Research Paper Prizes

Outstanding Papers

Gas, Guns, and Governments: Financial Costs of Anti-ESG Policies
Daniel Garrett and Ivan Ivanov
Paper | Knowledge at Wharton Story

Abstract: We study how regulation limiting ESG policies distorts financial market outcomes. In 2021 Texas enacted laws that prohibit municipalities from contracting with banks with certain ESG policies, leading to the exit of five of the largest municipal bond underwriters from the state. Issuers previously reliant on these underwriters face higher uncertainty and borrowing costs since the enactment of the laws. These effects are consistent with deterioration in underwriter competition as issuers face fewer potential underwriters. Texas issuers will incur $300-$500 million in additional interest on the $31.8 billion borrowed during the first eight months following enactment.

Green Tilts
Lubos Pastor, Robert Stambaugh, and Lucian Taylor
Paper | Knowledge at Wharton Story

Abstract:We estimate financial institutions’ portfolio tilts that relate to stocks’ environmental, social, and governance (ESG) characteristics. We find ESG-related tilts totaling 6% of the investment industry’s assets under management in 2021. ESG tilts are significant at both the extensive margin (which stocks are held) and the intensive margin (weights on stocks held). The latter tilts are larger. Institutions divest from brown stocks more by reducing positions than by eliminating them. The industry tilts increasingly toward green stocks, due to only the largest institutions. Other institutions and households tilt increasingly toward brown stocks. UNPRI signatories tilt greener; banks tilt browner.

Retail Investors and ESG News
Qianqian Li, Edward Watts, and Christina Zhu
Paper | Knowledge at Wharton Story

Abstract: An important debate exists around the extent to which retail investors make sustainable investments and why they do. We provide evidence relevant to this debate by investigating the aggregate trading patterns of retail investors around a comprehensive sample of key Environmental, Social, and Governance (ESG) news events for U.S. firms. We show that ESG news events appear to be an important and growing component of retail investors’ portfolio allocation decisions. Yet, inconsistent with non-pecuniary preferences, our evidence shows that retail investors mainly trade on this information when they deem it financially material to a company’s stock performance. We also find their net trading demand predicts future abnormal returns, consistent with retail traders benefiting from incorporating ESG-related information in their decision-making. Overall, we conclude that the average U.S. retail investor cares about firms’ ESG-related activities, but primarily to the extent they are financially material for company performance.

Outstanding Papers

Do Common Factors Really Explain the Cross-Section of Stock Returns?
Alejandro Lopez-Lira and Nikolai Roussanov
Paper | Knowledge at Wharton Story

Abstract: We document challenges to the notion of a trade-off between systematic risk and expected returns when analyzing the empirical ability of stock characteristics to predict excess returns. First, we measure individual stocks’ exposures to all common latent factors using a novel high-dimensional method. These latent factors appear to earn negligible risk premia despite explaining virtually all of the common time-series variation in stock returns. Next, we use machine learning methods to construct out-of-sample forecasts of stock returns based on a wide range of characteristics. A zero-cost beta-neutral portfolio that exploits this predictability but hedges all undiversifiable risk delivers a Sharpe ratio above one with no correlation with any systematic factor, thus rejecting the central prediction of the arbitrage pricing theory.

Duration-Based Valuation of Corporate Bonds
Jules van Binsbergen and Michael Schwert
Paper | Knowledge at Wharton Story

Abstract: We decompose corporate bond and equity index returns into duration-matched government bond returns and the excess returns over this duration-matched counterfactual, which we term duration-adjusted returns. Our decomposition leads to markedly different return patterns and asset pricing implications compared to previously used excess return definitions (i.e., returns in excess of Treasury bills). In particular, we find that investment-grade bonds earn a small credit risk premium, comparable in magnitude to the convenience yield, and that duration adjustment resolves the CAPM’s failure to price corporate bonds. These findings highlight the importance of adjusting for non-stationary interest rate environments in asset pricing tests

Pricing Public Information: The Role of Trade
Bradford (Lynch) Levy and Felix Nockher
Paper

Abstract: Using plausibly exogenous variation in the ability to short-sell, we provide evidence that public information is predominantly impounded into prices via trade. Studying the role of trade in the context of publicly-observed cash flow news, we find that only 6% of total price discovery is realized on announcement days with low trade. A portfolio strategy that focuses on stocks with high announcement-day trade yields monthly alpha of 2.46%. In contrast to the predictions of the literature on no-trade equilibria, our evidence suggests that trade plays a significant role in price discovery.

