Berk and Green (2004) make a theoretical argument that performance persistence should not exist since new money flows into well-performing mutual funds and there are diseconomies of scale, or because successful funds capture excess returns by raising fees. We find that performance prediction continues when we examine samples of larger and larger funds and that past performance predicts future performance for holding periods up to three years. Funds that outperform index funds of the same risk can be identified. We find that expense ratios are lower for large funds, and decrease as funds get larger or perform well.

As a result of poor asset allocation decisions by 401(k) participants, 72% of all plans now offer target date funds, and participants heavily invest in them. Here, we study the characteristics and performance of TDFs, providing a unique view by employing data on TDFs holdings. We show that additional expenses charged by TDFs are largely offset by the low-cost share classes they hold, not normally open to their investors. Additionally, TDFs are very active in their allocation decisions and increasingly bet on nonstandard asset classes. However, TDFs do not earn alpha from timing or their selection of individual assets.

The U.S. mortgage market exhibits competitive instability in which some lenders rapidly emerge from the fringe to substantial market shares. Using inferred discontinuities in application acceptance models to generate local lending shocks, we analyze the impact on a lender of a surge in originations by its competitors. We show that the quickest-growing (but not the largest) competitors divert applications and originations from other lenders. Facing a quickly growing competitor, lenders charge higher interest rates, partially because of the increased risk of their loans. Loan performance suffers for other lenders as the quickest-growing competitor’s originations increase.

This paper provides novel evidence that stronger contract enforcement mitigates holdup in business investment decisions using stark, externally imposed variation in contract enforcement across Native American reservations. My tests focus on the golf course industry. A high degree of sunk costs and long investment horizons in this industry make it naturally subject to the classical holdup problem. I find that state courts, which provide stronger contract enforcement than do tribal courts, lead to at least 27% more golf courses, with greater effects in areas with greater natural amenities. These findings suggest that courts play an important role in facilitating the oft-discussed contractual solutions to the holdup problem. Received November 13, 2017; editorial decision May 31, 2018 by Editor: Uday Rajan.

Do stocks bear a crash risk premium? We examine the empirical performance of the tail index measure from Kelly and Jiang (2014). We find that the tail index explains the cross-section of the discount rate component of returns, but not the cash-flow component. Moreover, in the time series the tail index is uncorrelated with theoretically motivated measures of aggregate uncertainty and systemic risk. In contrast, the tail index Granger causes and is Granger caused by the level of the term structure, and the slope of the term structure Granger causes tail risk. Received June 22, 2016; editorial decision December 23, 2017 by Editor Raman Uppal.

Prime brokers play an important role in intermediating arbitrage capital to hedge funds. A fund’s peer-group ranking, relative to funds that share the same prime broker, significantly affects how investors respond to its past performance. I decompose the standard performance-flow relationship into two components: (1) flows that respond to overall performance rank, and (2) flows that respond to relative (within prime broker) performance rank. Strong relative rank drives fund in-flows, while poor overall rank drives out-flows. These results suggest that prime brokers intermediate about 40% of the standard performance-flow relationship.

Recently, calendar spread futures, futures contracts whose underlying asset is the difference of two futures contracts with different delivery dates, have been successfully introduced for a number of financial futures contracts traded on the Chicago Board of Trade. A spread futures contract is not an obvious financial innovation, as it is a derivative on a derivative security: a spread futures position can be replicated by taking positions in the two underlying futures contracts, both of which may already be quite liquid. This paper provides a motivation for this innovation, demonstrating how the introduction of spread futures can, by changing the relative trading patterns of hedgers and informed traders, affect equilibrium bid–ask spreads, improve hedger welfare, and potentially improve market-maker expected profits. These results are robust both to allowing serial correlation of asset price changes, and investor preference for skewness.

A model of asymmetric asset value information and nonverifiability of liquidation motives is developed to examine the optimal design and governance of asset-backed securities. Because of adverse selection risk, the liquidation option of whole loan sale results in external price discounting of composite cash flows. The alternative liquidation option of senior/subordinated security design is shown to dominate whole loan sale, since cash flow splitting allows the issuer to internalize some or all of the lemons-related liquidation costs. Security subordination levels must increase relative to full information levels, however, to protect uninformed outside investors. Pool diversification and loan bundling are shown to be packaging strategies that can soften the lemons-related subordination effect and therefore increase liquidation proceeds. With respect to security governance, we show that it is the junior securityholder who should control the debt renegotiation process with pooled debt structures. Better asset value information and a first loss position are the reasons for junior securityholder control in our model. Numerous empirical implications of the model are also identified and discussed.Journal of Economic LiteratureClassification Numbers: D46, D81, D82, G13, G21, G24, G32, G33.

When the managers of a firm are not its owners, agency problems result if managers take actions that maximize their own utility rather than the value of the firm. This paper investigates the existence of agency problems in mutual savings and loans. Using a more general approach than in previous studies, I show that mutual S&Ls were operating with an inefficient output mix while stock S&Ls were not, suggesting an agency problem among mutual S&Ls. The results cast doubt on a common argument that mutuals convert to stock S&Ls to capture economies of scale.

How are neighboring firms affected when a bank learns more about a given firm? We analyze exchange-rate-induced movements of Peruvian firms across a threshold that governs their regulatory treatment by banks. Firms that cross the threshold supply more information to their banks and experience a substantial increase in financing. We find positive spillover effects: the neighbors of the above-threshold firms also experience increased financing. These spillovers are confined to neighbors sharing a bank, and the performance of new loans to these neighbors improves, suggesting that the bank has become better informed about other local firms.