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This monograph provides a thorough review of earnings quality issues and analysis. Its primary objectives are to help gain a deep understanding of earnings quality and facilitate the development of comprehensive, granular, and contextual earnings quality indicators and analyses. While there are several alternative definitions of earnings quality, the monograph focuses on the earnings sustainability or persistence view, which emphasizes valuation implications. With a working definition of earnings quality, the study then analyzes comprehensive and line-item financial statement indicators of earnings quality, and it relates the indicators to specific earnings quality issues. The monograph also describes nonfinancial indicators of earnings quality, including proxies for incentives and ability to manipulate earnings as well as transactions, events and circumstances that inform on earnings sustainability. The final two chapters discuss the role of earnings quality in valuation and review stock return anomalies related to earnings quality.

We present broad-based evidence that the monthly payment cycle induces systematic patterns in liquid markets around the globe. First, we document temporary increases in the costs of debt and equity capital that coincide with key dates associated with month-end cash needs. Second, we present direct and indirect evidence on the role of institutions in the genesis of these patterns and derive estimates of the associated costs borne by market participants. Finally, we investigate the limits to arbitrage that prevent markets from functioning efficiently. Our results indicate that many investors and their agents, including mutual funds, suffer from liquidity-related trading.

This paper shows how sustainable investing—through the joint practice of exclusionary screening and environmental, social, and governance (ESG) integration—affects asset returns. I develop an asset pricing model with partial segmentation and heterogeneous preferences. I characterize two exclusion premia generalizing Merton’s (1987) premium on neglected stocks and a taste premium that clarifies the relationship between ESG and financial performance. Focusing on U.S. stocks, I estimate the model by applying it to sin stocks as excluded assets and using the holdings of green funds to proxy for environmental integration. The average annual exclusion effect is 2.79% for the period 1999–2019. Although the annual taste effect ranges from −1.12% to +0.14% across industries for 2007–2019, the taste effect spread between the top and bottom terciles of companies within each industry can exceed 2% per year. Finally, I estimate and explain the dynamics of these premia.

We examine whether the application of basic concepts of fundamental analysis can yield significant abnormal returns. Using a collection of signals that reflect traditional rules of fundamental analysis related to contemporaneous changes in inventories, accounts receivables, gross margins, selling expenses, capital expenditures, effective tax rates, inventory methods, audit qualifications, and labor force sales productivity, we form portfolios that earn an average 12 month cumulative size-adjusted abnormal return of 13.2 percent. We find evidence that the fundamental signals provide information about future returns that is associated with future earnings news. Moreover, a significant portion of the abnormal returns is generated around subsequent earnings announcements. These findings are consistent with the underlying focus of fundamental analysis on the prediction of earnings. Significant abnormal returns to the fundamental strategy are not earned after the end of one year of return cumulation, indicating little support for the idea that the signals capture information about multiple-year-ahead earnings not immediately impounded in price or about long-term shifts in firm risk. Additional analysis on a holdout sample suggests that the strategy continues to generate abnormal returns in a period subsequent to the introduction of the fundamental signals in the literature, and contextual analyses indicate that the strategy performs better for certain types of firms (e.g. firms with prior bad news).

In this paper we examine a momentum strategy based on residual stock returns. We find that residual momentum exhibits risk-adjusted profits that are about twice as large as those associated with total return momentum. Moreover, we find that the main arguments that have been put forward in the academic literature to rationalize momentum are unsuccessful in explaining residual momentum. Our results have important implications for the theoretical debate on market efficiency as well as the practical implementation of momentum trading strategies.

The corporate information environment develops endogenously as a consequence of information asymmetries and agency problems between investors, entrepreneurs, and managers. We provide a framework for analyzing the three main decisions that shape the corporate information environment in a capital markets setting: (1) managers’ voluntary reporting and disclosure decisions, (2) reporting and disclosures mandated by regulators, and (3) reporting decisions by third-party intermediaries (analysts). We review current research on disclosure regulation, information intermediaries, and the determinants and economic consequences of corporate disclosure and financial reporting decisions. We conclude that in the last ten years, research has generated a number of useful insights. Despite this progress, we call for researchers to consider interdependencies between the various decisions that shape the corporate information environment and highlight changes in the economic financial environment that raise new and interesting issues for researchers to address.

