Professor John Griffin
Papers
How Do Crypto Flows Finance Slavery? The Economics of Pig Butchering
With Kevin Mei
Through blockchain addresses used by ‘‘pig butchering’’ victims, we trace crypto flows and uncover methods commonly used by scammers to obfuscate their activities, including multiple transactions, swapping between cryptocurrencies through DeFi smart contracts, and bridging across blockchains. The perpetrators interact freely with major crypto exchanges, sending over 104,000 small potential inducement payments to build trust with victims. Funds exit the crypto network in large quantities, mostly in Tether, through less transparent but large exchanges—Binance, Huobi, and OKX. These criminal enterprises pay approximately 87 basis points in transaction fees and appear to have recently moved at least $75.3 billion into suspicious exchange deposit accounts, including $15.2 billion from exchanges commonly used by U.S. investors. Our findings highlight how the ‘‘reputable’’ crypto industry provides the common gateways and exit points for massive amounts of criminal capital flows. We hope these findings will help shed light on and ultimately stop these heinous crimes.
“What is Forensic Finance?”
With Samuel Kruger
We survey a growing field studying aspects of finance that are potentially illegal, illicit, or immoral. Some of the literature is investigative in nature to uncover malfeasance that is recent and possibly ongoing. Other forensic finance research examines past events to generate a fuller understanding of the activities, economic magnitudes, incentives, and players involved. The work spans newer areas such as cryptocurrencies, financial advisor and broker misconduct, and greenwashing; and newer research in established fields that are still developing, such as insider trading, structured finance, market manipulation, political connections, public finance, and corporate fraud. We highlight investigative forensic finance, common economic questions, common empirical methods, industry and political opposition, censoring, and the importance of avoiding publication biases. Compared to other finance papers, forensic work has similar citations and SSRN downloads, and more media and Securities and Exchange Commission (SEC) citations. Along with prominent examples of industry reform and awareness, this highlights the potential for real-world impact. By laying out commonalities in research themes, questions, methods, and approaches across fields that may at first seem disparate, we hope to encourage more investigation of incentives and mechanisms in darker corners of finance.
“Did Pandemic Relief Fraud Inflate House Prices?”
with Samuel Kruger and Prateek Mahajan
Pandemic fraud is geographically concentrated and stimulated local purchases with effects on prices. Fraudulent PPP loan recipients significantly increased their home purchase rate after receiving a loan compared to non-fraudulent PPP recipients, and house prices in high fraud zip codes increased 5.8 percentage points more than in low fraud zip codes within the same county, with similar effects after controlling for other explanations for house price appreciation during COVID. Zip codes with fraud also experience heightened vehicle purchases and consumer spending in 2020 and 2021, with a return to normal in 2022.
"Is Fraud Contagious? Social Connections and the Looting of COVID Relief Programs”
With Samuel Kruger and Prateek Mahajan
Fraud indicators in the Paycheck Protection Program (PPP) COVID relief program are highly geographically concentrated. Areas with high PPP fraud also have heightened indicators of suspicious Economic Injury Disaster Loan (EIDL) advances and unemployment insurance claims. Zip codes and counties with high rates of suspicious PPP loans exhibit strong social connections to one another with evidence of fraud spreading over time through social connections. Additionally, individuals in suspicious social media groups have higher rates of PPP fraud, and socially connected zip codes frequently use the same specific FinTech lenders and EIDL agents, consistent with social connections influencing detailed loan decisions.
“Do Municipal Bond Dealers Give their Customers ‘Fair and Reasonable’ Pricing?”
with Nicholas Hirschey and Samuel Kruger. Journal of Finance
Municipal bonds exhibit considerable retail pricing variation, even for same-size trades of the same bond on the same day, and even from the same dealer. Markups vary widely across dealers. Trading strongly clusters on eighth price increments, and clustered trades exhibit higher markups. Yields are often lowered to just above salient numbers. Machine learning estimates exploiting the richness of the data show that dealers that use strategic pricing have systematically higher markups. Recent MSRB rules have had only a limited impact on markups. While a subset of dealers focus on best execution, many dealers appear focused on opportunistic pricing.
“Did FinTech Lenders Facilitate PPP Fraud?”
with Samuel Kruger and Prateek Mahajan. (2023). Journal of Finance
In the $793 billion Paycheck Protection Program (PPP), we examine metrics related to potential misreporting including non-registered businesses, multiple businesses at residential addresses, abnormally high implied compensation per employee, and large inconsistencies with jobs reported in another government program. These measures consistently concentrate in certain FinTech lenders and are cross-verified by seven additional measures. FinTech market share increased significantly over time, and suspicious lending by FinTechs in 2021 is four times the level at the start of the program. Suspicious loans are being overwhelmingly forgiven at similar rates to other loans.
“Is COVID Revealing a Virus in CMBS 2.0?”
with Alex Priest. (2023). Journal of Finance
Commercial loan valuations crucially depend on accurate loan income, but underwritten income on CMBS loans is commonly overstated relative to actual property income. Consistent with these differences being originator specific, income overstatement in CMBS 2.0 deals varies widely and persistently across originators, is priced by originators, related across property types within an originator, predictable ex-ante, and accompanied by inflation of past financials. Risk-retention and associated regulation had no discernable effect on income overstatement. Originator income overstatement is highly predictive of pre- and COVID-period loan distress. Overall, recent market
stresses reveal large systemic differences in underwriting standards across originators.
“Are CLO Collateral and Tranche Ratings Disconnected?”
with Jordan Nickerson. (2022). Review of Financial Studies
Between March and August 2020, S&P and Moody's downgraded approximately 25% of collateral feeding into CLOs and only 2% of tranche values, with rating actions concentrating in junior tranches. This paper examines explanations for this potential rating disconnect. We find no evidence that: rating agency model-implied risk disproportionately affect junior tranches, collateral downgrades were too severe, CLOs accumulated pre-COVID protective cushions, or value-creation through active management. Instead, we find evidence consistent with both non-model considerations by rating agencies and strategic CLO manager trading. The end result is that CLOs are considerably riskier than their current ratings suggest.
“Is the Chinese Anti-Corruption Campaign Authentic? Evidence from Corporate Investigations”
with Clark Liu and Tao Shu. (2021). Management Science
This paper examines whether the massive Chinese anti-corruption campaign ensnares corrupt firms, contains a political component, and reduces corporate corruption. Consistent with the campaign’s stated objectives, Chinese firms with characteristics commonly associated with measures of poor governance, self-dealing, and inefficiencies are more likely to have executives investigated. However, affiliations with prominent investigated political leaders increase investigation likelihood while university affiliations with current central leadership decrease investigation likelihood, possibly indicating political favoritism. Except for reported entertainment expenditures and CEO pay, there has been little evidence of a substantial overall decrease in measures of potential corporate corruption.
“Ten Years of Evidence: Was Fraud a Force in the Financial Crisis?”
