Three Chapters on Investments and Financial Institutions
Only the stock selection (“alpha”) decisions of fund managers who trade on firm-specific information should have predictive return content. Faced with the same information, skilled fund managers make similar stock selection decisions. In Chapter one, we introduce a new measure - stock investment quality - which uses fund quality to weight asymmetries in private information reflected in deviations of fund from peer group ownership on stocks in a style segment. We show stocks ranked high on investment quality generate significantly higher excess returns that persist through the ensuing year. The positive investment quality–future return relationship is robust to alternative fund quality proxies. In Chapter two, we use fund flow shocks from exogenous changes in ETF share demand to quantify the cost of trading stocks purchased or sold by APs in conjunction with the creation or redemption of ETF shares. We document a negative relation between return and the impact of primary market activities of APs on the liquidity of ETF-owned stocks. The stock-specific liquidity effect cannot be attributed to systematic asset pricing factors. Further, we find the improvements in liquidity from the primary market activities of APs enhance price discovery and strengthen the stock return-volatility relation. In Chapter three, we develop a top-down macro stress test that assesses a community bank’s ability to withstand a severe and prolonged period of high credit losses. The model groups banks by geography and subjects them to the 90th percentile chargeoff rates that banks experienced between 2008 and 2012. Because of local data limitations, our historical loss approach better reflects patterns of community bank stress than a linear econometric approach that estimates the relationship between macroeconomic conditions and bank performance. We put all U.S. community banks at year-end 2017 through the test and highlight two results. First, banks are much better prepared to withstand an adverse shock than they were on the verge of the financial crisis because banks haveshifted away from the riskiest loan types. Second, the Tax Cuts and Jobs Act of 2017 has increased bank insolvency risk from an adverse shock in 2018 because the higher bank capital is more than offset by the weaker automatic stabilizer effect from operating losses.
Asset Pricing, Banking, Community Banks, Institutional Investors, Investments, Finance, Finance and Financial Management
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