Guiding seminar I

Question 1

Two Pillars of Asset Pricing (Fama, Eugene F. (2014)

Answer 1

Main Question: Do asset prices reflect all available information, are markets efficient?

• Pillar I refers to whether capital mkt. are efficient, tested by checking whether stock prices adjust accurately to new information (shocks).
• Pillar II refers to whether the asset pricing models used are good.
• Finds in previous work that short term treasury bills include a rational forecast about inflation.
Conclusions: On average information about stock splits is incorporated in price months before the stock split (as per EMH), not true over longer periods.

Conclusions: On average information about stock splits is incorporated in price months before the stock split (as per EMH), not true over longer periods.

Question 2

Behavioral Economics: Past, Present, and Future (Thaler, R. 2016)

Answer 2

Main Problem: Relying on one theory to characterize optimal behavior as well as actual behavior ignores supposedly irrelevant factors (SIF’s), therefore theory must be augmented by behavioral psychology.

• It is likely that models for rational behavior are standard because they were easiest to solve.

Defenses of models and (refutes):
• One should judge theories based on whether they predict behavior (does not account for non-experts, remember example with billiard player)
• The errors of humans are randomly distributed with a mean of zero (humans make judgements that are systemically biased)
• When stakes are high people will optimize. (With high stakes there are rare opportunities to learn, people value a chosen bet lower than the one they initially abandoned)
• When interacting in the mkt. tendencies to misbehave will disappear (It is more profitable for businesses to exploit biases)
• CUBA fund example shows clear biases.

Question 3

Responsible investing: The ESG-efficient frontier (Pedersen, H. Lasse, Shaun Fitzgibbons, and Lukasz Pomorski (2021)

Answer 3

Main Problem: No theoretical framework on how to implement ESG factors into their decisions.

• Authors create a ESG-SR efficient frontier, with max Sharpe ratio at each level
• Separate investors in unaware, aware, and motivated, with corresponding portfolios

Conclusions: Governance (G) proxy contains some useful pictures, Environment (E) Does not contain much useful information.

Question 4

… and the Cross-Section of Expected Returns (Harvey, R. Campbell, Yan Liu, and Heqing Zhu (2016)

Answer 4

Main Problem: Many papers try to discover new factors to explain the returns. This may result in some factors deemed significant by pure chance.

• Authors check whether factor works on a sample period after discovery
• Argue that lower p value (higher t-statistic) is necessary to avoid Type I errors

Conclusions: Newly discovered factors should have a t-statistic that exceeds 3.0

Question 5

Alpha or beta in the eye of the beholder: What drives hedge fund flows? (Agarwal, Vikas, Clifton T. Green, and Honglin Ren (2018))

Answer 5

Main Question: Which risk model do investors use to evaluate performance? Is the response different to traditional risks and exotic? Are capital allocation decisions justified?

Conclusions: CAPM seems the most likely model used. Traditional and exotic risks are not dissociated. Investors should use more sophisticated models that differentiate between traditional and exotic risks.

Question 6

Wisdom of Crowds: The Value of Stock Opinions Transmitted Through Social Media (Chen, Hailiang, Prabuddha De, Yu Hu, and Byoung-Hyoun Hwang (2014))

Answer 6

Main Question: Do peer opinions in forums and public space have value relevant information?

• Authors check commentaries and articles in forum Seeking Alpha, compare to news outlets

Conclusions: Either SA articles contain valuable information or reflect false views that still cause investors to trade in direction that moves prices (less likely).

Question 7

Anomalies: The Law of One Price in Financial Markets (Lamont, Owen A. and Richard H. Thaler (2003))

Answer 7

Main Question: Authors examine when the law of one price does not hold in the markets.

• Closed end country funds following events have moderate discount (premia) over NAV.
• American depositary receipts – Infosys shares trading at a significant premium in US compared to India
• Twin shares – Royal Dutch/Shell prices were significantly deviating, although Royal Dutch was a part of S&P500 until 2012 after exit, the Royal Dutch premium disappeared.
• Dual class shares – after inclusion in S&P500 Molex voting shares premium rose substantially, irrational because voting rights shouldn’t become more valuable after inclusion.

Conclusion: A lot of mispricing appears to be due to constraints to short selling (regional restrictions etc.)