Research
Papers In Preparation
Categorical Processing in a Complex World (New 11/2024)
Joint with Thomas Graeber and Christopher Roth
*Draft Coming Soon*
Abstract: In real-world news environments, quantitative information is rarely presented in isolation; it is characterized through qualitative comparisons with various reference levels. Company earnings, for example, are commonly compared to analyst forecasts, previous earnings, and other benchmarks. We propose comparative noisy processing as a cognitive simplification strategy according to which people accurately incorporate qualitative comparisons to form category priors but integrate numerical signals imprecisely. In our framework, processing constraints induce excess sensitivity around category boundaries and insensitivity everywhere else. We study stock market reactions to about 200,000 earnings announcements, documenting that proxies for processing noise are associated with a more pronounced S shape around comparison points. The behavioral mechanism is corroborated by naturalistic experiments that exogenously manipulate processing constraints. We test two theories of what determines processing noise in the field. First, more common surprises might be processed with less noise as in models of efficient coding. We find that regions with more frequent surprises exhibit far higher return sensitivity and lower medium-term price corrections. Second, surprise may capture attention, leaving less capacity to process the numerical signal. We find that surprising qualitative realizations, e.g., a profit when a loss was expected, are associated with diminished sensitivity to quantitative information.
Who Clears the Market When Passive Investors Trade? (Updated 10/2024)
Joint with John J. Shim
Abstract: We find that firms are the primary sellers of shares when index funds are net buyers, providing shares at a nearly one-for-one rate. Rather than provide liquidity, most demand-side institutions trade in the same direction as index funds, especially over long horizons. To establish causality, we develop a novel instrument for inelastic index fund demand, and show that firms are the most responsive, with prices as the coordinating mechanism. We show evidence consistent with stock compensation as the main source of firm issuance to satisfy passive demand, consistent with firms clearing the market for index fund buying but not selling.
The Retail Habitat (Updated 10/2024)
Joint with Toomas Laarits
Abstract: Retail investors trade hard-to-value stocks. We document a large and persistent spread in the stock-level intensity of retail trading, even allowing for known biases in the attribution of retail trades. Stocks with a high share of retail-initiated trades are composed of more intangible capital, have longer duration cash-flows and a higher likelihood of being mispriced. Consistent with retail-heavy stocks being harder to value, we document that such stocks are less sensitive to earnings news, more sensitive to retail order flow and are particularly expensive to trade around earnings announcements. Overall, our findings document a new dimension of investor heterogeneity and suggest a comparative advantage of retail in trading hard-to-value stocks.
Primary Capital Market Transactions and Index Funds (Updated 10/2024)
Joint with Chris Murray
Abstract: We document the effects of mechanical buying by CRSP-index-tracking funds on post-IPO returns and IPO deal structure. Leveraging a difference-in-differences-style design built on a 2017 CRSP rule change, we find that expected index fund demand leads fast track IPOs to outperform non-fast track IPOs by 14 percentage points shortly after the IPO, although this outperformance largely reverts within six months. Further, fast track IPOs are priced higher and are more likely to be upsized, raising 7.7% more capital than similar non fast track IPOs, evidence that expected passive buying has real implications for firms raising capital in public markets.
Do Active Funds Do Better in What They Trade? (Updated 12/2023)
Joint with John J. Shim
Abstract: We develop two new measures to quantify active fund decisions at the position level. Our measures are designed to separate flow-based passive scaling from active rebalancing decisions. We find that additive active rebalancing – both for existing and new positions – predicts higher stock-level alpha over the following quarter. We show our results are not driven by mechanical price pressure, and provide evidence that funds may trade on forecasts for future earnings. Finally, we aggregate our stock-level measure to the portfolio level and show that actively adding to positions translates to outsized returns for fund investors.
What Triggers National Stock Market Jumps? (Updated 2/2022)
Joint with Scott Baker, Nicholas Bloom and Steven Davis
A copy of the paper can be found here
Abstract: We examine next-day newspaper accounts of large daily jumps in 19 national stock markets to assess their proximate cause, clarity as to cause, and geographic source of the market-moving news. Our sample of over 8,000 jumps yields several findings. First, policy news triggers a greater share of upward than downward jumps in all countries. Second, the policy share of upward jumps is inversely related to stock market performance in the preceding three months. These two patterns reflect the role of jumps triggered by monetary policy and government spending and have strengthened since World War II. Third, market volatility is much lower after jumps triggered by monetary policy news than after other similarly sized jumps, unconditionally and conditional on past volatility and other controls. Fourth, greater clarity as to jump reason also foreshadows lower volatility. Clarity has trended upwards over the past 90 years in the US and UK, the two countries for which we have long-span data. Finally, leading newspapers outside the U.S. attribute one-third of jumps in their own national stock markets to developments that originate in and relate to the United States. The U.S. role in this regard dwarfs that of Europe and China.
Retail Investors’ Contrarian Behavior Around News and the Momentum Effect (Updated 11/2021)
Joint with Cheng (Patrick) Luo, Enrichetta Ravina and Luis M. Viceira
Using a large panel of U.S. accounts trades and positions, we show that retail investors trade as contrarians after large earnings surprises, especially for loser stocks, and such contrarian trading contributes to post earnings announcement drift (PEAD) and momentum. Indeed, when we double-sort by momentum portfolios and retail trading flows, PEAD and momentum are only present in the top two quintiles of retail trading intensity. Finer sorts confirm the results, as do sorts by firm size and institutional ownership level. We show that the investors in our sample are representative of the universe of U.S. retail traders, and that the magnitude of the phenomena we describe indicate a quantitively substantial role of retail investors in generating momentum. The results on the timing of the flows and the magnitude of the return differences across momentum portfolios by retail trading intensity and size and sign of the earnings surprise, are confirmed at a longer two-year horizon. Alternative hypotheses, such as the disposition effect and stale limit orders, do not explain the phenomenon. We find that younger investors and day traders are more likely to be contrarians, while gender and number of trades are not correlated with our contrarian score, once other characteristics are controlled for. The pattern of web-clicks and the time spent analyzing each stock on the brokerage platform suggest an important role of attention in contrarian trading.
