Knowledge that Transforms

ABSTRACT The media are increasingly recognized as key players in financial markets. I investigate their causal impact on trading and price formation by examining national newspaper strikes in several countries. Trading volume falls 12% on strike days. The dispersion of stock returns and their intraday volatility are reduced by 7%, while aggregate returns are unaffected. Moreover, analysis of return predictability indicates that newspapers propagate news from the previous day. These findings demonstrate that the media contribute to the efficiency of the stock market by improving the dissemination of information among investors and its incorporation into stock prices.

ABSTRACT We provide novel evidence for an equilibrium link between investors' disagreement, the market price of volatility and correlation, and the differential pricing of index and individual equity options. We show that belief disagreement is positively related to (i) the wedge between index and individual volatility risk premia, (ii) the different slope of the smile of index and individual options, and (iii) the correlation risk premium. Priced disagreement risk also explains returns of option volatility and correlation trading strategies in a way that is robust to the inclusion of other risk factors and different market conditions.

ABSTRACT We explore the link between a firm's stock returns and credit risk using a simple insight from structural models following Merton ( ): risk premia on equity and credit instruments are related because all claims on assets must earn the same compensation per unit of risk. Consistent with theory, we find that firms' stock returns increase with credit risk premia estimated from CDS spreads. Credit risk premia contain information not captured by physical or risk‐neutral default probabilities alone. This sheds new light on the “distress puzzle”—the lack of a positive relation between equity returns and default probabilities—reported in previous studies.

ABSTRACT We identify two types of risk premia in commodity futures returns: spot premia related to the risk in the underlying commodity, and term premia related to changes in the basis. Sorting on forecasting variables such as the futures basis, return momentum, volatility, inflation, hedging pressure, and liquidity results in sizable spot premia between 5% and 14% per annum and term premia between 1% and 3% per annum. We show that a single factor, the high‐minus‐low portfolio from basis sorts, explains the cross‐section of spot premia. Two additional basis factors are needed to explain the term premia.

ABSTRACT Can managers influence the liquidity of their firms’ shares? We use plausibly exogenous variation in the supply of public information to show that firms actively shape their information environments by voluntarily disclosing more information than regulations mandate and that such efforts improve liquidity. Firms respond to an exogenous loss of public information by providing more timely and informative earnings guidance. Responses appear motivated by a desire to reduce information asymmetries between retail and institutional investors. Liquidity improves as a result and in turn increases firm value. This suggests that managers can causally influence their cost of capital via voluntary disclosure.

ABSTRACT What determines securitization levels, and should they be regulated? To address these questions we develop a model where originators can exert unobservable effort to increase expected asset quality, subsequently having private information regarding quality when selling ABS to rational investors. Absent regulation, originators may signal positive information via junior retentions or commonly adopt low retentions if funding value and price informativeness are high. Effort incentives are below first‐best absent regulation. Optimal regulation promoting originator effort entails a menu of junior retentions or one junior retention with size decreasing in price informativeness. Zero retentions and opacity are optimal among regulations inducing zero effort.

ABSTRACT Do fast, competitive markets yield liquidity measurement problems when using the popular Monthly Trade and Quote (MTAQ) database? Yes. MTAQ yields distorted measures of spreads, trade location, and price impact compared with the expensive Daily Trade and Quote (DTAQ) database. These problems are driven by (1) withdrawn quotes, (2) second (versus millisecond) time stamps, and (3) other causes, including canceled quotes. The expensive solution, using DTAQ, is first‐best. For financially constrained researchers, the cheap solution—using MTAQ with our new Interpolated Time technique, adjusting for withdrawn quotes, and deleting economically nonsensical states—is second‐best. These solutions change research inferences.

ABSTRACT This study shows that the guardians behind underaged accounts are successful at picking stocks. Moreover, they tend to channel their best trades through the accounts of children, especially when they trade just before major earnings announcements, large price changes, and takeover announcements. Building on these results, we argue that the proportion of total trading activity through underaged accounts (labeled BABYPIN ) should serve as an effective proxy for the probability of information trading in a stock. Consistent with this claim, we show that investors demand a higher return for holding stocks with a greater likelihood of private information, proxied by BABYPIN .

ABSTRACT We propose two data‐based performance measures for asset pricing models and apply them to models with recursive utility and habits. Excess returns on risky securities are reflected in the pricing kernel's dispersion and riskless bond yields are reflected in its dynamics. We measure dispersion with entropy and dynamics with horizon dependence, the difference between entropy over several periods and one. We compare their magnitudes to estimates derived from asset returns. This exercise reveals tension between a model's ability to generate one‐period entropy, which should be large, and horizon dependence, which should be small.

ABSTRACT q ‐based measures of the diversification discount are biased upward by mergers and acquisitions and its accounting implications. Under purchase accounting, acquired assets are reported at their transaction value, which typically exceeds the target's pre‐merger book value. Thus, measured q tends to be lower for the merged firm than for the portfolio of pre‐merger entities. Because conglomerates are more acquisitive than focused firms, their q tends to be lower. To mitigate this bias, I subtract goodwill from the book value of assets and a substantial part of the diversification discount is eliminated. Market‐to‐sales‐based measures do not have this bias.