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Costello College of Business finance professor receives coveted NSF early-career award

Greg Johnson — Thu, 22 Feb 2024 15:43:13 +0000

Costello College of Business finance professor receives coveted NSF early-career award Greg Johnson Thu, 02/22/2024 - 10:43

Jiasun Li, a recently promoted associate professor of finance at the Costello College of Business at ��AV, has received a prestigious CAREER award from the National Science Foundation (NSF).

Jiasun Li

According to the NSF website, the CAREER award is given to “early-career faculty who have the potential to serve as academic role models in research and education and to lead advances in the mission of their department or organization.”

The award totals $711,679 over five years. It will support Li’s ongoing research into the organization of digital services with the rise of emerging technologies.

This project jumps off from recent developments in cloud and decentralized computing. Both technologies present radical new possibilities for off-premise digital services, as evidenced by the rise of numerous cloud service providers as well as blockchain platforms.

However, the presence of strategic incentives may undermine the smooth and reliable functioning of such systems. For example, cloud providers may opt to short-charge clients when it comes to the provision of services, if it is in their best interests to do so. Alternatively, strategic actors may also disrupt the consensus protocols governing decentralized systems.

Li proposes to tackle these problems in an interdisciplinary manner, blending tools from computer science (as the topic is inherently about digital services) and economics (since incentive analysis traditionally falls in the domain of economics). He has finely honed this approach in a series of papers applying analytical models based on economic principles to decentralized systems such as blockchain proof-of-work technologies.

The ultimate goal of Li’s project, as stated in his NSF proposal, is to “guide the efficient organization of digital services for productivity gains, and thus enhance the economic competitiveness of the United States.”

Previously, Li received individual and collaborative grants from Mason’s Multidisciplinary Research Initiative, the U.S. Department of Homeland Security, and the Ethereum Foundation, among others. He was recently named an inaugural Faculty Fellow of Mason’s Institute for Digital Innovation (IDIA).

“I am extremely honored to receive an NSF CAREER Award because such grants are traditionally rare in business schools," said Li. "I really appreciate the trust NSF bestowed on me. This recognition is only possible thanks to the tremendous support and many forward-looking initiatives from Mason and the Costello College of Business, as well as many colleagues across different disciplines who have inspired, guided, and elevated me over the years. I look forward to carrying out the interdisciplinary research projects under the continued support from NSF and the University/Costello College of Business.”

Ajay Vinzé, dean of the Costello College of Business, said, “This prestigious award from NSF is a fitting recognition of Jiasun’s superb/impactful research record and a proud moment for Costello College of Business--Congratulations Jiasun! As the evolution of the digital economy plays out, research like Jiasun’s project is going to provide relevant and actionable insights. I look forward with great excitement to contributions that are forthcoming.”

More Costello College of Business Faculty Research

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Ajay Vinzé

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Four stop signs at intersections are one too many, suggests Mason researcher

Jennifer Anzaldi — Wed, 19 Oct 2022 14:18:05 +0000

Four stop signs at intersections are one too many, suggests Mason researcher Jennifer Anzaldi Wed, 10/19/2022 - 10:18

In This Story

For most drivers in the United States, obeying a stop sign upon approaching an intersection is an unavoidable annoyance. But for ��AV Finance Professor Jiasun Li, it’s a problem waiting to be solved.

His recent working paper proposes a simple and economical improvement: removing one stop sign from every four-way intersection. According to his calculations, this would boost not only driver safety, but environmental sustainability as well.

Li specializes in game theory, which models strategic interactions where rational agents seek – as humans generally do–to optimize outcomes for themselves. As he drove around Fairfax, Virginia, Li could not help but view four-way intersections through this academic lens.

He was struck by the suspicion that having four stop signs at an intersection was a flawed way of preventing traffic accidents. In effect, they lowered the potential cost of not stopping at the intersection, because drivers could assume that motorists from other directions, should there be any, would come to a stop. Drivers turning right, a shallower maneuver with less exposure to oncoming traffic, have the least risk to begin with and would have the greatest incentive to ignore the sign.

