Abstract Contrary to the prediction of the standard portfolio diversification theory, many investors place a large fraction of their stock investment in a small number of stocks. I show that underdiversification may be caused by solvency requirements. My model predicts that for quite general preferences and return distributions: (1) underdiversification decreases in discretionary wealth; and (2) expected return and covariance determine which stocks to invest in, but variance, higher moments, and Sharpe ratio do not matter for this choice. In addition, a less-diversified stock portfolio has a higher expected return, a higher volatility, and a higher skewness, and idiosyncratic risks are priced.

Nearly one in five hedge funds change their share restrictions (e.g., lockup) from 2007 to 2012. Using a large panel dataset, this paper is the first to empirically examine the incidence, determinants, and consequences of share restriction changes. We find that funds with high asset liquidity and low liquidity risk are more likely to decrease share restrictions and funds with good performance are more likely to increase share restrictions. A hazard model indicates that funds who actively manage liquidity concerns live longer by adjusting share restrictions. We examine whether changes in share restrictions create an endogeneity bias in the share illiquidity premium (Aragon, 2007) and find that 18% of the premium can be explained by the dynamic nature of contract changes.

This paper examines banks’ diversification–performance nexus from the perspective of demand, the magnitude of households’ financial participation, with bank data from 22 European countries over the period from 2002 to 2009. We argue that the magnitude of households’ financial participation develops asymmetric diversification effects on banks’ performance. The empirical investigation herein provides evidence for the asymmetric influence of households’ financial participation on the effect of banks’ income diversification on their performance. Our findings suggest that banks should take into account the deposit interest rates and the variety of households’ investment habits when they operate toward diversification.

ABSTRACT: This paper examines the ex ante effects of public information quality on market prices and how such effects vary with information asymmetry among traders in a two-period experimental market. We vary public information quality by changing its precision and information asymmetry among traders by varying the distribution of private signals. We find high-quality public disclosure leads to increased price efficiency and decreased cost of capital in the pre-announcement period when information asymmetry is high. The impending high-quality public information increases the competition among informed traders, which leads prices to impound more private information and alleviates the adverse selection problems facing uninformed traders. Our study suggests building a high-quality public information environment (e.g., by adopting high-quality accounting standards or committing to transparent disclosure policies) would likely provide ex ante benefits for firms with significant adverse selection among traders.

We hypothesize that poor country-level governance, which makes public information less reliable, induces fund managers to increase their use of semipublic information. Utilizing data from international mutual funds and stocks over the 2000–2009 period, we find that semipublic information-related stock rebalancing can be five times higher in countries with the worst quality of governance than in countries with the best. The use of semipublic information increases price informativeness but also increases information asymmetry and reduces stock liquidity. It also intensified the price impact and liquidity crunch during the recent global financial crisis.

We present a comprehensive analysis to calculate the Basel III liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) of U.S. commercial banks using Call Report data over the period 2001–2011, and provide indirect empirical evidence on net cash outflow rates of certain liability categories. In addition, we examine potential links between Basel III liquidity risk measures and bank failures using a model that differentiates between idiosyncratic and systemic liquidity risks. We find that while both the NSFR and the LCR have limited effects on bank failures, the systemic liquidity risk is a major contributor to bank failures in 2009 and 2010. This finding suggests that an effective framework of liquidity risk management needs to target liquidity risk at both the individual level and the system level.

We develop a speculation-based theory of home improvements. Housing services are produced from a mix of land and structures. Homeowners optimistic about future prices for these services speculate by making improvements, which we model as them increasing their structures holding fixed their land. The recoup value (the difference between the resale value of improvements and construction costs) is simultaneously increasing in home price appreciation and falls with construction cost growth. This prediction stands in contrast to a consumption-cum-financial constraints motive in which rising home prices loosen financial constraints and lead to lower recoup values. We provide evidence consistent with a speculative motive using data on the costs and recoup values of remodeling projects across US cities.

This paper examines the profits of revenue, earnings, and price momentum strategies in an attempt to understand investor reactions when facing multiple information of firm performance in various scenarios. We first offer evidence that there is no dominating momentum strategy among the revenue, earnings, and price momentums, suggesting that revenue surprises, earnings surprises, and prior returns each carry some exclusive unpriced information content. We next show that the profits of momentum driven by firm fundamental performance information (revenue or earnings) depend upon the accompanying firm market performance information (price), and vice versa. The robust monotonicity in multivariate momentum returns is consistent with the argument that the market does not only underestimate the individual information but also the joint implications of multiple information on firm performance, particularly when they point in the same direction. A three-way combined momentum strategy may offer monthly return as high as 1.44%. The information conveyed by revenue surprises and earnings surprises combined account for about 19% of price momentum effects, which finding adds to the large literature on tracing the sources of price momentum.

The paper empirically explores how more trade transparency affects market liquidity. The analysis takes advantage of a unique setting in which the Shanghai Stock Exchange offered more trade transparency to market participants subscribing to a new software package. First, the results show that the additional data disclosure increased trading activity, but also increased transactions costs through wider bid–ask spreads. Thus, in contrast to popular policy belief, the paper finds that more transparency need not improve market liquidity. Second, the paper finds a particularly strong immediate liquidity impact accompanied by altered trading behavior, which suggests a significant impact on institutional traders subscribing relatively early. Lastly, since the effective level of market transparency is bound to depend on how many traders are subscribing to the data, the study can empirically establish the functional form between market-wide transparency and liquidity. The relationship is non-monotonic, which can explain the lack of consensus in the existing literature where each empirical study is naturally confined to specific parts of the transparency domain.

We use China as a laboratory to test the effect of government quality on cash holdings. We build on, and extend, the existing literature on government expropriation and its interaction with firm-level agency problems by proposing a financial constraint mitigation argument. We find that firms hold less cash when local government quality is high, which is not consistent with the state expropriation argument, but supports the financial constraint mitigation argument. A good government lowers the investment sensitivity to cash flows and cash sensitivity to cash flows, decreases cash holdings more significantly in private firms, and improves access to bank and trade credit financing. We also test and find support for Stulz's (2005) model on the interaction between government and firm agency problems.