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Using financial accounting data from manufacturing firms in 16 countries for 1986-1995, we demonstrate that the value relevance of financial reports is lower for countries where the financial systems are bank-oriented rather than market-oriented; where private sector bodies are not involved in standard setting process; where accounting practices follow the Continental model as opposed to the British-American model; where tax rules have a greater influence on financial accounting measurements; and where spending on auditing services is relatively low. Results are robust to alternative measures of value relevance of financial accounting data, including measures based on earnings (using a regression and a hedge-portfolio approach), accruals, and earnings and book value of equity combined. We show that the extent to which earnings information is reflected in leading-period returns as compared to contemporaneous returns is greater for bank-oriented than for market-oriented countries. This feature potentially induces spurious associations between value relevance measures and financial system characteristics. Our results are robust to using value relevance measures adjusted for this confounding effect.

This article asks how sustainable investing (SI) contributes to societal goals, conducting a literature review on investor impact—that is, the change investors trigger in companies’ environmental and social impact. We distinguish three impact mechanisms: shareholder engagement, capital allocation, and indirect impacts, concluding that the impact of shareholder engagement is well supported in the literature, the impact of capital allocation only partially, and indirect impacts lack empirical support. Our results suggest that investors who seek impact should pursue shareholder engagement throughout their portfolio, allocate capital to sustainable companies whose growth is limited by external financing conditions, and screen out companies based on the absence of specific ESG practices that can be adopted at reasonable costs. For rating agencies, we outline steps to develop investor impact metrics. For policymakers, we highlight that SI helps to diffuse good business practices, but is unlikely to drive a deeper transformation without additional policy measures.

This paper examines how capital market pressures and institutional factors shape firms' incentives to report earnings that reflect economic performance. To isolate the effects of reporting incentives, we exploit the fact that, within the European Union, privately held corporations face the same accounting standards as publicly traded companies because accounting regulation is based on legal form. We focus on the level of earnings management as one dimension of accounting quality that is particularly responsive to firms' reporting incentives. We document that private firms exhibit higher levels of earnings management and that strong legal systems are associated with less earnings management in private and public firms. We also provide evidence that private and public firms respond differentially to institutional factors, such as book-tax alignment, outside investor protection and capital market structure. Moreover, legal institutions and capital market forces often appear to reinforce each other.

Option values are well-known to be the integral of a discounted transition density times a payoff function; this is just martingale pricing. It's usually done in 'S-space', where S is the terminal security price. But, for Levy processes the S-space transition densities are often very complicated, involving many special functions and infinite summations. Instead, we show that it's much easier to compute the option value as an integral in Fourier space - and interpret this as a Parseval identity. The formula is especially simple because (i) it's a single integration for any payoff and (ii) the integrand is typically a compact expression with just elementary functions. Our approach clarifies and generalizes previous work using characteristic functions and Fourier inversions. For example, we show how the residue calculus leads to several variation formulas, such as a well-known, but less numerically efficient, 'Black-Scholes style' formula for call options. The result applies to any European-style, simple or exotic option (without path-dependence) under any Levy process with a known characteristic function.

The economic value of derivatives depends on the funding costs encountered by the issuer. In this paper we derive general relations between the costs of running specific funding strategies while the issuer is alive and the resulting windfalls or shortfalls upon the issuer default. This gives rise to generalisations to the classical bilateral CVA adjustment that include the cost of running specific funding strategies and sets the stage to discuss ways to mitigate these effects. We give practical examples of different funding strategies and their resulting funding cost (FCA) and funding value adjustments (FVA).

