcoming
Abstract:
Copy trading allows traders in social networks to receive information on the success of other agents in financial markets and to directly copy their trades. Internet platforms like eToro, ZuluTrade, and Tradeo have attracted millions of users in recent years. The present paper studies the implications of copy trading for the risk taking of investors. Implementing a novel experimental financial asset market, we show that providing information on the success of others leads to a significant increase in risk taking of subjects. This increase in risk taking is even larger when subjects are provided with the option to directly copy others. We conclude that copy trading leads to excessive risk taking.
Dealers’ Insurance, Market Structure, and Liquidity
Francesca Carapella & Cyril Monnet
Journal of Financial Economics, forthcoming
Abstract:
We develop a parsimonious model to study the effect of regulations aimed at reducing counterparty risk on the structure of over-the-counter securities markets. We find that such regulations promote entry of dealers, thus fostering competition and lowering spreads. Greater competition, however, has an indirect negative effect on market-making profitability. General equilibrium effects imply that more competition can distort incentives of all dealers to invest in efficient technologies ex ante and so can cause a social welfare loss. Our results are consistent with empirical findings on the effects of post-crisis regulations and with the opposition of some market participants to those regulations.