Publications & Working Papers
Liquidity Components: Commonality in Liquidity, Underreaction, and Equity Returns at the Journal of Financial Markets(2022)
This paper decomposes firm-specific monthly-varying illiquidity into three components: (i) alpha, (ii) systematic, (iii) idiosyncratic. Investors demand a premium to hold stocks with high systematic illiquidity. However, systematic illiquidity premium disappears when very small stocks are excluded. On the other hand, investors tend to underreact to idiosyncratic (il)liquidity. Hence, stocks with high (low) idiosyncratic liquidity generate positive (negative) future risk-adjusted returns. More specifically, stocks in the highest idiosyncratic liquidity quintile generate 7% more annualized risk-adjusted return compared to stocks in the lowest idiosyncratic liquidity quintile.
Price of Regulations: Regulatory Costs and the Cross-section of Stock Returns with Han Ozsoylev (2022) R&R at the Review of Asset Pricing Studies(2022)
Regulations introduce significant fixed costs and add to operating leverage. Fixed regulatory costs that contribute to operating leverage should generate a risk premium. To explore whether such a premium exists, we introduce a measure of "regulatory operating leverage" that reflects the importance of fixed regulatory costs in a firm's cost structure. Regulatory operating leverage predicts stock returns in the cross-section, and a zero-cost high-low equal (value)-weighted regulatory operating leverage strategy generates 5.64% (5.28%) annualized risk-adjusted return. Finally, the impact of regulatory operating leverage on returns is due to the (systematic) risk contribution of fixed regulatory costs.
How Do Regulatory Costs Affect M&A Decisions and Outcomes? R&R at the Journal of Banking and Finance(2022)
Regulations introduce significant fixed costs and add to operating leverage. "Regulatory operating leverage", a measure of fixed regulatory costs, decreases a firm's value through implied cost of equity and profitability channels. Negative value implications of regulatory operating leverage motivate firms to decrease their regulatory cost exposure. One way to achieve this is to engage in M&A activities. Large (small) firms with high regulatory operating leverage are likely to make (receive) a bid to acquire (be acquired by) other firms within the same industry. In addition, regulatory operating leverage driven acquisitions are value increasing. Hence, regulatory operating leverage is an important factor in M&A decisions and outcomes.
While investors demand a premium to hold stocks with high illiquidity level and risk, they underreact to stock-level liquidity shocks and idiosyncratic liquidity. Built on Baker and Stein (2004) market liquidity model, this paper: (i) reports a significant relationship between market liquidity and investor sentiment, (ii) shows that market liquidity (illiquidity) negatively (positively) predicts subsequent market returns, (iii) provides market liquidity based explanation to the underreaction to liquidity shocks and idiosyncratic liquidity. Markets dominated by irrational sentiment-driven investors contribute significantly to the underreaction to liquidity shocks and idiosyncratic liquidity. As a result, a long-short liquidity shocks (idiosyncratic liquidity) strategy earns significantly high returns during abnormally liquid market states. On the other hand, the cross-sectional relationships between the liquidity measures and future stock returns weaken moving from abnormally liquid (positive sentiment) to illiquid (negative sentiment) market states.
This paper provides evidence to the importance of revisions in expected unemployment rate in the cross-sectional pricing of individual stocks. We introduce a measure of unemployment beta which quantifies monthly-varying stock sensitivity to the innovations in forecasted unemployment rate. Stocks in the lowest unemployment beta decile generate 7% more annualized risk-adjusted return compared to stocks in the highest unemployment beta decile. The unemployment premium is higher during low economic activity, high economic uncertainty, and high unemployment periods. The premium is robust to various regression specifications which account for various risk factors, and macroeconomic and financial variables. Finally, (labor) operating leverage is an important factor in the cross-sectional pricing of unemployment beta.
This paper investigates the importance of personal savings rate in the cross-sectional pricing of individual stocks. I estimate each stock's monthly-varying sensitivity to the personal savings rate and show that stocks in the lowest savings rate beta quintile generate 6% more annualized risk-adjusted return compared to stocks in the highest savings beta quintile. I find that the savings premium is driven by the outperformance (underperformance) of stocks with negative (positive) savings rate beta. These results are robust to controls for various firm-specific characteristics and risk factors. Moreover, the alpha spread between the highest and the lowest savings rate beta stocks increases during high economic uncertainty, low credit availability, and high income risk periods. Finally, the results are consistent with the risk correction predictions of the Consumption-CAPM literature.
Demand for Idiosyncratic Lottery-like Payoffs and the Cross-section of Expected Returns with Han Ozsoylev (2022)
Motivated by existing evidence of a preference among investors for stocks with high maximum daily returns, we document that daily extreme lottery-like payoffs measured by maximum daily returns are almost entirely idiosyncratic. Firm-level cross-sectional regressions and portfolio-sort analyses prove that there is a significant and negative relation between idiosyncratic maximum daily return (IMAX) and future stock returns. Retail investors tend to invest even further on high IMAX lottery-type stocks during high sentiment periods with loose funding liquidity constraints. Moreover, high market beta stocks are predominantly stocks that generate high idiosyncratic lottery-like payoffs. Hence, betting against beta phenomenon disappears when we control for IMAX.