Working Papers
The Social Dynamics of Performance, October 2012 |
A pervasive empirical finding is that mutual fund managers do not maintain their performance. In this paper, I show that social interactions can explain this fact. To do so, I allow a “crowd” of managers to meet at random times and exchange ideas within a rational-expectations equilibrium model. I show that social interactions simultaneously allow prices to become more efficient and better-informed managers to reap larger profits. Yet, social interactions cause managers’ alpha to become insignificant. The main implication is that increased efficiency causes managers to implement passive investment strategies for which they should not be rewarded. In addition, by increasing price informativeness, social interactions produce momentum in stock returns and induce most managers to become momentum traders, consistent with empirical findings.
Conference presentations: Gerzensee, 2012, Switzerland; EPFL research seminar, Lausanne, Switzerland, 2012.
Fear of Recessions, Heterogenous Beliefs, and Stock Price Under/Over-Reaction, with Michael Hasler, October 2011 |
Our purpose is to show how large difference of beliefs induced by the fear of a recession is amenable to large and persistent price responses to contemporaneous shocks. We construct a pure exchange economy populated by two agents who estimate strictly different models regarding the fundamental. In particular, one agent believes that recessions could occur whereas the second agent has smoother beliefs. We show that this setting is prone to generate disagreement whose persistence varies over a bearish phase. When economic conditions start to deteriorate, disagreement among agents significantly increases in a persistent fashion. Yet, after a sustained streak of bad news, disagreement gradually loses of its persistence. Contrary to the common wisdom that heterogeneous beliefs lead to large bets, we show that this pattern in disagreement ultimately causes the trading volume to dry up. As a result, price sensitivity to current shocks, along with persistence, is shown to be dramatically increased when compared with a model absent of heterogeneous beliefs, but with perceived recession risk. Using Google search data, we find empirical support for the main implication of the model.
Conference presentations: Gerzensee, 2011, Switzerland; 4th Financial Risks International Forum on Long Term Risks, Paris, France, 2011.
Information Percolation in Centralized Markets, with Daniel Andrei, May 2011 |
The tendency of asset prices to trend over short horizons and slowly revert over long horizons—momentum and reversal—can find an explanation within a simple, rational model. The key ingredient is word-of-mouth communication, which we introduce in the standard noisy rational expectations framework. Word-of-mouth communication accelerates the information revelation and generates momentum in asset returns. Due to social interactions, investors with heterogeneous trading strategies optimally coexist in the marketplace—some agents are contrarians, others are momentum traders, yet momentum is not completely eliminated. Finally, word-of-mouth communication can propagate a rumor and a price run-up; the price reverts once the rumor subsides.
Conference presentations: Princeton Workshop on Quantitative Finance 2011; Seminars at MIT Sloan School of Management, NorthWestern University Kellogg School of Management, Boston University School of Management and EPFL, 2011.
Global Public Signals, Heterogeneous Beliefs and Stock Markets Comovement, with Daniel Andrei, February 2010 |
We build an information-based two-country general equilibrium model. There are two dividend processes with correlated growth rates. Agents observe a global public signal informative about both growth rates. We first let agents rationally process information, and then we allow for reasonable departures from rationality. That is, agents are overconfident with respect to the signal, and thus have heterogeneous beliefs. We report a significant increase in comovement between stock returns. Moreover, we find that a small amount of misinterpretation of the global signal is sufficient to generate sizable comovement, as compared to the benchmark case of rational expectations. As an additional implication of overconfidence, we show that our model is able to produce a substantial home equity bias.
Conference presentations: Gerzensee 2009, Switzerland; 22nd Australasian Finance and Banking Conference 2009, Sydney, Australia.