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Faculty & Research

Research Colloquium 2013-2014

We're looking forward to seeing you at our upcoming Distinguished Speaker Series that kicks off November 12, 2014, here at UC Irvine with Kimberly Cripe, president and CEO of CHOC Children's, one of the top pediatric health care systems in the nation. More information coming soon!

 

Finance

 

Professors Zheng Sun
Title: “Dispersion in Beliefs Among Active Mutual Funds and the Cross-Section of Stock Returns”
Co-authors: Hao Jiang
Accepted at: Journal of Financial Economics

October 2013

 

We propose a measure of dispersion in fund managers’ beliefs about future stock returns based on their active holdings, i.e., deviations from benchmarks. We find that both the level of and the change in dispersion positively predict subsequent stock returns on a risk-adjusted basis. This effect is particularly pronounced among stocks with high information asymmetry and binding short-sale constraints. These results suggest that a subgroup of informed managers drive up the dispersion in active holdings when they place large bets after receiving positive private information. Binding short-sale constraints, however, prevent them from fully using their negative private information, leading to low dispersion in active holdings.

 


  

Professors David Hirshleifer and Siew Hong Teoh
Title: “Overvalued Equity and Financing Decisions"
Co-author: Ming Dong
Accepted at: The Review of Financial Studies

September 2012

   

We test whether and how equity overvaluation affects corporate financing decisions using an ex ante  misvaluation measure that filters firm scale and growth prospects from market price. We find that equity issuance and total financing increase with equity overvaluation; but only among overvalued stocks; and that equity issuance is more sensitive than debt issuance to misvaluation. Consistent with managers catering to maintain overvaluation and with investment scale economy effects, the sensitivity of equity issuance and total financing to misvaluation is stronger among firms with potential growth opportunities (low book-to-market, high R&D, or small size) and high share turnover.

 


  

Professor David Hirshleifer
Title: “Innovative Efficiency and Stock Returns"
Co-authors: Po-Hsuan Hsu and Dongmei Li
Accepted at: Journal of Financial Economics

May 2012

   

We find that innovative efficiency (IE), patents or citations scaled by R&D, is a strong positive predictor of future returns after controlling for firm characteristics and risk. The IE-return relation is associated with the loading on a mispricing factor, and the high Sharpe ratio of the Efficient Minus Inefficient (EMI) portfolio suggests that mispricing plays an important role. Further tests based upon attention and uncertainty proxies suggest that limited attention contributes to the effect. The high weight of the EMI portfolio return in the tangency portfolio suggests that IE captures incremental pricing effects relative to well-known factors.

 


 

Professors David Hirshleifer and Siew Hong Teoh
Title: “Are Overconfident CEOs Better Innovators?"
Co-author: Angie Low
Accepted at: The Journal of Finance

January 2012

Previous empirical work on adverse consequences of CEO overconfidence raises the question of why firms would hire overconfident managers. Theoretical research suggests a reason, that overconfidence can sometimes benefit shareholders by increasing investment in risky projects. Using options- and press-based proxies for CEO overconfidence, we find that over the 1993-2003 period, firms with overconfident CEOs have greater return volatility, invest more in innovation, obtain more patents and patent citations, and achieve greater innovative success for given research and development (R&D) expenditure. Overconfident managers only achieve greater innovation than non-overconfident managers in innovative industries. Our findings suggest that overconfidence may help CEOs exploit innovative growth opportunities.

 


  

Professor Lu Zheng
Title: “The Good or the Bad? Which Mutual Fund Managers Join Hedge Funds?”
Co-authors: Prachi Deuskar , Joshua Matthew Pollet and Zhi Jay Wang
Accepted at: The Review of Financial Studies

June 2011

Does the mutual fund industry lose its best managers to hedge funds? We find that mutual funds are able to retain managers with good performance in the face of competition from a growing hedge fund industry. On the other hand, poor performers are more likely to leave the mutual fund industry. A small fraction of these poor performers find jobs with smaller and younger hedge fund companies, especially when the hedge fund industry is growing rapidly. Analogously, a small fraction of the better performing mutual fund managers are retained by allowing them to manage a hedge fund side-by-side.

