We present a selection of seminar slides based on our 2013 Quarterly Journal of Economics paper, Managerial Miscalibration. Using a large panel of CFO forecasts of S&P 500 returns, we find that executives are severely miscalibrated,... more
We present a selection of seminar slides based on our 2013 Quarterly Journal of Economics paper, Managerial Miscalibration. Using a large panel of CFO forecasts of S&P 500 returns, we find that executives are severely miscalibrated, producing distributions that are far too narrow. Realized returns are within the executives' 80% confidence intervals only 36% of the time. We also find that executives who are miscalibrated about the stock market show similar miscalibration regarding their own firms’ prospects. Finally, firms with miscalibrated executives seem to follow more aggressive corporate policies: investing more and using more debt financing. We also feature an update where we nearly double our sample size. While it is often the case that results get weaker (or disappear) after publication, our new evidence suggests that the degree of miscalibration has worsened.
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It is well-established that financially constrained firms scale down their investment activity. The lost investment opportunities, however, could potentially be captured by other firms that are less financially constrained. We test this... more
It is well-established that financially constrained firms scale down their investment activity. The lost investment opportunities, however, could potentially be captured by other firms that are less financially constrained. We test this proposition using the Reg SHO pilot regulation, which relaxed short-selling constraints for about 30% of firms and thus tightened their financial constraints. Following the introduction of the regulation, pilot firms indeed reduced their investments, while their direct competitors increased their investments, expanded their market share, and became more profitable. We conclude that opportunities lost due to financial constraints could be salvaged by competing firms.
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[1]Hedge funds make great scapegoats. After all, how can anyone make money on Wall Street without cheating somehow, right? But as a crucible for active management, hedge funds often exaggerate behaviors that are endemic across all... more
[1]Hedge funds make great scapegoats. After all, how can anyone make money on Wall Street without cheating somehow, right? But as a crucible for active management, hedge funds often exaggerate behaviors that are endemic across all segments of investors. One oft-cited anomaly is the tendency for mutual funds to goose their reported returns by buying up their own holdings in the last few seconds of a quarter. According to a new study [2] by Itzhak Ben-David, Francesco Franzoni, Augustin Landier and Rabih Moussawi (of Ohio State, Swiss Finance Institute, Toulouse School of Economics and Wharton respectively), hedge funds also tend to “manipulate” their returns in this way.
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ABSTRACT We study the timing of foreclosures on delinquent mortgages in 2009-2010 and show that foreclosure starts were delayed for loans located in congressional districts of members of the Financial Services Committee in the U.S. House... more
ABSTRACT We study the timing of foreclosures on delinquent mortgages in 2009-2010 and show that foreclosure starts were delayed for loans located in congressional districts of members of the Financial Services Committee in the U.S. House of Representatives. This finding is robust to restricting the sample to the districts whose representatives were elected to the House and appointed to the Committee well before the financial crisis. The results are also robust to controlling for many loan- and zip code-level factors, state-specific time fixed effects, restricting the analysis to various subsamples, using alternative econometric methods and conducting placebo tests. Our results suggest that lenders’ foreclosure choices are sensitive to legislative developments.
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We explore the effects of mandatory third-party review of mortgage contracts on the terms, availability, and performance of mortgage credit. Our study is based on a natural experiment in which the State of Illinois required ‘high-risk ’... more
We explore the effects of mandatory third-party review of mortgage contracts on the terms, availability, and performance of mortgage credit. Our study is based on a natural experiment in which the State of Illinois required ‘high-risk ’ mortgage applicants acquiring or refinancing properties in 10 specific zip codes to submit loan offers from state-licensed lenders to review by HUD-certified financial counselors. We document that the legislation led to declines in both the supply of and demand for credit, with statelicensed lenders and lower-quality borrowers disproportionately exiting the affected area. Controlling for the salient characteristics of the remaining borrowers and lenders, we find that the legislation succeeded in reducing ex post default rates among counseled borrowers by close to 4 percentage points (about 35% decline). We attribute this result to actions of lenders responding to the presence of external review and, to a lesser extent, to counseled borrowers renegoti...
