Working Papers

Examining the ESG Obituary: Evidence from Corporate Transparency

Abstract (click to expand): We examine the change in ESG disclosure from 2021-2024, which covers the peak in popularity for ESG and the subsequent backlash. Our analysis is the first to examine the rich sustainability disclosure measures from the S&P Global CSA, which is the most comprehensive survey of corporate ESG activity. Our study provides multiple novel findings that contribute to the literature on ESG and corporate disclosure. Despite the perception of a sharp retreat from ESG, we show that ESG disclosure on both required public issues and additional (not required) issues have increased. The increase primarily occurs in small companies and is related to the political alignment of the CEO and the corporate exposure to political risk.

Intangible Measurement Matters: Price Informativeness and Opaque Signals

(with Jack Strauss and Cheng Zhang)

Abstract (click to expand): Empirical finance commonly deflates nominal measures using the book values of assets; however, this practice omits internally generated intangible capital. Applying an extended q-theory framework, we generate predictions for the impact of opaque OBS intangibles on price informativeness. Using multiple OBS intangible measures, we find consistent empirical support for our predictions, demonstrating that intangible capital significantly alters the information content of market prices and should be incorporated into empirical asset pricing frameworks. Results indicate that prices deflated by OBS intangibles provide incremental information beyond the book values of assets for firm fundamentals such as cash flows, R&D, patents, and returns. However, the heterogeneous and opaque nature of intangible assets implies no single proxy captures their full informational content, and thus tests based on a single asset deflator are susceptible to measurement error. We show that firms with higher intangible intensity exhibit lower price informativeness, consistent with the opacity and valuation challenges associated with intangibles. In contrast, firms with higher physical capital intensity exhibit greater price informativeness attributable to the greater transparency of tangible assets.

ESG News and Corporate Bond Pricing

(with Doina C. Chichernea and Alex Petkevich)

Abstract (click to expand): We examine how different ESG news scores shape corporate bond pricing. Using granular measures from LSEG MarketPsych ESG Analytics, we document that ESG Controversies, which reflect negative news, significantly widen credit spreads. ESG Buzz, reflecting the volume of ESG media coverage regardless of tone, has a similarly widening effect, underscoring the role of market attention. These effects are especially pronounced for firms closer to default, where investors are more sensitive to both negative signals and heightened coverage. In contrast, improvements in ESG Overall scores, which track net positive developments, are associated with narrower spreads, though the impact is modest and fades quickly.

Publications

Noise Trading and Stock Market Bubbles: What the Derivatives Market is Telling Us

Abstract (click to expand): This paper uniquely analyzes derivatives on the S&P 500 Index in order to detect the presence and influence of noise traders. The authors derive and implement a two-factor jump diffusion noise model. In their model, noise rectifies the difference of analysts' opinions, market information and beliefs among traders. By incorporating a reduced-form temporal expression of heterogeneities among traders, the model is rich enough to capture salient time-series characteristics of equity prices (i.e. stochastic volatility and jumps). A singular feature of the authors’ model is that stochastic volatility represents the random movements in asset prices that are attributed to nonmarket fundamentals. In the period from 1996 to 2003, this study finds significant changes in the volatility and mean reversion in the noise level and a significant increase in its relation to implied volatility in option prices. The results are consistent with a bubble in technology stocks that occurred with significant increases in noise trading.

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Price Discovery in the Price Disagreement between Equity and Option Markets: Evidence from SSE ETF50 Options of China

Abstract (click to expand): We study the price discovery in price disagreement between the China ETF 50 index and option markets. The price disagreement is measured by upper and lower option boundary violations that are usually considered evidence of market inefficiency. We find that option boundary violations contain information about future returns and contribute to the price discovery process. Lower option boundary violations are more informative than upper boundary violations. Short-term at-the-money options contribute more to the price discovery process than others. Pooling all the options together may introduce noise in the test of price discovery in the option market. These test results complement the mixed findings in literature regarding the price discovery in option markets.

