Knowledge that Transforms

[We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates payoffs that are on average large and uncorrelated with traditional risk factors. We argue that these payoffs reflect a peso problem. The underlying peso event features high values of the stochastic discount factor rather than very large negative payoffs.]

[We examine how experience affects the decisions of individual investors and institutions in IPO auctions to bid in subsequent auctions, and their bidding returns. We track bidding histories for all 31,476 individual investors and 1,232 institutional investors across all 84 IPO auctions during the period from 1995 to 2000 in Taiwan. For individual bidders, (1) high returns in previous IPO auctions increase the likelihood of participating in future auctions; (2) bidders' returns decrease as they participate in more auctions; (3) auction selection ability deteriorates with experience; and (4) those with greater experience bid more aggressively. These findings are consistent with naïve reinforcement learning wherein individuals become unduly optimistic after receiving good returns. In sharp contrast, there is little sign that institutional investors exhibit such behavior.]

[Miller and Modigliani (1961) show that in perfect and complete financial markets a firm's value is unaffected by its dividend policy. Much of the more recent research has demonstrated that dividend policy becomes important in the presence of taxation, asymmetric information, incomplete contracts, institutional constraints, and transaction costs. By examining the effects of dividend policies on 475 British firms existing between 1895 and 1905, and consequently operating in an environment of very low taxation with an absence of institutional constraints, we find strong support for asymmetric information theories of dividend policy, and little support for agency models.]

[This article studies how relative wealth concerns, in which a person's satisfaction with their own consumption depends on how much others are consuming, affect investors' incentives to acquire information. We find that such externalities can generate complementarities in information acquisition within the standard rational expectations paradigm. When agents are sensitive to the wealth of others, they herd on the same information, trying to mimic each other's trading strategies. We show that there can be multiple herding equilibria in which different communities pursue different information acquisition strategies. This multiplicity of equilibria generates price discontinuities: An infinitesimal shift in fundamentals can lead to a discrete price movement.]

[Pensions and deferred compensation represent substantial components of CEO incentives. We study stockholder and bondholder reactions to companies' initial reports of CEOs' inside debt positions following a 2007 SEC disclosure reform. We find that bond prices rise, equity prices fall, and the volatility of both securities drops for firms whose CEOs have sizeable defined benefit pensions or deferred compensation. Similar changes occur for credit default swap spreads and exchange-traded options. The results indicate a reduction in firm risk, a transfer of value from equity toward debt, and an overall destruction of enterprise value when CEOs' inside debt holdings are large.]

[We show that new managers who take over mutual fund portfolios sell off inherited momentum losers at higher rates than stocks in any other momentum decile, even after adjusting for concurrent trades in these stocks by continuing fund managers. This behavior is observed regardless of fund characteristics and is stronger when new managers are external hires. The tendency of continuing fund managers to hold on to losers could be consistent with either a behavior bias stemming from an inability to ignore the sunk costs associated with the stocks' past underperformance or a conscious desire to protect their careers by not admitting prior mistakes. Furthermore, we present evidence that selling off loser stocks helps improve fund performance.]

[Mutual funds change their risk levels significantly over time. Risk shifting might be caused by ill-motivated trades of unskilled or agency-prone fund managers who trade to increase their personal compensation. Alternatively, risk shifting might occur when skilled fund managers trade to take advantage of their stock selection and timing abilities. This article investigates the performance consequences of risk shifting and sheds light on the mechanisms and the economic motivations behind risk-shifting behavior. Using a holdings-based measure of risk shifting, we find that funds that increase risk perform worse than funds that keep stable risk levels over time, suggesting that risk shifting either is an indication of inferior ability or is motivated by agency issues.]

[We show that several well-known asset pricing puzzles are largely mitigated if we endow the representative agent with an arbitrarily small minimum consumption level. This allows us to solve the model for parameter values where the standard "Lucas tree" model is not defined. For these parameters, disasters become more important, and the market risk premium therefore higher, even though consumption is less risky. Our model yields reasonable risk premia, Sharpe ratios, and discount rates; excess price volatility; and a high market price-dividend ratio. We derive closed-form solutions for all variables of interest.]

[Standard approaches to building and estimating dynamic term structure models rely on the assumption that yields can serve as the factors. However, the assumption is neither theoretically necessary nor empirically supported. This article documents that almost half of the variation in bond risk premia cannot be detected using the cross-section of yields. Fluctuations in this hidden component have strong forecast power for both future short-term interest rates and excess bond returns. They are also negatively correlated with aggregate economic activity, but macroeconomic variables explain only a small fraction of variation in the hidden factor.]

[We investigate corporate governance experts' claim that it is detrimental to a firm to reappoint former CEOs as directors after they step down as CEOs. We find that more successful and more powerful former CEOs are more likely to be reappointed to the board multiple times after they step down as CEOs. Firms benefit, on average, from the presence of former CEOs on their boards. Firms with former CEO directors have better accounting performance, have higher relative turnover-performance sensitivity of the successor CEO, and can rehire their former CEO directors as CEOs after extremely poor firm performance under the successor CEOs.]