Knowledge that Transforms

Using high‐frequency, granular panel data on short‐term debt securities issued in Europe, we study the existence, empirical boundaries, and fragility of private assets' safety. We show that only securities with the shortest maturities, issued by banks (certificates of deposit, or CDs), benefit from a safety premium. The supply of such CDs responds positively to excess safety demand. During periods of stress, this relation vanishes for all issuers of private securities, even though their aggregate volumes do not collapse. Other dimensions of heterogeneity, including issuers' balance sheets or their domicile countries' fiscal capacity, are less relevant for private safety.

Poor financial health of intermediaries coincides with low asset prices and high risk premiums. Is this because intermediaries matter for asset prices, or because their health correlates with economy‐wide risk aversion? In the first case, return predictability should be more pronounced for asset classes in which households are less active. We provide evidence supporting this prediction, suggesting that a quantitatively sizable fraction of risk premium variation in several large asset classes such as credit or mortgage‐backed securities (MBS) is due to intermediaries. Movements in economy‐wide risk aversion create the opposite pattern, and we find this channel also matters.

Using U.S. household‐level data and plausibly exogenous variation in the location‐timing of home purchases with a single lender, I find that negative home equity causes a 2% to 6% reduction in household labor supply. Supporting causality, households are observationally equivalent at origination and equally sensitive to local housing shocks that do not cause negative equity. Results also hold comparing purchases within the same year‐metropolitan statistical area that differ by only a few months. Though multiple channels are likely at work, evidence of nonlinear effects is broadly consistent with costs associated with housing lock and financial distress.

Limited stock market participation can potentially explain the disconnect between international asset prices and macro quantities. An incomplete markets model in which risk sharing for stockholders is high generates highly correlated equity returns and relatively smooth exchange rates. Risk sharing for nonstockholders is limited because of their nonparticipation in stock markets and borrowing constraints, reducing the aggregate consumption correlation and the correlation between aggregate consumption differentials and exchange rates. Financial integration widens the disconnect by benefiting stockholders but hurting nonstockholders. Survey data indicate that international risk sharing for stockholders is better than that for nonstockholders, consistent with the predictions.

This paper examines dealer inventory capacity, or liquidity supply, as a driver of liquidity and expected returns in the corporate bond market. We identify shocks to aggregate liquidity supply using data on corporate bond yields and dealer positions. Liquidity supply shocks lead to persistent changes in market liquidity, are correlated with proxies for dealer financial constraints, and have significant explanatory power for cross‐sectional and time‐series variation in expected returns, beyond standard risk factors. Our findings point to liquidity supply by financially constrained intermediaries as a main driver of market liquidity and asset prices.

Using data on individual portfolio holdings and on mutual fund flows, we find that low interest rates lead to significantly higher demand for income‐generating assets such as high‐dividend stocks and high‐yield bonds. We argue that this “reaching‐for‐income” phenomenon is driven by investors who follow the “living off income” rule‐of‐thumb. Our empirical analysis shows that this preference for current income affects both household portfolio choices and the prices of income‐generating assets. In addition, we explore the implications of reaching for income for capital allocation and the effectiveness of monetary policy.

I examine the effects of information asymmetry–driven mispricing on security issuance. Using predisclosure changes in purchase obligations as a proxy for information asymmetry–driven mispricing, I find that managers avoid (prefer) issuing securities when they perceive their firms to be undervalued (overvalued). The effects of information asymmetry–driven mispricing are stronger on equity issuance than debt issuance. Consequently, undervaluation (overvaluation) causes an increase (decrease) in leverage. These effects are more pronounced for firms, periods, and securities associated with greater information asymmetry. The stock‐trading patterns that managers follow suggest that their perceived mispricing is an important factor in both private and firm‐level decisions.

Using the most comprehensive data set of leveraged funds known to the literature, we measure the market‐wide shadow cost of leverage constraints and examine its pricing implications. The shadow cost averages 0.53% per annum from 2006 to 2016, spikes upon quarter‐ends when banks face tighter capital requirements, positively predicts future betting‐against‐beta (BAB) returns, and negatively correlates with contemporaneous BAB returns. Stocks that experience lower returns when the shadow cost increases earn 0.85% more per month. Overall, our shadow cost measure fits the predictions of leverage‐constraint‐based theories better than the widely used TED spread.

We test whether personal real estate shocks affect professional misconduct by financial advisors. We use a panel of advisors' home addresses and examine within‐advisor variation relative to other advisors who work at the same firm and live in the same ZIP code. We find a negative relation between housing returns and misconduct. We show that advisors' housing returns explain misconduct against out‐of‐state customers, breaking the link between customer and advisor housing shocks. Furthermore, the results are stronger for advisors with lower career risk from committing misconduct, and for advisors with greater borrowing constraints.

Using data on $18 trillion of assets under management, we show that actively managed institutional accounts outperformed strategy benchmarks by 75 (31) bps on a gross (net) basis during the period 2000 to 2012. Estimates from a Sharpe model imply that asset managers' outperformance came from factor exposures. If institutions had instead implemented mean‐variance efficient portfolios using index and institutional mutual funds available during the sample period, they would not have earned higher Sharpe ratios. Our results are consistent with the average asset manager having skill, managers competing for institutional capital, and institutions engaging in costly search to identify skilled managers.