Knowledge that Transforms

We explore the factor structure in delta-hedged equity option returns. A sparse latent factor model generates a correlation of 0.90 or higher between average and predicted option returns. A comparable performance is achieved with a characteristic-based model containing four factors: the equally weighted option portfolio, a factor based on the difference between historical and implied volatilities, a factor based on the ratio of corporate cash holdings to the total value of the firm’s assets, and a factor based on volatility of volatility. Traditional stock return factors cannot explain these option factors.

Measured as yield spreads against Treasury securities and AAA corporate bonds, the convenience premium of newly issued agency MBS averages more than half of the long-term Treasury convenience premium. The agency MBS convenience premium and issuance amount vary negatively with mortgage rate, consistent with a prepayment-driven channel. Placing agencies into conservatorship in 2008 and introducing liquidity regulations in 2013 significantly affected MBS convenience premium, consistent with government guarantee and regulatory treatment channels. Analyses of dispersion of dealers’ prepayment forecasts, seasoned MBS, and investors’ MBS holdings deliver further economic implications for agency MBS as safe assets.

We show that scale in active equity portfolios is understated by at least 65% because the majority of mutual funds have “twin” institutional vehicles (IVs) managed under the same strategies. Omitting these IVs can severely skew crucial estimates in asset management research: by including IV assets, diminishing returns to scale of active investments is significantly reduced, and dollar value added of active strategies is more substantial and persistent than previously suggested. We further show that IV assets meaningfully influence managers’ portfolio decisions. In addition, these measurement issues apply to common flow measures and extend to passive funds and bond funds.

We identify and estimate price informativeness, a necessary step in testing theories of information aggregation. Starting from a pricing equation and a stochastic process for payoffs, we show how to recover relative price informativeness from regressions of asset price changes on changes in payoffs. Applying our identification results, we estimate a panel of stock-specific measures of informativeness for U.S. stocks. In the cross-section, large stocks with high turnover, idiosyncratic volatility, institutional ownership, and analyst coverage have higher informativeness. In the time series, the median, mean, and standard deviation of the distribution of informativeness have steadily increased since the mid-1980s.

A core responsibility of a central bank is to ensure financial stability by acting as the “lender of last resort” through its Discount Window. The Discount Window, however, has not been effective because its usage is stigmatized. In this paper, we study experimentally how such stigma can be cured. We find that, once a Discount Window facility is stigmatized, removing stigma is difficult. This result is consistent with the Federal Reserve’s experiences which have been unsuccessful at removing the stigma associated with its Discount Window.

We extract information from earnings call transcripts to develop a comprehensive and reliable measure of labor shortage exposure. After validating the measure at the state, industry, and firm levels, we show that firms with labor shortage exposures experience lower earnings call CARs, future stock returns and operating performance. Firms respond to labor shortages by substituting labor with capital and R&D investments, and by producing more production-process patents. Such responses help mitigate the negative effects on future performance. Our measure has broad applicability, and our findings provide new insight into labor-capital substitution in imperfectly competitive labor markets.

We find that firms are the primary sellers who clear the market for index fund buying, providing shares at a nearly one-for-one rate. Most demand-side institutions trade in the same direction as index funds rather than accommodating passive demand. We use two instruments for index fund demand and show that firms causally respond to exogenous passive demand, with prices serving as the coordinating mechanism. Firms satisfy passive demand mostly through nonprimary market issuance, for example, through employee stock-based compensation. Our results suggest that passive investing has systematically supplied capital to firms by enabling equity issuance over the last two decades.

Government-provided flood insurance contracts have strict coverage limits, leaving some households underinsured against flood risk. This paper exploits these strict coverage limits as well as staggered flood map updates to show that mortgage lenders screen for uninsurable flood risk by requiring lower loan-to-value ratios at origination. This credit rationing leads delinquency rates to equalize inside and outside of flood zones, and shifts the composition of mortgage borrowers in flood zones toward richer and higher credit quality individuals. I conclude that lenders reduce credit supply when they retain residual uninsured exposures to flood risk, which has distributional consequences for flood zones.

Long-dated inflation swap contracts provide widely used estimates of expected inflation. We develop methods to estimate complementary tail probabilities for persistently very high or low inflation using inflation options prices. We show that three new adjustments to conventional methods are crucial: inflation, horizon, and risk. We find that: (a) U.S. deflation risk in 2011–2014 has been overstated, (b) ECB unconventional policies lowered deflation disaster probabilities, (c) inflation expectations deanchored in 2021–2022, (d) reanchored as policy tightened, (e) but the 2021–2024 disaster left scars, and (f) U.S. expectations are less sensitive to inflation realizations than in the eurozone.

This paper estimates willingness to pay (WTP) for carbon mitigation from demand for carbon offsets in a field experiment with an online supermarket. The experiment randomizes whether the firm subsidizes the price of the offset or matches the offset’s impact on carbon mitigation. Consumers are price-elastic but fully impact-inelastic, implying that they buy the offset but their WTP for the carbon it mitigates is zero. If the firm informs consumers that it contributes to the offset costs, WTP increases to 16 EUR/tCO$ _2 $. A complementary survey shows that consumers’ stated WTP is 238 EUR/tCO$ _2 $, far above their revealed preferences.