Stock Prices Under Pressure: How Tax and Interest Rates Drive Seasonal Variation in Expected Returns (with J. Kang, T. Pekkala, and C. Polk), link
ABSTRACT: We show that interest rates drive mispricing at the turn of a tax period as investors face the trade-off between selling a temporarily-depressed stock this period and selling next period at fundamental value, but with tax implications delayed accordingly. We confirm these patterns in US returns, volume, and individual selling behaviour as well as in UK data where tax and calendar years differ. At quarter-end, the trade-off is only present following recessions, consistent with the tax code. We then link a significant portion of the variation in the risks and abnormal returns of size, value, and momentum to tax-motivated trading.
Term Structure(s) of Equity Risk Premium (with L. Gomes), under revision
ABSTRACT: Using dividend and variance swap data simultaneously, we provide a series of novel facts on the term structure of equity risk premium. We also show the importance of another dimension of the term structure related to investment horizon and how the term structure changes over time. Moreover, we uncover new information on the level and variation of the term structure of the (physical) expectation of dividend growth. Among many facts, we show that: risk premium in increasing and concave on maturity; risk premium is also increasing and concave on investment horizon, but increases much faster than maturity; independently of maturity, most of the risk premium is associated with short-horizon risk premium; dividends are highly predictable once we account for time variation in the horizon term structure; and liquidity explains the high returns of dividend contracts and the term structure puzzle. Using both dimensions jointly highlights additional challenges to asset pricing models, but, unlike previous literature, we show that all these facts are consistent, for instance, with a long-run risk model with jump risks.
Dividend Factors and the Cross-Section of Stock Returns (with N. Doskov and T. Pekkala), under revision, link to old version
ABSTRACT: We propose a new set of tradable aggregate risk factors that help us understand the cross-section of stock returns. We argue that the true stochastic discount factor is a combination of aggregate return factors that drive equity market returns. Hence, we consider new factors using data such as market dividend swaps and market volatility futures. In the particular case of value and size portfolios, we find that differences in expected returns can be explained by a single-factor projection of the discount factor that loads only on a dividend growth return factor constructed with market dividend swap data. Hence, value and small capitalization stocks have higher expected returns due to their exposure to dividend growth returns implying that growth risks (dividend growth news and/or expected return news associated with dividend growth) are the only source of their risk premia. A tradable dividend level factor and a volatility-based factor are also priced in the cross-section of other stock portfolios sorted on dividend yield, earnings yield and cash-flow-to-price.
Gambling and Asset Pricing (with C. Carvalho, D. Cordeiro and E. Zilberman), link
ABSTRACT: A measure of the propensity to gamble in casinos constructed without any asset price data provides relevant information for asset pricing. It improves the fit of conditional asset pricing models such as the conditional CAPM, explains cross-sectional differences in future returns for portfolios sorted on various characteristics, and helps forecast market and portfolio excess returns out of sample. The relationship between risk appetite and asset prices appears to be mainly explained by simultaneous changes in risk and risk premia, but some results suggest that our measure may also capture changes in investor sentiment.
Sentiment, Electoral Uncertainty and Stock Prices (with C. Carvalho and E. Zilberman), link
ABSTRACT: We study the effect a huge sentiment shock, not related to economic conditions or government actions, on both political and stock market outcomes. To do so, we explore an empirical strategy that allows us to extract daily political news content from stock market data. Brazil's 7-1 humiliating defeat to Germany in the 2014 World Cup was perceived by financial market participants to lead to a substantial punishment against the incumbent candidate at the polls three months later. A long-short portfolio strategy aiming to profit from political developments against the incumbent had a 6.4 percent return after the 7-1 match, while the overall market was up by 1.7 percent. According to this metric, the 7-1 match was the third largest political development against the incumbent (and sixth overall) during the election period. Hence, the effect of a negative change in investor mood on stock prices may not be necessarily negative as found in the literature, whenever the change in mood also has an impact on the expected outcome of closely disputed general elections.
Work in Progress
Momentum, Impatience and Fund Flows (with M. Bonomo and N. Camanho)
Forecasting Large Realized Covariance Matrices (with M. Medeiros and D. Siebra)
Hedging Momentum Crashes (with M. Medeiros and D. Siebra)
Macroeconomic Announcements and Risk Premium (with V. Martelo)
Predicting Pockets of Predictability
High-Frequency Trading and Market Liquidity (with M. Bonomo)
Estimating Political Return Factors (with C. Carvalho and E. Zilberman)
Very Old Stuff
The Excess Comovement of International Stock Markets in Bad Times: A Rational Expectations Equilibrium Model (with P. Veronesi), 2002, link
ABSTRACT: We present an intertemporal, rational expectations equilibrium model where the cross-sectional covariances and correlations of international market returns increase during bad times, as a consequence of an endogenous increase in the uncertainty about the global economy. We assume that the drift rates of the fundamental processes of international economies are jointly affected by an unobservable global business cycle indicator. We show that as investors strive to learn the state of the global economy, their uncertainty fluctuate, thereby affecting the cross-covariances and correlations of asset returns. Excess comovement during bad times is so obtained as a reflection of higher uncertainty. When estimated with data on seven major countries, the model is able to replicate well the historical pattern of international average covariances and correlations.
Predictable Dividends and Returns , 2002
ABSTRACT: The conventional wisdom is that the aggregate stock price is predictable by the lagged price-dividend ratio, and that aggregate dividends follow approximately a random-walk. Contrary to this belief, this paper finds that variation in the aggregate dividends and price-dividend ratio is related to changes in expected dividend growth. The inclusion of labor income in a cointegrated vector autoregression with prices and dividends allows the identification of predictable variation in dividends. Most of the variation in the price-dividend ratio is due to changes in expected returns, but this paper shows that part of variation is related to transitory dividend growth shocks. Moreover, most of the variation in dividend growth can be attributed to these temporary changes in dividends. I also show that the price-dividend ratio (or dividend yield) can be constructed as the sum of two distinct, but correlated, variables that separately predict dividend growth and returns. One of these components, which could be called the expected return state variable, predicts returns better than the price-dividend ratio does.