Horizon bias and the term structure of equity returns
(with Stefano Cassella, Huseyin Gulen, and Peter Kelly)
The Review of Financial Studies, accepted for publication

ABSTRACT: We label the degree to which individuals are more optimistic at long horizons relative to short horizons the horizon bias. We examine whether time-series variation in the horizon bias can explain the time-series variation in the equity term structure. We use analyst earnings forecasts to measure the degree of the horizon bias in the stock market. Consistent with the intuition from a stylized present value model, we find that periods of above-average horizon bias are associated with negative term premia, whereas periods of below-average horizon bias are associated with positive term premia.

ABSTRACT: We estimate investor disagreement from synthetic long and short stock trades in the equity options market. We show that high disagreement predicts low stock returns after positive earnings surprises and high stock returns after negative earnings surprises. The negative effect is stronger for high-beta stocks and stocks that are more difficult to sell short. In the cross-section of all stocks and the subset of the 500 largest companies, high disagreement robustly predicts low monthly and weekly stock returns.

ABSTRACT: Using comprehensive data on London Interbank Offer Rate (Libor) submissions from 2001 through 2012, we provide evidence consistent with banks manipulating Libor to profit from Libor-related positions and to signal their creditworthiness during distressed times. Evidence of manipulation is stronger for banks that were eventually sanctioned by regulators and disappears for all banks in the aftermath of the Libor investigations that began in 2010. Our findings suggest that the threat of large penalties and the loss of reputation that accompany public enforcement can be effective in deterring financial market misconduct.

ABSTRACT: We combine annual stock market data for the most important equity markets of the last four centuries: the Netherlands and UK (1629–1812), UK (1813–1870), and US (1871–2015). We show that dividend yields are stationary and consistently forecast returns. The documented predictability holds for annual and multi-annual horizons and works both in- and out-of-sample, providing strong evidence that expected returns in stock markets are time- varying. In part, this variation is related to the business cycle, with expected returns increasing in recessions. We also find that, except for the period after 1945, dividend yields predict dividend growth rates.

ABSTRACT: Fund managers are double agents; they serve both fund investors and owners of management firms. This conflict of interest may result in trading to support securities prices. Tests of this hypothesis in the Spanish mutual fund industry indicate that bank-affiliated mutual funds systematically increase their holdings in the controlling bank stock around seasoned equity issues, at the time of bad news about the controlling bank, before anticipated price drops, and after non-anticipated price drops. The results seem mainly driven by bank managers’ incentives. Ownership of asset management companies thus matters and can distort capital allocation and asset prices.

ABSTRACT: The dividend-price ratio is a noisy proxy for expected returns when expected dividend growth is time-varying. This paper uses a new and forward-looking measure of dividend growth extracted from S&P 500 futures and options to correct the dividend-price ratio for changes in expected dividend growth. Over January 1994 through June 2011, dividend growth implied by derivative markets reliably forecasts future dividend growth, and the corrected dividend-price ratio predicts S&P500 returns substantially better than the standard dividend-price ratio, in-sample and out-of-sample. Time-varying expected dividend growth is important to explain price movements, especially because it is highly correlated with expected returns.

ABSTRACT: We show that Standard & Poor’s (S&P) 500 futures are pulled toward the at-the-money strike price on days when serial options on the S&P 500 futures expire (pinning) and are pushed away from the cost-of-carry adjusted at-the-money strike price right before the expiration of options on the S&P 500 index (anti-cross-pinning).  These effects are driven by the interplay of market makers’ rebalancing of delta hedges due to the time decay of those hedges as well as in response to reselling (and early exercise) of in-the-money options by individual investors.  The associated shift in notional futures value is at least $115 million per expiration day.

Working papers
Home-country media slant and equity prices
(with Rasa Karapandza)
last version: March 2020
EFA 2018, Colorado Finance Summit 2018, AFA 2019,  News & Finance Conference 2019, SFS Cavalcade 2019

ABSTRACT: We study national newspaper reporting and investor beliefs across the U.S., Germany, and Japan. Using comprehensive hand-coded media data for the automotive industry, we show that news about companies is systematically more positive in companies’ home countries than abroad. Home-country media slant increases during bad times for companies, and it correlates strongly with equity prices. Cross-country difference in news tone predicts temporary price deviations of cross-listed stocks. Abnormally high home-media news tone predicts low monthly domestic stock returns. The effects are strongest for confirmatory news and weakest when home-biased investors are likely distracted by sporting events.

Horizon bias in expectations formation
(with Stefano Cassella, Huseyin Gulen, and Peter Kelly)
last version: January 2021
Quadrant Behavioral Finance Conference 2019, TAU Finance Conference 2019, Colorado Finance Summit 2019, ASU Sonoran Winter Finance Conference 2020

ABSTRACT: We provide empirical evidence that optimism bias in expectations of economic quantities increases with the forecasting horizon. We label this empirical regularity the horizon bias. We document significant horizon bias in the macroeconomic expectations of professional forecasters, both in the U.S. and abroad. We show that horizon bias is unlikely to be the result of career concerns, asymmetric loss, information rigidities, or cognitive mistakes. We then provide theoretical support to the notion that horizon bias can arise within theories of motivated beliefs. Finally, following the conceptual framework
of Bénabou (2015), we test whether theory-based drivers of motivated beliefs can explain time-series variation in the horizon bias. We find strong support for many of these drivers. Overall, we offer strong evidence that motivated beliefs lead to biases in expectations formation.

Equity duration and predictability
(with Peter Koudijs)
last version: April 2020
AFA 2021, EFA 2020

ABSTRACT: One of the most puzzling findings in asset pricing is that expected returns dominate variation in the dividend-to-price ratio, leaving little room for dividend growth rates. Even more puzzling is that this dominance only emerged after 1945. We develop a present value model to argue that a general increase in equity duration can explain these findings. As cash flows to investors accrue further into the future, shocks to highly persistent expected returns become relatively more important than shocks to growth rates. We provide supportive empirical evidence from dividend strips, the time-series, and the cross-section of stocks.

Asset managers as buyers of last resort
(with Antonino Emanuele Rizzo and Rafael Zambrana)
last version: January 2021

ABSTRACT: We show that mutual funds systematically overweight financial companies that are ultimate owners of their brokers. Moreover, in times of distress, funds act as buyers of last resort and increase their ownership in their brokers' companies. The results indicate that such trading activity contributes to the price stability of large financial conglomerates, which has implications for the systemic risk of the financial sector. Portfolio performance analysis suggests that funds act as buyers of last resort for brokers that provide them with privileged investment information. The relationship is strongest for brokers that have long-lasting business ties with their clients. Exogenous changes in business ties due to brokerage firm acquisitions confirm the causal nature of the relationship.