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The Stock Market Crash Really Did Cause the Great Recession
Roger Farmer
NBER Working Paper, August 2013
Abstract:
This note shows that a big stock market crash, in the absence of central bank intervention, will be followed by a major recession one to four quarters later. I establish this fact by studying the forecasting ability of three models of the unemployment rate. I show that the connection between changes in the stock market and changes in the unemployment rate has remained structurally stable for seventy years. My findings demonstrate that the stock market contains significant information about future unemployment.
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Harrison Hong & David Sraer
Journal of Financial Economics, forthcoming
Abstract:
Motivated by the recent subprime mortgage crisis, we explore whether speculative bubble models of equity based on investor disagreement and short-sales constraints can also provide an explanation for the overvaluation of debt contracts. We find that this is unlikely. Equity bubbles are loud: price and volume go together as investors speculate on capital gains from reselling to more optimistic investors. But this resale option is limited for debt since its upside payoff is bounded. Debt bubbles then require an optimism bias among investors. But greater optimism leads to less speculative trading as investors view the debt as safe and having limited upside. Debt bubbles are hence quiet — high price comes with low volume. We find the predicted price-volume relationship of credits over the 2003–2007 credit boom.
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The Abnormal Psychology of Investment Performance
Fernando Patterson & Robert Daigler
Review of Financial Economics, forthcoming
Abstract:
We examine a range of mental health characteristics (e.g. depression, paranoia, and schizophrenia) in subjects engaged in simulated investment trading, showing that certain abnormal personality characteristics have a statistically significant association with the degree of investment diversification, the return achieved, the degree of risk undertaken, and the resultant risk-adjusted performance. These financially educated individuals are more paranoid and psychopathically deviant than the average person, with high scores on these characteristics associated with greater risk-taking. Finally, male and female investors possess different mental health strengths and weaknesses in relation to their financial performance.
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Estimating the Costs of Issuer-Paid Credit Ratings
Jess Cornaggia & Kimberly Cornaggia
Review of Financial Studies, September 2013, Pages 2229-2269
Abstract:
We compare the stability and timeliness of credit ratings produced by a traditional issuer-paid rating agency (Moody's Investors Service) and a subscriber-paid rater (Rapid Ratings). Moody's ratings exhibit less volatility but are slower to identify default risk. We control for Moody's aversion to ratings volatility and still find its ratings lag Rapid Ratings'. More importantly, accuracy ratios indicate that Rapid Ratings provides a better ordinal ranking of credit risk. We quantify the loss avoidance associated with Rapid Ratings' signals to estimate costs associated with regulatory and contractual systems based on issuer-paid ratings.
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Are Analysts' Forecasts Informative to the General Public?
Oya Altıkılıç, Vadim Balashov & Robert Hansen
Management Science, forthcoming
Abstract:
Contrary to the common view that analysts are important information agents, intraday returns evidence shows that announcements of analysts' forecast revisions release little new information, on average. Further cross-sectional evidence from returns around the announcements confirms that revisions are virtually information free. Daily announcement returns used in the literature appear to overstate the analyst's role as information agent, because forecast announcements are often issued directly after reports of significant news about the followed firm. The evidence reveals a sequential relationship between events and news and forecast revisions indicative of analyst piggybacking, not prophecy. These new findings about the most sought-after analyst reports broaden significantly the evidence indicating that price reactions to analysts' reports reveal little new information.
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Internet and the efficiency of decentralized markets: Evidence from automobiles
David Rapson & Pasquale Schiraldi
Economics Letters, forthcoming
Abstract:
We estimate the effect of Internet on the volume of used car transactions. From 1997 to 2007, Internet use tripled in California, causing an increase in volume-of-trade of 7.2 percent. This implies a substantial welfare gain via improved allocative efficiency.
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Regulating IPOs: Evidence from Going Public in London, 1900-1913
Carsten Burhop, David Chambers & Brian Cheffins
Explorations in Economic History, forthcoming
Abstract:
This study assesses the impact of self-regulation on equity markets by analysing IPO failure rates on the London Stock Exchange during 1900-13. Focussing on differences between Official Quotation (OQ) and Special Settlement (SS), we find that the failure rate of IPOs by way of SS was considerably higher even after controlling for the presence of underwriters and elite directors. Furthermore, overall market-adjusted returns for SS IPOs, including the relatively few IPO “winners”, were extremely poor. Our findings have implications for the literature on self-regulation of securities markets as well as long-standing debates on British capital market development before 1914.
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Time-Varying Fund Manager Skill
Marcin Kacperczyk, Stijn Van Nieuwerburgh & Laura Veldkamp
Journal of Finance, forthcoming
Abstract:
We propose a new definition of skill as general cognitive ability to pick stocks or time the market. We find evidence for stock picking in booms and market timing in recessions. Moreover, the same fund managers that pick stocks well in expansions also time the market well in recessions. These fund managers significantly outperform other funds and passive benchmarks. Our results suggest a new measure of managerial ability that weighs a fund's market timing more in recessions and stock picking more in booms. The measure displays more persistence than either market timing or stock picking alone and predicts fund performance.
