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Abstract:
We test a Wall Street investment strategy known as pairs trading' with daily data over the period 1962 through 1997. Stocks are matched into pairs according to minimum distance in historical normalized price space. We test the profitability of several trading rules with six-month trading periods over the 1962-1997 period, and find average annualized excess returns of up to 12 percent for a number of self-financing portfolios of top pairs. Part of these profits may be due to market microstructure effects. Nevertheless, our historical trading profits exceed a conservative estimate of transaction costs through most of the period. We bootstrap random pairs in order to distinguish pairs trading from pure mean-reversion strategies. The bootstrap results suggest that the pairs' effect differs from previously documented mean reversion profits.

Abstract:
We test a Wall Street investment strategy, pairs trading, with daily data over 1962-2002. Stocks are matched into pairs with minimum distance between normalized historical prices. A simple trading rule yields average annualized excess returns of up to 11 percent for selffinancing portfolios of pairs. The profits typically exceed conservative transaction costs estimates. Bootstrap results suggest that the pairs effect differs from previously-documented reversal profits. Robustness of the excess returns indicates that pairs trading profits from temporary mis-pricing of close substitutes. We link the profitability to the presence of a common factor in the returns, different from conventional risk measures.

Abstract:
We examine the performance of the off-shore hedge fund industry over the period 1989 through 1995 using a database that includes both defunct and currently operating funds. The industry is characterized by high attrition rates of funds, low covariance with the U.S. stock market, evidence consistent with positive risk-adjusted returns over the time, but little evidence of differential manager skil.

Abstract:
We test the hypothesis that hedge funds were responsible for the crash in the Asian currencies in late 1997. To do so, we develop estimates of the changing positions of the largest ten currency funds in one currency, the Malaysian ringgit and to a basket of Asian currencies. Our methodology is adapted from the Sharpe?s (1992) style analysis approach that decomposes fund returns. We find that the net long or short positions in the ringgit or its correlates did fluctuate dramatically over the last four years. However, these fluctuations were not associated with moves in the exchange rate. The estimated net positions of the major funds were not unusual during the crash period, nor were the profits of the funds during the crisis. In sum, we find no empirical evidence to support the hypothesis that George Soros, or any other hedge fund manager was responsible for the crisis.

Abstract:
The popular perception is that hedge funds follow a reasonably well defined market-neutral investment style. While this long-short investment strategy may have characterized the first hedge funds, today hedge funds are a reasonably heterogeneous group. They are better defined in terms oftheir freedom from the constraints imposed by the Investment Company Act of 1940, than they are by the particular style of investment. We study the monthly return history of hedge funds over the period 1989 through to January 2000 and find that there are in fact a number of distinct styles of management. We find that differences in investment style contribute about 20 per cent of the crosssectional variability in hedge fund performance. This result is consistent across the years of our sample and is robust to the way in which we determine investment style. We conclude that appropriate style analysis and style management are crucial to success for investors looking to invest in this market.

Abstract:
The popular perception is that hedge funds follow a reasonably well defined market-neutral investment style. While this long-short investment strategy may have characterized the first hedge funds, today hedge funds are a reasonably heterogeneous group. They are better defined in terms of their freedom from the constraints imposed by the Investment Company Act of 1940, than they are by the particular style of investment. We study the monthly return history of hedge funds over the period 1989 through to January 2000 and find that there are in fact a number of distinct styles of management. We find that differences in investment style contribute about 20 per cent of the cross sectional variability in hedge fund performance. This result is consistent across the years of our sample and is robust to the way in which we determine investment style. We conclude that appropriate style analysis and style management are crucial to success for investors looking to invest in this market.

Abstract:
The popular perception is that hedge funds follow a reasonably well defined market-neutral investment style. While this long- short investment strategy may have characterized the first hedge funds, today hedge funds are a reasonably heterogeneous group. They are better defined in terms of their freedom from the constraints imposed by the Investment Company Act of 1940, than they are by the particular style of investment. We study the monthly return history of hedge funds over the period 1989 through to January 2000 and find that there are in fact a number of distinct styles of management. We find that differences in investment style contribute about 20 percent of the cross sectional variability in hedge fund performance. This result is consistent across the years of our sample and is robust to the way in which we determine investment style. We conclude that appropriate style analysis and style management are crucial to success for investors looking to invest in this market.

Abstract:
Alfred Cowles' (1934) test of the Dow Theory apparently provided strong evidence against the ability of Wall Street's most famous chartist to forecast the stock market. In this paper, we review Cowles' evidence and find that it supports the contrary conclusion -- that the Dow Theory, as applied by its major practitioner, William Peter Hamilton over the period 1902 to 1929, yielded positive risk-adjusted returns. A re-analysis of the Hamilton editorials suggests that his timing strategies yield high Sharpe ratios and positive alphas. Neural net modeling to replicate Hamilton's market calls provides interesting insight into the nature and content of the Dow Theory. This allows us to examine the properties of the Dow Theory itself out-of-sample.

Abstract:
Over the years numerous portfolio performance measures have been proposed. In general they are designed to capture some particular enhancement that might result from active management. However, if a principal uses a measure to judge an agent, then the agent has an incentive to game the measure. Our paper shows that such gaming can have a substantial impact on a number of popular measures even in the presence of extremely high transactions costs. The question then arises as to whether or not there exists a measure that cannot be gamed? As this paper shows there are conditions under which such a measure exists and fully characterizes it. This manipulation-proof measure looks like the average of a power utility function, calculated over the return history. The case for using our alternative ranking metric is particularly compelling in the hedge fund industry, in which the use of derivatives is unconstrained and manager compensation itself induces a non-linear payoff and thus encourages gaming.

Abstract:
Modern accounting-based valuation models such as residual income and EVA may be thought of as careful estimates of the economic return to investors in excess of the firm's cost of capital. The framework for these models can be traced to theoretical and empirical work in the early part of the century, coincidental with the introduction of mathematical economics to America and with the availability of standardized accounting data for use by professional statisticians. By the middle of the century these "economic theory" and "practical empirical" tracks began to merge and corporate managers consciously adapted and applied performance evaluation technology in the decision making process.

The development of corporate performance measurement over the past century has its genesis in the work of statisticians, economists and managers who sought to understand the functions of the American corporation and through this understanding to improve its operation. In this essay, we trace the development of early attempts by academics to compare economic performance across firms using empirical data. We also list significant developments in economic theory that are relevant to the performance assessment of firms. We argue that, even though several of the key concepts driving today's measures of corporate performance had their origin in the 1920's, much of the debate about corporate performance evaluation which still rages today has to do with the ability (or lack of ability) to generate appropriate accounting numbers to input into the theoretically correct economic models.

Abstract:
Incentive fees for money managers are frequently accompanied by high-water mark provisions that condition the payment of the performance fee upon exceeding the previously achieved maximum share value. In this paper, we show that hedge fund performance fees are valuable to money managers, and conversely, represent a claim on a significant proportion of investor wealth. The high-water mark provisions in these contracts limit the value of the performance fees. We provide a closed-form solution to the cost of the high-water mark contract under certain conditions. Our results provide a framework for valuation of a hedge fund management company.

Abstract:
Incentive or performance fees for money managers are frequently accompanied by high-water mark provisions which condition the payment of the performance fee upon exceeding the maximum achieved share value. In this paper, we show that hedge fund performance fees are valuable to money managers, and conversely represent a claim on a significant proportion of investor wealth. The high-water mark provisions in these contracts limit the value of the performance fees. We provide a closed-form solution to the high-water mark contract under certain conditions. This solution shows that managers have an incentive to take risks. Our results provide a framework for valuation of a hedge fund management company.