 


 

Professors Lu Zheng and Zheng Sun
Title: “The Road Less Traveled: Strategy Distinctiveness and Hedge Fund Performance”
Co-authors: Ashley Wang
Accepted at: The Review of Financial Studies

June 2011

We investigate whether skilled hedge fund managers are more likely to pursue unique investment strategies that result in superior performance. We propose a measure of the distinctiveness of a fund’s investment strategy based on historical fund return data. We call the measure the “Strategy Distinctiveness Index” (SDI). We document substantial cross-sectional variations as well as strong persistence in SDI. Our main result indicates that, on average, a higher SDI is associated with better subsequent performance. Funds in the highest SDI quintile outperform funds in the lowest quintile by 3.5 percent in the subsequent year after adjusting for risk.

 


  

Professors David Hirshleifer and Siew Hong Teoh
Title: “Limited Investor Attention and Stock Market Misreactions to Accounting Information”
Co-authors: Sonya Lim
Accepted at: Review of Asset Pricing Studies

April 2011


We document considerable return comovement associated with accruals after controlling for other common factors. An accrual-based factor-mimicking portfolio has a Sharpe ratio of 0.16, higher than that of the market factor or the SMB and HML factors of Fama and French (1993). According to rational frictionless asset pricing models, the ability of accruals to predict returns should come from the loadings on this accrual factor-mimicking portfolio. However, our tests indicate that it is the accrual characteristic rather than the accrual factor loading that predicts returns. These findings suggest that investors misvalue the accrual characteristic, and cast doubt on the rational risk explanation.

 


 

Professor David Hirshleifer
Title: “Limited Investor Attention and Stock Market Misreactions to Accounting Information”
Co-authors:
Siew Hong Teoh and Sonya Lim
Accepted at: The Review of Asset Pricing Studies

March 2011
 

We provide a model in which a single psychological constraint, limited investor attention, explains both under- and over-reaction to different earnings components.  Investor neglect of information in current-period earnings about  future earnings induces post-earnings announcement drift and the profit anomaly. Neglect of earnings components causes accruals and cash flows to predict abnormal returns.  We derive new untested empirical implications relating the strength of the drift, accruals, cash flow, and profit anomalies to the forecasting  power of current earnings-related information for future earnings, the degree of investor attention to different types of information, and  the volatilities of and correlation between accruals and cash flows. We also show that owing to costs of attention, in equilibrium some investors may decide not to attend to the implications of earnings or its components.
 


 

Professor Lu Zheng
Title: “Side-by-Side Management of Hedge Funds and Mutual Funds”
Co-authors: Tom Nohel and Zhi Wang
Accepted at: The Review of Financial Studies

February 2011

We examine situations where the same fund manager simultaneously manages mutual funds and hedge funds. We refer to this as side-by-side management. We document 112 such cases involving 189 hedge funds and 304 mutual funds. The 155 side-by-side managed mutual funds in our sample in existence in 2004 managed a total of $123 billion, raising significant concerns for regulators. Proponents of this practice argue that it is essential to hire and retain star performers. Detractors argue that the temptation for abuse is high and the practice should be banned. Our analysis based on various performance metrics shows that side-by-side mutual fund managers significantly outperform peer funds, consistent with this privilege being granted primarily to star performers. Interestingly, side-by-side hedge fund managers under-perform their style category peers, casting further doubt on the idea that conflicts of interest undermine mutual fund investors. Thus, we find no evidence of welfare loss for mutual fund investors due to exploitation of conflicts of interest.
 


