"Hedge Funds vs. Alternative Risk Premia"
Professor(s): Professor Philippe Jorion
Accepted at: Financial Analysts Journal
Alternative risk premia (ARP) are designed to provide low-cost exposures to long/short risk premia often embedded in hedge fund returns. This paper describes the performance of the ARP market in the form of bank-provided total return swaps, which are investible strategies that provide after-cost access to ARP. Over the 2010-2020 period, many of these risk premia provided significantly positive returns. In addition, these ARP explain a high fraction of returns on hedge fund indices, especially for quantitative strategies, along with traditional market factors. Finally, we find that ARP and market factors largely eat away hedge fund index returns.
"Does Mutual Fund Illiquidity Introduce Fragility into Asset Prices? Evidence from the Corporate Bond"
Professor(s): Professor Zheng Sun
Co-author(s): Hao Jiang, Yi Li and Ashley Wang
Accepted at: Journal of Financial Economics (Journal on Financial Times Top 50 list)
Open-end corporate bond mutual funds invest in illiquid assets while providing liquid claims to shareholders. Does such liquidity transformation introduce fragility to the corporate bond market? To address this question, we create a novel bond-level latent fragility measure based on asset illiquidity of mutual funds holding the bond. We find that corporate bonds bearing higher fragility subsequently experience higher return volatility and more outflows-induced mutual fund selling over the period of 2006-2019. Using the Covid-19 crisis as a natural experiment, we find that bonds with higher pre-crisis fragility experienced more negative returns and larger reversals around March 2020.
"Moonshots, Investment Booms, and Selection Bias in the Transmission of Cultural Traits"
Professor(s): David Hirshleifer
Co-author(s): Joshua Plotkin
Accepted at: Proceedings of the National Academy of Sciences
Biased information about the payoffs received by others can drive innovation, risk-taking and investment booms. We study this cultural phenomenon using a model based on two premises. The first is a tendency for large successes, and the actions that lead to them, to be more salient to onlookers than small successes or failures. The second premise is selection neglect -- the failure of observers to adjust for biased observation. In our model, each firm in sequence chooses to adopt or to reject a project that has two possible payoffs, one positive and one negative. The probability of success is higher in the high state of the world than in the low state. Each firm observes the payoffs received by past adopters before making its decision, but there is a chance that an adopter's outcome will be censored, especially if the payoff was negative. Failure to account for biased censorship causes firms to become overly optimistic, leading to irrational booms in adoption. Booms may eventually collapse, or may last forever. We describe these effects as a form of cultural evolution with adoption or rejection viewed as traits transmitted between firms. Evolution here is driven not only by differential copying of successful traits, but also by cognitive reasoning about which traits are more likely to succeed -- quantified using the Price Equation to decompose the effects of mutation pressure and evolutionary selection. This account provides a new explanation for investment booms, merger and IPO waves and waves of technological innovation.
"Can Individual Investors Beat the Market?"
Professor(s): David Hirshleifer
Co-author(s): Joshua Coval and Tyler Shumway
Accepted at: Review of Asset Pricing Studies
The thoughts and behaviors of financial market participants depend upon adopted cultural traits, including information signals, beliefs, strategies and folk economic models. Financial traits compete to survive in the human population, and are modified in the process of being transmitted from one agent to another. These cultural evolutionary processes shape market outcomes, which in turn feed back into the success of competing traits. This evolutionary system is studied in an emerging paradigm, social finance . In this paradigm, social transmission biases determine the evolution of financial traits in the investor population. It considers an enriched set of cultural traits, both selection on traits and mutation pressure, and market equilibrium at different frequencies. Other key ingredients of the paradigm include psychological bias, social network structure information asymmetries, and institutional environment.
"Social Finance: Cultural Evolution, Transmission Bias and Market Dynamics"
Professor(s): David Hirshleifer
Co-author(s): Erol Akçay
Accepted at: Proceedings of the National Academy of Sciences
We document strong persistence in the performance of trades of individual investors. The correlation of the risk-adjusted performance of an individual across sample periods is about 10 percent. Investors classified in the top performance decile in the first half of our sample subsequently outperform those in the bottom decile by about 8 percent per year. Strategies long in firms purchased by previously successful investors and short in firms purchased by previously unsuccessful investors earn abnormal returns of 5 basis points per day. These returns are not confined to small stocks nor to stocks in which the investors are likely to have inside information. Our results suggest that skillful individual investors exploit market inefficiencies to earn abnormal profits, above and beyond any profits available from well-known strategies based upon size, value or momentum.
