Knowledge that Transforms

I find that foreign multinational firms engage in tax-motivated income shifting out of the United States. The analysis uses novel data on foreign-owned U.S. subsidiaries as well as variation in foreign countries’ tax rates and controlled foreign corporation rules. Foreign multinational firms primarily rely on tax-motivated transfer pricing to shift income out of the United States, and the aggregate amount of shifted income is modest. When foreign tax policy changes inhibit income shifting, foreign-owned U.S. subsidiaries’ investment and employment fall. The results indicate that the U.S. economy has limited exposure to tax policies set abroad through foreign direct investment in the United States.

We propose a new asset pricing model that generalizes the mean-variance framework by including probability weighting, specifically the overweighting of rare, high-impact events. Our model—the $ Π $-CAPM—generates several new predictions: (i) skewness has a positive price effect, amplified by volatility; (ii) the price effect of volatility is negative for left-skewed assets but positive for right-skewed assets; and (iii) option-implied variance premiums for stocks have a U-shaped relation to skewness, amplified by volatility. We find strong empirical support for these predictions. Finally, we show that the $ Π $-CAPM predicts an exaggerated co-movement of assets and can explain the correlation premium.

This paper provides evidence that the U.S. dollar affects trade through a financial channel of the exchange rate. Using global data over three decades, we show that dollar appreciation increases import prices and decreases import quantities for non-U.S. dollar countries. In line with a financial channel, these effects are stronger when the exporting country borrows more in U.S. dollars abroad. The financial channel was active before the global financial crisis, has strengthened since, and operates independently of the dominant currency invoicing channel. Instrumenting the dollar is key to uncovering the full effect of the financial channel.

We study how passive investing affects asset prices. Flows into passive funds disproportionately raise the stock prices of the economy’s largest firms, especially those large firms in high demand by noise traders. Because of this effect, the aggregate market can rise even when flows are entirely due to investors switching from active to passive funds. Intuitively, passive flows increase the idiosyncratic risk of large firms in high demand, which discourages investors from correcting the flows’ effects on prices. Consistent with our theory, prices and idiosyncratic volatilities of the largest S&P500 firms rise the most following flows into that index.

The availability of big data and analytics expertise provides insurers with informational advantages over policyholders in estimating risk. We study competition between heterogeneously informed insurers, showing that their information may or may not be revealed in equilibrium. We find that all equilibria are profitable and that noninformative equilibria entail risk pooling and possibly efficiency. In informative equilibria, the signaling problem interacts with the screening problem that arises endogenously from insurers’ revelation of information, implying underinsurance. Our main insights are robust to changes in insurers’ information precision and market concentration and to the presence of two-sided asymmetric information and withdrawable contracts.

Firms enter new sectors by either building on their resources or buying existing companies. Using French administrative data, we propose a measure of human capital distance between a firm and a sector of entry. Using a shift-share instrument, we show that firms build in close sectors and buy in distant sectors in terms of human capital distance. Firms build by hiring new workers, which becomes increasingly costly in distant sectors as it requires not only hiring more workers but also having more organizational capital to integrate these workers. Hence, firms buy in distant sectors to acquire already operational human capital.

A number of delta-hedged equity option strategies exhibit very large average returns. We show that much of the profitability of these strategies can be explained by an IPCA factor model. The economic magnitude of the return-adjustment produced by IPCA is impressive: even before transaction costs, the average IPCA alpha of 46 long-short trading strategies constructed on previously discovered signals, is close to zero and contrasts with average realized returns of over 80 basis points per month. Our IPCA model can be used as a benchmark for assessing the performance of other option portfolios.

We document political sentiment effects on U.S. inventors. Democratic inventors are more likely to patent (relative to Republicans) after the 2008 election of Obama but less likely after the 2016 election of Trump. These effects are at least twice as strong among politically active Democrats and are present even within firms and within firm$ × $technology. We also show that partisans tend to cluster in technologies (e.g., Democrats in Biotechnology and Republicans in Weapons), so that sentiment effects aggregate to more patents in the technologies dominated by the winning party.

We study how bank advertising practices contribute to racial disparities in financial markets by steering minorities toward inferior products. We exploit a regulatory change that incentivizes deposit collection at the Freedman’s Savings Bank, the first institution to collect deposits from African Americans post-Emancipation, by facilitating misuse of depositor funds. After deregulation, advertising volume rises, particularly in African American newspapers, leading to increased deposits from Black depositors despite the bank’s insolvency. We identify persuasion as a key mechanism; prescriptive stereotypes and false claims likely amplify advertising’s impact on African Americans, exacerbating historically large depositor losses after the bank’s collapse.

We study the role of brokers in selection markets. We find broker-clients in the Canadian mortgage market are observationally different from branch-clients. They finance larger loans with more leverage and longer amortization. We build and estimate a model of mortgage demand to disentangle three possible explanations for these riskier product choices: (1) selection on observables, (2) unobserved borrower preferences for riskier loans, and (3) a causal effect of brokers. Although we find that brokers influence product choices, the main reason borrowers choose high-leverage products is unobserved preferences. Borrowers prefer larger loans and brokers facilitate qualification for them.