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Practical Applications of Adding Value in Student-Managed Funds: Benchmark and Sector Selection

Abstract (click to expand): We propose a low-risk approach for portfolio management that offers significant opportunities for alpha generation. They focus on midcap stocks and propose a formal sector allocation strategy to identify mispriced sectors. The authors recommend using the ratio of enterprise value (EV) to EBITDA to determine which sectors to over- and underweight in portfolio allocation.

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Risk Management in Student-Managed Funds: Earnings Announcements and the Collar Strategy

Abstract (click to expand): Student-managed investment funds typically pursue “plain vanilla” objectives. The purpose of this paper is to demonstrate the value of adding option strategies to reduce the risk of equity positions around earnings announcements. The collar strategy is one such technique with the advantages of a low net cost and limited potential losses. Risk management strategies can enhance the pedagogical value of student-managed investment funds. The authors document how students have successfully utilized the collar strategy to immunize risk. The proper implementation of these strategies requires students to learn the complex mechanisms associated with corporate earnings dissemination and analyst coverage. This also provides an opportunity to study earnings drift, which is a persistent and economically significant financial anomaly.

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Adding Value in Student-Managed Funds: Benchmark and Sector Selection

Abstract (click to expand): Student-managed portfolios offer a practical learning environment but often miss opportunities for outperformance. The authors provide several recommendations for structuring fund trades to enhance the pedagogical experience for the students in addition to generating alpha. A strategy that targets midcap stocks offers favorable risk–return characteristics and focuses on a market capitalization category that receives relatively less attention from professional money managers. Furthermore, a formal sector allocation strategy provides an additional source of portfolio outperformance when using a metric that is robust to differences in companies across sectors. The authors document the high relative return dispersion among sectors in midcap stocks and show that enterprise value/EBITDA is a consistently effective ratio in identifying both undervalued and overvalued stocks.

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Portfolio Allocations Using Fundamental Ratios: Are Profitability Measures Effective in Selecting Firms and Sectors?

Abstract (click to expand): Our study assesses the performance of portfolios formed using out-of-sample sector forecasts and past firm fundamental ratios. Portfolio allocations based on profitability measures—gross profit, operating profit, and earnings before interest, taxes, depreciation, and amortization (EBITDA)—generate substantially better performance than the benchmark. Long/short portfolio allocations using these fundamentals possess alphas over 14% and increase Sharpe ratios by over 60%. A composite variable provides the highest payoff for firm allocations, whereas EBITDA produces the most profitable out-of-sample sector allocations. Profitability metrics are superior indicators of sustainable economic performance because these ratios are more strongly linked to future returns and cash flows than net income.

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Stock Returns and the US Dollar: The Importance of Monetary Policy

Abstract (click to expand): In the increasingly globalized economy, foreign exchange fluctuations have multiple, conflicting effects on domestic stock prices. The purpose of this paper is to examine return data to determine the relation between the dollar’s value and stock prices as it relates to monetary policy. Over the last 40 years, US stock returns were 2.5 times higher when the dollar was trending up vs down. The factor model of returns shows that equity returns are positively associated with periods when the dollar appreciated. Returns were particularly high when the dollar was in an uptrend during accommodative monetary policy. During these periods, stocks in the consumer goods and services industries provided relatively high returns. This occurred with strong economic growth due to consumer spending. Stocks exhibited the lowest returns when the dollar was depreciating and the Federal Reserve was tightening. The key contribution of the research is that currency trends should be analyzed in the light of monetary policy. During periods of accommodative monetary policy and dollar appreciation, the US stock market provided average returns of 18.7 percent compared to −3.29 percent during a period of restrictive monetary policy and dollar depreciation. This result is driven by stronger economic growth, which is composed of consumer spending that more than offsets the dollar’s impact on net exports.

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Chasing Two Rabbits: Challenges in Benchmarking Liquid Alternatives

Abstract (click to expand): Liquid alternatives are required to compare their performance to a broad-based market index. Despite their objective to offer low correlations with equity returns, these funds provide traditional equity indexes as benchmarks two and a half times more than any other benchmark category. By pursuing strategies unrelated to their primary benchmarks, liquid alternatives can generate significant tracking errors, which cause biased information ratios. We review the challenges of benchmarking liquid alternatives and recommend use of the downside deviation or maximum drawdown. This issue is important, as research shows how performance relative to even a mismatched benchmark is a significant determinant of fund flows.