 

 

Professor Lu Zheng
Title: “The ABCs of Mutual Funds: On the Introduction of Multiple Share Classes”
Co-authors: Vikram Nanda and Jay Wang
Accepted at: The Journal of Financial Intermediation

February 2011

In the 1990s, many load funds introduced additional share classes that give investors the choice of paying back-end loads and/or annual fees instead of front-end loads. The transition to a multiple-class structure provides a well-controlled setting for research with regard to investor clienteles and fund performance. We examine (a) whether the new fee structures increase the level and volatility of fund cash flows by attracting new investor clienteles; (b) whether changes induced in fund flow characteristics by the new investor clienteles affect fund performance - despite little change in fund management and investment objectives. We find that investors in the new classes tend to have a shorter investment horizon and greater sensitivity to past fund performance than investors in the front-end load class. Introducing the new classes attracts significantly more new money in the first one to two years, controlling for performance and other fund attributes. The downside, however, is that about two years after introducing the new classes, funds experience a significant drop in performance, which is expected to substantially erode the cash flow growth induced by the new classes. The results in the paper have significant implications for empirical studies of mutual funds using the data in the 1990s.
 


 

Professor David Hirshleifer
Title: “Taking the Road Less Traveled: Does Conversation Eradicate Pernicious Cascades?”
Co-authors: Bing Han and H. Henry Cao
Accepted at: Journal of Economic Theory

February 2011

We offer a model in which sequences of individuals often converge upon poor decisions and are prone to fads, despite communication of the payoff outcomes from past choices. This reflects both direct and indirect action-based information externalities. In contrast with previous cascades literature, cascades here are spontaneously dislodged and in general have a probability less than one of lasting forever. Furthermore, the ability of individuals to communicate can reduce average decision accuracy and welfare.
 


 
Professor David Hirshleifer
Title: “Do Investors Learn from Experience? Evidence from Frequent IPO Investors”
Co-authors: Yao-Min Chiang, Yiming Qian, and Ann E. Sherman
Accepted at: Review of Financial Studies

December 2010

We examine how experience affects the decisions of individual investors and institutions in IPO auctions to bid in subsequent auctions, and their bidding returns. We track bidding histories for all 31,476 individual investors and 1,232 institutional investors across all 84 IPO auctions during 1995-2000 in Taiwan. For individual bidders: (1) high returns in previous IPO auctions increase the likelihood of participating in future auctions; (2) bidders’ returns decrease as they participate in more auctions; (3) auction selection ability deteriorates with experience; and (4) bidders with greater experience bid more aggressively. These findings are consistent with naïve reinforcement learning wherein individuals become unduly optimistic after receiving good returns. In sharp contrast, there is little sign that institutional investors exhibit such behavior.    
 


 

Professor David Hirshleifer
Title: “The Accrual Anomaly: Risk or Mispricing?”
Co-authors:
Siew Hong Teoh and Kewei Hou
Accepted at: Management Science

December 2010

We document considerable return comovement associated with accruals after controlling for other common factors. An accrual-based factor-mimicking portfolio has a Sharpe ratio of 0.16, higher than that of the market factor or the SMB and HML factors of Fama and French (1993). According to rational frictionless asset pricing models, the ability of accruals to predict returns should come from the loadings on this accrual factor-mimicking portfolio. However, our tests indicate that it is the accrual characteristic rather than the accrual factor loading that predicts returns. These findings suggest that investors misvalue the accrual characteristic, and cast doubt on the rational risk explanation.
 


 

Professor David Hirshleifer
Title: “Short Arbitrage, Return Asymmetry and the Accrual Anomaly”
Co-authors:
Siew Hong Teoh and Jeff Jiewei Yu
Accepted at: Review of Financial Studies

December 2010

We find a positive association between short-selling and accruals during 1988-2009, and that asymmetry between the up- and down- sides of the accrual anomaly is stronger when constraints on short-arbitrage are more severe (low availability of loanable shares as proxied by institutional holdings). Short arbitrage occurs primarily among firms in the top accrual decile. Asymmetry is only present on NASDAQ. Thus, there is short arbitrage of the accrual anomaly, but short sale constraints limit its effectiveness.

