Knowledge that Transforms

Dynamic equilibrium models based on present value computation not only imply that returns are predictable but also generate particular short-term patterns of predictability in asset returns. I take advantage of this to construct a set of tests of equilibrium generated predictability (EGP). I apply the tests to document two puzzles: First, option-implied or realized measures of volatility ought to predict returns but do not; and second, the variance risk premium (VRP) predicts returns but only at long horizons. VRP fails the tests of EGP as the term structure of predictable variation is inconsistent with an equilibrium interpretation.

We develop methods for testing factor models when the weights in portfolios of factors and test assets can vary with lagged information. We derive and evaluate consistent standard errors and finite sample bias adjustments for unconditional maximum squared Sharpe ratios and their differences. Bias adjustment using a second-order approximation performs well. We derive optimal zero-beta rates for models with dynamically trading portfolios. Factor models’ Sharpe ratios are larger but standard test asset portfolios’ maximum Sharpe ratios are larger still when there is dynamic trading. As a result, most of the popular factor models are rejected.

Returns to currency carry and momentum compensate for the risk of global interest rate volatility (IRV), with risk exposures explaining 92% of the cross-sectional return variations. This unified explanation stems from its impact on foreign exchange intermediaries. An intermediary-based exchange rate model shows that a higher global IRV increases the uncertainty of future risk-taking and tightens current financial constraints. Position unwinding triggers loss of carry and momentum. Additional empirical results confirm this economic channel. Global IRV risk is also negatively priced in other currency strategies and momentum. The explanatory power is not driven by existing measures of uncertainty or intermediary constraints.

This article proposes and estimates a tractable, arbitrage-free valuation model for corporate coupon bonds that includes a more realistic recovery rate process. Most existing studies use a recovery rate process that is misspecified because it includes recovery for coupons due after default. Misspecification errors from assuming recovery on all coupons can be substantial; they increase with recovery rates, coupons, maturity, and default probabilities. For a large sample of market transactions, i) our model has lower pricing errors than one assuming recovery on all coupons and ii) the magnitude of our model’s outperformance is linked to misspecification errors from assuming recovery on coupons.

We examine how changes in foreign labor regulations affect U.S. multinationals’ operating strategies. We show that firms with integrated operations in countries where labor regulations become tighter tend to establish arm’s-length relations with local business partners in that nation. The substitution between integrated and arm’s-length operations is stronger toward joint ventures than suppliers and weaker in the presence of financial constraints. Our findings are consistent with the idea that when firms find it harder to terminate their workers in integrated operations, they change to an operating model where it is easier to replace or discontinue business partners instead of employees.

We introduce a test to assess mutual funds’ “conditional” performance that is based on updated information and corrects data snooping bias. Our method, named the functional false discovery rate “plus” ( $ fFDR^+ $ ), incorporates fund characteristics in estimating fund performance free of data snooping bias. Simulations suggest that the $ fFDR^+ $ controls well the ratio of false discoveries and gains considerable power over prior methods that do not account for extra information. Portfolios of funds selected by the $ fFDR^+ $ outperform other tests not accounting for information updating, highlighting the importance of evaluating mutual funds from a conditional perspective.

Using a hand-collected sample of 18,269 equity analysts from 42 countries over the period of 2004 to 2019, we establish an intriguing negative association between a country’s institutional/economic development and its female share of equity analysts. We show that, in individualistic countries only, there is no gender gap in analyst forecast accuracy. We further show that female analysts are more skilled and more likely to drop out when underperforming in individualistic countries compared to peers in collectivistic countries. The evidence supports our hypothesis that the national cultural value of individualism encourages women to make career choices consistent with their general aversion to competition.

We examine whether the heterogeneity of expectations is associated with idiosyncratic variations in experience. Combining household survey data and administrative data from the Netherlands, we find that given market development, households’ expectations about house price changes vary with their individual experience. This association is related to the use of information conveyed by experience, which varies in terms of informativeness, recency, and household sophistication. Finally, we find that individual experience also explains how far house price expectations deviate from realized house prices and that it may affect household behavior. Our findings elucidate the role that individual experience plays in expectation formation.

We investigate whether bank loan financing from 1994 to 2018 conveys valuable private information using a sample of over 10,000 bank loan announcements identified from 8-K filings. We show that the positive announcement effect is persistent and closely related to the information revealed in loan characteristics: The effect is stronger when deals have higher materiality, more favorable pricing, larger lead bank shares, and higher syndicate concentration. The effect is also stronger when lenders have higher credit quality and when credit market conditions are worse. The insignificant wealth effect documented in several early studies is potentially driven by small sample size.

We show that attention constraints on decision-makers create barriers to financial inclusion. Using administrative data on retail loan-screening processes, we find that attention-constrained loan officers exert less effort reviewing applicants of lower socioeconomic status (SES) and reject them more frequently. More importantly, when externally imposed increases in loan officers’ workloads tighten attention constraints, loan officers are even more prone to quickly reject low-SES applicants but quickly accept very high-SES applicants without careful review. Such selective attention allocation further widens the approval rate gap between high- and low-SES applicants—a unique prediction of this attention-based mechanism.