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What Advisors Need to Know about Monetary Policy and Domestic Stock Returns

Abstract (click to expand): Clients are often concerned with the impact of macroeconomic factors on their stock portfolios. Recent shifts in monetary policy and the consequent appreciation of the dollar have topped the business news headlines. How have stocks performed under different monetary policies and dollar trends? Historical equity returns have been positive regardless of the monetary policy or dollar trend. Advisors can use the historical results to keep clients focused on a long-term investment strategy instead of overreacting to the latest news story. This analysis also identifies two scenarios when stocks provided average returns 10 percent above/below the historical average.

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Why Does ETF Short Selling Provide a Different Signal?

Abstract (click to expand): Short selling is of great interest to investors because it has predictive value for future stock returns. We investigate whether this extends to foreign stock ETFs. In contrast to regular stocks, ETFs with high short interest experience positive abnormal returns. Our analysis suggests that the creation and redemption of ETF shares influences the level of short selling. Foreign stock ETFs, with low short interest, also have positive abnormal returns. These abnormal returns are typically caused by higher prices in foreign stock markets and not exchange rate changes.

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The Efficiency of International Information Flow: Evidence from the ETF and CEF Prices

Abstract (click to expand): While similar in their trading and organization, closed-end funds (CEFs) and exchange-traded funds (ETFs) differ in their liquidity and ease of arbitrage. We compare their price transmission dynamics using a sample of funds that invest in foreign securities and are most likely to show the deficiencies in the manner in which they process information. Our analysis shows that ETF returns are more closely related to their portfolio returns than are CEF returns. However, both fund types underreact to portfolio returns but overreact to domestic stock market returns. A simple trading strategy using these results is profitable with roundtrip trading costs less than 1.38% for CEFs and 0.71% for ETFs.

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Ownership Structure, Expectations, and Short Sales on the Nasdaq

Abstract (click to expand): We estimate expected short interest for Nasdaq stocks. Extending prior work, our research is among the first to investigate the impact of ownership structure on short-selling activity. We find that short interest is negatively related to institutional ownership and positively related to inside ownership; stocks with greater liquidity and smaller relative spreads are more heavily shorted. We also develop a measure of the unanticipated level of short selling; relative to the reported amount of short interest, this unexpected level of short selling seems at first to better represent the opinions of informed investors engaging in costly short-selling activities. However, the power of the unanticipated level of short-selling factor is displaced when we make allowances for traditional market, firm-size, and momentum variables.

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Does Order Flow Commonality Extend Across Trade Sizes and Securities?

Abstract (click to expand): We examine commonality in order imbalances across different types of securities and find that the extent of commonality is greater than previously documented. Order imbalances in portfolios of small stocks, large stocks, and closed-end funds have explanatory power for other portfolio returns even in the presence of own order flow. Our analysis of order flow composition reveals commonality in small and medium trades, but not in large trades, across portfolios. The activity from small-size trades is systemic, but not generally associated with returns on other securities. Order imbalances from larger size trades provide more information relevant to stock prices.

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Identifying Regime Changes in Closed-End Fund Discounts

Abstract (click to expand): In seeming contradiction of the efficient markets hypothesis, closed-end fund shares typically trade at discounts to their portfolio values. We find that about half of these discounts are non-stationary. Focusing only on those funds that have stationary discounts, this study applies the Bai and Perron (1998, 2003a,b) methodology to test for structural breaks in the mean discounts. Virtually all have structural breaks, and our findings contradict previous studies that indicate closed- end fund discounts revert to a long-term mean value. The data indicate that closed-end fund trading strategies are more risky than they superficially appear. As structural breaks in mean discounts do not occur together, our analysis does not find support for a common factor (possibly investor sentiment) causing these breaks.

