Research articles for the 2019-12-28
Asset Allocation Under Dynamic Constraints: Role of Information and Wealth Inequality
SSRN
Resource allocation is an integral part of the lives of every individual living in today’s modern society where capitalism has made available a plethora of choices ranging from choosing your career to choosing your meal. Irrational decision making leads to a cascading effect not on just the well-being of the individuals but also on the society as a whole. Intuitive causality tells us that in decisions made under the absence of information lead to poor results. Today information asymmetry is playing a major rule into the already burgeoning inequality between the people of highest and lowest strata. It might be possible to reduce this inequality by addressing the problem of information asymmetry. We attempt to juxtapose the decisions made in presence and absence of certain information by experiments and try to decipher till what extent the lack of information leads to a poor decision-making and what remedies can be thought of to address the problem. We design a set of experiments carried out with two groups of university students, where one group has access to certain decision inputs while the other group is constrained with limited information. In the dynamic resource allocation game, we observe that the participants with more information were able to take decisions relating to allocation of financial resources that led to better outcomes. This was reflected from the amount of investments made by the group as well as the job choices chosen. These results point towards a dire need for information dissemination especially when it comes to the role of informed resource allocation in reducing inequality in a rapidly growing country like India. When individuals are aware of the opportunities at hand as well as the risks and rewards attributed to the same they are able to make choices that help them lift out of poverty. These results can be particularly useful in conceiving and designing government programmes that are targeted towards the poor. Despite the presence of numerous schemes, the lack of adequate information leads to poor outcomes.
SSRN
Resource allocation is an integral part of the lives of every individual living in today’s modern society where capitalism has made available a plethora of choices ranging from choosing your career to choosing your meal. Irrational decision making leads to a cascading effect not on just the well-being of the individuals but also on the society as a whole. Intuitive causality tells us that in decisions made under the absence of information lead to poor results. Today information asymmetry is playing a major rule into the already burgeoning inequality between the people of highest and lowest strata. It might be possible to reduce this inequality by addressing the problem of information asymmetry. We attempt to juxtapose the decisions made in presence and absence of certain information by experiments and try to decipher till what extent the lack of information leads to a poor decision-making and what remedies can be thought of to address the problem. We design a set of experiments carried out with two groups of university students, where one group has access to certain decision inputs while the other group is constrained with limited information. In the dynamic resource allocation game, we observe that the participants with more information were able to take decisions relating to allocation of financial resources that led to better outcomes. This was reflected from the amount of investments made by the group as well as the job choices chosen. These results point towards a dire need for information dissemination especially when it comes to the role of informed resource allocation in reducing inequality in a rapidly growing country like India. When individuals are aware of the opportunities at hand as well as the risks and rewards attributed to the same they are able to make choices that help them lift out of poverty. These results can be particularly useful in conceiving and designing government programmes that are targeted towards the poor. Despite the presence of numerous schemes, the lack of adequate information leads to poor outcomes.
Asset Pricing with Price Levels
SSRN
We derive an exact identity linking future abnormal returns to current price-level deviations in order to estimate asset-pricing models using price levels rather than returns. Our identity highlights that abnormal returns occurring sooner, in more valuable states, or after relatively large capital gains are associated with larger price-level deviations. With our novel approach in hand, we measure the extent to which several well-known return anomalies are associated with price-level deviations from the CAPM. We are unable to reject the hypothesis that the CAPM explains the cross-section of prices of size-, book-to-market-, momentum-, and profitability-sorted portfolios well. However, the cross-section of prices of investment-sorted portfolios rejects the model.
SSRN
We derive an exact identity linking future abnormal returns to current price-level deviations in order to estimate asset-pricing models using price levels rather than returns. Our identity highlights that abnormal returns occurring sooner, in more valuable states, or after relatively large capital gains are associated with larger price-level deviations. With our novel approach in hand, we measure the extent to which several well-known return anomalies are associated with price-level deviations from the CAPM. We are unable to reject the hypothesis that the CAPM explains the cross-section of prices of size-, book-to-market-, momentum-, and profitability-sorted portfolios well. However, the cross-section of prices of investment-sorted portfolios rejects the model.
Investing in U.S. Sectors: Mutual Funds vs. ETFs
SSRN
This paper examines performance of 95 actively managed U.S. sector equity mutual funds from 29 fund families relative to their peer exchange-traded funds, SPDR sector ETFs, in the period of 2008 to 2017. Our results do not show considerable evidence that actively managed sector mutual funds outperform their passive counterparties. None of the mutual fund portfolios produces a significant positive alpha through factor models or delivers a significant positive alpha against their peer ETFs. When focusing on the 9 oldest actively managed Fidelity sector mutual funds, outperformance in the period of 1999-2010, which is reported in literature, appears to fade away during the period of 2011-2017. Alpha analyses of a larger sample of 60 sector mutual funds show similar performance deterioration in the same 19-year period. The results indicate that U.S. sector equity market has become more efficient in the past decade.