"The Exploratory Mindset and Corporate Innovation"
Professor(s): David Hirshleifer
Co-author(s): Zhaozhao He
Accepted at: Journal of Financial and Quantitative Analysis (Journal on Financial Times Top 50 list)
The thoughts and behaviors of financial market participants depend upon adopted cultural traits, including information signals, beliefs, strategies and folk economic models. Financial traits compete to survive in the human population, and are modified in the process of being transmitted from one agent to another. These cultural evolutionary processes shape market outcomes, which in turn feed back into the success of competing traits. This evolutionary system is studied in an emerging paradigm, social finance . In this paradigm, social transmission biases determine the evolution of financial traits in the investor population. It considers an enriched set of cultural traits, both selection on traits and mutation pressure, and market equilibrium at different frequencies. Other key ingredients of the paradigm include psychological bias, social network structure, information asymmetries and institutional environment.
"Social Transmission Bias and Investor Behavior"
Professor(s): David Hirshleifer
Co-author(s): Bing Han and Johan Walden
Accepted at: Journal of Financial and Quantitative Analysis (Journal on Financial Times Top 50 list)
We offer a new social approach to investment decision making and asset prices. Investors discuss their strategies and convert others to their strategies with a probability that increases in investment returns. The conversion rate is shown to be convex in realized returns. Unconditionally, active strategies (e.g., high variance and skewness) dominate, although investors have no inherent preference over these characteristics. The model has strong predictions for how adoption of active strategies depends on investors’ social networks. In contrast with nonsocial approaches, sociability, selfenhancing transmission and other features of the communication process determine the popularity and pricing of active investment strategies.
"Gender Gaps in Venture Capital Performance"
Professor(s): Yuhai Xuan
Co-author(s): Paul Gompers, Vladimir Mukharlyamov, and Emily Weisburst
Accepted at: Journal of Financial and Quantitative Analysis (Journal on Financial Times Top 50 list)
We explore gender differences in performance in a comprehensive sample of venture capital investments in the United States. Investments by female venture capital investors have significantly lower success rates than investments by their male colleagues controlling for personal characteristics including employment and educational history and portfolio companies' characteristics. The gender differences in investment outcomes are not due to female investors being less skilled but rather largely attributable to female investors receiving less benefit from the track records of their colleagues. Performance differences disappear in older, larger firms and firms with other female investors. This supports the view that formal feedback mechanisms and hierarchies are potentially useful in ameliorating the female performance gap
"First Impression Bias: Evidence from Analyst Forecasts"
Professor(s): David Hirshleifer and Ben Lourie
Co-author(s): Thomas G. Ruchti and Phong Truong
Accepted at: Review of Finance
We present evidence of first impression bias among finance professionals in the field. Equity analysts’ forecasts, target prices, and recommendations suffer from first impression bias. If a firm performs particularly well (poorly) in the year before an analyst follows it, that analyst tends to issue optimistic (pessimistic) evaluations. Consistent with negativity bias, we find that negative first impressions have a stronger effect than positive ones. The market adjusts for analyst first impression bias with a lag. Finally, our findings contribute to the literature on experience effects. We show that a set of professionals in the field, equity analysts, apply U-shaped weights to their sequence of past experiences, with greater weight on first experiences and recent experiences than on intermediate ones.
