Paper Abstracts

"Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change".
Traditional portfolio balance theory derives a downward sloping currency demand function from limited international asset substitutability. Historically, this theory enjoyed little empirical support. We provide direct evidence by examining the exchange rate effect of a major redefinition of the MSCI global equity index in 2001 and 2002. The index redefinition implied large changes in the representation of different countries in the MSCI world index and therefore produced strong exogenous equity flows by index funds. Our event study reveals that countries with a relatively increasing equity representation experienced a relative currency appreciation upon announcement of the index change. Moreover, currencies with upweighted (downweighted) stock markets tend to commove more (less) with the other MSCI currencies.

“Product Market Competition, Insider Trading and Stock Market Efficiency”.
How does competition in firms' product markets influence their behavior in equity markets? Do product market imperfections spread to equity markets? I examine these questions in a noisy rational expectations model in which firms operate under monopolistic competition while their shares trade in perfectly competitive markets. Firms use their monopoly power to pass on shocks to customers, thereby insulating their profits. This encourages stock trading, expedites the capitalization of private information into prices and improves the allocation of capital. Several implications are derived and tested.

“Media Coverage and the Cross-Section of Stock Returns”.
By reaching a broad population of investors, mass media can alleviate informational frictions and affect security pricing even if it does not supply genuine news. We investigate this hypothesis by studying the cross-sectional relation between media coverage and expected stock returns. We find that stocks with no media coverage earn higher returns than stocks with high media coverage even after controlling for well-known risk factors. These results are more pronounced among small stocks and stocks with high individual ownership, low analyst following, and high idiosyncratic volatility. Our findings suggest that the breadth of information dissemination affects stock returns.

“The Tradeoff between Risk Sharing and Information Production in Financial Markets”.
 show that the production of information in financial markets is limited by the extent of risk sharing. The wider a stock's investor base, the smaller the risk borne by each shareholder and the less valuable information. A firm which expands its investor base without raising capital affects its information environment through three channels: (i) it induces incumbent shareholders to reduce their research effort as a result of improved risk sharing, (ii) it attracts potentially informed investors, and (iii) it may modify the composition of the base in terms of risk tolerance or liquidity trading. These results have implications for individual firms and the market as a whole.

“Information vs. Entry Costs: What Explains U.S. Stock Market Evolution”.
I investigate whether changes in stock market participation costs can explain the long term increase in the number of U.S. stockholders. I separate these costs into two components, an information cost (the cost of collecting information about the market) and an entry cost (all other costs, including commissions and fees). I disentangle their general equilibrium implications in a noisy rational expectations economy. A falling information cost cannot explain the observed increase in stock market participation, unlike a falling entry cost. In addition, a falling entry cost accounts for several other features of the U.S. economy, (i) the falling equity premium, (ii) rising return variances and (iii) the boom in passive investing relative to active investing.

“Wealth, Information Acquisition and Portfolio Choice”.
I solve (with an approximation) a Grossman-Stiglitz economy under general preferences, thus allowing for wealth effects. Because information generates increasing returns, decreasing absolute risk aversion, in conjunction with the availability of costly information, are sufficient to explain why wealthier households invest a larger fraction of their wealth in risky assets. One no longer needs to resort to decreasing relative risk aversion, an empirically questionable assumption. Furthermore, I show how to distinguish empirically between these two explanations. Finally, I find that the availability of costly information exacerbates wealth inequalities.

“Optimal Portfolios of Foreign Currencies”.
We show how an investor can form portfolios of currencies that benefit from the forward bias and that trade off risk and return optimally. Applying a mean-variance analysis under the assumption that exchange rates behave as random walks leads to portfolio weights that are stable over time without resorting to exogenous constraints on weights. Optimal currency portfolios invested in the German deutschemark, the Japanese yen, the British pound, and the Swiss franc with the U.S. dollar as the risk-free asset generate an average excess return of 2.79% per year over the period 1989 through 1999. The Sharpe ratio on these returns is better than that on a U.S. Treasury index and that on a global Treasury index (unhedged for currency risk). Moreover, the returns are uncorrelated with major fixed-income and equity indexes. These findings suggest that the methodology can provide a useful benchmark for fund managers interested in optimal currency overlays.

“Media Coverage and Investors’ Attention to Earnings Announcements”
Does investors’ inattention contribute to the post-earnings announcement drift? I study this question using media coverage as a proxy for attention. I compare announcements made by the same firm in the same year and generating the same earnings surprise, when one announcement is covered in the Wall Street Journal while the other is not. I find that announcements with media coverage generate a stronger price and trading volume reaction at the time of the announcement and less subsequent drift. Moreover, this effect is less pronounced for more visible firms and on high-distraction days. These results are both economically and statistically strong. They lend support to the notion that limited attention is an important source of friction in financial markets.

“Learning about Technologies and Technological Progress”
I present a model of financial development and technological progress based on imperfect information. In the model, entrepreneurs innovate more when financiers are better informed about their projects because they expect their successful projects to receive more funding. Conversely, financiers collect more information about projects when entrepreneurs innovate more because the opportunity cost of misinvesting, i.e. of funding unsuccessful projects, is higher. Thus, knowledge about technologies and technological knowledge are mutually reinforcing. The model is consistent with several empirical regularities. Empirical strategies for testing the model are discussed.

“Learning from Stock Prices and Economic Growth”
The stock market contributes to economic growth by relaxing informational constraints. The partial revelation of private information through stock prices, on    one hand, enables investors to share their information truthfully, but on the other hand, undermines the incentive to collect costly information. It has a positive impact on the growth rate of income but this impact is only transitory. The growth path is characterized by rising capital efficiency, total factor productivity, industrial specialization, stock trading intensity and idiosyncratic stock return volatility.

“Dynamics of Swaps Spreads: A Cross-Country Study”.
We examine the empirical behavior of swap spreads in Germany, Britain and the US over the last five years. Swap spreads of three maturities (2-, 5- and 10-year) are considered. The movements of swap spreads are explained using the movements in credit spreads, Libor-gc spreads, the shape of the government curve and returns on equity market indices.