Li surmised that the outcome of all drivers obeying the sign fell short of a Nash equilibrium–game theory’s term for a stable set of norms that all parties are incentivized to follow.

His working paper presents mathematical models that support his intuition. Comparing the risks of collision against the gains from ignoring the sign (i.e. a smooth driving experience or conserving gasoline), he finds that a symmetric equilibrium under the current four-sign mechanism to be one in which left-turners and straight-line travellers honor the stop sign but right-turners do not.

In real life, of course, fear of getting slapped with a moving violation increases the likelihood of compliance with stop signs. But the need for law enforcement is less than ideal, Li says. If the four-way stop system were self-enforcing, expensive police resources could be directed toward serious crimes and away from preventive punishment for traffic violators.

Li’s working paper first considers what would happen if traffic laws were changed to allow right-turners to run the stop sign legally. In an intersection with four stop signs, this would indeed prevent accidents. However, many U.S. intersections have only two signs, which would place right-turners at risk of colliding with traffic coming from the left. In addition, Li argues that old habits die hard, including behind the wheel.

“If you need people to change their behavior, that’s going to be difficult,” he says.

Instead, Li recommends removing one sign–any sign–from among the four. In that case, drivers would know that running a stop sign could send them straight into the path of an oncoming car that has not been directed to stop. The universal fear would incentivize compliance without relying on the threat of police punishment. “Importantly, although the safety and incentive analysis rely on game theoretical reasoning, once implemented, a three-sign mechanism does not require any changes in behaviors for law-abiding drivers,” Li says.

Further, Li’s back-of-the-envelope math suggests that his relatively mundane change could be surprisingly impactful. Based on official statistics from various U.S. authorities, he estimates there are about one million four-way intersections with stop signs in the U.S., each one being traversed by more than 760,000 vehicles per year. That amounts to more than 760 billion (760,000 x one million) stops and starts in a year, one-fourth of which (190 billion) would be avoided in a three-sign setup.

According to Li’s calculations, assuming it takes 124.9 kilojoules of work to bring a car of average weight to a full stop, and the same amount to resume the previous level of speed, adopting a three-sign system would save a total of 118.65 trillion kJ in the U.S. per year. That equates to one billion gallons of gasoline, or about 2.7 days’ worth of national gas consumption.

Looking farther out on the technological horizon, Li speculates in the paper that “when self-driving cars finally become real, our new simpler mechanism may also economize AI computational costs.”

Li has no illusions about the resistance his recommendation may provoke. “You’re challenging people’s conventional wisdom. If there’s criticism, that’s to be expected. For example, some cops might not like this idea, because I’m taking away one of their income sources, even though there could be an overall gain to the whole society.”

This paper is only one manifestation of what Li sees as a scholarly mission to apply novel perspectives – in this case, an economics viewpoint derived from game theory – to real-world problems, especially those that have been taken for granted for so long that they are not even recognized as problems.

“Economics thinking should be applicable to a lot of different fields and improve our daily lives,” Li explains.

What seems totally natural in one context, after all, may be foreign in another. Many countries–including China, where Li was born–don’t use four-way stop intersections. “If I grew up with these stop signs, I probably wouldn’t think about it,” he says. This is an example, Li suggests, of how diverse experiences and ideas imported via immigration can enrich host nations. Far from wanting the last word on the issue, Li is hoping to inspire wide-ranging conversation about how to change environments and communities for the better.

“I would rather have the discussion ongoing and people give me ideas,” he says. “Only through debate will people understand it better.”

