Working papers

Concentrated Ownership and Equilibrium Asset Prices

Revised 07/14

Abstract: Investors can choose to hold diversified or levered, concentrated portfolios of risky assets. This paper studies the dynamics of asset prices in an economy in which both investment styles coexist in equilibrium even though all agents are ex-ante identical. I capture the tradeoff between risk sharing and productivity gains by introducing what I call “active capital.” People who participate in such investments are restricted in their outside opportunities but receive extra compensation for the productivity gains they bring to the corresponding enterprises. I show that fluctuations in the quantity of active capital increase the volatility of asset prices relative to a standard economy. Not all shocks shift the distribution of ownership: risk considerations determine the willingness to provide active capital, whereas current and expected future economic activity do not play a role. Therefore, active capital fluctuates jointly with risk premia, amplifying their variations. As a consequence, the price of volatility risk exposure can be large, and return volatility is mainly induced by fluctuations in future expected returns. These results are particularly strong when fundamental volatility is low, because at such times, a large number of concentrated owners are likely to exit their positions and sell off their assets.

Buyout Activity: the Impact of Aggregate Discount Rates (with Erik Loualiche and Matthew Plosser)

Revised 03/13; Supplementary appendix

Abstract: We argue buyout waves form in response to fluctuations in aggregate discount rates. In our model, discount rates alter the present value of cash-flow improvements and the illiquidity premium demanded by buyout investors. We empirically confirm our predictions. Overall deal activity varies positively with the risk premium and negatively with the risk-free rate, with heterogeneous effects across firms. Cross-sectionally, firms with high systematic or idiosyncratic risk are less likely targets. We structurally decompose variation in activity between changes in the value of cash flow and the illiquidity premium. The positive correlation of the two explains the wave behavior of activity.

Information Aversion (with Marianne Andries)

08/14

Abstract: We propose a theory of inattention solely based on preferences, absent any cognitive limitations and external costs of acquiring in- formation. Under disappointment aversion, information decisions and risk attitude are intertwined, and agents are intrinsically information averse. We illustrate this link between attitude towards risk and information in a standard portfolio problem, in which agents balance the costs, endogenous in our framework, and benefits of information. We show agents never choose to receive information continuously in a diffusive environment: they optimally acquire information at infrequent intervals only. We highlight a novel channel through which the optimal frequency of information acquisition decreases when risk increases, consistent with empirical evidence. We show that state-dependent signals, in particular alerts in bad states of the world, help agents better manage their wealth, at a minimal utility cost. Our framework accommodates a broad range of applications, suggesting our approach can explain many observed features of decision under uncertainty.

Detail Disagreement and Innovation Booms (with Paul Ho and Erik Loualiche)

Draft available upon request

Abstract: We argue it is natural for investors in financial markets to disagree on precisely which types of innovations are likely to be successful in a specific field. We call this type of heterogenous priors detail disagreement. Detail disagreement in financial markets profoundly affects the innovative process. Our model predicts the presence of detail disagreement creates a form of competition neglect. This mechanism entails higher asset prices that subsequently crash, more investment, firm creation, and specifically to our approach, more diversity in innovation. We show investors’ portfolios, asset prices, and both the quantity and nature of firm creation during the tech boom of the early 2000s as well as the last few years are consistent with our approach. We discuss the potential welfare implications of such speculative episodes.

Work in progress

Monetary Policy Announcements: Content and Impact (with Nina Boyarchenko and Matthew Plosser)

Changing Risk: Volatility or Persistence?