Outstanding Papers

Mutual Fund Risk Shifting and Risk Anomalies
Xiao Han, Nikolai Roussanov, and Hongxun Ruan 
Paper | Knowledge at Wharton Story

Abstract: Risk-shifting by underperforming funds increases their demand for risky stocks. We investigate its contribution to the well known risk anomalies: the apparent overvaluation of stocks with high beta, idiosyncratic volatility, and skewness. We show that these anomalies are concentrated among stocks mainly held by laggard funds. Exploiting the Morningstar methodology change in 2002, whereby its “star” ratings became based on relative performance within a style category rather than across the entire fund universe, we show that the beta anomaly is significant only when beta is measured against the S&P 500 index for the pre-2002 period and against the relevant category index for the post-2002 period. Using a demand system approach we find that removing holdings of the bottom performance quintile of funds substantially reduces the beta anomaly returns.

Retail Investor Trade and the Pricing of Earnings
Jeremy Michels
Paper | Knowledge at Wharton Story

Abstract: New technologies have reduced trading costs for retail investors. In this paper, I examine how the corresponding surge in retail investor trade is associated with the pricing of earnings. I measure retail investor trade with the number of Robinhood users holding a firm’s shares. I find increases in these relatively inexperienced investors are associated with a more positive market response to both positive and negative earnings surprises. This manifests in a more pronounced overall market response per unit of earnings surprise for positive earnings surprises but a muted market response for negative earnings surprises. Further intraday analysis suggests that retail investors respond to stock returns following the earnings announcement instead of the earnings news itself. Finally, in smaller firms and firms that are costly to sell short, and for both the most positive and negative earnings surprises, returns drift upward following the earnings announcement when retail trade is high.

Sea Level Rise Exposure and Municipal Bond Yields
Paul Goldsmith-Pinkham, Matthew Gustafson, Ryan Lewis, and Michael Schwert
Paper | Knowledge at Wharton Story

Abstract: Municipal bond markets begin pricing increased risk of sea level rise (SLR) exposure in 2013, coinciding with upward revisions of SLR projections. The effect is present across maturities, but larger for long-maturity bonds. We do not observe similar patterns using measures of immediate flood risk. We apply a structural model of credit risk to show that municipal bond investors expect a one standard deviation increase in SLR exposure to correspond to a reduction of 2% to 5% in the present value or an increase of 1% to 3% in the volatility of the local government cash flows supporting debt repayment.

Outstanding Papers

Dissecting Bankruptcy Frictions
Winston Wei Dou, Lucian Taylor, Wei Wang, and Wenyu Wang
Paper

Abstract: How efficient is corporate bankruptcy in the U.S.? Two frictions, asymmetric information and conflicts of interest among creditors, can cause several inefficiencies: excess liquidation, excess continuation, and excess delay. We find that the bankruptcy process is quite inefficient, mainly due to excess delay. Eliminating information asymmetries would increase average total payouts by 4%, and eliminating conflicts of interest would increase them by 18% more. Without these frictions, 14% more cases would be resolved pre-court, and the remaining court cases would be 73% shorter. With less delay, bankruptcy’s indirect costs would be much lower. In contrast, inefficiencies from excess liquidation and excess continuation are quite small.

Sustainable Investing in Equilibrium
Lubos Pastor, Robert Stambaugh, and Lucian Taylor
Paper | Knowledge at Wharton Story

Abstract: We model investing that considers environmental, social, and governance (ESG) criteria. In equilibrium, green assets have low expected returns because investors enjoy holding them and because green assets hedge climate risk. Green assets nevertheless outperform when positive shocks hit the ESG factor, which captures shifts in customers’ tastes for green products and investors’ tastes for green holdings. The ESG factor and the market portfolio price assets in a two-factor model. The ESG investment industry is largest when investors’ ESG preferences differ most. Sustainable investing produces positive social impact by making firms greener and by shifting real investment toward green firms.

Undisclosed SEC Investigations
Terrence Blackburne, John Kepler, Phillip Quinn, and Daniel Taylor
Paper | Knowledge at Wharton Story

Abstract: One of the hallmarks of the SEC’s investigative process is that it is shrouded in secrecy––only the SEC staff, high-level managers of the company being investigated, and outside counsel are typically aware of active investigations. We obtain novel data on all investigations closed by the SEC between 2000 and 2017––data that was heretofore non-public––and find that such investigations predict economically material declines in future firm performance. Despite evidence that the vast majority of these investigations are economically material, firms are not required to disclose them, and only 19% of investigations are initially disclosed. We examine whether corporate insiders exploit the undisclosed nature of these investigations for personal gain. Despite the undisclosed and economically material nature of these investigations, we find that insiders are not abstaining from trading. In particular, we find a pronounced spike in insider selling among undisclosed investigations with the most severe negative outcomes; and that abnormal selling activity appears highly opportunistic and earns significant abnormal returns. Our results suggest that SEC investigations are often undisclosed, economically material non-public events and that insiders are trading in conjunction with these events.