With average hedge fund performance steadily deteriorating and equity markets picking up again, interest in hedge fund return replication as a cheaper means of obtaining hedge fund-like returns is growing steadily. Currently, there are various products on offer. Compared to real hedge funds (of funds), all of them offer improved liquidity, transparency, capacity, etc. and thereby solve a range of problems surrounding hedge fund investment. There are, however, substantial differences in terms of their attraction as portfolio diversifiers. The multi-strategy replication products offered by Merrill Lynch (Factor Index), Goldman Sachs (ART Index), and Partners Group (ABS fund) exhibit a strong correlation with the stock market. This severely limits these products' attraction as portfolio diversifiers. FundCreator does not necessarily replicate any specific fund or index, but allows investors to design their own diversifier from scratch. This gives investors a unique opportunity to create new tailor-made diversifiers with characteristics that are optimal given their existing portfolios. Clearly, this makes FundCreator-based synthetic funds much more attractive than the various multi-strategy hedge fund replication and alternative beta products currently on offer

We present a systematic approach to detect fake transactions on cryptocurrency exchanges by exploiting robust statistical and behavioral regularities associated with authentic trading. Our sample consists of 29 centralized exchanges, among which the regulated ones feature transaction patterns consistently observed in financial markets and nature. In contrast, unregulated exchanges display abnormal first-significant-digit distributions, size rounding, and transaction tail distributions, indicating widespread manipulation unlikely driven by specific trading strategy or exchange heterogeneity. We then quantify the wash trading on each unregulated exchange, which averaged over 70% of the reported volume. We further document how these fabricated volumes (trillions of dollars annually) improve exchange ranking, temporarily distort prices, and relate to exchange characteristics (e.g., age and user base), market conditions, and regulation. Overall, our study cautions against potential market manipulations on centralized crypto exchanges with concentrated power and limited disclosure requirements, and highlights the importance of FinTech regulation.Online appendix available at: https://ssrn.com/abstract=4529817

Momentum in individual stock returns emanates from momentum in factor returns. Most factors are positively autocorrelated: the average factor earns a monthly return of 6 basis points following a year of losses and 51 basis points following a positive year. We find that factor momentum concentrates in factors that explain more of the cross section of returns and that it is not incidental to individual stock momentum: momentum-neutral factors display more momentum. Momentum found in high-eigenvalue PC factors subsumes all forms of individual stock momentum. Our results suggest that momentum is not a distinct risk factor; it times other factors.

The developments of company law in countries belonging to five legal families illustrate the principle-agent conflicts that company law faces and the range of solutions it offers to cope with them. Comparative company law is about learning from each other's experience in a competitive way, and solving together the cross-border problems arising for and from companies that are facing global competition. Comparative company law today is conceived and created equally by legislators, lawyers, academics, and courts. Examples include the influence of German, French, and U.S. law on company law codifications in Japan and other countries, the legal practice in regard to cross-border transactions, the worldwide growing presence of academic comparative research, and last but not least the decision-making of the European Court of Justice. The driving forces of comparative company law can be traced back to the spread of the 1930s' U.S. securities regulation into European Union member states, Eastern European states, and also China; the harmonization efforts of the European Community since the late 1950s; and most recently, the international rise of the corporate governance and code movements in the 1990s that had some famous origins in the United Kingdom. This leads to modern challenges such as the pros and cons of self-regulation in company law and beyond. From a broader perspective, there is a need for the adjustment of company and capital market law in all the legal families considered. In this respect, comparative company law is a highly promising source for exploring the key issues, including convergence and divergence in company and capital market law, harmonization versus regulatory competition, and the means and institutions that provide for operative enforcement. Comparative research, together with economic and empirical analysis, will thus contribute to an understanding of the real functioning of company law - a core task for the future of the European internal market, but also beyond in a globalized world.

The average Market Risk Premium (MRP) used in 2011 by professors for the USA (5.7%) is higher than the one used by analysts (5.0%) and companies (5.6%). The standard deviation of the MRP used in 2011 by analysts (1.1%) is lower than the ones of companies (2.0%) and professors (1.6%). Most previous surveys have been interested in the Expected MRP, but this survey asks about the Required MRP. The paper also contains the references used to justify the MRP, comments from 58 persons that do not use MRP, and comments of 110 that do use MRP. The comments illustrate the various interpretations of the required MRP and its usefulness. Professors, analysts and companies that cite Ibbotson as their reference use MRP for USA between 2% and 14.5%, and the ones that cite Damodaran as their reference use MRP between 2% and 10.8%.

