This website uses cookies.

By clicking the "Accept" button or continuing to browse our site, you agree to first-party and session-only cookies being stored on your device to enhance site navigation and analyze site performance and traffic. For more information on our use of cookies, please see our Privacy Policy.

« Back to Results

Financial Institutions

Paper Session

Friday, Jan. 4, 2019 2:30 PM - 4:30 PM

Hilton Atlanta, 209-210-211
Hosted By: American Finance Association
  • Chair: Zhiguo He, University of Chicago

The Sound of Many Funds Rebalancing

Alexander Chinco
,
University of Illinois
Vyacheslav (Slava) Fos
,
Boston College

Abstract

This paper proposes that complexity generates noise in financial markets. There is a large number of funds following a wide variety of different trading rules. And, because it’s too computationally complex to predict how these trading rules will interact with one another, a stock’s demand can appear random even if you yourself are fully rational. We first model a particular kind of trading rule—index-fund rebalancing—to show how complexity can generate demand noise. In the model, it’s easy to predict if a stock will be involved in an index-fund rebalancing cascade, but it’s computationally infeasible to predict how the stock’s demand will be affected (buy? or sell?). As a result, traders treat the demand coming from index-fund rebalancing cascades as noise. We then analyze the rebalancing activity of a particular kind of index fund—exchange-traded funds (ETFs)— to give empirical evidence that complexity actually does generate demand noise in real-world financial markets. We document that ETF rebalancing cascades transmit economically large demand shocks that are statistically unpredictable.

The Dark Side of Liquid Bonds in Fire Sales

Maria Chaderina
,
Vienna University of Economics and Business
Alexander Muermann
,
Vienna University of Economics and Business
Christoph Scheuch
,
Vienna Graduate School of Finance

Abstract

We investigate which bonds institutional investors sell in fire sales. We find that these are mostly bonds that were trading in liquid markets before the fire sale, and that they are sold by other institutions as well. Somewhat surprisingly, the price impacts in these markets are higher than in bonds that were trading in less liquid markets before the fire sale, but are also liquidated during fire sales. It appears as if liquid bonds in fire-sales exhibit larger price impacts than less liquid bonds. We argue this is because institutions fail to fully account for the effect of selling common bonds on other market participants. Controlling for commonality of bonds, we find that liquid bonds have smaller price impacts in fire sales. This result matters for the measurement of systemic risk: the commonality of liquid bonds exacerbates fire sales losses, as they are sold more in fire sales. Measures of portfolio similarity should thus overweight liquid bonds overlap, not underweight it.

Alpha Decay

Rick Di Mascio
,
Inalytics Ltd.
Anton Lines
,
Columbia University
Narayan Y. Naik
,
London Business School

Abstract

Using a novel sample of professional asset managers, we document positive incremental alpha on newly purchased stocks that decays over twelve months. While managers are successful forecasters at these short-to-medium horizons, their average holding period is substantially longer (2.2 years). Both slow alpha decay and the horizon mismatch can be explained by strategic trading behavior. Managers accumulate positions gradually and unwind gradually once the alpha has run out; they trade more aggressively when the number of competitors and/or correlation among information signals is high, and do not increase trade size after unexpected capital flows. Alphas are lower when competition/correlation increases.
Discussant(s)
Maryam Farboodi
,
Princeton University
Valentin Haddad
,
University of California-Los Angeles
Ron Kaniel
,
University of Rochester
JEL Classifications
  • G1 - General Financial Markets