Investors have too often extrapolated from the American experience and from relatively recent evidence. In the 1950s, who but the most rampant optimist would have dreamed that, over the next fifty years, the real return on equities would be 9 percent per year? Yet this is exactly what happened in the US stock market. In this study we extend our knowledge of financial market performance across regions and across time. We present a comprehensive and consistent analysis of investment returns for equities, bonds, bills, currencies, and inflation, spanning sixteen countries from the end of the nineteenth century to the beginning of the twenty-first. Our indexes are chosen to avoid survivorship bias, and all returns include reinvested income. This enables us to study topics such as the size effect, the value premium, interest rates and inflation, dividend growth, and the equity risk premium over more than a century. The markets we cover comprise two in North America, seven in the Euro area, four others in Europe, two in the Asia-Pacific region, and one in Africa. We present in this extract from our work a summary of capital market history in all sixteen countries. We find that over the long haul stocks beat bonds in every market, and bonds beat bills almost everywhere. The full study is forthcoming as a book, 'Triumph of the Optimists: 101 Years of Global Investment Returns', to be published by Princeton University Press in February/March 2002

We propose a conditional factor model for corporate bond returns with five factors and time-varying factor loadings. We have three main empirical findings. First, our factor model excels in describing the risks and returns of corporate bonds, improving over previously proposed models in the literature by a large margin. Second, our benchmark model recommends a systematic bond investment portfolio that significantly outperforms leading corporate credit investment strategies. Third, we find closer integration between debt and equity markets than found in prior literature.

This paper is concerned with the optimality of a trend following trading rule. The idea is to catcha bull market at its early stage, ride the trend, and liquidate the position at the first evidence ofthe subsequent bear market. We characterize the bull and bear phases of the markets mathematically using the conditional probabilities of the bull market given the up to date stock prices. The optimal buying and selling times are given in terms of a sequence of stopping times determined by two threshold curves. Numerical experiments are conducted to validate the theoretical results and demonstrate how they perform in a marketplace.

This study examines whether Bitcoin, a digital decentralized currency, can become a viable alternative to fiat currencies. Bitcoin currently does not fulfill the criteria of being a currency because it does not function as a medium of exchange, a unit of account, and a store of value. Bitcoin’s biggest obstacle from fulfilling these functions is the price volatility. A GARCH (1,1) model is used to analyze Bitcoin’s volatility in respect to the macroeconomic variables of countries where Bitcoin is being traded the most. Bitcoin already behaves similarly to fiat currencies in China, the U.S. and the European Union but not in Japan. There is also evidence that Bitcoin acts as a safe-haven asset in China. The volatility of Bitcoin has been steadily decreasing throughout its lifetime. If it follows the trend of its six years of existence, it will reach the volatility levels of fiat currencies in 2019-2020 and become a functioning alternative to fiat currencies.

We provide a survey of 31 quantitative measures of systemic risk in the economics and finance literature, chosen to span key themes and issues in systemic risk measurement and management. We motivate these measures from the supervisory, research, and data perspectives in the main text, and present concise definitions of each risk measure - including required inputs, expected outputs, and data requirements - in an extensive appendix. To encourage experimentation and innovation among as broad an audience as possible, we have developed open-source Matlab code for most of the analytics surveyed.

Momentum risk premium is one of the most important alternative risk premia. Since it is considered a market anomaly, it is not always well understood. Many publications on this topic are therefore based on backtesting and empirical results. However, some academic studies have developed a theoretical framework that allows us to understand the behavior of such strategies. In this paper, we extend the model of Bruder and Gaussel (2011) to the multivariate case. We can find the main properties found in academic literature, and obtain new theoretical findings on the momentum risk premium. In particular, we revisit the payoff of trend-following strategies, and analyze the impact of the asset universe on the risk/return profile. We also compare empirical stylized facts with the theoretical results obtained from our model. Finally, we study the hedging properties of trend-following strategies.

P-hacking is a well-understood cause of false positives in factor investing. A far less studied cause is factor model specification choices. We prove that specification errors cause factor strategies to underperform and potentially yield systematic losses, even if all risk premia remain constant and are estimated with the correct sign. The erratic performance of factor investing strategies is better explained by specification errors than by time-varying risk premia. The implication is that specification errors are more common and dangerous to factor investors than previously thought. We also show that standard econometric practices cause researchers to over-control for colliders, increasing the likelihood of adverse outcomes. To our knowledge, this is the first study that connects specification errors, factor model selection practices, underperformance and systematic losses through a causal mechanism. These findings challenge the scientific soundness and long-term profitability of the current (associational, casual, non-causal) multi-trillion-dollar factor investing industry. To overcome these pitfalls, academics and practitioners should rebuild the financial economics literature on the more scientifically rigorous grounds of causal factor investing.

