Knowledge that Transforms

This paper develops first measures of housing sentiment for 34 cities across the United States by quantifying the qualitative tone of local housing news. Housing media sentiment has significant predictive power for future house prices, leading prices by nearly two years. Consistent with theories of investor sentiment, the media sentiment index has a greater effect in markets in which speculative investors are more prevalent and demand appears less informed. Directly examining the content across news articles finds that results are not driven by news stories of unobserved fundamentals.

At the settlement time of the VIX Volatility Index, volume spikes on S & P 500 Index (SPX) options, but only in out-of-the-money options used to calculate the VIX, and more so for options with a higher and discontinuous influence on VIX. We investigate alternative explanations of hedging and coordinated liquidity trading. Tests including those utilizing differences in put and call options, open interest around the settlement, and a similar volatility contract with an entirely different settlement procedure in Europe are inconsistent with these explanations but consistent with market manipulation. Large transient deviations in prices demonstrate the importance of settlement design.

Using data from individual Census records on the wealth of managers’ parents, we find that mutual fund managers from poor families outperform managers from rich families. We argue that managers born poor face higher entry barriers into asset management. Consistent with this view, managers born poor are promoted only if they outperform, while those born rich are more likely to be promoted for reasons unrelated to performance. Overall, we establish a first link between fund managers’ family descent and their ability to create value. Received December 8, 2016; editorial decision November 20, 2017 by Editor Andrew Karolyi.

We study the credit market impact and real effects of one of the largest borrower bailouts in history, enacted by the government of India against the backdrop of the 2007–2008 financial crisis. We find that the bailout led to a significant reallocation of credit and greater defaults, but had no offsetting positive effect on productivity, wages, or consumption. Post-program loan performance deteriorates faster in districts with greater program exposure, an effect that is not driven by greater risk-taking of banks. Loan defaults become more sensitive to the electoral cycle after debt relief, suggesting strategic default in response to the bailout.

I document large and persistent errors in investors’ expectations about the short-term interest rate over the business cycle. The largest errors arise in economic downturns and during Fed easings when investors overestimate future short rates and, thus, underestimate future bond returns. At a one-year horizon, errors about the path of the real rate (as opposed to inflation) account for 80% of short-rate forecast error variance, with more than half of that number attributed to the Fed easing more aggressively than the public expected. Short-rate forecast errors induce ex post predictability of excess returns on Treasury bonds that is not due to time-varying risk premium. Received June 10, 2016; editorial decision February 1, 2018 by Editor Robin Greenwood.

In this paper, we examine the Federal Reserve’s newest policy tool, known as the overnight reverse repo (ONRRP) facility, to understand its effects on the repo market. Using exogenous variation in the parameters of the ONRRP, we show that private repo activity is crowded out when money funds invest in the ONRRP. Additionally, we find that the ONRRP increases lenders’ bargaining power, thereby raising borrower funding costs. Lastly, we show that repo borrowers reallocate to repo backed by riskier collateral and borrow more from ONRRP-ineligible asset managers, both of which could increase financial vulnerability due to instability in dealer funding. Received April 27, 2017; editorial decision October 19, 2017 by Editor Stijn Van Nieuwerburgh.

We show that the martingale component in the long-term factorization of the stochastic discount factor due to Alvarez and Jermann (2005) and Hansen and Scheinkman (2009) is highly volatile, produces a downward-sloping term structure of bond Sharpe ratios, and implies that the long bond is far from growth optimality. In contrast, the long forward probabilities forecast an upward sloping term structure of bond Sharpe ratios that starts from zero for short-term bonds and implies that the long bond is growth optimal. Thus, transition independence and degeneracy of the martingale component are implausible assumptions in the bond market.

Using a hand-collected sample of election nominations for more than 30,000 directors over the period 2001–2010, we construct a novel measure of director proximity to elections called Years-to-election. We find that the closer directors of a board are to their next elections, the higher CEO turnover-performance sensitivity is. A series of tests, including one that exploits variation in Years-to-election that comes from other boards, supports a causal interpretation. Further analyses show that other governance mechanisms do not drive the relation between board Years-to-election and CEO turnover-performance sensitivity. We conclude that director elections have important implications for corporate governance.

When investors sell one asset and quickly buy another (“reinvestment days”), their trades suggest the original mental account is not closed, but is instead rolled into the new asset. Retail investors trading on their own accounts display a rolled disposition effect, selling the new position when its value exceeds the initial investment in the original position. On reinvestment days, these investors display no disposition effect (consistent with no disutility from realizing a loss) and make better selling decisions. Using a laboratory experiment, we show that reinvestment causally reduces the disposition effect and improves trading.

We study the importance of trust in the investment advisory industry by exploiting the geographic dispersion of victims of the Madoff Ponzi scheme. Residents of communities that were exposed to the fraud subsequently withdrew assets from investment advisers and increased deposits at banks. Additionally, exposed advisers were more likely to close. Advisers who provided services that can build trust, such as financial planning advice, experienced fewer withdrawals. Our evidence suggests that the trust shock was transmitted through social networks. Taken together, our results show that trust plays a critical role in the financial intermediation industry.