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A NAV a Day Keeps the Inefficiency Away? Fund Trading Strategies using Daily Net Asset Values

Abstract (click to expand): Previous research documents the value of closed-end fund trading rules based on the size of the weekly discount. The growing number of closed-end funds that provide daily net asset value data provides an opportunity to test the profitability of short-term fund trading strategies. We find that short-term trading strategies that purchase fund shares after large negative discount changes are profitable, on average, even when transaction costs are incorporated. However, strategies that short sell fund shares after large positive discount changes do not produce an average profit. The limited amount of trading in closed-end funds may make it difficult to achieve short-term profits from discount fluctuations.

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Who are the Noise Traders?

Abstract (click to expand): Closed-end funds often trade at a discount to net asset value. Previous research suggests that the positive correlation in discounts is associated with investor sentiment that causes systematic mispricing by noise traders. We use a newly available sample of daily fund valuations to examine the relation between intraday trading activity and discount changes. Contrary to the assumption that retail investors are noise traders, we find no relation between discount changes and the order-flow imbalances of individual investors. Large daily discount changes are associated with institutional trading, and this may reflect the price inelasticity of closed-end fund shares.

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The Effects of Market Segmentation on Country Funds: An Analysis of Short-Term Trading Strategies

Abstract (click to expand): Economists disagree about how sensitive country fund prices are to U.S. market returns. We provide additional evidence on this issue through an examination of daily funds discounts. Fund shares provide significant average returns in the three days following large positive and negative discount changes. This finding suggests that large short-term changes in the relation between price and underlying value are not quickly mitigated in the market for country fund shares. Following large negative discount changes, the returns on fund shares and NAVs are of greater magnitude when the S&P 500 Index declines by more than 1%. This is consistent with negative changes in U.S. market sentiment affecting both country fund prices and NAVs in the short-term. Simple trading strategies that take advantage of large discount changes around big changes in the U.S. market appear generally profitable even after adjusting for transaction costs. The limited liquidity in country fund shares suggests that it may be difficult to implement such strategies.

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A Reexamination of Information Flow in Financial Markets: The Impact of Regulation FD and Decimalization

Abstract (click to expand): We investigate the impact of Regulation FD on information flow in the equities market. Our analysis indicates that information flow around earnings announcements, proxied by abnormal return volatility around those announcements, of U.S. stocks increased in the first effective quarter of Regulation FD (the fourth quarter of 2000). The information flow of ADRs, which are exempt from Regulation FD, does not change. This supports the inference that Regulation FD, not general market conditions, caused the increase in volatility, but Regulation FD did not have a persistent impact on information flow. A multivariate regression analysis shows that our results are robust to controls that include decimalization, which was implemented concurrently with Regulation FD and has reduced return volatility. Our comparison of return volatilities across firm size indicates that small firms temporarily had larger return volatilities; thus, Regulation FD only temporarily had a differential impact on the information environment of small firms.

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How Effective is Arbitrage of Foreign Stocks? The Case of the Malaysia Exchange-Traded Fund

Abstract (click to expand): Unlike closed-end country funds that usually trade at large premiums to the values of their portfolios, exchange-traded funds facilitate arbitrage to prevent their prices from deviating from their underlying values. However, such arbitrage can involve significant transaction costs, which have caused some to question the ability of their arbitrage to reduce premiums. This study examines the premiums on the iShares Malaysia Fund, which is the only exchange-traded fund that has experienced and extended suspension of arbitrage. The results illustrate the importance of arbitrage in providing the full benefits of international diversification associated with exchange-traded funds that invest in foreign securities.

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An Intraday Analysis of the Mexican Stock Exchange

Abstract (click to expand): This paper provides an intraday analysis of the Mexican Stock Exchange. Although the structure of this developing market differs from that of the U.S., intraday patterns are similar: volume, returns, standard deviations, bid-ask spreads and the spread adverse selection component follow U-shaped patterns throughout the trading day. We examine the effect of competition from U.S. markets by comparing intraday behavior of Mexican stocks with and without American Depositary Receipts (ADRs).

