Knowledge that Transforms

We use credit report data to study consumer financial distress in America. We report large, persistent disparities in financial distress across regions. To understand these patterns, we conduct a “movers” analysis. For collections and default, there is only weak convergence following a move, suggesting these types of distress are not primarily caused by place-based factors (e.g., local economic conditions and state laws) but instead reflect person-based characteristics (e.g., financial literacy and risk preferences). In contrast, for personal bankruptcy, we find a sizable place-based effect, which is consistent with anecdotal evidence on how local legal factors influence personal bankruptcy.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

We show that mutual fund investors rely on simple signals and likely do not engage in sophisticated learning about managers’ alpha as widely believed. Simplistic performance chasing best explains aggregate flows to the mutual fund space and flows across funds. These results hold for both actively managed and passive index funds. Empirical patterns commonly interpreted as reflecting learning about managerial skill also appear in falsification tests and are mechanical. Our results are consistent with the view that, on average, households are homo sapiens with limited financial sophistication rather than hyperrational alpha-maximizing agents, as often assumed in the literature.

We develop a novel 10-K text-based model of product life cycles and examine firm investment policies. Conditioning on the life cycle substantially improves the power of q to explain investment and reveals a natural ordering of investments over the life cycle. While R&D and CAPX sensitivity are high early in the cycle, acquisitions arise as products mature, and divestitures and product extension investments arise as products decline. q-sensitivities that condition on the life cycle can vary by as much as 400% from traditional sensitivities. The life cycle framework further reveals an enriched relationship between competition, investment, and corporate profits. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

We identify fixed-income mutual funds as an important contributor to the unusually high selling pressure in liquid asset markets during the COVID-19 crisis. We show that mutual funds experienced pronounced investor outflows amplified by their liquidity transformation. In meeting redemptions, funds followed a pecking order by first selling their liquid assets, including Treasuries and high-quality corporate bonds, which generated the most concentrated selling pressure in these markets. Overall, the estimated price impact of mutual funds was sizable at a third of the increase in Treasury yields and a quarter of the increase in corporate bond yields during the COVID-19 crisis.

This paper presents a tractable dynamic equilibrium model of stock return extrapolation in the presence of stochastic volatility. In the model, consistent with survey evidence, investors expect future returns to be higher (lower) but also less (more) volatile following positive (negative) stock returns. The biased volatility expectation introduces a new channel through which past returns and investor sentiment affect derivative prices. In particular, through this novel channel, the model reconciles the otherwise puzzling evidence of past returns affecting option prices and the evidence of variance risk premium predicting future stock market returns even after controlling for the realized variance.