(2021). Journal of Economic Literature
This article takes stock of ten years of academic research by synthesizing the large literature regarding the various players in RMBS securitization at the center of the U.S. housing and financial crisis. Underwriting banks facilitated wide-scale mortgage fraud by knowingly misreporting key loan characteristics underlying mortgage-backed securities. Under the cover of complexity, credit rating agencies catered to investment banks by issuing increasingly inflated ratings on both RMBS and CDOs. Originators who engaged in mortgage fraud gained market share as did CDO managers who catered to underwriters by accepting the lowest-quality MBS collateral. Appraisal targeting and inflated appraisals were the norm. RMBS and CDO prices indicate that the marginal AAA investor was unaware of pervasive mortgage fraud and rating inflation, but these factors were strongly related to future deal performance. The supply of fraudulent credit was not uniform, but clustered in certain geographic regions and zip codes. As these dubious originators extended credit to those who could not afford the loans, the credit expansion led to house price booms and subsequent crashes in these zip codes. Overall, there is substantial evidence that conflicts of interest, misreporting, and fraud were focal features of the financial crisis.
“What Drove the 2003-2006 House Price Boom and Subsequent Collapse? Disentangling Competing Explanations”
with Samuel A. Kruger and Gonzalo Maturana. (2021). Journal of Financial Economics
Ten years after the financial crisis, the central question of what explains the rise and fall in house prices remains unresolved. We provide a unified framework to examine four excess credit supply variables and three speculation variables that have been proposed in the literature. Credit supply variables, particularly subprime share and worse originator share, strongly relate to future zip code level house price changes in the boom and bust, whereas none of the speculation variables consistently relate to house prices within MSAs. Pre-trends, supply elasticity, and depressed areas suggest these relations are not driven by lenders anticipating house price growth.
“Is Bitcoin Really Un-Tethered?”
with Amin Shams. (2020). The Journal of Finance
This paper investigates whether Tether, a digital currency pegged to the U.S. dollar, influenced Bitcoin and other cryptocurrency prices during the 2017 boom. Using algorithms to analyze blockchain data, we find that purchases with Tether are timed following market downturns and result in sizable increases in Bitcoin prices. The flow is attributable to one entity, clusters below round prices, induces asymmetric autocorrelations in Bitcoin, and suggests insufficient Tether reserves before month-ends. Rather than demand from cash investors, these patterns are most consistent with the supply-based hypothesis of unbacked digital money inflating cryptocurrency prices.
“Personal Infidelity and Professional Conduct in 4 Settings”
with Samuel A. Kruger and Gonzalo Maturana. (2019). Proceedings of the National Academy of Sciences
We survey a growing field studying aspects of finance that are potentially illegal, illicit, or immoral. Some of the literature is investigative in nature to uncover malfeasance that is recent and possibly ongoing. Other forensic finance research examines past events to generate a fuller understanding of the activities, economic magnitudes, incentives, and players involved. The work spans newer areas such as cryptocurrencies, financial advisor and broker misconduct, and greenwashing; and newer research in established fields that are still developing, such as insider trading, structured finance, market manipulation, political connections, public finance, and corporate fraud. We highlight investigative forensic finance, common economic questions, common empirical methods, industry and political opposition, censoring, and the importance of avoiding publication biases. Compared to other finance papers, forensic work has similar citations and SSRN downloads, and more media and Securities and Exchange Commission (SEC) citations. Along with prominent examples of industry reform and awareness, this highlights the potential for real-world impact. By laying out commonalities in research themes, questions, methods, and approaches across fields that may at first seem disparate, we hope to encourage more investigation of incentives and mechanisms in darker corners of finance.
“Do Labor Markets Discipline? Evidence from RMBS Bankers”
with Samuel A. Kruger and Gonzalo Maturana. (2019). Journal of Financial Economics
This paper examines whether employees involved in RMBS securitization experienced internal and external labor market consequences relative to similar non-RMBS employees in the same banks, and why. Senior RMBS bankers experienced similar levels of job retention, promotion, and external job market opportunities. Even signers of RMBS deals with high loss and misreporting rates, or deals implicated in lawsuits experienced no adverse internal or external labor market outcomes. These findings are likely not explained by targeted or delayed employee discipline, small legal fines, or protection due to pending litigation, but are consistent with implicit upper-management approval of RMBS activities.
“Manipulation in the VIX?”
with Amin Shams. (2018). Review of Financial Studies.
At the settlement time of the VIX Volatility Index, volume spikes on S&P 500 Index (SPX) options, but only in out-of-the-money options used to calculate the VIX, and more so for options with a higher and discontinuous influence on VIX. We investigate alternative explanations of hedging and coordinated liquidity trading. Tests including those utilizing differences in put and call options, open interest around the settlement, and a similar volatility contract with an entirely different settlement procedure in Europe are inconsistent with these explanations but consistent with market manipulation. Large transient deviations in prices demonstrate the importance of settlement design.
“Debt Correlations in the Wake of the Financial Crisis: What are Appropriate Default Correlation for Structured Products?”
with Jordan Nickerson. (2017). Journal of Financial Economics
This paper proposes several frameworks to estimate the appropriate default correlations for structured products, each of which jointly considers the role of co-movements in modeled risk characteristics and unmodeled systematic risk, or ‘frailty.’ We contrast our estimates with credit rating agencies’ default correlation assumptions, which were only 0.01 for Collateralized Loan Obligations (CLOs) pre-crisis and have increased to 0.03 post-crisis. In contrast, the joint consideration of observable risk factors and frailty leads to substantially higher estimates of 0.12. We show that this translates into CLOs with credit risk understated by 26%, suggesting caution for the post-crisis structured finance market.
“Did Dubious Mortgage Origination Practices Distort House Prices?”
with Gonzalo Maturana. (2016). Review of Financial Studies
ZIP codes with high concentrations of originators who misreported mortgage information experienced a 75% larger relative increase in house prices from 2003 to 2006 and a 90% larger relative decrease from 2007 to 2012 compared to other ZIP codes. Several causality tests show that high fractions of dubious originators in a ZIP code lead to large price distortions. Originators with high misreporting gave credit to borrowers with high ex-ante risk, yet further understated the borrowers' true risk. Overall, excess credit facilitated through dubious origination practices explain much of the regional variation in house prices over a decade.
“Who Facilitated Misreporting in Securitized Loans?”
with Gonzalo Maturana. (2016). Review of Financial Studies
This paper examines apparent fraud among securitized nonagency loans using three indicators: unreported second liens, owner occupancy misreporting, and appraisal overstatements. We find that around 48% of loans exhibited at least one indicator of misrepresentation. Surprisingly, misreporting is similar in both low and full documentation loans and is associated with a 51% higher likelihood of delinquency. Two-thirds of loans with unreported second liens had the same originator issuing both the first and second lien. Misrepresentations in MBS pools can explain substantial cross-sectional differences in future losses. Losses were predictable and initiating from apparent fraud by MBS underwriters and loan originators.
“How Important are Foreign Ownership Linkages for International Stock Returns?”
with Sohnke Bartram, Tae-Hoon Lim, and David Ng. (2015). Review of Financial Studies
We derive a foreign ownership return as the weighted average return of foreign stocks that are connected to a stock through common ownership. The foreign ownership return is of similar economic significance as traditional country and industry factors in explaining international stock returns. It is not related to omitted fundamentals or wealth effects, but shifts substantially around ADR and index listings when the investor habitat changes. A decomposition shows that the foreign ownership return is driven by active reallocations of global institutions as opposed to fund flows from end investors. Our finding has important implications for international portfolio diversification.
