Research

A small group of financial intermediaries manages over 90% of the prime brokerage business, with prior research establishing shocks to these prime brokers as a systematic risk factor. We show that the average hedge fund's exposure to systematic financial intermediary risk exceeds the intermediary risk of its holdings. This heightened exposure is asymmetric, driven solely by negative shocks to financial intermediaries. In contrast, mutual funds and other risk factors show no similar effect. Examining idiosyncratic risk, we find that large adverse shocks to an individual prime broker only impact the performance of hedge funds using that broker exclusively, highlighting diversifiability of idiosyncratic shocks. Our findings underscore the unique risks of hedge funds due to their prime brokerage dependencies.

We find that systematic financial intermediary risk, measured by the covariation between fund returns and shocks to the equity capital ratio of key financial intermediaries - New York Federal Reserve Primary Dealers - is a strong determinant of the cross-section of hedge fund returns. A portfolio of hedge funds with high financial intermediary risk exposure outperforms, on average, a low-exposure portfolio by approximately 7% per year on a risk-adjusted basis. This positive relationship remains robust after controlling for a comprehensive set of fund characteristics and other risk factors known to influence the cross-section of hedge fund returns.

Streaks in returns, which we define as n-day consecutive over-/under-performance relative to the market, predict future daily returns. A value-weighted portfolio buying stocks with negative streaks and selling stocks with positive streaks yields annualized Sharpe ratios around 1.8 in the U.S. (1998--2022). We replicate the result in international equity markets and find low correlations across regions. Predictability is robust among the largest (market capitalization above the 50\% or 80\% NYSE quantiles) and most liquid stocks (e.g., low bid-ask spread or Amihud measure tercile). A model of short-term return extrapolation among investors generates predictions consistent with the empirical findings.

We review the academic findings from psychology and economics on disagreement, and specifically on the effect of disagreement on asset prices. We discuss measurement of disagreement, and how disagreement coupled with constraints on short selling can sideline pessimistic investors and result in overpricing. We review the literature on short selling in financial markets, paying particular attention to how and why some issues become "hard-to-borrow", what factors go into the determination of borrowing costs, and discuss the evolution of borrowing costs over the last several decades.  We show how an examination of the prices and borrowing costs for constrained stocks can lead to an improved understanding of how disagreement in financial markets arises and is resolved, and finally discuss directions for future research.

In this paper, we infer how the estimates of firm value by "optimists" and "pessimists" evolve in response to information shocks. Specifically, we examine returns and disagreement measures for portfolios of short-sale-constrained stocks that have experienced large gains or large losses. Our analysis suggests the presence of two groups, one of which overreacts to new information and remains biased over about 5 years, and a second group, which underreacts and whose expectations are unbiased after about 1 year. Our results have implications for the belief dynamics that underlie the momentum and long-term reversal effect.

A common practice in the finance literature is to create characteristic portfolios by sorting on characteristics associated with average returns. We show that the resultant portfolios are likely to capture not only the priced risk associated with the characteristic but also unpriced risk. We develop a procedure to remove this unpriced risk using covariance information estimated from past returns. We apply our methodology to the five Fama-French characteristic portfolios. The squared Sharpe ratio of the optimal combination of the resultant characteristic-efficient portfolios is 2.13, compared with 1.17 for the original characteristic portfolios.

We show, using data from the Italian Survey on Household Income and Wealth and the German Socio-economic Panel, that household consumption drops after a child moves out of a household, while at the same time adult-equivalent consumption increases significantly. After all children are gone, parents upgrade their personal lifestyle to a level approximately that of childless peers, and save only a small proportion of the freed-up resources. Since parents had fewer resources to save while they were young, retirement preparedness among them is a more serious concern than among childless individuals.