All in

Kevin Lewis

January 29, 2018

Price Manipulation in the Bitcoin Ecosystem
Neil Gandal et al.
Journal of Monetary Economics, forthcoming


To its proponents, the cryptocurrency Bitcoin offers the potential to disrupt payment systems and traditional currencies. It has also been subject to security breaches and wild price fluctuations. This paper identifies and analyzes the impact of suspicious trading activity on the Mt. Gox Bitcoin currency exchange, in which approximately 600,000 bitcoins (BTC) valued at $188 million were fraudulently acquired. During both periods, the USD-BTC exchange rate rose by an average of four percent on days when suspicious trades took place, compared to a slight decline on days without suspicious activity. Based on rigorous analysis with extensive robustness checks, the paper demonstrates that the suspicious trading activity likely caused the unprecedented spike in the USD-BTC exchange rate in late 2013, when the rate jumped from around $150 to more than $1,000 in two months.

Pay for Praise: Do Rating Agencies Get Paid More When They Provide Higher Ratings? An Examination of the Consequences of the Recalibration of Municipal Debt
Jacquelyn Gillette et al.
MIT Working Paper, November 2017


We ask whether credit rating agencies receive higher fees and gain greater market share when they provide more favorable ratings. We investigate this issue using Fitch and Moody’s 2010 recalibration of their rating scales, which increased ratings in the absence of any underlying change in issuer credit quality. Consistent with concerns raised by critics of the issuer pay model, we find that compared to S&P, the governmental entities rated by Moody’s and Fitch received better ratings, were charged higher fees, and issued bonds with lower yields after the recalibration event. This recalibration also led to increases in Fitch and Moody’s market share. Overall the results are consistent with concerns that issuers will pay more for higher ratings.

Cultural Proximity and the Processing of Financial Information
Qianqian Du, Frank Yu & Xiaoyun Yu
Journal of Financial and Quantitative Analysis, December 2017, Pages 2703-2726


This paper examines how culture affects information asymmetry in financial markets. We extract firms traded in the United States but headquartered in regions sharing Chinese culture (“Chinese firms”), and we manually identify a group of U.S. analysts of Chinese ethnic origin (“Chinese analysts”). We find that Chinese analysts issue more accurate forecasts on Chinese firms than non-Chinese analysts. The effect is stronger among firms with less transparent information environments. Further evidence suggests that cultural proximity can go beyond language commonality and analysts’ pre-existing channels for information. Market reaction is stronger when Chinese analysts issue favorable forecast revisions or upgrades about Chinese firms.

Oh What a Beautiful Morning! Diurnal Influences on Executives and Analysts: Evidence from Conference Calls
Jing Chen, Elizabeth Demers & Baruch Lev
Management Science, forthcoming


This study provides novel evidence that expert economic agents’ work-related activities are systematically influenced by the time of day. We use archival data derived from time-stamped quarterly earnings conference calls together with linguistic algorithms to measure and track the moods of executives and analysts at different times of the day. The evidence indicates that the tone of conference call discussions deteriorates markedly over the course of the trading day, with both analysts’ and executives’ moods becoming more negative as the day wears on. Capital market pricing tests reveal that the time-of-day-induced negative tone leads to temporary stock mispricings. Our findings are relevant because the diurnal variations in behavior documented in the context of quarterly earnings calls are likely to extend across other important corporate communication, decision making, and performance situations, leading to potentially significant economic consequences.

Agnostic fundamental analysis works
Söhnke Bartram & Mark Grinblatt
Journal of Financial Economics, forthcoming


To assess stock market informational efficiency with minimal data snooping, we take the view of a statistician with little knowledge of finance. The statistician uses techniques such as least squares to estimate peer-implied fair values from the market values of replicating portfolios with the same accounting statements as the company being valued. Divergence of a company's peer-implied value estimate from its market value represents mispricing, motivating a convergence trade that earns risk-adjusted returns of up to 10% per year and is economically significant for both large and small cap firms. The rate of convergence decays to zero over the subsequent 34 months.

