Search Results
Working Paper
Crashes and recoveries in illiquid markets
We study the dynamics of liquidity provision by dealers during an asset market crash, described as a temporary negative shock to investors? aggregate asset demand. We consider a class of dynamic market settings where dealers can trade continuously with each other, while trading between dealers and investors is subject to delays and involves bargaining. We derive conditions on fundamentals, such as preferences, market structure and the characteristics of the market crash (e.g., severity, persistence) under which dealers provide liquidity to investors following the crash. We also characterize ...
Working Paper
Search in asset markets: market structure, liquidity, and welfare
This paper investigates how market structure affects efficiency and several dimensions of liquidity in an asset market. To this end, we generalize the search-theoretic model of financial intermediation of Darrell Duffie et al. (2005) to allow for entry of dealers and unrestricted asset holdings.
Working Paper
Search in asset markets
We investigate how trading frictions in asset markets affect portfolio choices, asset prices and efficiency. We generalize the search-theoretic model of financial intermediation of Duffie, Grleanu and Pedersen (2005) to allow for more general preferences and idiosyncratic shock structure, unrestricted portfolio choices, aggregate uncertainty and entry of dealers. With a fixed measure of dealers, we show that a steady-state equilibrium exists and is unique, and provide a condition on preferences under which a reduction in trading frictions leads to an increase in the price of the asset. We ...
Working Paper
Do behavioral biases adversely affect the macro-economy?
This study investigates whether the adverse effects of investors' behavioral biases extend beyond the domain of financial markets to the broad macro-economy. We focus on the risk sharing (or income smoothing) role of financial markets and demonstrate that risk sharing levels are higher in U.S. states in which investors have higher cognitive abilities and exhibit weaker behavioral biases. Further, states with better risk sharing opportunities achieve higher levels of risk sharing if investors in those states exhibit greater financial sophistication. Among the various determinants of risk ...
Working Paper
Stock market participation, portfolio choice and pensions over the life-cycle
The empirical evidence on stock market participation and portfolio choice defies the predictions of standard life-cycle theory. In this paper we develop and estimate a model of portfolio choice that can account for the limited stock market participation and substantial portfolio diversification seen in the data. We present three realistic extensions to the basic framework: per period fixed costs, public pension provision, and a small chance of a disastrous event in the stock market. The estimated model is able to explain observed patterns at reasonable wealth levels, while keeping to a fairly ...
Working Paper
Does health affect portfolio choice?
Previous studies find a strong and positive empirical connection between health status and the share of risky assets held in household portfolios. But is this relationship truly causal, in the sense that households respond to changes in health by altering their portfolio allocation, or does it simply reflect unobserved differences across households? We find that most of the variation by health is on the extensive margin of stock ownership (rather than the marginal allocation conditional on ownership), which more plausibly points to non-causal explanations. Moreover, we find that any link ...
Working Paper
Dynamic factor value-at-risk for large, heteroskedastic portfolios
Trading portfolios at Financial institutions are typically driven by a large number of financial variables. These variables are often correlated with each other and exhibit by time-varying volatilities. We propose a computationally efficient Value-at-Risk (VaR) methodology based on Dynamic Factor Models (DFM) that can be applied to portfolios with time-varying weights, and that, unlike the popular Historical Simulation (HS) and Filtered Historical Simulation (FHS) methodologies, can handle time-varying volatilities and correlations for a large set of financial variables. We test the DFM-VaR ...
Working Paper
Decomposing the U.S. external returns differential
We decompose the returns differential between U.S. portfolio claims and liabilities into the composition, return, and timing effects. Our most striking and robust finding is that foreigners exhibit poor timing when reallocating between bonds and equities within their U.S. portfolios. The poor timing of foreign investors--caused primarily by deliberate trading, not a lack of portfolio rebalancing--contributes positively to the U.S. external returns differential. We find no evidence that the poor timing is driven by mechanical reserve accumulation by emerging market countries; rather, it is ...
Working Paper
U.S. international equity investment and past prospective returns
Counter to extant stylized facts, using newly available data on country allocations in U.S. investors' foreign equity portfolios we find that (i) U.S. investors do not exhibit returns-chasing behavior, but, consistent with partial portfolio rebalancing, tend to sell past winners; and (ii) U.S. investors increase portfolio weights on a country's equity market just prior to its strong performance, behavior inconsistent with an informational disadvantage. Over the past two decades, U.S. investors' foreign equity portfolios outperformed a value-weighted foreign benchmark by 160 basis points per ...
Working Paper
Diversification across characteristics
I study long-short portfolio strategies formed on seven different stock characteristics representing various measures of past returns, value, and size. Each individual characteristic results in a profitable portfolio strategy, but these single-characteristic strategies are all dominated by a diversified strategy that places equal weight on each of the single-characteristic strategies. The benefits of diversifying across characteristic-based long-short strategies are substantial and can be attributed to the mostly low, and sometimes substantially negative, correlation between the returns on ...