 


 

Professor David Hirshleifer
Title: “Investor Overconfidence and the Forward Premium Puzzle”
Co-authors: Craig Burnside, Bing Han, and Tracy Wang
Accepted at: Review of Economic Studies

July 2010

We offer an explanation for the forward premium puzzle in foreign exchange markets based upon investor overconfidence. In the model, overconfident individuals overreact to their information about future inflation, which causes greater overshooting in the forward rate than in the spot rate. Thus, when agents observe a signal of higher future inflation, the consequent rise in the forward premium predicts a subsequent downward correction of the spot rate. The model can explain the magnitude of the forward premium bias and several other stylized facts related to the joint behavior of forward and spot exchange rates. Our approach is also consistent with the availability of profitable carry trade strategies.

  


 

Professor David Hirshleifer
Title: “The Psychological Attraction Approach to Accounting and Disclosure Policy”

Co-author: Siew Hong Teoh
Accepted at: Contemporary Accounting Research

June 2010

We offer here the psychological attraction approach to accounting and disclosure rules, regulation, and policy as a program for positive accounting research. We suggest that psychological forces have shaped and continue to shape rules and policies in two different ways. (1) Good Rules for Bad Users: rules and policies that provide information in a form that is useful for users who are subject to bias and cognitive processing constraints. (2) Bad Rules: superfluous or even pernicious rules and policies that result from psychological bias on the part of the ‘designers’ (managers, users, auditors, regulators, politicians, or voters). We offer some initial ideas about psychological sources of the use of historical costs, conservatism, aggregation, and a focus on downside outcomes in risk disclosures. We also suggest that psychological forces cause informal shifts in reporting and disclosure regulation and policy, which can exacerbate boom/bust patterns in financial markets.

  


 

Professor David Hirshleifer
Title: “Systemic Risk, Coordination Failures, and Preparedness Externalities: Applications to Tax and Accounting Policy”

Co-author: Siew Hong Teoh
Accepted at: Journal of Financial Economic Policy

June 2010

Sometimes resources are badly employed because of coordination failures. Actions by decisionmakers that affect the likelihood of such failures cause ‘systemic risk.’ We consider here the externality in the choice of ex ante risk management policies by individuals and firms: they are concerned with private risk, not with their contribution to systemic risk. One consequence is that individuals and firms become overleveraged from a social viewpoint. The US tax system taxes equity more heavily than debt, and therefore exacerbates the bias toward overleveraging. A possible solution is to reduce or eliminate taxation of corporate income and capital gains. Preparedness externalities can also cause firms to become too transparent, and thereby subject to financial runs. We consider the implications for debates over fair value accounting.

  


 

Professor David Hirshleifer
Title: “Promotion Tournaments and Capital Rationing”
Co-authors: Bing Han and John Persons
Accepted at: Review of Financial Studies

June 2010

We analyze capital allocation in a conglomerate where divisional managers with uncertain abilities compete for promotion to CEO. A manager can sometimes gain by unobservably adding variance to divisional performance. Capital rationing can limit this distortion, increase productive efficiency, and allow the owner to make more accurate promotion decisions. Firms for which CEO talent is more important for firm performance are more likely to ration capital. A rationed manager is more likely to be promoted even though all managers are identical ex ante. When the tournament payoff is relatively small, offering an incentive wage can be more efficient than rationing capital; however, when tournament incentives are paramount, rationing is more efficient.

  


 

Professor David Hirshleifer
Title: “Fear of the Unknown: Familiarity and Economic Decisions”
Co-authors: H. Henry Cao, Bing Han, and Harold H. Zhang
Accepted at: Review of Finance

June 2010

Evidence indicates that people fear change and the unknown. We offer a model of familiarity bias in which individuals focus on adverse scenarios in evaluating defections from the status quo. The model explains the endowment effect, portfolio underdiversification, home and local biases. Equilibrium stock prices reflect an unfamiliarity premium. In an international setting, our model implies that the absolute pricing error of the standard CAPM is positively correlated with the amount of home bias. It also predicts that a modified CAPM holds wherein the market portfolio is replaced with a portfolio of the stock holdings of investors not subject to familiarity bias.