The Power of Firm Fundamentals in Explaining Stock Returns
Shuai Shao, Robert Stoumbos & Frank Zhang
Columbia University Working Paper, December 2017


Prior literature shows that earnings have come to explain less stock price movement over time, suggesting that firm fundamentals have become less important. In this paper, we replace earning with earnings announcement returns as a measure of fundamental news and find that earnings news has come to explain more price movement over time. In the years after 2004, earnings announcement returns explain roughly 20% of the annual return — twice as much as they did before, indicating that firm fundamentals have become more important, not less. This pattern occurs for other forms of fundamental news. Collectively, the returns around earnings announcements, analyst forecast revisions, analyst recommendations, and 8-K filings went from explaining 15% of annual returns in the 1990s to 35% in the 2010s. In exploring possible explanations for the increase in the explanatory power of fundamental news, we find evidence consistent with regulatory changes, such as Sarbanes-Oxley and the Global Settlement, collectively making disclosures more credible and informative. In contrast, neither pre-announcement information leaks, sample composition changes, nor concurrent information events (e.g., management forecasts) explain the increase in explanatory power.

Should Retail Investors' Leverage Be Limited?
Rawley Heimer & Alp Simsek
NBER Working Paper, December 2017


Does the provision of leverage to retail traders improve market quality or facilitate socially inefficient speculation that enriches financial intermediaries? This paper evaluates the effects of 2010 regulations that cap the provision of leverage to previously unregulated U.S. retail traders of foreign exchange. Using three unique data sets and a difference-in-differences approach, we document that the leverage constraint reduces trading volume by 23 percent, improves high-leverage traders' portfolio return by 18 percentage points per month (thereby alleviating their losses by 40 percent), and reduces brokerages' operating capital by 25 percent. Yet, the policy does not affect the relative bid-ask prices charged by the brokerages. The announcement of pending leverage restrictions has no effect on the traders or the market. We reconcile these findings with a model in which traders with heterogeneous and dogmatic beliefs take speculative positions in pursuit of high returns, and a competitive brokerage sector intermediates these trades subject to technological and informational costs. The model is largely consistent with our empirical findings, and it suggests that the leverage constraint policy generates a sizable belief-neutral improvement in social welfare by economizing on the productive resources used to intermediate speculation.

The Changing Pattern of Stock Ownership in the US: 1989–2013
James Poterba
Eastern Economic Journal, January 2018, Pages 1–17


In 1989, 32 percent of US households reported some stock ownership, either directly, through a mutual fund, or through an investment held in a defined contribution retirement plan. Twelve years later, in 2001, more than half of all households – 53 percent – reported some stock ownership. Expansion of equity mutual fund ownership, inside and outside defined contribution retirement plans, was the central driver of this expansion. Direct stock ownership also rose over this period, from 17 to 21 percent. The growth of stock ownership slowed, and in some cases reversed, in the subsequent twelve years. The overall rate of stock ownership fell to 49 percent in 2013, and direct stock ownership declined to 14 percent. The substantial increase in stock ownership during the 1990s, and the slight decline since then, may help to distinguish among competing explanations for the low rate of overall stock market participation. There is some evidence that US households became more risk tolerant during the 1990s, and that the transactions costs of equity market participation declined. While transactions costs have not increased in the subsequent period, self-reported risk tolerance has declined. The rapid expansion of defined contribution retirement plans in the 1990s, and the slowdown in that expansion after 2001, is also an important factor in explaining the ownership pattern over time.

Flow-Induced Trading Pressure and Corporate Investment
Xiaoxia Lou & Albert Wang
Journal of Financial and Quantitative Analysis, forthcoming


The impact of liquidity-motivated institutional trading on firms’ real decisions is not confined to periods of financial crisis. Firms subject to mutual fund flow-driven selling pressure reduce share issuance and investment, whereas firms experiencing buying pressure do not increase investment, although they issue more equity. Firms under extreme selling pressure cut quarterly investment by 0.075 percentage points of total assets, which is 4.3% of the average quarterly investment in our sample. We also find evidence that the effect is not attributed to managerial learning or catering incentives. Rather, flow-driven trading affects investment mainly through its impact on the financing cost.

Do Alpha Males Deliver Alpha? Testosterone and Hedge Funds
Yan Lu & Melvyn Teo
University of Central Florida Working Paper, January 2018


Using facial width-to-height ratio (fWHR) as a proxy for pubertal testosterone, we show that high-testosterone hedge fund managers significantly underperform low-testosterone hedge fund managers after adjusting for risk. Moreover, high-testosterone managers are more likely to terminate their funds, disclose violations on their Form ADVs, and display greater operational risk. We trace the underperformance to high-testosterone managers' greater preference for lottery-like stocks and reluctance to sell loser stocks. Our results are robust to adjustments for sample selection, marital status, sensation seeking, and manager age, and suggest that investors should eschew masculine hedge fund managers.

