Passive-Aggressive Trading: The Supply and Demand of Liquidity by Mutual Funds (with Susan Christoffersen, Donald Keim, and David Musto)
Review of Finance, 26(5): 1145-1177, September 2022.
Non-Standard Errors (with 342 co-authors from 34 countries and 207 institutions (mostly universities))
Journal of Finance, forthcoming.
Active liquidity management, strategic complementarities, and market price of liquidity — R&R
Presentations: American Finance Association 2017, Northern Finance Association 2016, Asian Finance Association 2018, USC Marshal PhD Conference in Finance 2015, PhD Nordic Finance Workshop 2015, Bank for International Settlements, Bank of Canada, Copenhagen Business School, Copenhagen University, Aarhus University, IESE, BI Oslo, Rotterdam School of Management, WU Vienna University of Economics and Business, Deutsche Bundesbank, Geothe University, DeGroote School of Business, School of Administrative Studies (York University), and Schulich School of Business
This paper empirically investigates a channel through which market uncertainty affects the liquidity premium. Using data at the mutual fund level, I document that increases in market uncertainty are associated with lower performance and more withdrawals. Consequently, funds adjust the composition of their portfolio towards more liquid assets in order to meet potential redemptions. Aggregated over many funds, this `flight-to-liquidity’ places significant upward price pressure on the liquidity premium: a one standard deviation increase in my measure of active liquidity management yields a 1.22 standard deviation increase in the return spread between illiquid and liquid stocks.
Online Appendix is available here.
Liquid Co-Illiquidity Management (with Massimo Massa and Søren Hvidkjær) — R&R
Presentations: Mutual Fund, Hedge Fund and Factor Investing Conference 2019, 8th Luxembourg Asset Management Summit 2019, WU Vienna University of Economics and Business, Schulich School of Business
We study the link between illiquidity and co-movement in illiquidity and the way asset managers trade off illiquidity and co-illiquidity in their portfolio allocation decision. By exploring two experiments – the 2005 SHO Regulation and the 2008 short selling ban – we document that in the face of sudden illiquidity shocks, short-term investors are willing to accept high portfolio co-illiquidity to circumvent and increase in their holdings’ illiquidity.
Skilled active liquidity management — a natural experiment — R&R
I study the active liquidity management of equity mutual funds in US. First, I show that mutual funds actively increase the liquidity of their portfolio in response to a negative and exogenous shock to investor flows. I document that fund managers use both equity and cash holdings to adjust their portfolio’s liquidity when subject to sudden and unexpected withdrawals. Second, I argue that active liquidity management is an effective device that skilled managers use to minimize the cost imposed by redemption obligations. I find that funds that actively manage their liquidity to a greater degree outperform their less liquidity focused peers by up to 4.92% per year.
The salience of ESG Ratings for Stock Pricing: Evidence from (Potentially) Confused Investors (with Kathleen Weiss Hanley and Loriana Pelizzon)
Semi-finalist of Best Paper Award in Investments at FMA 2021
Presentations: Tinbergen Institute Amsterdam, Frankfurt School of Management, Ca’ Foscari University of Venice, European Central Bank, Frankfurter Institute fur Risikomanagement und Regulierung, European Central Bank, Bundesbank, IWFSAS 2021 Conference, Credit 2021 Conference*, IRMC Conference, Aarhus University, JRC Ispra, University of Verona, Zurich University, Adam Smith Business School COP26 ESG and Climate Finance Conference, Canadian Sustainable Finance Network 2021, CEMFI Banking & Finance Workshop 2021,Credit 2021 Conference, Financial Management Associate 2021, International Workshop on Financial System Architecture and Stability 2021, International French Finance Association 2022, OCC Symposium on Climate Risk in Finance and Banking 2022, Wolfe QES ESG Investment Conference 2022.
We exploit a modification to Sustainalytics’ environmental, social, and governance (ESG) rating methodology, which is subsequently adopted by Morningstar, to study whether ESG ratings are salient for stock pricing. We show that the inversion of the rating scale but not new information leads some investors to make incorrect assessments about the meaning of the change in ESG ratings. They buy (sell) stocks they misconceive as ESG upgraded (downgraded) even when the opposite is true. This trading behavior exerts transitory price pressure on affected stocks. Our paper highlights the importance of ESG ratings for investors and consequently for asset prices.
Money in the Right Hands: The Price Effects of Specialized Demand (with Rüdiger Weber)
Presentations: Theory-based Empirical Asset Pricing Research Conference*, International Conference of the French Finance Association*, Canadian Economic Association Conference, German Finance Association*, Financial Management Association Conference, and New Zealand Finance Meeting
We study stock liquidity from a demand-based perspective in the context of mutual fund fire sales and index reconstitutions. We introduce a stock-level measure of specialized demand, capturing the available investment capacity of investors likely to have a high valuation for a stock and find that it determines non-fundamental price discounts. When specialized, elastic demand is scarce, we observe the price pressure documented in the literature. Specialized demand does not proxy for informed trading, and neither asset quality nor adverse selection explain our results. Rather, inefficient allocations induced by fire sales lead to transiently higher discount rates and price pressure.
Local Economic Conditions and Local Equity Preferences: Evidence from Mutual Funds during the U.S. Housing Boom and Bust (with Chandler Lutz and Ben Sand)
Presentations: Urban Economic Association 2017, Canadian Economic Association 2017*, Copenhagen Business School, WU Vienna University of Economics and Business
This paper examines the impact of local economic conditions on mutual fund preferences for geographically proximate stocks and consequently fund performance. Specifically, we demonstrate that mutual funds favoritism towards firms located within close geographic proximity varies with local housing price shocks. A decrease in local house prices is strongly associated with an increase in mutual fund home bias and results in a portfolio adjustment towards safer and higher quality holdings. This previously undocumented behavioral bias is of first order importance, as the shift in mutual fund preferences towards local stocks induced by deterioration in local economic conditions is associated with mutual fund underperformance: a one percentage point increase in home bias causes a decrease in a fund’s characteristic-adjusted 3-month future return by 35.3 bps.
House Prices and Taxes (with Mads Nielsen Gjedsted)
Presentations: Word Finance Conference 2014* and European Economic Association & Econometric Society 2014*
By using the 2007 municipality reform in Denmark as an exogenous shock to municipal tax rates, we find that a 1%-point increase in income tax rates lead to a drop in house prices of 7.9% and a 1‰-point increase in the property tax rates lead to a 1.1% drop in house prices. The simple present values of a 1%-point perpetual income tax increase and a 1‰-point property tax increase, relative to the median house price, are 7% and 3.3%, respectively. Our findings are thus in line with the predicted median tax loss. This indicates that the housing market efficiently incorporates taxes into house prices. The exogeneity of the shock to taxes and the size of the data set is an improvement over earlier studies.
Work in Progress
- Peer fragility, liquidity preferences, and the propagation of financial shocks (with Ben Sand)
- Issuer Certification in Money Markets (with Sven Klingler and Olav Syrstad)
* presented by co-author