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Beyond the business case for Corporate Social Responsibility

Jennifer Anzaldi — Wed, 12 Oct 2022 12:25:31 +0000

Beyond the business case for Corporate Social Responsibility Jennifer Anzaldi Wed, 10/12/2022 - 08:25

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Lei Gao

Corporate social responsibility (CSR) has been on the business leadership agenda for more than 50 years, yet executives and corporate boards still demand to see the “business case” for CSR. Clearly, CSR’s familiarity as a concept has not translated into coherent ideas of where it fits into the cost-benefit calculations that motivate business strategy.

A forthcoming article in the Journal of Financial and Quantitative Analysis by Lei Gao, associate professor of finance at ��AV School of Business, Jie (Jack) He (of University of Georgia) and Juan (Julie) Wu (of University of Nebraska – Lincoln) goes beyond the business case to form cause-and-effect connections involving companies’ CSR efforts. Gao and his co-authors found that companies under negative share-price pressure have used CSR to telegraph their strong fundamentals to investors, a tactic that paid off in the marketplace. The researchers homed in on real-life scenarios where companies randomly received tougher treatment in equities markets, so that price pressure could be cleanly separated from business fundamentals. They chose to look at the arbitrarily selected pilot group of companies affected by Regulation SHO, an SEC rule that abolished the “uptick rule” for short selling – thereby potentially making these companies more attractive targets. As an additional setting, they studied companies exposed to downward pricing pressure due to mutual fund fire sales.

The companies that suffered through these forms of arbitrary adversity exhibited higher-than-average levels of CSR activity, as reflected in the MSCI KLD Stats Database. KLD reports on individual companies’ strengths and weaknesses across seven areas, including employee relations, the natural environment, and human rights. To ensure accuracy, the KLD scores were double-checked against Thomson Reuters ASSET4, a leading CSR data provider for thousands of global companies.

Gao explains that when companies are randomly swept up in forces beyond their control (such as new regulations and asset fire sales) that throw their market value into doubt, executives try to send countersignals that reflect positively on company fundamentals. And if these countersignals can help the company connect with an entirely new category of well-informed investors, so much the better.

“If I want to show I’m a better company than peers, I can do a special dividend, or a share repurchase. This is a kind of signalling that is very direct and expensive, and only reaches existing shareholders,” Gao says. “CSR is basically kind of broadcasting to so many different kinds of stakeholders, including environmentally and socially aware investors.”

These messages seemed to reach their intended targets. The researchers found that in both the Regulation SHO and mutual fund fire sale settings, socially responsible institutional investors increased their holdings of price-pressured companies that stepped up their CSR signalling.

Enlarged positions from this investor class was a main contributor to an overall decline in cost of equity capital for CSR-signalling companies. In the case of the Regulation SHO pilot stocks, capital cost declined by around 50-60 basis points, compared to non-CSR-signallers and non-pilot stocks.

CSR initiatives, then, help firms with strong fundamentals distinguish themselves from others undergoing similar pricing pressures. But that doesn’t mean CSR can be used as a smokescreen for badly run businesses, or a cynical short-term evasion.

“Companies should keep in mind that it’s not a one-and-done,” Gao says. “You have to keep working to keep these investors happy once you’ve won them over…Signalling is not cheap talk or a rumor. This is something they have committed to. They have the resources to do so, and they believe it will benefit them in the long run.”

The companies in Gao’s sample were highly incentivized to undertake CSR signalling. But the tactic would presumably work for strong companies in general, regardless of pricing pressures. When it comes to CSR, therefore, “business case” thinking may be backward. Instead of pursuing a short-term upside, well-run companies may consider CSR engagement as a way toward claiming their proper status – and the rewards that go with it – in the eyes of investors. To put it another way: Rather than vegetables swallowed down dutifully, CSR could represent the icing on the cake of success.

