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  5. Asset Pricing and Policy
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Asset Pricing and Policy

Paper Session

Tuesday, Jan. 5, 2021 3:45 PM - 5:45 PM (EST)

Hosted By: American Finance Association
  • Chair: Howard Kung, London Business School

Don’t Take Their Word For It: The Misclassification of Bond Mutual Funds

Huaizhi Chen
,
University of Notre Dame
Lauren Cohen
,
Harvard University
Umit Gurun
,
University of Texas-Dallas

Abstract

We provide evidence that bond fund managers misclassify their holdings, and that these misclassifications have a real and significant impact on investor capital flows. In particular, many funds report more investment grade assets than are actually held in their portfolios to important information intermediaries, making these funds appear significantly less risky. This results in pervasive misclassification across the universe of US fixed income mutual funds. The problem is widespread- resulting in up to 31.4% of funds being misclassified with safer profiles, when compared against their true, publicly reported holdings. “Misclassified funds” – i.e., those that hold risky bonds, but claim to hold safer bonds– appear to on-average outperform the low-risk funds in their peer groups. “Misclassified funds” moreover receive higher Morningstar Ratings (significantly more Morningstar Stars) and higher investor flows due to this perceived on-average outperformance. However, when we correctly classify them based on their actual risk, these funds are mediocre performers. These Misclassified funds also significantly underperform precisely when junk-bonds crash in returns. Misreporting is stronger following several quarters of large negative returns.

The Corona Virus, the Stock Market’s Response, and Growth Expectations

Niels J. Gormsen
,
University of Chicago
Ralph S.J. Koijen
,
University of Chicago

Abstract

We use data from the aggregate equity market and dividend futures to quantify how investors’ expectations about economic growth across horizons evolve in response to the corona virus outbreak and subsequent policy responses. Dividend futures, which are claims to dividends on the aggregate stock market in a particular year, can be used to compute a lower bound on growth expectations across maturities. We study how this bound evolves over time in both Europe and the US. As of March 13, the lower bound on expected GDP growth has been revised down by as much as 8% in the US and 10% in Europe. There are signs of catch-up growth from year 4 to year 10. News about economic relief programs on March 13 appear to have increased stock prices by lowering risk aversion and lift long-term growth expectations, but did little to improve expectations about short-term growth.

Should the United States Government Issue Floating Rate Notes?

Jonathan S. Hartley
,
Harvard University
Urban Jermann
,
University of Pennsylvania

Abstract

Since January 2014 the U.S. Treasury has been issuing floating rate notes (FRNs). We estimate that the U.S. FRNs have been paying excess interest between 5 and 39 basis points above the implied cost for other Treasury securities. With more than 300 billion dollars of FRNs outstanding, the excess borrowing cost for 2017 is estimated to be about 700 million dollars. To rationalize this finding, we examine the role of FRNs from the perspective of optimal government debt management to smooth taxes. In the model, bills can be cheaper to issue than FRNs, and the payo¤s for FRNs are perfectly correlated with future short rates. FRNs can be used to manage the refinancing risk from rolling over short-term debt. We derive conditions under which the issuance of FRNs can optimally be positive.

The U.S. Public Debt Valuation Puzzle

Zhengyang Jiang
,
Northwestern University
Hanno N. Lustig
,
Stanford University
Stijn Van Nieuwerburgh
,
Columbia University
Mindy Xiaolan
,
University of Texas-Austin

Abstract

The government budget constraint ties the market value of government debt to the expected present discounted value of fiscal surpluses. Bond investors fail to impose this no-arbitrage restriction in the U.S., resulting in a government debt valuation puzzle. Both cyclical and long-run dynamics of tax revenues and government spending make the surplus claim risky. Under a realistic asset pricing model, this risk in surpluses creates a wedge of 299% of GDP between the value of debt and that the surplus claim, and implies an expected return on the debt portfolio that far exceeds the observed yield on Treasuries.
Discussant(s)
Jawad Addoum
,
Cornell University
Jessica Wachter
,
University of Pennsylvania
Juliana Salomao
,
University of Minnesota
Lorenzo Bretscher
,
London Business School
JEL Classifications
  • G1 - Asset Markets and Pricing