SSRN
This paper examines performance of 95 actively managed U.S. sector equity mutual funds from 29 fund families relative to their peer exchange-traded funds, SPDR sector ETFs, in the period of 2008 to 2017. Our results do not show considerable evidence that actively managed sector mutual funds outperform their passive counterparties. None of the mutual fund portfolios produces a significant positive alpha through factor models or delivers a significant positive alpha against their peer ETFs. When focusing on the 9 oldest actively managed Fidelity sector mutual funds, outperformance in the period of 1999-2010, which is reported in literature, appears to fade away during the period of 2011-2017. Alpha analyses of a larger sample of 60 sector mutual funds show similar performance deterioration in the same 19-year period. The results indicate that U.S. sector equity market has become more efficient in the past decade.
It’s a Small World: The Importance of Social Connections with Auditors to Mutual Fund Managers’ Portfolio Decisions
SSRN
We examine the impact of social connections between mutual fund managers and auditors of public firms on mutual fund stock-holdings. We find that mutual funds whose managers are socially connected with firm auditors hold more shares of these firms. In cross-sectional results consistent with expectations, we find that the effect of social connections on mutual fund stock-holdings is more pronounced when the social connections are stronger, for small audit firms, and for public firms with greater business opacity, stock price synchronicity, and systematic risk. We further document that mutual funds with socially connected auditors engage more in informed trading and generate superior portfolio returns. In compensation, connected auditors benefit from more audit business and higher audit and non-audit fees from public firms. Our evidence implies information transfer from auditors to mutual fund managers through their social connections, which improves mutual fund portfolio decisions.
SSRN
We examine the impact of social connections between mutual fund managers and auditors of public firms on mutual fund stock-holdings. We find that mutual funds whose managers are socially connected with firm auditors hold more shares of these firms. In cross-sectional results consistent with expectations, we find that the effect of social connections on mutual fund stock-holdings is more pronounced when the social connections are stronger, for small audit firms, and for public firms with greater business opacity, stock price synchronicity, and systematic risk. We further document that mutual funds with socially connected auditors engage more in informed trading and generate superior portfolio returns. In compensation, connected auditors benefit from more audit business and higher audit and non-audit fees from public firms. Our evidence implies information transfer from auditors to mutual fund managers through their social connections, which improves mutual fund portfolio decisions.
Lending Along the Supply Chain
SSRN
Despite the fact that economic interconnections among firms are very common, there is little research that examines the equilibrium outcome of such interconnections in the loan market. We focus on how supply chain interconnections among borrowers within a lender’s loan portfolio affect equilibrium loan spread and lead arranger share in the syndicated loan market. We find that both loan spread and lead arranger share are significantly lower when the lead arranger has a pre-existing loan with the borrower’s major customer. This finding suggests that such “supply chain loans†ease syndicate participants’ moral hazard concerns more than they exacerbate concerns about adverse selection. Consistent with supply chain loans providing benefits to both the borrower and lead arranger, we provide evidence that a borrower is more likely to obtain a loan from a lender who already has an existing loan with its key customer. Our findings provide insights into the mechanisms through which supply chain interdependencies, and more generally, economic relationships, affect debt markets.
SSRN
Despite the fact that economic interconnections among firms are very common, there is little research that examines the equilibrium outcome of such interconnections in the loan market. We focus on how supply chain interconnections among borrowers within a lender’s loan portfolio affect equilibrium loan spread and lead arranger share in the syndicated loan market. We find that both loan spread and lead arranger share are significantly lower when the lead arranger has a pre-existing loan with the borrower’s major customer. This finding suggests that such “supply chain loans†ease syndicate participants’ moral hazard concerns more than they exacerbate concerns about adverse selection. Consistent with supply chain loans providing benefits to both the borrower and lead arranger, we provide evidence that a borrower is more likely to obtain a loan from a lender who already has an existing loan with its key customer. Our findings provide insights into the mechanisms through which supply chain interdependencies, and more generally, economic relationships, affect debt markets.
The Diminishing Hedging Role of Crude Oil: Evidence From Time Varying Financialization
SSRN
Using daily data from 1999 to 2019, we document a diminishing hedging role that crude oil plays for the stock market as a result of growing financialization. With interest rates driven near zero after the crisis of 2007-2009 and the extreme volatility of oil prices, vector auto-regressions (VARs) suggest larger roles of oil prices in explaining stock returns during the 2007-2009 crisis and afterwards. We also find increased co-movement between stock-oil during post-crisis period. Our results indicate that more short positions in crude oil are required to hedge long positions in equity markets during post-crisis period, i.e., it cost more to use crude oil investments as a hedging tool lately compared to pre-crisis period. Therefore, investors holding a mixed portfolio of stocks and oil face less diversification.