"Evolutionary Dynamics of Culturally Transmitted, Fertility Reducing Traits"
Professor(s): David Hirshleifer
Co-author(s): Dominik Wodarz, Shaun Stipp, and Natalia Komarova
Accepted at: Proceedings of the Royal Society B: Biological Sciences
Human populations in many countries have undergone a phase of demographic transition, characterized by a major reduction in fertility at a time of increased resource availability. A key stylized fact is that the reduction in fertility is preceded by a reduction in mortality and a consequent increase in population density. Various theories have been proposed to account for the demographic transition process, including maladaptation, increased parental investment in fewer offspring, and cultural evolution. None of these approaches, including formal cultural evolutionary models of the demographic transitions, have addressed a possible direct causal relationship between a reduction in mortality and the subsequent decline in fertility. We provide mathematical models in which low mortality favors the cultural selection of low fertility traits. This occurs because reduced mortality slows turnover in the model, which allows the cultural transmission advantage of low fertility traits to out-race their reproductive disadvantage. For mortality to be a crucial determinant of outcome, a cultural transmission bias is required where slow reproducers exert higher social influence. Computer simulations of our models that allow for exogenous variation in the death rate can reproduce the central features of the demographic transition process, including substantial reductions in fertility within only 1-3 generations. A model assuming continuous evolution of reproduction rates through imitation errors predicts fertility to fall below replacement levels, if death rates are sufficiently low. This can potentially explain the very low preferred family sizes in Western Europe.
"Presidential Address: Social Transmission Bias in Economics and Finance"
Professor(s): David Hirshleifer
Accepted at: Journal of Finance
I discuss a new intellectual paradigm, social economics and finance: the study of the social processes that shape economic thinking and behavior. This emerging field recognizes that people observe and talk to each other. A key, underexploited building block of social economics and finance is social transmission bias: a systematic directional shift in signals or ideas induced by social transactions. I use five "fables" (models) to illustrate the novelty and scope of the transmission bias approach, and offer several emergent themes. For example, social transmission bias compounds recursively, which can help explain booms, bubbles, return anomalies, and swings in economic sentiment.
"Misvaluation and Corporate Inventiveness"
Professor(s): David Hirshleifer and Siew Hong Teoh
Co-author(s): Ming Dong
Accepted at: Journal of Financial and Quantitative Analysis
We test how market overvaluation affects corporate innovation. Estimated stock overvaluation is very strongly associated with measures of innovative inventiveness (novelty, originality, and scope), as well as R&D and innovative output (patent and citation counts). Misvaluation affects R&D more via a non-equity channel than via equity issuance. The sensitivity of innovative inventiveness to misvaluation is increasing with share turnover and overvaluation. The frequency of exceptionally high innovative inputs/outputs increases with overvaluation. This evidence suggests that market overvaluation may generate social value by increasing innovative output and by encouraging firms to engage in highly inventive innovation.
"Attention Induced Trading and Returns: Evidence from Robinhood Users"
Professor(s): Professor Christopher Schwarz
Co-Author(s): Brad Barber, Xing Huang, Terrance Odean
Accepted at: Journal of Finance (Journal on Financial Times Top 50 list)
We study the influence of financial innovation by fintech brokerages on individual investors’ trading and stock prices. Using data from Robinhood, we find that Robinhood investors engage in more attention-induced trading than other retail investors. For example, Robinhood outages disproportionately reduce trading in high-attention stocks. While this evidence is consistent with Robinhood attracting relatively inexperienced investors, we show that it can also be partially driven by the app’s unique features. Consistent with models of attention-induced trading, intense buying by Robinhood users forecast negative returns. Average 20-day abnormal returns are -4.7% for the top stocks purchased each day.
"How Fast Do Investors Learn? Asset Management Investors and Bayesian Learning "
Professor(s): Professors Christopher Schwarz and Zheng Sun
Accepted at: Review of Financial Studies (Journal on Financial Times Top 50 list)
We study how fast investors learn about manager skills by examining the speed at which their disagreement converges. Using a novel measure of disagreement, we find that hedge fund investors learn as fast as suggested by Bayes’ rule. However, we also find mutual fund investors learn much more slowly than Bayes’ rule. Mutual fund investors’ slow learning is not caused by investors potentially paying attention to different performance measures, institutional frictions such as loads, or lack of sophistication, but is likely due to a low payoff from learning. Our results suggest learning speed depends on the motivation of financial participants.
"Macro News and Micro News: Complements or Substitutes?"