Outstanding Papers

Comovement in Arbitrage Limits
Jianan Liu
Paper

Abstract: Estimates of mispricing, such as deviations from no-arbitrage relations, strongly comove across five financial markets. One common component the arbitrage gap—explains the majority of variability in mispricing estimates for futures, Treasury securities, foreign exchange, and options. Prominent equity anomalies also comove significantly with the arbitrage gap. Variables affecting arbitrage capital availability, such as the TED spread and hedge-fund flows and returns, explain two-thirds of the arbitrage gap’s variation. During periods of tighter capital constraints, the comovement in mispricings becomes stronger. The findings support theoretical predictions that common sources of funding shocks can cause comovement in mispricings across markets.

Countercyclical Labor Income Risk and Portfolio Choices over the Life-Cycle
Sylvain Catherine
Paper

Abstract: I structurally estimate a life-cycle model of portfolio choices that incorporates the relationship between stock market returns and the skewness of idiosyncratic income shocks. The cyclicality of skewness can explain (i) low stock market participation among young households with modest financial wealth and (ii) why the equity share of participants slightly increases until retirement. With an estimated relative risk aversion of 5 and yearly participation cost of $290, the model matches the evolution of wealth, of participation and of the conditional equity share over the life-cycle. Nonetheless, I find that cyclical skewness increases the equity premium by at most 0.5%.

Risk Free Interest Rates
Jules van Binsbergen, William Diamond, and Marco Grotteria
Paper

Abstract: We estimate risk free rates unaffected by the convenience yield on safe assets by inferring them from risky options and futures prices. Our data provides time-varying estimates of the term structure of convenience yields from maturities of 1 month to 2.5 years at a minutely frequency. The convenience yield on government bonds equals about 40 basis points on average, is larger below 3 months maturity, and grows substantially during periods of financial distress. With our unique intraday estimates of the term structure of convenience yields, we estimate the high frequency response of convenience yields to monetary policy and quantitative easing. Convenience yields respond most strongly to central bank policy in the depths of the financial crisis, and both conventional and unconventional monetary stimulus reduce convenience yields. Additionally, a factor constructed from our measure of the term structure of convenience yields predicts excess bond returns even when controlling for commonly used factors in the literature. Finally, we study the dynamics of a large panel of other arbitrage spreads and find that our implied convenience yields predict other spreads and face the smallest idiosyncratic shocks, suggesting that they are highly informative measures of frictions in financial markets.

Outstanding Papers

Anomalies Abroad: Beyond Data Mining
Xiaomeng Lu, Robert Stambaugh, and Yu Yuan
Paper

Abstract: A pre-specified set of nine prominent U.S. equity return anomalies produce significant alphas in Canada, France, Germany, Japan, and the U.K. All of the anomalies are consistently significant across these five countries, whose developed stock markets afford the most extensive data. The anomalies remain significant even in a test that assumes their true alphas equal zero in the U.S. Consistent with the view that anomalies reflect mispricing, idiosyncratic volatility exhibits a strong negative relation to return among stocks that the anomalies collectively identify as overpriced, similar to results in the U.S.

Cyclical Dispersion in Expected Defaults
Joao Gomes, Marco Grotteria, and Jessica Wachter
Paper

Abstract: A growing literature shows that credit indicators forecast aggregate real outcomes. While researchers have proposed various explanations, the economic mechanism behind these results remains an open question. In this paper, we show that a simple, frictionless, model explains empirical findings commonly attributed to credit cycles. Our key assumption is that firms have heterogeneous exposures to underlying economy-wide shocks. This leads to endogenous dispersion in credit quality that varies over time and predicts future excess returns and real outcomes.

Political Connections and the Informativeness of Insider Trades
Alan Jagolinzer, David Larcker, Gaizka Ormazabal, and Daniel Taylor
Paper | Knowledge at Wharton Story

Abstract: We examine the relation between political connections and informed trading by corporate insiders at leading financial institutions during the Financial Crisis. We find strong evidence of a relation between political connections and informed trading, that the relation is strongest during the period in which TARP funds were disbursed, and strongest among TARP recipients. Notably, we find evidence of abnormal trading by politically connected insiders 30 days in advance of TARP infusions, and that these trades predict the market reaction to the infusion. Our results suggest that politically connected insiders had a significant information advantage during the Crisis and opportunistically timed their trades to exploit this advantage.

Outstanding Papers