Blake Phillips

Price Inflation and Wealth Transfer During the 2008 SEC Short-Sale Ban

Using a factor-analytic model that extracts common valuation information from the prices of stocks that were not banned, we estimate that the ban on short-selling financial stocks imposed by the SEC in September 2008 led to substantial price inflation in the banned stocks. The inflation reversed somewhat following the ban, but the data are too noisy to conclusively link the reversal to the ban. Other factors such as the pending TARP legislation may also have affected prices, though our results suggest that it was not a significant factor. If prices were inflated, buyers paid more than they otherwise would have paid for the banned stocks during the period of the ban. We provide an estimate of

The wisdom of crowds: Mutual fund investors’ aggregate asset allocation decisions

4.9 billion for the resulting wealth transfer from buyers to sellers. Such transfers should interest policymakers concerned about maintaining fair markets.

Credit Default Swaps and the Market for Sovereign Debt

We find that the aggregate asset allocation decisions of US mutual fund investors depend on economic conditions. Both anticipated economic downturns and periods of turmoil lead investors to direct flow away from risky equity funds and towards lower-risk money market funds. These patterns are markedly stronger for investors in low cost and low turnover funds relative to investors in high cost and high turnover funds, consistent with sophisticated investors being more sensitive to changing conditions. Benchmarked against a buy-and-hold strategy, these asset allocation strategies reduce risk without degrading the risk-return trade-off. Our evidence suggests that individual investors, often dismissed as noise traders, collectively react to economic signals in a sensible manner when determining asset allocations.

Past Performance May Be an Illusion: Performance, Flows, and Fees in Mutual Funds

This paper analyzes the determinants and effect of credit default swap (CDS) trading initiation on sovereign bonds in 54 countries, focusing on market completeness, price efficiency and borrowing costs. We find that CDS initiation enhances market completeness in the majority of countries in our sample. Our results suggest that for high default risk and low financial openness countries, CDS initiation provides significant price efficiency benefits in the underlying market. In addition, we find that CDS initiation reduces risk premiums to investment-grade sovereigns while increasing borrowing costs for sub-investment-grade economies. CDS trading initiation is more likely following increases in local stock index volatility and the volatility risk premium and decreases in foreign currency reserves and the local currency exchange rate with the USD. Our results are robust to CDS initiation endogeneity controls constructed with these factors.

Do Hedge Funds Dynamically Manage Systematic Risk

Mutual funds report performance in the form of a holding period return (HPR) over standardized horizons. Changes in HPRs are equally influenced by new and previously reported stale returns which enter and exit the horizon. Investors appear unable to differentiate between the joint determinants, reacting with equal strength to both signals. Stale performance chasing is amplified for funds which promote performance via advertising and is more pronounced during periods of uncertainty in financial markets. Fund managers exploit this behavior by preferentially timing fee increases to align with periods of heightened investor demand resulting from stale performance chasing.

Detecting Superior Mutual Fund Managers: Evidence from Copycats

Defining systematic risk management (SRM) skill as persistently low fund systematic risk, we find evidence of time varying allocation of hedge fund management effort across the business cycle. In weak market states, skilled managers focus on minimization of systematic risk via dynamic reallocations across asset classes at the cost of fund alpha and foregoing market timing opportunities. As markets strengthen, attention shifts to asset selection within consistent asset classes. The superior performance of low systematic risk funds previously documented arises due to the superior asset selection ability of managers in strong market states. Incremental allocations by investors arise due to this superior performance and not due to recognition of SRM skill.

Economic Conditions, Flight-to-Quality and Mutual Fund Flow

We examine the ex ante ability of investors to identify superior mutual fund managers among the investor set likely most able, and with the greatest incentive to do so, their rivals. Identifying actual copycat funds via comparisons of trading in consecutive periods, we find little evidence to suggest that managers are able to detect superior funds. Copycats select funds with high prior performance and investment inflows, and the performance of the target fund reverses following copying initiation. If superior managers exist, our results suggest that the source of skill lies in private information obtained by these managers. These results are consistent with information models indicating that private, but not public, information can be profitable.

Options, short-sale constraints and market efficiency: A new perspective.

We study the effects of economic conditions and destabilizing events on the aggregate asset allocations of mutual fund investors. In the universe of U.S. mutual funds between 1991 and 2008, we find that excess flow is consistently related to proxies for economic conditions. An expected improvement in economic conditions causes investors to direct flow away from relatively safe money market funds and towards riskier equity funds. Around major crises, we find evidence of flight-to-quality, that is, significant flow into money market funds and out of equity funds. The same patterns exist in the population of Canadian mutual funds. Flow for low fee or low turnover funds, likely to be held by sophisticated investors, shows a sharper reaction to economic conditions and crises. Consistent with these allocations being a response to economic conditions, we find that high money market flow is associated with high T-bill returns, and that this association weakens once we control for economic conditions. We estimate that investors with moderate to high levels of risk aversion receive higher utility by switching between money market and equity funds in anticipation of changes in economic conditions, relative to a buy-and-hold strategy in equities.