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The distress anomaly: Where finance theory breaks down

Jennifer Anzaldi — Thu, 22 Sep 2022 13:54:03 +0000

The distress anomaly: Where finance theory breaks down Jennifer Anzaldi Thu, 09/22/2022 - 09:54

In This Story

Alexander Philipov

Exceptions may prove the rule, but they must first be explained. That is why finance researchers are drawn to the distress anomaly-- a well-documented phenomenon that challenges the risk-return paradigm in equity markets. Generally, higher-risk investments are expected to yield higher returns than safer, more stable securities. In recent years, however, studies have shown that high-credit-risk securities for companies in distress – i.e. when their already-low credit rating is being downgraded -- realize abnormally low returns compared to non-distressed securities of the same or lower risk.

��AV have proposed a range of rationales for this puzzle. Alexander Philipov, finance area chair and associate professor at ��AV, says they mainly fall into two categories. One is risk-based, stating that the pattern could be explained by time-varying risk (e.g. having low risk in bad times), or by hidden value transfers during bankruptcy, when equity holders could extract value from other stakeholders. The other rationales look at possible investor biases, such as investors having lottery type preferences and chasing after sky-high returns in an unlikely recovery from distress. Other psychological biases, such as tendencies to hold on to losing stocks in the hope they would turn around may also be at play. These biases would be exhibited by retail investors while institutional investors are not likely susceptible to them. As yet, there is no consensus among academics on which rationales, if any, get closest to the truth of the distress anomaly.

Philipov’s recent paper in Review of Finance[1] is the first to show that the distress anomaly extends to corporate bonds. In addition, the anomaly is associated with potentially severe implications for the real economy. The researchers documented this by comparing the stock and bond portfolios of distressed firms with those of other portfolios.

Corporate bonds help evaluate existing rationales because their payoff structure, liquidity, and investor base are different from those of stocks. The study shows that existing rationales for the distress anomaly are inconsistent with the return patterns of corporate bonds. Specifically, rationales involving value transfers from bondholders to stockholders are inconsistent with the data showing that both bonds and stocks of distressed firms are similarly overpriced. Furthermore, the anomaly is more pronounced in market downturns, as is the distressed stocks and bonds’ risk—evidence against the time-varying risk story.

The study also finds the distress anomaly implies real distortions in the real economy because corporate decisions are undertaken based on incorrect asset prices. These suboptimal decisions may include excess investments, and over issuance of debt and equity. “We provide suggestive evidence that real distortions are not only economically significant but also severely understated if measured based on equity mispricing alone (as in previous studies). Adding bonds brings new light to the magnitude of these distortions,” says Philipov.

Based on the new bond evidence, the most coherent rationale for the distress anomaly appears to be underreaction to financial distress, even by the most sophisticated investors. The researchers conclude that the distress anomaly is an unresolved puzzle, deeper than previously thought.

Philipov suggests that future research on the distress risk anomaly may focus on alternative ways of measuring risk or on new advances in behavioral finance, such as cumulative prospect theory which focuses on how investors under- or overestimate probabilities. Clues may also lie in the investment strategies of smart market actors. “If there are many investors with biases, especially biases that you could possibly predict, you should be able to find market players which are exploiting these biases,” Philipov says. Lack of evidence of such profit-taking activity may imply that trading frictions may be too high to take advantage of pricing misalignments. Yet another promising research strategy could be to look beyond the data, into what really goes on behind the scenes at distressed companies. “Maybe what those public investors are losing, there are some players that are gaining from it,” Philipov says. “But we’re not able to observe that.”

He further suggests that interdisciplinary work may be able to tackle questions such as, “Do distressed companies advertise more or less? Do they allocate less for research? What do their operations look like? Are they trying to apply new management techniques or are they quickly losing talent?”

��AV are drawn to find explanations to market phenomena like the distress anomaly where theory breaks down. “We should be trying to explain what’s going on, because that’s where you get new insights: studying corners where things aren’t working as general theory dictates,” Philipov says.

[1] Co-authored by Doron Avramov of ISC Herzliya, Tarun Chrodia of Emory University and Gergana Jostova of George Washington University.

