Asset Pricing Program Meeting

November 5, 2010 -
Sydney Ludvigson and Lasse H. Pedersen, both of New York University and NBER, Organizers

Snehal Banerjee, Northwestern University, and Jeremy Graveline, University of Minnesota
The Cost of Short-Selling Liquid Securities

Since long investors typically pay higher prices for liquid securities, common intuition suggests that they are solely responsible for any liquidity premium. Banerjee and Graveline argue that short-sellers also may pay a liquidity premium if their borrowing costs are higher than what they expect to recoup from future price declines. Market clearing implies that not every long investor can lend out her entire position to collect these higher borrowing rates. Therefore, both long investors and short-sellers can simultaneously contribute to the liquidity premium. The authors characterize this decomposition of the premium in terms of cash prices, borrowing fees, and the fraction of the outstanding security sold short. They use this decomposition to show that, from November 1995 through July 2009, short-sellers accounted for an average of 50 percent of the liquidity premium for on-the-run Treasuries.

Ke Tang, Renmin University of China, and Wei Xiong, Princeton University and NBER

Index Investment and Financialization of Commodities (NBER Working Paper No. 16385)

Tang and Xiong find that, concurrent with the rapid growing index investment in commodities markets since the early 2000s, futures prices of different commodities in the United States became increasingly correlated with each other. This trend was significantly more pronounced for commodities in the two popular GSCI and DJUBS commodity indices. This finding reflects a financialization process of commodities markets and helps to explain the synchronized price boom-and-bust of a broad set of seemingly unrelated commodities in the United States in 2006-8. In contrast, such commodity price co-movements were absent in China, which refutes growing commodity demands from emerging economies as the driver.

Robert Novy-Marx, University of Rochester and NBER

The Other Side of Value: Good Growth and the Gross Profitability Premium (NBER Working Paper No. 15940)

Novy-Marx finds that profitability, as measured by gross profits-to-assets, has roughly the same power as book-to-market in predicting the cross-section of average returns. Profitable firms generate significantly higher returns than unprofitable firms, despite having significantly higher valuation ratios. Controlling for profitability also dramatically increases the performance of value strategies, especially among the largest, most liquid stocks. These results are difficult to reconcile with popular explanations of the value premium, because profitable firms are less prone to distress, have longer cash flow durations, and have lower levels of operating leverage. Controlling for gross profitability explains most earnings related anomalies, and a wide range of seemingly unrelated profitable trading strategies.

Tim Bollerslev, Duke University and NBER, and Viktor Todorov, Northwestern University
Tails, Fears and Risk Premia

Bollerslev and Todorov show that the compensation for rare events explains a large fraction of the average equity and variance risk premia. Exploiting the special structure of the jump tails and the pricing thereof, the researchers identify and estimate a new Investor Fears index. The index suggests both large and time-varying compensations for fears of disasters. The empirical investigation in the paper is essentially model-free, involving new extreme value theory approximations and high-frequency intra-day data for estimating the expected jump tails under the statistical probability measure, and short maturity out-of-the money options and new model-free implied variation measures for estimating the corresponding risk neutral expectations.

Lubos Pastor and Pietro Veronesi, University of Chicago and NBER

Uncertainty about Government Policy and Stock Prices (NBER Working Paper No. 16128)

Pastor and Veronesi analyze how changes in government policy affect stock prices. Their general equilibrium model features uncertainty about government policy and a government that has both economic and non-economic motives. The government tends to change its policy after performance downturns in the private sector. Stock prices fall at the announcements of policy changes, on average. The price fall is expected to be large if uncertainty about government policy is large, as well as if the policy change is preceded by a short or shallow downturn. Policy changes increase volatility, risk premia, and correlations among stocks. The jump risk premium associated with policy decisions is positive, on average.

Alexander Dyck, University of Toronto, and Adair Morse, University of Chicago
Sovereign Wealth Fund Portfolios

Using a novel dataset of Sovereign Wealth Fund (SWF) investments in public equities, private firms, private equity, and real estate, Dyck and Morse test for the importance of various objectives. They find that financial investor objectives help to explain their investment decisions, but there is great variation across funds. Considering state industrial planning as an alternative objective significantly increases explanatory power, particularly for the less-transparent funds. Consistent with this objective, SWFs are more likely to invest with larger stakes bringing control in particular industries (especially finance, but also transport, telecommunications and energy) and in particular regions (the Middle East and Asia).