Knowledge that Transforms

Abstract We study trading among strategic traders who may incorrectly assess the degree of market crowdedness. These mistakes distort equilibrium strategies and prices. When traders underestimate market crowdedness, they target larger inventories and trade more aggressively, but their actual profits are lower than expected because they underestimate the amount of information already impounded in prices. Crowded markets are prone to abrupt crashes. The magnitude of price dislocations and the speed of recovery during fire-sale events can help infer traders’ beliefs about market crowdedness.

Abstract After medical marijuana legalization (MML) by U.S. states, firms’ cost of equity (COE) decreases, especially for those with more growth opportunities, higher productivity, or a more skilled workforce. This policy change also reduces firm risk and leads to an increase in labor supply through increased labor force participation, employment, hours worked, and net migration. Further, home prices rise after MML, reflecting increased local housing demand due to a growing supply of workers. These findings align with theoretical models that link asset prices to labor markets and suggest that MML can lower firms’ COE by mitigating labor search frictions.

Abstract Active equity mutual funds that own shares in product-market competitors have higher risk-adjusted returns, even after fees. This positive association comes from their common ownership positions, and remains robust after controlling for industry concentration, common stock selection, and the tendency to invest in firms with more common ownership. These funds charge higher fees and are active voters: more likely to vote against executive pay-for-performance and for directors with existing directorships in competitors. Our findings suggest that actively managed equity mutual funds are incentivized to soften product-market competition, and proxy voting may serve as a mechanism for influencing corporate policy.

Abstract This article proposes a theoretical explanation for the positive pre-announcement drift empirically documented ahead of scheduled announcements, using the Federal Open Market Committee (FOMC) meetings as a main example. The framework entails a general equilibrium model of disagreement (differences of opinion), where investors interpret a costly signal differently. Investors optimally decide to stop learning when an announcement is imminent, increasing the risk premium ahead of an announcement. The model jointly rationalizes puzzling empirical evidence by generating i) an upward drift in prices just before scheduled announcements, regardless of the announcement’s content, which coexists with ii) low volatility and iii) low trading volume.

Abstract I analyze the effects of bank competition on gender and racial gaps in entrepreneurship. By leveraging interstate bank deregulation from 1994 to 2021, I find that stronger bank competition increases the quantity and quality of banking services offered to minority borrowers. Developing a novel measure of discrimination using narrative information in the complaints filed with the Consumer Financial Protection Bureau, I demonstrate that bank competition reduces discrimination, alleviating the financial constraints of female and minority entrepreneurs. Stronger bank competition also reduces gender and racial gaps in firm performance and business equity accumulation, promoting wealth equality and fostering equitable economic growth.

Abstract We investigate whether judges’ political ideology affects corporate tax behaviors. We find that firms engaging in less aggressive tax planning when Circuit Court judges are more liberal. Cross-sectionally, the deterrent effect of liberal judge ideology is more pronounced for firms that engage in judiciary-sensitive tax strategies, face higher enforcement risk from the Internal Revenue Service (IRS), or have larger reputational costs from tax disputes. Our findings further suggest that liberal judge ideology reduces firms’ R&D investments and market value by constraining tax planning. Overall, our evidence highlights the importance of judge ideology for firm behavior in the context of corporate tax planning.

Abstract Practical real-world activities consume energy and emit thermal infrared radiation (TIR). Leveraging this physical fact, we develop a direct, real-time measure of firms’ operating activity using satellite data. Tracking 28,236 factories of Chinese listed firms, we find TIR declines significantly following operational shocks and strongly forecasts subsequent sales growth, costs, investment, employment, and profits. TIR also predicts future stock returns, especially among opaque firms and those with limited investor access, yet sophisticated investors largely ignore this information. Our findings highlight TIR as a distinctive, under-exploited indicator of corporate fundamentals.

Abstract Using individual records of about 950,000 financial advisors, we find that the probability and intensity of financial advisor misconduct significantly increase after local newspaper closures. The impact is more pronounced in counties with a higher proportion of seniors, minorities, and individuals with lower education levels. Male advisors are more likely to commit misconduct following newspaper closures than female advisors. The sensitivity of advisors’ job turnover to misconduct decreases after closures, suggesting a lower cost of committing misconduct. Our evidence indicates that local newspapers play a distinct role in mitigating financial advisor misconduct, as media exposure raises the costs of misbehavior.

Abstract We document that climate-triggered institutional portfolio rebalancing affects S&P 500 firms’ cost of equity through climate change price pressure (CCPP). Using a demand-based asset pricing framework, we estimate firm-level CCPP from physical and transition exposures over 2005–2021. A one-standard-deviation intensification of CCPP raises the cost of equity by up to 6% of its average, with banks and insurers as the main drivers. Yet firms do not subsequently improve environmental performance, indicating that the statistically significant effect of CCPP on cost of equity is ineffective to alter corporate behavior. Our CCPP metrics can help policymakers and investors design targeted environmental strategies.

Abstract Using high-frequency disagreement data from the investor social network StockTwits, we find that greater unsophisticated disagreement facilitates informed buying and selling. During periods of overvaluation, the facilitating effect of disagreement on trading is dampened for informed buyers but is amplified for informed sellers. These findings are unexplained by sentiment, news, and retail order flow, and they remain when we measure disagreement overnight and disagreement of technical investors, which alleviates the concern that disagreement and informed trading respond to a common shock. These findings suggest that informed traders respond meaningfully but differently to valuation changes induced by unsophisticated disagreement.