Information-based Explanation Research Articles

Foreign bias in institutional portfolio allocation: The role of social trust

Foreign bias in institutional portfolio allocation: The role of social trust

Rate-Distortion-Based Stego: A Large-Capacity Secure Steganography Scheme for Hiding Digital Images.

Steganography is one of the most crucial methods for information hiding, which embeds secret data on an ordinary file or a cover message for avoiding detection. We designed a novel rate-distortion-based large-capacity secure steganographic system, called rate-distortion-based Stego (RD-Stego), to effectively solve the above requirement. The considered effectiveness of our system design includes embedding capacity, adaptability to chosen cover attacks, and the stability of the trained model. The proposed stego scheme can hide multiple three-channel color images and QR codes within another three-channel color image with low visual distortion. Empirically, with a certain degree of robustness against the chosen cover attack, we state that the system offers up to 192+ bits-per-pixel (bpp) embedding of a payload and leaks no secret-related information. Moreover, to provide theoretical foundations for our cost function design, a mutual information-based explanation of the choices of regulation processes is herein included. Finally, we justify our system’s claimed advantages through a series of experiments with publicly available benchmark datasets.

The Role of Leveraged ETFs and Option Market Imbalances on End-of-Day Price Dynamics

Leveraged ETFs and market makers who are active in option markets must ad-just imbalances arising from market movements. Establishing delta-neutrality may cause either return momentum or reversal depending on the sign and size of the imbalance vis-a-vis market prevailing liquidity. We find that a large and negative (positive) aggregated gamma imbalance, relative to the average dollar volume, gives rise to an economically and statistically significant end-of-day momentum (rever-sal). We compare this channel to the rebalancing of leveraged ETFs and find that the effect generated by leveraged ETFs is economically larger. Consistent with the notion of temporary price pressure, the documented effects quickly revert at the next day’s open. Information-based explanations are unlikely to cause the results, suggesting a non-informational channel through which leveraged ETFs and option markets affect underlying stocks towards the market close.

Institutional Trading around FOMC Meetings: Evidence of Fed Leaks

Using detailed institutional transaction records from Ancerno, I find evidence consistent with informed trading on the days before the Federal Open Market Committee (FOMC) scheduled announcements. The institutional trading imbalances on highly exposed stocks are in the direction of the subsequent monetary policy surprises. On the three days before a 1% surprise rate increase, the institutional trading imbalance is 27.7% higher for high-MPE stocks as compared to low-MPE stocks. This result is particularly strong before easing monetary policy shocks - when the aggregate market reaction is positive -, for the most-active traders and the hedge fund management companies, and for the US institutions that are headquartered close to one of the regional reserve banks. It holds throughout the Ancerno's sample, from 1999 to 2014. Overall, these findings are consistent with a hypothesis of a systematic informal communication of Fed officials with the financial sector, provide an additional channel through which institutions make abnormal profits from their intra-quarter trades, and contribute to an information-based explanation of the pre-FOMC drift.

Can Concrete Language Help to Mitigate the Home Bias in Equity Investing? An Extension of Elliott, Rennekamp, and White (2015)

ABSTRACT Research by Elliott, Rennekamp, and White (2015; hereafter, ERW) finds that highlighting concrete rather than abstract language in a disclosure can mitigate investors' local bias (i.e., the tendency to favor domestic firms headquartered closer to an investor), particularly when a firm feels more psychologically distant. This paper extends ERW to examine the effects of highlighting concrete language on home bias (i.e., the tendency to favor domestic over foreign firms), given that there are a number of information-based explanations for home bias that differ from explanations for local bias. We predict and find that highlighting concrete language in disclosures increases willingness to invest in foreign firms, consistent with the idea that home bias is driven, in part, by non-information-based psychological distance. Our paper addresses calls for more replication, provides convergent evidence on the results in ERW, and suggests a tool—highlighting concrete language—that firms can use to attract foreign investors. Data Availability: Data are available from the authors upon request.

Earnings notifications, investor attention, and the earnings announcement premium

Abstract This paper provides new evidence that investor attention explains positive returns around earnings announcements and reconciles the attention explanation with information-based explanations in the literature. I use earnings notifications, which are attention-grabbing announcements of the upcoming earnings date but otherwise provide little new information. I find positive returns, more EDGAR searches, and higher trading volumes on notification days. I also find that attention and returns around the earnings announcement are lower in the presence of notifications, consistent with notifications attenuating investor attention. I show that attention has its strongest effect on returns in the days immediately following the earnings announcement.

Lobbying on Regulatory Enforcement Actions: Evidence from Banking

This paper analyzes the relationship between bank lobbying and supervisory decisions of regulators, and documents its moral hazard implications. Exploiting bank-level information on the universe of commercial and savings banks in the United States, I find that regulators are less likely to initiate enforcement actions against lobbying banks. In addition, I show that lobbying banks are riskier and reliably underperform their non-lobbying peers. Overall, these results appear rather inconsistent with an information-based explanation of bank lobbying, but consistent with the theory of regulatory capture.

