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Suleyman Basak
Anna Pavlova
Alex Shapiro

Abstract

This paper investigates a fund manager's risk-taking incentives induced by an increasing and convex fund-flows to relative-performance relationship. In a dynamic portfolio choice framework, it shows that the ensuing convexities in the manager's objective give rise to a finite risk-shifting range over which she gambles to finish ahead of her benchmark. Such gambling entails either an increase or a decrease in the volatility of the manager's portfolio, depending on her risk tolerance. In the latter case, the manager reduces her holdings of the risky asset despite its positive risk premium. This empirical analysis lends support to the novel predictions of the model. Under multiple sources of risk, with both systematic and idiosyncratic risks present, it shows that optimal managerial risk shifting may not necessarily involve taking on any idiosyncratic risk. Costs of misaligned incentives to investors resulting from the manager's policy are demonstrated to be economically significant.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=879294

James Dow
Itay Goldstein
Alexander Guembel

Abstract

A fundamental role of financial markets is to gather information on firms' investment opportunities, and so help guide investment decisions in the real sector. This paper studies the incentives for information production when prices perform this allocational role. It argues that firms' overinvestment is sometimes necessary to induce speculators in financial markets to produce information. If firms always cancel planned investments following poor stock market response, the value of their shares will become insensitive to information on investment opportunities, so that speculators will be deterred from producing information. The paper discuss several commitment devices firms can use to facilitate information production. It shows that the mechanism studied in the paper amplifies shocks to fundamentals across stages of the business cycle.

http://facultyresearch.london.edu/docs/commitment_dow_goldstein_guembel.pdf

Viral V. Acharya
Tanju Yorulmazer

Abstract

As the number of bank failures increases, the set of assets available for acquisition by the surviving banks enlarges but the total amount of available liquidity within the surviving banks falls. This results in "cash-in-the-market" pricing for liquidation of banking assets.

At a sufficiently large number of bank failures, and in turn, at a sufficiently low level of asset prices, there are too many banks to liquidate and inefficient users of assets who are liquidity-endowed may end up owning the liquidated assets. In order to avoid this allocation inefficiency, it may be ex-post optimal for the regulator to bail out some failed banks. Ex ante, this gives banks an incentive to herd by investing in correlated assets, thereby making aggregate banking crises more likely. These effects are robust to allowing the surviving banks to issue equity and allowing the regulator to price-discriminate against outsiders in the market for bank sales.

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Viral V. Acharya
Timothy C. Johnson

Abstract

Insider trading in the credit derivatives market has become a significant concern for regulators and participants. This paper attempts to quantify the problem. Using news reflected in the stock market as a benchmark for public information, we report evidence of significant incremental information revelation in the credit default swap (CDS) market, consistent with the occurrence of insider trading. We show that the degree of this activity increases with the number of banks that have lending/monitoring relations with a given firm, and that this effect is robust to controls for non-informational trade. Furthermore, consistent with hedging activity by informed banks with loan exposure, information revelation in the CDS market is asymmetric, consisting exclusively of bad news. We find no evidence, however, that the degree of insider activity adversely affects prices or liquidity in either the equity or credit markets. If anything, with regard to liquidity, the reverse appears to be true.

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João F. Cocco
Paolo F. Volpin

Abstract

This paper studies the governance of defined-benefit pension plans in the United Kingdom. We construct a governance measure, equal to the proportion of trustees of the pension plan who are also executive directors of the sponsoring company. Our findings indicate that pension plans of indebted companies with a higher proportion of insider-trustees: (i) invest a higher proportion of the pension plan assets into equities, (ii) contribute less into the pension plan, and (iii) have a larger dividend payout ratio. This evidence supports an agency view, whereby insider-trustees act in the interest of shareholders of the sponsoring company, and not necessarily pension plan members.

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Christopher J. Malloy,
Ning Zhu

Abstract

We test the hypothesis that investment in actively managed mutual funds is linked to investor clienteles. We document that individual investors located in less affluent, less educated, and ethnic minority neighborhoods invest more in funds with expensive load fees. They also tend to invest a disproportionate amount in funds with no minimum-balance requirements, and find fewer funds and (fewer no-load funds in particular) to invest in. Our results suggest that less sophisticated neighborhoods may be faced with an inferior investment opportunity set. We find no evidence that investors in these areas tend to trade significantly more or are more likely to redeem their fund holdings each year.

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Francisco J. Gomes
London Business School

Abstract

This paper measures the utility gains from exploiting short-run predictability in equity returns in the presence of transaction costs, short-selling constraints and parameter uncertainty. We focus our analysis primarily on predictability in the volatility of stock returns. We find that the corresponding utility gains are quite significant, even in the presence of frictions and while taking into account for parameter uncertainty. In contrast, the utility gains from exploiting predictability in the risk premium due to short-run positive autocorrelation, are quite small once we take into account for frictions, parameter uncertainty or both.

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