We show that a real-time trading strategy which front-runs the anticipated forced sales by mutual funds experiencing extreme capital outflows generates an alpha of 0.5% per month during the 1990–2010 period. The abnormal return stems from selling pressure among stocks that are below the NYSE mean size and cannot be attributed to the arrival of public information. While the largest stocks also exhibit downward price pressure, their prices revert before the front-running strategy can detect it. The duration of the anticipated selling pressure has decreased from about a month in the 1990s to about two weeks in the most recent decade. Our results suggest that publicly available information of fund flows and holdings exposes mutual funds in distress to predatory trading.

We construct hypothetical copycat funds to investigate the performance of free-riding strategies that duplicate the disclosed asset holdings of actively managed mutual funds. On average, copycat funds are able to generate performance that is comparable to their target mutual funds, taking into account transaction costs and expenses. However, their relative success increased significantly after 2004 when the SEC imposed quarterly disclosure regulations on all mutual funds. We also find substantial cross-sectional dispersion in the relative performance of copycat funds. Free-riding on the portfolios disclosed by past winning funds and funds that disclose representative holdings generates significantly better performance net of trading costs and expenses than the vast majority of mutual funds. The results indicate that free-riding on disclosed fund holdings is an attractive strategy and suggest that mutual funds can suffer from the information disclosure requirements.

Using monthly return data of more than 6400 US equity mutual funds we investigate short-run performance persistence over the period 1984–2003. We sort funds into rank portfolios based on past performance, and evaluate the portfolios’ out-of-sample performance. To cope with short ranking periods, we employ an empirical Bayes approach to measure past performance more efficiently. Our main finding is that when funds are sorted into decile portfolios based on 12-month ranking periods, the top decile of funds earns a statistically significant, abnormal return of 0.26 percent per month. This effect persists beyond load fees, and is mainly concentrated in relatively young, small cap/growth funds.

This paper tests the static tradeoff theory against the pecking order theory. We focus on an important difference in prediction: the static tradeoff theory argues that a firm increases leverage until it reaches its target debt ratio, while the pecking order yields debt issuance until the debt capacity is reached. We find that for our sample of US firms the pecking order theory is a better descriptor of firms’ issue decisions than the static tradeoff theory. In contrast, when we focus on repurchase decisions we find that the static tradeoff theory is a stronger predictor of firms’ capital structure decisions.

Copulas offer financial risk managers a powerful tool to model the dependence between the different elements of a portfolio and are preferable to the traditional, correlation-based approach. In this paper, we show the importance of selecting an accurate copula for risk management. We extend standard goodness-of-fit tests to copulas. Contrary to existing, indirect tests, these tests can be applied to any copula of any dimension and are based on a direct comparison of a given copula with observed data. For a portfolio consisting of stocks, bonds and real estate, these tests provide clear evidence in favor of the Student’s t copula, and reject both the correlation-based Gaussian copula and the extreme value-based Gumbel copula. In comparison with the Student’s t copula, we find that the Gaussian copula underestimates the probability of joint extreme downward movements, while the Gumbel copula overestimates this risk. Similarly we establish that the Gaussian copula is too optimistic on diversification benefits, while the Gumbel copula is too pessimistic. Moreover, these differences are significant.

Systemic crises can have grave consequences for investors in international equity markets, because they cause the risk-return trade-off to deteriorate severely for a longer period. We propose a novel approach to include the possibility of systemic crises in asset allocation decisions. By combining regime switching models with Merton [Merton, R.C., 1969. Lifetime portfolio selection under uncertainty: The continuous time case. Review of Economics and Statistics 51, 247–257]-style portfolio construction, our approach captures persistence of crises much better than existing models. Our analysis shows that incorporating systemic crises greatly affects asset allocation decisions, while the costs of ignoring them is substantial. For an expected utility maximizing US investor, who can invest globally these costs range from 1.13% per year of his initial wealth when he has no prior information on the likelihood of a crisis, to over 3% per month if a crisis occurs with almost certainty. If a crisis is taken into account, the investor allocates less to risky assets, and particularly less to the crisis prone emerging markets.