Knowledge that Transforms

Abstract This article investigates two research questions: do investors see a relationship between risk attitude and the amount invested into risky assets? Further, do investors adjust their investments if provided with assets that have different volatilities? In an experimental study, investors allocate an amount between a risky and a risk-free asset. Investors’ risk attitude predicts risk taking. Investors are, however, unable to adapt to risky assets with different volatilities; they choose almost the same allocation to the risky asset independently of its volatility, thus amassing significantly different portfolios.

Abstract Household portfolios include risky bonds, beyond stocks, and respond to permanent labor income shocks. This article brings these features into a life-cycle setting, and shows that optimal stock investment is constant or increasing in age before retirement for realistic parameter combinations. The driver of such inversion in the life-cycle profile is the resolution of uncertainty regarding social security pension, which increases the investor’s risk appetite. This occurs if a small positive contemporaneous correlation between permanent labor income shocks and stock returns is matched by a realistically high degree of risk aversion. Absent this combination, the typical downward-sloping profile obtains. Overlooking differences in optimal investment profiles across heterogeneous workers results in large welfare losses, in the order of 15–30% of lifetime consumption.

Abstract Despite the size and importance of separately managed accounts (SMAs) and collective investment trusts, their characteristics and performance have not been studied in detail. We show that separate account performance is similar to that of index funds and superior to that of actively managed mutual funds. Management supplies a benchmark for each separate account. When the management-selected benchmark is used to measure performance, performance is significantly overstated. Despite this, investors react to differences in performance from the management-preferred benchmark in choosing among SMAs. Finally we find variables that explain both the cross section of alphas and the cross section of cash flows.

Abstract In this article, I model bargaining between an entrepreneur and a venture capitalist over the profits from an investment project. I show that, conditional on venture capital being available, more personal wealth, even if it is not invested in the project, helps the entrepreneur capture a larger fraction of the profits. I also show that access to bank financing can preclude access to venture capital. This occurs when bank financing works as a lever that raises the fraction of the profits the entrepreneur demands up to a level that is not incentive compatible with initiative from the venture capitalist.

Abstract We investigate whether the extent to which firms concentrate their borrowing from banks mitigates the credit contraction that followed the default of Lehman. Using micro data from a large sample of Italian firms, we show that firms borrowing from fewer banks and those with more concentrated borrowing suffer on average a smaller contraction in bank credit and have a lower probability of being credit-rationed. The results hold controlling for several firm-level characteristics and for the possible endogeneity of the measures of concentration of borrowing.

Abstract Standard Gaussian term structure models impose the Markov property: the conditional mean is a function of the risk factors. We relax this assumption and consider models where yields are linear in the conditional mean (but not in the risk factors). To illustrate, yields should span expected inflation but not inflation. Second, expected and surprise yield changes can have opposite contemporaneous effects on expected inflation. Third, the survey forecasts and inflation rate can both be in the state. These three features are inconsistent with the Markov assumption. These effects matter empirically in the USA and in Canada.

Abstract We develop a structural model to quantitatively analyze the effects of asymmetric beliefs and agency conflicts on capital structure. Capital structure reflects the dynamic tradeoff between the positive incentive effects of managerial optimism and the negative effects of risk-sharing costs. Consistent with empirical evidence, long-term debt declines with optimism, whereas short-term borrowing increases. Permanent and transitory risk components have contrasting effects. Long-term debt increases with the intrinsic risk, but varies nonmonotonically with the transient risk. Short-term borrowing declines with the intrinsic risk, but increases with the transient risk. Overall, our findings show that asymmetric beliefs significantly influence firms’ financial policies.

Abstract This article shows how to extract future real activity information from optimally combined size-sorted portfolios. In particular, we analyze the capacity of the size-based model-free Hansen–Jagannathan volatility bound to predict future economic growth. We find that the volatility bound is a powerful in-sample and out-of-sample predictor of future industrial production growth. The asymmetric sensitivities of small and large companies through the business cycle explain our findings. Alternative volatility bounds estimated with sorting procedures based on book-to-market, momentum, or dividend yield do not show these asymmetric sensitivities or forecasting capacity of output growth.

Abstract This article provides cross-country evidence that variations in bank regulatory policies result in differences in income distribution. In particular, the overall liberalization of banking systems decreases income inequality significantly. However, this effect becomes insignificant for countries with low levels of economic and institutional development and for market-based economies. Among liberalization policies, credit and interest rate controls have the most significant negative effect on inequality. Privatizations and liberalization of international capital flows also decrease income inequality; the latter also increases the income share of the relatively poor. In contrast, liberalization of securities markets increases income inequality substantially.

Abstract Using comprehensive time stamp data on earnings announcements collected from newswires, we show that earnings news announced within trading hours results in approximately 50% smaller immediate reaction compared to similar earnings announced outside trading hours. Negative news tends to be announced during trading hours, which, together with the reduced response, may allow for managerial opportunistic behavior. We also provide evidence that announcement timing is affected by internal corporate governance. Recent regulations that tightened firms’ governance are associated with a significant shift to announcing outside trading hours, especially for firms with better corporate governance. Our surveys of corporate managers corroborate these results.