We conjecture that the existence of high-water mark compensation is due to decreasing returns to scale in the industry. Empirical evidence on the relationship between fund return and net money flows into and out of funds suggests that successful managers, and large fund managers are less willing to take new money than small fund managers.

Abstract:
We summarize some of our own past findings and place them in the context of the historical development of the idea of the equity risk premium and its empirical measurement by financial economists. In particular, we focus on how the theory of compensation for investment risk developed in the 20th century in tandem with the empirical analysis of historical investment performance. Finally, we update our study of the historical performance of the New York Stock Exchange over the period 1792 to the present, and include a measure of the U.S. equity risk premium over more than two centuries. This last section is based upon indices constructed from individual stock and dividend data collected over a decade of research at the Yale School of Management, and contributions by other scholars.

financial history, equity premium

Abstract:
Using a sample of daily net flows to nearly 1,000 U.S. mutual funds over a year and a half period, we identify a set of systematic factors that explain a significant amount of the variation in flows. This suggests the existence of a common component to mutual fund investor behavior and indicates which asset classes may be regarded as economic substitutes by the participants in the market for mutual fund shares. We find that flows into equity funds -- both domestic and international -- are negatively correlated to flows to money market funds and precious metals funds. This suggests that investor rebalancing between cash and equity explains a significant amount of trade in mutual fund shares. The negative correlation of equities to metals suggests that this timing is not simply due to liquidity concerns, but rather to sentiment about the equity premium.

We address the question of whether behavioral factors spread returns by using the mutual fund flow factors as pre-specified regressors in a Fama-MacBeth asset pricing framework. We find that the factors derived from flows alone explain as much as 45% of the cross-sectional variation in mutual fund returns. The fund flow factors provide significant incremental explanatory power in the cross-sectional regressions on daily returns.

We consider a number of alternatives to explain our evidence including causality from returns to flows and vice-versa. Our evidence is consistent with the existence of a pervasive investor sentiment variable.

Abstract:
In this paper we examine the correlation structure of the major world equity markets over 150 years. We find that correlations vary considerably through time and are highest during periods of economic and financial integration such as the late 19th and 20th centuries. Our analysis suggests that the diversification benefits to global investing are not constant, and that they are currently low compared to the rest of capital market history. We decompose the diversification benefits into two parts: a component that is due to variation in the average correlation across markets, and a component that is due to the variation in the investment opportunity set. There are periods, like the last two decades, in which the opportunity set expands dramatically, and the benefits to diversification are driven primarily by the existence of marginal markets. For other periods, such as the two decades following World War II, risk reduction is due to low correlations among the major national markets. From this, we infer that periods of globalization have both benefits and drawbacks for international investors. They expand the opportunity set, but diversification relies increasingly on investment in emerging markets.

Abstract:
The correlation structure of the world equity markets varies considerably over the past 150 years. We show that correlations were high during periods of economic and financial integration. We decompose the benefits of international diversification into two parts: a component that measures variation of the average correlation across markets, and a component that measures variation of the investment opportunity set. Globalization is associated with relatively high correlations, and an increase in the investment opportunity set. From this, we infer that periods of globalization have both benefits and drawbacks for international investors.

Abstract:
The correlations among international real estate markets are surprisingly high, given the degree to which they are segmented. While industrial, office and retail properties exist all around the world, they are not economic substitutes because of locational specificity. In addition, the broad securitization of real estate property companies has, until recently, lagged that of other types of companies. Never-the-less, international property returns move together in dramatic fashion. In this paper, we use eleven years of global property returns to explore the factors influencing this co-movement. We attribute a substantial amount of the correlation across world property markets to the effects of changes in GNP, suggesting that real estate is a bet on fundamental economic variables which are correlated across countries. A decomposition shows that a local production factor is more important in some countries than in others.

Abstract:
Funds of funds are an increasingly popular avenue for hedge fund investment. Despite the increasing interest in hedge funds as an alternative asset class, the high degree of fund specific risk and the lack of transparency may give fiduciaries pause. In addition, many of the most attractive hedge funds are closed to new investment. Funds of funds resolve these issues by providing investors with diversification across manager styles and professional oversight of fund operations that can provide the necessary degree of due diligence. In addition, many such funds hold shares in hedge funds otherwise closed to new investment allowing smaller investors access to the most sought-after managers. However, the diversification, oversight and access comes at the cost of a multiplication of the fees paid by the investor. It is not generally understood that the incentive fee component of the fee on fee arrangement may under certain circumstances exceed the realized return on the fund. In this paper we argue that the disappointing after fee performance of some fund of funds may be explained by the nature of this fee arrangement. We examine an alternative fee arrangement that may provide better incentives at a lower cost to investors in these funds.

Abstract:
Funds of funds are an increasingly popular avenue for hedge fund investment. Despite the increasing interest in hedge funds as an alternative asset class, the high degree of fund specific risk and the lack of transparency may give fiduciaries pause. In addition, many of the most attractive hedge funds are closed to new investment. Funds of funds resolve these issues by providing investors with diversification across manager styles and professional oversight of fund operations that can provide the necessary degree of due diligence. In addition, many such funds hold shares in hedge funds otherwise closed to new investment allowing smaller investors access to the most sought-after managers. However, the diversification, oversight and access comes at the cost of a multiplication of the fees paid by the investor. One would expect that the information advantage of funds of funds would more than compensate investors for these fees. Unfortunately, individual hedge funds dominate fund of funds on an after-fee return or Sharpe ratio basis. In this paper we argue that the disappointing after-fee performance of some fund of funds might be explained by the nature of this fee arrangement, and that fund of funds providers may actually benefit from considering other possible fee arrangements. These alternative arrangements will improve reported performance and may make funds of funds more attractive to a growing institutional clientele.

Abstract:
Funds of funds are an increasingly popular avenue for hedge fund investment. Despite theincreasing interest in hedge funds as an alternative asset class, the high degree of fund specific risk and the lack of transparency may give fiduciaries pause. In addition, many of the most attractivehedge funds are closed to new investment. Funds of funds resolve these issues by providing investors with diversification across manager styles and professional oversight of fund operations that can provide the necessary degree of due diligence. In addition, many such funds hold shares inhedge funds otherwise closed to new investment allowing smaller investors access to the most sought-after managers. However, the diversification, oversight and access comes at the cost of a multiplication of the fees paid by the investor. It is not generally understood that the incentive feecomponent of the fee on fee arrangement may under certain circumstances exceed the realized return on the fund. In this paper we argue that the disappointing after fee performance of some fund of funds may be explained by the nature of this fee arrangement. We examine an alternative feearrangement that may provide better incentives at a lower cost to investors in these funds.

Abstract:
Funds of funds are an increasing popular avenue for hedge fund investment. Despite the increasing interest in hedge funds as an alternative asset class, the high degree of fund specific risk and the lack of transparency may give fiduciaries pause. In addition, many of the most attractive hedge funds are closed to new investment. Funds of funds resolve these issues by providing investors with diversification across manager styles and professional oversight of fund operations that can provide the necessary degree of due diligence. In addition, many such funds hold shares in hedge funds otherwise closed to new investment allowing smaller investors access to the most sought-after managers. However, the diversification, oversight and access comes at the cost of a multiplication of the fees paid by the investor. One would expect that the information advantage of funds of funds would more than compensate investors for these fees. Unfortunately, individual hedge funds dominate fund of funds on an after-fee return to Sharpe ratio basis. In this paper we argue that the disappointing after-fee performance of some fund of funds might be explained by the nature of this fee argument, and that fund of funds providers may actually benefit from considering other possible fee arrangements. These alternative arrangements will improve reported performance and may make funds of funds more attractive to a growing institutional clientele.