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This paper can be downloaded without charge from:
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This paper can be downloaded without charge from:
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We examine how insiders and firms trade when arbitrage is limited. When arbitrage is costly (proxied by high idiosyncratic risk), insiders and firms earn higher absolute returns on their trades (insider trading, share repurchases, and... more
We examine how insiders and firms trade when arbitrage is limited. When arbitrage is costly (proxied by high idiosyncratic risk), insiders and firms earn higher absolute returns on their trades (insider trading, share repurchases, and seasoned equity offerings) in the following year. Furthermore, they initiate their trades following greater past price movements in the preceding year. These results are not driven by information asymmetry or firm size. Overall, our results are consistent with the idea that insiders and firms compete with outside arbitrageurs in exploiting mispricings and benefit when outside arbitrage is limited.
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We study the behavior of banks around the announcement of the centralization of banking supervision in Europe. On December 2012, European authorities announced that within a year the supervisory responsibilities for mid-size and large... more
We study the behavior of banks around the announcement of the centralization of banking supervision in Europe. On December 2012, European authorities announced that within a year the supervisory responsibilities for mid-size and large banks would be transferred to the European Central Bank. We document that following the announcement banks around the size threshold shrank their assets by contracting their credit book and liquid assets. Then, we use the size threshold to measure the effects of central supervision on banks. After accounting for banks’ strategic behavior, the effects of central supervision are materially larger than previously-thought. JEL classification: G21, G28
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We examine how investor preferences and beliefs affect trading in relation to past gains and losses. The probability of selling as a function of profit is V-shaped; at short holding periods, investors are more likely to sell big losers... more
We examine how investor preferences and beliefs affect trading in relation to past gains and losses. The probability of selling as a function of profit is V-shaped; at short holding periods, investors are more likely to sell big losers than small ones. There is little evidence of an upward jump in selling at zero profits. These findings provide no clear indication that realization preference explains trading. Furthermore, the disposition effect is not driven by a simple direct preference for selling a stock by virtue of having a gain versus loss. Trading based on belief revisions can potentially explain these findings. Paper available at: https://ssrn.com/abstract=1876594.
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Attention-deficit/hyperactivity disorder (ADHD) exerts lifelong impairment, including difficulty sustaining employment, poor credit, and suicide risk. To date, however, studies have assessed selected samples, often via self-report. Using... more
Attention-deficit/hyperactivity disorder (ADHD) exerts lifelong impairment, including difficulty sustaining employment, poor credit, and suicide risk. To date, however, studies have assessed selected samples, often via self-report. Using mental health data from the entire Swedish population (N = 11.55 million) and a random sample of credit data (N = 189,267), we provide the first study of objective financial outcomes among adults with ADHD, including associations with suicide. Controlling for psychiatric comorbidities, substance use, education, and income, those with ADHD start adulthood with normal credit demand and default rates. However, in middle age, their default rates grow exponentially, yielding poor credit scores and diminished credit access despite high demand. Sympathomimetic prescriptions are unassociated with improved financial behaviors. Last, financial distress is associated with fourfold higher risk of suicide among those with ADHD. For men but not women with ADHD wh...
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ABSTRACT This study presents evidence about the mechanism that links investor overconfidence to the disposition effect. Our evidence indicates that overconfidence heightens the trading frequency of institutional investors while impacting... more
ABSTRACT This study presents evidence about the mechanism that links investor overconfidence to the disposition effect. Our evidence indicates that overconfidence heightens the trading frequency of institutional investors while impacting asymmetrically on their trading between past winners and losers. Using 20 years of trading data of institutional investors, we find that although institutional investors do not exhibit the disposition effect with respect to the purchase price, they are reluctant to sell losers when the current price is below the ever-high price. Our empirical design is based on exploiting variation in information ambiguity of stocks in order to identify the effect of overconfidence. We document that when stocks have ambiguous information investors show signs of overconfident trading: they trade more frequently, although they lose 1% to 4.5% per year on their trades. Regardless of loss reference price, institutional investors exhibit greater disposition effect when information ambiguity increases.
