Research

Working Papers

Security Lending Market, Secondary Market Arbitrageurs, and ETF Mispricing, Job Market Paper

Abstract: This paper examines the effect of ETF short-sale costs on ETF pricing efficiency. I find that ETF premiums are positively associated with the costs of borrowing ETFs, which are primarily a friction for ETF secondary market arbitrageurs. Leveraging two exogenous variations in ETF borrowing costs, I establish a causal effect of borrowing costs on ETF mispricing. Furthermore, the sensitivity of ETF mispricing on borrowing costs depends on the activeness of primary market arbitrageurs. Collectively, empirical findings in the paper emphasize the role of the secondary market participants in the ETF arbitrage mechanism, and reveal an interdependence between the primary and secondary markets.

Idiosyncratic Skewness Co-movement and Aggregate Stock Returns, with Federico Nardari and Qi Zeng

Abstract: We find a strong co-movement pattern in firm idiosyncratic skewness. We, then, show that the common component in idiosyncratic skewness (CIS) is a powerful non-linear predictor of future market excess returns and it outperforms a battery of existing equity premium predictors, both in and out of sample. Further, CIS predictive power adds economic value out-of-sample to mean-variance investors for a wide range of relative risk aversion. Our results are robust across observation frequencies and out-of-sample evaluation periods. Within a standard valuation framework, we show that CIS predictive power stems from the discount rate channel. The non-linear predictive relation is consistent with state-dependent preferences for idiosyncratic skewness and investor underreaction.

Leverage and the Common Factor Structure in Idiosyncratic Volatility, with Thijs van der Heijden, Qi Zeng, and Yichao Zhu, Reject and Resubmit at Management Science

Abstract: Time-varying leverage driven by common shocks to firm asset returns introduces a factor structure in idiosyncratic volatilities (IVOL) of both equity and debt returns. In a standard dynamic capital structure model in which the CAPM holds for asset returns, we show that leverage dynamics drive the residual (equity and debt) return volatility dynamics. This multiplicative relation is not captured by standard (linear) factor models. We confirm the common factor structure in leverage and develop a multifactor model to explain the IVOL cross-section. Our findings also shed light on the negative IVOL-return puzzle and the time-series pattern of average IVOL.

Short-Selling Volume and Cross-Sectional Stock Returns: The Role of Liquidity, with Zhuo Zhong

Abstract: This paper reexamines the relation between daily short-selling volume and future stock returns in the cross-section. We confirm previous findings that heavily shorted stocks underperform lightly shorted ones. The portfolio that longs the most heavily shorted firms and shorts the most lightly shorted firms generates significantly negative alphas. However, we find that negative alphas of the long-short portfolio come from the positive abnormal returns of lightly shorted firms, instead of the negative returns of heavily shorted firms. Our results indicate that the underperformance of heavily shorted firms is not consistent with the hypothesis that short sellers are informed on average. Furthermore, after controlling for liquidity, the predictive power of short-selling volume on future returns becomes statistically insignificant. Our results hold for both short selling in exchanges (lit markets) and dark pools.

Safety Accidents and Mutual Fund Flows, with Xuefeng Hu, Rong Xu, and Yifan Zhou, Under Review

Abstract: Using a hand-collected dataset on major safety accidents (MSAs) in China, we find investors leave equity funds for bond funds following MSAs. Within equity funds, riskier funds demonstrate higher sensitivities to casualties than safer funds do. Consistent with the salience theory, "extraordinarily serious" accidents’ impact on flows is larger than "serious" accidents'. Furthermore, subsequent commercial insurance purchases increase with casualties. Flows are not explained by funds’ exposure to MSAs, MSAs’ economic losses, or concurrent natural disasters. Collectively, we conclude that MSAs’ effect on flows is a consequence of investors’ increased risk aversion stemming from the negative emotions associated with MSAs.