Hedge funds, funds-of-funds, incentive fees

Abstract:
Funds of funds are an increasingly popular avenue for hedge fund investment. Despite the increasing interest in hedge funds as an alternative asset class, the high degree of fund specific risk and the lack of transparency may give fiduciaries pause. In addition, many of the most attractive hedge funds are closed to new investment. Funds of funds resolve these issues by providing investors with diversification across manaager styles and professional oversight of fund operations that can provide the necessary degree of due diligence. In addition, many such funds hold shares in hedge funds otherwise closed to new investment allowing smaller investors access to the most sought-after managers. However, the diversification, oversight and access comes at the cost of a multiplication of fees paid by the investor. One would expect that the information advantage of funds of funds would more than compensate investors for these fees. Unfortunately, individual hedge funds dominate fund of funds on an after-fee return or Sharpe ratio basis. In this paper we argue that the disappointing after-fee performance of some fund of funds may be explained by the nature of this fee arrangement. Fund of funds providers pass on individual hedge fund incentive fees in the form of after-fee returns, although they are in a better position to hedge these fees than are their investors. We examine a new fee arrangement emerging in the industry that may provide better incentives at a lower cost to investors in these funds.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Funds of funds are an increasingly popular avenue for hedge fund investment. Despite the increasing interest in hedge funds as an alternative asset class, the high degree of fund specific risk and the lack of transparency may give fiduciaries pause. In addition, many of the most attractive hedge funds are closed to new investment. Funds of funds resolve these issues by providing investors with diversification across manager styles and professional oversight of fund operations that can provide the necessary degree of due diligence. In addition, many such funds hold shares in hedge funds otherwise closed to new investment allowing smaller investors access to the most sought-after managers. However the diversification, oversight and access comes at the cost of a multiplication of the fees paid by the investor. One would expect that the information advantage of funds would more than compensate investors for these fees. Unfortunately, individual hedge funds dominate fund of funds on an after-fee return or Sharpe ratio basis. In this paper we argue that the disappointing after-fee performance of some fund of funds might be explained by the nature of this fee arrangement, and that fund of funds providers may actually benefit from considering other possible fee arrangements. These alternative arrangements will improve reported performance and may make funds of funds more attractive to a growing institutional clientele.

Abstract:
Daily pricing of mutual funds provides liquidity to investors but is subject to valuation errors due to the inability to observe synchronous, fair security prices at the end of the trading day. This may hurt fund investors if speculators strategically seek to exploit mispricing or if the net flow of money into funds is correlated with these pricing errors. We show that mutual funds are exposed to speculative traders by using a simple day trading rule that yields large profits in a sample of 391 U.S.-based open-end international mutual funds. We propose a simple "fair pricing" mechanism that alleviates these concerns by correcting net asset values for stale prices. We argue that fund companies and regulators should look at alternatives that allow funds to offer fair pricing to investors, which in turn decreases the need to resort to monitoring for day traders and redemption penalties.

Abstract:
Daily pricing of mutual funds provides liquidity to investors but is subject to valuation errors due to the inability to observe synchronous, fair security prices at the end of the trading day. This may hurt fund investors if speculators strategically seek to exploit mispricing or if the net flow of money into funds is correlated with these pricing errors. We show that mutual funds are exposed to speculative traders by using a simple day trading rule that yields large profits in a sample of 391 U.S.-based open-end international mutual funds. We propose a simple "fair pricing" mechanism that alleviates these concerns by correcting net asset values for stale prices. We argue that fund companies and regulators should look at alternatives that allow funds to offer fair pricing to investors, which in turn decreases the need to resort to monitoring for day traders and redemption penalties.

Abstract:
We investigate whether hedge fund and commodity trading advisor [CTA] return variance is conditional upon performance in the first half of the year. Our results are consistent with the Brown, Harlow and Starks (1994) findings for mutual fund managers. We find that good performers in the first half of the year reduce the volatility of their portfolios, but not vice-versa. The result that manager "variance strategies" depend upon relative ranking not distance from the high water mark threshold is unexpected, because CTA manager compensation is based on this absolute benchmark, rather than relative to other funds or indices. We conjecture that the threat of disappearance is a significant one for hedge fund managers and CTAs. An analysis of performance preceding departure from the database shows an association between disappearance and underperformance. An analysis of the annual hazard rates shows that performers in the lowest decile face a serious threat of closure. We find evidence to support the fact that survivorship and backfilling are both serious concerns in the use of hedge fund and CTA data.

Abstract:
We analyze cross-sectional and time series information from forty-six equity markets around the world to consider whether short sales restrictions affect the efficiency of the market and the distributional characteristics of returns to individual stocks and market indices. We construct two measures of price efficiency that quantify the asymmetric response of individual stock returns to negative vs. positive information, and find some evidence that prices incorporate negative information faster in countries where short sales are allowed and practiced. This evidence is consistent with more efficient price discovery at the individual security level. A common conjecture by regulators is that short sales restrictions can reduce the relative severity of a market panic. We test this conjecture by examining the skewness of market returns. We find strong evidence that in markets where short selling is either prohibited or not practiced, market returns display significantly less negative skewness. However, at the individual stock level, short sales restrictions appear to make no difference.

Short Sales, Market Efficiency, Market Crashes

Abstract:
We analyze cross-sectional and time series information from forty-seven equity markets around the world, to consider whether short-sales restrictions affect the efficiency of the market, and the distributional characteristics of returns to individual stocks and market indices. Using the approach developed in Morck et.al. (2000) we find significantly more cross-sectional variation in equity returns in markets where short selling is feasible and practiced, controlling for a host of other factors. This evidence is consistent with more efficient price discovery at the individual security level. A common conjecture by regulators is that short-selling restrictions can reduce the relative severity of a market panic. We test this conjecture by examining the skewness of market returns. We find that in markets where short selling is either prohibited or not practiced, returns display significantly less negative skewness, and the frequency of extreme negative returns is lower. On the other hand, the overall volatility of individual returns and market returns is higher.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
We analyze cross-sectional and time series information from forty-six equity markets around the world, to consider whether short sales restrictions affect the efficiency of the market, and the distributional characteristics of returns to individual stock and market indices. We construct two measures of price efficiency that quantify the asymmetric response of individual stock returns to negative vs. positive information, and find that prices incorporate information faster in countries where short sales are allowed and practiced. This evidence is consistent with more efficient price discovery at the individual security level. A common conjecture by regulators is that short sales restrictions can reduce the relative severity of a market panic. We test this conjecture by examining the skewness of market returns. We find some evidence that in markets where short selling is either prohibited or not practices, market returns display significantly less negative skewness. However, at the individual stock level, short sales restrictions appear to make no difference.

Abstract:
We use an iterative relocation algorithm to identify factors in common stock returns. The benefit of the approach is that factors are portfolios of assets with non-negative weights. As a result, they are readily interpreted in terms of their characteristics of the underlying securities. The positive portfolio factors have comparatively high explanatory power in sample and out-of-sample. We find evidence of a size factor and factors identified with certain industries. Factors extracted from the mutual fund universe perform marginally better than factors from the universe of equities.

Abstract:
We use an iterative relocation algorithm to identify factors in common stock returns. The benefit of the approach is that factors are portfolios of assets with non-negative weights. As a result, they are readily interpretable in terms of the characteristics of the underlying securities. The positive portfolio factors have comparatively high explanatory power in sample and out of sample. We find evidence of a size factor and factors identified with certain industries. Factors extracted from the mutual fund universe perform marginally better than factors from the universe of equities.

Abstract:
In this paper, we collect individual stock prices for NYSE stocks over the period 1815 to 1925 and individual dividend data over the period 1825 to 1870. We use monthly price and dividend information on more than 600 individual securities over the period to estimate a stock price index and total return series that extends virtually to the beginning of the New York Stock Exchange. We use this data to estimate the power of past returns and dividend yields to forecast future long-horizon returns. We find some evidence of predictabiity in sub-periods but little predictability over the long term. We estimate the time-varying volatility of the U.S. market over the period 1815 to 1925 and find evidence of a leverage effect on risk. This new database will allow future researchers to test a broad range of hypotheses about the U.S. capital markets in a rich, untouched sample.

