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Asset Pricing: Portfolio Choice and Asset Allocation

Paper Session

Friday, Jan. 3, 2020 8:00 AM - 10:00 AM (PDT)

Manchester Grand Hyatt, Seaport A
Hosted By: American Finance Association
  • Chair: Russell Wermers, University of Maryland

Trading Opportunities and the Portfolio Choices of Institutional Investors

Terry Zhang
,
Australian National University

Abstract

I theoretically and empirically investigate how institutional investors with different holding horizons make investment decisions. Long-term and short-term institutions have persistent differences in their portfolio tilt with short-term institutions more willing to invest in low-return stocks. To explain this phenomenon, I propose a model in which short-term institutions can trade more frequently than long-term institutions. The optimal portfolio of short-term institutions is to tilt towards stocks that are more exposed to future speculative demand, which creates transient trading opportunities. Short-term institutions can take advantage of these trading opportunities by selling at better prices. In equilibrium, these speculative stocks have lower buy-and-hold returns, making them less desirable for long-term investors. Empirical findings are consistent with my model: in the cross section, stocks with more short-term institutional investors have higher CAPM beta, higher idiosyncratic volatility, and lower buy-and-hold abnormal returns. From these stocks, short-term institutions make more trading profits, offsetting the reduced buy-and-hold returns of these stocks. In the time series, the trading profits of short-term institutions increase with the market sentiment. My paper shows that the desirability of investing in speculative stocks depends on one's trading ability. My paper also suggests that empirical assessment of a manager’s stock-picking skill should measure stock returns commensurate with the manager’s investment horizon.

Tactical Target Date Funds

Francisco Gomes
,
London Business School
Alex Michaelides
,
Imperial College London
Yuxin Zhang
,
Renmin University of China

Abstract

We propose target date funds modified to exploit
stock return predictability driven by the variance risk premium. The
portfolio rule of these tactical target date funds (TTDFs) is extremely
simplified relative to the optimal one, making it easy to implement and
communicate to investors. We show that saving for retirement in TTDFs
generates economically large welfare gains, even after we introduce turnover
restrictions and transaction costs, and after taking into account parameter
uncertainty. Crucially, we show that this predictability is uncorrelated
with individual household risk, confirming that households are in a prime
position to exploit it.

Reach for Yield by United States Public Pension Funds

Lina Lu
,
Federal Reserve Bank of Boston
Matthew Pritsker
,
Federal Reserve Bank of Boston
Andrei Zlate
,
Federal Reserve Board
Kenechukwu Anadu
,
Federal Reserve Bank of Boston
Jim Bohn
,
Federal Reserve Bank of Boston

Abstract

This paper studies whether U.S. public pension funds reach for yield by taking more investment risk in a low interest rate environment. To perform our analysis, we first present a simple theoretical model relating funds’ risk-taking behavior to the level of risk-free rates, the extent of their underfunding, and the fiscal condition of their state sponsors. To test the model implications empirically, we create a new methodology for inferring funds’ risk from limited public information on their annual returns and portfolio weights for the interval 2002-2016. In order to better measure the extent of underfunding, we revalue funds’ liabilities using discount rates that better reflect their risk. In line with our model implications, we find that funds on average took more risk when risk-free rates were lower. This was the case especially for funds that were more underfunded or affiliated with state or municipal sponsors with weaker public finances. We estimate that up to one-third of the funds’ total risk was related to underfunding and low interest rates at the end of our sample period.

When Can the Market Identify Old News?

Anastassia Fedyk
,
University of California-Berkeley
James Hodson
,
Jozef Stefan Institute

Abstract

Why do investors react to old information? We provide survey evidence to experimentally document that active finance professionals are more susceptible to old information when it comes as a recombination of content from multiple sources. To evaluate the market implications of this mechanism, we exploit a comprehensive dataset of news passing through the Bloomberg terminal. Recombination of old information prompts larger price moves and subsequent reversals than direct reprints of old stories. Furthermore, while overall reactions to old information have declined over time, differential reactions to recombination stories have risen. Altogether, we document investors' increased sophistication in discarding simple reprints but continuing susceptibility to recombination of old information.
Discussant(s)
Chunhua Lan
,
University of New Brunswick
Lubos Pastor
,
University of Chicago
Daniel Barth
,
U.S. Office of Financial Research
Alan Huang
,
University of Waterloo
JEL Classifications
  • G1 - General Financial Markets