Published & Forthcoming Papers
Passive Ownership and Price Informativeness (Management Science, 9/2024)
Abstract: I show that passive ownership negatively affects the degree to which stock prices anticipate earnings announcements. Estimates across several research designs imply that the rise in passive ownership over the last 30 years has caused the amount of information incorporated into prices ahead of earnings announcements to decline by approximately 1/4th of its whole sample mean and 1/6th of its whole sample standard deviation.
The Passive-Ownership Share Is Double What You Think It Is (Journal of Financial Economics, 7/2024)
Previously circulated with the title Excess Reconstitution-Day Volume
Joint with Alex Chinco
Abstract: Each time a stock gets added to or dropped from an index, we ask: “How much money would have to be tracking that index to explain the huge spike in rebalancing volume we observe on reconstitution day?” While index funds held 16% of the US stock market in 2021, we put the overall passive ownership share at 33.5%. Our headline number is twice as large because it reflects index funds as well as other kinds of passive investors, such as institutional investors with internally managed index portfolios and active managers who are closet indexing.
The Disappearing Index Effect (Journal of Finance, forthcoming)
Joint with Robin Greenwood
Abstract: The abnormal return associated with a stock being added to the S&P 500 has fallen from an average of 7.4% in the 1990s to less than 1% over the past decade. This has occurred despite a significant increase in the share of stock market assets linked to the index. A similar pattern has occurred for index deletions, with large negative abnormal returns during the 1990s, but only 0.1% between 2010 and 2020. We investigate the drivers of this surprising phenomenon and discuss implications for market efficiency. Finally, we document a similar decline in the index effect among other families of indices.
Customer Churn and Intangible Capital (JPE: Macro, September 2023)
Previously circulated with the title Firm Customer Bases: Churn and Networks
Joint with Scott Baker and Brian Baugh
Firm-level data, SSRN link Publisher Link
Abstract: Intangible capital is a crucial and growing piece of firms’ capital structure, but many of its distinct components are difficult to measure. We develop and make available several new firm-level metrics regarding a key component of intangible capital – firms’ customer bases – using an increasingly common class of household transaction data. Linking household spending to customer-facing firms that make up over 30% of total household spending, we show that churn in customer bases is associated with lower markups and market-to-book ratios and higher leverage. Churn is closely linked to firm-level volatility and risk, both cross-sectionally and over time. This new measure provides a clearer picture of firms’ customer and brand capital than existing metrics like capitalized SG&A, R&D, or advertising expenditures and is also observable for private firms. We demonstrate that low levels of customer churn push firms away from neoclassical investment responsiveness and that low churn firms are better able to insulate organization capital from the risk of key talent flight.
Trade Policy Uncertainty and Stock Returns (Journal of International Money and Finance, September 2021)
Joint with Marcelo Bianconi and Federico Esposito
Abstract: A recent literature has documented large real effects of trade policy uncertainty (TPU) on trade, employment, and investment, but there is little evidence that investors are compensated for bearing such risk. To quantify the risk premium associated with TPU, we exploit quasi-experimental variation in exposure to TPU arising from Congressional votes to revoke China’s preferential tariff treatment between 1990 and 2001. A long-short portfolio designed to isolate exposure to TPU earns a risk-adjusted return of 3.6-6.2% per year. This effect is larger in sectors less protected from globalization, and more reliant on inputs from China. Industries more exposed to trade policy uncertainty also had a larger drop in stock prices when the uncertainty began, and more volatile returns around key policy dates. Our results are not explained by the effects of policy uncertainty on expected cash-flows, investors’ forecast errors, and import competition from China.
The Unprecedented Stock Market Reaction to COVID-19 (The Review of Asset Pricing Studies, July 2020)
Joint with Scott Baker, Nicholas Bloom, Steven J. Davis, Kyle Kost, and Tasaneeya Viratyosin.
A copy of the paper can be found here
Abstract: No previous infectious disease outbreak, including the Spanish Flu, has impacted the stock market as forcefully as the COVID-19 pandemic. In fact, previous pandemics left only mild traces on the U.S. stock market. We use text-based methods to develop these points with respect to large daily stock market moves back to 1900 and with respect to overall stock market volatility back to 1985. We also evaluate potential explanations for the unprecedented stock market reaction to the COVID-19 pandemic. The evidence we amass suggests that government restrictions on commercial activity and voluntary social distancing, operating with powerful effects in a service-oriented economy, are the main reasons the U.S. stock market reacted so much more forcefully to COVID-19 than to previous pandemics in 1918-19, 1957-58 and 1968.
Environmental, Social, and Governance Criteria: Why Investors Are Paying Attention (Journal of Investment Management, January 2018)
Joint with Ravi Jagannathan and Ashwin Ravikumar
A copy of the paper can be found here
Abstract: We find that money managers could reduce portfolio risk by incorporating Environmental, Social, and Governance (ESG) criteria into their investment process. ESG-related issues can cause sudden regulatory changes and shifts in consumer tastes, resulting in large asset price swings which leave investors limited time to react. By incorporating ESG criteria in their investment strategy, money managers can tilt their holdings towards firms which are well prepared to deal with these changes, thereby managing exposure to these rare but potentially large risks.