Professor(s): Professor Jinfei Sheng
Co-Author(s): David Hirshleifer
Accepted at: Journal of Financial Economics (Journal on Financial Times Top 50 list)
We study how the arrival of macro-news affects the stock market’s ability to incorporate the information in firm-level earnings announcements. Existing theories suggest that macro and firm-level earnings news are attention substitutes; macro-news announcements crowd out firm-level attention, causing less efficient processing of firm-level earnings announcements. We find the opposite: the sensitivity of announcement returns to earnings news is 17% stronger, and post-earnings announcement drift 71% weaker, on macro-news days. This suggests a complementary relationship between macro and micro news that is consistent with either investor attention or information transmission channels.
"Credit Rating Inflation and Firms' Investments"
Professor(s): Chong Huang
Co-author(s): Itay Goldstein
Accepted at: Journal of Finance
We analyze credit ratings' effects on firms' investments in a rational debt-financing game that features a feedback loop. The credit rating agency (CRA) inflates the rating, providing a biased but informative signal to creditors.Creditors'response to the rating affects the firm's investment decision and credit quality, which is reflected in the rating. The CRA might reduce ex-ante economic efficiency, which results solely from the feedback effect of the rating: The CRA assigns more firms high ratings and allows them to gamble for resurrection. We derive empirical predictions on the determinants of rating standards and inflation and discuss policy implications.
“More than Money: Venture Capitalists on Boards”
Professor(s): Professor Yuhai Xuan
Co-author(s): Natee Amornsiripanitch and Paul A. Gompers
Accepted at: The Journal of Law, Economics, & Organization
We explore patterns of board structure and function in the venture capital industry, identifying factors that influence whether venture capitalists receive a board seat and whether they take action to help portfolio companies in which they invest. In a comprehensive sample of US-based and non-US-based companies, we find that a venture capital firm’s prior relationship with the founder, lead investor status, track record, network size, and geographical proximity to the portfolio company are positively correlated with its likelihood of taking a board seat in an investment round. When venture capital investors serve on the board, portfolio companies tend to recruit managers and board members from these investors’ network and are more likely to exit via relationship-based acquisitions. These patterns are particularly strong for successful and well- connected venture capitalists on the board.
“Mood Betas and Seasonalities in Stock Returns”
Professor(s): David Hirshleifer
Co-author(s): Danling Jiang and Yuting Meng
Accepted at: Journal of Financial Economics
Existing research has documented cross-sectional seasonality of stock returns—the periodic outperformance of certain stocks during the same calendar months or weekdays. We hypothesize that assets’ different sensitivities to investor mood explain these effects and imply other seasonalities. Consistent with our hypotheses, relative performance across individual stocks or stock portfolios during past high or low mood months and weekdays tends to recur in periods with congruent mood and reverse in periods with noncongruent mood. Furthermore, assets with higher sensitivities to aggregate mood—higher mood betas—subsequently earn higher returns during ascending mood periods and lower returns during descending mood periods.
“There is Little Evidence that the Industrial Revolution was Caused by a Preference Shift”
Professor(s): David Hirshleifer and Siew Hong Teoh
Accepted at: Behavioral and Brain Sciences
The idea, based on Life History Theory, that the Industrial Revolution was a positive feedback process wherein prosperity induced prosperity-promoting preference shifts, is just an intriguing speculation. The evidence does not distinguish this explanation from simple alternatives. For example, increased prosperity may have freed up time for individuals to engage in innovative activity, and increased the benefits from doing so.
“Decision Fatigue and Heuristic Analyst Forecasts”
Professor(s): David Hirshleifer, Ben Lourie, Siew Hong Teoh
Co-author(s): Yaron Levi
Accepted at: Journal of Financial Economics
Psychological evidence indicates that decision quality declines after an extensive session of decision-making, a phenomenon known as decision fatigue. We study whether decision fatigue affects analysts’ judgments. Analysts cover multiple firms and often issue several forecasts in a single day. We find that forecast accuracy declines over the course of a day as the number of forecasts the analyst has already issued increases. Also consistent with decision fatigue, we find that the more forecasts an analyst issues, the higher the likelihood the analyst resorts to more heuristic decisions by herding more closely with the consensus forecast, by self-herding (i.e., reissuing their own previous outstanding forecasts), and by issuing a rounded forecast. Finally, we find that the stock market understands these effects and discounts for analyst decision fatigue.
