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Investor Sentiment and the CrossSection of Stock Returns
, 2003
"... We examine how investor sentiment affects the crosssection of stock returns. Theory predicts that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly subjective and are difficult to arbitrage. We test this prediction by studying how the crosssection of subse ..."
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Cited by 224 (7 self)
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We examine how investor sentiment affects the crosssection of stock returns. Theory predicts that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly subjective and are difficult to arbitrage. We test this prediction by studying how the crosssection of subsequent stock returns varies with proxies for beginningofperiod investor sentiment. When sentiment is low, subsequent returns are relatively high on smaller stocks, high volatility stocks, unprofitable stocks, nondividendpaying stocks, extremegrowth stocks, and distressed stocks, consistent with an initial underpricing of these stocks. When sentiment is high, on the other hand, these patterns attenuate or fully reverse. The results are consistent with predictions and appear unlikely to reflect an alternative explanation based on compensation for systematic risk.
Deciphering the Liquidity and Credit Crunch 200708
"... This paper summarizes and explains the main events of the liquidity and credit crunch in 200708. Starting with the trends leading up to the crisis, I explain how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and ..."
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Cited by 176 (13 self)
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This paper summarizes and explains the main events of the liquidity and credit crunch in 200708. Starting with the trends leading up to the crisis, I explain how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.
Episodic Liquidity Crises: Cooperative and Predatory Trading
 Journal of Finance
, 2007
"... We describe how episodic illiquidity arises from a breakdown in cooperation between market participants. We first solve a oneperiod trading game in continuoustime, using an asset pricing equation that accounts for the price impact of trading. Then, in a multiperiod framework, we describe an equil ..."
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Cited by 52 (3 self)
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We describe how episodic illiquidity arises from a breakdown in cooperation between market participants. We first solve a oneperiod trading game in continuoustime, using an asset pricing equation that accounts for the price impact of trading. Then, in a multiperiod framework, we describe an equilibrium in which traders cooperate most of the time through repeated interaction, providing apparent liquidity to one another. Cooperation breaks down when the stakes are high, leading to predatory trading and episodic illiquidity. Equilibrium strategies that involve cooperation across markets lead to less frequent episodic illiquidity, but cause contagion when cooperation breaks down.
Risk in Dynamic Arbitrage: Price Effects of Convergence Trading ∗
, 2006
"... This paper studies the adverse price effects of convergence trading. I assume two assets with identical cash flows traded in segmented markets. Initially, there is gap between the prices of the assets, because local traders face asymmetric temporary shocks. In the absence of arbitrageurs, the gap re ..."
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Cited by 33 (1 self)
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This paper studies the adverse price effects of convergence trading. I assume two assets with identical cash flows traded in segmented markets. Initially, there is gap between the prices of the assets, because local traders face asymmetric temporary shocks. In the absence of arbitrageurs, the gap remains constant until a random time when the difference across local markets disappears. While arbitrageurs ’ activity reduces the price gap, it also generates potential losses: the price gap widens with positive probability at each time instant. With the increase of arbitrage capital on the market, the predictability of the dynamics of the gap decreases, and the arbitrage opportunity turns into a risky speculative bet. In a calibrated example I show that the endogenously created losses alone can explain episodes when arbitrageurs lose most of their capital in a relatively short time.
C.T.,2011, Regulatory pressure and fire sales in the corporate bond market
 Journal of Financial Economics
"... This paper investigates fire sales of downgraded corporate bonds induced by regulatory constraints imposed on insurance companies. Regulations either prohibit or impose large capital requirements on the holdings of speculativegrade bonds. As insurance companies hold over one third of all outstandin ..."
