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Friday, November 5, 2010

Ph.D. Program - Potential Research Topics

Below is a subset of the research topics that are actively studied and analyzed by the finance
faculty at the Fuqua School of Business, and a sample of abstracts of papers that they have
written on these topics.

Asset Pricing Theory

* Asset Pricing

The authors model consumption and dividend growth rates as containing both a small long-run
predictable component and fluctuating economic uncertainty (consumption volatility). These
dynamics, for which they provide empirical support, in conjunction with generalized recursive
preferences, can explain key asset markets phenomena. The model can justify the equity
premium, the risk-free rate, and the volatility of the market return, risk-free rate, and the price-
dividend ratio. As in the data, dividend yields predict returns and the volatility of returns is time-

* Dynamic Portfolio Choice

The authors present a novel approach to dynamic portfolio selection that is as easy to implement
as the static Markowitz paradigm. They expand the set of assets to include mechanically
managed portfolios and optimize statically in this extended asset space. They consider
"conditional" portfolios, which invest in each asset an amount proportional to conditioning
variables, and "timing" portfolios, which invest in each asset for a single period and in the risk-
free asset for all other periods. The static choice of these managed portfolios represents a
dynamic strategy that closely approximates the optimal dynamic strategy for horizons up to five

* Term Structure of Interest Rates

The authors develop a term structure model where the short interest rate and the market price of
risks are subject to discrete regime shifts. Empirical evidence from Efficient Method of Moments
estimation provides considerable support for the regime shifts model. Standard models, which
include affine specifications with up to three factors, are sharply rejected in the data. Their
diagnostics show that only the regime shifts model can account for the well documented
violations of the expectations hypothesis, the observed conditional volatility, and the conditional
correlation across yields. They find that regimes are intimately related to business cycles.

Empirical Asset pricing

* International Investment

A number of countries have delayed the opening of their capital markets to international
investment because of reservations about the impact of foreign speculators on both expected
returns and market volatility. The authors propose a cross-sectional time-series model that
attempts to assess the impact of market liberalizations, in the form of the offering of depositary
receipts, country funds and other financial instruments, in an extranational market, on the cost of
capital and market volatility in emerging equity markets. They also examine the impact of capital
market liberalizations on the correlation of emerging equity market returns and the world market
return. Their empirical approach is designed to control for other economic events, which might
confound the impact of foreign speculators on local equity markets. Whatever the empirical
specification, the cost of capital always decreases after a capital market liberalization, with the
effect varying between 5 and 90 basis points depending on the specification. There is little
impact on volatility. While correlation with world markets increases after liberalizations, it is
unlikely that this higher correlation will impact global investors looking to diversify their
international portfolios.

* Analysts Forecasts and Market Reaction

Using a large database of analysts' target prices issued over the period 1997–1999, the authors
examine short-term market reactions to target price revisions and long-term comovement of
target and stock prices. They find a significant market reaction to the information contained in
analysts' target prices, both unconditionally and conditional on contemporaneously issued stock
recommendation and earnings forecast revisions. Using a cointegration approach, they analyze
the long-term behavior of market and target prices. They find that, on average, the one-year-
ahead target price is 28 percent higher than the current market price.

* The Impact of Hedge Funds Strategies on Asset Prices

Hedge funds often employ opportunistic trading strategies on a leveraged basis. It is natural to
find their footprints in most major market events. A "small bet" by large hedge funds can be a
sizeable transaction that can impact a market. This study estimates hedge fund exposures during
a number of major market events. In some episodes, hedge funds had significant exposures and
were in a position to exert substantial market impact. In other episodes, hedge fund exposures
were insignificant, either in absolute terms or relative to other market participants. In all cases,
the authors found no evidence of hedge funds using positive feedback trading strategies. There
was also little evidence that hedge funds systematically caused market prices to deviate from
economic fundamentals.

