Recent empirical studies of mutual fund competition examine the relation between a fund’s performance, the fund manager’s compensation, and the fund manager’s choice of portfolio risk. This paper models a manager’s portfolio choice for compensation rules that can be either a concave, linear, or convex function of the fund’s performance relative to that of a benchmark. For particular compensation structures, a manager increases the fund’s “tracking error” volatility as its relative performance declines. However, declining performance does not necessarily lead the manager to raise the volatility of the fund’s return. The paper presents nonparametric and parametric tests of the relation between mutual fund performance and risk taking for more than 6,000 equity mutual funds over the 1962 to 2006 period. There is a tendency for mutual funds to increase the standard deviation of tracking errors, but not the standard deviation of returns, as their performance declines. This risk-shifting behavior appears more common for funds whose managers have longer tenures.

It has been hypothesized that momentum might be rationally explained as a consequence of the cross-sectional variation of unconditional expected returns. Stocks with relatively high unconditional expected returns will on average outperform in both the portfolio formation period and in the subsequent holding period. We evaluate this explanation by first removing unconditional expected returns for each stock from raw returns and then testing for momentum in the resulting series. We measure the unconditional expected return on each stock as its mean return in the whole sample period. We find momentum effects vanish in demeaned returns.

Recent theoretical models derive return continuation in a setting where investors have heterogeneous beliefs or receive heterogeneous information. This paper tests the link between heterogeneity of beliefs and return continuation in the cross-section of U.S. stock returns. Heterogeneity of beliefs about a firm’s fundamentals is measured by the dispersion in analyst forecasts of earnings. The results show that momentum profits are significantly larger for portfolios characterized by higher heterogeneity of beliefs. Predictive cross-sectional regressions show that heterogeneity of beliefs has a positive effect on return continuation after controlling for a stock’s visibility, the speed of information diffusion, uncertainty about fundamentals, information precision, and volatility. The results in this paper are robust to the potential presence of short-sale constraints and are not explained by arbitrage risk.

This paper documents significantly negative stock price reactions to shareholder-initiated class action lawsuits. We find that shareholders partially anticipate these lawsuits based on lawsuit filings against other firms in the same industry and capitalize part of these losses prior to a lawsuit filing date. We show that the more likely a firm is to be sued, the larger the partial anticipation effect (shareholder losses capitalized prior to a lawsuit filing date) and the smaller the filing date effect (shareholder losses measured on the lawsuit filing date). Our evidence suggests that previous research that typically focuses on the filing date effect understates the magnitude of shareholder losses, and that such an understatement is greater for firms with a higher likelihood of being sued.

We conduct a comprehensive study of commonality in liquidity using intraday spread and depth data from 47 stock exchanges. We find that firm-level changes in liquidity are significantly influenced by exchange-level changes across most of the world’s stock exchanges. Emerging Asian exchanges have exceptionally strong commonality, while those of Latin America exhibit little if any commonality. After documenting the pervasive role of commonality within individual exchanges, we examine commonality across exchanges. We find evidence of a distinct, global component in bid-ask spreads and depths. Local (exchange-level) sources of commonality represent roughly 39% of the firm’s total commonality in liquidity, while global sources contribute an additional 19%. We also investigate potential sources of exchange-level and global commonality. We show that commonality is driven by both domestic and U.S. macroeconomic announcements.

This paper examines the intertemporal relation between downside risk and expected stock returns. Value at Risk (VaR), expected shortfall, and tail risk are used as measures of downside risk to determine the existence and significance of a risk-return tradeoff. We find a positive and significant relation between downside risk and the portfolio returns on NYSE/AMEX/Nasdaq stocks. VaR remains a superior measure of risk when compared with the traditional risk measures. These results are robust across different stock market indices, different measures of downside risk, loss probability levels, and after controlling for macroeconomic variables and volatility over different holding periods as originally proposed by Harrison and Zhang (1999).

This article shows how structured financing can be used to solve the asset substitution problem in a dynamic setting. Structuring induces the firm’s owner to optimally choose the first best operating strategy even though the owner’s value function might be locally convex (concave), which would ordinarily lead to overinvestment (underinvestment) in risky projects. This result is demonstrated in two different continuous time settings—one that is based on the risk-shifting framework of Leland (1998) and one that generalizes the scaled return model of Green (1984). It is shown that the contractual nature of the structuring is a key determinant of the issuing firm’s dynamic asset volatility. Furthermore, unlike nonstructured financing, the default (conversion) probability of a structured debt security may be increasing (decreasing) in the firm’s total assets. Structured securities are therefore hedge assets, which potentially explains the popularity of structured securities among investors and third-party issuers.

We investigate the joint dynamics of returns and trading volume of 556 foreign stocks cross-listed on U.S. markets. Heterogeneous-agent trading models rationalize how trading volume reflects the quality of traders’ information signals and how it helps to disentangle whether returns are associated with portfolio-rebalancing trades or information-motivated trades. Based on these models, we hypothesize that returns in the home (U.S.) market on high-volume days are more likely to continue to spill over into the U.S. (home) market for those cross-listed stocks subject to the risk of greater informed trading. Our empirical evidence provides support for these predictions, which confirms the link between information, trading volume, and international stock return comovements that has eluded previous empirical investigations.

This paper estimates an internally consistent structural model that imposes cross-sectional restrictions on the dynamics of the term structure of interest rates, inflation, and output growth. Distinct from previous term structure settings, this model introduces both time-varying central tendencies and a stochastic conditional mean of output growth. The estimation of the model, which is based on U.S. data over a 1960 to 2005 sample period, provides reliable estimates for the implicit term structures of real interest rates, expected inflation rates, and inflation risk premia, as well as for expectations of macroeconomic variables. The model has better out-of-sample forecasting properties than a number of alternative models, and it contradicts the puzzling evidence that during the “Great Moderation” in inflation subsequent to the mid-1980s, the forecasting ability of structural models deteriorated with respect to atheoretic statistical models.