REVISION: Confounded Factors
Date Posted: Mar 28, 2013
Book-to-market (BE/ME) ratios explain variation in expected returns because they correlate with recent changes in the market value of equity. Although the remaining variation in BE/ME ratios captures comovement among stocks, it does not predict returns. Therefore, the HML factor is a sum of two parts: one with a positive price of risk ("priced part") and the other with a zero price of risk ("unpriced part"). The unpriced part confounds the HML factor and distorts inferences. First, portfolio man
New: Common Factors in Stock Market Seasonalities
Date Posted: Feb 25, 2013
Well-diversified portfolios of stocks formed by either characteristics or factor loadings have relatively high or low returns every year in the same calendar month. These common seasonalities account for at least 80% of the seasonalities in individual stock returns. The source of seasonalities matters: a trading strategy that tries to profit from seasonalities in individual stock returns is necessarily exposed to common return factors. We develop a model in which seemingly firm-specific seasonal
REVISION: Do Investors Buy What They Know? Product Market Choices and Investment Decisions
Date Posted: Mar 24, 2012
This paper shows individuals’ product market choices influence their investment decisions. Using microdata from the brokerage and automotive industries, we find a strong positive relation between customer relationship, ownership of a company, and size of the ownership stake. Investors also are more likely to purchase and less likely to sell shares of companies they frequent as customers. These effects are stronger for individuals with longer customer relationships. A merger-based natural experim
REVISION: Reverse Survivorship Bias
Date Posted: Nov 17, 2011
Mutual funds often disappear following poor performance. When this poor performance is partly attributable to negative idiosyncratic shocks, funds' estimated alphas understate their true alphas. This paper estimates a structural model to correct for this bias. Although most funds still have negative alphas, they are not nearly as low as those suggested by the fund-by-fund regressions. Approximately 12% of funds have net four-factor model alphas greater than 2% per year. All studies that run fund
REVISION: Lack of Anonymity and the Inference from Order Flow
Date Posted: Oct 17, 2011
This paper investigates the information content of signals about the identity of investors and whether they affect price formation. We use a dataset from Finland that combines information about the identity of investors with complete order flow records. While we document that investors use multiple brokers, our study demonstrates that broker identity can nonetheless be used as a powerful signal about the identity of investors who initiate trades. This finding testifies to the existence of fricti
REVISION: IQ and Stock Market Participation
Date Posted: Jan 23, 2011
Stock market participation is monotonically related to IQ, controlling for wealth, income, age, and other demographic and occupational information. The high correlation between IQ, measured early in adult life, and participation, exists even among the affluent. Supplemental data from siblings, studied with an instrumental variables approach and regressions that control for family effects, demonstrate that IQ’s influence on participation extends to females and does not arise from omitted familial
REVISION: Reading the Tea Leaves: Why Serial Correlation Patterns in Analysts' Forecast Errors are not Evidenc
Date Posted: Dec 22, 2010
This paper argues that an absence of serial correlation in forecast errors is not the appropriate benchmark for rational analyst behavior. We put forward a model that confronts analysts with two layers of uncertainty. An initial layer of uncertainty about firm-specific parameters leads analysts to underreact to signals from some firms and overreact to signals from others. A subsequent layer of uncertainty about the distributions from which these firm-specific parameters are drawn causes the null
REVISION: Jensen's Inequality, Parameter Uncertainty, and Multi-Period Investment
Date Posted: Nov 02, 2010
Classical approaches to estimation and decisions requiring estimation often are at odds. When values critical to the decision are convex or concave functions of unknown parameters, the statistician’s estimation error adjustments are the opposite of what is appropriate for the decision. We illustrate the conflict by studying multi-period investment problems. The proper application of Jensen’s inequality to the decision turns finance intuition on its head. For example, multi-period investments wit
REVISION: Do Limit Orders Alter Inferences About Investor Performance and Behavior?
Date Posted: Feb 09, 2010
Individual investors lose money around earnings announcements, experience poor post-trade returns, exhibit the disposition effect, and make contrarian trades. Using simulations and trading records of all individuals in Finland, I find that investors’ use of limit orders is largely responsible for these trading patterns. These patterns arise mechanically because limit orders are price-contingent and face the adverse selection problem. Reverse causality from behavioral biases to order choices does
The Anatomy of Day Traders
Date Posted: Dec 08, 2003
This paper examines the complete trading records of all day traders in Finland. A typical day trader is a male in his late 30s, who lives in the metropolitan area and trades in larger quantities than an investor in a size-matched control group even after ignoring day trades. These traders day-trade stocks that grab their attention, that they own, or that they have day-traded before. They pay close attention to the state of the limit order book, are very active near the end of the trading session