SSRN
Using daily data from 1999 to 2019, we document a diminishing hedging role that crude oil plays for the stock market as a result of growing financialization. With interest rates driven near zero after the crisis of 2007-2009 and the extreme volatility of oil prices, vector auto-regressions (VARs) suggest larger roles of oil prices in explaining stock returns during the 2007-2009 crisis and afterwards. We also find increased co-movement between stock-oil during post-crisis period. Our results indicate that more short positions in crude oil are required to hedge long positions in equity markets during post-crisis period, i.e., it cost more to use crude oil investments as a hedging tool lately compared to pre-crisis period. Therefore, investors holding a mixed portfolio of stocks and oil face less diversification.
The Impact of Corporate Reporting Readability on Informational Efficiency
SSRN
Purpose â€" Informational efficiency is a fundamental aspect of capital market quality, and therefore, regulators, managers and practitioners attempt to find ways to improve the informational efficiency. Since prior studies majorly focus on the numerical attributes of corporate reporting, it is not yet adequately known whether or not the linguistic attributes of corporate reporting affect informational efficiency. Thus, the purpose of this paper is to examine whether corporate reporting readability (readability), as an important linguistic attribute of corporate reporting, affects informational efficiency. Design/methodology/approach â€" To measure readability, this paper uses Fog index. Moreover, to measure informational efficiency, the paper uses stock return variance ratios. Findings â€" The findings reveal a positive and significant association between readability and informational efficiency. Moreover, the findings show that the association of readability and informational efficiency is stronger for firms with higher information asymmetry. The findings further document the spillover effect of readability, in the sense that the readability of economically related public firms affects a firm’s informational efficiency. Overall, the results support the arguments that readability enhances informational efficiency. Originality/value â€" This study contributes to the literature by providing evidence on the internalities and externalities of readability in the context of informational efficiency. Thus, the study will be of interest to regulators, managers and practitioners, especially in the emerging capital market, who tend to find practical and easy ways to improve the informational efficiency.
SSRN
Purpose â€" Informational efficiency is a fundamental aspect of capital market quality, and therefore, regulators, managers and practitioners attempt to find ways to improve the informational efficiency. Since prior studies majorly focus on the numerical attributes of corporate reporting, it is not yet adequately known whether or not the linguistic attributes of corporate reporting affect informational efficiency. Thus, the purpose of this paper is to examine whether corporate reporting readability (readability), as an important linguistic attribute of corporate reporting, affects informational efficiency. Design/methodology/approach â€" To measure readability, this paper uses Fog index. Moreover, to measure informational efficiency, the paper uses stock return variance ratios. Findings â€" The findings reveal a positive and significant association between readability and informational efficiency. Moreover, the findings show that the association of readability and informational efficiency is stronger for firms with higher information asymmetry. The findings further document the spillover effect of readability, in the sense that the readability of economically related public firms affects a firm’s informational efficiency. Overall, the results support the arguments that readability enhances informational efficiency. Originality/value â€" This study contributes to the literature by providing evidence on the internalities and externalities of readability in the context of informational efficiency. Thus, the study will be of interest to regulators, managers and practitioners, especially in the emerging capital market, who tend to find practical and easy ways to improve the informational efficiency.
The Impact of ETFs on Asset Markets: Experimental Evidence
SSRN
We examine how exchange traded funds (ETFs) affect asset pricing, volatility and trade volume in a laboratory asset market. We consider markets with zero or negative correlations in asset returns and the presence or absence of composite ETF assets. We find that when the returns on assets are negatively correlated, the presence of an ETF asset reduces mis-pricing and price volatility without decreasing trading volume. In the case where returns have zero correlation, the ETF asset has no impact. Thus, our findings suggest that ETFs do not harm, and may in fact improve, price discovery and liquidity in asset markets.
SSRN
We examine how exchange traded funds (ETFs) affect asset pricing, volatility and trade volume in a laboratory asset market. We consider markets with zero or negative correlations in asset returns and the presence or absence of composite ETF assets. We find that when the returns on assets are negatively correlated, the presence of an ETF asset reduces mis-pricing and price volatility without decreasing trading volume. In the case where returns have zero correlation, the ETF asset has no impact. Thus, our findings suggest that ETFs do not harm, and may in fact improve, price discovery and liquidity in asset markets.
The Ties that Bind: Work Connections and Mutual Fund Investment Ideas
SSRN
Mutual funds with managers who share a work connection have greater overlap in portfolio holdings, equity purchases, and equity sales. This result persists even after the work connection ends. Several tests to mitigate endogeneity concerns provide supportive evidence of a causal interpretation that work connections lead to the sharing of investment ideas among mutual fund managers. Finally, we find that equity purchases shared through work connections outperform non-connected purchases, particularly in fund families that provide strong incentives to compete, suggesting that managers likely share information with a quid-pro-quo expectation.
SSRN
Mutual funds with managers who share a work connection have greater overlap in portfolio holdings, equity purchases, and equity sales. This result persists even after the work connection ends. Several tests to mitigate endogeneity concerns provide supportive evidence of a causal interpretation that work connections lead to the sharing of investment ideas among mutual fund managers. Finally, we find that equity purchases shared through work connections outperform non-connected purchases, particularly in fund families that provide strong incentives to compete, suggesting that managers likely share information with a quid-pro-quo expectation.
