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Job Market Paper
Visual Deception in Financial Markets. SSRN Revise & Resubmit at Management Science
Abstract:
Digital charts have become ubiquitous in financial markets, often featuring a default auto-scaling function that adjusts price paths to fit the screen. While intended to enhance readability, this auto-scaling feature imposes varying visual scales across different stocks. I provide experimental evidence that such auto-scaled charts can mislead investors’ perceptions of risk. Moreover, I show that exposure to visual scaling of stocks helps explain the diminishing positive risk-return relationship, which was prominent prior to the 1980s but has become less evident since then.
In my experiment, participants using fixed-scale charts accurately perceive risk consistent with historical volatility. In contrast, auto-scaled charts distorted this perception, as participants did not judge stocks with higher standard deviation to be riskier.
In stock return data, the premium associated with higher volatility diminished after the 1980s (sigma). However, once accounting for visual scaling exposure (VSE), high-volatility stocks consistently carried a positive premium across all sample periods(sigma_within_VSE). A strategy exploiting this visual deception (visual) began earning a premium after 1980, but this effect has weakened since around 2005, likely due to investor learning and the rise of algorithmic trading.
Working Papers
Luck and Skill in the World of Diseconomies of Scale SSRN (Ready to submit)
(with Juan Yao)
Abstract
We find that most of the variation in mutual funds’ realized alphas is driven by luck. We revisit Berk and Green (2004) by introducing luck into a world with performance-chasing investors and non-optimizing managers operating under diseconomies of scale. In this framework, luck negatively predicts future performance, leading to short-term capital misallocation and value destruction. We find that backward-looking quantitative ratings mainly capture luck, whereas forward-looking qualitative ratings better predict future performance. We caution against using historical value added as a proxy for skill, but emphasize that it can serve as an incentive mechanism to foster a more efficient equilibrium.
Luck Dominates Star Ratings. Star ratings based on historical alpha are strongly dominated by luck which is beyond the manager's control. For example, 5-star funds contain 70.2% good-luck funds, while 69.1% of 1-star funds suffered from bad luck.
Luck plays a key role in influencing investors' capital flows, leading to significant capital misallocation that ultimately destroys value in the mutual fund industry. For example, funds that are underfunded experience capital outflow due to bad luck (Bad Luck x Underfunded), while overfunded funds receive further inflow due to good luck (Good Luck x Overfunded).
Discrete Performance Evaluation and Reference-Dependent Preferences: Evidence from the Star Rating System
SSRN (Ready to submit)
(with Stephen Satchell and Juan Yao)
Abstract
Discrete performance evaluation is common in business and organizations. We examine how it affects evaluatees’ risk appetite among active mutual fund managers under star rating system. We show that rating thresholds serve as reference points that induce asymmetric risk-shifting behavior: funds just below an upgrade threshold increase risk, while those just above a downgrade threshold reduce risk. The causal relation is further supported by Morningstar’s 2002 methodology reform, which serves as a quasi-natural experiment. Importantly, risk-shifting funds do not exhibit higher abnormal returns or a greater likelihood of future rating improvements, ruling out strategic rating management.
Discrete rating systems lead to unintended risk-shifting behavior. Funds nearing a rating upgrade (purple) increase portfolio risk, while those close to a rating downgrade (blue) become risk-averse.
Presentations
2025 FMA Asia/Pacific Conference Luck and Skill in the World of Diseconomies of Scale
39th Australian PhD Conference in Economics and Business Luck and Skill in the World of Diseconomies of Scale
2025 FIRN PhD Symposium Visual Deception in Financial Markets
University of Melbourne Brownbag Visual Deception in Financial Markets
Macquarie University Brownbag Visual Deception in Financial Markets
University of Adelaide Brownbag Visual Deception in Financial Markets
5th Global Phd Student Colloquium Luck and Skill in the World of Diseconomies of Scale
University of Sydney Brownbag Visual Deception in Financial Markets
University of Sydney PhD Colloquium 2024 Visual Deception in Financial Markets
AFBC 2024 Visual Deception in Financial Markets
AsianFA 2024 Discrete Performance Evaluation and Reference-Dependent Preferences
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