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Impact Fall 2023

Unpacking the Graphic Content of Annual Reports

Jennifer Anzaldi — Thu, 28 Apr 2022 14:46:07 +0000

Unpacking the Graphic Content of Annual Reports Jennifer Anzaldi Thu, 04/28/2022 - 10:46

In This Story

Lei Gao

Bo Hu

Lei Gao and Bo Hu

Viewed one way, the corporate annual report is redundant, merely repeating information in publicly available 10-K filings, as well as on Bloomberg, Yahoo! Finance, etc. Still, most companies that issue stock publish annual reports for the general public, despite the SEC not requiring them to do so.

Part of the reason may be that with the annual report, companies are in complete control of the presentation. They can use graphic elements to capture and direct investor attention. Visuals can also convey suggestive messages that, though non-explicit, can exert subtle influence. Color choices, for example, carry emotional associations that can transfer over to the firm; pleasant or exciting illustrations can affect how readers interpret information. These graphic effects can help managers hint at hidden strengths or intangible assets not yet reflected in the firm’s financials.

According to a recent working paper co-authored by Mason finance professors Lei Gao and Bo Hu, more than 80 percent of U.S. public firms use graphics in their annual reports. Further, visual presentation has market benefits as well as aesthetic ones.

Lei and Bo, and their co-authors Wesley Deng of University of New South Wales and Guofu Zhou of Washington University in St. Louis, analyzed the annual reports of 1,322 companies from 1994-2019 alongside their financial performance. They focused particularly on reports that, from one year to the next, exhibited a sudden increase in “graphicity”—a construct invented by the researchers to measure the ratio of visual to verbal information contained in a report. Graphicity was calculated with the help of a machine learning algorithm capable of detecting, among other things, the relative size, color, and number of graphic elements in a document.

The researchers discovered that firms that went in a more graphical direction received an average abnormal return of 3.5 percent over the three-to-six-month period following the release of their report. The bump in stock returns could not be explained through other characteristics such as institutional ownership, analyst coverage and short selling constraints.

The three-to-six-month delay represents the time it takes for the subtle information in graphic reports to permeate the market. “Numbers can be picked up in no time by algorithms and factored into the stock price,” Lei said. “But graphic information takes time to consume, it’s harder to pick up this kind of information.”

The researchers also looked at the firms’ business activities to determine whether going graphic could be construed as signaling an intention. They found a pattern of increased R&D investment in the three years following a pivot to visual communications in the annual report.

“An optimistic take on this correlation would be that firms are using visuals to telegraph their soon-to-be-realized potential to investors,” Bo said. In other words, graphicity could function as a kind of “Watch out, here I come” announcement to the market. Visual cues can also give a non-specific sense of what’s being planned in terms of innovation and tech adoption. For example, a manufacturing firm can display its aspirations through an image of a futuristic factory.

On the other hand, graphicity can sometimes be misleading. “Not every R&D initiative will be value-adding,” Lei reminds us. Firms could be using images to paint a risky investment with a rosier tint. “These firms are doing something serious, but it’s hard to deliver. They might face more uncertainty. So, they use soft information to make claims, because if you put in hard numbers you’re liable for the risks.”

Lei and Bo say that theirs is the first paper to quantify the market impact of the tacit messaging conveyed by the graphic design of annual reports. Their findings imply that regulators should perhaps pay attention, since the visual content of corporate documents are absorbed by investors as information, not decoration. Moreover, the signals embedded within visual cues are not wholly ambiguous but consistently predictive of future firm activity, i.e. R&D investment. You could say that high-graphicity reports are communicating with investors on two dimensions at once— visual and verbal—while regulators now are probably concerned only with the latter.

If the government were to monitor the graphic content of annual reports, Lei and Bo’s methodology gives some clues about how it might be done fairly and with minimal human labor. Primed with a construct such as graphicity, an algorithm could crawl through annual reports (usually found within the “Investor Relations” section of a corporate website) and trigger an alert whenever it spotted abrupt and sizeable shifts—50 percent was the threshold the researchers used—from verbal to visual presentation.