This paper surveys the literature on socially responsible investments (SRI). Over the past decade, SRI has experienced an explosive growth around the world. Particular to the SRI funds is that both financial goals and social objectives are pursued. While corporate social responsibility (CSR) - defined as good corporate governance, sound environmental standards, and good management towards stakeholder relations - may create value for shareholders, participating in other social and ethical issues is likely to destroy shareholder value. Furthermore, the risk-adjusted returns of SRI funds in the US and UK are not significantly different from those of conventional funds, whereas SRI funds in Continental Europe and Asia-Pacific strongly underperform benchmark portfolios. Finally, the volatility of money-flows is lower in SRI funds than of conventional funds, and SRI investors' decisions to invest in an SRI fund are less affected by management fees than the decisions by conventional fund investors.

Originally developed as a statistical tool for empirical research in accounting and finance, event studies have since migrated to other disciplines as well, including economics, history, law, management, marketing, and political science. Despite the elegant simplicity of a standard event study, variations in methodology and their relative merits continue to attract attention in the literature. This paper reviews some of the fundamental topics in short-term event study methodology, with an attempt to add new perspectives to some pressing topics.

The United States has both an active venture capital industry and well-developed stock markets. Japan and Germany have neither. We argue here that this is no accident -- that venture capital can flourish especially -- and perhaps only -- if the venture capitalist can exit from a successful portfolio company through an initial public offering (IPO), which requires an active stock market. Understanding the link between the stock market and the venture capital market requires understanding the contractual arrangements between entrepreneurs and venture capital providers especially the importance of exit by venture capitalists and the opportunity, present only if IPO exit is possible, for the venture capitalist and the entrepreneur to enter into an implicit contract over control, in which a successful entrepreneur can reacquire control from the venture capitalist by using an IPO as the means of exit.Note: This article is a shortened version of Black and Gilson, "Venture Capital and the Structure of Capital Markets: Banks versus Stock Markets," Journal of Financial Economics, Vol. 47, pp. 243-277, 1998. A nearly final version of the longer article is available on SSRN at http://ssrn.com/abstract=46909

We show that motivated by sensation seeking, hedge fund managers who own powerful sports cars take on more investment risk but do not deliver higher returns, resulting in lower Sharpe ratios, information ratios, and alphas. Moreover, sensation-seeking managers trade more frequently, actively and unconventionally, and prefer lottery-like stocks. We show further that some investors are themselves susceptible to sensation seeking and that sensation-seeking investors fuel the demand for sensation-seeking managers. While investors perceive sensation seekers to be less competent, they do not fully appreciate the superior investment skills of sensation-avoiding fund managers.

This paper investigates hedge fund performance and risk. The empirical evidence indicates that hedge funds differ substantially from traditional investment vehicles such as mutual funds. The funds with watermarks significantly outperform the funds without watermarks. The average hedge fund returns are related positively to incentive fees, the size of the fund, and the lockup period. Hedge funds follow dynamic trading strategies and have low systematic risk. There are low correlations among different strategies. Compared with mutual funds, hedge funds offer better risk-return trade-offs: they have higher Sharpe ratios, lower market risks, and higher abnormal returns. In the period of January 1994 to December 1996, hedge funds provide positive abnormal returns. Overall, hedge fund strategies dominate mutual fund strategies, hence hedge funds provide a more efficient investment opportunity set for investors.

The global credit crisis has led to systemic instability, the accrual of massive losses in major US and European banks, and created significant public costs. It has also shown that the current model of national and international banking regulation is inadequate. This paper attempts to answer questions relating to the future shape of national and international financial regulation in light of lessons drawn from this crisis. While most policy proposals for the overhaul of the US, UK, and international financial regulation predominantly deal with issues relating to the containment of a systemic crisis, the paper offers more radical solutions, which deal with the prevention of such a crisis. In this mode, it suggests a pluralistic regime for the licensing and supervision of banking institutions at a domestic level and the establishment of a global multi-tiered licensing and supervisory scheme for transnational investment funds with systemic importance. The supervision of investment funds' compliance with the suggested prudential regime should be assigned to an independent global regulatory authority, which would utilize the market research and surveillance infrastructure of the IMF. The findings of behavioural finance provide solid support for the suggested reforms.