Informed Trading, Forced Trades and Amplification Mechanisms

We analyze non-fundamental asset price deviations and their evolutions, and propose a rational, information-based explanation to them when traders are exposed to forced-trades (e.g. fire-sales, fire-purchases). The first objective of this study is to provide a generalized, information-based framework for examining various types of asset price deviations stemming from traders' funding constraints. We do so within an information-setting that allows a second dimension of uncertainty (in the fraction of forced-trades, in addition to the one in the asset value). Our model predicts under-(over-) shooting in the prices when the fraction of unobserved fire-sales is initially under-(over-) estimated by the market maker. Second, using this framework, our study explains persistent price deviations (e.g. crashes) following high-leverage periods, by dynamically modeling the mechanism producing the forced-trades via margin calls that arise due to adverse price changes over time. We demonstrate within this dynamic set-up that, when the constrained traders are the informed traders, rather than the uninformed traders, then due to an informational positive feedback mechanism the mispricing exhibits persistence, as opposed to reversal (correction). Finally, we discuss policy issues that could mitigate the destabilizing effects of forced trades.

Lobbying on Regulatory Enforcement Actions: Evidence from Banking

There is growing concern, but still little systematic evidence, about the incidence and drivers of lobbying efforts made by the U.S. banking industry. This paper documents the relationships between lobbying, regulatory oversight, and bank risk taking. Using a large sample of commercial and savings banks, I find that lobbying banks are less likely to be subject to a severe enforcement action, suggesting that banks engage in lobbying to gain preferential treatment. Among the lobbying dimensions studied, lobbyists with prior employment in public offices are more effective at reducing the probability of an action, especially in period of intense enforcement activity. These findings are robust to controlling for supervisory ratings and account for endogeneity concerns by employing instrumental variables strategies. I also show an increase in default and credit risk at lobbying banks. Overall, these results appear rather inconsistent with an information-based explanation of bank lobbying, but consistent with the capture theory of regulation.

Lobbying on Regulatory Enforcement Actions: Evidence from U.S. Commercial and Savings Banks

This paper analyzes the relationship between bank lobbying and supervisory decisions of regulators and documents its moral hazard implications. Exploiting bank-level information on the universe of commercial and savings banks in the United States, I find that regulators are 44.7% less likely to initiate enforcement actions against lobbying banks. This result is robust across measures of lobbying and accounts for endogeneity concerns by employing instrumental variables strategies. In addition, I show that lobbying banks are riskier and reliably underperform their nonlobbying peers. Overall, these results appear rather inconsistent with an information-based explanation of bank lobbying, but consistent with the theory of regulatory capture.This paper was accepted by Amit Seru, finance.

Insider trading and firm-specific return volatility

Roll (J Financ 43:541–566, 1988) argues that firm-specific stock return volatility may result either from informed trading or from noise trading that is unrelated to information. In this paper we provide evidence that insider purchases are inversely related to the idiosyncratic volatility of stocks. We also find that stock idiosyncratic volatilities are generally inversely related to future 6- and 12-month returns. Our results are primarily driven by the timing of insider sales rather than insider purchases. The results are consistent with an information-based explanation of firm-specific return volatility.

Do Portfolio Distortions Reflect Superior Information or Psychological Biases?

AbstractUsing a demographics-based proxy for smartness, we show that the portfolio distortions of “smart” investors reflect an informational advantage, while the distortions of “dumb” investors reflect psychological biases. Specifically, smart investors outperform dumb investors by about 3% annually on a risk-adjusted basis. Furthermore, among investors with high portfolio distortions, smart investors outperform passive benchmarks by 2%, and the smart-dumb performance differential is 5%. At the stock level, a portfolio of stocks with smart investor clientele outperforms the dumb clientele portfolio by 3.50% annually. These findings suggest that behavioral and information-based explanations for portfolio distortions apply to distinct subsets of investors.

Contagious Bank Runs: Experimental Evidence

We conduct a laboratory experiment to examine under which circumstances a depositor-run at one bank may lead to a depositor-run at another bank. We implement two-person coordination games which capture the essence of the Diamond-Dybvig (1983) bank-run model. Subjects in the roles of followers observe the deposit withdrawal decisions of leaders before they make their own deposit withdrawal decisions. In one treatment followers know that there are no economic linkages between the leaders' and the followers' banks. In a second treatment followers know that there are economic linkages between the leaders' and the followers' banks. Our results suggest that deposit withdrawals are strongly contagious across banks only when depositors know that there are economic linkages between banks'. The contagion of withdrawals is by a change in beliefs about bank asset quality and in beliefs about the behavior of other depositors, with the latter channel being more pronounced. Our results reconcile panic-based and information-based explanations of bank runs.

Betting Markets Efficiency: Evidence from European Football

This paper uses data from up to 79 bookmakers in any one match to analyze the efficiency of European football betting markets during the 2005/2006 season. We first examine the empirical derivatives of the longshot bias, and find that the bias is much more pronounced for high-grade matches. This arguably supports the information-based explanation of the longshot bias. We also show that internet betting, by giving access to a large number of bookmakers, improves significantly bettors' potential return. Finally, we find that average odds do not provide the best estimate of the likelihood of a result. Indeed, the best available odds are informative as well, even after controlling for the average odds.

