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
Data and Code
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.
Disagreement in the Equity Options Market and Stock Returns
(with Ruslan Goyenko)
The Review of Financial Studies (2022)
for data, see https://ruslangoyenko.com/research/
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.
Financial Market Misconduct and Public Enforcement: The Case of Libor Manipulation
(with Priyank Gandhi, Jens Jackwerth and Alberto Plazzi)
Management Science (2019)
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.
Monetary Policy and the Equity Term Structure
(with Ben Matthies)
first version: December 2020
last version: June 2022
ABSTRACT: We use a high-frequency event study approach to analyze the impact of monetary policy surprises on the term structure of equity prices. We document that short-term and long-term equity prices respond in opposite ways to changes in monetary policy. Following an unanticipated cut to the target rate, short-term equity prices fall while long-term equity prices rise on average. We develop a model which shows this pattern arises when policy decisions signal information about economic conditions. Consistent with model predictions, the short-term asset price response significantly predicts short-term macroeconomic growth and is positively related to central bank soft information.
ABSTRACT: We study media reporting and investor beliefs across the United States, Germany, and Japan. Using comprehensive newspaper data for the automotive industry from 2007 to 2016, we show that companies obtain more media coverage and are presented with a substantially more positive news tone in their home countries than abroad. The results hold for general-interest newspapers, business newspapers, and the international editions of the Wall Street Journal. The home-country media slant increases during bad times for companies and it is most prominent for news reported by journalists who have a native-sounding name. Cross-country differences in news tone predict differences in time-matched prices of cross-listed stocks. The predictive relation is strongest for confirmatory news reported by home-country journalists. The link is weakest on days when sporting events likely disrupt trading.
Motivated Beliefs in Macroeconomic Expectations
(with Stefano Cassella, Huseyin Gulen, and Peter Kelly)
last version: May 2022
Quadrant Behavioral Finance Conference 2019, TAU Finance Conference 2019, Colorado Finance Summit 2019, ASU Sonoran Winter Finance Conference 2020
ABSTRACT: Motivated beliefs are an important framework for understanding macroeconomic expectations. We extend popular motivated belief models and show that they predict an upward sloping term structure of optimism (horizon bias). Analyzing professional forecasts over the past fifty years, we find that forecast errors exhibit both optimism bias and horizon bias. Further, consistent with the conceptual framework of Bénabou (2015), we show that time-series variation in the optimism bias is related to theory-based drivers of motivated beliefs like uncertainty and anxiety. Finally, we find that forecasters react more strongly to good than bad news, consistent with motivated beliefs.
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.
Holding Period Effects in Dividend Strip Returns
(with Jens Jackwerth)
last version: June 2022
ABSTRACT: We estimate short-duration dividend strip prices from 25 years-worth of S&P 500 index options data (1996-2020). We show that short-duration strips offer substantially more attractive returns than does the market, but the measurement error obscures this result at monthly holding periods. For holding periods longer than one year, where the effect of the measurement error dissipates, the strip Sharpe ratio is two to four times the market Sharpe ratio. This outperformance holds in different subperiods, as well as conditionally on recessions or expansions. We also document that the return on the strip in excess of the market is highly predictable.
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.