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The cross-section of speculator skill: Evidence from day trading
Brad Barber et al.
Journal of Financial Markets, forthcoming
Abstract:
We document economically large cross-sectional differences in the before- and after-fee returns earned by speculative traders by analyzing day traders in Taiwan from 1992 to 2006. We sort day traders based on their returns in year y and analyze their performance in year y+1; the 500 top-ranked day traders go on to earn daily before-fee (after-fee) returns of 61.3 (37.9) bps per day; bottom-ranked day traders go on to earn daily before-fee (after-fee) returns of -11.5 (−28.9) bps per day. Less than 1% of the day trader population is able to predictably and reliably earn positive abnormal returns net of fees.
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Regulating the timing of disclosure: Insights from the acceleration of 10-K filing deadlines
Lisa Bryant-Kutcher, Emma Yan Peng & David Weber
Journal of Accounting and Public Policy, forthcoming
Abstract:
We study the effects of regulating the timing of disclosure on the quality of accounting information, using a 2003 US regulatory change that accelerates 10-K filing deadlines as a research setting. Employing a difference-in-differences design, we find that the likelihood of issuing financial statements that are later restated increases for firms that are required to file more quickly, relative to firms whose filing practices are not affected by the regulatory change. This effect is particularly pronounced during the audit busy season, when auditors also face significant time pressure. These results are consistent with a tradeoff between how quickly accounting reports are required to be filed and the reliability of the resulting reports.
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Informational Holdup and Performance Persistence in Venture Capital
Yael Hochberg, Alexander Ljungqvist & Annette Vissing-Jørgensen
Review of Financial Studies, forthcoming
Abstract:
Why don’t VCs eliminate excess demand for follow-on funds by raising fees? We propose a model of learning that leads to informational holdup. Current investors learn about skill whereas outside investors observe only returns. This gives current investors holdup power when the VC raises his next fund: Without their backing, no-one will fund him, as outside investors interpret the lack of backing as a sign of low skill. Holdup power diminishes the VC’s ability to increase fees in line with performance, leading to return persistence. Empirical evidence supports the model. We estimate that up to two-thirds of VC firms lack skill.
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Is a VC Partnership Greater than the Sum of its Partners?
Michael Ewens & Matthew Rhodes-Kropf
NBER Working Paper, June 2013
Abstract:
This paper investigates whether individual venture capitalists have repeatable investment skill and to what extent their skill is impacted by the VC firm where they work. We examine a unique dataset that tracks the performance of individual venture capitalists’ investments across time and as they move between firms. We find evidence of skill and exit style differences even among venture partners investing at the same VC firm at the same time. Furthermore, our estimates suggest the partner’s human capital is two to five times more important than the VC firm’s organizational capital in explaining performance.
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On the Role of Inexperienced Venture Capitalists in Taking Companies Public
Alexander Butler & Sinan Goktan
Journal of Corporate Finance, September 2013, Pages 299–319
Abstract:
We use venture-backed initial public offerings (IPOs) to identify and examine the comparative advantage of inexperienced venture capitalists. We argue that, vis-a-vis more established counterparts, younger venture capital firms have a comparative advantage at producing soft information about relatively opaque start-up companies due to their organizational structure. We then quantify an outcome — IPO initial return — from the matching of venture capitalists and start-up companies that demonstrates how this comparative advantage arises. Our findings thus reveal an important aspect of how inexperienced venture capitalists support start-up companies.
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When Nothing Is Better than Something: Cognitive Status and the Hazard of Small Early Investments
Rembrand Koning & Jacob Model
Stanford Working Paper, August 2013
Abstract:
Conventional wisdom and formal models of organizational status and cumulative advantage assume that an investment, no matter its magnitude, improves the likelihood of entrepreneurial success. We argue that such models are underdeveloped in that they do not account for widely recognized cognitive processes which likely affect perceptions of status. Integrating these cognitive processes into theories of status, we predict that relatively small initial investments may actually be harmful to entrepreneurial ventures. We test our theory using a natural field experiment on a crowdfunding platform. Our novel experimental design allows us to causally estimate our hypothesized effects and overcome several significant problems of unobserved heterogeneity which plague much of the status and cumulative advantage literatures. We find strong evidence for our proposed theory with small investments decreasing the chance of crowdfunded projects reaching their funding goals. Our results contribute to our understanding of evaluations of status emerge.