We thank Caitlin Kearns for outstanding research assistance. We thank Amit Seru and an anonymous referee for important and insightful comments. Thanks are also due to participants at numerous conferences and seminars for their helpful... more
We thank Caitlin Kearns for outstanding research assistance. We thank Amit Seru and an anonymous referee for important and insightful comments. Thanks are also due to participants at numerous conferences and seminars for their helpful feedback. Ben-David’s research is supported by the Dice Center and the Neil Klatskin Chair in Finance and Real Estate. The views in this paper are those of the authors and may not reflect those of the Federal Reserve System, the Federal Reserve Bank of Chicago, the Office of the Comptroller of the Currency, or the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
We test whether top financial executives are miscalibrated using a unique 10-year panel that includes over 13,300 probability distributions of expected stock market returns. We find that executives are severely miscalibrated, producing... more
We test whether top financial executives are miscalibrated using a unique 10-year panel that includes over 13,300 probability distributions of expected stock market returns. We find that executives are severely miscalibrated, producing distributions that are too narrow: realized market returns are within the executives’ 80 % confidence intervals only 36 % of the time. We show that the lower bound of the forecast confidence interval is lower during times of high market uncertainty; however, ex-post miscalibration is worst during these episodes. We also find that executives who are miscalibrated about the stock market show similar miscalibration regarding their own firms ’ prospects. Finally, firms with miscalibrated executives appear to follow more aggressive corporate policies: investing more and using more debt financing.
We study a controlled corporate experiment in which loan officers was altered from fixed salary to volume-based pay. The incentives increased aggressiveness of origination: higher origination rates (+31%), loan sizes (+15%), and default... more
We study a controlled corporate experiment in which loan officers was altered from fixed salary to volume-based pay. The incentives increased aggressiveness of origination: higher origination rates (+31%), loan sizes (+15%), and default rate (+28%). The effects are partly driven by moral hazard: approval decision is driven by loan officers ’ discretion; however, default is uncorrelated with discretion. Default rate is higher when discretion is used to accept loans and when loan terms are unfoundedly aggressive. End-of-month approvals (i.e., larger marginal bonus) are more likely to default. Marginal originated loans have a negative net present value.
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We study a controlled corporate experiment in which loan officers ’ compensation structure was altered from fixed salary to volume-based pay. The incentives increased aggressiveness of origination: higher origination rates (+31%), loan... more
We study a controlled corporate experiment in which loan officers ’ compensation structure was altered from fixed salary to volume-based pay. The incentives increased aggressiveness of origination: higher origination rates (+31%), loan sizes (+15%), and default rate (+28%). The effects are partly driven by moral hazard: approval decisions are driven by loan officers ’ discretion; however, default is uncorrelated with discretion. The default rate is higher when discretion is used to accept loans and when loan terms are unfoundedly aggressive. End-of-month approvals (i.e., larger marginal bonus) are more likely to default. Marginal originated loans have a negative net present value.
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Favorable changes in Russian leasing law are making leasing more attractive than other financing methods for both Russian lessees and foreign lessors. Increased economic effectiveness, flexibility, and accessibility are some of the... more
Favorable changes in Russian leasing law are making leasing more attractive than other financing methods for both Russian lessees and foreign lessors. Increased economic effectiveness, flexibility, and accessibility are some of the positive changes.
The disposition effect (greater realization of winners than losers) is often taken as proof that investors have an inherent preference for realizing winners over losers. In contrast, we find that the disposition effect is not primarily... more
The disposition effect (greater realization of winners than losers) is often taken as proof that investors have an inherent preference for realizing winners over losers. In contrast, we find that the disposition effect is not primarily driven by realization preference. The probability of selling as a function of profit is V-shaped, so that at short holding periods investors are much more likely to sell big losers than small ones. There is little indication of a jump discontinuity in selling probability at zero profits, as implied by an investor concern for the sign of realized returns. In a placebo test, there is a reverse disposition effect for the probability of buying additional shares. The speculative motive for trade potentially helps explain these findings.