Abstract:
The expected return on equity capital is possibly the most important driving factor in asset allocation decisions. Yet, the long-term estimates we typically use are derived from U.S. data only. There are reasons to suspect, however, that these estimates of return on capital are subject to survivorship, as the United States is arguably the most successful capitalist system in the world; most other countries have been plagued by political upheaval, war, and financial crises. The purpose of this paper is to provide estimates of return on capital from long-term histories for world equity markets. By putting together a variety of sources, we collected a database of capital appreciation indexes for 39 markets with histories going back as far back as the l920s. Our results are striking. We find that the United States has by far the highest uninterrupted real rate of appreciation of all countries, at about 5 percent annually. For other countries, the median real appreciation rate is about 1.5 percent. The high return premium obtained for U.S. equities therefore appears to be the exception rather than the rule. Our global databases also allow us to reconstruct monthly real and dollar-valued capital appreciation indices for global markets, providing further evidence on the benefits of international diversification.

Abstract:
This paper examines the contribution of Leonardo of Pisa [Fibonacci] to the history of financial mathematics. Evidence in Leonardo's Liber Abaci (1202) suggests that he was the first to develop present value analysis for comparing the economic value of alternative contractual cash flows. He also developed a general method for expressing investment returns, and solved a wide range of complex interest rate problems. The paper argues that his advances in the mathematics of finance were stimulated by the commercial revolution in the Mediterranean during his lifetime, and in turn, his discoveries significantly influenced the evolution of capitalist enterprise and public finance in Europe in the centuries that followed. Fibonacci's discount rates were more culturally influential than his famous series.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper examines the contribution of Leonardo of Pisa [Fibonacci] to the history of financial mathematics. Evidence in Leonardo's Liber Abaci (1202) suggests that he was the first to develop present value analysis for comparing the economic value of alternative contractual cash flows. He also developed a general method for expressing investment returns, and solved a wide range of complex interest rate problems. The paper argues that his advances in the mathematics of finance were stimulated by the commercial revolution in the Mediterranean during his lifetime, and in turn, his discoveries significantly influenced the evolution of capitalist enterprise and public finance in Europe in the centuries that followed. Fibonacci's discount rates were more culturally influential than his famous series.

Abstract:
We use a two-year panel of individual accounts in an S&P 500 index mutual fund to examine the trading and investment behavior of more than 91 thousand investors who have chosen a low-cost, passively managed vehicle for savings. This allows us to characterize investors' heterogeneity in terms of their investment patterns. In particular, we identify positive feedback traders as well as contrarians whose activities are conditional upon preceding day stock market moves. We test the consistency and profitability of these conditional strategies over time. We find that more frequent traders are typically contrarians, while infrequent traders are more typically momentum investors.

The dynamics of these investor classes help us to partially examine the question of the marginal investor over the period of our study. We find that the behavior of momentum investors is typically more correlated to changes in the S&P 500 and we trace its dynamics over time. We build up "behavioral factors" based on contrarian and momentum flows and show that they perform well against a benchmark of loadings on latent factors extracted from returns. We also use the behavior of momentum and contrarian investors to build a measure of "market polarization". This captures the dispersion of beliefs among the investors and helps to account for asset pricing better than standard measures of dispersion of beliefs.

Abstract:
Our analysis of daily index fund flows indicates a strong contemporaneous correlation between fund inflows and S&P market returns. We also document a strong negative correlation between fund out flows and S&P market returns with the exception of outflows from a back-end load fund. These effects may be interpreted in two ways. Either investor supply and demand affects S&P market prices, or investors condition their demand and supply on intra-day market fluctuations. To sort out these effects, we examine trailing investor reaction to market moves. Our results suggest the market reacts to daily demand. However, only negative reactions appear due to past returns.

We investigate whether index investor demand shocks are permanent or temporary by examining the related behavior of the S&P futures index. Clear evidence supports the hypothesis that they are permanent. This result may help explain the unusual recent relative performance of the S&P 500 index.

Using the average market-timing newsletter recommendation over the period, we find that investors appear to react to "expert" advice about the market. Bullish newsletter sentiment is associated with greater inflows, although outflows are not well explained by newsletter advice. Dispersion in advice is associated with lower inflows. We find a high correlation among a number of variables used as a proxy for investor disagreement.

Abstract:
We find evidence that is consistent with the hypothesis that daily mutual fund flows may be instruments for investor sentiment about the stock market. We use this finding to construct a new index of investor sentiment, and validate this index using data from both the United States and Japan. In both markets exposure to this factor is priced, and in the Japanese case, we document evidence of negative correlations between â¬SBullâ¬? and â¬SBearâ¬? domestic funds. The flows to bear foreign funds in Japan display some evidence of negative correlation to domestic and foreign equity funds, suggesting that there is a foreign vs. domestic sentiment factor in Japan that does not appear in the contemporaneous U.S. data. By contrast, U.S. mutual fund investors appear to regard domestic and foreign equity mutual funds as economic substitutes.

Abstract:
We find evidence that is consistent with the hypothesis that daily mutual fund flows may be instruments for investor sentiment about the stock market. We use this finding to construct a new index of investor sentiment, and validate this index using data from both the United States and Japan. In both markets exposure to this factor is priced, and in the Japanese case, we document evidence of negative correlations between â¬SBullâ¬? and â¬SBearâ¬? domestic funds. The flows to bear foreign funds in Japan display some evidence of negative correlation to domestic and foreign equity funds, suggesting that there is a foreign vs. domestic sentiment factor in Japan that does not appear in the contemporaneous U.S. data. By contrast, U.S.mutual fund investors appear to regard domestic and foreign equity mutual funds aseconomic substitutes.

Abstract:
We find evidence that is consistent with the hypothesis that daily mutual fund flows may be instruments for investor sentiment about the stock market. We use this finding to construct a new index of investor sentiment, and validate this index using data from both the United States and Japan. In both markets exposure to this factor is priced, and in the Japanese case, we document evidence of negative correlations between 'Bull' and 'Bear' domestic funds. The flows to bear foreign funds in Japan display some evidence of negative correlation to domestic and foreign equity funds, suggesting that there is a foreign vs. domestic sentiment factor in Japan that does not appear in the contemporaneous U.S. data. By contrast, U.S. mutual fund investors appear to regard domestic and foreign equity mutual funds as economic substitutes.

Abstract:
We find evidence that is consistent with the hypothesis that daily mutual fund flows may be instruments for investor sentiment about the stock market. We use this finding to construct a new index of investor sentiment, and validate this index using data from both the United States and Japan. In both markets exposure to this factor is priced, and in the Japanese case, we document evidence of negative correlations between "Bull" and "Bear" domestic funds. The flows to bear foreign funds in Japan display some evidence of negative correlation to foreign bull and equity funds. They appear to be independent of domestic bull and bear fund flows, suggesting that there is a foreign vs. domestic sentiment factor in Japan that does not appear in the contemporaneous U.S. data. By contrast, U.S. mutual fund investors appear to regard domestic and foreign equity mutual funds as economic complements.

Investor Sentiment, Mutual Fund Flows, Bull and Bear Funds, Factor Pricing Mod

Abstract:
This paper examines governance explanations for the discount of preferred shares to common shares in the Russian market. Conflicts between shareholder classes may help explain the discount. However, for this to be the sole explanation the estimated models suggest that the magnitude of future adverse shareholder events would have to be very high. Nevertheless, evidence of a common factor potentially related to governance seems evident in the data, implying that corporate control issues may at least be partially responsible for the observed preferred share discount.

