Assistant Professor of Finance
Safe Minus Risky: Do Investors Pay a Premium for Stocks that Hedge Stock Market Downturns? (with Nishad Kapadia, Barbara Ostdiek, and James Weston), 2018. Forthcoming, JFQA Internet Appendix.
Stocks that hedge against sustained market downturns — periods from peak to trough in S&P500 levels at the business cycle frequency — should have low expected returns, but they do not. We use ex-ante firm characteristics and covariances to construct a tradeable Safe Minus Risky (SMR) portfolio that hedges market downturns out-of-sample. Although downturns correspond to significant declines in GDP growth, SMR has significant positive average returns and four factor alphas (both about 0.75% per month). Risk-based models do not explain SMR’s returns, but mispricing does. Risky stocks are overpriced when sentiment is high, resulting in subsequent returns of -1% per month.
The entire annual return of a typical stock accrues on the four days (on average) on which its stock price experiences jumps, or large idiosyncratic movements relative to its volatility, Stock prices drift down by about 2% before jumps. These patterns are likely due to a premium for idioysncratic jump risk. A trading strategy that buys stocks with high ex-ante jump probability earns high average returns and alphas. Returns for the strategy are higher when/where costs of arbitrage are high.
Financial Integration and Credit Democratization: Linking Banking Deregulation to Economic Growth (with Elizabeth Berger, Alexander W. Butler, and Edwin Hu), 201. R&R, JFI.
We document a positive effect of financial integration on economic growth. Using US state-by-state financial deregulations, we find that economic growth occurred in states where bank deregulation solved a capital immobility problem. We use a matching method that constructs synthetic counterfactual states to identify the channels that link bank deregulation to financial integration, and thereby to economic growth. Our results reveal a correlation between financial integration and subsequent banking sector changes including improved bank efficiency, better lending and borrowing rates, and an expansion in loan recipients. We show that financial integration democratizes lending and spurs economic growth.
Wage stickiness and firm-specific human capital induce operating leverage that contributes to the risk exposure of the firm. This leverage produces momentum in returns as well as a positive relationship between profits and subsequent returns. I demonstrate these relationships in the context of a partial equilibrium production model. I empirically show that momentum and profitability returns are more pronounced in the presence of labor-induced operating leverage. A novel implication of the model is that recession-resistant stocks earn higher returns during subsequent expansions. This prediction holds empirically and is distinct from other anomalies.