The objective of this study is to determine the impact of COVID-19 on the performance of Pakistani Stock Market. This study uses the data of COVID-19 related positive cases, fatalities, recovers and the closing prices of PSX 100 index of the first half of 2020. The findings of the study suggest that only COVID-19 recoveries are influencing the performance of the index and the daily positive cases and fatalities are insignificantly related to the performance. Further studies can be performed by incorporating other variables such as economic growth, interest rate and inflation rate along with the COVID-19 related variables at a cross-country level.

Modern financial economics assumes that we behave with extreme rationality but we do not. Furthermore, our deviations from rationality are often systematic. Behavioral finance relaxes the traditional assumptions of financial economics by incorporating these observable, systematic, and very human departures from rationality into standard models of financial markets. This paper describes empirical tests of two predictions of behavioral finance: that investors tend to sell their winning stocks and to hold on to their losers and that, as a result of overconfidence, investors trade too much. Statman and Shefrin (1985) predict that investors will sell their winning investments too soon and hold on to their losers too long. They dub this tendency the disposition effect. Using account data from a large discount broker, we document that individual investors are 50 percent more likely to sell a winning investment than a losing investment (relative to their opportunities to do so). The analysis also indicates that many investors engage in tax-motivated selling, especially in December. Alternative explanations have been proposed for why investors might realize their profitable investments while retaining their losing investments. Investors may rationally, or irrationally, believe that their current losers will in the future outperform their current winners. They may sell winners to rebalance their portfolios. Or they may refrain from selling losers due to the higher transactions costs of trading at lower prices. When the data are controlled for rebalancing and for share price, the disposition effect is still observed. And the winning investments that investors choose to sell continue in subsequent months to outperform the losers they keep. This investment behavior is difficult to justify rationally; it is pure folly in an investor?s taxable account. It is difficult to reconcile the volume of trading observed in equity markets with the trading needs of rational investors. Rational investors make periodic contributions and withdrawals from their investment portfolios, rebalance their portfolios, and trade to minimize their taxes. Those possessed of superior information may trade speculatively, though rational speculative traders will generally not choose to trade with each other. It is unlikely that rational trading needs account for a turnover rate of 76 percent on the New York Stock Exchange in 1998. We believe there is a simple and powerful explanation for high levels of trading on financial markets: overconfidence. Human beings are overconfident about their abilities, their knowledge, and their future prospects. Odean (1998b) shows that overconfident investors trade more than rational investors and that doing so lowers their expected utilities. Greater overconfidence leads to greater trading and to lower expected utility. We present evidence that the average individual investor pays an extremely large performance penalty for trading. Those investors who trade most actively earn, on average, the lowest returns. And the stocks individual investors purchase do not outperform those they sell by enough to even cover the costs of trading. In fact, the stocks individual investors purchase, on average, subsequently underperform those they sell. This is the case even when trading is not apparently motivated by liquidity demands, tax-loss selling, portfolio rebalancing, or a move to lower-risk stocks. Our common psychological heritage insures that we systematically share decision biases that can lead to suboptimal investment behavior. Overconfidence provides the will to act on these biases. It gives us the courage of our misguided convictions.

