Knowledge that Transforms

Short-term traders could affect the informativeness of stock prices about long-run fundamentals. Less (more) short-termism may thus induce managers to rely more (less) on stock prices in real investment decisions. Supporting this notion, we show that the investment-to-price sensitivity is inversely related to two short-termism proxies (controlling for firm size): institutional churn and liquidity. We confirm this finding using decimalization and an increase in mutual fund disclosure frequency as exogenous shocks to short-termism. Furthermore, short-termism is associated with an increased likelihood of voluntary capital expenditure forecasts by managers, suggesting a greater tendency to solicit market feedback when short-termism is high.

According to recent theoretical work, a more transparent and precise benchmark assessment should positively impact liquidity in the underlying market. We exploit a benchmark regime change in the $289 trillion interest rate swaps market to test this prediction. Utilizing proprietary electronic order book data, we find improved liquidity effects in the USD swaps market following the transition to the regulated ICE Swap Rate. Regulations that improve the methodology and oversight of benchmarks can, therefore, impact markets positively. Conservative estimates of direct savings in a single swap tenor on one trading platform are in the region of $4 million - $7 million.

Previous research shows that Democrat- and Republican-leaning investors hold different stock market expectations. In this paper, I identify a novel channel through which political opinions affect investor behavior. Instead of political affiliation, I consider nonpartisan evaluations of the executive from presidential approval rating polls. I find that large net disapproval over the U.S. president’s job is followed by low stock returns, especially in times of high political uncertainty and low market-wide sentiment. Notably, this mechanism explains away Santa-Clara and Valkanov’s (2003) “presidential puzzle.” Overall, the findings suggest that nonpartisan political views have a substantial impact on stock prices.

I decompose firm-specific monthly-varying illiquidity into three components: (i) alpha, (ii) systematic, and (iii) idiosyncratic. Investors demand a premium to hold stocks with high systematic illiquidity. However, the systematic illiquidity premium disappears when very small stocks are excluded. On the other hand, investors tend to underreact to idiosyncratic (il)liquidity. Hence, stocks with high (low) idiosyncratic liquidity generate positive (negative) future risk-adjusted returns. More specifically, stocks in the highest idiosyncratic liquidity quintile generate 7% more annualized risk-adjusted return compared to stocks in the lowest idiosyncratic liquidity quintile.

We study the role mutual funds play in the recovery from fast intraday crashes based on data from the National Stock Exchange of India for a single large stock. During normal times, trading activity and liquidity provision by mutual funds is negligible compared to other traders at around 4% of overall activity. Nevertheless, for the two intraday market-wide crashes in our sample, price recovery took place only after mutual funds moved in. Market stability may require the presence of well-capitalized standby liquidity providers for recovery from fast crashes.

The Hong Kong Stock Exchange adopted a standard closing call auction mechanism in 2008 but suspended its operation ten months later due to suspicion of widespread price manipulation. The Exchange revamped the mechanism with manipulation-deterrence enhancements and relaunched it in 2016. We exploit this unique setting to examine the effect of call auction design on closing price manipulation. Our results indicate that the standard call auction mechanism is vulnerable to closing price manipulation. Under this mechanism, overnight price reversal is more pronounced on days when derivatives expire and on days when large orders were submitted just before the market close.