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In stark contrast to the sophisticated methods advocated by academics in business schools, actual business practices are typically simple and intuitive (e.g., valuation, debt management, compensation). Methods that have these... more
In stark contrast to the sophisticated methods advocated by academics in business schools, actual business practices are typically simple and intuitive (e.g., valuation, debt management, compensation). Methods that have these characteristics are more likely to become widely used business practices for two reasons. First, they are less prone to overfitting to a particular setting and therefore are robust across economic environments and applicable in new settings. Second, they are easy to communicate and are verifiable. Therefore, they can spread easily across organizations and are hard to replace with new and improved methods. This explanation of business practices can help resolve puzzles in corporate finance, such as the variation in debt leverage across industries.
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Existing literature predicts that highly-levered distressed banks suffer from a debt overhang that leads them to take more risk and avoid actions that decrease their leverage. Using two distinct periods that include financial crises and... more
Existing literature predicts that highly-levered distressed banks suffer from a debt overhang that leads them to take more risk and avoid actions that decrease their leverage. Using two distinct periods that include financial crises and are subject to different regulations (1985-1994, 20052014), we investigate whether these predictions are supported. We find that distressed banks reduce their leverage in various forms: increase their equity, reduce the size of their balance sheet, reduce the number of branches and employees. They also decrease observable measures of riskiness. The global financial crisis is associated with weaker deleveraging. We show that the deleveraging of distressed banks increases after the adoption of FDICIA and does not increase after the adoption of Dodd-Frank compared to the pre-global financial crisis period.
We explore the effects of mandated financial counseling on terms and availability of mortgage credit. Our study is based on a natural experiment in which the State of Illinois required ‘high-risk’ mortgage applicants acquiring or... more
We explore the effects of mandated financial counseling on terms and availability of mortgage credit. Our study is based on a natural experiment in which the State of Illinois required ‘high-risk’ mortgage applicants acquiring or refinancing properties in 10 specific zip codes to submit loan offers from statelicensed lenders to third-party review. We document that as a consequence of the legislation both the supply of and demand for credit declined, and marginal borrowers were pushed out of the market. Statelicensed lenders disproportionately exited the affected area and sharply increased their loan application rejection rates. Although home sales activity dropped off during the treatment period, we fail to detect a material impact on transaction prices. Controlling for salient characteristics of remaining borrowers and lenders, we find that mortgages originated during the legislation period were less likely to default, and that their terms improved somewhat. We attribute these impr...
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To understand better the role of loan officers in the origins of the financial crisis, we study a controlled experiment conducted by a large bank. In the experiment, the incentive structure of a subset of small business loan officers was... more
To understand better the role of loan officers in the origins of the financial crisis, we study a controlled experiment conducted by a large bank. In the experiment, the incentive structure of a subset of small business loan officers was changed from fixed salary to commission-based compensation. We use a diffin-diff design to show that while the characteristics of loan applications did not change, commissionbased loan officers are 19% more likely to accept loan applications, and approve loan amounts larger by 23%. Although the observable credit quality of loans booked by commission-based loan officers increased, they were 28% more likely to default. We show that the increase in default occurs primarily at the population of loans that would not have been accepted in the absence of commission-based compensation. Our results show that the explosion in mortgage volume during the crisis and the deterioration of underwriting standards can be partly attributed to the incentives of loan of...
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We show that mutual fund ratings generate correlated demand that creates systematic price fluctuations. Mutual fund investors chase fund performance via Morningstar ratings. Until June 2002, funds pursuing the same investment style had... more
We show that mutual fund ratings generate correlated demand that creates systematic price fluctuations. Mutual fund investors chase fund performance via Morningstar ratings. Until June 2002, funds pursuing the same investment style had highly correlated ratings. Therefore, rating-chasing investors directed capital into winning styles, generating style-level price pressures, which reverted over time. In June 2002, Morningstar reformed its methodology of equalizing ratings across styles. Style-level correlated demand via mutual funds immediately became muted, significantly altering the time-series and cross-sectional variation in style returns.