“Short and Long Horizon Behavioral Factors”
Professor(s): David Hirshleifer
Co-author(s): Kent Daniel and Lin Sun (Merage PhD ’15)
Accepted at: Review of Financial Studies
We propose a theoretically-motivated factor model based on investor psychology and assess its ability to explain the cross-section of U.S. equity returns. Our factor model augments the market factor with two factors which capture long- and short-horizon mispricing. The long-horizon factor exploits the information in managers' decisions to issue or repurchase equity in response to persistent mispricing. The short-horizon earnings surprise factor, which is motivated by investor inattention and evidence of short-horizon underreaction, captures short-horizon anomalies. This three-factor risk-and-behavioral model outperforms other proposed models in explaining a broad range of return anomalies.
“The Causal Effect of Limits to Arbitrage on Asset Pricing Anomalies”
Professor(s): David Hirshleifer
Co-author(s): Yongqiang Chu and Liang Ma
Accepted at: Journal of Finance
We examine the causal effect of limits to arbitrage on 11 well-known asset pricing anomalies using the pilot program of Regulation SHO, which relaxed short-sale constraints for a quasi-random set of pilot stocks, as a natural experiment. We find that the anomalies became weaker on portfolios constructed with pilot stocks during the pilot period. The pilot program reduced the combined anomaly long-short portfolio returns by 72 basis points per month, a difference that survives risk adjustment with standard factor models. The effect comes only from the short legs of the anomaly portfolios.
“Shared Analyst Coverage: Unifying Momentum Spillover Effects”
Professor(s): David Hirshleifer
Co-author(s): Usman Ali
Accepted at: Journal of Accounting and Economics
Identifying stock connections by shared analyst coverage, we find that a connected-stock (CS) momentum factor generates a monthly alpha of 1.68% (t = 9.67). In spanning regressions, the alphas of industry, geographic, customer, customer/supplier industry, single- to multi-segment, and technology momentum factors are insignificant/negative after controlling for CS momentum. Similar results hold in cross-sectional regressions and in developed international markets. Sell-side analysts incorporate news about linked stocks sluggishly. These effects are stronger for complex and indirect linkages. These results indicate that previously documented momentum spillover effects represent a unified phenomenon that is captured by shared analyst coverage.
“There Is Little Evidence that the Industrial Revolution Was Caused by a Preference Shift”
Professor(s): David Hirshleifer and Siew Hong Teoh
Co-author(s): Usman Ali
Accepted at: Behavioral and Brain Sciences
The idea, based on Life History Theory, that the Industrial Revolution was a positive feedback process wherein prosperity induced prosperity-promoting preference shifts, is just an intriguing speculation. The evidence does not distinguish this explanation from simple alternatives. For example, increased prosperity may have freed up time for individuals to engage in innovative activity, and increased the benefits from doing so.
“A Theory of Multi-Period Debt Structure”
Professor(s): Chong Huang
Co-author(s): Martin Oehmke and Hongda Zhong
Accepted at: Review of Financial Studies
We develop a theory of multi-period debt structure. A simple trade-off between the termination threat required to make repayments incentive compatible and the desire to avoid early liquidation determines the number of repayments, their timing, and repayment amounts. As firms increase their borrowing, they add periodic risky repayments from the back of the maturity structure, with the time between repayments increasing in cash-flow risk. Cash-flow growth or a significant risk-free cash-flow component limit the number of periodic risky repayments. Firms with significant risk-free cash-flow component choose dispersed maturity profiles with relatively safe repayments every period, rather than riskier, periodic repayments.
“Star Ratings and the Incentives of Mutual Funds”
Professor(s): Chong Huang
Co-author(s): Fei Li and Xi Weng
Accepted at: Journal of Finance
We propose a theory of reputation to explain how mutual funds' flows rationally respond to their star ratings. A fund's performance is determined by its information advantage, which can be acquired but decays stochastically. Investors form beliefs about whether the fund is informed based on its past performance. We refer to such beliefs as the fund's reputation, which determines its flows. In equilibrium, as its performance records change continuously, the fund's reputation may jump among discrete values. When discrete reputations are labeled by stars, investors rationally respond to star ratings, even though stars do not provide investors with new information.