Abstract:
In this paper we review evidence about the development of the Chinese capital markets over a crucial period in world market history, and place that development in the context of world financial markets at the time. Despite fundamental differences between China today and China 100 years ago, it is still important to consider the dangers of an imbalance between domestic and international investor markets, and the mismatch between domestic and foreign expectations about investor protection. The lessons of the last century suggest that China today should consider opening Chinese investor access to foreign capital markets in order to equilibrate the level of diversification between foreign and domestic investors. In addition, protection of domestic corporate investor rights is at least as important as protecting foreign investor rights.

This paper is available in Chinese at: http://papers.ssrn.com/abstract=289143

Abstract:
Mandatory disclosure is a regulatory tool intended to allow market participants to assess operational risk. We examine the value of disclosure through the controversial SEC requirement, since overturned, which required major hedge funds to register as investment advisors and file Form ADV disclosures. Leverage and ownership structures suggest that lenders and equity investors were already aware of operational risk. However, operational risk does not mediate flow-performance relationships. Investors either lack this information or regard it as immaterial. These findings suggest that regulators should account for the endogenous production of information and the marginal benefit of disclosure to different investment clienteles.

Hedge funds, operational risk, SEC filing, Form ADV

Abstract:
In this paper we address the factors influencing the institutional decision to allocate resources to real estate. We survey a sample of major institutional investors via a web questionnaire. They were willing to answer questions about their target real estate allocation, their plans to increase or decrease their allocation, the major reasons for investing in real estate, and views on the major risks and relative expense of doing so. We find that the endowments in our sample typically had a relatively short history of real estate investment, but planned to increase their allocation to the asset class - more so than pension funds. We also find uncertainty about use of historical data to be a significant factor in the allocation choice.

Behavioral Finance, real estate, investing, risk, uncertainty

Abstract:
Home equity is the single largest component of household wealth for the majority of American households. Yet, there is virtually no way for the average family to insure itself against drops in home value and the ensuing destructive financial loss. Much of U.S. housing policy has focused on helping them against the risk that home ownership entails.

In this paper, we document the development and implementation of a home equity insurance program launched in 2002 in Syracuse, New York. The range of issues arising from the practical implementation of a home equity insurance program, as well as the institutional challenges offer useful data for further extensions of the program.

Highlights of the outcome, to date, of the pilot program include the finding that implementation of the program was feasible on the local level, that customers understand and wanted to take part, and that clean data on housing transactions is a vital component of the future success and expansion of the project.

Abstract:
There is considerable empirical evidence that emotion influences decision-making. In this paper, we use a database of individual investor accounts to examine the weather effects on traders. Our analysis of the trading activity in five major US cities over a six-year period finds virtually no difference in individuals' propensity to buy or sell equities on cloudy days as opposed to sunny days. If the association between cloud cover and stock returns documented for New York and other world cities is indeed caused by investor mood swings, our findings suggest that researchers should focus on the attitudes of market-makers, news providers or other agents physically located in the city hosting the exchange. NYSE spreads widen on cloudy days. When we control for this, the weather effect becomes smaller and insignificant. We interpret this as evidence that the behaviour of market-makers, rather than individual investors, may be responsible for the relation between returns and weather.

Abstract:
Saunders (1993) and Hirshleifer and Shumway (2001) document the effect of weather on stock returns. The proposed explanation in both papers is that investor mood affects cognitive processes and trading decisions. In this paper, we use a database of individual investor accounts to examine the weather effects on traders. Our analysis of the trading activity in five major U.S. cities over a six-year period finds vistually no difference in individuals propensity to buy or sell equities on cloudy days as opposed to sunny days. If the association between cloud cover and stock returns documented for New York and other world cities is indeed caused by investor mood swings, our findings suggest that researchers should focus on the attitudes of market-makers, news providers or other agents physically located in the city hosting the exchange. NYSE spreads widen on cloudy days. When we control for this, the significance of the weather effect is dramatically reduced. We interpret this as evidence that the behavior of market-makers, rather than individual investors, may be responsible for the relation between returns and weather.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Saunders (1993) and Hirshleifer and Shumway (2001) document the effect of weather on stock returns. The proposed explanation in both papers is that investor mood affects cognitive processes and trading decisions. In this paper, we use a database of individual investor accounts to examine the weather effects on traders. Our analysis of the trading activity in five major U.S. cities over a six-year period finds virtually no difference in individuals' propensity to buy or sell equities on cloudy days as opposed to sunny days. If the association between cloud cover and stock returns documented for New York and other world cities is indeed caused by investor mood swings, our findings suggest that researchers should focus on the attitudes of market-makers, news providers or other agents physically located in the city hosting the exchange. NYSE spreads widen on cloudy days. When we control for this, the significance of the weather effect is dramatically reduced. We interpret this as evidence that the behavior of market-makers, rather that individual investors, may be responsible for the relation between returns and weather.

Weather Effect, Market Efficiency, Order Flow, Volatility, Individual Behavior

Abstract:
Using a complete set of the SEC filing information on hedge funds (Form ADV) and the TASS data, we develop a quantitative model called the ω-Score to measure hedge fund operational risk. The ω-Score is related to conflict of interest issues, concentrated ownership, and reduced leverage in the ADV data. With a statistical methodology, we further relate the ω-Score to readily available information such as fund performance, volatility, size, age, and fee structures. Finally, we demonstrate that while operational risk is more significant than financial risk in explaining fund failure, there is a significant and positive interaction between operational risk and financial risk. This is consistent with rogue trading anecdotes that suggest that fund failure associated with excessive risk taking occurs when operational controls and oversight are weak.

mutual funds, hedge funds, investments, the Omega Score

Abstract:
We examine the trades of individual and professional investors around stock splits and find that splits bring about a significant shift in investor clientele. We find that a higher fraction of post-split trades are made by less sophisticated investors, as individual investors increase and professional investors reduce their aggregate buying activity following stock splits. This behavior supports the common practitioners' belief that stock splits help attract new investors and improve stock liquidity. The shift in clientele also influences return properties, price discovery, and asset prices: stocks exhibit stronger serial correlation after splits; stocks co-move more with the market index; and the introduction of new investors explains part of the positive post-split drift puzzle.

Stock Splits, Clientele Change, Market Efficiency, Noise Trading, Investor Sophistication, Splits, Clientele Shift, Liquidity

Abstract:
Abstract: A variety of models have been proposed to explain the rise and
fall of stocks prices in the U.S. around the turn of the millennium. Many
models focus on behavioral explanations in which and investor beliefs
about their own capabilities and the efficiency of market prices play a role. In this paper we provide empirical evidence on these beliefs.

We surveyed a large sample of investors who bought stock in a telecommunications company at least once in the 1999-2000 period. We solicited their views on the efficiency of the stock market, and the basis for their personal trading decisions. A significant fraction appear to hold beliefs inconsistent with various implications of the efficient market hypothesis. Their motives for trade are based upon a belief in the value of fundamental research and a belief in the importance of past price trends. These investors on average believe that markets over-react to news announcements. Many admitted to buying stocks they believed at the time to be over-valued, but claimed to have done so on the anticipation that the share prices would continue to rise.

Abstract:
This paper documents twenty years of performance of commercial real estate in the U.S. using a portfolio of properties that comprise the widely followed NCREIF Property Index (NPI). We develop an extension of the repeated-measures regression to examine the magnitude and duration of the of the crash in property values in the early 1990's. We find that total returns based upon income and capital were -15% over a three year period beginning in 1990.