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Withdrawal Patterns and Rebalancing Costs for Taxable Portfolios

Abstract (click to expand): This article quantifies the effect of taxes on the magnitude and variability of cash flows from taxable retirement portfolios. While previous research focuses on pretax cash flows, this paper includes taxes associated with rebalancing and withdrawals. We incorporate the differential tax treatment of interest income and capital gains. Taxes have dramatic effects on the size and variability of the after-tax cash flows withdrawn from the portfolio. Financial planners may use our results to determine the ideal equity allocation in taxable retirement portfolios. For withdrawals below 5% and above 8% of initial portfolio value, our results suggest that the 100% equity allocation generally provides the most attractive trade-off between risk and return during the retirement period. Even for withdrawals (as a percentage of initial portfolio value) from 5% to 8%, the 100% equity allocation is an attractive choice because it has substantially higher mean terminal value and similarly higher mean after-tax cash flows. An analysis of inflation-adjusted withdrawal amounts also strongly favors the 100% equity allocation.

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• CFP Outstanding Research Award

Withdrawal Rates, Buffer Portfolios, and Asset Allocation: Simulation Results

Abstract (click to expand): The appropriate size of the sustainable withdrawal rates from portfolios of assets intended to fund investors' retirement years has attracted the attention of several researchers over the years (Bengen, 1994, 1996, 1997; Cooley, Hubbard, and Walz [hereafter CHW], 1998, 1999). Recently, Ogbome and Woerheide [hereafter OW] (2001) introduced the concept of a "buffer portfolio" into the study of withdrawal rates. This paper examines OW's work, but is unable to reproduce their results demonstrating superior performance when buffer portfolios are used. This paper then uses Monte Carlo simulation to generate statistically robust descriptions of the optimum asset allocation to sustain various withdrawal rates over periods of twenty, twenty-five, and thirty years. We find that for low withdrawal rates (5% per year or less), success rates are relatively high without regard to the proportion of retirement assets invested in equities versus debt. On the other hand, for high withdrawal rates (11 % or 12% ), the optimum asset allocation is 100% equity, but success rates generally fall below 50% even at the optimum 100% equity allocation. For withdrawal rates of 6% and 7%, the evidence is ambiguous. However, for withdrawal rates between 8% and 10% inclusive, the optimum asset allocation approaches 100% equities and there is a high correlation between success rates and the proportion of the portfolio invested in equities. We conclude that asset allocation is unimportant at low withdrawal rates and pointless at high withdrawal rates (unless clients are willing to accept success rates below 50%). For withdrawal rates from 8% to 10%, asset allocation is the crucial determinant of success and the optimum allocation is at or near to 100% equity.

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Premiums on Exchange-Traded Funds: Should Traders be Concerned?

Abstract (click to expand): The high turnover of ETF shares indicates that many short-term traders find this investment vehicle attractive. Are these investors trading fund shares at prices that reflect the value of the fund holdings? My findings indicate that the structure of ETFs causes prices to closely track net asset values. The mean premium in the sample is 0.38%, and 80% of the daily premiums are within the range of –0.64% to 1.50%. In addition, high premiums are rarely persistent, although there is cross-sectional variation in ETF premium size among members of the iShares MSCI Index Fund Series. These results suggest that arbitrage is highly effective in reducing fund premiums. When the creation or redemption of iShares does occur, the price, on average, quickly moves closer to NAV. Three trading days after the creation (redemption) of shares, the average premium (discount) narrows by 39% (64%). The high premiums observed on the iShares Malaysia Fund after the imposition of capital controls provide further substantiation of the ability of fund-facilitated arbitrage to minimize deviations from NAV. The success of the fund-facilitated arbitrage of ETFs suggests a solution for the persistent discounts that plague some closed-end funds. Institutional investors in a closed-end fund could be allowed to return a minimum percentage of the fund’s outstanding shares (say, 5%) to the fund company. The fund company would provide the investor with securities worth the net asset value of the fund’s shares. The buying pressure associated with this in-kind redemption process would greatly reduce the discount.

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