Do Portfolio Distortions Reflect Superior Information or Psychological Biases?

The recent behavioral literature has shown that individual investors hold concentrated portfolios, trade excessively, and exhibit a preference for local stocks. These results are puzzling because in all three instances portfolio distortions could reflect either an informational advantage or psychological biases. In this study, using a demographics-based proxy for smartness, we show that the portfolio distortions of investors reflect an informational advantage that generate high risk-adjusted returns. In contrast, the distortions of investors arise from psychological biases because they experience low risk-adjusted performance. When we do not condition on the level of portfolio distortions, the average net performance of smart investors is below passive benchmarks, but smart investors outperform dumb investors by about 3% annually on a risk-adjusted basis. Further, among investors with high portfolio distortions, smart investors outperform passive benchmarks by about 2% and the smart-dumb performance differential is over 5%. We also show that a portfolio of stocks with smart investor clientele outperforms the dumb clientele portfolio by about 3.50% annually. Taken together, these results suggest that both behavioral and information-based explanations for portfolio distortions are appropriate, but they apply to groups of dumb and smart investors, respectively.

Stealth Trading by Corporate Insiders

This paper analyzes stealth trading by corporate insiders in US equity markets. Stealth trading is the practice to break up trades into sequences of smaller trades. We find that stealth trading is pervasive and distinguish two explanations. The first argues that insiders break up trades in order to conceal private information about the fundamental value of the stock, whereas the second holds that insiders act like discretionary liquidity traders who want to reduce the tem-porary price impact from trading large stakes. We find some, but inconsistent evidence for information-based explanations, but strong and unambiguous evidence for liquidity-based ex-planations. These conclusions hold across subsamples for transactions before and after the Sarbanes-Oxley act and for NASDAQ as well as NYSE stocks.

Limited Attention and the Earnings Announcement Returns of Past Stock Market Winners

We document that stocks with the strongest prior 12-month returns experience a significant average market-adjusted return of 1.58 percent during the five trading days before their earnings announcements and a significant average market-adjusted return of 1.86 percent in the five trading days afterward. These returns remain significant even after accounting for transactions costs. We empirically test two possible explanations for these anomalous returns. The first is that unexpectedly positive news hits the market over the few days prior to these firms' earnings announcements, and that unexpectedly negative news comes out just afterwards. The second possibility is that stocks with sharp run-ups tend to attract individual investors' attention, and investment dollars, particularly before their earnings announcements. We do not find evidence for an information-based explanation; however, our analysis suggests the possibility that the trading decisions of individual investors are at least partly responsible for the return pattern we observe.

Social Networks and Credit Access in Indonesia

Abstract In this paper, we investigate how family and community networks affect an individual's access to credit institutions using new data from the Indonesia Family Life Surveys. Our theoretical framework emphasizes the family and community's role in providing information, thus lowering the search costs of the borrower and monitoring and enforcement costs for the lender. From our empirical results, community and family networks are important in knowing a place to borrow, as well as for loan approval. Consistent with an information-based explanation of networks, family and community networks have a larger impact on credit awareness of new credit institutions with a lower impact on awareness of established credit sources. Interestingly, we find that women benefit from participating in community networks more than men. There is no evidence that the rich benefit from community networks more than the poor. Our results on the benefits from participation in the community network are robust to the inclusion of community fixed effects.

Does Familiarity Breed Investment? An Empirical Analysis of Foreign Equity Holdings

Traditional financial diversification theory states that one should hold a portfolio with a well diversified mix of assets, both nationally and internationally. Using new international asset holdings data, this paper examines the foreign diversification of more than thirty countries around the world. It confirms the lack of international diversification is still an ongoing phenomenon, but more importantly this article demonstrates that the small diversification that is present is not even well diversified across foreign equity markets. What then affects the diversification that is present? The empirical analysis finds significance in familiarity factors such as a common language, trade and possibly immigrant links, which would support an information-based explanation for equity home bias. Additionally, the results demonstrate that interestingly, other factors such as monetary unions and market trading costs are insignificant. Overall the results help shed some light on foreign diversification and the equity home bias phenomenon.

Effects of Noise on Optimal Exercise Decisions: The Case of Risky Debt Secured by Renewable Lease Income

This paper considers the valuation and default exercise policy of risky coupon debt that is secured by a lease-encumbered noisy real asset. For parameter values used in our analysis, asset value noise is shown to reduce the value of waiting to default. Moreover, the borrower is shown to delay default exercise until the noisy signal of asset value is far into-the-money. This latter finding provides an information-based explanation for the apparent under-exercise of the mortgage default option that has been observed in the literature. An implication of this finding is that, if the claimholder recognizes that noise exists, but the empiricist—who is trying to compare observed exercise policy with that predicted by a noiseless model of asset prices—does not, a “sub-optimal” exercise policy may be inferred when in fact the policy is rational given the information available. This explanation is consistent with evidence from mortgage default studies as to why the observed default exercise boundary is lower than that predicted by standard theoretical option-based models.