Abstract:
Recent research shows that emerging markets are distinguished by high returns and low covariances with global market factors. These are striking results because of their immediate implications for the international investor. One key issue is whether these results may be attributed to recent emergence. Most of today's emerging markets are actually re-emerging markets, i.e. markets that attracted international attention earlier in the century, and for various political, economic and institutional reasons experienced discontinuities in data sources. To analyze the effects of conditioning on recent emergence, we simulate a simple, general model of global markets in which markets are priced according to their exposure to a world factor; returns are only observed if the price level exceeds a threshold at the end of the observation period. The simulations reveal a number of new effects. In particular, we find that the brevity of a market history is related to the bias in annual returns as well as to the world beta. These patterns are confirmed by long-term histories of global capital markets and by recent empirical" evidence on emerging and submerged markets. Even though these results can also be explained by alternative theories, the common message is that basing investment decisions on the past performance of emerging markets is likely to lead to disappointing results.

Abstract:
Recent research shows that emerging markets are distinguished by high returns and low covariances with global market factors. These are striking results, because of their immediate implications for the international investor. One key issue is whether these results may be attributed to selection biases. In particular, we only observe markets that have "emerged," where emergence is typically conditioned upon recently exceeding a size threshold. We often do not have information about markets that "submerged" in the past, and then "re-emerged" recently. Most of today's emerging markets are actually re- emerging markets, but data before their last submergence is difficult to obtain. We simulate a simple, general model of global markets, in which markets are priced according to a world factor, but for which returns are only observed if the market capitalization exceeds a threshold at the end of the observation period. The simulations reveal that recently emerged markets display substantial biases in observed returns -- returns are too high. Conditioning upon recent emergence "picks out" markets with low betas. Turning to recent empirical evidence, we show that there are reasons to suspect conditioning biases. In particular, returns immediately after emergence are greater than later on, and than before emergence. We also report that the performance of less-followed submerged markets is typically inferior to that of emerged markets.

Abstract:
This study shows that U.S. individual investors hold under-diversified portfolios, where the level of under-diversification is greater among younger, low-income, less-educated, and less-sophisticated investors. The level of under-diversification is also correlated with investment choices that are consistent with over-confidence, trend-following behavior, and local bias. Furthermore, investors who over-weight stocks with higher volatility and higher skewness are less diversified. In contrast, there is little evidence that diversification is constrained by portfolio size or transaction costs. Under-diversification is costly to most investors, except for a small subset of investors who under-diversify because of superior information.

Individual investors, diversification, local bias, over-confidence, trend-following behavior

Abstract:
This study shows that U.S. individual investors hold under-diversified portfolios, where the level of under-diversification is greater among younger, low-income, less-educated, and less-sophisticated investors. The level of under-diversification is also correlated with investment choices that are consistent with over-confidence, trend-following behavior, and local bias. Furthermore, investors who over-weight stocks with higher volatility and higher skewness are less diversified. In contrast, there is little evidence that portfolio size or transaction costs constrains diversification. Under-diversification is costly to most investors, but a small subset of investors under-diversify because of superior information.

Individual investors, diversification, over-confidence, trend-following behavior, local bias.

Abstract:
In this paper, we estimate the behavioral component of the Grinblatt and Han (2002) model and derive several testable implications about the expected relationship between the preponderance of disposition-prone investors in a market and volume, volatility and stock returns. To do this, we use a large sample of individual accounts over a six-year period in the 1990's in order to identify investors who are subject to the disposition effect. We then use their trading behavior to construct behavioral factors. We show that when the fraction of irrational' investor purchases in a stock increases, the unexplained portion of the market price of the stock decreases. We further show that statistical exposure to a disposition factor explains cross-sectional differences in daily returns, controlling for a host of other factors and characteristics. The evidence is consistent with the hypothesis that trade between disposition-prone investors and their counter-parties impacts relative prices.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
In this paper, we estimate the behavioral component of the Grinblatt and Han (2002) model and derive several testable implications about the expected relationship between the preponderance of disposition - prone investors in a market and volume, volatility and stock returns. To do this, we use a large sample of individual accounts over a six-year period in the 1990's in order to identify investors who are subject to the disposition effect. We then use their trading behavior to construct behavioral factors. We show that when the fraction of "irrational" investor purchases in a stock increases, the unexplained portion of the market price of the stock decreases. We further show that statistical exposure to a disposition factor explains cross-sectional differences in daily returns, controlling for a host of other factors and characteristics. The evidence is consistent with the hypothesis that trade between disposition-prone investors and their counter-parties impact relative prices.

Abstract:
In this paper we simulate the performance of real estate portfolios using cash flows from commercial properties over the period 1977 Q4 through 2004 Q2. Our methodology differs from analyses that rely upon historical time-weighted rates of return on property. We relax implicit rebalancing and mark to market assumptions inherent in time-series analysis. We use the distribution of internal rates of return to analyze the performance distribution of commercial property investment. We examine the performance of real estate in the context of portfolios of stocks and bonds over the same period.

Asset Allocation, Real Estate

Abstract:
Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a sample of 444 due diligence (DD) reports from a major hedge fund DD firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%). Misrepresentation, the failure to use a major auditing firm, and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk. We find that DD reports are typically performed after positive performance and investor inflows. We control for potential bias due to this and other potential conditioning. An operational risk score based on information contained in the DD reports significantly predicts subsequent fund failure and statistical performance characteristics out of sample. Finally we find that observed operational risk characteristics do not appear to moderate fund flow.

Abstract:
Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a sample of 444 due diligence (DD) reports from a major hedge fund DD firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%). Misrepresentation, the failure to use a major auditing firm, and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk. We find that DD reports are typically performed after positive performance and investor inflows. We control for potential bias due to this and other potential conditioning. An operational risk score based on information contained in the DD reports significantly predicts subsequent fund failure and statistical performance characteristics out of sample. Finally we find that observed operational risk characteristics do not appear to moderate fund flow.

Hedge Funds, Operational Risk, Due Diligence

Abstract:
This paper addresses the bias associated with parametric measurement of timing skill based on monthly timer returns when timers can make daily timing decisions. Simulations suggest that the classic Henriksson-Merton parametric measure of timing skill is weak and biased downward when applied to the monthly returns of a daily timer. The paper proposes an adjustment that mitigates this problem without the need to collect daily timer returns. Four tests of timing skill, carried out on a sample of 558
mutual funds, show that very few funds exhibit statistically significant timing skill. More encompassing, the adjusted-FF3 test (based on the specification that incorporates both the proposed adjustment and the Fama-French three-factor model) is the least biased measure of timing skill among the four--it provides for a sharper inference regarding timing skill and helps mitigate biases associated with the choice of investment style.

Abstract:
Recent empirical evidence has suggested that the Japanese mutual fund industry has underperformed dramatically in the past two decades. Conjectured reasons for under performance range from tax-dilution effect to high fees, high turnover and poor asset management. In this paper, we show that this underperformance is largely due to tax-dilution effects and not necessarily due to poor management. Using a broad database of funds which includes investment trusts closed to new investment we show that once an instrument for the time-varying tax-dilution exposure is included in a factor model, there is little evidence of poor risk-adjusted performance. A style analysis of the industry demonstrates that managers appear to pursue tax-driven dynamic strategies.

Abstract:
We address the issue of how heterogeneity of trade among investors affects stock returns. We develop a model of the dispersion of opinion among investors that has implications for asset pricing. We test the relationship between dispersion of investor opinion and stock returns using a two-year panel of more than 91 thousand individual accounts in a S&P 500 index fund. We show that dispersion of opinion, proxied by the heterogeneity of trade among investor classes, explains part of the returns not accounted for by standard asset pricing factors. We show that the explanatory power of the dispersion of opinion increases at the very time when standard pricing models based on standard asset pricing factors fare worse.

