This paper studies the pricing of volatility risk using the first-order conditions of a long-term equity investor who is content to hold the aggregate equity market instead of overweighting value stocks and other equity portfolios that are attractive to short-term investors. We show that a conservative long-term investor will avoid such overweights to hedge against two types of deterioration in investment opportunities: declining expected stock returns and increasing volatility. We present novel evidence that low-frequency movements in equity volatility, tied to the default spread, are priced in the cross section of stock returns

This paper investigates execution quality issues in corporate bond trading. Using an extensive sample of bond trades by insurance companies, we find that an insurance company entering a trade of similar size and on the same side for the same bond on the same day with the same dealer will receive a better price if the insurance company is a more active trader than if it is a less active trader. Trading with the dominant dealer or underwriter worsens these differentials, while greater transparency and smaller trading networks lessens these effects. Our results provide strong evidence that execution quality differences remain pervasive in corporate bond trading

Prior theory suggests that time variation in the degree to which leverage constraints bind affects the pricing kernel. We propose a measure for this leverage constraint tightness by inverting the argument that constrained investors tilt their portfolios to riskier assets. We show that the average market beta of actively managed mutual funds—intermediaries facing leverage restrictions—captures their desire for leverage and thus the tightness of constraints. Consistent with theory, it strongly predicts returns of the betting-against-beta portfolio, and is a priced risk factor in the cross-section of mutual funds and stocks. Funds with low exposure to the factor outperform high-exposure funds by 5% annually, and for stocks this difference reaches 7%. Our results show that the tightness of leverage constraints has important implications for asset prices.

The size premium has been accused of having a weak historical record, being meager relative to other factors, varying significantly over time, weakening after its discovery, being concentrated among microcap stocks, residing predominantly in January, relying on price-based measures, and being weak internationally. We find, however, that these challenges disappear when controlling for the quality, or its inverse, junk, of a firm. A significant size premium emerges, which is stable through time, robust to specification, not concentrated in microcaps, more consistent across seasons, and evident for non-price-based measures of size, and these results hold in 30 different industries and 24 international equity markets. The resurrected size effect is on par with anomalies such as value and momentum in terms of economic significance and gives rise to new tests of, and challenges for, existing asset pricing theories.

Using variation in bank scope generated by the stepwise repeal of the Glass–Steagall Act in the US, we show that the deregulation of universal banks allowed them to finance firms with 14% higher volatility. This increase in risk is compensated by lasting improvements in firms’ total factor productivity of 3%. Using bank scope-expanding mergers to identify shocks to universal banks’ private information about borrower firms, we provide evidence that informational economies of scope across loans and non-loan products account for the firm-level real effects of universal banking.

Firms strategically choose more conservative capital structures when they face greater competitive threats stemming from the potential loss of their trade secrets to rivals. Following the recognition of the Inevitable Disclosure Doctrine by US state courts, which exogenously increases the protection of a firm's trade secrets by reducing the mobility of its workers who know its secrets to rivals, the firm increases its leverage relative to unaffected rivals. The effect is stronger for firms with a greater risk of losing key employees to rivals, for those facing financially stronger rivals, and for those in industries where competition is more intense.

We develop a model of the joint capital structure decisions of banks and their borrowers. Bank leverage of 85% or higher emerges because bank seniority both dramatically reduces bank asset volatility and incentivizes risk-taking by producing a skewed return distribution. Nonfinancial firms choose low leverage to protect their banks, presenting a partial resolution to the low-leverage puzzle. Our setup naturally extends to include government actions as we model bank assets using a modified Basel framework. Deposit insurance and bailout expectations lead banks and borrowers to take on more risk. Capital regulation lowers bank leverage but can increase bank risk due to a compensating increase in borrower leverage. Despite this, doubling current capital requirements reduces bank default risk by up to 90%, with only a small increase in loan interest rates.

Long-short anomaly returns are strongly related to the day of the week. Anomalies for which the speculative leg is the short (long) leg experience the highest (lowest) returns on Monday. The opposite pattern is observed on Friday. The effects are large. Monday (Friday) alone accounts for over 100% of returns for all anomalies examined for which the short (long) leg is the speculative leg. Consistent with a mispricing explanation, the pattern is driven by the speculative leg. The observed patterns are consistent with the abundance of evidence in the psychology literature that mood increases on Friday and decreases on Monday.

Original issue premium (OIP) bonds are the norm in the US tax-exempt market but very rare in the taxable market. A tax subsidy helps explain this disparity. Unlike bonds issued at par or discount, the price of OIP bonds can fall and yet remain above par, providing secondary market buyers with more tax-exempt coupon and less taxable market discount gain. The subsidy for OIP bonds explains additional, previously undocumented empirical facts. In a calibration exercise, the subsidy’s expected cost to the U.S. Treasury is estimated at $1.7 billion per year.