We examine the cost of liquidity in rates on CDs purchased by money market funds (MMFs). We find no evidence that rates vary directly with the size of CDs. However, we do find that large MMFs receive higher rates on large CDs than small MMFs. This suggests banks pay for (potential) liquidity.

Theoretical models of portfolio choice that incorporate ambiguity predict that investors’ propensity to invest in equities is reduced when ambiguity in the stock market increases. Although this hypothesis stems from the extant theoretical literature, there is no empirical work examining whether it is supported in the data. We test this hypothesis, measuring participation using equity fund flows and ambiguity with dispersion in analyst forecasts about aggregate returns. Our results confirm this hypothesis, as we show that, controlling for other factors that affect flows, increases in ambiguity are associated with outflows from equity funds. Moreover, using data from the Survey of Consumer Finances, we find that increases in ambiguity significantly reduce the likelihood that the average household invests in equities.

We test whether the rejections of the expectations hypothesis can be explained by two behavioral biases: the law of small numbers and conservatism. We use the term structure to decompose excess bond returns into components related to expectation errors and expectation revisions, enabling a direct test of behavioral models using the expectations of market participants. We find systematic patterns in expectation errors, and expectation revisions, which are consistent with these two biases. We show that a trading strategy that exploits these biases delivers significant economic profits and that our results are unlikely to be driven by a time-varying risk premium.

We develop a method to estimate which side will win a civil war using data from international financial markets. The key insight we deliver is that, for typical sovereign debt contracts, the probability of debt repayment will equal the probability of victory in a civil war. We test our predictor for standard outcomes in civil wars, including when the incumbent government loses (the Chinese Nationalists), when a new government is installed by a foreign power and decides to repudiate debt (the restoration of Ferdinand VII of Spain), and when there is a secession (the U.S. Confederacy). For China, markets were predicting a Communist victory three years before it happened. For the U.S., markets never gave the South much more than a 40 percent chance of maintaining the Confederacy. For Spain, markets considered the restoration of Ferdinand VII as likely (probabilities above 50%) as soon as France declared its intention to send military forces to the area.