Learning, Asset Pricing, Market Confidence, Behavioral Finance

Abstract:
In this paper we review evidence about the development of the Chinese capital markets over a crucial period in world market history, and place that development in the context of world financial markets at the time. Despite fundamental differences between China today and China 100 years ago, it is still important to consider the dangers of an imbalance between domestic and international investor markets, and the mismatch between domestic and foreign expectations about investor protection. The lessons of the last century suggest that China today should consider opening Chinese investor access to foreign capital markets in order to equilibrate the level of diversification between foreign and domestic investors. In addition, protection of domestic corporate investor rights is at least as important as protecting foreign investor rights.

This paper is available in English at: http://papers.ssrn.com/abstract=289139

Abstract:
Short-selling differs significantly around the world, and practice depends not only on regulatory structure but upon costs and tax considerations. Our survey of world markets suggests that, while as much as 93 percent of the world's equity market by capitalization is shortable, there are particular regions of the world where it is difficult to take a short position. These include several countries in Southeast Asia and South America. When dual listings in markets allowing short-sales are considered, the capitalization that is potentially shortable increases to 96 percent. In this paper, we examine what factors in the global equity universe are not shortable and consider the implications for long-short strategies tied to global indices and futures instruments. We find important periods when an index of non-shortable securities is a major determinant of the global equity portfolio. We ask whether short-sales constraints are binding on global index arbitrage.

Abstract:
Many scholars have asked whether British investors benefited from overseas investment investing in the 19th century and whether this export of capital had negative effects. We re-visit the issue using modern portfolio theory. We examine the set of investment opportunities available to British investors, the developments in information transmission technology, and advances in financial and investment theory at the time. We use mean-variance optimization techniques to take into account the risk and return characteristics of domestic and international investments available to a British investor, and to quantify the benefits from international diversification. Evidence suggests that capital export was a consequence of both the opportunity and the understanding of diversification. foreign assets offered higher rates of return, but equally important, they offered significant diversification benefits. Even when - by setting expected return on each foreign asset class equal to that of the corresponding UK asset class - we put foreign assets at a disadvantage, we find that it was rational for a British investor to include foreign debts and equity in the portfolio.

Abstract:
Many scholars have asked whether British investors benefited from overseas investment investing in the 19th century and whether this export of capital had negative effects. We re-visit the issue using modern portfolio theory. We examine the set of investment opportunities available to British investors, the developments in information transmission technology, and advances in financial and investment theory at the time. We use meanvariance optimization techniques to take into account the risk and return characteristics of domestic and international investments available to a British investor, and to quantify the benefits from international diversification. Evidence suggests that capital export was a consequence of both the opportunity and the understanding of diversification. Foreign assets offered higher rates of return, but equally important, they offered significant diversification benefits. Even when - by setting expected return on each foreign asset class equal to that of the corresponding UK asset class - we put foreign assets at a disadvantage, we find that it was rational for a British investor to include foreign debt and equity in the portfolio.

International Diversification, Modern Portfolio Theory, International Investment Flows, British Overseas Investment

Abstract:
This paper examines the emergence of corporate ownership in China from the final decades of the Qing empire in the late 19th century to the early Republican period in the 1910s and 1920s. By analyzing the actual process of incorporation, the development of the legal and financial environment, in particular the role of the state, we ask whether the top-down approach, in which the central government established a legal framework for corporate enterprise based on Western models and the assumption that it would work as it did for Western firms and markets, was a viable approach to the modernization of a financial system traditionally dominated by family businesses and economic state patronage. Using business records from turn-of-the-century Chinese corporate companies, this paper argues that the government's top-down approach, while clearly well-intentioned, created a framework which only insufficiently promoted the system of corporate capitalism in pre-war China.

Abstract:
This paper examines the pricing implications of time-variation in assets' market betas over the business cycle in a conditional CAPM framework. We use a half century of real GDP growth expectations from economists' surveys to determine forecasted economic states. This approach largely avoids the confounding effects of econometric forecasting model error. The expectation measure forecasts the market return controlling for existing predictive variables. The loadings on the expectation measure explain a significant fraction of cross-sectional variation in stock returns. A fully tradable, ex ante mimicking portfolio generates positive risk-adjusted returns during good economic times over four decades.

conditional CAPM, beta-instability risk, value and growth betas, time-varying premium, business cycle, Livingston Survey, investor expectations

Abstract:
Real estate is regarded as an inflation hedge, however the autocorrelation of property return indices and the autocorrelation of changes in the CPI pose serious problems of inference. In this paper we address these problems in two ways. First, we use robust methods to test of changes in the relationship between property returns and inflation. Second, we perform simulations of sample investment portfolios using vector autoregressions to study the ability of commercial and residential housing to hedge inflation. Despite the relatively short sample period available, we find that property is likely to hedge inflation well.

Real Estate, Finance, Investment

Abstract:
We use traded options on growth and value indices to test for clientele differences in risk preferences. Value investors appear to have exhibited a higher average level of risk aversion than growth investors for two different time periods in the late 1990's and early 2000's. We construct a model of time-varying clientele preferences that allows investors with different levels of risk-aversion to switch between investment styles conditional upon the evolution of returns and risk. The model makes predictions about the autocorrelations structure of measured risk parameters and also about the autocorrelation and cross-autocorrelation of fund flows by style. Empirical tests of the model provide evidence consistent with the existence of style switchers¿investors who move funds between growth and value securities. We construct trading strategies in the value and growth index options markets that effectively buy risk from one clientele and sell it to another. These strategies generated modest positive returns over the period of study.

Risk preferences, Risk aversion, Investor clienteles, Value and growth investing

Abstract:
History demonstrates that global capital markets can contract as well as expand. A long-term view of finance suggests that we should prepare for periodic segmentation as well as integration of markets in the 21st Century. Anti-capitalist ideologies have historically been the vectors of attack on the cross-border flow of capital, however the fundamental cause may actually be domestic hostility towards foreign ownership and control. The roots of the conflict between domestic interests and foreign investors may be inherent in global equilibrium models. In a frictionless capital market, foreigners will always own a greater proportion of a small economy's assets. By the same token, domestic investors in small economies will always seek to export most of their capital. This equilibrium is at odds with a stable condition of national ownership and control of assets.

Imperialism, International Finance, Diversification

Abstract:
We address the issue of how the heterogeneity of trade among investors affects stock returns. We model and test the relationship between dispersion of opinion, heterogeneity of trade and stock returns. The empirical investigation makes use of a two-year panel of more than 91 thousand individual accounts in an S&P 500 index mutual fund. We show that dispersion of opinion, proxied by the heterogeneity of trade among investors, explains part of the returns not accounted for by the fundamentals. We analytically and empirically show that the explanatory power of the dispersion of opinion increases at the very time when standard pricing models based on fundamentals fare worse.

Index Funds, Heterogeneity of Beliefs, Learning

Abstract:
This paper examines governance explanations for the discount of preferred shares to common shares in the Russian market. Conflicts between shareholder classes may help explain the discount. However, for this to be the sole explanation the estimated models suggest that the magnitude of future adverse shareholder events would have to be very high. Nevertheless, evidence of a common factor potentially related to governance seems evident in the data, implying that corporate control issues may at least be partially responsible for the observed preferred share discount.

Abstract:
Home ownership increases the incentive to maintain property and neighborhood, as well as decreasing the outflow of rents from low-income zones. However, these benefits are not costless to homeowners. With a mortgage comes the possibility of default, the financial demands of maintenance, a reduction in alternate investment opportunities, an increased exposure to fluctuations in local economic conditions, and a drastic reduction in the liquidity of personal wealth.

