Forthcoming Articles

Improving Minimum Variance Portfolios by Alleviating Over-Dispersion of Eigenvalues

Fangquan Shi, Lianjie Shu, Aijun Yang, and Fangyi He

In portfolio risk minimization, the inverse covariance matrix of returns is often unknown and has to be estimated in practice. Yet the eigenvalues of the sample covariance matrix are often over-dispersed, leading to severe estimation errors in the inverse covariance matrix. To deal with this problem, we propose a general framework by shrinking the sample eigenvalues based on Schatten norm. The proposed framework has the advantage to be computationally efficient as well as structure free. The comparative studies show that our approach behaves reasonably well in terms of reducing out-of-sample portfolio risk and turnover.

 

Investment Shocks and Asset Prices: An Investment-Based Approach

Lorenzo Garlappi and Zhongzhi Song

We propose a new approach, based on investment data, to determine firms’ return exposure to investment-specific technology~(IST) shocks. When applied to U.S. data, we find that, in contrast to the pattern estimated from empirical IST proxies, value firms have higher exposure to IST shocks than growth firms. When applied to simulated data from existing theoretical models, our approach reveals that existing empirical findings may result from measurement errors in the IST proxies. Importantly, our simulation analysis uncovers the key role played by investment data in determining the economic mechanism through which IST shocks affect cross-sectional asset prices.

 

Order Flow Segmentation, Liquidity and Price Discovery: The Role of Latency Delays

Michael Brolley and David A. Cimon

Latency delays intentionally slow order execution at an exchange, often to protect market-makers against latency arbitrage. We study informed trading in a fragmented market in which one exchange introduces a latency delay on market orders. Liquidity improves at the delayed exchange, as informed investors emigrate to the conventional exchange, where liquidity worsens. In aggregate, implementing a latency delay worsens total expected welfare. We find that the impact on price discovery depends on the relative abundance of speculators. If the exchange with delay technology competes against a conventional exchange, it implements a delay only if it has sufficiently low market share.

Why Do Firms Disagree with Short Sellers? Managerial Myopia versus Private Information

Leonce Bargeron and Alice Bonaime

Though short sellers on average succeed at identifying overvalued equity, firms often signal disagreement with short sellers by repurchasing stock when short interest increases. We investigate whether this disagreement reflects a myopic defense of inflated prices, or positive private information. These repurchases appear motivated by managers’ private information, not agency issues, even when managerial benefits to short-termism are enhanced or monitoring is weaker. Managers’ informational advantage relates to subsequent news, earnings, and risk, but is attenuated if activists target management or insiders sell. A trading strategy based on our findings earns 7.5% annually.

Managerial Entrenchment and Information Production

Chen Lin, Lai Wei, and Wensi Xie

In this paper, we evaluate the effect of managerial entrenchment on corporate information production using the voting outcomes of shareholder-initiated proposals intended to mitigate managerial entrenchment. We focus on the proposals that are passed or rejected by a small margin of votes, which generate plausibly exogenous variations in managerial entrenchment. We find that a reduction in managerial entrenchment enhances corporate information production. The effects are stronger for firms with greater information asymmetries and severer agency frictions. Overall, the evidence is consistent with the view that reducing managerial entrenchment enhances corporate disclosure by aligning the incentives of managers and shareholders.

Optimists and Pessimists in (In)Complete Markets

Nicole Branger, Patrick Konermann, and Christian Schlag

We study the effects of market incompleteness on speculation, investor survival, and asset pricing moments, when investors disagree about the likelihood of jumps and have recursive preferences. We consider two models. In a model with jumps in aggregate consumption, incompleteness barely matters, since the consumption claim resembles an insurance product against jump risk and effectively reproduces approximate spanning. In a long-run risk model with jumps in the long-run growth rate, market incompleteness affects speculation, and investor survival. Jump and diffusive risks are more balanced regarding their importance and, therefore, the consumption claim cannot reproduce approximate spanning.

Do Public and Private Firms Behave Differently? An Examination of Investment in the Chemical Industry

Albert Sheen

I compare the U.S. capacity expansion decisions of public and private producers of seven commodity chemicals from 1989–2006. I find that private firms invest differently than public firms. Private firms are more likely than public firms to increase capacity prior to a positive demand shock (an increase in price and quantity) and less likely to increase capacity before a negative demand shock. Potential mechanisms include public firm overextrapolation of past demand shocks and agency problems arising from greater separation between ownership and control.

The Predictive Power of the Dividend Risk Premium

Davide E. Avino, Andrei Stancu, and Chardin Wese Simen

We show that the dividend growth rate implied by the options market is informative about (i) the expected dividend growth rate and (ii) the expected dividend risk premium. We model the expected dividend risk premium and explore its implications for the predictability of dividend growth and stock market returns. Correcting for the expected dividend risk premium strengthens the evidence of dividend growth and stock market return predictability both in- and out-of-sample. Economically, a market timing investor who accounts for the time varying expected dividend risk premium realizes an additional utility gain of 2.02% per year.