Jacob S. Sagi

Predicting Risk from Financial Reports with Regression

We address a text regression problem: given a piece of text, predict a real-world continuous quantity associated with the texts meaning. In this work, the text is an SEC-mandated financial report published annually by a publicly-traded company, and the quantity to be predicted is volatility of stock returns, an empirical measure of financial risk. We apply well-known regression techniques to a large corpus of freely available financial reports, constructing regression models of volatility for the period following a report. Our models rival past volatility (a strong baseline) in predicting the target variable, and a single model that uses both can significantly outperform past volatility. Interestingly, our approach is more accurate for reports after the passage of the Sarbanes-Oxley Act of 2002, giving some evidence for the success of that legislation in making financial reports more informative.

Anchored Preference Relations

This note explores the implications of a simple and intuitive restriction on reference-dependent preferences assuming the status quo serves as the reference point. The condition imposed potentially rules out situations in which a decision maker has a choice between two prospects, selects one which subsequently becomes the new reference point, and then regrets her initial choice. It is shown that a surprising number of models in a riskless and risky setting violate this behavioral assumption, including Cumulative Prospect Theory as well as any theory exhibiting local non satiation in which all reference-dependent indifference surfaces are smooth. It is also shown that the condition does admit a class of non-trivial reference-dependent preferences.

THEORY OF NUCLEAR MAGNETIC RELAXATION IN HALDANE-GAP ANTIFERROMAGNETS

A theory of Nuclear Magnetic Resonance (NMR) is developed for integer-spin, one-dimensional antiferromagnets, which exhibit the Haldane gap. We consider free boson, free fermion and non-linear sigma model approaches, all of which give similar results. Detailed anisotropy and magnetic field dependence is calculated and compared with experiment.

An inequality measure for stochastic allocations

Few papers in the literature on inequality measurement deal with uncertainty, particularly when the ranking of cohorts may not be fixed. We present a set of axioms implying such a class of inequality measures under uncertainty that is a one-parameter extension of the generalized Gini mean over the distribution of average allocations. The extension consists of a quadratic term accounting for inter-personal correlations. In particular, our measure can simultaneously accommodate a preference for “shared destiny”, a preference for probabilistic mixtures over unfair allocations, and a preference for fairness “for sure” over fairness in expectation.

Information Content of Public Firm Disclosures and the Sarbanes-Oxley Act

We find evidence that public firm disclosure, in the form of Management Discussion and Analysis (Sections 7 and 7a of annual reports), is more informative about the firms future risk following the passage of the Sarbanes-Oxley Act of 2002. Employing a novel text regression, we are able to predict, out of sample, firm return volatility using the Management Discussion and Analysis section from annual 10-K reports (which contains forward-looking views of the management). Using the relative performance of the text model as a proxy for the informativeness of reports, we show that the MD&A sections are significantly more informative after the passage of SOX. We further show that this additional information is associated with a reduction in share illiquidity, suggesting that the information divulged was new to investors. Finally, we find that the increase in informativeness of MD&A reports is most pronounced for firms with higher costs of adverse selection.

Managed Distribution Policies in Closed-End Funds and Shareholder Activism

In closed-end funds, a managed distribution policy (MDP) is a dividend commitment potentially requiring the liquidation of assets. We argue that MDPs lower managerial claims on fund assets and, when the fund is at a discount, increase shareholder value. This transfer of wealth can be rationalized by managers wishing to deter a challenge from activist shareholders through a costly proxy vote. We find strong empirical evidence that managers respond to the presence of activists using MDPs, that MDPs constitute an effective wealth transfer to shareholders, and that activists are less likely to challenge management when an MDP is in place.

Monopole-catalysed baryon decay: A boundary conformal field theory approach

Abstract Monopole-mediated baryon-number violation, the Callan-Rubakov effect, is reexamined using boundary conformal field theory techniques. It is shown that the low energy behaviour is described simply by free fermions with a conformally invariant boundary condition at the dyon location. When the number of fermion flavours is greater than two, this boundary condition is of a non-trivial type which has not been elucidated previously.

You Need to Recognize Ambiguity to Avoid it

We study the influence of attention and comprehension on ambiguity attitudes. Subjects are presented with screening questions before choosing between two alternatives represented by payoff-matrices which are essentially equivalent to those in Ellsberg’s (1961) two-urn problem. The observed rate of ambiguity aversion for the standard two-urn problem is similar to what is reported in the literature regardless of the level of comprehension. When facing the essentially equivalent yet more complex matrix-based choice task, high-comprehension subjects continue to exhibit ambiguity aversion typical of the standard two-urn problem while low-comprehension subjects appear to behave randomly. We also classify subjects as “probability minded” or “ambiguity minded” based on whether they assign probabilities to draws from a deck of cards with unknown composition during the screening phase. High-comprehension subjects who are ambiguity-minded are far more likely to be ambiguity averse than those who are probability-minded. Significantly, subject “mindedness” appears to explain ambiguity attitudes an order of magnitude more than all other demographic characteristics combined. Contrary to intuition about subjects’ sophistication, ambiguity-minded high-comprehension subjects are younger, more educated, more analytic, and more reflective about their choices compared with their probability-minded counterparts.

Asset-Level Risk and Return in Real Estate Investments

Relatively little is known in the academic literature about the idiosyncratic returns of individual real estate investments, though quite a few commercial properties command prices commensurate with the market values of small publicly traded companies. I use purchase and sale data from the National Council of Real Estate Investment Fiduciaries (NCREIF) to compute holding period price appreciation returns for commercial properties. In stark contrast with liquid asset returns, idiosyncratic drift and volatility estimates diverge as the holding period shrinks. This puzzling phenomenon survives a variety of controls for vintage effects, systematic risk heterogeneity, and sample selection biases. I derive an equilibrium search-based illiquid asset pricing model which, when calibrated, fits the data very well. Thus a structural model of illiquidity seems crucial to a descriptive theory of real estate investment returns. These insights can potentially be extended to other illiquid asset classes such as private equity, mergers and acquisitions, large whole loans, and other real assets. The model can also be used to price derivatives such as debt claims.

A Neoclassical Model of Managed Distribution Plans: Theory and Evidence

Jensen (1986) identifies the need to motivate managers to distribute funds that earn a ‘below-market’ rate of return as a major problem in corporate finance. Equity closed-end funds (CEFs) provide an example of how capital markets perform this function. CEFs exist to provide investors with portfolio services that investors cannot easily obtain on their own (e.g., liquidity or superior stock picking ability). When a fund does not convincingly provide these services, it trades at a discount to its net asset value (NAV) because managerial compensation is larger than managerial contribution. A Managed Distribution Plan (MDP), where investments might be partially liquidated to increase investors’ cash flows, lowers the value of the manager’s claim on the assets of the fund. This is a direct transfer of wealth from the manager to the shareholders a la Jensen, and will be adopted by managers who fear an eventual liquidation of the fund via a proxy vote. We model the threat of such liquidation through the intermediation of an activist shareholder. Among other things, our model predicts that MDPs are more likely to be adopted by funds that appear to be less effective in providing portfolio services to their investors and that are relatively easy to liquidate or ‘attack’. We test the model on a panel of 236 CEFs and find good agreement with our model.