With a year of equity loans by a major lender, we measure the effect of actual short-selling costs and constraints on trading strategies that involve short-selling. We find the loans of initial public offering (IPOs), DotCom, large-cap, growth and low-momentum stocks to be cheap relative to the strategies' documented profits and that investors who can short only stocks that are cheap and easy to borrow can enjoy at least some of the profits of unconstrained investors. Most IPOs are loaned on their first settlement days and throughout their first months, and the underperformance around lockup expiration is significant even for the IPOs that are cheap and easy to borrow. The effect of short-selling frictions appears strongest in merger arbitrage. Acquirers' stock is expensive to borrow, especially when the acquirer is small, though the major influence on trading profits is not through expense but availability. Disciplines Finance | Finance and Financial ManagementThis journal article is available at ScholarlyCommonsWith a year of equity loans by a major lender, we measure the effect of actual shortselling costs and constraints on trading strategies that involve short-selling. We find that wholesale costs of equity loans for shorting IPO's, DotComs, large-cap, growth and lowmomentum stocks are small relative to the documented benefit, and that investors who can short only stocks that are cheap and easy to borrow can closely track the returns of unconstrained investors. Most IPO's are loaned on their first settlement days and throughout their first months, and the underperformance around lockup expiration is significant even for the subset of stocks that are cheap and easy to borrow. The effect of short-selling frictions appears strongest with merger arbitrage. Acquirers' stock is expensive to borrow, especially acquirers with small market capitalizations. The additional cost paid in merger arbitrage positions does not significantly affect profits, but the shortage of available issues reduces profits by more than half.
The literature documents a convex relation between past returns and fund flows of mutual funds. We show this to be consistent with fund incentives, because funds discard exactly those strategies which underperform. Past returns tell less about the future performance of funds which discard, so flows are less sensitive to them when they are poor. Our model predicts that strategy changes only occur after bad performance, and that bad performers who change strategy have dollar flow and future performance that are less sensitive to current performance than those that do not. Empirical tests support both predictions. Disciplines Finance | Finance and Financial ManagementThis journal article is available at ScholarlyCommons: http://repository.upenn.edu/fnce_papers/276 How Investors Interpret Past Fund ReturnsAnthony W. Lynch and David K. Musto * * Lynch is from New York University and NBER and Musto is from University of Pennsylvania. We are grateful for comments from Franklin Allen, Stephen Brown, Jennifer Carpenter, Doug Diamond, Ned Elton, Will Goetzmann, Gary Gorton, Bruce Grundy, Rudi Schadt, René Stulz, S. Viswanathan and participants in the Corporate Finance and Friday lunchtime seminars at Wharton, and also for research support from Dan Mingelgrin. Two anonymous referees get special thanks. How Investors Interpret Past Fund Returns ABSTRACTThe literature documents a convex relation between past returns and fund flows of
We present evidence that fund managers inflate quarter-end portfolio prices with last-minute purchases of stocks already held. The magnitude of price inflation ranges from 0.5 percent per year for large-cap funds to well over 2 percent for small-cap funds. We find that the cross section of inflation matches the cross section of incentives from the flow/performance relation, that a surge of trading in the quarter's last minutes coincides with a surge in equity prices, and that the inflation is greatest for the stocks held by funds with the most incentive to inflate, controlling for the stocks' size and performance. Leaning for the Tape: Evidence of Gaming Behavior In Equity Mutual Funds AbstractWe show that quarter-end prices of equity funds are inflated, presenting a large profit opportunity to potential sellers and an equivalent hazard to buyers and remaining shareholders. The magnitude of price inflation ranges from 50 basis points per year for large-cap funds to well over 200 basis points for small-cap funds. Evidence suggests that fund managers cause the inflation with last-minute purchases of stocks already held, deliberately moving performance to one period from the next. We find that the cross section of inflation matches the cross section of incentives from the flow/performance relation, that a surge of trading in the quarter's last minutes coincides with a surge in equity prices, and that the inflation is greatest for the stocks held by the funds with most incentive to inflate, controlling for the stocks' size and performance.
One reason why funds charge different prices to their investors is that they face different demand curves. One source of differentiation is asset retention: Performance-sensitive investors migrate from worse to better prospects, taking their performance sensitivity with them. In the cross-section we show that past attrition significantly influences the current pricing of retail but not institutional funds. In time-series we show that the repricing of retail funds after merging in new shareholders is predicted by the estimated effect on its demand curve. This result is robust to other influences on repricing, including asset and account-size changes.
Federal law mandates the removal of personal bankruptcies from credit reports after 10 years. The removal's effect is market efficiency in reverse. The short-term effect is a spurious boost in apparent creditworthiness, especially for the more creditworthy bankrupts, delivering a substantial increase in both credit scores and the number and aggregate limit of bank cards. The longer-term effect is lower scores and higher delinquency than initial full-information scores predict. These findings relate to both the debate over the bankruptcy code and the wisdom of influencing market clearing by removing information. Disciplines Finance and Financial ManagementThis journal article is available at
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