Knowledge that Transforms

Given the complex and controversial nature of short-selling regulation, we review the academic literature and provide insights for policy makers and academics. We organize the complex history of short-selling regulation into three areas: trading restrictions, securities lending regulations, and disclosure requirements. We identify, analyze, and discuss 45 distinct regulations promulgated from 1896 to 2021, primarily by reviewing the academic literature and the data sources employed. We provide several insights regarding the effectiveness of regulatory approaches and the wider impact of short-selling regulation on markets. (JEL G2, G12, G14, G15, G34)

We provide evidence that investors with leverage constraints demand leverage for the sake of leverage. We study the equity closed-end fund (CEF) market and document a strong positive relation between fund leverage and CEF premiums, indicating that investors pay a relative premium for leverage. We perform a quasi-natural experiment and identify leverage as a causal driver of the premium. Leverage changes do not signal improved fund performance. Instead, the only benefit to investors of increased leverage is amplified exposure via greater volatility and risk exposure. We supply external validity by relating our results to the betting-against-beta factor. (JEL G12, G14, G32)

We provide the first systematic asset pricing analysis of one of the main safe asset categories, the repurchase agreement (repo). Based on the temporal and cross-sectional variation in short-term rates, we form a carry that, together with a market factor, prices these near-money assets in a linear pricing model. The carry depicts heterogeneity in nonpecuniary convenience yields of collateral assets and increases in the safety premium and the liquidity premium reflecting opportunity cost. Our carry helps explain the cross-section of short-term rates, as well as of long-term bond returns after accounting for standard bond pricing factors. (JEL E40, E41, G00, G01, G10, G11). 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 develop a model of information and portfolio choice in which ex ante identical investors choose to specialize because of fixed attention costs required in learning about securities. Without this friction, investors would invest in all securities and would be indifferent across a wide range of information choices. When securities’ dividends depend on an aggregate (macro) risk factor and idiosyncratic (micro) shocks, fixed attention costs lead investors to specialize in either macro or micro information. Our results favor Samuelson’s dictum that markets are more micro than macro efficient. We derive testable predictions from our model and find empirical support for our predictions in specialization by U.S. equity mutual funds. (JEL G12, G14, G23) 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 develop a new approach to determine investors’ risk compensations for all distributional moments of a security. Using the concept of entropy, which is a summary of all moments of a risky security, we derive the relationship between expected returns and their compensation for entropy risk. Entropy risk premium (ERP), which is entropy under the physical minus the risk-neutral measure, indicates the hedging cost against changes in risks associated with all moments of the return’s distribution. Applying our model to the commodity markets, we find that ERP carries economically significant information for the cross-section of returns that is different from individual or combined moments. 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.

This paper investigates the firm-level, asset pricing implications of government expenditures. Higher government sales dependency (GD), unconditional on political partisanship cycles, significantly predicts positive future returns, and a GD-weighted portfolio substantially improves the tangency portfolio’s ex post Sharpe ratio. Conditionally, the results are stronger during Republican presidencies. Higher returns do not stem from political connections or political and regulatory risks. The underlying economic channel is higher expected cash flow from increased profitability. Atypical provisions of government contracts and information asymmetry likely drive higher profit margins. A risk versus a mispricing analysis elicits more convincing evidence for mispricing as an explanation for abnormal returns. (JEL G18, G38, H50, H57, H72) 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 perform portfolio-level analyses to understand insurance firms’ preferred habitat behavior in the government bond market. Based on portfolio durations and portfolio weights across maturities, we find that interest rate risk exposures of insurers’ portfolios are related to their operating liabilities and financing constraints. We show that this habitat behavior significantly affects bond pricing. During the “quantitative easing” era, bond purchases by the Federal Reserve have a larger impact on the yields of Treasury bonds with a higher habitat demand. (JEL E43, E52, G11, G12, G23) 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.

The value effect and the idiosyncratic volatility (IVol) discount arise because growth firms and high IVol firms beat the CAPM during periods of increasing aggregate volatility (market volatility and average IVol), that makes their risk low. All else equal, growth options’ value increases with volatility, an effect that is stronger for high IVol firms, for which growth options take a larger fraction of the firm value and firm volatility responds more to aggregate volatility changes. The factor model with the market factor, the market volatility risk factor, and the average IVol factor explains the value effect and the IVol discount. 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.

Predicted stock issuers (PSIs) are firms with expected high-investment and low-profit profiles that earn extremely low returns. We evaluate alternative explanations for this empirical phenomenon. Our results show top-PSI firms are cash-strapped, have lottery-like payoffs, high volatility, high beta, low liquidity, and high shorting costs. Over the next 2 years, top-PSI firms earn return on assets of −30% per year, report disappointing earnings, and experience strongly negative forecast revisions. They perform poorly in down markets and are six times more likely to delist for performance-related reasons. Overall, we find substantial support for mispricing, some support for nonstandard preferences, and virtually no support for the risk explanation. (JEL G12, G14, G32, G40, G41) 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.

This paper explores the impact of product market competition on the positive relation between labor mobility (LM) and future returns. We develop a production-based model and formalize the intuition that low exposure to systematic risk in a concentrated industry limits LM’s amplifying effect on operating leverage. Therefore, the model predicts a stronger positive relation between LM and expected returns for firms in competitive industries. Consistent with the model’s prediction, we empirically find that LM predicts returns only among firms in competitive industries. This evidence suggests that the intensity of competition in firms’ product market potentially drives the positive LM-return relation. (JEL G12, G14, J69) 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.