Abstract: A basic intuition is that arbitrage is easier when markets are most liquid. Surprisingly, we find that momentum profits are markedly larger in liquid market states. This finding is not explained by variation in liquidity risk, time-varying exposure to risk factors, or changes in macroeconomic condition, cross-sectional return dispersion, and investor sentiment. The predictive performance of aggregate market illiquidity for momentum profits uniformly exceeds that of market return and market volatility states. While momentum strategies have been unconditionally unprofitable in the United States, in Japan, and in the Eurozone countries in the last decade, they are substantial following liquid market states.
“Short-Term Reversals: The Effects of Past Returns and Institutional Exits”, with Allaudeen Hameed, Avanidhar Subrahmanyam, and Sheridan Titman, 2017, Journal of Financial and Quantitative Analysis 52, 143─173. [Published Version]
Abstract: Price declines over the previous quarter lead to stronger reversals across the subsequent 2 months. We explain this finding based on the dual notions that liquidity provision can influence reversals and that agents who act as de facto liquidity providers may be less active in past losers. Supporting these observations, we find that active institutions participate less in losing stocks and that the magnitude of monthly return reversals fluctuates with changes in the number of active institutional investors. Thus, we argue that fluctuations in liquidity provision with past return performance account for the link between return reversals and past returns.
“Scaling Up Market Anomalies”, with Doron Avramov, Amnon Schreiber, and Koby Shemer, 2017, Journal of Investing 26, 89─105.
Abstract: This paper implements momentum among a host of market anomalies. Our investment universe consists of the 15 top (long-leg) and 15 bottom (short-leg) anomaly portfolios. The proposed active strategy buys (sells short) a subset of the top (bottom) anomaly portfolios based on past one-month return. The evidence shows statistically strong and economically meaningful persistence in anomaly payoffs. Our strategy consistently outperforms a naive benchmark that equal weights anomalies and yields an abnormal monthly return ranging between 1.273% and 1.471%. The persistence is robust to the post-2000 period, and various other considerations, and is stronger following episodes of high investor sentiment.
“The Unexpected Activeness of Passive Investors: A Worldwide Analysis of ETFs”, with Massimo Massa and Hong Zhang
Abstract: The global ETF industry provides more complicated investment vehicles than low-cost index trackers. Instead, we find that the real investments of ETFs may deviate from their benchmarks to leverage informational advantages (which leads to a surprising stock-selection ability) and to help affiliated OEFs through cross-trading. These effects are more prevalent in ETFs domiciled in Europe. Moreover, ETF flows seem to respond to additional risk. These results have important normative implications for consumer protection and financial stability.
“Mutual Funds and Mispriced Stocks”, with Doron Avramov and Allaudeen Hameed
Abstract: We propose a new measure of fund investment skill, Active Fund Overpricing (AFO), encapsulating the fund’s active share of investments, the direction of fund active bets with regard to mispriced stocks, and the dispersion of mispriced stocks in the fund’s investment opportunity set. We find strong evidence that high (low) AFO funds take active bets by deviating from their benchmark portfolios, and bet on the wrong (right) side of stock mispricing and consequently achieve inferior (superior) fund performance. The differential performance of low and high AFO fund deciles is large, ranging from 1.8% to 3.6% per annum, in our sample of actively managed mutual funds.
“Does Financial Globalization Propagate Managerial Skills? Lessons from the Mutual Fund Industry”, with Massimo Massa and Hong Zhang
Abstract: We examine whether financial globalization helps propagate the managerial skills of financial institutions via enhanced global competition or simply enable some companies to avoid domestic competition. Using a complete sample of global mutual funds, we find that low-skilled fund companies may strategically differentiate their products by launching new funds that track less-explored foreign equity market indices. These new funds bring in asset growth to their managing companies but fail to deliver performance or diversification benefits to their investors. Moreover, their associated cross-border capital flows reduce price efficiency and liquidity in the target country, suggesting that globalization is not necessarily accompanied by the propagation of the beneficial influence of managerial skills.
“Private Company Valuations by Mutual Funds”, with Vikas Agarwal, Brad Barber, Allaudeen Hameed, and Ayako Yasuda
Abstract: We study how cross-sectional and temporal variation in valuation practice of private startup holdings by mutual funds affects investors’ access to these pre-IPO firms. Price dispersion across fund families holding the same security averages 10.0%, and is as large as 25% in some quarters. 42% of reported prices are not updated between quarters but large valuation changes occur when startups close a new funding round. Thus, follow-on rounds lead to predictably strong fund returns in the days after the event. Fund families tend to allocate private securities to their best performers and high-fee funds. Moreover, fund managers with incentives to boost periodic returns mark up their private securities more aggressively after the year-end follow-on rounds. We also find weak evidence of strategic return smoothing with lower incidence of markdowns of private securities in bear markets.
“Short-Sale Constraints and the Pricing of Managerial Skills”, with Massimo Massa and Hong Zhang
Abstract: We investigate the impact of the absence of short selling on the pricing of managerial skills in the mutual fund industry. In the presence of divergent opinions regarding managerial skills, fund managers can strategically use fees to attract only the most optimistic capital. The recognition of this fee strategy helps explain a set of stylized observations and puzzles in the mutual fund industry, including the underperformance of active funds, the existence of flow convexity, and the negative correlation between gross-of-fee α and fees.