Forthcoming Articles

Investor Heterogeneity and Liquidity

Kalok Chan, Si Cheng, and Allaudeen Hameed

Fund flows are more correlated among funds with similar investment horizon, consistent with correlated demand for liquidity. We find that stocks held by institutions with more heterogeneous investment horizon are more liquid and have lower volatility of liquidity. Identification tests confirm the improvement in stock liquidity holds when the increase in investor heterogeneity arises from (a) addition of a stock to the S&P 500 index, and (b) an exogenous shock due to the 2003 tax reform. Additionally, extreme flow-induced trading by institutional funds has a bigger price impact when stocks have less heterogeneous investor base.


The Shadow Costs of Illiquidity

Kristy A. E. Jansen and Bas J. M. Werker

We solve a flexible model that captures transactions costs and infrequencies of trading opportunities for illiquid assets to better understand the shadow costs of illiquidity for different origins of asset illiquidity and heterogeneous investor types. We show that illiquidity that results in suboptimal asset allocation carries low shadow costs, whereas these costs are high when illiquidity restricts consumption. As a result, the shadow costs are high for short-term investors, investors who face substantial liquidity shocks, and investors who desire to allocate a large fraction of their wealth to illiquid assets.

Taxing the Disposition Effect: The Impact of Tax Awareness on Investor Behavior

William J. Bazley, Jordan Moore, and Melina Murren Vosse

Standard portfolio choice models predict that investors consider the tax implications of trading. However, individuals are disposed toward realizing gains and holding losing investments, behaviors that worsen their performance. We show, in an experimental market, that increasing tax salience reduces the disposition effect between 22% and 47%, leading to higher portfolio balances without increasing total trading activity. Using field data, we find that investors’ disposition is sensitive to taxes around tax rate changes, when taxes are likely salient. Our analysis demonstrates that increasing tax awareness can affect households’ portfolio choices, which suggests policy implications for improving financial decision-making.

The Digital Credit Divide: Marketplace Lending and Entrepreneurship

Douglas Cumming, Hisham Farag, Sofia Johan, and Danny McGowan

We conjecture that marketplace lending provokes an increase in the quantity of entrepreneurship, particularly in more regionally disadvantaged areas, albeit at lower average quality. Using a fuzzy regression discontinuity design that exploits exogenous variation in borrowers’ access to marketplace loans along US state borders, we estimate a 10% increase in marketplace lending causes a 0.44% increase in business establishments per capita. The effects are more pronounced for less experienced entrepreneurs, for small and less profitable firms, firms more dependent upon external finance, in industries with lower sunk costs of entry, and for low-income regions with inferior access to financial institutions.

Does CEO Succession Planning (Disclosure) Create Shareholder Value?

John J. McConnell and Qianru Qi

Average cumulative abnormal returns around proxy statements containing “in-depth” disclosures of planning for CEO succession are significantly positive indicating that succession planning is a value-added undertaking. Exploiting a quasi-natural experiment based on a 2009 SEC ruling that induced more succession planning disclosures, we find that succession planning is not value-adding for all firms. Rather, succession planning is value-enhancing for larger, more complex, and more stable firms. Importantly, CEO succession planning appears to be value reducing for smaller, simpler, less stable firms.

The Pricing of Volatility and Jump Risks in the Cross-Section of Index Option Returns

Guanglian Hu and Yuguo Liu

Existing studies relate the puzzling low average returns on out-of-the-money index call and put options to non-standard preferences. We argue the low option returns are primarily due to the pricing of market volatility risk. When volatility risk is priced, expected option returns match the realized average option returns. Moreover, consistent with its theoretical effect on expected option returns, the volatility risk premium is positively related to future index option returns and this relationship is stronger for OTM options and ATM straddles. Lastly, we find the jump risk premium contributes to some portion of OTM put option returns.

Market Development, Information Diffusion and the Global Anomaly Puzzle

Charlie Xiaowu Cai, Kevin Keasey, Peng Li, and Qi Zhang

Previous literature finds anomalies are at least as prevalent in developed markets as in emerging markets, namely, the global anomaly puzzle. We show that while market development and information diffusion are linearly related, information diffusion has a nonlinear impact on anomalies. This is consistent with theoretical developments concerning the process of information diffusion. In extremely low efficiency regimes, without newswatchers sowing the seeds of price discovery and ensuring the long-run convergence of price to fundamentals, initial mispricing and subsequent correction will not occur. The concentration of emerging countries in low efficiency regimes provides an explanation to the puzzle.

Flooded Through the Back Door: The Role of Bank Capital in Local Shock Spillovers

Oliver Rehbein and Steven Ongena

This paper demonstrates that low bank capital carries a negative externality because it amplifies local shock spillovers. We exploit a natural disaster that is transmitted to firms in non-disaster areas via their banks. Firms connected to a strongly disaster-exposed bank with lowest-quartile capitalization significantly reduce their total borrowing by 6.6% and tangible assets by 6.9% compared to similar firms connected to a well-capitalized bank. These findings translate to negative regional effects on GDP and unemployment. Additionally, following a disaster event, banks reduce their exposure to currently unaffected but generally disaster-prone areas.