“The Fix is In: Properly Backing out Backfill Bias”
Professor(s): Philippe Jorion and Christopher Schwarz
Accepted at: Review of Financial Studies
With assets now exceeding $3 trillion, the hedge fund market has become an essential segment of the asset management industry. This growth has been predicated upon the belief that hedge fund managers can add substantial value added. Measuring this performance accurately, however, is quite difficult, due to the fact that hedge funds are voluntarily reporting to commercial hedge fund databases, unlike mutual funds where reporting is mandatory. Such voluntary reporting creates the potential for “backfill bias.” This occurs when a hedge fund manager decides to list in a database, presumably after a period of good performance. In contrast, funds with poor performance never show up in databases, creating an upward bias in reported returns during the backfill period. Our paper finds that many empirical results in the literature are affected by this bias. We also show that the best practice for dealing with this issue is to remove returns prior to the listing date. However, since many hedge fund databases do not include listing dates, we propose a novel method to infer listing dates when not available.
“Do People Feel Less at Risk? Evidence from Disaster Experience”
Doctoral Candidate Yushui Shi
Co-author(s): Ming Gao and Yu-Jane Liu
Accepted at: Journal of Financial Economics
Past studies typically have focused on whether people perceive more rare risk after experiencing catastrophic disasters. We show that people can also feel less risk with unexpected “lucky” disaster experience. By exploring a novel identification strategy based on households’ expectations, we find that households perceive less (more) risk when they experience disasters that have lower (higher) actual fatalities than what was expected. This opposite experience effect of rare disasters is substantial: a one standard deviation increase in the negative (positive) experience shock is associated with a 1.71% decrease (a 1.31% increase) in the life insurance-to-portfolio ratio. We discuss three possible mechanisms to account for our empirical findings: incomplete information learning, salience theory, and change in risk preferences.
“Reaching for Dividends”
Professor(s): Zheng Sun
Co-author(s): Hao Jiang
Accepted at: Journal of Monetary Economics
Interest rates dived into uncharted territories for an extended period after the financial crisis. What is the impact on investor behavior and asset prices? We find that when interest rates fall, flows into income-oriented equity funds increase, with higher dividend-yielding funds attracting more inflows after controlling for fund returns. Responding to their incentives, income fund managers tend to aggressively over-weight high dividend stocks in a low-rate environment. This behavior of “reaching for dividends” generates market impact: high dividend stocks tend to have higher prices when interest rates fall, and lower excess returns when interest rates subsequently normalize.
“Home Bias and Local Contagion: Evidence from Funds of Hedge Funds”
Professor(s): Zheng Sun and Lu Zheng
Co-author(s): Clemens Sialm
Accepted at: Review of Financial Studies
Our paper analyzes the geographical preferences of hedge fund investors and the implication of these preferences for hedge fund performance. We find that funds of hedge funds overweigh their investments in hedge funds located in the same geographical areas and that funds with a stronger local bias exhibit superior performance. This local bias also gives rise to excess flow comovement and extreme return clustering within geographic areas. Overall, our results suggest that while funds of funds benefit from local advantages, their local bias also creates market segmentation that can destabilize the underlying hedge funds.
“Revisiting Mutual Fund Disclosure”
Professor Christopher Schwarz
Co-author(s): Mark Potter
Accepted at: Review of Financial Studies, September 2016
We document that CRSP and Thomson contain many voluntarily reported mutual fund portfolios that are not in SEC filings while, additionally, CRSP and Thomson are missing many SEC mandated portfolios available in SEC filings. We document that the voluntary disclosures are likely driven by convenience rather than duplicity. Although mandated portfolios contain securities with more return momentum, we find use of SEC or Thomson data lead to similar empirical findings. CRSP, however, contains inaccurate position information prior to 2008. Our findings have important implications, such as highlighting a 35% increase in observed manager trading by combining data sources.
