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Asset Pricing Program Meeting.

The NBER'S Asset Pricing Program met in Chicago on April 25. Hanno Lustig, University of California, Los Angeles and NBER, and Monika Piazzesi, University of Chicago, organized the meeting. These papers were discussed:

Zhi Da and Pengjie Gao, University of Notre Dame, and Ravi Jagannathan, Northwestern University and NBER, "When Does A Mutual Fund's Trade Reveal its Skill?"

Discussant: Jonathan Berk, University of California, Berkeley and NBER

Rui Albuquerque and Jianjun Miao, Boston University, "Advance Information and Asset Prices"

Discussant: Snehal Banerjee, Northwestern University

Zhiguo He and Arvind Krishnamurthy, Northwestern University, "Intermediary Asset Pricing"

Discussant: Stavros Panageas, University of Pennsylvania

Christine A. Parlour and Johan Walden, University of California, Berkeley, "Capital, Contracts, and the Cross Section of Stock Returns"

Discussant: Adriano Rampini, Duke University

Pedro Santa-Clara, University of California, Los Angeles and NBER, and Shu Yan, University of South Carolina, "Crashes, Volatility, and the Equity Premium: Lessons from the S&P 500 Options"

Discussant: Ravi Bansal, Duke University and NBER

John H. Coehrane University of Chicago and NBER, "A Mean-Variance Benchmark for Intertemporat Portfolio Theory"

Discussant: Stanley Zin, Carnegie Mellon University and NBER

Da, Gao, and Jagannathan conjecture that a mutual fund manager with superior stock selection ability is more likely to benefit from trading in stocks affected by information-events. Taking the probability of informed trading (PIN, Easley, Kiefer, O'Hara, and Paperman, 1996) to measure the amount of informed trading in a stock, and inferring mutual fund trades from a large sample of mutual fund holdings, the authors provide empirical support for the conjecture. Funds trading high-PIN stocks exhibit superior performance on average, and superior performance that is more likely to persist. The findings are not attributable to price momentum or the higher returns earned by high-PIN stocks on average. The conclusions remain the same after testing for alternative measures for the amount of informed trading. Decomposing a fund's stock selection ability into "informed trading" and "liquidity provision" adds further insight into fund's underlying strengths. Impatient informed trading is a significant source of alpha for funds trading high-PIN stocks, while liquidity provision is more important as a source of alpha for funds trading low-PIN stocks.

Albuquerque and Miao provide an explanation for momentum and reversal in stock returns within a rational expectations equilibrium framework in which investors are heterogeneous in their information and investment opportunities. The authors assume that informed investors privately receive advance information about company earnings that materializes into the future. This information is immediately incorporated into prices, and thus stock prices may move in ways unrelated to current fundamentals. Investors' speculative and rebalancing trades in response to advance information generate short-run momentum, mimicking an underreaction pattern. When this information materializes, the stock price reverts back to its long-run mean, mimicking an overreaction pattern.

He and Krishnamurthy present an equilibrium asset pricing model in which intermediaries are marginal in setting prices. The intermediaries modeled are hedge funds, mutual funds, banks, or insurance companies. The authors calibrate the model to a hedge fund crisis episode where parameters are chosen so that the marginal investor resembles a hedge fund with leverage. The researchers are able to qualitatively and quantitatively match the behavior of risk premia and interest rates in a financial crisis. Moreover, their model captures the slow mobility of capital during a crisis and can replicate observed crisis recovery times. They also calibrate their model to a broad intermediation scenario where parameters are chosen so that the marginal investor is an amalgam of the intermediaries we observe in practice. They show that the intermediation effects help to generate a volatile pricing kernel and a market risk premium matching the empirically observed equity premium.

Parlour and Walden present a tractable, static, general equilibrium model with multiple sectors in which firms offer workers incentive contracts and simultaneously raise capital in stock markets. Workers optimally invest in the stock market and at the same time hedge labor income risk. Firms rationally take agents' portfolio decisions into account. In equilibrium, the cost of capital of each sector is endogenous. The authors compare the first-best, in which workers' effort levels are observable, to an economy in which workers' effort is observed with noise. In the presence of moral hazard, the CAPM fails because firms, by choosing optimal incentive contracts, transfer risk both through wages and through the stock market. This leads to several cross-sectional asset pricing "anomalies," such as size and value effects. As the researchers characterize optimal contracts, they present empirical predictions relating workers' compensation, firm productivity, firm size and financial market abnormal returns. They also demonstrate some general equilibrium implications of endogenous contracts; for example the ex-ante value of human capital can be higher in an economy with moral hazard.

Santa-Clara and Yan use a novel pricing model to imply times series of diffusive volatility and jump intensity from S&P 500 index options. These two measures capture the ex-ante risk assessed by investors. The researchers find that both components of risk vary substantially over time, are quite persistent, and correlate with each other and with the stock index. Using a simple general equilibrium model with a representative investor, they trans late the implied measures of ex-ante risk into an ex-ante risk premium. They find that the average premium that compensates the investor for the ex-ante risks implicit in option prices, 11.8 percent, is more than 70 percent higher than the premium required to compensate the same investor for the realized volatility, 6.8 percent. Moreover, the ex-ante equity premium that they uncover is highly volatile, with values between 0.3 and 54.9 percent. The component of the premium that corresponds to jump risk varies between zero and 45.4 percent. The equity premium implied from option prices significantly predicts subsequent stock market returns.

Cochrane notes that by reinterpreting the symbols, one-period mean-variance portfolio theory can apply to dynamic intertemporal problems in incomplete markets, with non-marketed income. Investors first hedge non-traded income and preference shocks. Then, their optimal payoffs are split between an indexed perpetuity and a "long-run mean-variance efficient" payoff, which avoids variation over time as well as variation across states of nature. In equilibrium, the market payoff and the average outside-income hedge payoff span the long-run mean-variance frontier, and long-run expected returns are linear functions of long-run market and outside income-hedge betas. State variables for investment opportunities and outside income are conveniently absent in these characterizations.
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Title Annotation:Program and Working Group Meetings; National Bureau of Economic Research
Publication:NBER Reporter
Article Type:Conference news
Geographic Code:1USA
Date:Jun 22, 2008
Previous Article:Science of Science Day.
Next Article:Corporate Finance.

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