Knowledge that Transforms

We propose a new decomposition of the traditional market beta into four semibetas that depend on the signed covariation between the market and individual asset returns. We show that semibetas stemming from negative market and negative asset return covariation predict significantly higher future returns, while semibetas attributable to negative market and positive asset return covariation predict significantly lower future returns. The two semibetas associated with positive market return variation do not appear to be priced. The results are consistent with the pricing implications from a mean-semivariance framework combined with arbitrage risk driving a wedge between the risk premiums for long and short positions. We conclude that rather than betting against the traditional market beta, it is better to bet on and against the “right” semibetas.

This study investigates whether a private firm’s decision to go public affects the IPO decisions of its competitors. Using detailed data from the drug development industry, we identify a private firm’s direct competitors at a precise level through a novel approach using similarity in drug development projects based on disease targets. The analysis shows that a private firm is significantly more likely to go public after observing the recent IPO of a direct competitor, and this effect is distinct from “hot” market effects or other common shocks. Furthermore, our effects are centered on firms that operate in more competitive areas. We additionally explore peer effects in private firm funding propensities more broadly, such as through venture capital or being acquired, and find results consistent with a competitive channel.

We estimate a dynamic model, featuring agency conflicts and a stochastic tax reform arrival, to evaluate how the change from a worldwide to territorial tax system, enacted under the Tax Cuts and Jobs Act (TCJA), affects foreign investment. Although a worldwide system imposes a higher tax liability on foreign income, we show it encourages excess foreign investment by depressing the opportunity cost of capital. In our estimated model, the TCJA reduces foreign investment by 15.6% on average, with larger declines for services firms and firms with lesser agency conflicts. The reform probability, which we estimate in the model, significantly affects firms’ investment and cash holdings.

The growth of the asset management industry has made it commonplace for firms to have multiple institutional blockholders. In such firms, the strength of governance via exit depends on how blockholders react to each other’s exit. We present a model to show that open-ended institutional investors such as mutual funds react strongly to an informed blockholder’s exit, leading to correlated exits that enhance corporate governance. Our analysis points to a new role for mutual funds in corporate governance. We examine the trades of mutual funds around exits by activist hedge funds to present empirical evidence consistent with our model.

We construct a sample of over 200,000 supply chains between 2003 and 2018 to conduct a chain-based analysis of trade credit. Our study uncovers novel stylized facts about trade credit both within and across supply chains. More upstream firms borrow more from suppliers, lend more to customers, and hold more net trade credit. This upstreamness effect in trade credit is weaker for more profitable firms and for longer chains. Firms in more central or more profitable chains provide more net trade credit. Our results are generally consistent with the recursive moral hazard theory of trade credit. Evidence for the financing advantage theory is mixed.

Firms in global markets often belong to business groups. We argue that this feature can have a profound influence on international asset pricing. In bad times, business groups may strategically reallocate risk across affiliated firms to protect core “central firms.” This strategic behavior induces co-movement among central firms, creating a new intertemporal risk factor. Based on a novel data set of worldwide ownership for 2002–2012, we find that central firms are better protected in bad times and that they earn relatively lower expected returns. Moreover, a centrality factor augments traditional models in explaining the cross section of international stock returns.

We identify a yield news shock as an innovation that does not move Treasury yields contemporaneously but explains a maximum share of their future variation. Yields do not immediately respond to the news shock as the initial reaction of term premiums and expected short rates offset each other. While the impact on term premiums fades quickly, expected short rates and thus yields decline persistently. As a result, the shock explains a staggering 50% of Treasury yield variation several years out. A positive yield news shock is associated with a coincident sharp increase in stock and bond market volatility, a contemporaneous response of leading economic indicators, and is followed by a persistent decline of real activity and inflation which is accommodated by the Federal Reserve. Identified shocks to realized stock market volatility and business cycle news imply similar impulse responses and together capture the bulk of variation of the yield news shock.

Using new employer-employee matched data, this paper investigates the impact of uncertainty, as measured by idiosyncratic stock market volatility, on individual outcomes. We find that firms provide at best partial insurance to their workers. Increased firm-level uncertainty reduces total compensation, especially variable pay, and workers reduce their durable goods consumption in response. Such shocks also lead to greater financial fragility among lower-income earners. Constructing a new county-level uncertainty shock, we find that local uncertainty shocks reduce county-level durable consumption. Taken together, these findings show that uncertainty shocks can significantly affect local economic activity through households’ consumption and savings decisions.

Modern investors face a high-dimensional prediction problem: thousands of observable variables are potentially relevant for forecasting. We reassess the conventional wisdom on market efficiency in light of this fact. In our equilibrium model, N assets have cash flows that are linear in J characteristics, with unknown coefficients. Risk-neutral Bayesian investors learn these coefficients and determine market prices. If J and N are comparable in size, returns are cross-sectionally predictable ex post. In-sample tests of market efficiency reject the no-predictability null with high probability, even though investors use information optimally in real time. In contrast, out-of-sample tests retain their economic meaning.

We develop new liquidity measures for bond markets. Existing measures suffer from the combination of two effects. First, transaction costs in OTC markets strongly depend on trade size. Second, many bonds trade only scarcely with strongly differing trading volumes. Therefore, changes in average transaction costs often indicate changing trade sizes rather than changing liquidity. We combine full-sample information for the size-cost relation with individual transaction data to eliminate such measurement problems. We find that size-adapted measures make a difference when analyzing liquidity dynamics in the U.S. corporate bond market, liquidity differences between bonds, and the asset pricing implications of liquidity.