“Complex Securities and Underwriter Reputation: Do Reputable Underwriters Produce Better Securities?”
with Richard Lowery and Alessio Saretto. (2014). Review of Financial Studies
Conventional wisdom suggests that high-reputation banks will generally produce good securities to maintain their long-run reputation. We show with a simple model that when securities are complex a high-reputation bank may produce assets that underperform during market downturns. We examine this possibility using a unique sample of 10.1 trillion dollars of CLO, MBS, ABS, and CDOs. Contrary to the conventional view, securities issued by more reputable banks did not outperform but, rather, had higher proportions of capital in default.
“Rating Shopping or Catering? An Examination of the Response to Competitive Pressure for CDO Credit Ratings”
with Jordan Nickerson and Dragon (Yongjun) Tang. (2013). Review of Financial Studies
We examine whether “rating shopping” or “rating catering” is a more accurate characterization of rating agency interactions regarding collateralized debt obligations (CDOs) prior to the credit crisis. Although investors paid a premium for dual-ratings, AAA CDO tranches rated by both Moody’s and S&P defaulted more frequently than tranches rated by only one of them, which is inconsistent with pure rating shopping. Even though AAA-rated tranche sizes were typically identical, there was considerable disagreement between S&P’s and Moody’s assumptions on default correlations and even collateral quality. Rating agencies made upward adjustments beyond their model outputs when their competitor had more lenient assumptions. Finally, although S&P’s and Moody’s adjustments and disagreements were not reflected in yields at issuance, they were reflected in subsequent rating downgrades, suggesting that rating agencies later reverted towards their initial models.
“Did Subjectivity Play a Role in CDO Credit Ratings?”
with Dragon Tang. (2012). Journal of Finance
Analyzing 916 collateralized debt obligations (CDOs), we find that a top credit rating agency frequently made positive adjustments beyond its main model that amounted to increasingly larger AAA tranche sizes. These adjustments are difficult to explain by likely determinants, but exhibit a clear pattern: CDOs with smaller model-implied AAA sizes receive larger adjustments. CDOs with larger adjustments experience more severe subsequent downgrading. Additionally, prior to April 2007, 91.2% of AAA-rated CDOs only comply with the credit rating agency’s own AA default rate standard. Accounting for adjustments and the criterion deviation indicates that on average AAA tranches were structured to BBB support levels.
“Examining the Dark Side of Financial Markets: Do Institutions Trade on Information from Investment Bank Connections?”
with Tao Shu and Selim Topaloglu. (2012). Review of Financial Studies
Institutions often have access to corporate inside information through their connections, but relatively little is known about the extent to which they exploit their informational advantage through short-term trading. We employ broker-level trading data to systematically examine possible cases of connected trading. Despite examining the issue from multiple angles, we are unable to find much evidence to support that investment bank clients take advantage of connections through takeover advising, IPO and SEO underwriting, or lending relationships. In contrast to recent academic literature and popular press, our findings suggest that institutional investors are reluctant to use inside information in traceable manners.
“How Important is the Financial Media in Global Markets?”
with Nicholas H. Hirschey and Patrick J. Kelly. (2011). Review of Financial Studies
This article studies differences in the information content of 870,000 news announcements in 56 markets around the world. In most developed markets, a firm’s stock price moves much more on days with public news about the firm. In contrast, in many emerging markets volatility is similar on news and non-news days. We examine several hypotheses for our findings. Cross-country differences in stock price reactions are best explained by insider trading, followed by differences in the quality of the news dissemination mechanism. Our findings are useful for quantifying the extent of insider trading and how the financial media affects international markets.
“Did Credit Rating Agencies Use Biased Assumptions?”
with Dragon Tang. (2011). American Economic Review
Financial intermediaries are often in conflicting situations where large, short-term profits can be made by deviating from conventional standards. The frequency and severity of such deviations is a source of substantial disagreement. During the “dot-com” period, equity analysts knowingly inflated their ratings on Internet stocks that their banks underwrote, and most large investment banks engaged in questionable IPO allocation practices (John M. Griffin,Jeffrey H. Harris, and Selim Topaloglu 2007). However, other studies suggest that such behaviors are exceptions rather than the norm. For example, Hamid Mehran and Rene M. Stulz (2007, 293) summarize that “the academic literature on conflicts of interest, using large samples, reaches conclusions that are weaker and often more benign than the conclusions drawn by journalists and politicians.” The credit crisis provides a new testing ground for such debate.
“Who Drove and Burst the Tech Bubble?”
with Jeffrey Harris, Tao Shu, and Selim Topaloglu. (2011). The Journal of Finance
From 1997 to March 2000, as technology stocks rose more than five-fold, institutions bought more new technology supply than individuals. Among institutions, hedge funds were the most aggressive investors, but independent investment advisors and mutual funds (net of flows) actively invested the most capital in the technology sector. The technology stock reversal in March 2000 was accompanied by a broad sell-off from institutional investors but accelerated buying by individuals, particularly discount brokerage clients. Overall, our evidence supports the bubble model of Abreu and Brunnermeier (2003), in which rational arbitrageurs fail to trade against bubbles until a coordinated selling effort occurs.
“Do Market Efficiency Measures Yield Correct Inferences? A Comparison of Developed and Emerging Markets”
with Patrick Kelly and Federico Nardari. (2010). Review of Financial Studies
Using data from 56 markets, we find that short-term reversal, post-earnings drift, and momentum strategies earn similar returns in emerging and developed markets. Variance ratios and market delay measures often show greater deviations from random walk pricing in developed markets. Conceptually, we show that commonly used efficiency tests can yield misleading inferences because they do not control for the information environment. Our evidence corrects misperceptions that emerging markets feature larger trading profits and higher return autocorrelation, highlights crucial limitations of weak and semi-strong form efficiency measures, and points to the importance of measuring informational aspects of efficiency.
“How Smart are the Smart Guys? A Unique View from Hedge Fund Stock Holdings”
with Jin Xu. (2009). Review of Financial Studies
Compared to mutual funds, hedge funds prefer smaller, opaque value securities, and have higher turnover and more active share bets. Decomposing returns into three components, we find that hedge funds are better than mutual funds at stock picking by only 1.32% per year on a value-weighted basis, and this result is insignificant on an equal-weighted basis or with price-to-sales benchmarks. Hedge funds exhibit no ability to time sectors or pick better stock styles. Surprisingly, we find only weak evidence of differential ability between hedge funds. Overall, our study raises serious questions about the perceived superior skill of hedge fund managers.
“Do Investors Trade More When Stocks Have Performed Well? Evidence from 46 Countries”
with Federico Nardari and René M. Stulz. (2007). Review of Financial Studies
This article investigates the dynamic relation between market-wide trading activity and returns in 46 markets. Many stock markets exhibit a strong positive relation between turnover and past returns. These findings stand up in the face of various controls for volatility, alternative definitions of turnover, differing sample periods, and are present at both the weekly and daily frequency. The relation is more statistically and economically significant in countries with high levels of corruption, with short-sale restrictions, and in which market volatility is high.
