Knowledge that Transforms

ABSTRACT We provide novel evidence that funding frictions can limit firms’ short‐term investments in receivables and inventories, reducing their production capacity. We propose a credit multiplier driven by these considerations and empirically isolate its importance by comparing how a similar firm responds to shocks differently when these shocks are initiated in their most profitable quarter (“main quarter”). We implement this test using recurring and unpredictable shocks (e.g., oil shocks) and provide extensive evidence supporting our identification strategy. Our results suggest that funding constraints and credit multiplier effects are significant for smaller firms that heavily rely on financing from suppliers.

ABSTRACT The disposition effect for a stock significantly weakens if the portfolio is at a gain, but is large when it is at a loss. We find this portfolio‐driven disposition effect (PDDE) in four independent settings: U.S. and Chinese archival data, as well as U.S. and Chinese experiments. The PDDE is robust to a variety of controls in regression specifications and is not explained by extreme returns, portfolio rebalancing, tax considerations, or investor heterogeneity. Our evidence suggests that investors form mental frames at both the stock and the portfolio levels and that these frames combine to generate the PDDE.

ABSTRACT The share of secured debt issued (as a fraction of total corporate debt) declined steadily in the United States over the twentieth century. This stems partly from financial development giving creditors greater confidence that high‐quality borrowers will respect their claims even if creditors do not obtain security upfront. Consequently, such borrowers prefer retaining financial flexibility by not giving security up front. Instead, security is given contingently—when a firm approaches distress. This also explains why, superimposed on the secular decline, the share of secured debt issued is countercyclical.

ABSTRACT We formalize the concept of “dark matter” in asset pricing models by quantifying the additional informativeness of cross‐equation restrictions about fundamental dynamics. The dark‐matter measure captures the degree of fragility for models that are potentially misspecified and unstable: a large dark‐matter measure indicates that the model lacks internal refutability (weak power of optimal specification tests) and external validity (high overfitting tendency and poor out‐of‐sample fit). The measure can be computed at low cost even for complex dynamic structural models. To illustrate its applications, we provide quantitative examples applying the measure to (time‐varying) rare‐disaster risk and long‐run risk models.

ABSTRACT Twelve trillion dollars are allocated to private market funds that require outside investors to commit to transferring capital on demand. We show within a novel dynamic portfolio allocation model that ex‐ante commitment has large effects on investors' portfolios and welfare, and we quantify those effects. Investors are underallocated to private market funds and are willing to pay a larger premium to adjust the quantity committed than to eliminate other frictions, like timing uncertainty and limited tradability. Perhaps counterintuitively, commitment risk premiums increase with secondary market liquidity, and they do not disappear when investments are spread over many funds.

ABSTRACT We propose a text‐based method for measuring the cross‐border propagation of large shocks at the firm level. We apply this method to estimate the expected costs, benefits, and risks of Brexit and find widespread reverberations in listed firms in 81 countries. International (i.e., non‐U.K.) firms most exposed to Brexit uncertainty (the second moment) lost significant market value and reduced hiring and investment. International firms also overwhelmingly expected negative first‐moment impacts from the U.K.'s decision to leave the European Union (EU), particularly related to regulation, asset prices, and labor market impacts of Brexit.

ABSTRACT Liquidity transformation, a key role of banks, is thought to increase fragility, as uninsured depositors face an incentive to withdraw money before others (a so‐called panic run). Despite much theoretical work, however, there is little empirical evidence establishing this mechanism. In this paper, we provide the first large‐scale evidence of this mechanism. Banks that engage in more liquidity transformation exhibit higher fragility, as captured by stronger sensitivities of uninsured deposit flows to bank performance and greater levels of uninsured deposit outflows when performance is poor. We also explore the effects of deposit insurance and systemic risk.

ABSTRACT We use a portfolio‐based framework to understand what drives the decline of the U.S. net foreign asset (NFA) position and the reversal in returns earned on the U.S. NFA (exorbitant privilege). We show that global savings gluts and monetary policies widened the U.S. NFA position, while investor demand shifts partially offset this widening. Moreover, U.S. privilege declined after 2010, in line with increasing foreign demand for U.S. equity. We also highlight a quantity dimension of the U.S. privilege: The U.S. can issue substantially more debt than other countries for a given yield increase.

ABSTRACT A higher U.S. government debt‐to‐output (D‐O) ratio does not forecast higher surpluses or lower returns on Treasurys in the future. Neither future cash flows nor discount rates account for the variation in the current D‐O ratio. The market valuation of Treasurys is surprisingly insensitive to macro fundamentals. Instead, the future D‐O ratio accounts for most of the variation because the D‐O ratio is highly persistent. Systematic surplus forecast errors may help account for these findings. Since the start of the Global Financial Crisis, surplus projections have anticipated a large fiscal correction that failed to materialize.