Knowledge that Transforms

We propose a new framework to explain the factor structure in the full cross section of Treasury bond returns. Our method unifies non-parametric curve estimation with cross-sectional factor modeling. We identify smoothness as a fundamental principle of the term structure of returns. Our approach implies investable factors, which correspond to the optimal spanning basis functions in decreasing order of smoothness. Our factors explain the slope and curvature shapes frequently encountered in PCA. In a comprehensive empirical study, we show that the first four factors explain the time-series variation and risk premia of the term structure of excess returns. Cash flows are covariances as the exposure of bonds to factors is fully explained by cash flow information. We identify a state-dependent complexity premium. The fourth factor, which captures complex shapes of the term structure premium, substantially reduces pricing errors and pays off during recessions.

We study how fatal and nonfatal health shocks affect households’ ability to meet their financial obligations. We find that fatal shocks substantially increase the likelihood of default and that housing wealth plays a key role as a self-insurance mechanism. Surviving spouses who experience the largest income losses are more likely to sell their homes, and those without housing wealth face a sharply higher risk of debt collection. In the most financially vulnerable families, these shocks even generate intergenerational spillovers. In contrast, nonfatal health shocks lead to only modest increases in default risk. Taken together, our findings suggest that strengthening survivors’ benefits for households with limited resources could improve welfare across generations.

The sensitivity of the external finance premium to firms’ net-worth-to-capital ratio is central to the strength of the financial accelerator, yet direct firm-level evidence remains scarce. We estimate this elasticity using balance sheet and income statement data for Swiss nonfinancial firms over 1998–2016. To address the endogeneity of net worth, we employ two complementary instrumental variable strategies: one based on firms’ non-operating income and the other a shift-share design that interacts predetermined exposure to financial income with aggregate dividend returns. Mapping the estimated elasticity into the costly state verification framework as implemented by Bernanke et al. (1999) yields structural monitoring costs of about one quarter of firms’ gross return on capital, with estimates ranging from 0.15 to 0.35 across specifications. Our results provide direct firm-level support for the financial accelerator mechanism and imply monitoring costs of the same order of magnitude as the benchmark calibration of Bernanke et al. (1999).

We examine how in-person and virtual interactions shape mutual fund investment decisions using a comprehensive dataset of corporate site visits. Before COVID-19, fund pairs jointly attending in-person visits trade more similarly (by 20% of a standard deviation) than matched controls. The effect holds for stocks unrelated to the hosting firm and appears in firm-level, industry, geographic, and asset allocation decisions; it is stronger among managers with prior familiarity, similar seniority, and mixed gender. Stocks purchased by jointly visiting funds earn higher subsequent returns, indicating that these exchanges convey valuable information. Exploiting the exogenous shift to virtual communication induced by COVID-19, we find that in-person visits remain associated with correlated trading during the pandemic, whereas virtual visits have substantially weaker effects. A survey of fund managers confirms that site visits prompt information exchange, follow-up research, and portfolio adjustments. In-person interactions appear central to information acquisition; and virtual interactions do not easily replicate this function.

This paper documents a non-monotonic impact of local mutual funds on the pricing of municipal bond issuance. Offering yield spreads are higher in states where municipal bond funds’ headquarters are located, and in states with larger aggregate local fund size. However, controlling for local fund size, yield spreads decrease as the number of local fund families increases. These findings are consistent with a security pricing model with multiple imperfectly informed investors and with the empirical evidence supporting local funds’ informational advantage. Specifically, mutual fund trades predict local bonds’ credit rating changes.

Investment funds hold disproportionately more domestic than foreign stocks, which has been attributed to stock market development and familiarity factors such as language and distance. However, the literature typically assumes that funds represent investors in their country of incorporation, neglecting the substantial allocation of investors’ assets to foreign funds domiciled in financial centers. Using a novel “look-through approach” that combines supervisory holdings statistics with granular security-level fund portfolios, we provide a more accurate view of investors’ indirect equity allocations, independent of the fund’s legal country of incorporation. Our findings reveal three key insights. First, home bias estimates are significantly smaller than previously documented, reflecting greater geographical portfolio diversification through investment funds. Second, in most euro area countries, home bias is primarily driven by country-specific rather than common-currency preferences. Third, familiarity plays a larger role in cross-border investments for households than for institutional fund investors, highlighting the importance of investor sophistication.

We propose that the arrival of new information is a source of systematic risk for the holder of a financial security. Using several measures of information flows, we demonstrate that a stock’s sensitivity to market-wide information flow is associated with a robust cross-sectional return premium that is distinct from other return premia. We find that the amount of information impounded in prices through trading has increased in recent years consistent with declining trading costs and the rise of algorithmic trading. We show that the information flows risk premium is increasing through time.

We utilize the Eurosystem securities lending facilities as a laboratory to investigate the impact of collateral scarcity on market functioning. The reduction of securities lending fees, implemented in November 2020, provides a quasi-natural experiment for our analyses. This policy change results in a surge in the utilization of securities lending facilities, particularly for bonds with limited supply elasticity in the repo market. We find no evidence of substitution effects; instead, the overall activity in the repo market expands through the collateral multiplier. The improved pricing conditions alleviate collateral scarcity and enhance market quality in both the repo and cash markets.

We examine the causal effects of a policy allowing early withdrawal of pension funds on individuals’ investment behavior. Upon turning 55, eligible individuals may withdraw a portion of their pension savings. Using detailed brokerage data, we find that this liquidity access triggers increased trading of 9% to 33%, especially in riskier, leveraged assets, without improving investment performance. The resulting increase in trading costs and portfolio volatility, particularly among males and lower-income investors, ultimately diminishes retirement wealth.

We exploit unexpected corporate data breaches to study the loss and repair of corporate reputation. Reputation loss decreases equity and brand values, increases customer churn, and prompts more negative media coverage. Firms repair their reputation by increasing their charitable donations and have CSR scores that are more than 0.5 standard deviations higher. They increase political contributions, employee wages, and IT investment. These actions are targeted to stakeholders that are particularly important or in situations that are particularly salient to their stakeholders. We observe similar dynamics of reputation loss and repair following the release of negative news about firms’ social behaviors.