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Cited by 29 (1 self)
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This paper investigates fire sales of downgraded corporate bonds induced by regulatory constraints imposed on insurance companies. Regulations either prohibit or impose large capital requirements on the holdings of speculativegrade bonds. As insurance companies hold over one third of all outstanding investmentgrade corporate bonds, the collective need to divest downgraded issues may be limited by a scarcity of counterparties and associated bargaining power. Using insurance company transaction data from 20012005, we find insurance companies that are relatively more constrained by regulation are, on average, more likely to sell downgraded bonds. This forced selling generates elevated selling pressure around the downgrade which causes price pressures and subsequent price reversals, indicative of significant periods during which transaction prices deviate from fundamental values. Conditionally, the selling pressure, as well as the resulted price reversals, appears larger during periods in which insurance companies as a group are more constrained and other potential buyers ’ capital is scarce. In the cross section, bonds widely held by constrained insurance companies experience significantly larger selling pressure and larger price reversals. Investors providing liquidity to this market appear to earn
Dynamic Trading with Predictable Returns and Transaction Costs
, 2009
"... This paper derives in closed form the optimal dynamic portfolio policy when trading is costly and security returns are predictable by signals with different mean reversion speeds. The optimal updated portfolio is a linear combination of the existing portfolio, the optimal current portfolio absent tr ..."
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Cited by 28 (4 self)
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This paper derives in closed form the optimal dynamic portfolio policy when trading is costly and security returns are predictable by signals with different mean reversion speeds. The optimal updated portfolio is a linear combination of the existing portfolio, the optimal current portfolio absent trading costs, and the optimal portfolio based on future expected returns. Predictors with slower mean reversion (alpha decay) get more weight since they lead to a favorable positioning both now and in the future. We implement the optimal policy for commodity futures and show that the resulting portfolio has superior returns net of trading costs relative to more naive benchmarks. Finally, we derive natural equilibrium implications, including that demand shocks with faster mean reversion command a higher return premium.
Constrained portfolio liquidation in a limit order book model
 Banach Center Publ
, 2008
"... Abstract. We consider the problem of optimally placing market orders so as to minimize the expected liquidity costs from buying a given amount of shares. The liquidity price impact of market orders is described by an extension of a model for a limit order book with resilience that was proposed by Ob ..."
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Cited by 26 (9 self)
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Abstract. We consider the problem of optimally placing market orders so as to minimize the expected liquidity costs from buying a given amount of shares. The liquidity price impact of market orders is described by an extension of a model for a limit order book with resilience that was proposed by Obizhaeva and Wang (2006). We extend their model by allowing for a timedependent resilience rate, arbitrary trading times, and general equilibrium dynamics for the unaffected bid and ask prices. Our main results solve the problem of minimizing the expected liquidity costs within a given convex set of predictable trading strategies by reducing it to a deterministic optimization problem. This deterministic problem is explicitly solved for the case in which the convex set of strategies is defined via finitely many linear constraints. A detailed study of optimal portfolio liquidation in markets with opening and closing call auctions is provided as 2000 Mathematics Subject Classification: 91B26, 91B28, 91B70, 93E20, 60G35. Key words and phrases: liquidity risk, optimal portfolio liquidation, limit order book with resilience, call auction, market impact model, constrained trading strategies, market order. Research of the first two authors was supported by Deutsche Forschungsgemeinschaft through the Research Center Matheon “Mathematics for key technologies ” (FZT 86). The paper is in final form and no version of it will be published elsewhere. [9] c ○ Instytut Matematyczny PAN, 200810 A. ALFONSI ET AL. an illustration. We also obtain closedform solutions for the unconstrained portfolio liquidation problem in our timeinhomogeneous setting and thus extend a result from our earlier paper [1]. 1. Introduction. A
The liquidity risk of liquid hedge funds
 Journal of Financial Economics
, 2011
"... This paper evaluates hedge funds that grant favorable redemption terms to investors. Within this group of purportedly liquid funds, high net inflow funds subsequently outperform low net inflow funds by 4.79 percent per year after adjusting for risk. The return impact of fund flows is stronger when f ..."
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Cited by 15 (0 self)
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This paper evaluates hedge funds that grant favorable redemption terms to investors. Within this group of purportedly liquid funds, high net inflow funds subsequently outperform low net inflow funds by 4.79 percent per year after adjusting for risk. The return impact of fund flows is stronger when funds embrace liquidity risk, when market liquidity is low, and when funding liquidity, as measured by the TED spread, aggregate hedge fund flows, and prime broker stock returns, is tight. In keeping with an agency explanation, funds with strong incentives to raise capital, low manager option deltas, and no manager capital coinvested are more likely to take on excessive liquidity risk. These results resonate with the theory of funding liquidity by Brunnermeier and Pedersen (2009). __________ * We thank an anonymous referee for numerous insights and suggestions that substantially improved the paper.