Knowledge that Transforms

Journal Article Cover Get access The Review of Financial Studies, Volume 24, Issue 6, June 2011, Page NP, https://doi.org/10.1093/rfs/hhr046 Published: 01 June 2011

Journal Article Cover Get access The Review of Financial Studies, Volume 24, Issue 10, October 2011, Page NP, https://doi.org/10.1093/rfs/hhr104 Published: 01 October 2011

Using U.K. microeconomic data, we analyze the empirical determinants of voluntary annuity market demand. We nd that annuity market participation increases with nancial wealth, life expectancy and education and decreases with other pension income and a possible bequest motive for surviving spouses. We then show that these empirically-motivated determinants of annuity market participation have the same, quantitatively important, eects in a life-cycle model of annuity demand, saving and portfolio choice. Moreover, reasonable preference parameters predict annuity demand levels comparable to the data, thereby questioning the conventional wisdom that limited annuity market participation is a puzzle to be explained.

Through explicitly incorporating analysts ’ forecasts as observable factors in a dynamic arbitragefree model of the yield curve, this paper proposes a framework for studying the impact of shifts in market sentiment on interest rates of all maturities. An empirical examination reveals that survey expectations about inflation, output growth and the anticipated path of monetary policy actions contain important information for explaining movements in bond yields. Although perceptions about inflation are largely responsible for movements in long-term interest rates, an explicit slope factor is necessary to adequately capture the dynamics of the yield curve. Macroeconomic forecasts play an important role in explaining time-variation in the market prices of risk, with forecasted GDP growth playing a dominant role. The estimated coefficients from a forward-looking monetary policy rule support the assertion that the central bank preemptively reacts to inflationary expectations while suggesting patience in accommodating real output growth expectations. Models of this type may provide traders and policymakers with a new set of tools for formally assessing the reaction of bond yields to shifts in market expectations due to the arrival of news or central bank statements and announcements.

Problems with mortgage financing are widely considered to be a major cause of the recent financial meltdown. Several modern programs have been designed to mimic the Home Owners' Loan Corporation of the 1930s. The HOLC replaced the toxic assets on the balance sheets of financial institutions by buying troubled mortgages and then refinanced the mortgages to allow home owners to avoid losing their homes. We analyze the impact of the HOLC on the nonfarm rental and owned home markets after developing a new data set for over 2800 counties in the United States. In counties with fewer than 50,000 people, where financial markets were not as well developed as in larger cities, the HOLC's financial interventions helped stimulate the demand for owned housing more than it influenced the supply. In rental markets the HOLC appears to have contributed to an increase in the supply of rental housing that was likely associated the improvement of the balance sheets of lending institutions.

We examine the conflicts of interest and the flow of information between divisions of financial institutions. Using data on analyst recommendations and stockholdings of investment banks advising acquirers in mergers, we find evidence that information from investment banking flows to other divisions of the bank. Specifically, following a merger announcement, changes in a bank's stockholdings of the acquirer are positively associated with changes in recommendations by its analyst. This relationship, however, does not exist before the merger announcement. Additional tests show that the relationship between stockholdings and recommendations following a merger announcement is strongest when conflicts of interest for analysts are likely the smallest.

When agents can learn about their abilities as active investors, they rationally “trade to learn ” even if they expect to lose from active investing. The model used to develop this insight draws conclusions that are consistent with empirical study of household trading behavior: Households ’ portfolios underperform passive investments; their trading inten-sity depends on past performance; and they begin by trading small sums of money. Using household data from Finland, the article estimates a structural model of learning and trad-ing. The estimated model shows that investors trade to learn even if they are pessimistic about their abilities as traders. It also demonstrates that realized returns are significantly downward-biased measures of investors ’ true abilities. (JEL D10, G11) While most households adjust their stock portfolios only infrequently, some trade very actively and underperform passive investments.1 I ask whether a model in which investors rationally learn from experience can explain this be-havior, and, if so, what the model tells us about households ’ beliefs. In my model, investors are uncertain about their abilities and learn as they trade. If the value of observing another signal is high, then an investor trades even if she expects to lose money, thus apparently trading “too much. ” If a trade is successful, the investor infers skill and subsequently trades more. If an investor loses money, she will infer less skill and subsequently trade less. After enough losses, she stops trading altogether. Investors who are especially uncertain about their abilities trade small amounts early in their careers until

We analyze complex bond portfolios within the framework of a dynamic general equilibrium asset-pricing model. Equilibrium bond portfolios are nonsensical and imply a trading volume that vastly exceeds observed trading volume on financial markets. Instead, portfolios that combine bond ladders with a market portfolio of equity assets are nearly optimal investment strategies. The welfare loss of these simple investment strategies, when compared to the equilibrium portfolio, converges to zero as the length of the bond ladder increases. This article, therefore, provides a rationale for naming bond ladders as a popular bond investment strategy.

We analyze determinants of secondary debt market liquidity, identifying conditions under which a large investor can profitably buy stakes from small bondholders and offer unilateral debt relief to a distressed firm. We show that endogenous trading by small bondholders may result in multiple equilibria. Some equilibria entail vanishing liquidity and sharp increases in yields absent changing fundamentals. In turn, anticipation of illiquid equilibria induces firms to eschew public debt financing, since such equilibria create higher bankruptcy costs and debt illiquidity discounts. The model thus offers a rational micro-foundation for stylized facts commonly attributed to investor sentiment and CFO market timing. Finally, we show that the vulnerability of debt markets to multiple equilibria is highest during downturns, when small bondholders face severe adverse selection. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.