Friday, Jan. 4, 2019 2:30 PM - 4:30 PM
- Chair: Zhiguo He, University of Chicago
The Dark Side of Liquid Bonds in Fire Sales
AbstractWe investigate which bonds institutional investors sell in fire sales. We find that these are mostly bonds that were trading in liquid markets before the fire sale, and that they are sold by other institutions as well. Somewhat surprisingly, the price impacts in these markets are higher than in bonds that were trading in less liquid markets before the fire sale, but are also liquidated during fire sales. It appears as if liquid bonds in fire-sales exhibit larger price impacts than less liquid bonds. We argue this is because institutions fail to fully account for the effect of selling common bonds on other market participants. Controlling for commonality of bonds, we find that liquid bonds have smaller price impacts in fire sales. This result matters for the measurement of systemic risk: the commonality of liquid bonds exacerbates fire sales losses, as they are sold more in fire sales. Measures of portfolio similarity should thus overweight liquid bonds overlap, not underweight it.
AbstractUsing a novel sample of professional asset managers, we document positive incremental alpha on newly purchased stocks that decays over twelve months. While managers are successful forecasters at these short-to-medium horizons, their average holding period is substantially longer (2.2 years). Both slow alpha decay and the horizon mismatch can be explained by strategic trading behavior. Managers accumulate positions gradually and unwind gradually once the alpha has run out; they trade more aggressively when the number of competitors and/or correlation among information signals is high, and do not increase trade size after unexpected capital flows. Alphas are lower when competition/correlation increases.
- G1 - General Financial Markets