  


 

Professor David Hirshleifer
Title: “A Cross-Cultural Study of Reference Point Adaptation: Evidence from China, Korea, and the US”
Co-authors: Danling Jiang and Sonya Lim  
Accepted at: Organizational Behavior and Human Decision Processes

June 2010

We examined reference point adaptation following gains or losses in security trading using participants from China, Korea, and the US. In both questionnaire studies and trading experiments with real money incentives, reference point adaptation was larger for Asians than for Americans. Subjects in all countries adapted their reference points more after a gain than after an equal-sized loss. When we introduced a forced sale intervention that highlighted a prior price change, Americans showed greater adaptation toward the new price, whereas Asians showed less adaptation. We offer possible explanations both for the cross-cultural similarities and the cross-cultural differences.

  


 

Professor David Hirshleifer
Title: “Commonality in Misvaluation, Equity Financing, and the Cross Section of Stock Returns”
Co-authors: Danling Jiang
Accepted at: Review of Financial Studies

June 2010

Behavioral theories suggest that investor misperceptions and market mispricing will be correlated across firms. This paper uses equity financing to identify comovement in returns and commonality in misvaluation. A zero-investment portfolio (UMO, Undervalued Minus Overvalued) built from repurchase and new issue stocks captures excess comovement in general stock returns relative to a set of multi-factor models. Adding UMO to the 3-factors makes the alphas insignificant for portfolios with extreme size and book-to-market, or based on M&A, convertible bond issuance, and dividend initiation, resumption, and omission. The loadings on UMO incrementally predict the cross-section of returns on portfolios as well as individual stocks. Further evidence is consistent with the UMO loading proxying for the common component of a stock's misvaluation. Note the October 20, 2009, "Narrow Banking" speech to reform the banking system by the Governor of the Bank of England Mervyn King.

  


 

Professor Zheng Sun
Title: “Institutional Demand Pressure and Cost of Corporate Loans”
Co-author:  Victoria Ivashina
Accepted at: Journal of Financial Economics

August 2010
 
Between 2001 and 2007, annual institutional funding in highly leveraged loans went up from $32 billion to $426 billion, accounting for nearly 70% of the jump in total syndicated loan issuance over the same period. Did the inflow of institutional funding in the syndicated loan market lead to mispricing of credit? To understand this relation, we look at the institutional demand pressure defined as the number of days a loan remains in syndication. Using market-level and cross-sectional variation in time-on-the-market, we find that a shorter syndication period is associated with a lower final interest rate. The relation is robust to the use of institutional fund flow as an instrument. Furthermore, we find significant price differences between institutional investors’ tranches and banks’ tranches of the same loans, even though they share the same underlying fundamentals. Increasing demand pressure causes the interest rate on institutional tranches to fall below the interest rate on bank tranches. Overall, a one-standard-deviation reduction in average time-on-the-market decreases the interest rate for institutional loans by over 30 basis points per annum. While this effect is significantly larger for loan tranches bought by structured investment vehicles (CDOs), it is not fully explained by their role.

  


 

Professor Zheng Sun
Title: “Institutional Stock Trading on Loan Market Information”
Co-author: Victoria Ivashina
Accepted at: Journal of Financial Economics

August 2010
 
One of the most important developments in the corporate loan market over the past decade has been the growing participation of institutional investors. As lenders, institutional investors routinely receive private information about borrowers. However, most of these investors also trade in public securities. This leads to a controversial question: Do institutional investors use private information acquired in the loan market to trade in public securities? This paper examines the stock trading of institutional investors whose portfolios also hold loans. Using SEC filings of loan amendments, we identify institutional investors with access to private information disclosed during loan amendments. We then look at abnormal returns on subsequent stock trades. We find that institutional participants in loan renegotiations subsequently trade in the stock of the same company and outperform trades by other managers and trades in other stocks by approximately 5.4% in annualized terms.