“Why are IPO Investors Net Buyers through Lead Underwriters?”
with Jeffrey Harris and Selim Topaloglu. (2007). Journal of Financial Economics
In Nasdaq initial public offerings (IPOs) issued between 1997 and 2002, purchases of lead underwriter clients exceed sales by an amount equal to 8.79% of the total issue. We find that lead underwriter clients do not buy to build larger long-term positions, capitalize on superior execution quality, or because of clientele effects. However, characteristics of net buying that are at odds with these explanations and other behaviors (like institutional purchases of cold IPOs) are all consistent with lead underwriters engaging in quid pro quo arrangements with clients. Price contribution analysis shows that such client buying activity contributes significantly to first-day price increases.
“Measuring the Economic Importance of Exchange Rate Exposure”
with Craig Doidge and Rohan Williamson. (2006). Journal of Empirical Finance
Previous literature finds mixed empirical support for a relation between exchange rate exposure and its theoretical determinants and that exposure is of negligible economic importance. To re-examine the nature and the economic significance of the exchange rate to firm value relation, we construct an international database of over 17,000 non-financial firms from 18 countries. We find that firms’ foreign activity is broadly and significantly related to exchange rate exposure and that after controlling for this activity, large firms are more sensitive to currency movements than small firms. Using a portfolio approach to investigate the economic importance of these effects, we find that firms with high international sales outperform those with no international sales during periods of large currency depreciations by 0.72 percent per month, whereas they underperform by 1.10 percent per month during periods of large currency appreciations. Exchange rate movements have an economically significant impact on firm value in ways that are consistent with theory.
“The Informational Content of Option Volume Prior to Takeovers”
with Charles Cao and Zhiwu Chen. (2005). Journal of Business
This paper examines the information embedded in both the stock and option markets prior to takeover announcements. During normal periods, buyer-seller initiated stock volume imbalances are significant predictors of next-day stock returns and option volume imbalances are uninformative. However, prior to takeover announcements, call volume imbalances are strongly positively related to next-day stock returns. Cross-sectional analysis shows that those takeover targets with the largest pre-announcement call-imbalance increases experience the highest announcement-day returns. The largest increase in buyer-initiated trading activity is in short-term out-of-the-money calls that subsequently experience the largest returns. Collectively, these findings are consistent with the hypothesis that, in the presence of pending extreme informational events, the options market plays an important role in price discovery.
“Global Momentum Strategies: A Portfolio Perspective”
with Susan Ji and Spencer Martin (2005). Journal of Portfolio Management
We provide practical perspectives on momentum investing in stocks internationally. First, momentum is generally more profitable on the long side than on the short side, making it accessible to a broad range of institutional capital. Second, both price and earnings momentum profits are significant globally. Third, internationally, earnings momentum is distinct from price momentum, and using price and earnings momentum in conjunction produces larger economic profits. Fourth, momentum profits have weaker co-movements across markets than market indices. Interestingly, while market correlations are much higher in down markets than in up markets, momentum correlations are low in both market conditions. Fifth, momentum strategies do not differ appreciably in profitability between up and down markets, which means timing is less important to momentum traders. Finally, momentum strategies are not riskless historically there have often occurred periods of several months where they have netted low or negative returns. Altogether, these findings suggest that momentum is useful in international portfolio management, but its implementation should be thoughtfully considered.
“Daily Cross-border Equity Flows: Pushed or Pulled?”
with Federico Nardari and René M. Stulz. (2004). The Review of Economics and Statistics
We investigate the conditions under which an intertemporal equilibrium model based on investors’ portfolio decisions can explain the dynamics of high-frequency equity flows. Our model shows that, when there are barriers to international investment and when the expectations of foreign investors are more extrapolative than those of domestic investors (either due to foreigners being less informed or for behavioral reasons), unexpectedly high worldwide or local stock returns lead to net equity inflows in small countries. We investigate these predictions using daily data on net equity flows for nine emerging-market countries. Equity flows are positively related to host-country stock returns as well as market performance abroad at daily frequencies. Though these effects are remarkably robust at the daily frequency, they dissipate quickly.
“The Dynamics of Institutional and Individual Trading”
with Jeffrey Harris and Selim Topaloglu. (2003). Journal of Finance
We study the daily and intradaily cross-sectional relation between stock returns and the trading of institutional and individual investors in Nasdaq 100 securities. Based on the previous day’s stock return, the top performing decile of securities is 23.9% more likely to be bought in net by institutions (and sold by individuals) than those in the bottom performance decile. Strong contemporaneous daily patterns can largely be explained by net institutional (individual) trading positively (negatively) following past intradaily excess stock returns (or the news associated therein). In comparison, evidence of return predictability and price pressure are economically small.
“Momentum Investing and Business Cycle Risk: Evidence from Pole to Pole”
with Susan Ji and Spencer Martin. (2003). Journal of Finance
We examine whether macroeconomic risk can explain momentum profits internationally. Neither an unconditional model based on the Chen, Roll, and Ross (1986) factors nor a conditional forecasting model based on lagged instruments provides any evidence that macroeconomic risk variables can explain momentum. In addition, momentum profits around the world are economically large and statistically reliable in both good and bad economic states. Further, these momentum profits reverse over 1- to 5-year horizons, an action inconsistent with existing risk-based explanations of momentum.
“Does Book-to-Market Equity Proxy for Distress Risk?”
with Mike Lemmon. (2002). Journal of Finance
This paper examines the relationship between book-to-market equity, distress risk, and stock returns. Among firms with the highest distress risk as proxied by Ohlson’s (1980) O-score, the difference in returns between high and low book-to-market securities is more than twice as large as that in other firms. This large return differential cannot be explained by the three-factor model or by differences
in economic fundamentals. Consistent with mispricing arguments, firms with high distress risk exhibit the largest return reversals around earnings announcements, and the book-to-market effect is largest in small firms with low analyst coverage.
“Are the Fama and French Factors Global or Country-Specific?”
(2002). Review of Financial Studies
This article examines whether country-specific or global versions of Fama and French’s three-factor model better explain time-series variation in international stock returns. Regressions for portfolios and individual stocks indicate that domestic factor models explain much more time-series variation in returns and generally have lower pricing errors than the world factor model. In addition, decomposing the world factors into domestic and foreign components demonstrates that the addition of foreign factors to domestic models leads to less accurate in-sample and out-of-sample pricing. Practical applications of the three-factor model, such as cost of capital calculations and performance evaluations, are best performed on a country-specific basis.
“International Competition and Exchange Rate Shocks: A Cross-Country Industry Analysis”
with René M. Stulz. (2001). Review of Financial Studies
This article systematically examines the importance of exchange rate movements and industry competition for stock returns. Common shocks to industries across countries are more important than competitive shocks due to changes in exchange rates. Weekly exchange rate shocks explain almost nothing of the relative performance of industries. Using returns measured over longer horizons, the importance of exchange rate shocks increases slightly and the importance of industry common shocks increases more substantially. Both industry and exchange rate shocks are more important for industries that produce internationally traded goods, but the importance of these shocks is economically small for these industries as well.
