Several recent studies document that sorting stocks first on certain stock-level characteristics and then on past returns results in elevated momentum profits. We show that such strategies enhance momentum profits simply by trading in stocks with more extreme past returns. Adjusted for this effect, elevated momentum profits resulting from characteristics (size, R2, turnover, age, analyst coverage, analyst forecast dispersion, market-to-book, price, illiquidity, credit rating) disappear almost entirely. Interaction patterns have been used to support behavioral and limits-to-arbitrage explanations of momentum; our findings imply that explanations of momentum should instead focus on the link between momentum profits and extreme past returns.

This paper investigates the effects of financial institutions issuing contingent capital, a debt security that automatically converts into equity if assets fall below a predetermined threshold. We decompose bank liabilities into sets of barrier options and present closed-form solutions for their prices. We quantify the reduction in default probability associated with issuing contingent capital instead of subordinated debt. We then show that appropriate choice of contingent capital terms (in particular the conversion ratio) can virtually eliminate stockholders' incentives to risk-shift, a motivation that is present when bank liabilities instead include either subordinated debt or additional equity. Importantly, risk-taking incentives continue to be weak during times of financial distress. Our findings imply that contingent capital may be an effective tool for stabilizing financial institutions.

This paper explores the determinants of corporate failure and the pricing of financially distressed stocks whose failure probability, estimated from a dynamic logit model using accounting and market variables, is high. Since 1981, financially distressed stocks have delivered anomalously low returns. They have lower returns but much higher standard deviations, market betas, and loadings on value and small‐cap risk factors than stocks with low failure risk. These patterns are more pronounced for stocks with possible informational or arbitrage‐related frictions. They are inconsistent with the conjecture that the value and size effects are compensation for the risk of financial distress.

We show that, rather than maintaining a constant style, active equity funds alter their factor loadings over time. Style changes are larger following quarters in which funds either substantially under- or out-perform other funds based on returns or fund flows, which is explained by managers both not correcting the resulting passive style drift and deliberately reallocating a portion of the portfolio. Motivated by this observation, we identify a new measure of manager skill, which we call “tactical investment skill.” It captures a manager’s ex-ante observable ability to increase future returns through loadings changes. We show that high-skill managers outperform their low-skill peers in the following month in terms of raw returns and alphas. This outperformance is more pronounced following quarters with large loadings changes.

This article proposes and estimates a tractable, arbitrage-free valuation model for corporate coupon bonds that includes a more realistic recovery rate process. Most existing studies use a recovery rate process that is misspecified because it includes recovery for coupons due after default. Misspecification errors from assuming recovery on all coupons can be substantial; they increase with recovery rates, coupons, maturity, and default probabilities. For a large sample of market transactions, i) our model has lower pricing errors than one assuming recovery on all coupons and ii) the magnitude of our model’s outperformance is linked to misspecification errors from assuming recovery on coupons.

Long-dated inflation swap contracts provide widely used estimates of expected inflation. We develop methods to estimate complementary tail probabilities for persistently very high or low inflation using inflation options prices. We show that three new adjustments to conventional methods are crucial: inflation, horizon, and risk. We find that: (a) U.S. deflation risk in 2011–2014 has been overstated, (b) ECB unconventional policies lowered deflation disaster probabilities, (c) inflation expectations deanchored in 2021–2022, (d) reanchored as policy tightened, (e) but the 2021–2024 disaster left scars, and (f) U.S. expectations are less sensitive to inflation realizations than in the eurozone.

This paper proposes a new method for measuring the impact of inflation on the real value of public debt. The distribution of debt debasement is based on two inputs: the distribution of privately held nominal debt by maturity, for which we provide new estimates, and the distribution of risk-adjusted inflation dynamics, for which we provide a novel copula estimator using options data. We find that inflation by itself is unlikely to lower the U.S. fiscal burden significantly because debt is concentrated at short maturities and perceived inflation shocks have little short-run persistence and are small.