Knowledge that Transforms

Abstract We administer a theory-driven, lab-in-the-field experiment to study the disposition effect among financial professionals. Our novel design identifies, at the individual participant level, key behavioral drivers of the disposition effect: reference-dependent risk attitudes (“tastes”), second-order uncertainty attitudes (including “ambiguity”), and subjective likelihood assessments (“beliefs”). Among the 237 professionals in our sample, 34% exhibited the disposition effect, which seems to be primarily driven by non-Bayesian beliefs. Our experimental results suggest that, when faced with new information about their asset’s performance, financial professionals failed to update their beliefs sufficiently leading them to sell the asset that gained (lost) value more (less) readily.

Abstract This article documents adverse selection in Ginnie Mae issuers’ early buyout decisions. Conditional on default, we find a 1 percentage point increase in interest rate spread increases the probability of an early buyout by 7–9 percentage points. Issuers buy out higher interest rate spread loans because they generate greater economic gains when they reperform. We illustrate how issuers acquire private soft information that provides direct insight into the likelihood of reperformance. Although the soft information is ostensibly collected on behalf of investors during the delinquent loan servicing process, issuers can exploit the information in their early buyout decisions.

Abstract Earlier research finds correlation between sentiment and future economic growth, but disagrees on the channel that explains this result. We shed new light on this issue by exploiting cross-sectional variation in country size and market efficiency. We find that sentiment shocks in the largest advanced economies increase economic activity, but only temporarily and without affecting productivity. Conversely, sentiment shocks in smaller or less advanced economies predict prolonged economic growth and a corresponding increase in productivity. The results support the view that sentiment can create economic booms, although only in economies where sentiment and fundamentals are harder to disentangle.

Abstract We document a strong, negative relation between the curvature of stock price paths (i.e., price-path convexity) and future short-horizon returns at both the aggregate and firm levels. This relation obtains regardless of the cumulative return during the convexity estimation period. At the aggregate level, convexity is a better predictor of future returns than many commonly used predictors. At the firm level, this effect is not explained by known return predictors, microstructure frictions, or illiquidity. Using survey-based expectations of short-horizon returns, we show that the negative relation between convexity and future returns is driven in part by overextrapolation of past returns.

Firms with more competitive threats from the product market are less likely to commit violations and pay lower penalties. These findings are robust to alternative measures, specifications, and subsamples, as well as different attempts that mitigate endogeneity concerns. Further analyses reveal that the disciplining effect of competition is more pronounced when managers have greater incentives to shirk and when internal governance is weaker, and that violations are associated with poor product market performance only in the presence of competitive pressure. Firms under competitive pressure are more likely to adopt ESG-related incentives in executive compensation contracts and exhibit better worker safety practices. Overall, our evidence suggests that product market threats reduce managerial slack in combating misconduct by increasing the expected damage of violations.

Abstract We utilize Bayesian model averaging to estimate a stochastic discount factor (SDF) for single-stock options. A Bayesian model averaging SDF outperforms reduced-form benchmark models in-sample and out-of-sample in pricing option return anomalies and portfolios. We document that the SDF is dense in characteristics with the implied-realized volatility spread, option return momentum, and jump risk emerging as the most likely included factors. The option SDF exhibits a distinct business cycle pattern and aligns more closely with its counterpart in the stock market than in the bond market.

Abstract Employing a cross-country sample, we examine how a population’s underlying cultural values help explain gender compensation variation across corporate executives. The results show that the cultural differences, embedded in societies long before the board’s compensation decisions, have significant explanatory power for the observed gender gap in executive compensation. Using an Oaxaca–Blinder decomposition combined with variables previously shown to be fundamental determinants of executive compensation, we find that adding cultural measures increases the model’s explanatory power of the gender compensation gap from 44% to 95%. We use further identification strategies to support causal inference.

Abstract Can social norms give rise to distorted information in China? We observe that China’s leading social norm related to alcohol consumption and social drinking enhances earnings management. An analysis of toxic alcohol scandals supports a causal interpretation. Further evidence suggests that the influence of alcohol may come from the negative externality that it creates, which is propagated by corporate leaders and cannot be attenuated by market-oriented institutions. Our results reveal a social norm externality that may have important normative implications.

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