“Another Look at the Role of the Industrial Structure of Markets for International Diversification Strategies”
with G. Andrew Karolyi. (1998). Journal of Financial Economics
This paper re-examines the extent to which gains from international diversification are due to differences in industrial structure across countries. Recent papers by Roll (1992), Journal of Finance 47, 3—42 and Heston and Rouwenhorst (1994), Journal of Financial Economics 36, 3—27 investigate this issue and find conflicting evidence. Using a new database, the Dow Jones World Stock Index, with coverage in 25 countries and over 66 industry classifications, we decompose comprehensively both country and industrial sources of variation. We confirm that little of the variation in country index returns can be explained by their industrial composition. We also uncover differences in the proportion of variation in industry index returns that is captured by country and industry factors and discuss the implications for global diversification strategies.
"How Do Crypto Flows Finance Slavery? The Economics of Pig Butchering"
with Kevin Mei
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Through blockchain addresses used by ‘‘pig butchering’’ victims, we trace crypto flows and uncover methods commonly used by scammers to obfuscate their activities, including multiple transactions, swapping between cryptocurrencies through DeFi smart contracts, and bridging across blockchains. The perpetrators interact freely with major crypto exchanges, sending over 104,000 small potential inducement payments to build trust with victims. Funds exit the crypto network in large quantities, mostly in Tether, through less transparent but large exchanges—Binance, Huobi, and OKX. These criminal enterprises pay approximately 87 basis points in transaction fees and appear to have recently moved at least $75.3 billion into suspicious exchange deposit accounts, including $15.2 billion from exchanges commonly used by U.S. investors. Our findings highlight how the ‘‘reputable’’ crypto industry provides the common gateways and exit points for massive amounts of criminal capital flows. We hope these findings will help shed light on and ultimately stop these heinous crimes.
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with Samuel Kruger
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We survey a growing field studying aspects of finance that are potentially illegal, illicit, or immoral. Some of the literature is investigative in nature to uncover malfeasance that is recent and possibly ongoing. Other forensic finance research examines past events to generate a fuller understanding of the activities, economic magnitudes, incentives, and players involved. The work spans newer areas such as cryptocurrencies, financial advisor and broker misconduct, and greenwashing; and newer research in established fields that are still developing, such as insider trading, structured finance, market manipulation, political connections, public finance, and corporate fraud. We highlight investigative forensic finance, common economic questions, common empirical methods, industry and political opposition, censoring, and the importance of avoiding publication biases. Compared to other finance papers, forensic work has similar citations and SSRN downloads, and more media and Securities and Exchange Commission (SEC) citations. Along with prominent examples of industry reform and awareness, this highlights the potential for real-world impact. By laying out commonalities in research themes, questions, methods, and approaches across fields that may at first seem disparate, we hope to encourage more investigation of incentives and mechanisms in darker corners of finance.
“Did Pandemic Relief Fraud Inflate House Prices?”
with Samuel Kruger and Prateek Mahajan
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Pandemic fraud is geographically concentrated and stimulated local purchases with effects on prices. Fraudulent PPP loan recipients significantly increased their home purchase rate after receiving a loan compared to non-fraudulent PPP recipients, and house prices in high fraud zip codes increased 5.8 percentage points more than in low fraud zip codes within the same county, with similar effects after controlling for other explanations for house price appreciation during COVID. Zip codes with fraud also experience heightened vehicle purchases and consumer spending in 2020 and 2021, with a return to normal in 2022.
"Is Fraud Contagious? Social Connections and the Looting of COVID Relief Programs”
with Samuel Kruger and Prateek Mahajan
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Fraud indicators in the Paycheck Protection Program (PPP) COVID relief program are highly geographically concentrated. Areas with high PPP fraud also have heightened indicators of suspicious Economic Injury Disaster Loan (EIDL) advances and unemployment insurance claims. Zip codes and counties with high rates of suspicious PPP loans exhibit strong social connections to one another with evidence of fraud spreading over time through social connections. Additionally, individuals in suspicious social media groups have higher rates of PPP fraud, and socially connected zip codes frequently use the same specific FinTech lenders and EIDL agents, consistent with social connections influencing detailed loan decisions.
“Do Municipal Bond Dealers Give their Customers ‘Fair and Reasonable’ Pricing?”
with Nicholas Hirschey and Samuel Kruger. Journal of Finance
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​Municipal bonds exhibit considerable retail pricing variation, even for same-size trades of the same bond on the same day, and even from the same dealer. Markups vary widely across dealers. Trading strongly clusters on eighth price increments, and clustered trades exhibit higher markups. Yields are often lowered to just above salient numbers. Machine learning estimates exploiting the richness of the data show that dealers that use strategic pricing have systematically higher markups. Recent Municipal Securities Rulemaking Board rules have had only a limited impact on markups. While a subset of dealers focus on best execution, many dealers appear focused on opportunistic pricing.
“Did FinTech Lenders Facilitate PPP Fraud?”
with Samuel Kruger and Prateek Mahajan. (2023). Journal of Finance
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In the $793 billion Paycheck Protection Program, we examine metrics related to potential misreporting including nonregistered businesses, multiple businesses at residential addresses, abnormally high implied compensation per employee, and large inconsistencies with jobs reported in another government program. These measures consistently concentrate in certain FinTech lenders and are cross-verified by seven additional measures. FinTech market share increased significantly over time, and suspicious lending by FinTechs in 2021 is four times the level at the start of the program. Suspicious loans are being overwhelmingly forgiven at rates similar to other loans.
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“Is COVID Revealing a Virus in CMBS 2.0?”
with Alex Priest. (2023). Journal of Finance
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Commercial loan valuations crucially depend on accurate loan income, but underwritten income on commercial mortgage-backed securities (CMBS) loans is commonly overstated relative to actual property income. Consistent with these differences being originator-specific, income overstatement in CMBS 2.0 deals varies widely and persistently across originators, is priced by originators, is related across property types within an originator, is predictable ex ante, and is accompanied by inflation of past financials. Risk retention and associated regulation had no discernible effect on income overstatement. Originator income overstatement is highly predictive of pre- and COVID-period loan distress. Overall, recent market stresses reveal large systemic differences in underwriting standards across originators.
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“Are CLO Collateral and Tranche Ratings Disconnected?”
with Jordan Nickerson. (2022). Review of Financial Studies
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Between March and August 2020, S&P and Moody’s downgraded approximately 25% of collateral feeding into CLOs and only 2% of tranche values, with rating actions concentrating in junior tranches. Both S&P and Moody’s modeling indicate that the impacts should have been considerably larger, especially for higher-rated tranches. Neither changes in correlation nor the accumulation of pre-COVID-19 protective cushions can explain the downgrade asymmetry on upper tranches. Instead, CLO managers repositioned their collateral pools to dampen the negative credit shock and rating agencies incorporated qualitative adjustments in their CLO ratings. Important potential policy and market implications from these findings are discussed.
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“Is the Chinese Anti-Corruption Campaign Authentic? Evidence from Corporate Investigations”
with Clark Liu and Tao Shu. (2021). Management Science
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This paper examines whether the massive Chinese anticorruption campaign ensnares corrupt firms, contains a political component, and reduces corporate corruption. Consistent with the campaign’s stated objectives, investigated executives are more likely to come from Chinese firms with characteristics commonly associated with measures of poor governance, self-dealing, and inefficiencies. However, affiliations with prominent investigated political leaders increase investigation likelihood, while university affiliations with current central leadership decrease investigation likelihood, possibly indicating political partiality. Except for reported entertainment expenditures and chief executive officer pay, there has been little evidence of a substantial overall decrease in measures of potential corporate corruption.
