If asset returns have systematic skewness, expected returns should include rewards for accepting this risk. We formalize this intuition with an asset pricing model that incorporates conditional skewness. Our results show that conditional skewness helps explain the cross-sectional variation of expected returns across assets and is significant even when factors based on size and book-to-market are included. Systematic skewness is economically important and commands a risk premium, on average, of 3.60 percent per year. Our results suggest that the momentum effect is related to systematic skewness. The low expected return momentum portfolios have higher skewness than high expected return portfolios. THE SINGLE FACTOR CAPITAL ASSET PRICING MODEL ~CAPM! of Sharpe ~1964! and Lintner ~1965! has come under recent scrutiny. Tests indicate that the crossasset variation in expected returns cannot be explained by the market beta alone. For example, a growing number of studies show that “fundamental” variables such as size, book-to-market value, and price to earnings ratios

Macroeconomic models of nominal exchange rates perform poorly. The proportion of monthly exchange rate changes that these models can explain is essentially zero. Ths paper presents

We use a new database to perform a comprehensive analysis of the mutual fund industry. We find that funds hold stocks that outperform the market by 1.3 percent per year, but their net returns underperform by one percent. Of the 2.3 percent difference between these results, 0.7 percent is due to the underperformance of nonstock holdings, whereas 1.6 percent is due to expenses and transactions costs. Thus, funds pick stocks well enough to cover their costs. Also, high-turnover funds beat the Vanguard Index 500 fund on a net return basis. Our evidence supports the value of active mutual fund management. DO MUTUAL FUND MANAGERS WHO actively trade stocks add value? Academics have debated this issue since the seminal paper of Jensen ~1968!. Although some controversy still exists, the majority of studies now conclude that actively managed funds ~e.g., the Fidelity Magellan fund!, on average, underperform their passively managed counterparts ~e.g., the Vanguard Index 500 fund!. 1 For example, Gruber ~1996! finds that the average mutual fund underperforms

Using a unique data set, we study the trading behavior of foreign portfolio investors in Korea before and during the currency crisis. Different categories of investors have significant differences as well as similarities. First, non-resident institutional investors are always positive feedback traders, whereas resident investors before the crisis were negative feedback (contrarian) traders but switch to be positive feedback traders during the crisis. Second, individual investors herd significantly more than institutional investors. Non-resident (institutional as well individual) investors herd significantly more than their resident counterparts. Third, differences in the Western and Korean news coverage are correlated with differences in net selling by nonresident investors relative to resident investors.

We analyze the trading activity of the mutual fund industry from 1975 through 1994 to determine whether funds “herd ” when they trade stocks and to investigate the impact of herding on stock prices. Although we find little herding by mutual funds in the average stock, we find much higher levels in trades of small stocks and in trading by growth-oriented funds. Stocks that herds buy outperform stocks that they sell by 4 percent during the following six months; this return difference is much more pronounced among small stocks. Our results are consistent with mutual fund herding speeding the price-adjustment process. DO INSTITUTIONAL INVESTORS “F LOCK TOGETHER ” ~or “herd, ” as it is often called! when they trade securities? Do some investors follow the lead of others when they trade? Such questions have interested researchers for some time, and are central to understanding the impact of institutional trading on securities markets and to understanding the way in which information becomes incorporated into market prices. 1

This paper explores daily, international portfolio flows into and out of 44 countries from 1994 through 1998. We find several facts concerning the behavior of flows and their relationship with equity returns. First, we detect regional flow factors that have increased in importance through time. Second, the flows are stationary, but far more persistent than returns. Third, flows are strongly influenced by past returns, consistent with positive feedback trading by international investors. Fourth, inflows have positive forecasting power for future equity returns, statistically significant in emerging markets. Fifth, the sensitivity of local stock prices to foreign inflows is positive and large. Sixth, prices seem consistent with flow persistence, in that transitory inflows impact future returns negatively.

We document strong positive correlation between changes in institutional ownership and returns measured over the same period. The result suggests that either institutional investors positive feedback trade more than individual investors or institutional herding impacts prices more than herding by individual investors. We find evidence that both factors play a role in explaining the relation. We find no evidence, however, of return mean-reversion in the year following large changes in institutional ownership -- stocks institutional investors purchase subsequently outperform those they sell. Moreover, institutional herding is positively correlated with lag returns and appears to be related to stock return momentum. 1 "Herding" (a group of investors trading in the same direction over a period of time) and "feedback trading" (correlation between herding and lag returns) have the potential to explain a number of financial phenomena, e.g., excess volatility, momentum, and reversals in stoc...

We investigate the value of active mutual fund management by examining the stockholdings and trades of mutual funds. We find that stocks widely held by funds do not outperform other stocks. However, stocks purchased by funds have significantly higher returns than stocks that are sold—this is true for large stocks as well as small stocks, and for value stocks as well as growth stocks. Moreover, growth-oriented funds exhibit better stockselection skills than income-oriented funds, especially in picking large growth stocks. Finally, funds trading more frequently have, at best, marginally better stock-selection skills than funds that trade less often. The Value of Active Mutual Fund Management: An Examination of the Stockholdings and Trades of Fund Managers I.

We present a simple model of a stock market where a random communication structure between agents generically gives rise to heavy tails in the distribution of stock price variations in the form of an exponentially truncated power-law, similar to distributions observed in recent empirical studies of high frequency market data. Our model provides a link between two well-known market phenomena: the heavy tails observed in the distribution of stock market returns on one hand and 'herding' behavior in financial markets on the other hand. In particular, our study suggests a relation between the excess kurtosis observed in asset returns, the market order flow and the tendency of market participants to imitate each other. Keywords: heavy tails, financial markets, herd behavior, market organization, intermittency, random graphs, percolation. JEL Classification number: C0, D49, G19 1 R. Cont gratefully acknowledges an AMX fellowship from Ecole Polytechnique (France) and thanks Science & Financ...

We review extensive evidence about how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource misallocation. We argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market participants. However, individuals as political participants remain subject to the biases and self-interest they exhibit in private settings. Indeed, correcting contemporaneous market pricing errors is probably not government’s relative advantage. Government and private planners should establish rules ex ante to improve choices and efficiency, including disclosure, reporting, advertising, and default-option-setting regulations. Especially