“Consistent with our model, this work provides evidence of a new anomaly in financial markets,” Bo said. “If it is not recognized, it must be novel and needs more attention from market participants.”

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Mapping Blockchain's Frontiers

Kiel Stone — Tue, 15 Feb 2022 17:39:10 +0000

Mapping Blockchain's Frontiers Kiel Stone Tue, 02/15/2022 - 12:39

In This Story

Let’s unpack the portmanteau word “cryptocurrency.” The combination of two unlikely bedfellows—cryptography, a subfield of computer science, and currency, a topic in economics—is at the heart of the transformative potential of its underlying blockchain technology. But the uniqueness of the pairing can make it very difficult for research professionals in either field to predict, let alone positively influence, blockchain’s future development.

Jiasun Li, an assistant professor of finance at Mason, is among an elite group of academics who are bridging the divide by merging relevant concepts from computer science with game theory—a subfield of economics that studies the interactions of decisions made by interdependent economic actors.

Jiasun Li

“Learning from the interaction between both economics and computer science is going to be very fruitful,” Li says. “People working in crypto already know this. The problem is that there are very few people well-versed in both fields; economists don’t understand what computer scientists are talking about, and vice versa. Part of my value-add as a researcher is that I can interpret between them.”

For example, in a 2021 Review of Financial Studies article (co-authored by Lin William Cong of Cornell University and Zhiguo He of University of Chicago), Li looked into whether the phenomenal growth of Bitcoin mining pools would lead to dangerous centralization over time—a possibility concerning to many practitioners. If too much activity were concentrated within one or a few pools, it might undermine the purpose of a decentralized system.

As Li’s game-theoretical models demonstrate, however, the very force driving miners to form pools—i.e. the desire to stabilize mining income via risk sharing with peer miners—acts as a drag on centralization. Optimal risk-sharing strategies for an individual miner would include distributing computing powers across multiple pools, rather than putting all their eggs in one basket. A large pool will optimally charge a higher percentage fee, so it tends to grow more slowly as miners choose to reallocate their computing power to different pools. Therefore, Bitcoin mining has a certain degree of built-in resistance to monopoly.

Li's working paper with co-author William Mann (of Emory University) has significant policy implications for initial coin offerings (ICOs) and digital tokens. Tokenization is widely considered to be the capitalization engine of many blockchain projects, yet regulators are divided on how to treat tokens. Are they securities like any other, and thus subject to existing laws such as the Securities Act of 1933?

Li’s model, incorporating a concept from game theory called forward induction, shows that purchasing a platform-specific token can signal future intention to adopt the platform, in addition to potentially supplying capital in the here and now. For example, purchasers of the FIL token can be reasoned to be future users of Filecoin’s “decentralized storage” services, which in turn motivates potential storage providers to contribute. The token serves as both a medium of exchange and a coordination tool for building—and binding together—both sides of the platform. Therefore, the researchers suggest that tokens that do both deserve their own regulatory category.

The above dynamic

presumes a token with little or no worth outside the originating platform. As the off-platform value of the token rises, its coordinating power drops because the temptation to cash in their chips becomes stronger for token holders. Therefore, the authors also recommend that entrepreneurs who seek to build successful platforms curtail token holders’ ability to engage in speculation, e.g. by offering separate security and utility tokens rather than issuing only one type of token.

Li’s most recent paper employing game theory (co-authored by Hanna Halaburda of New York University and Zhiguo He) examines the economic incentives involved when nodes within a blockchain form consensus. How well this consensus formation process works is a critical issue for blockchain systems. For example, in the application of cryptocurrencies, transaction histories must remain the same across blockchain nodes in order for the system to remain reliable. Furthermore, blockchains must have a way of reaching consensus even if some nodes do not work properly (for example, in cases of some nodes malfunctioning or being hacked).

