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Working papers
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Asymmetric information and the pecking order
(joint with Paolo Fulghieri and Dirk Hackbarth)
In this paper we reconsider
the Pecking Order Theory of external financing in the context of a
real options model. We show that, when firm value is characterized
by an exchange option, equity financing can dominate debt financing
while the only friction is the asymmetric information between the
firm's owners and outside investors. We characterize the conditions
under which equity dominates debt analytically, and we provide new
testable empirical predictions. We further establish that equity
financing is relatively more attractive when the firm already has
some debt in its capital structure. The paper finally argues that
equity-like securities, namely convertible debt and warrants, are
optimal when considering a security design problem.
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Sentiment during recessions
This paper studies the effect of sentiment on asset prices during
the 20th century (1905--2005). As a proxy for sentiment, we use
the fraction of positive and negative words in two columns of
financial news from the New York Times. The main contribution of
the paper is to show that, controlling for other well-known
time-series patterns, the predictability of stock returns using
news' content is concentrated in recessions. A one standard
deviation shock to our news measure during recessions changes the
conditional average return on the DJIA by twelve basis points over
one day.
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Noise and aggregation of
information in large markets
(joint with Branko Urosevic)
We study a novel class of noisy rational expectations equilibria in markets with large
number of agents. We show that, as long as noise (liquidity traders, endowment shocks)
increases with the number of agents in the economy, the limiting competitive equilibrium
is well-defined and leads to non-trivial information acquisition,
and partially revealing prices, even if per-capita noise tends to zero. We find that
in such equilibrium risk sharing and price revelation play different roles than in the standard
limiting economy in which per-capita noise is not negligible. We apply our model to
study information sales by a monopolist, information acquisition in multi-asset markets,
and derivatives trading, and show that our model leads to qualitatively different results
with respect to those in the existing literature. Our notion of large noise is shown to be
necessary and sufficient to have limiting economies with perfectly competitive behavior.
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Optimal contracts with privately informed
agents and active principals
This paper considers an optimal contracting problem between an informed risk-averse
agent and a principal, when the agent needs to perform multiple tasks, and the principal
is active, namely she can influence some aspect of the agency relationship on top of the
contract itself (i.e. capital budgets, task assignments). The main contribution is to show
that asymmetric information makes incentives and investment decisions substitutes for the
principal under rather general conditions. This result yields novel implications for the
capital budgeting literature that studies informational problems. In particular the nature
of the private information, e.g. whether it affects the marginal value of investment, the value
of the agent's effort choice, or potential interactions between effort and investment, plays
a crucial role in the optimal contracts. The paper also shows that asymmetric information
considerations yield a positive relationship between the noise of the performance measure
and the action scope of managers.
Published papers
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Geographic dispersion and stock returns
(joint with Oyvind Norli), forthcoming
in the Journal of Financial Economics
This paper shows that stocks of truly local firms have
returns that exceed the return on stocks of geographically dispersed firms by
70 basis points per month. By extracting state name counts from annual
reports filed with the SEC on form 10-K, we distinguish firms with
business operations in only a few states from firms with operations in
multiple states. Our findings are consistent with the view that lower
investor recognition for local firms results in higher stock returns to
compensate investors for insufficient diversification.
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Journalists and the Stock Market
(joint with Casey Dougal, Joseph Engelberg and Christopher Parsons),
forthcoming in the Review of Financial Studies.
We use exogenous scheduling of Wall Street Journal columnists
to identify a causal relation between financial reporting and stock
market performance. To measure the media's unconditional effect, we
add columnist fixed effects to a daily regression of excess Dow
Jones Industrial Average returns. Relative to standard control
variables, these fixed effects increase the R-squared by about 35
percent, indicating each columnist's average persistent
"bullishness" or "bearishness." To measure the media's
conditional effect, we interact columnist fixed effects with lagged
returns. This increases explanatory power by yet another one-third,
and identifies amplification or attenuation of prevailing sentiment
as a tool used by financial journalists.
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Information sales and strategic trading
(joint with Francesco Sangiorgi),
Review of Financial Studies, 2011, 24(9), 3069-3104.
We
study information sales in financial markets with strategic
risk-averse traders. Our main result establishes that the optimal
selling mechanism is one of the following two: (i) sell to as many
agents as possible very imprecise information; (ii) sell to a single
agent a signal as precise as possible. As noise trading per unit of
risk-tolerance becomes large, the "newsletters" or "rumors" associated
with (i) dominate the "exclusivity" contract in (ii). The optimal
information sales contracts share similar properties in market-orders
and limit-orders markets, while models in which competitive behavior
is assumed yield qualitatively different equilibria. The endogeneity
of the information allocation implies a ranking reversal of the
informational efficiency of prices across markets and
models. Equilibrium prices become more informative in market-orders
than in limit-orders markets, and the model with imperfect competition
yields more informative prices than its competitive counterpart. These
results are driven by the seller of information offering more precise
signals when the externality in the valuation of information is
relatively less intense.