Recently, policy makers have sought to increase mortgage lending in traditionally underserved markets. In this paper we consider the effects of this policy in light of the risk and return of housing and the current tax treatment of the home mortgage deduction. We find housing to be a relatively poor asset class in which to invest the bulk of family wealth. Trends in housing suggest that a large percentage of homeowners who bought and sold within a five year horizon in the United States over the last twenty years lost money on the investment. Lowering the equity required to purchase a home does little to alleviate the problem. We show that the current tax code - if anything - encourages renting over buying and gentrification of low income housing markets.

If the government wishes to encourage home ownership among low income families despite the risks, then we argue that government agencies should share information about the risk and return of home ownership with its citizens. In addition, a direct subsidy through a tax credit may be both warranted and necessary to achieve the desired result.

Abstract:
This paper argues that econometric analysis of housing price indexes before 2006 generated forecasts of future long-term price growth and low estimated probabilities of extreme price decreases. These forecasts of future increases in home-loan collateral values may have affected both the demand and the supply of mortgages. Standard time series models using repeat-sales indices suggested that positive trends had a long half-life. Expectations based on such models supported expectations that could lead to an asset bubble. Analysis of data from the HMDA loan data base and LoanPerformance.com at the MSA level and at the loan level substantiates both supply and demand effects of past price trends in housing markets, particularly with respect to subprime mortgage applications and approvals. At the MSA level, past home price increases are associated with higher subprime applications and loan to value ratios. Approval probability of subprime loans was not affected by higher loan to value ratios. At the loan level, the approval probability of subprime applications is also positively associated with past home price appreciation. These results differ for prime mortgages.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper argues that econometric analysis of housing price indexes before 2006 generated forecasts of future long-term price growth and low estimated probabilities of extreme price decreases. These forecasts of future increases in home-loan collateral values may have affected both the demand and the supply of mortgages. Standard time series models using repeat-sales indices suggested that positive trends had a long half-life. Expectations based on such models supported expectations that could lead to an asset bubble. Analysis of data from the HMDA loan data base and LoanPerformance at the MSA level and at the loan level substantiates both supply and demand effects of past price trends in housing markets, particularly with respect to subprime mortgage applications and approvals. At the MSA level, past home price increases are associated with higher subprime applications and loan to value ratios. Approval probability of subprime loans was not affected by higher loan to value ratios. At the loan level, the approval probability of subprime applications is also positively associated with past home price appreciation. These results differ for prime mortgages.

Abstract:
Foreign investment management firms have recently started to play a major role in the investment trust business in Japan. In terms of assets under management, their size and market share have almost doubled in thepast several years. In part, the relative success of foreign managed firms inattracting market share may be attributed to the fact that Japanese investment trusts have underperformed benchmarks in quite a dramaticfashion over the past two decades. This is at best indirect evidence that Japanese funds under perform their foreign counterparts. In a recent paper (Brown, Goetzmann, Hiraki, Otsuki and Shiraishi 2001) we show that theunder performance can be attributed almost entirely to the unique tax environment of Japanese investment trusts, which had the effect of heavily penalizing early withdrawals. The relaxation of these regulations coincided with a major inflow of new money into the investment trust business. We examine the relative performance of Japanese and foreign investment management firms before and after this change in tax regulations, and find that the poor relative performance of Japanese funds from April 2000 through December 2001 may in part be attributed to the huge inflow of new moneyinto this sector and the style shifts made necessary to accommodate this flow.

Abstract:
Foreign investment management firms have recently started to play a major role in the investment trust business in Japan. In terms of assets under management, their size and market share have almost doubled in the past several years. In part, the relative success of foreign managed firms in attracting market share may be attributed to the fact that Japanese investment trusts have underperformed benchmarks in quite a dramatic fashion over the past two decades. This is at best indirect evidence that Japanese funds underperform their foreign counterparts. In a recent paper (Brown, Goetzmann, Hiraki, Otsuki and Shiraishi 2001) we show that the underperformance can be attributed almost entirely to the unique tax environment of Japanese investment trusts, which had the effect of heavily penalizing early withdrawals. The relaxation of these regulations coincided with a major inflow of new money into the investment trust business. We examine the relative performance of Japanese and foreign investment management firms before and after this change in tax regulations, and find that the poor relative performance of Japanese funds from April 2000 through December 2001 may in part be attributed to the huge inflow of new money into this sector and the style shifts made necessary to accommodate this flow.

Abstract:
This paper explores the feasibility of a government-sponsored insurance company, patterned after the government-sponsored mortgage agencies, that would be authorized to sell government-insured wage-indexed retirement annuities. This enterprise would assume the current obligations and cash flows of the social security system in exchange for the exclusive right to sell additional insurance contracts. It may or may not choose to finance itself through the issuance of equity shares. The empirical analysis in the paper focuses on the stochastic nature of the liabilities faced by such an agency and in particular examines the optimal portfolio of assets required to hedge wage-indexed liabilities.

Social Security, Wage Inedexation

Abstract:
There is a growing literature on the differential impact of "soft" vs. "hard" information on organizational structure and behavior. This study is an attempt to empirically quantify the value of soft information, using a data-base on the market for screenplays. Script quality is difficult to estimate without subjective evaluation. Therefore soft information should be an integral part of the pricing of these intellectual assets. In our empirical analysis, we find that "hard information" (reputation) variables as well as "soft information" proxies are priced. Screenplays with high soft information content are priced significantly lower than "high concept" "harder information" - type scripts. We also follow the screenplays to production, and find that buyers seem to be able to forecast the success of a script, paying more for screenplays resulting in more successful films. In other words, "high concept" (harder information) screenplays sell for more and result in more successful movies.

Abstract:
The first global financial bubble in stock prices occurred 1720 in Paris, London and the Netherlands. Explanations for these linked bubbles primarily focus on the irrationality of investor speculation and the corresponding stock price behavior of two large firms: the South Sea Company in Great Britain and the Mississippi Company in France. In this paper we examine a broad cross�section of security price data to evaluate the causes of the bubbles. Using newly collected stock prices for British and Dutch firms in 1720, we find evidence against indiscriminate irrational exuberance and evidence in favor of speculation about two factors: the Atlantic trade and the incorporation of insurance companies. We study the role of innovation in the insurance market by examining market betas and volatilities of new insurance company shares, like (Pastor & Veronesi, Technological Revolutions and Stock Prices, 2009). We find strong evidence for a revolution in the insurance business in 1720. Our findings are consistent with the hypothesis that financial bubbles require a plausible story to justify investor optimism.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
The first global financial bubble in stock prices occurred 1720 in Paris, London and the Netherlands. Explanations for these linked bubbles primarily focus on the irrationality of investor speculation and the corresponding stock price behavior of two large firms: the South Sea Company in Great Britain and the Mississippi Company in France. In this paper we examine a broad cross‐section of security price data to evaluate the causes of the bubbles. Using newly collected stock prices for British and Dutch firms in 1720, we find evidence against indiscriminate irrational exuberance and evidence in favor of speculation about two factors: the Atlantic trade and the incorporation of insurance companies. We study the role of innovation in the insurance market by examining market betas and volatilities of new insurance company shares, like (Pastor & Veronesi, Technological Revolutions and Stock Prices, 2009). We find strong evidence for a revolution in the insurance business in 1720. Our findings are consistent with the hypothesis that financial bubbles require a plausible story to justify investor optimism.

Abstract:
We develop a method for classification of works of art based on their price dynamics. The method is in the same spirit a factor models commonly used within financial economics. Factor models assume that price dynamics of assets are related to underlying fundamental characteristics. We assume that such characteristics exist for works of art, and that they are associated with what we intuitively think of as style. We use a recently developed clustering algorithm to group artists that represent similar styles. This algorithm is specifically well-suited for situations where statistical distributions are far from normal - A description we believe fits well with markets for art. We test the method empirically on a ten-year sample of price data for paintings by 58 artists. Even with this limited data set, we clearly identify five groups and show that these are related to a standard classification of style.