No abstract

I study the dynamics of investor cash flows in socially responsible mutual funds. Consistent with anecdotal evidence of loyalty, the monthly volatility of investor cash flows is lower in socially responsible funds than in conventional funds. I find strong evidence that cash flows into socially responsible funds are more sensitive to lagged positive returns than cash flows into conventional funds, and weaker evidence that cash outflows from socially responsible funds are less sensitive to lagged negative returns. These results indicate that investors derive utility from the socially responsible attribute, especially when returns are positive.

No abstract

Existing studies of mutual fund market timing analyze monthly returns and find little evidence of timing ability. We show that daily tests are more powerful and that mutual funds exhibit significant timing ability more often in daily tests than in monthly tests. We construct a set of synthetic fund returns in order to control for spurious results. The daily timing coefficients of the majority of funds are significantly different from their synthetic counterparts. These results suggest that mutual funds may possess more timing ability than previously documented.

This paper examines the relation between net buying pressure and the shape of the implied volatility function (IVF) for index and individual stock options. We find that changes in implied volatility are directly related to net buying pressure from public order f low. We also find that changes in implied volatility of S&P 500 options are most strongly affected by buying pressure for index puts, while changes in implied volatility of stock options are dominated by call option demand. Simulated delta-neutral optionwriting trading strategies generate abnormal returns that match the deviations of the IVFs above realized historical return volatilities.If people are willing to pay foolish prices for insurance, why shouldn't we sell it to them? (Lowenstein (2000)).ONE OF THE MOST INTRIGUING ANOMALIES REPORTED in the derivatives literature is the "implied volatility smile." The name arose from the fact that, prior to the October 1987 market crash, the relation between the Black and Scholes (1973) implied volatility of S&P 500 index options and exercise price gave the appearance of a smile. Since October 1987, however, the index implied volatility function (hereafter, IVF), as we refer to it, decreases monotonically across exercise prices. Under the assumptions of the Black-Scholes model, the IVF should be f lat and constant through time.Most attempts to explain the shape of the IVF focus on relaxing the BlackScholes assumption of constant volatility by allowing the local volatility rate of underlying security returns to evolve either deterministically or stochastically through time. Emanuel and MacBeth (1982) examine the power of the deterministic Cox and Ross (1976) constant elasticity of variance (CEV) model to explain the cross-sectional distribution of stock option prices. With its additional degree of freedom, the CEV model (necessarily) fits the observed structure of option prices better than the Black-Scholes constant volatility model. Out of sample, however, Emanuel and MacBeth conclude that the CEV model does * Owen Graduate School of Management, Vanderbilt University and Fuqua School of Business, Duke University. We gratefully acknowledge the comments/assistance of Cliff Ball, Alon Brav, Mike Lemmon, Joseph Levin, Joshua Rosenberg, Eileen Smith, Tom Smith and seminar participants at Vanderbilt University, Nashville, TN, and the 2003 American Finance Association meetings, Washington, D.C. We are especially grateful to an anonymous referee for providing many useful and insightful comments and suggestions. 712The Journal of Finance no better than the Black-Scholes model. Similarly, the implied binomial tree framework of Dupire (1994), Derman andKani (1994), andRubinstein (1994) offers a deterministic local volatility structure so f lexible that, in sample, it can describe the cross-section of options prices exactly at any point in time. 1 Empirical tests by Dumas, Fleming, and Whaley (1998), however, show that a model based on a simple deterministic volatility structure has parameters that are highly ...

We find a significant discontinuity in the pooled distribution of reported hedge fund returns: the number of small gains far exceeds the number of small losses. The discontinuity is present in live funds, defunct funds, and funds of all ages, suggesting that it is not caused by database biases. The discontinuity is absent in the three months culminating in an audit, funds that invest in liquid assets, and hedge fund risk factors, suggesting that it is generated neither by the skill of managers to avoid losses nor by nonlinearities in hedge fund asset returns. A remaining explanation is that hedge fund managers avoid reporting losses to attract and retain investors.Hedge funds are currently attracting a great deal of attention from investors, academics, and regulators for a number of reasons, but primarily due to the returns that hedge fund managers report. Investors want to share in the riches, academics want to understand the underlying risk factors, and regulators are concerned about the potential for fraud. Some members of the SEC support additional regulation of hedge funds, and championed an amendment to the Investment Advisors Act to force more hedge fund managers to register.1 Others argue that the low number of hedge fund fraud cases indicates that there is no need for greater oversight. 2 Though the number of fraud cases is modest, violations of the law may be widespread but undetected. In particular, the discretion with which managers voluntarily submit returns to databases may permit purposeful misreporting to attract and retain investors. We conduct a simple test for misreporting that measures discontinuities in the pooled cross-sectional, time series distribution of monthly hedge fund returns. In particular, we examine the histogram of returns to determine whether certain categories, e.g. those just below zero, appear systematically underrepresented. Our analytical framework has been used in prior research linking asymmetric incentives around a fixed hurdle with breakpoints in the empirical distribution of an outcome. Examples include the frequency of corporate earnings just below and just above zero (Burgstahler and Dichev (1997)), the winning percentage of sumo wrestlers in critical bouts (Duggan and Levitt (2002)), and the ability of management to sponsor shareholder resolutions that receive just enough votes for approval (Listokin (2007)). Our test is also related to Abdulali's (2006) bias ratio, which compares the number of positive returns to the number of negative returns within one standard deviation of zero. 4 An unusually high bias ratio is suggestive of manipulated returns, although it is unclear what levels are expected under the null hypothesis of distortion-free returns. In contrast, the null hypothesis for our test is based on the simple assumption that the distribution of returns is smooth. returns. The interpretation in both papers that incentives lead to performance relies on the assumption that some managers are skillful. The classic method of distinguishing luck from ski...

No abstract

In this paper, I develop an option valuation framework that explicitly incorporates a product life cycle. I then use the framework to value the real option to change a project's capacity. Standard techniques for valuing real options typically ignore product life cycle models and specify instead a constant expected growth rate for demand or price. I show that this specification can lead to significant error in the valuation of capacity options. In particular, the standard technique tends to undervalue the option to contract capacity and overvalue the option to expand capacity. This result has important implications for capital investment decisions, especially in high-technology industries that feature regular introductions of newly improved products.real option, product life cycle, contingent claim