April 9, 2016
Stefano Giglio and Bryan T. Kelly, University of Chicago and NBER
Giglio and Kelly document a form of excess volatility that is irreconcilable with standard models of prices, even after accounting for variation in discount rates. They compare prices of claims on the same cash flow stream but with different maturities. Standard models impose precise internal consistency conditions on the joint behavior of long and short maturity claims and these are strongly rejected in the data. In particular, long maturity prices are significantly more variable than justified by the behavior at short maturities. The researchers reject internal consistency conditions in all term structures that they study, including equity options, currency options, credit default swaps, commodity futures, variance swaps, and inflation swaps.
Camelia M. Kuhnen, University of North Carolina at Chapel Hill and NBER, and Andrei C. Miu, Babes-Bolyai University, Romania
The majority of lower socioeconomic status (SES) households in the U.S. and Europe do not have any stock investments, which is detrimental to wealth accumulation. Here, Kuhnen and Miu examine one explanation for this puzzling fact, namely, that economic adversity may influence how people learn from financial information. Using experimental and survey data from the U.S. and Romania, they find that lower SES individuals form more pessimistic beliefs about the distribution of stock returns and are less likely to invest in stocks. SES shapes people's beliefs about stocks, leading to large differences across households in their propensity to participate in financial markets.
J. Anthony Cookson, University of Colorado, and Marina Niessner, Yale University
Cookson and Niessner develop a new measure of disagreement based on the sentiment expressed by investors on a social network investing platform. Changes in their measure of disagreement robustly forecast abnormal trading volume, even though it is unlikely that investor trades from those on the investing platform move the market. Using information on the investment philosophies of the investors (e.g., technical, fundamental, short term, long term), the researchers test existing theories that suggest that differing investment philosophies are an important source of disagreement. Although they also find significant scope for disagreement among investors with the same investment philosophy, the findings suggest that investment approaches matter fundamentally to disagreement. Therefore, even with perfectly informationally efficient markets, investor disagreement, and thus high trading volume and volatility, would likely persist.
Jeffrey Hoopes, Ohio State University; Patrick Langetieg, Internal Revenue Service; Stefan Nagel and Joel Slemrod, University of Michigan and NBER; Daniel Reck and Bryan Stuart, University of Michigan
Hoopes, Langetieg, Nagel, Reck, Slemrod, and Stuart examine individual stock sales from 2008 to 2009 using population tax return data. The share of sales by the top 0.1 percent of income recipients and other top income groups rose sharply following the Lehman Brothers bankruptcy and remained elevated throughout the financial crisis. Sales by top income and older age groups were relatively more responsive to increased stock market volatility. Volatility-driven sales were not concentrated in any one sector, but mutual fund sales responded more strongly to increased volatility than stock sales. Additional analysis suggests that gross sales in tax return data are informative about unobserved net sales.
Jean-Philippe Bouchaud, CFM; Philipp Krüeger, University of Geneva; Augustin Landier, Toulouse School of Economics; and David Thesmar, HEC Paris
Bouchaud, Krüger, Landier, and Thesmar propose a simple model in which investors price a stock using a persistent signal and sticky belief dynamics á la Coibion and Gorodnichenko (2012). In this model, returns can be forecasted using (1) past profits, (2) past change in profits, and (3) past returns. The model thus provides a joint theory of two of the most economically significant anomalies, i.e. quality and momentum. According to the model these anomalies should be correlated, and be stronger when signal persistence is higher, or when earnings expectations are stickier. Using I/B/E/S data, the researchers measure expectation stickiness at the analyst level. They find that analysts are on average sticky and, consistent with a limited attention hypothesis, more so when they cover more industries. They find strong support for the model's prediction in the data: both the momentum and the quality anomaly are stronger for stocks with more persistent profits, and for stocks which are followed by stickier analysts. Consistent with the model, both strategies also comove significantly.
Juhani T. Linnainmaa, University of Chicago and NBER; Brian T. Melzer, Northwestern University; and Alessandro Previtero, University of Western Ontario
A common view of retail finance is that rampant conflicts of interest explain the high cost of financial advice. Using detailed data on financial advisors and their clients, however, Linnainmaa, Melzer, and Previtero show that most advisors invest their personal portfolios just like they advise their clients. They trade frequently, chase returns, and prefer expensive, actively managed funds over cheap index funds. Differences in advisors' beliefs affect not only their own investment choices, but also cause substantial variation in the quality and cost of their advice. Advisors do not hold expensive portfolios only to convince clients to do the same their own performance would actually improve if they held exact copies of their clients' portfolios, and they exhibit similar trading behavior even after they leave the industry. This evidence suggests that many advisors offer well-meaning, but misguided, recommendations rather than self-serving ones. Eliminating conflicts of interest may therefore reduce the cost of advice less than policymakers hope.