Jonathan B. Berk

Optimal Investment, Growth Options, and Security Returns

As a consequence of optimal investment choices, firms assets and growth options change in predictable ways. Using a dynamic model, we show that this imparts predictability to changes in a firms systematic risk, and its expected return. Simulations show that the model simultaneously reproduces: (i) the time series relation between the book-to-market ratio and asset returns, (ii) the cross-sectional relation between book to market, market value and return, (iii) contrarian effects at short horizons, (iv) momentum effects at longer horizons, and (v) the inverse relation between interest rates and the market risk premium.

Assessing Asset Pricing Models Using Revealed Preference

We propose a new method of testing asset pricing models that relies on using quantities rather than simply prices or returns. We use the capital flows into and out of mutual funds to infer which risk model investors use. We derive a simple test statistic that allows us to infer, from a set of candidate models, the model that is closest to the model that investors use in making their capital allocation decisions. Using our method, we assess the performance of the most commonly used asset pricing models in the literature.

Five Myths of Active Portfolio Management

Five myths are debunked here. It is not true that: the return investors earn in an actively managed fund measures the skill level of the manager; the average active manager is not skilled and therefore does not add value; if managers are skilled their returns should persist—they should be able to consistently beat the market; in light of evidence that there is little or no persistence in actively managed funds returns, investors who pick funds on the basis of past returns are not behaving rationally; and finally, because most active managers compensation does not depend on the return they generate, their compensation is not performance–based.

Matching Capital and Labor

We establish an important role for the firm by studying capital reallocation decisions of mutual fund firms. At least 30% of the value mutual fund managers add can be attributed to the firms role in efficiently allocating capital amongst its mutual fund managers. We find no evidence of a similar effect when a firm hires managers from another firm. We conclude that an important reason why firms exist is the private information that derives from the firms ability to better assess the skill of its own employees.

The Acquisition of Information in a Dynamic Market

SummaryThis paper models the information acquisition process in an intertemporal rational expectations framework. It demonstrates that equilibria do not generally exist in intertemporal economies in which agents are assumed to know the state-contingent price path and the information acquisition process is endogenous. In addition, an example of a fully revealing equilibrium in which agents pay a strictly positive amount for information is provided. Finally, we also show that it is possible for an equilibrium to exist in which agents choose to purchase information even if all agents, including the agents who purchased the information, are made strictly worse off by the purchase.

Active Managers are Skilled: On Average, They Add More Than

Active fund managers are skilled and, on average, have used their skill to generate about

3 Million Per Year

3.2 million per year. Large cross-sectional differences in skill persist for as long as 10 years. Investors recognize this skill and reward it by investing more capital in funds managed by better managers. These funds earn higher aggregate fees, and a strong positive correlation exists between current compensation and future performance.

Adjustable Rate Mortgages: Valuation

A simulation method is employed to value Adustable Rate Mortgages, (ARMS). It is used to price two typical instruments: an ARM linked to a Treasury interest rate and an ARM linked to a “Cost of Funds” Index. Contractual provisions such as the margin over the index, caps and floors on the ARMs rate or on the monthly prepayment, reset frequency, and the “teaser” rate are examined for their influence on value. The effects of interest rate trend and volatility are also analysed.

Mutual Funds in Equilibrium

Historically, the literature on money management has not consistently applied the rational expectations equilibrium concept. We explain why and summarize developments in the money management literature that do apply this concept correctly. We demonstrate that the rational expectations equilibrium approximates the observed equilibrium in the money management space at least as well as it does in the stock market. The puzzles that have plagued the earlier literature are a consequence of failing to apply the equilibrium concept correctly. Recent work reveals that there is little support for the common conclusion that, as a group, investors in the money management space are naive and that mutual fund managers are charlatans. Even today, equilibrium thinking is not nearly as prevalent in mutual fund research as it is in the rest of asset pricing. This state of play provides a multitude of opportunities for future research in the area.

Preparing a Referee Report: Guidelines and Perspectives

Peer review is fundamental to the efficacy of the scientific process. We draw from our experience both as editors, authors and association representatives to provide a set of guidelines for referees in preparing their reports and cover letters to journal editors. While our document is directed to anyone asked to review a paper, our suggestions are especially relevant for new members of the profession when preparing their first reports.The Appendix to this document contains a Checklist. The Checklist is also available here.Also see our companion paper, How to Write an Effective Referee Report and Improve the Scientific Review Process, which includes comments by former editors of economics and finance journals.