“The Real Costs of Financial Efficiency When Some Information Is Soft”
Professor Chong Huang
Co-author(s): Alex Edmans and Mirko Heinle
Accepted at: Review of Finance, August 2016
This article shows that improving financial efficiency may reduce real efficiency. While the former depends on the total amount of information available, the latter depends on the relative amounts of hard and soft information. Disclosing more hard information (e.g., earnings) increases total information, raising financial efficiency and reducing the cost of capital. However, it induces the manager to prioritize hard information over soft by cutting intangible investment to boost earnings, lowering real efficiency. The optimal level of financial efficiency is non-monotonic in investment opportunities. Even if low financial efficiency is desirable to induce investment, the manager may be unable to commit to it. Optimal government policy may involve upper, not lower, bounds on financial efficiency.
“Superstition and Financial Decision Making”
Professor David Hirshleifer
Co-author(s): Jian Ming, and Huai Zhang
Accepted at: Management Science, July 2016
In Chinese culture, certain digits are lucky and others unlucky. We test how such numerological superstition affects financial decision in the China IPO market. We find that the frequency of lucky numerical stock listing codes exceeds what would be expected by chance. Also consistent with superstition effects, newly listed firms with lucky listing codes experience inferior post-IPO abnormal returns. Further tests suggest that our conclusions are not driven by endogeneity.
“Opportunism as a Managerial Trait: Predicting Insider Trading Profits and Misconduct”
Professor David Hirshleifer
Co-author(s): Usman Ali
Accepted at: Journal of Financial Economics, November 2016
We show that opportunistic insiders can be identified through the profitability of their trades prior to quarterly earnings announcements (QEAs), and that opportunistic trading is associated with various kinds of firm/managerial misconduct. A value-weighted trading strategy based on (not necessarily pre-QEA) trades of opportunistic insiders earns monthly 4-factor alphas of over 1%—much higher than in past insider trading literature and substantial/significant even on the short side. Firms with opportunistic insiders have higher levels of earnings management, restatements, SEC enforcement actions, shareholder litigation, and executive compensation. These findings suggest that opportunism is a domain-general trait.
“How Psychological Bias Shapes Accounting and Financial Regulation”
Professors David Hirshleifer and Siew Hong Teoh
Accepted at: Behavioral Public Policy Journal, November 2016
Most applications of behavioral economics, finance, and accounting research to policy focus on alleviating the adverse effects of individuals’ biases and cognitive constraints, e.g., through investor protection rules or nudges. We argue that it is equally important to understand how psychological bias can cause a collective dysfunction—badaccounting policy and financial regulation. We discuss here how psychological bias on the part of the designers of regulation and accounting policy (voters, regulators, politicians, media commentators, managers, users, auditors, and financial professionals) has helped shape existing regulation, and how understanding of this process can improve regulation in the future. Regulatory ideologies are belief systems that have evolved and spread by virtue of their ability to recruit psychological biases. We examine how several psychological factors and social processes affect regulatory ideologies.
“How to Write an Effective Referee Report and Improve the Scientific Review Process”
Professors David Hirshleifer
Co-author(s): Jonathan B. Berk and Campbell R. Harvey
Accepted at: Journal of Economic Perspectives, December 2016
Drawing on insights of current and past editors of top economics and finance journals, we provide guidelines for reviewers in preparing referee reports and cover letters for journals. Peer review is fundamental to the progress of science, and we believe that fundamental changes in reviewing practices are needed to improve the integrity, quality, and efficiency of the publication process. Such changes will also allow scholars to reallocate time from navigating the publication process to developing innovative research.
“Coordination and Social Learning”
Professors Chong Huang
Accepted at: Economic Theory, December 2016
This paper studies the interaction between coordination and social learning in a dynamic regime change game. Social learning provides public information, to which players overreact due to the coordination motive. Coordination affects the aggregation of private signals through players’ optimal choices. Such endogenous provision of public information results in informational cascades and thus inefficient herds, with positive probability, even if private signals have an unbounded likelihood ratio property. An extension shows that if players can individually learn, there exists an equilibrium in which inefficient herding disappears, and thus, coordination is almost surely successful.