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On the Market for Venture Capital
Boyan Jovanovic & Balázs Szentes
Journal of Political Economy, June 2013, Pages 493-527
Abstract:
We propose a theory of the market for venture capital that links the excess return to venture equity to the scarcity of venture capitalists (VCs). High returns make the VCs more selective and eager to terminate nonperforming ventures because they can move on to new ones. The scarcity of VCs enables them to internalize their social value, and the competitive equilibrium is socially optimal. Moreover, the bilaterally efficient contract is a simple equity contract. We estimate the model for the period 1989–2001 and compute the excess return to venture capital, which turns out to be 8.6 percent. Finally, we back out the return of solo entrepreneurs, which is increasing in their wealth and ranges between zero and 3.5 percent.
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Géraldine David, Kim Oosterlinck & Ariane Szafarz
Economics Letters, October 2013, Pages 23–25
Abstract:
Art is often used as an investment vehicle. Given the importance of market efficiency in finance, we use a large auction-based index to test whether the art market is weakly efficient. Evidence reveals that returns on artworks exhibit high positive auto-correlation. We attribute this result to price truncation resulting from unobservable reserve prices in auctions. We conclude that the art market is not efficient, mainly because price formation is opaque to outsiders who lack information on unsold artworks.
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Urs von Arx & Andreas Ziegler
Quantitative Finance, forthcoming
Abstract:
This paper provides new empirical evidence for the effect of corporate social responsibility on corporate financial performance. In contrast to former studies, we examine two different regions, namely the USA and Europe, and disentangle firm and sector specific impacts. Our econometric analysis shows that environmental and social activities of a firm compared with other firms within the industry are valued by financial markets in both regions. However, the respective positive effects on average monthly stock returns between 2003 and 2006 are more robust in the USA and, in addition, non-linear. Our analysis furthermore points to biased parameter estimates if incorrectly specified econometric models are applied: the seemingly significantly negative effect of environmental and social performance of the industry to which a firm belongs strongly declines and mostly becomes insignificant if the explanation of stock performance is based on the Fama–French three-factor or the Carhart four-factor models instead of the simple Capital Asset Pricing Model.
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David Easley, Terrence Hendershott & Tarun Ramadorai
Journal of Financial Markets, forthcoming
Abstract:
We examine the impact on stock prices of a major upgrade to the New York Stock Exchange's trading environment. The upgrade improved information dissemination on the trading floor and reduced the latency in reporting trades and quotes. The portion of the upgrade that reduced latency for electronic orders had significant impacts on liquidity, turnover, and returns. A portfolio that is long stocks undergoing the upgrade in the first 20 days of the upgrade and short stocks receiving the upgrade later has a return of roughly 3% over the period. The abnormal return was a priced effect of the improved liquidity produced by the upgrade.
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The dynamics of crowdfunding: An exploratory study
Ethan Mollick
Journal of Business Venturing, forthcoming
Abstract:
Crowdfunding allows founders of for-profit, artistic, and cultural ventures to fund their efforts by drawing on relatively small contributions from a relatively large number of individuals using the internet, without standard financial intermediaries. Drawing on a dataset of over 48,500 projects with combined funding over $237 M, this paper offers a description of the underlying dynamics of success and failure among crowdfunded ventures. It suggests that personal networks and underlying project quality are associated with the success of crowdfunding efforts, and that geography is related to both the type of projects proposed and successful fundraising. Finally, I find that the vast majority of founders seem to fulfill their obligations to funders, but that over 75% deliver products later than expected, with the degree of delay predicted by the level and amount of funding a project receives. These results offer insight into the emerging phenomenon of crowdfunding, and also shed light more generally on the ways that the actions of founders may affect their ability to receive entrepreneurial financing.
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The U.S. left behind? Financial globalization and the rise of IPOs outside the U.S.
Craig Doidge, Andrew Karolyi & René Stulz
Journal of Financial Economics, forthcoming
Abstract:
From 1990 to 2011, the share of world IPO activity by non-U.S. firms increased because of financial globalization and because of a decrease in U.S. IPO activity. Financial globalization reduces the impact of national institutions on domestic IPO activity and enables more non-U.S. firms from countries with weak institutions to go public with a global IPO. U.S. IPO activity does not benefit from financial globalization. Compared to other countries, the rate of small-firm IPO activity in the U.S. is abnormally low in the 2000s. This abnormally low rate cannot be explained by the regulatory changes of the early 2000s.
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Douglas Cumming & Sofia Johan
Managerial and Decision Economics, forthcoming
Abstract:
Statistics reporting litigated cases of fraud on an exchange-by-exchange basis are not readily available to investors. This paper introduces data from three countries with multiple exchanges operating under different listing standards – Canada, the United Kingdom and the United States – to show litigated cases of fraud significantly vary by country, and the different exchanges within the country. Comparisons are also made to Brazil, China and Germany to assess out-of-sample inferences. The data examined suggest there are significant differences in the nature of observed fraud across exchanges within the United States; by contrast, outside the United States there appears to be a comparative lack of enforcement. The data also suggest policy implications for the ways in which fraud should ideally be reported to improve investor knowledge, market transparency and market quality.