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“Ten Years of Evidence: Was Fraud a Force in the Financial Crisis?”
(2021). Journal of Economic Literature
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This article synthesizes the large literature regarding the role of various players in residential mortgage-backed securities (RMBS) securitization at the center of the 2008–09 US housing and financial crisis. Underwriting banks facilitated wide-scale mortgage fraud by knowingly misreporting key loan characteristics underlying mortgage-backed securities (MBS). Under the cover of complexity, credit rating agencies catered to investment banks by issuing increasingly inflated ratings on both RMBS and collateralized debt obligations (CDOs). Originators who engaged in mortgage fraud gained market share, as did CDO managers who catered to underwriters by accepting the lowest-quality MBS collateral. Appraisal targeting and inflated appraisals were the norm. RMBS and CDO prices indicate that the marginal AAA investor was unaware of pervasive mortgage fraud and ratings inflation, but these factors were strongly related to future deal performance. The supply of fraudulent credit was not uniform, but clustered in certain geographic regions and zip codes. As these dubious originators extended credit to those who could not afford the loans, the credit expansion led to house price booms and subsequent crashes in these zip codes. Overall, a consistent narrative based on substantial research indicates that conflicts of interest, misreporting, and fraud were focal features of the financial crisis.
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with Samuel A. Kruger and Gonzalo Maturana. (2021). Journal of Financial Economics
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Ten years after the financial crisis, the central question of what explains the rise and fall in house prices remains unresolved. We provide a unified framework to examine four excess credit supply variables and three speculation variables that have been proposed in the literature. Credit supply variables, particularly subprime share and worse originator share, strongly relate to future zip-code-level house price changes in the boom and bust, whereas none of the speculation variables consistently relate to house prices within MSAs. Pre-trends, supply elasticity, and depressed areas suggest these relations are not driven by lenders anticipating house price growth.
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“Is Bitcoin Really Un-Tethered?”
with Amin Shams. (2020). The Journal of Finance
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This paper investigates whether Tether, a digital currency pegged to the U.S. dollar, influenced Bitcoin and other cryptocurrency prices during the 2017 boom. Using algorithms to analyze blockchain data, we find that purchases with Tether are timed following market downturns and result in sizable increases in Bitcoin prices. The flow is attributable to one entity, clusters below round prices, induces asymmetric autocorrelations in Bitcoin, and suggests insufficient Tether reserves before month-ends. Rather than demand from cash investors, these patterns are most consistent with the supply-based hypothesis of unbacked digital money inflating cryptocurrency prices.
“Personal Infidelity and Professional Conduct in 4 Settings”
with Samuel A. Kruger and Gonzalo Maturana. (2019). Proceedings of the National Academy of Sciences
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We study the connection between personal and professional behavior by introducing usage of a marital infidelity website as a measure of personal conduct. Police officers and financial advisors who use the infidelity website are significantly more likely to engage in professional misconduct. Results are similar for US Securities and Exchange Commission (SEC) defendants accused of white-collar crimes, and companies with chief executive officers (CEOs) or chief financial officers (CFOs) who use the website are more than twice as likely to engage in corporate misconduct. The relation is not explained by a wide range of regional, firm, executive, and cultural variables. These findings suggest that personal and workplace behavior are closely related.
“Do Labor Markets Discipline? Evidence from RMBS Bankers”
with Samuel A. Kruger and Gonzalo Maturana. (2019). Journal of Financial Economics
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This paper examines whether employees involved in residential mortgage-backed security (RMBS) securitization experienced internal and external labor market consequences relative to similar non-RMBS employees in the same banks and why. Senior RMBS bankers experienced similar levels of job retention, promotion, and external job opportunities. Even signers of RMBS deals with high loss and misreporting rates or deals implicated in lawsuits experienced no adverse internal or external labor market outcomes. These findings are likely not explained by targeted or delayed employee discipline, small legal fines, or protection due to pending litigation but are consistent with implicit upper management approval of RMBS activities.
with Amin Shams. (2018). Review of Financial Studies.
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At the settlement time of the VIX Volatility Index, volume spikes on S&P 500 Index (SPX) options, but only in out-of-the-money options used to calculate the VIX, and more so for options with a higher and discontinuous influence on VIX. We investigate alternative explanations of hedging and coordinated liquidity trading. Tests including those utilizing differences in put and call options, open interest around the settlement, and a similar volatility contract with an entirely different settlement procedure in Europe are inconsistent with these explanations but consistent with market manipulation. Large transient deviations in prices demonstrate the importance of settlement design.
with Jordan Nickerson. (2017). Journal of Financial Economics
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This paper proposes several frameworks to estimate the appropriate default correlations for structured products, each of which jointly considers the role of co-movements in modeled risk characteristics and unmodeled systematic risk, or ‘frailty.’ We contrast our estimates with credit rating agencies’ default correlation assumptions, which were only 0.01 for Collateralized Loan Obligations (CLOs) pre-crisis and have increased to 0.03 post-crisis. In contrast, the joint consideration of observable risk factors and frailty leads to substantially higher estimates of 0.12. We show that this translates into CLOs with credit risk understated by 26%, suggesting caution for the post-crisis structured finance market.
“Did Dubious Mortgage Origination Practices Distort House Prices?”
with Gonzalo Maturana. (2016). Review of Financial Studies
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ZIP codes with high concentrations of originators who misreported mortgage information experienced a 75% larger relative increase in house prices from 2003 to 2006 and a 90% larger relative decrease from 2007 to 2012 compared with other ZIP codes. Several causality tests show that high fractions of dubious originators in a ZIP code lead to large price distortions. Originators with high misreporting gave credit to borrowers with high ex ante risk, yet further understated the borrowers’ true risk. Overall, excess credit facilitated through dubious origination practices explain much of the regional variation in house prices over a decade.
“Who Facilitated Misreporting in Securitized Loans?”
with Gonzalo Maturana. (2016). Review of Financial Studies
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This paper examines apparent fraud among securitized nonagency loans using three indicators: unreported second liens, owner occupancy misreporting, and appraisal overstatements. We find that around 48% of loans exhibited at least one indicator of misrepresentation. Surprisingly, misreporting is similar in both low and full documentation loans and is associated with a 51% higher likelihood of delinquency. Two-thirds of loans with unreported second liens had the same originator issuing both the first and second lien. Misrepresentations in MBS pools can explain substantial cross-sectional differences in future losses. Losses were predictable and initiating from apparent fraud by MBS underwriters and loan originators.