Over decades, computer scientists have developed “Byzantine fault tolerance” (BFT) protocols to work around compromised, or “Byzantine” nodes and obtain consensus. These protocols are now widely used by almost all major tech companies for their in-house services. The permissionless nature of many blockchains, however, distinguishes them from those existing in-house applications. Since they don’t fall under one organizational umbrella, nodes in a blockchain may develop an adversarial relationship due to misaligned incentives. Hence, protocol designers must carefully specify the payoffs and penalties each node derives from successful or failed consensus. Enriching prior BFT research, Li’s game-theoretical model in this paper shows that there are many equilibria within such systems (an equilibrium of a game specifies a set of strategies by all nodes so that each does what is optimal for itself).

For example, there is always an equilibrium in which nodes fail to commit to anything at all. The model provides a framework to further analyze alternative versions of BFT protocols with explicit account of economic incentives.

Game theory is a valuable tool because it enables Li to model the “action space” of a decentralized system like in a blockchain and thus start to make sense of how it works. From there, academics can theorize about the answers to critical questions about this emerging technology.

Sources: Lin William Cong, Zhiguo He, Jiasun Li (2021). “Decentralized mining in centralized pools,” Review of Financial Studies

Jiasun Li, William Mann (2020). “Digital tokens and platform building,” working paper.

Hanna Halaburda, Zhiguo He, Jiasun Li (2021). “An economic model of consensus on distributed ledgers,” working paper.

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Even Smart Investors Get the Rainy Day Blues

Marianne Klinker — Tue, 07 Dec 2021 16:24:59 +0000

Even Smart Investors Get the Rainy Day Blues Marianne Klinker Tue, 12/07/2021 - 11:24

In This Story

Lin Sun

Because of their power and influence in financial markets, large institutional investors are often presumed to be cut from a different cloth than your average retail trader. But Lin Sun, an assistant professor of finance at the ��AV School of Business, has uncovered that even top investors share a very human weakness– their professional acumen can be thrown off by inclement weather. This weather-sensitivity may have strong implications for pricing.

Lin Sun

Her recent paper for Journal of Corporate Finance (co-authored with Danling Jiang of Stony Brook University and Southwest Jiaotong University, China, and Dylan Norris of Troy University) studies institutional investors’ response to earnings announcements over a 26-year period (1990-2016). The data encompassed more than 133,000 firm-announcement observations. For each firm-announcement in the study, the researchers identified the firm’s top ten largest institutional investors, and the prevailing local weather conditions at these investors’ headquarter cities (adjusted by seasonal norms) over the two weeks prior to announcement.

When a firm’s major institutional investors collectively experienced significantly worse weather conditions (wind, rain, snow, etc.) than usual, the stock market was slower to respond to earnings announcements that deviated from analyst forecasts in either direction – positively or negatively. This amounted to an approximate ten percent reduction in the range of immediate response, compared to normal-weather announcements. The delayed immediate reaction was corrected over the following months, producing a higher-than-average post-announcement price drift (otherwise known as the PEAD effect).

For firms as a whole, regardless of whether their actual earnings matched analyst forecasts or not, bad-weather institutional investors gave a higher price discount during the pre-announcement period. Once the earnings were announced, there was a correction, resulting in higher average returns during the announcement period.

Generally, firms earn higher returns during announcement months than non-announcement months – finance scholars call the phenomenon earnings announcement premium. But this effect is magnified when a firm’s top institutional investors experience adverse weather pre-announcement. A one-standard-deviation increase in cloud cover in the weeks prior to announcement was associated with a boost in earnings announcement premium of as much as 90%, according to the researchers’ estimates.

If you keep in mind what bad weather looks and feels like, these results aren’t hard to understand. Conditions such as unseasonable cold snaps, washed-out weekends and sunless skies that last for days on end produce a malaise that weighs on our minds, limiting our attention to work. Practical inconveniences such as longer commutes, residential damage and physical discomfort may worsen the distraction.

