Knowledge that Transforms

Mutual funds seek alpha, but coskewness is also an important performance attribute. Coskewness of fund returns is associated with market timing, liquidity management, and derivative use. Measures of active management associated with positive alphas are also associated with undesirable coskewness. When controlling for other characteristics, coskewness is positively associated with activity measures related to market timing and negatively associated with activity measures related to stock picking. In the cross-section of funds, the latter effect dominates, so funds generate undesirable coskewness in the pursuit of alpha. Money flows to funds with desirable coskewness. Received October 25, 2016; editorial decision January 29, 2018 by Editor Stijn Van Nieuwerburgh. 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.

Using a firm-level international panel data set, we study if unemployment insurance offered by the government and by firms are substitutes. We exploit cross-country and time-series variation in public unemployment insurance as a shifter of workers’ demand for insurance within firms, and family versus nonfamily ownership as a shifter of firms’ supply of insurance. Our evidence supports the substitutability hypothesis: employment stability in family firms is greater, and the wage discount larger, in countries and periods with less generous public unemployment insurance, whereas no such substitutability emerges for nonfamily firms.

Standard option valuation models leave no room for option illiquidity premia. Yet we find the risk-adjusted return spread for illiquid over liquid equity options is 3.4% per day for at-the-money calls and 2.5% for at-the-money puts. These premia are computed using option illiquidity measures constructed from intraday effective spreads for a large panel of U.S. equities, and they are robust to different empirical implementations. Our findings are consistent with evidence that market makers in the equity options market hold large and risky net long positions, and positive illiquidity premia compensate them for the risks and costs of these positions.

Liquidity provision for corporate bonds has become significantly more expensive after the 2008 crisis. Using index exclusions as a natural experiment during which uninformed index trackers request immediacy, we find that the cost of immediacy has more than doubled. In addition, the supply of immediacy has become more elastic with respect to its price. Consistent with a stringent regulatory environment incentivizing smaller dealer inventories, we also find that dealers revert deviations from their target inventory more quickly after the crisis. Finally, we investigate the pricing impact of information, changes in ownership structure, and differences between bank and nonbank dealers. Received February 22, 2017; editorial decision May 29, 2018 by Editor Itay Goldstein. 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 use the Bayesian method introduced by Gallant and McCulloch (2009) to estimate consumption-based asset pricing models featuring smooth ambiguity preferences. We rely on semi-nonparametric estimation of a flexible auxiliary model in our structural estimation. Based on the market and aggregate consumption data, our estimation provides statistical support for asset pricing models with smooth ambiguity. Statistical model comparison shows that models with ambiguity, learning, and time-varying volatility are preferred to the long-run risk model. We also analyze asset pricing implications of the estimated models. Received April 12, 2016; editorial decision September 11, 2018 by Editor Stijn Van Nieuwerburgh. 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 document that firms can effectively retain executives by granting deferred equity pay. We show this by analyzing a unique regulatory change (FAS 123-R) that prompted 723 firms to suddenly eliminate stock option vesting periods. This allowed CEOs to keep 33% more options when departing the firm, and we find that voluntary CEO departure rates subsequently rose from 5% to 21%. Our identification strategy exploits FAS 123-R’s almost-random timing, which was staggered by firms’ fiscal year-ends. Firms that experienced departures suffered negative stock price reactions, and responded by increasing compensation for remaining and newly hired executives.

Investment-based asset pricing research highlights the role of irreversibility as a determinant of firms’ risk and expected return. In a neoclassical model of a firm with costly scale adjustment options, we show that the effect of scale flexibility (i. e., contraction and expansion options) is to determine the relation between risk and operating leverage: risk increases with operating leverage for inflexible firms, but decreases for flexible firms. Guided by theory, we construct easily reproducible proxies for inflexibility and operating leverage. Empirical tests provide support for the predicted interaction of these characteristics in stock returns and risk.

Human capital acquired while working in other industries before joining fund management provides fund managers with an information advantage. Fund managers exploit this advantage by overweighting their experience industries and by picking outperforming stocks from these industries. These managers’ superior information is impounded into stock prices slowly, suggesting that their information is unique and takes a while to be discovered by the markets. Families exploit their manager’s industry-specific human capital by broadly employing their investment ideas in other funds. The investment value of industry experience is unaffected by whether or not the manager with such experience is in a team. Received August 25, 2016; editorial decision December 24, 2017 by Editor Andrew Karolyi.

We propose a production-based general equilibrium model to study the link between timing of cash flows and expected returns, both in the cross-section of stocks and along the aggregate equity term structure. Our model incorporates long-run growth news with time-varying volatility and slow learning about the exposure that firms have with respect to these shocks. Our framework provides a unified explanation of the stylized features of the slope of the term structure of equity returns, its variations over the business cycle, and the negative relationship between cash-flow duration and expected returns in the cross-section of book-to-market-sorted portfolios. Received May 27, 2017; editorial decision October 12, 2017 by Editor Itay Goldstein.

We examine “reaching for yield” in U.S. corporate bond mutual funds. We define reaching for yield as tilting portfolios toward bonds with yields higher than the benchmarks. We find that funds generate higher returns and attract more inflows when they reach for yield, especially in periods of low-interest rates. Returns for high reaching-for-yield funds nevertheless tend to be negative on a risk-adjusted basis. Funds engage in rank-chasing behavior by reaching for yield, although these incentives are moderated by the illiquid nature of corporate bonds. High reaching-for-yield funds hold less cash and less liquid bonds, exacerbating redemption risks.