The most important determinant for the existence of a Green premium is the perceived "Green--credibility" of a bond and its issuer. We analyze a sample of more than 1,500 Green bonds with respect to their pricing on the primary and secondary market. On both markets, only certain types of bonds trade at a Green premium (i.e., exhibit lower yields) relative to their conventional counterparts, namely those, which are issued by governments or supranational entities, denominated in EUR, or corporate bonds with very large issue sizes. These bonds and their issuers seem to be viewed as more credible in terms of a better implementation or a greater impact of the Green projects financed with the proceeds. For corporate issues, credibility of the Green label is of particular importance. Investors are more likely to pay a premium for a Green bond, when it is certified as such by a third party, or when it is listed on an exchange with a dedicated Green bond segment and tight listing requirements.

We document economically large cross-sectional differences in the before- and after-fee returns earned by speculative traders. We establish this result by focusing on day traders in Taiwan from 1992 to 2006. We argue that these traders are almost certainly speculative traders given their short holding period. We sort day traders based on their returns in year y and analyze their subsequent day trading performance in year y 1; the 500 top-ranked day traders go on to earn daily before-fee (after-fee) returns of 61.3 (37.9) basis points (bps) per day; bottom-ranked day traders go on to earn daily before-fee (after-fee) returns of -11.5 (-28.9) bps per day. The spread in returns between top-ranked and bottom-ranked speculators exceeds 70 bps per day. However, less than 1% of the total population of day traders is able to predictably and reliably earn positive abnormal returns net of fees. Our results contribute to the evidence that cross-sectional variation in investor skill is an important feature of financial markets.

Currently the real, inflation-adjusted, price of gold is almost as high as it was in January 1980 and August 2011. Since 1975, periods of high real gold prices have occurred during periods of elevated concern about high future price inflation. Five years after the real price peaks in January 1980 and August 2011 the nominal (real) prices of gold fell 55% (67%) and 28% (33%), respectively. Today’s high real price of gold suggests that gold is an expensive inflation-hedge with a low prospective real return. However, “massive passive” ETF financialization of gold ownership may introduce a period of “irrational exuberance”.See our related work: The Golden Dilemma.

Studying 30 countries, we find that the link between employee satisfaction and stock returns is significantly increasing in a country’s labor market flexibility. This result is consistent with employee satisfaction having greater recruitment, retention, and motivation benefits where firms face fewer hiring and firing constraints and employees have greater ability to respond to satisfaction. Labor market flexibility also increases the link between employee satisfaction and current valuation ratios, future profitability, and future earnings surprises, inconsistent with omitted risk factors and identifying channels through which employee satisfaction may affect stock returns. The findings have implications for the differential profitability of socially responsible investing strategies around the world – in particular, the importance of considering institutional factors when forming such strategies.

Motivated by the industry practice of pairs trading, we study the optimal timing strategies for trading a mean-reverting price spread. An optimal double stopping problem is formulated to analyze the timing to start and subsequently liquidate the position subject to transaction costs. Modeling the price spread by an Ornstein-Uhlenbeck process, we apply a probabilistic methodology and rigorously derive the optimal price intervals for market entry and exit. As an extension, we incorporate a stop-loss constraint to limit the maximum loss. We show that the entry region is characterized by a bounded price interval that lies strictly above the stop-loss level. As for the exit timing, a higher stop-loss level always implies a lower optimal take-profit level. Both analytical and numerical results are provided to illustrate the dependence of timing strategies on model parameters such as transaction cost and stop-loss level.

Consider an economy in which the underlying security returns follow a linear factor model with constant coeffcients. While portfolios that invest in these securities willin general, have a linear factor structure, it will be one with time-varying coeffcients. However, under certain assumptions regarding the portfolio's investment strategy, it is possible to estimate these time-varying alphas and betas. Importantly, this can be done without direct knowledge of either the portfolio manager's exact investment strategy or of the alphas and betas of the individual securities in which the portfolio invests. This paper develops and estimates a Kalman filter statistical model to track time-varying fund alphas and betas. Several tests indicate that relative to a rolling OLS model the Kalman filter model produces more accurate fund factor loadings both in and out of sample. This appears to be in large part due to the attempts of fund managers to time the market by varying their fund's risk exposure from period to period. Another advantage of the Kalman filter model is that the dynamic parameter estimates can be used to classify funds by their trading strategies and to determine the source of a fund's profits or losses. The tests in this paper indicate that the superior and inferior returns produced by some funds arise almost entirely from attempts at market timing rather than managerial selectionability. However, as other research in the area of mutual fund performance measurement have found, overall there appears to be little evidence that, inaggregate, fund investors earn superior returns.

We show, as simply as possible, the model’s development, its implications and the assumptions on which it is based.The paper also contains 307 interesting comments and criticism from several professors, finance professionals and Ph.D. students about the CAPM: 234 basically agree in using the adjective “absurd” to qualify the CAPM and 71 do not agree for several reasons that are in sections 3 and 4. I thank very much to all of them: I have learned a lot reading (and thinking about) their opinions: real opinions of real persons that know finance and have thought about the CAPM, the market return, the beta, the market risk premium.