 


 

Professor Nai-fu Chen
Title: “Banking Reforms for the 21st Century: a Perfectly Stable Banking System Based on Financial Innovations”
Accepted at: International Review of Finance

September 2009

Although bank loans themselves are somewhat illiquid because of private information, most of their cashflows are not.  Recent financial innovations allow commercial loans to be liquefied via credit derivatives and actual and synthetic securitizations. The loan originating bank holds the remaining illiquid equity tranche containing the concentrated credit risk, private information rent and the “excess spread” that incentivize the bank to continue to monitor and service the loans.  Empirically, we find that the average size of the equity tranche is about 3% for the representative commercial loan portfolios in our sample.  The liquefaction of bank loans makes possible a banking system that restricts the guaranteed accounts to be backed by 100% reserves and the non-guaranteed deposits to be backed by liquid securitized loan tranches, while retaining the deposit-lending synergy. Such a system is perfectly safe without deposit insurance and it renders banks bankruptcy-remote without sacrificing a bank’s traditional role as a financial intermediary.

 


 

Professor Christopher Schwarz
Title: “Estimating Operational Risk for Hedge Funds: The ω-Score”            
Accepted at: Financial Analysts Journal
Co-authors: Stephen Brown, William Goetzmann and Bing Liang

February 2009

Using a complete set of the SEC filing information on hedge funds (Form ADV) and the TASS data, we develop a quantitative model called the ω-Score to measure hedge fund operational risk. The ω-Score is related to conflict of interest issues, concentrated ownership, and reduced leverage in the ADV data. With a statistical methodology, we further relate the ω-Score to readily available information such as fund performance, volatility, size, age, and fee structures. Finally, we demonstrate that while operational risk is more significant than financial risk in explaining fund failure, there is a significant and positive interaction between operational risk and financial risk. This is consistent with rogue trading anecdotes that suggest that fund failure associated with excessive risk taking occurs when operational controls and oversight are weak.

  


 

Professor Christopher Schwarz
Title: “Mandatory Disclosure and Operational Risk: Evidence from Hedge Fund Registration”       
Accepted at: Journal of Finance
Co-authors: Stephen Brown, William Goetzmann and Bing Liang

January 2009
 
Mandatory disclosure is a regulatory tool intended to allow market participants to assess operational risk. We examine the value of disclosure through the controversial SEC requirement, since overturned, which required major hedge funds to register as investment advisors and file Form ADV disclosures. Leverage and ownership structures suggest that lenders and equity investors were already aware of operational risk. However, operational risk does not mediate flow-performance relationships. Investors either lack this information or regard it as immaterial. These findings suggest that regulators should account for the endogenous production of information and the marginal benefit of disclosure to different investment clienteles.

  


 

Professor David Hirshleifer
Title: “The Psychological Attraction Approach to Accounting and Disclosure Policy”

Co-author: Siew Hong Teoh
Accepted at: Contemporary Accounting Research

Winter 2009

We offer here the psychological attraction approach to accounting and disclosure rules, regulation, and policy as a program for positive accounting research. We suggest that psychological forces have shaped and continue to shape rules and policies in two different ways. (1) Good Rules for Bad Users: rules and policies that provide information in a form that is useful for users who are subject to bias and cognitive processing constraints. (2) Bad Rules: superfluous or even pernicious rules and policies that result from psychological bias on the part of the ‘designers’ (managers, users, auditors, regulators, politicians, or voters). We offer some initial ideas about psychological sources of the use of historical costs, conservatism, aggregation, and a focus on downside outcomes in risk disclosures. We also suggest that psychological forces cause informal shifts in reporting and disclosure regulation and policy, which can exacerbate boom/bust patterns in financial markets.

 


 

Professor Lu Zheng
Title: “Investor Flows and Stock Market Returns”
Accepted at: Journal of Empirical Finance
Co-authors: Brian Boyer

April 2009

This study simultaneously analyzes the relation between aggregate stock market returns and cash flows (net purchases of equity) from a broad array of investor groups in the United States over a long period of time from 1952 to 2004. We find strong evidence that quarterly flows are autocorrelated for each of the different investor groups. We further document a significant and positive contemporaneous relation between stock market returns and flows of Mutual Funds and Foreign Investors.