Size Doesn't Matter: Diseconomies of Scale in the Mutual Fund Industry Revisited
Blake Phillips, Kuntara Pukthuanthong & Raghavendra Rau
Journal of Banking & Finance, forthcoming


The academic literature has found mixed evidence that fund size is negatively related to performance. One reason for the lack of consensus may be that the fund size and performance relation is endogenous. In this paper, we identify a set of instrumental variables that influence fund size but are unrelated to expected fund performance. Using this specification, we show that fund size does not appear to affect fund performance.

Going for Gold: An Analysis of Morningstar Analyst Ratings
Will Armstrong, Egemen Genc & Marno Verbeek
Management Science, forthcoming


We investigate Morningstar’s new qualitative, forward-looking analyst ratings, which reflect independent analysts’ expectations of a fund’s future performance. We find relatively higher flows to funds receiving higher ratings, suggesting that the average investor values the analyst’s subjective views when allocating their wealth. Performance tests show that investors would have earned significantly higher returns over our sample period by investing in funds with the highest analyst conviction. These results suggest that independent research that expands the information set to include qualitative elements may help investors make better investment allocation decisions.

Davids, Goliaths, and Business Cycles
Jefferson Duarte & Nishad Kapadia
Journal of Financial and Quantitative Analysis, December 2017, Pages 2429-2460


We show that a simple, intuitive variable, Goliath versus David (GVD), reflects time variation in discount rates related to changes in aggregate business conditions. GVD is the annual change in the weight of the largest 250 firms in the aggregate stock market and is motivated by research that shows that small firms are more severely impacted than large firms by economic shocks due to differences in access to external finance. We find that GVD is the best single predictor of out-of-sample market returns among traditional predictors, predicting quarterly market returns with an out-of-sample R 2 of 6.3% in the 1976–2011 evaluation period.

Venture capital and career concerns
Nicholas Crain
Journal of Corporate Finance, forthcoming


This paper finds evidence that the market for follow-on capital discourages risk taking by venture capital fund managers. The amount of follow-on capital raised by venture capitalists is concave with respect to current fund performance. In addition, managers with less consistent performance are slower, and less likely, to raise a follow-on fund. Venture capitalists adjust their investment strategy to balance fundraising incentives against the incentive to pursue risk provided by carried interest. The findings are consistent with models of career concerns, where an agent's compensation is designed to (partially) offset the implicit incentives created by future employment opportunities.

Horses for Courses: Fund Managers and Organizational Structures
Yufeng Han, Tom Noe & Michael Rebello
Journal of Financial and Quantitative Analysis, December 2017, Pages 2779-2807


We model and test the relations between the team management of mutual funds, managers’ ability, performance, and holdings. Our model predicts that team-managed funds perform better and behave more conservatively than single-manager funds. However, the effect of team management is masked in equilibrium because high-ability managers rationally self-select into single-manager funds. Consistent with the model’s prediction, we find that team-managed funds perform better and deviate less from their benchmark allocations than single-manager funds with the same characteristics. These differences are marked after we control for the endogenous self-selection of managers.

Four centuries of return predictability
Benjamin Golez & Peter Koudijs
Journal of Financial Economics, forthcoming


We combine annual stock market data for the most important equity markets of the last four centuries: the Netherlands and UK (1629–1812), UK (1813–1870), and US (1871– 2015). We show that dividend yields are stationary and consistently forecast returns. The documented predictability holds for annual and multi-annual horizons and works both in- and out-of-sample, providing strong evidence that expected returns in stock markets are time-varying. In part, this variation is related to the business cycle, with expected returns increasing in recessions. We also find that, except for the period after 1945, dividend yields predict dividend growth rates.

Subsidizing Liquidity with Wider Ticks: Evidence from the Tick Size Pilot Study
Robert Bartlett & Justin McCrary
University of California Working Paper, November 2017


Using data from the 2016-2018 tick size pilot study, we examine the efficacy of using wider tick sizes to subsidize market-making in small capitalization stocks. We demonstrate that realized spreads decay quickly within the initial microseconds of a trade, consistent with market makers being subject to adverse selection from asymmetrical speed among market makers. The effect reduces the subsidy offered by wider tick sizes, particularly for non-HFT market makers. The profit subsidy from wider tick sizes is also compromised by a significant shift in trading to “taker/maker” exchanges and to midpoint trading in non-exchange venues. The pilot’s exception for midpoint trades also accounts for the fact that nearly a third of trading remains in non-exchange venues despite the inclusion of a trade-at rule. Overall, these findings point to considerable inefficiencies in the pilot study’s goal of using wider tick sizes to subsidize liquidity provision in small capitalization stocks.

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