We use firm-level data that measure forward-looking physical climate risk to examine the impact of climate risk on capital structure. We find that greater physical climate risk leads to lower leverage in the post-2015 period, i.e., after the Paris Agreement and the first step of standardization of disclosure of climate risk information. Our results hold after controlling for firm characteristics known to determine leverage, including credit ratings. Our evidence shows that the reduction in leverage related to climate risk is shared between a demand effect (the firm’s optimal leverage decreases) and a supply effect (bankers and bondholders increase spreads when lending to firms with the greatest risk). Our results are consistent with the hypothesis that physical climate risk affects leverage via larger expected distress costs and higher operating costs.

We confirm the effectiveness of using cyclically-adjusted valuation metrics to identify high performing stocks. The Shiller P/E, or cyclically-adjusted price-to-earnings (CAPE) ratio, is not the optimal way to implement a cyclically-adjusted value measure. At the margin, the cyclically-adjusted book-to-market (CA-BM) is a better measure to predict returns. We find that more frequent rebalancing and momentum can enhance strategies based on cyclically-adjusted valuation metrics.

In two previous articles, we assessed the structural limitations of existing models for equity derivatives and introduced a new model based on the direct modelling of the joint dynamics of the spot and the implied variance swap volatilities. Here we present new work on an extension of this model which, while remaining Markovian, provides control on the smile of forward variances and can be calibrated to VIX futures and options.

This article reviews ten notable financial applications where ML has moved beyond hype and proven its usefulness. This success does not mean that the use of ML in finance does not face important challenges. The main conclusion is that there is a strong case for applying ML to current financial problems, and that financial ML has a promising future ahead.For a presentation on this topic, see https://ssrn.com/abstract=3197726.

Portfolio theory must address the fact that, in reality, portfolio managers are evaluated relative to a benchmark, and therefore adopt risk management practices to account for the benchmark performance. We capture this risk management consideration by allowing a prespecified shortfall from a target benchmark-linked return, consistent with growing interest in such practice. In a dynamic setting, we demonstrate how a risk averse portfolio manager optimally under- or overperforms a target benchmark under different economic conditions, depending on his attitude towards risk and choice of the benchmark. The analysis therefore illustrates how investors can achieve their desired performance profile for funds under management through an appropriate combined choice of the benchmark and money manager. We consider a variety of extensions, and also highlight the ability of our setting to shed some light on documented return patterns across segments of the money management industry.

Do corporate tax avoidance activities advance shareholder interests? This paper tests alternative theories of corporate tax avoidance that yield distinct predictions on the valuation of corporate tax avoidance. Unexplained differences between income reported to capital markets and to tax authorities are used to proxy for tax avoidance activity. These "book-tax" gaps are shown to be larger when firms are alleged to be involved in tax shelters. OLS estimates indicate that the average effect of tax avoidance on firm value is not significantly different from zero, but is positive for well-governed firms as predicted by an agency perspective on corporate tax avoidance. An exogenous change in tax regulations that affected the ability of some firms to avoid taxes is used to construct instruments for tax avoidance activity. The IV estimates yield larger overall effects and reinforce the basic result that higher quality firm governance leads to a larger effect of tax avoidance on firm value. The results are robust to a wide variety of tests for alternative explanations. Taken together, the results suggest that the simple view of corporate tax avoidance as a transfer of resources from the state to shareholders is incomplete given the agency problems characterizing shareholder-manager relations.

This paper reports descriptive evidence about how managers attempt to manage earnings, based on a sample of 515 earnings-management attempts obtained from a survey of 253 experienced auditors (and also analyzed by Nelson et al. 2002). We classify attempts first according to primary approach: expense recognition, revenue recognition, issues unique to business combinations, and other issues. Then, within each of those broad categories, we subclassify attempts by the particular approach used in the attempt. For each specific approach, we report the accounts involved, the frequency with which the approach increased or decreased current-period income (and the frequency of adjustments required by the auditor), and provide descriptions by auditors of income-increasing and income-decreasing examples of the more frequent approaches. We also link our findings to recent SEC Accounting and Auditing Enforcement Releases ("AAERs") that illustrate extreme versions of the specific approaches identified by our participants. This experienced-based, example-rich framework and frequency data should assist investors, auditors, audit committees, and other participants in the financial reporting process who need to be vigilant for earnings-management approaches.