We show that mutual fund investors rely on simple signals and likely do not engage in sophisticated learning about managers’ alpha as widely believed. Simplistic performance chasing best explains aggregate flows to the mutual fund space... more
We show that mutual fund investors rely on simple signals and likely do not engage in sophisticated learning about managers’ alpha as widely believed. Simplistic performance chasing best explains aggregate flows to the mutual fund space and flows across funds. These results hold for both actively managed and passive index funds. Empirical patterns commonly interpreted as reflecting learning about managerial skill also appear in falsification tests and are mechanical. Our results are consistent with the view that, on average, households are homo sapiens with limited financial sophistication rather than hyperrational alpha-maximizing agents, as often assumed in the literature.
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We present evidence that equity momentum strategies are partially driven by positive-feedback trading intermediated via the mutual fund sector. We identify a U.S.-specific structural break to this channel that substantially weakened the... more
We present evidence that equity momentum strategies are partially driven by positive-feedback trading intermediated via the mutual fund sector. We identify a U.S.-specific structural break to this channel that substantially weakened the relationship between fund flows and past style returns. As a result, trading strategies that load on flow-driven positive-feedback trading (including momentum in stocks, styles, and factors) experienced a profitability decline. Consistent with the proposed channel, the profitability decline was limited to the U.S. market. Moreover, factors that were more directly exposed to the structural break experienced a sharp return “kink” in the months after the event.
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Using 14,800 forecasts of one-year S&P 500 returns made by Chief Financial Officers over a 12-year period, we track the individual executives who provide multiple forecasts to study how their beliefs evolve dynamically. While CFOs’... more
Using 14,800 forecasts of one-year S&P 500 returns made by Chief Financial Officers over a 12-year period, we track the individual executives who provide multiple forecasts to study how their beliefs evolve dynamically. While CFOs’ return forecasts are systematically unbiased, their confidence intervals are far too narrow, implying significant miscalibration. We find that when return realizations fall outside of ex-ante confidence intervals, CFOs’ subsequent confidence intervals widen considerably. These results are consistent with a model of Bayesian learning which suggests that the evolution of beliefs should be impacted by return realizations. However, the magnitude of the updating is dampened by the strong conviction in beliefs inherent in the initial miscalibration and, as a result, miscalibration persists. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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We study the long-run outcomes associated with hedge funds' compensation structure. Over a 22-year period, the aggregate effective incentive fee rate is 2.5 times the average contractual rate (i.e., around 50% instead of 20%).... more
We study the long-run outcomes associated with hedge funds' compensation structure. Over a 22-year period, the aggregate effective incentive fee rate is 2.5 times the average contractual rate (i.e., around 50% instead of 20%). Overall, investors collected 36 cents for every dollar earned on their invested capital (over a risk-free hurdle rate and before adjusting for any risk). In the cross-section of funds, there is a substantial disconnect between lifetime performance and incentive fees earned. These poor outcomes stem from the asymmetry of the performance contract, investors' return-chasing behavior, and underwater fund closures. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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This paper explores the effects of mandatory third-party review of mortgage contracts on consumer choice. The study is based on a legislative pilot carried out in Illinois in 2006, under which mortgage counseling was triggered by... more
This paper explores the effects of mandatory third-party review of mortgage contracts on consumer choice. The study is based on a legislative pilot carried out in Illinois in 2006, under which mortgage counseling was triggered by applicant credit scores or by their choice of “risky mortgages.” Low-credit score applicants for whom counselor review was mandatory did not materially alter their contract choice. Conversely, higher credit score applicants who could avoid counseling by choosing nonrisky mortgages did so, decreasing their propensity for high-risk contracts between 10 and 40 percent. In the event, one of the key goals of the legislation—curtailment of high-risk mortgage products—was only achieved among the population that was not counseled. (JEL D14, D18, G21, R21)
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We use account-level data to document that households respond differently to expected transitory cash receipts than to cash payments. Consumers increase consumption spending when they receive tax refunds; however, they do not reduce their... more
We use account-level data to document that households respond differently to expected transitory cash receipts than to cash payments. Consumers increase consumption spending when they receive tax refunds; however, they do not reduce their spending when they make expected tax payments. The central asymmetry in response and its pattern across liquidity and income levels is consistent with the behavior of rational consumers with liquidity constraints, but this canonical model cannot explain the lack of spending days before arrival of a refund or the lack of spending response to information about taxes around filing.