Modern Portfolio Theory (MPT) teaches us that active equity managers who use judgment to make investment decisions won’t be able to match the returns (after fees and expenses) of blindly-invested, passively-managed index funds. Data on returns supports the theory, so it’s no surprise that investors are leaving actively managed funds in droves for the better average returns of super-diversified index strategies. Yet the reality is much murkier than we’ve been led to believe. It turns out that the portfolio theories which inspired the creation and popularity of index funds and top-down, quantitatively-driven index-like strategies, are both flawed and impractical. There’s compelling evidence, moreover, that a subset of active managers do persistently outperform indexes. However, this important fact has been lost because we allow MPT to define the debate in its own misleading terms, tilting the field in its favor and hiding the reality about active manager performance in a complex game of circular arguments. MPT relies on a number of unrealistic assumptions including an inaccurate definition of risk. Yet this characterization of risk sets the rules for comparing active vs. passive strategies, often causing active strategies to appear more risky and less efficient than their index counterparts. The same flawed logic is used to risk-adjust returns, biasing them downward for more active, concentrated managers, and rendering this highly important measure highly suspect. Furthermore, reliance on MPT’s measure of risk pressures active managers to super-diversify. The average active fund is thus disfigured to the point where the typical "active" manager is not very active at all, casting the fund in an unfavorable light in a beauty contest versus super-efficient index funds. Stripping away the influence of portfolio theory involves isolating and evaluating the relatively small group of equity managers who rely heavily on judgment to build concentrated equity portfolios. Empirical data from multiple studies show that these concentrated managers, in fact, persistently outperform indexes. The implications of this statement are enormous. Concentrated manager returns present the best test of whether human judgment can add value in allocating capital, and they win, convincingly. Yet while judgment has prevailed over passive investing, few have taken notice. Most investors continue to look at average active manager returns, not recognizing that these returns are minimally influenced by judgment. Regardless of MPT’s shortcomings on both a theoretical and empirical level, its dominating influence will not easily be dislodged. MPT is deeply woven into the fabric of our financial system, its mathematical grounding and precise answers inspire confidence. Further, its application is crucial in bringing increased scale and profitability to the financial services industry. Few want to see change. As such, common sense and judgment will continue to diminish in importance as top-down, quantitative strategies and blind diversification gain investment dollars. An informed investor should welcome this shift. As highly-diversified strategies gain assets, inefficiencies become more prevalent because share prices are increasingly driven by factors other than fundamentals. Individual investors, seeking to exploit these inefficiencies and outperform indexes, should invest in several concentrated funds with strong track records. Managers of these funds have proven themselves adept at turning inefficiencies into strong returns for their investors, and persistence data demonstrates that past performance can indicate which managers are likely to continue to outperform. Concentrated fund returns may exhibit more volatility than indexes, but we now have proof that over the long-term, good judgment will be rewarded.

A power law is the form taken by a large number of surprising empirical regularities in economics and finance. This article surveys well-documented empirical power laws concerning income and wealth, the size of cities and firms, stock market returns, trading volume, international trade, and executive pay. It reviews detail-independent theoretical motivations that make sharp predictions concerning the existence and coefficients of power laws, without requiring delicate tuning of model parameters. These theoretical mechanisms include random growth, optimization, and the economics of superstars coupled with extreme value theory. Some of the empirical regularities currently lack an appropriate explanation. This article highlights these open areas for future research.

The contributions of asset selection and incremental leverage to buyout investment performance are more important than typically assumed or estimated to be. Buyout funds select small firms with distinct value characteristics. Public equities with these characteristics have high risk-adjusted returns relative to common factors. Adding incremental leverage to a publicly traded stock portfolio increases both risks and mean returns in this sample. Direct investments in private equity funds earn lower mean returns than a replicating strategy designed to mimic these key economic features of their investment process with public equities and brokerage loans.

Berk and Green (2004) argue that investment inflow at high-performing mutual funds eliminates return persistence because fund managers face diminishing returns to scale. Our study examines the role of trading costs as a source of diseconomies of scale for mutual funds. We estimate annual trading costs for a large sample of equity funds and find that they are comparable in magnitude to the expense ratio; that they have higher cross-sectional variation that is related to fund trade size; and that they have an increasingly detrimental impact on performance as the fund's relative trade size increases. Moreover, relative trade size subsumes fund size in regressions of fund returns, which suggests that trading costs are the primary source of diseconomies of scale for funds.

We study how migration of firms across size and value portfolios contributes to the size and value premiums in average stock returns. The size premium is almost entirely due to the small stocks that earn extreme positive returns and as a result become big stocks. The value premium has three sources: (i) value stocks that improve in type either because they are acquired by other firms or because they earn high returns and so migrate to a neutral or growth portfolio; (ii) growth stocks that earn low returns and as a result move to a neutral or value portfolio; and (iii) slightly higher returns on value stocks that remain in the same portfolio compared to growth stocks that do not migrate.