- Mutual Fund Flight-to-Liquidity
This paper empirically investigates a channel through which market uncertainty affects the liquidity premium. Using data at the mutual fund level, I document that increases in market uncertainty are associated with lower performance and more withdrawals. Consequently, funds adjust the composition of their portfolio towards more liquid assets in order to meet potential redemptions. Aggregated over many funds, this `flight-to-liquidity’ places significant upward price pressure on the liquidity premium: a one standard deviation increase in my measure of active liquidity management yields a 1.22 standard deviation increase in the return spread between illiquid and liquid stocks.
- Local Economic Conditions and Local Equity Preferences: Evidence from Mutual Funds during the U.S. Housing Boom and Bust (with Chandler Lutz and Ben Sand)
This paper examines the impact of local economic conditions on mutual fund preferences for geographically proximate stocks and consequently fund performance. Specifically, we demonstrate that mutual funds favoritism towards firms located within close geographic proximity varies with local housing price shocks. A decrease in local house prices is strongly associated with an increase in mutual fund home bias and results in a portfolio adjustment towards safer and higher quality holdings. This previously undocumented behavioral bias is of first order importance, as the shift in mutual fund preferences towards local stocks induced by deterioration in local economic conditions is associated with mutual fund underperformance: a one percentage point increase in home bias causes a decrease in a fund’s characteristic-adjusted 3-month future return by 35.3 bps.
- Passive-Aggressive Trading: The Supply and Demand of Liquidity by Mutual Funds (with Susan Christoffersen, Donald Keim, and David Musto)
Fund managers can demand liquidity for their trading ideas or provide liquidity for others’ ideas. We identify the roles of these motives using a database of the individual transactions by Canadian equity funds. Both the cost and subsequent performance of their buys decline after strong inflows, indicating the depletion of ideas and substitution into liquidity provision as funds quickly put new money to work. Sales show little of this substitution, consistent with funds’ narrower latitude to provide liquidity to buyers. In general, the option to provide liquidity makes fund performance positive in the transactions costs of buys, but not of sells.
- House Prices and Taxes (with Mads Nielsen Gjedsted)
By using the 2007 municipality reform in Denmark as an exogenous shock to municipal tax rates, we find that a 1%-point increase in income tax rates lead to a drop in house prices of 7.9% and a 1‰-point increase in the property tax rates lead to a 1.1% drop in house prices. The simple present values of a 1%-point perpetual income tax increase and a 1‰-point property tax increase, relative to the median house price, are 7% and 3.3%, respectively. Our findings are thus in line with the predicted median tax loss. This indicates that the housing market efficiently incorporates taxes into house prices. The exogeneity of the shock to taxes and the size of the data set is an improvement over earlier studies.
Informed Trading and Co-Illiquidity (with Massimo Massa and Søren Hvidkjær)
We study the link between informed trading and co-movement in liquidity. We argue that investors concerned with liquidity and fire sale shocks respond to an increase in informed trading by shifting their portfolios away from stocks with high information asymmetry. Their rebalancing results in a substitution in ownership away from the very same investors that induce financial fragility and co-movement in liquidity. This reduces co-illiquidity of the affected stocks. We exploit a unique natural experiment that increases the incentives of informed traders to trade. Our results suggest that informed traders reduce the exposure to co-movement in liquidity: one of the major problems during the latest global financial crisis.
Work in Progress
- Political uncertainty and the value of debt (with Agatha Murgoci)