Knowledge that Transforms

This paper documents new stylized facts about returns and cashflow growth rates on stocks and housing over decade‐long holding periods. While cashflow growth rates on the two assets comove positively, their returns comove negatively until the Global Financial Crisis and positively thereafter. These facts present a puzzle for representative‐agent models that imply positive return comovement for assets with similar cashflows. I consider a heterogeneous‐agent model with segmented stock and housing markets connected through credit. News about the aggregate economy generates negative return comovement. Recent shifts such as wealthier homebuyers and institutional housing purchases reduce the importance of credit and segmentation.

Young firms' contribution to aggregate employment has been underwhelming. We show that a similar trend is not apparent, however, in their contribution to aggregate sales or stock market capitalization, implying that these firms have exhibited a high average‐to‐marginal revenue product of labor. We study the implications of a gradual shift in the average‐to‐marginal revenue product of labor within a model of dynamic firm heterogeneity. We show that this shift provides (i) a unified explanation for several aspects of the decline in dynamism and (ii) a possible explanation for why large declines in young‐firm employment may have only a moderate effect on aggregate output and consumption.

Farmer, Schmidt, and Timmermann (FST) document time‐variation in market return predictability, identifying “pockets” of significant predictability through kernel regressions. However, our analysis reveals a critical discrepancy between the method outlined by FST and the code actually implemented. Instead of using a one‐sided kernel, which guarantees out‐of‐sample forecasts, they perform in‐sample estimation with a two‐sided kernel. As a result, future information leaks into the forecasting model, undermining its reliability. Rectifying this error qualitatively alters the findings, invalidating most conclusions of the FST study. Thus, attempts to exploit such “pockets”—should they exist—offer little help in forecasting market returns.

Short‐sale costs eliminate the abnormal returns on asset pricing anomaly portfolios. While many anomalies persist out‐of‐sample before accounting for short‐sale costs, they cannot be exploited with long‐short strategies due to stock borrow fees. Using a comprehensive sample of 162 anomalies, the average long‐short portfolio return is a significant 0.14% per month before short‐sale costs, and the returns are due to the short leg. However, the average is −0.01% once returns are adjusted for borrow fees. Moreover, anomalies are not profitable even before fees if the high‐fee observations, representing 12% of stock dates, are excluded from the analysis.

This article quantifies the effects of a multiday cyberattack that forced offline a technology service provider (TSP) to the banking sector. The attack impaired customers’ ability to send payments through the TSP, but the business continuity plans of banks and the TSP reduced the effect by more than half. Large banks performed better. Through contagion, banks not directly exposed to the attack experienced a liquidity shortfall, causing them to borrow funds or tap reserves. The ability to send payments after hours helped avoid further contagion. These results highlight the importance of preparedness by the private and official sector for cyberattacks.

A war‐related factor model derived from textual analysis of media news reports explains the cross section of expected stock returns. Using a semisupervised topic model to extract discourse topics from 7,000,000 New York Times stories spanning 160 years, the war factor predicts the cross section of returns across test assets derived from both traditional and machine learning construction techniques, and spanning 138 anomalies. Our findings are consistent with assets that are good hedges for war risk receiving lower risk premia, or with assets that are more positively sensitive to war prospects being more overvalued. The return premium on the war factor is incremental to standard effects.

This paper establishes that mutual funds strategically time their trades in environmental, social, and governance (ESG) stocks around disclosure dates to inflate their sustainability ratings. This claim is supported by three empirical findings. First, we show that funds' ESG betas increase shortly before disclosure and decrease shortly afterwards. Second, we document that post‐disclosure fund returns are higher but have lower ESG exposure than disclosed portfolios. Third, we provide evidence that ESG stock prices temporarily rise before disclosure and decline afterwards. Overall, we establish that green window dressing positively impacts fund sustainability ratings, performance, and flows.

We investigate the expected consequences of negative environmental, social, and governance (ESG) news on firms' future profits. After learning about negative ESG news, analysts significantly downgrade their forecasts at short and longer horizons. Negative ESG news affects forecasts more strongly at longer horizons than other types of negative corporate news. The negative revisions of earnings forecasts following negative ESG news largely reflect expectations of lower future sales, rather than higher future costs. Quantitatively, forecast revisions can explain most of the negative impacts of ESG news on firm value. Analysts are correct to revise forecasts downward following negative ESG news.

Over‐the‐counter (OTC) trading thrives despite competition from exchanges. We let OTC dealers cream skim from exchanges in an otherwise standard Glosten and Milgrom framework. Restricting the dealer's ability to cream skim induces “cheap substitution”: some traders exit while others with larger gains from trade enter. Cheap substitution implies trading costs, trade volumes, and market shares are poor policy indicators. In a benchmark case, restricting the dealer raises welfare only if trading cost increases, volume falls, and OTC market share is high. By contrast, the restriction improves welfare when adverse selection risk is low. A simple procedure implements the optimal Pigouvian tax.

An entrepreneur makes offers to multiple investors to fund a project that requires a minimum investment. Concerned about other investors' decisions, each investor strategically communicates information about the project to others. When investors have conflicts of interest, those with contractually stronger incentives to invest attempt to persuade others to invest. Depending on the project's ex ante quality, the entrepreneur may promise investors different returns to create conflicts of interest and induce persuasion, or may promise investors an identical return to align their interests and induce truthful communication. The paper illustrates a new motivation for syndication and hierarchy within syndicates.