For institutional investors, bad weather may dull ordinarily sharp market reflexes. When surprising earnings announcements come through, it takes more time for them to register a proportional response. Hence the muted reaction immediately after the announcement, and the heightened drift later on as the magnitude of the news pierces through their mental fog.

Bad weather is also an insistent reminder of what we cannot control. Portfolio managers may hold significant sway on Wall Street, but have no power over the sun or wind. The sense of being out of control creates a heightened feeling of anxiety and uncertainty aversion. In this nervous state of mind, investors may discount shares of firms in the suspenseful period preceding the earnings announcement, for which they compensate once the uncertainty has been resolved – hence, the higher earnings announcement premium.

Past research in behavioral finance has shown that equity markets as a whole are subject to weather effects. For example, a 1993 paper found that cloudy weather in New York City had a significant depressive effect on daily Dow Jones returns. A subsequent study found the same for 26 global stock exchanges, including Singapore, London, Paris and Rio de Janeiro.

Sun’s paper adds needed clarity and specificity to this growing body of literature. It shows that weather-based biases are not confined to amateur participants such as retail investors – even professionals (such as institutional investors) let the rainy day blues get to them. Similarly, a 2017 paper focused on equity analysts – another highly influential group of participants – also identified delayed reaction to earnings announcements associated with unpleasant weather.

It may be that no amount of education, experience or market savvy will wholly insulate stock pricing from uncontrollable events in the surrounding environment. Other examples of such events may include natural disasters, political crises and, of course, pandemics – to say nothing of the mercurial weather driven by the advancing impact of climate change. Metaphorically speaking, the skies are rarely bright, blue, and untroubled for long in our increasingly unpredictable world.

In this context, there simply may not be as great a difference, in terms of susceptibility to bias, between retail and institutional investors as is commonly thought. But because institutional investors manage much larger assets than typical retail investors, it means much more for the market when their trading behaviors are subject to moods or biases, based on bad weather or other conditions.

Source: Danling Jiang, Dylan Norris and Lin Sun (2021). “Weather, institutional investors and earnings news,” Journal of Corporate Finance

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Determinants of International Buyout Investments

Marianne Klinker — Fri, 03 Dec 2021 19:49:50 +0000

Determinants of International Buyout Investments Marianne Klinker Fri, 12/03/2021 - 14:49

New research by Serdar Aldatmaz, assistant professor of finance, benefits organizations that are seeking to move operations overseas. In an attempt to better understand global capital formation today and in coming years, Aldatmaz, together with Greg W. Brown from the University of North Carolina at Chapel Hill and Asli Demirguc-Kunt from the World Bank, researched buyout investments across 61 countries and 19 industries over the period of 1990 – 2017.

Serdar Aldatmaz

“We found evidence that macro-economic conditions, development of stock and credit markets, and the regulatory environment in a country are all important drivers of international buyout capital flows,” says Aldatmaz. The team found evidence that countries receive more buyout investment following reductions in unemployment and expansions in stock market activity as well as following regulatory reforms related to better contract enforcement and investor protection.

Aldatmaz has been interested in studying the implications of private equity for the real economy for many years. He says the changing nature of capital markets in the United States and other major economies in recent years, including a trend toward more global private equity investment, motivated the team to study the factors that determine international private equity investments.

With this research, the team can provide forecasts on which countries may receive more buyout investment in coming years based on their models. “Given what we know about the positive implications of private equity investments on industry operations and growth, our predictions might be useful for business leaders and organizations that are considering expanding operations overseas,” says Aldatmaz.

“Based on our models, we expect countries like China, Argentina, New Zealand, and Austria to receive more buyout investment in coming years, while countries like Poland, Qatar, and Philippines are likely saturated (or even over-allocated) with buyout investment currently.”

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Examining the Untapped Potential of Blockchain Technology

Marianne Klinker — Tue, 16 Nov 2021 20:47:36 +0000

Examining the Untapped Potential of Blockchain Technology Marianne Klinker Tue, 11/16/2021 - 15:47

In This Story