“How Important are Foreign Ownership Linkages for International Stock Returns?”
with Sohnke Bartram, Tae-Hoon Lim, and David Ng. (2015). Review of Financial Studies
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We derive a foreign ownership return as the weighted average return of foreign stocks that are connected to a stock through common ownership. The foreign ownership return is of similar economic significance as traditional country and industry factors in explaining international stock returns. It is not related to omitted fundamentals or wealth effects but shifts substantially around ADR and index listings when the investor habitat changes. A decomposition shows that the foreign ownership return is driven by active reallocations of global institutions as opposed to fund flows from end investors. Our findings have important implications for international portfolio diversification.
with Richard Lowery and Alessio Saretto. (2014). Review of Financial Studies
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Conventional wisdom suggests that high-reputation banks will generally produce good securities to maintain their long-run reputation. We show with a simple model that, when securities are complex a high-reputation bank may produce assets that underperform during market downturns. We examine this possibility using a unique sample of $10.1 trillion of CLO, MBS, ABS, and CDOs. Contrary to the conventional view, securities issued by more reputable banks did not outperform but, rather, had higher proportions of capital in default.
with Jordan Nickerson and Dragon (Yongjun) Tang. (2013). Review of Financial Studies
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We examine whether “rating shopping” or “rating catering” is a more accurate characterization of rating agency interactions regarding collateralized debt obligations (CDOs). Although investors paid a premium for dual ratings, AAA CDO tranches rated by both Moody’s and S&P defaulted more frequently than tranches rated by only one of them, which is inconsistent with pure rating shopping. Rating agencies made upward adjustments beyond their model when their competitor had more lenient assumptions. Finally, consistent with rating catering, S&P’s and Moody’s adjustments and disagreements at security issuance were reflected in subsequent rating downgrades, suggesting that adjustments were harmful.
“Did Subjectivity Play a Role in CDO Credit Ratings?”
with Dragon Tang. (2012). Journal of Finance
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Analyzing 916 collateralized debt obligations (CDOs), we find that a top credit rating agency frequently made positive adjustments beyond its main model that amounted to increasingly larger AAA tranche sizes. These adjustments are difficult to explain by likely determinants, but exhibit a clear pattern: CDOs with smaller model-implied AAA sizes receive larger adjustments. CDOs with larger adjustments experience more severe subsequent downgrading. Additionally, prior to April 2007, 91.2% of AAA-rated CDOs only comply with the credit rating agency’s own AA default rate standard. Accounting for adjustments and the criterion deviation indicates that on average AAA tranches were structured to BBB support levels.
with Tao Shu and Selim Topaloglu. (2012). Review of Financial Studies
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Institutions often have access to corporate inside information through their connections, but relatively little is known about the extent to which they exploit their informational advantage through short-term trading. We employ broker-level trading data to systematically examine possible cases of connected trading. Despite examining the issue from multiple angles, we are unable to find much evidence to support that investment bank clients take advantage of connections through takeover advising, IPO and SEO underwriting, or lending relationships. In contrast to recent academic literature and popular press, our findings suggest that institutional investors are reluctant to use inside information in traceable manners.
“How Important is the Financial Media in Global Markets?”
with Nicholas H. Hirschey and Patrick J. Kelly. (2011). Review of Financial Studies
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This article studies differences in the information content of 870,000 news announcements in 56 markets around the world. In most developed markets, a firm’s stock price moves much more on days with public news about the firm. In contrast, in many emerging markets volatility is similar on news and non-news days. We examine several hypotheses for our findings. Cross-country differences in stock price reactions are best explained by insider trading, followed by differences in the quality of the news dissemination mechanism. Our findings are useful for quantifying the extent of insider trading and how the financial media affects international markets.
“Did Credit Rating Agencies Use Biased Assumptions?”
with Dragon Tang. (2011). American Economic Review
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Financial intermediaries are often in conflicting situations where large, short-term profits can be made by deviating from conventional standards. The frequency and severity of such deviations is a source of substantial disagreement. During the “dot-com” period, equity analysts knowingly inflated their ratings on Internet stocks that their banks underwrote, and most large investment banks engaged in questionable IPO allocation practices (John M. Griffin,Jeffrey H. Harris, and Selim Topaloglu 2007). However, other studies suggest that such behaviors are exceptions rather than the norm. For example, Hamid Mehran and Rene M. Stulz (2007, 293) summarize that “the academic literature on conflicts of interest, using large samples, reaches conclusions that are weaker and often more benign than the conclusions drawn by journalists and politicians.” The credit crisis provides a new testing ground for such debate.
“Who Drove and Burst the Tech Bubble?”
with Jeffrey Harris, Tao Shu, and Selim Topaloglu. (2011). The Journal of Finance
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From 1997 to March 2000, as technology stocks rose more than five-fold, institutions bought more new technology supply than individuals. Among institutions, hedge funds were the most aggressive investors, but independent investment advisors and mutual funds (net of flows) actively invested the most capital in the technology sector. The technology stock reversal in March 2000 was accompanied by a broad sell-off from institutional investors but accelerated buying by individuals, particularly discount brokerage clients. Overall, our evidence supports the bubble model of Abreu and Brunnermeier (2003), in which rational arbitrageurs fail to trade against bubbles until a coordinated selling effort occurs.
with Patrick Kelly and Federico Nardari. (2010). Review of Financial Studies
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Using data from 56 markets, we find that short-term reversal, post-earnings drift, and momentum strategies earn similar returns in emerging and developed markets. Variance ratios and market delay measures often show greater deviations from random walk pricing in developed markets. Conceptually, we show that commonly used efficiency tests can yield misleading inferences because they do not control for the information environment. Our evidence corrects misperceptions that emerging markets feature larger trading profits and higher return autocorrelation, highlights crucial limitations of weak and semi-strong form efficiency measures, and points to the importance of measuring informational aspects of efficiency.
“How Smart are the Smart Guys? A Unique View from Hedge Fund Stock Holdings”
with Jin Xu. (2009). Review of Financial Studies
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Compared to mutual funds, hedge funds prefer smaller, opaque value securities, and have higher turnover and more active share bets. Decomposing returns into three components, we find that hedge funds are better than mutual funds at stock picking by only 1.32% per year on a value-weighted basis, and this result is insignificant on an equal-weighted basis or with price-to-sales benchmarks. Hedge funds exhibit no ability to time sectors or pick better stock styles. Surprisingly, we find only weak evidence of differential ability between hedge funds. Overall, our study raises serious questions about the perceived superior skill of hedge fund managers.
“Do Investors Trade More When Stocks Have Performed Well? Evidence from 46 Countries”
with Federico Nardari and René M. Stulz. (2007). Review of Financial Studies
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This article investigates the dynamic relation between market-wide trading activity and returns in 46 markets. Many stock markets exhibit a strong positive relation between turnover and past returns. These findings stand up in the face of various controls for volatility, alternative definitions of turnover, differing sample periods, and are present at both the weekly and daily frequency. The relation is more statistically and economically significant in countries with high levels of corruption, with short-sale restrictions, and in which market volatility is high.
“Why are IPO Investors Net Buyers through Lead Underwriters?”
with Jeffrey Harris and Selim Topaloglu. (2007). Journal of Financial Economics
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In Nasdaq initial public offerings (IPOs) issued between 1997 and 2002, purchases of lead underwriter clients exceed sales by an amount equal to 8.79% of the total issue. We find that lead underwriter clients do not buy to build larger long-term positions, capitalize on superior execution quality, or because of clientele effects. However, characteristics of net buying that are at odds with these explanations and other behaviors (like institutional purchases of cold IPOs) are all consistent with lead underwriters engaging in quid pro quo arrangements with clients. Price contribution analysis shows that such client buying activity contributes significantly to first-day price increases.