 


 

Professor David Hirshleifer
Title: “Accruals, Cashflows, and Aggregate Stock Returns”
Co-authors: Siew Hong Teoh and Kewei Hou

Accepted at: Journal of Financial Economics 91(2009)389-406
2009

This paper examines whether the firm-level accruals and cash flow effects extend to the aggregate stock market. In sharp contrast to previous firm-level findings, aggregate accruals is a strong positive time series predictor of aggregate stock returns, and cash flows is a negative predictor. In addition, innovations in accruals are negatively contemporaneoiusly correlated with aggregate returns, and innovations in cash flows are positively correlated with returns. These findings suggest that innovations in accruals and cash flwos contain information about changes in discount rates, or that firms manage earnings in response to marketwide undervaluation.

 


 

Professor David Hirshleifer
Title: “Do Individual Investors Cause Post-Earnings Announcement Drift? Direct Evidence from Personal Trades” 

Co-authors: Siew Hong Teoh, James N. Myers and Linda A. Myers            

Accepted at: The Accounting Review
December 2008
    
This study tests whether naïve trading by individual investors, or some class of individual investors, causes post-earnings announcement drift (PEAD). Inconsistent with the individual trading hypothesis, individual investor trading fails to subsume any of the power of extreme earnings surprises to predict future abnormal returns. Moreover, individuals are significant net buyers after both negative and positive extreme earnings surprises, consistent with an attention effect, but not with their trading causing PEAD. Finally, we find no indication that trading by individuals explains the concentration of drift at subsequent earnings announcement dates.

  


 

Professor David Hirshleifer
Title: “Driven to Distraction: Extraneous Events and Underreaction to Earnings News”     

Co-authors: Siew Hong Teoh and Lim, S.
Accepted at: Journal of Finance
December 2008
   
Recent studies propose that limited investor attention causes market underreactions.  This paper directly tests this explanation by measuring the information load faced by investors. The investor distraction hypothesis holds that extraneous news inhibits market reaction to relevant news. We find that the immediate price and volume reaction to a firm’s earnings surprise is much weaker, and post-announcement drift much stronger, when a greater number of same-day earnings announcements are made by other firms. We evaluate the economic importance of distraction effects through a trading strategy, which yields substantial alphas. Industry-unrelated news and large absolute earnings surprises have a stronger distracting effect.

  


 

Professor Kerry Vandell and Major Coleman IV, PhD Student
Title: “Subprime lending and the housing bubble: Tail wags dog?”
Accepted at: Journal of Housing Economics  
Co-author:  Michael LaCour-Little (CSU Fullerton)

November 2008
 
The cause of the ‘‘housing bubble” associated with the sharp rise and then drop in home prices over the period 1998–2008 has been the focus of significant policy and research attention. The dramatic increase in subprime lending during this period has been broadly blamed for these market dynamics. In this paper we empirically investigate the validity of this hypothesis vs. several other alternative explanations. A model of house price dynamics over the period 1998–2006 is specified and estimated using a cross-sectional time-series data base across 20 metropolitan areas over the period 1998–2006. Results suggest that prior to early 2004, economic fundamentals provide the primary explanation for house price dynamics. Subprime credit activity does not seem to have had much impact on subsequent house price returns at any time during the observation period, although there is strong evidence of a price-boosting effect by investor loans (Non-owner occupied mortgages). However, we do find strong evidence that a credit regime shift took place in late 2003, as the Fannie Mae and Freddie Mac were displaced in the market by investment banks and hedge funds as originators and buyers of new mortgage products. Market fundamentals became insignificant in affecting house price returns, and the price-momentum conditions characteristic of a ‘‘bubble” were created. Thus, rather than causing the run-up in house prices, the subprime market may well have been a joint product, along with house price increases, (i.e., the ‘‘tail”) of the changing institutional, political, and regulatory environment characteristic of the period after late 2003 (the ‘‘dog”).