Technical appendix
accompanying the paper - gives more details on the derivation of the equilibria
(standard and tedious, but necessary).
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Relative wealth concerns and complementarities in information acquisition
(joint with Gunter Strobl),
Review of Financial Studies, 2011, 24(1), 169-207.
This paper studies how relative consumption effects, in which a
person's satisfaction with their own consumption depends on how much
others are consuming, affect investors' incentives to acquire
information. We find that such consumption externalities can
generate complementarities in information acquisition within the
standard rational expectations paradigm. When agents are sensitive
to the wealth of others, they herd on the same information, trying
to mimic each other's trading strategies. We show that there can be
multiple herding equilibria in which some assets receive
considerable attention while others with similar characteristics are
ignored. Further, different communities of agents may specialize in
different assets. This multiplicity of equilibria also generates
jumps in asset prices: an infinitesimal shift in fundamentals can
lead to a discrete price movement.
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Information acquisition and mutual funds
(joint with Joel Vanden),
Journal of Economic Theory, 2009, 144(5), 1965-1995.
We
study the size and the existence of the mutual fund industry by
generalizing the standard competitive noisy rational expectations
framework with endogenous information acquisition. Since informed
agents optimally choose to open mutual funds in order to sell their
private information, mutual funds are an endogenous feature of our
equilibrium. Our model yields novel predictions on price
informativeness, optimal fund fees, the equilibrium risk premium, and
the size and competitiveness of the mutual fund industry. In
particular, we show that a sufficiently competitive mutual fund sector
yields more informative prices and a lower equity risk premium. Thus,
the paper explicitly links the existence of mutual funds to
equilibrium asset prices.
Supplement
accompanying the paper - gives details on the proofs of the paper.
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Sports sentiment and stock returns
(joint with Alex Edmans and Oyvind Norli)
,
Journal of Finance, 2007, 62(4), 1967-1998.
This paper investigates the stock market reaction to sudden changes in investor mood. Motivated
by psychological evidence of a strong link between soccer outcomes and mood, we
use international soccer results as our primary mood variable. We find a significant market
decline after soccer losses. For example, a loss in the World Cup elimination stage leads to
a next-day abnormal stock return of -38 basis points. This loss effect is stronger in small
stocks and in more important games, and is robust to methodological changes. We also
document a loss effect after international cricket, rugby, and basketball games.
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Overconfidence and market efficiency with heterogeneous agents
(joint with Francesco Sangiorgi and Branko Urosevic),
Economic Theory,
2007, 30(2), 313-336.
We study financial markets in which both rational and overconfident agents coexist
and make endogenous information acquisition decisions. We demonstrate the following
irrelevance result: when a positive fraction of rational agents (endogenously) decides to
become informed in equilibrium, prices are set as if all investors were rational, and as a
consequence the overconfidence bias does not affect informational efficiency, price volatility,
rational traders' expected profits or their welfare. Intuitively, as overconfidence goes up, so
does price informativeness, which makes rational agents cut their information acquisition
activities, effectively undoing the standard effect of more aggressive trading by the overconfident.
The main intuition of the paper, if not the irrelevance result, is shown to be
robust to different model specifications.
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Monotonicity in direct revelation mechanisms,
Economics Letters, 2005, 88(1), 21-26.
This paper studies a standard screening problem where the principal's allocation rule
is multi-dimensional, and the agent's private information is a one-dimensional continuous
variable. Under standard assumptions, that guarantee monotonicity of the allocation rule in
one-dimensional mechanisms, it is shown that the optimal allocation will be non-monotonic
in a (weakly) generic sense once the principal can use all screening variables. The paper
further gives conditions on the model's parameters that guarantee that non-monotonic
allocation rules will be optimal.
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Convergence and biases of Monte Carlo estimates of American
option prices using a parametric exercise rule,
Journal of Economic Dynamics & Control, 2003, 27(10), 1855-
1879.
This paper presents an algorithm for pricing American options using Monte Carlo simulation.
The method is based on using a parametric representation of the exercise boundary.
It is shown that, as long as this parametric representation subsumes all relevant stopping times,
error bounds can be constructed using two different estimates, one which is biased
low and one which is biased high. Both are consistent and asymptotically unbiased estimators
of the true option value. Results for high-dimensional American options confirm the
viability of the numerical procedure. The convergence results of the paper shed light into
the biases present in other algorithms proposed in the literature.
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