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“Measuring the Economic Importance of Exchange Rate Exposure”
with Craig Doidge and Rohan Williamson. (2006). Journal of Empirical Finance
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Previous literature finds mixed empirical support for a relation between exchange rate exposure and its theoretical determinants and that exposure is of negligible economic importance. To re-examine the nature and the economic significance of the exchange rate to firm value relation, we construct an international database of over 17,000 non-financial firms from 18 countries. We find that firms’ foreign activity is broadly and significantly related to exchange rate exposure and that after controlling for this activity, large firms are more sensitive to currency movements than small firms. Using a portfolio approach to investigate the economic importance of these effects, we find that firms with high international sales outperform those with no international sales during periods of large currency depreciations by 0.72 percent per month, whereas they underperform by 1.10 percent per month during periods of large currency appreciations. Exchange rate movements have an economically significant impact on firm value in ways that are consistent with theory.
“The Informational Content of Option Volume Prior to Takeovers”
with Charles Cao and Zhiwu Chen. (2005). Journal of Business
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This paper examines the information embedded in both the stock and option markets prior to takeover announcements. During normal periods, buyer-seller initiated stock volume imbalances are significant predictors of next-day stock returns and option volume imbalances are uninformative. However, prior to takeover announcements, call volume imbalances are strongly positively related to next-day stock returns. Cross-sectional analysis shows that those takeover targets with the largest pre-announcement call-imbalance increases experience the highest announcement-day returns. The largest increase in buyer-initiated trading activity is in short-term out-of-the-money calls that subsequently experience the largest returns. Collectively, these findings are consistent with the hypothesis that, in the presence of pending extreme informational events, the options market plays an important role in price discovery.
“Global Momentum Strategies: A Portfolio Perspective”
with Susan Ji and Spencer Martin (2005). Journal of Portfolio Management
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We provide practical perspectives on momentum investing in stocks internationally. First, momentum is generally more profitable on the long side than on the short side, making it accessible to a broad range of institutional capital. Second, both price and earnings momentum profits are significant globally. Third, internationally, earnings momentum is distinct from price momentum, and using price and earnings momentum in conjunction produces larger economic profits. Fourth, momentum profits have weaker co-movements across markets than market indices. Interestingly, while market correlations are much higher in down markets than in up markets, momentum correlations are low in both market conditions. Fifth, momentum strategies do not differ appreciably in profitability between up and down markets, which means timing is less important to momentum traders. Finally, momentum strategies are not riskless historically there have often occurred periods of several months where they have netted low or negative returns. Altogether, these findings suggest that momentum is useful in international portfolio management, but its implementation should be thoughtfully considered.
“Daily Cross-border Equity Flows: Pushed or Pulled?”
with Federico Nardari and René M. Stulz. (2004). The Review of Economics and Statistics
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We investigate the conditions under which an intertemporal equilibrium model based on investors’ portfolio decisions can explain the dynamics of high-frequency equity flows. Our model shows that, when there are barriers to international investment and when the expectations of foreign investors are more extrapolative than those of domestic investors (either due to foreigners being less informed or for behavioral reasons), unexpectedly high worldwide or local stock returns lead to net equity inflows in small countries. We investigate these predictions using daily data on net equity flows for nine emerging-market countries. Equity flows are positively related to host-country stock returns as well as market performance abroad at daily frequencies. Though these effects are remarkably robust at the daily frequency, they dissipate quickly.
“The Dynamics of Institutional and Individual Trading”
with Jeffrey Harris and Selim Topaloglu. (2003). Journal of Finance
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We study the daily and intradaily cross-sectional relation between stock returns and the trading of institutional and individual investors in Nasdaq 100 securities. Based on the previous day’s stock return, the top performing decile of securities is 23.9% more likely to be bought in net by institutions (and sold by individuals) than those in the bottom performance decile. Strong contemporaneous daily patterns can largely be explained by net institutional (individual) trading positively (negatively) following past intradaily excess stock returns (or the news associated therein). In comparison, evidence of return predictability and price pressure are economically small.
“Momentum Investing and Business Cycle Risk: Evidence from Pole to Pole”
with Susan Ji and Spencer Martin. (2003). Journal of Finance
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We examine whether macroeconomic risk can explain momentum profits internationally. Neither an unconditional model based on the Chen, Roll, and Ross (1986) factors nor a conditional forecasting model based on lagged instruments provides any evidence that macroeconomic risk variables can explain momentum. In addition, momentum profits around the world are economically large and statistically reliable in both good and bad economic states. Further, these momentum profits reverse over 1- to 5-year horizons, an action inconsistent with existing risk-based explanations of momentum.
“Does Book-to-Market Equity Proxy for Distress Risk?”
with Mike Lemmon. (2002). Journal of Finance
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This paper examines the relationship between book-to-market equity, distress risk, and stock returns. Among firms with the highest distress risk as proxied by Ohlson’s (1980) O-score, the difference in returns between high and low book-to-market securities is more than twice as large as that in other firms. This large return differential cannot be explained by the three-factor model or by differences
in economic fundamentals. Consistent with mispricing arguments, firms with high distress risk exhibit the largest return reversals around earnings announcements, and the book-to-market effect is largest in small firms with low analyst coverage.
“Are the Fama and French Factors Global or Country-Specific?”
(2002). Review of Financial Studies
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This article examines whether country-specific or global versions of Fama and French’s three-factor model better explain time-series variation in international stock returns. Regressions for portfolios and individual stocks indicate that domestic factor models explain much more time-series variation in returns and generally have lower pricing errors than the world factor model. In addition, decomposing the world factors into domestic and foreign components demonstrates that the addition of foreign factors to domestic models leads to less accurate in-sample and out-of-sample pricing. Practical applications of the three-factor model, such as cost of capital calculations and performance evaluations, are best performed on a country-specific basis.
“International Competition and Exchange Rate Shocks: A Cross-Country Industry Analysis”
with René M. Stulz. (2001). Review of Financial Studies
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This article systematically examines the importance of exchange rate movements and industry competition for stock returns. Common shocks to industries across countries are more important than competitive shocks due to changes in exchange rates. Weekly exchange rate shocks explain almost nothing of the relative performance of industries. Using returns measured over longer horizons, the importance of exchange rate shocks increases slightly and the importance of industry common shocks increases more substantially. Both industry and exchange rate shocks are more important for industries that produce internationally traded goods, but the importance of these shocks is economically small for these industries as well.
with G. Andrew Karolyi. (1998). Journal of Financial Economics
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This paper re-examines the extent to which gains from international diversification are due to differences in industrial structure across countries. Recent papers by Roll (1992), Journal of Finance 47, 3—42 and Heston and Rouwenhorst (1994), Journal of Financial Economics 36, 3—27 investigate this issue and find conflicting evidence. Using a new database, the Dow Jones World Stock Index, with coverage in 25 countries and over 66 industry classifications, we decompose comprehensively both country and industrial sources of variation. We confirm that little of the variation in country index returns can be explained by their industrial composition. We also uncover differences in the proportion of variation in industry index returns that is captured by country and industry factors and discuss the implications for global diversification strategies.