Knowledge that Transforms

[I use daily mutual fund returns to shed new light on the question of whether or not mutual fund managers are successful market timers. Previous studies find that funds are unable to time the market return. I study the funds' ability to time market volatility. I show that volatility timing is an important factor in the returns of mutual funds and has led to higher risk-adjusted returns. The returns of surviving funds are especially sensitive to market volatility; those of nonsurvivors are not.]

[We evaluate the performance of models for the covariance structure of stock returns, focusing on their use for optimal portfolio selection. We compare the models' forecasts of future covariances and the optimized portfolios' out-of-sample performance. A few factors capture the general covariance structure. Portfolio optimization helps for risk control, and a three-factor model is adequate for selecting the minimum-variance portfolio. Under a tracking error volatility criterion, which is widely used in practice, larger differences emerge across the models. In general more factors are necessary when the objective is to minimize tracking error volatility.]

[This study uses laboratory experiments to determine the effects of trade and quote disclosure on market efficiency, bid-ask spreads, and trader welfare. We show that trade disclosure increases the informational efficiency of transaction prices, but also increases opening bid-ask spreads, apparently by reducing market-makers' incentives to compete for order flow. As a result, trade disclosure benefits market makers at the expense of liquidity traders and informed traders. We find that quote disclosure has no discernible effects on market performance. Overall our results demonstrate that the degree of market transparency has important effects on market equilibria and on trader and market-maker welfare.]

[For a sample of 1163 mutual funds started over the period 1979-1992, we find that fund initiations are positively related to the level of assets invested in and the capital gains embedded in other funds with the same objective, the fund family's prior performance, the fraction of funds in the family in the low range of fees, and the decision by large families to open similar funds in the prior year. In addition, consistent with the presence of scale and scope economies in fund openings, we find that large families and families that have more experience in opening funds in the past are more likely to open new funds.]

[We model fundamental differences across economic systems and propose optimal bankruptcy laws. We show that creditor-debtor relationships in a given economy are affected by the ability of creditors to obtain information about fundamentals and the managers' ability to strategically use their private information. An optimal bankruptcy law utilizes creditors' information while minimizing managers' use of strategic information. Our proposed laws for a developed bank-based system like Germany include a creditor chapter only, for a developed market-based system like the United States include both a creditor chapter and a debtor chapter, and for an underdeveloped system include both a creditor chapter and a debtor chapter that gives the manager more protection than in a market-based system.]

[We examine communication in laboratory games with asymmetric information. Sellers know true asset qualities. Potential buyers only know the quality distribution. Prohibiting communication, we document the degree of adverse selection. Then we examine two alternative communication mechanisms. Under "cheap talk," each seller can announce any subset of qualities. Under "antifraud," the subset must include the true quality. Both mechanisms improve market efficiency, but very differently. Relying on sellers' frequently exaggerated claims, buyers often overpay under cheap talk. Efficiency gains come at the buyers' expense. The antifraud rule improves efficiency further and eliminates the wealth transfer from buyers to sellers.]

[Portfolio turnpike theorems show that if preferences at large wealth levels are similar to power utility, then the investment strategy converges to the power utility strategy as the horizon increases. We state and prove two simple and general portfolio turnpike theorems. Unlike existing literature, our main result does not assume independence of returns and depends only on discounting of future cash flows. We also provide a critique of portfolio turnpike results, based on the observations that (1) the time required for convergence is often too large to be relevant, and (2) there is no convergence for consumption withdrawal problems.]

[In dealership markets disclosure of size and price details of public trades is typically incomplete. We examine whether full and prompt disclosure of public-trade details improves the welfare of a risk-averse investor. We analyze a model of dealership market where a market maker first executes a public trade and then offsets her position by trading with other market makers. We distinguish between quantity risk and price revision risk. We show that if the market maker learns some information about the motive behind public trade, neither regime is unambiguously welfare superior. This is because greater transparency improves quantity risk sharing but worsens price revision risk sharing.]

[We analyze a unique dataset that includes the full demand schedules of 27 Israeli IPOs that were conducted as nondiscriminatory (uniform price) auctions. To the best of our knowledge, this is the first time the whole demand schedule for any asset is described. The demand schedules are relatively flat around the auction clearing price: The average elasticity is 37. The elasticity is low when the return distribution contains a large unique component. We also find a significant average abnormal return of 4.5% on the first trading day and a positive correlation between the abnormal return and the elasticity of demand.]

Recent nonparametric estimation studies pioneered by Aït-Sahalia document that the diffusion of the short rate is similar to the parametric function, ^1.5, estimated by Chan et al., whereas the drift is substantially nonlinear in the short rate. These empirical properties call into question the efficacy of the existing affine term structure models and beg for alternative models which admit the observed behavior. This article presents such a model. Our model delivers closed-form solutions for bond prices and a concave relationship between the interest rate and the yields. We show that in empirical analyses, our model outperforms the one-factor affine models in both time-series as well as cross-sectional tests.