We study the relation between hedge fund equity holdings and measures of informational efficiency of stock prices derived from intraday transactions as well as daily data. Our findings support the role of hedge funds as arbitrageurs who reduce mispricing in the market. Hedge funds invest in stocks that are relatively inefficiently priced, and the price efficiency of these stocks improves after hedge funds increase their holdings. Hedge fund ownership contributes more to efficient pricing than ownership by other types of institutional investors. However, stocks held by hedge funds experienced large declines in price efficiency during several liquidity crises.Received July 27, 2016; editorial decision January 07, 2017 by Editor Wayne Ferson.

We nest multiple volatility components, fat tails, and a U-shaped pricing kernel in a single option model and compare their contribution in describing returns and option data. All three features lead to statistically significant model improvements. A U-shaped pricing kernel is economically most important and improves option fit by 17%, on average, and more so for two-factor models. A second volatility component improves the option fit by 9%, on average. Fat tails improve option fit by just over 4%, on average, but more so when a U-shaped pricing kernel is applied. Overall, these three model features are complements rather than substitutes: the importance of one feature increases in conjunction with the others.

Twitter posts covering 1,082 firms from November 2008 to June 2011 reveal that sentiment in nonlocal Twitter posts is negatively related to future returns, and this negative relation is due to nonlocal posts favoring overpriced stocks, which earn lower subsequent returns. In contrast, local posts do not exhibit this failing. Since nonlocal posts dominate social media, this result highlights the danger of a naive reliance on social media sentiment. The nonlocal disadvantage is larger for firms without public news and firms with higher information asymmetry, suggesting that richer information constrains the exuberance of nonlocal investors.

We show that an increase in a stock’s breadth of institutional ownership or turnover is followed by a significant, but temporary, increase in its CAPM beta estimate and a decrease in its CAPM alpha. The increasing effect of breadth of ownership on beta estimates is mainly driven by short-term investors. These transitory trading-activity-driven components of beta estimates contribute to the empirical failure of the CAPM and the large returns to long-short portfolios that bet against beta. Relations between ownership breadth, turnover, and betas, which we document, help explain the puzzling fact that, on average, betas increase after seasoned equity offerings and stock splits and decrease after stock repurchases.Received November 26, 2015; editorial decision February 17, 2017 by Editor Jeffrey Pontiff.

A simple general equilibrium production economy matches moments of the value premium and equity premium. Value firms have low productivity, but will eventually produce high cash flows. The present value of these temporally distant cash flows is especially sensitive to equity premium movements. The value premium is the reward for bearing this sensitivity. Capital adjustment costs are important. Without these costs, value firms would disinvest heavily, leading to high cash flows today, low cash-flow growth going forward, and little exposure to discount rate shocks. Empirical evidence verifies that value firms have higher cash-flow growth and supports other predictions.

We distinguish between identification and establishing causality. Identification means forming a unique mapping from features of data to quantities that are of interest to economists. Establishing causality by finding sources of exogenous variation is often considered synonymous with identification, but these two concepts are distinct. Exogenous variation is only sometimes necessary and never sufficient to identify economically interesting parameters. Instead, even for causal questions, identification must rest on an underlying economic model. We illustrate these points by analyzing identification in three recent papers and by examining the estimation of a simple dynamic model. Received June 6, 2017; editorial decision September 26, 2017 by Editor Gregor Matvos. Authors have furnished supplementary code, which is available on the Oxford University Press Web site next to the link to the final published paper online

By considering banks as portfolios of assets in different locations, we study how real estate shocks are transmitted across bank’s business areas, while controlling for local demand shocks and bank location-specific factors. Affected banks substantially alter their loan portfolios: we find evidence of real estate price declines affecting both real estate and non-real-estate types of lending. Banks also roll over and fail to liquidate problematic loans, while accumulating more nonperforming loans. These results provide evidence of internal contagion in real estate shocks within banks.

We study the evolution of investment-banking relationships from 1933 to 2007. Relationship exclusivity and client concerns for the state of their banking relationships were strong through the first part of our sample period but then entered a period of sharp decline beginning around 1970. We interpret the bank-client relationship as an informal governance mechanism for curbing opportunistic behavior in a weak contracting environment and examine how technological change aggravated conflicts of interest within investment banks and between banks and their clients. This perspective sheds light on why trust between banks and their clients now appears to be in short supply.Received March 2, 2018; editorial decision June 11, 2018 by Editor Paolo Fulghieri.

We present a novel way to examine macro-financial linkages by focusing on the real effects of bank supervisors’ enforcement actions. Exploiting plausibly exogenous variation in supervisory monitoring intensity, we show that enforcement actions in single-market banks trigger temporarily large adverse effects for the macroeconomy by reducing personal income growth, the number of establishments, and increasing unemployment. These effects are related to contractions in bank lending and liquidity creation, and are more pronounced when we consider enforcement actions on both single-market and multi-market banks, and in counties with fewer banks and greater external financial dependence.

We investigate how seasoned equity offerings (SEOs) by issuers with large customers affect both trading partners’ market values and the relationship's health. We hypothesize that SEOs reveal adverse information about an issuer's major customers and find that issuers and their large customers experience negative returns on SEO announcements. These results are more pronounced when customers have higher levels of information asymmetry and when customer-supplier relationships are particularly important. Large customers of issuers experience larger declines in post-SEO sales, operating performance, and credit ratings than large customers of non-issuers. Also, SEO issuer sales to large customers and relationship duration significantly decline.