Theoretical Corporate Finance

* Information Asymmetry and Heterogeneous Trading

The authors analyze a multi-period model of trading with differentially informed traders,
liquidity traders, and a market maker. Each informed trader's initial information is a noisy
estimate of the long-term value of the asset, and the different signals received by informed
traders can have a variety of correlation structures. With this setup, informed traders not only
compete with each other for trading profits, they also learn about other traders' signals from the
observed order flow. Their work suggests that the initial correlation among the informed traders'
signals has a significant effect on the informed trader’s profits and the informativeness of prices.

* Leasing and Debt Capacity

This paper studies the financing role of leasing and secured lending. The authors argue that the
benefit of leasing is that repossession of a leased asset is easier than foreclosure on the collateral
of a secured loan, which implies that leasing has higher debt capacity than secured lending.
However, leasing involves agency costs due to the separation of ownership and control. More
financially constrained firms value the additional debt capacity more and hence lease more
of their capital than less constrained firms. They provide empirical evidence consistent with this
prediction. Their theory is consistent with the explanation of leasing by practitioners, namely that
leasing "preserves capital," which the
academic literature considers a fallacy.

Empirical Corporate Finance

* Capital Structure

The author integrates under firm-specific benefit functions to estimate that the capitalized tax
benefit of debt equals 9.7 percent of firm value (or as low as 4.3 percent, net of personal taxes).
The typical firm could double tax benefits by issuing debt until the marginal tax benefit begins to
decline. He infers how aggressively a firm uses debt by observing the shape of its tax benefit
function. Paradoxically, large, liquid, profitable firms with low expected distress costs use
debt conservatively. Product market factors, growth options, low asset collateral, and planning
for future expenditures lead to conservative debt usage. Conservative debt policy is persistent.

* Mergers and Acquisitions

Mergers are the mechanisms that redraw the boundaries of the firm. In this paper, the authors
relate incomplete contracts, upon which much of our understanding of firm boundaries is based,
to empirical regularities in the market for mergers and acquisitions. They begin by empirically
challenging conventional wisdom about mergers and acquisitions: high M/B acquirers typically
do not purchase low M/B targets. Instead, mergers typically pair together firms with similar M/B
ratios. To show why this occurs, they build a continuous time model of investment and merger
activity that combines search, relative scarcity, and asset complementarity. Their model shows
that the "like buys like" empirical finding is a natural consequence of a prediction from the
property rights theory of the firm; namely, that complementary assets should be placed under
common control. A number of new empirical predictions emerge from their analysis. First, if
asset complementarity is important, then we should see small differences in the M/B of targets
and acquirers. It also predicts that the difference in M/B ratios should increase when discount
rates are high and valuations are low. In additional tests, the authors show that both of these
predictions are borne out by the data. Their findings suggest that the incomplete contracts theory
of the firm is central to understanding the empirical regularities of the market for mergers and

Behavioral Finance

* Overconfidence, Investment Policy, and CEO Compensation

In the context of a capital budgeting problem, the authors show how and when a manager's
overconfidence can be beneficial to a firm. Risk-averse managers sometimes choose to stay away
from risky projects that would increase firm value. Overconfident managers overestimate their
personal ability to reduce risk, and as a result may make capital budgeting decisions that are in
the better interest of shareholders. This benefit to the firm does not necessarily result in
diminished welfare for the manager. First, when compensation endogenously adjusts to reflect
outside opportunities, moderate levels of overconfidence lead firms to offer the manager flatter
compensation contracts that provide him with better insurance. Second, since overconfident
managers overvalue the product of their information acquisition efforts, their bias naturally
commits them to exert effort. This reduction of moral hazard problems sometimes makes an
overconfident manager hireable when an equally skilled but rational counterpart would not be
considered. Still, too much overconfidence is detrimental to the manager as it leads him to accept
highly convex compensation contracts that expose him to excessive risk.
* Managerial Overconfidence and Corporate Policies

The authors present empirical evidence that managerial overconfidence is associated with
aggressive corporate policies including investment, financing, financial reporting, and executive
compensation. In particular, they collect five years worth of forecasts by Chief Financial Officers
(CFOs) about stock market returns together with confidence intervals. CFOs are miscalibrated on
average: realized returns are within respondents’ 80% confidence range only 39% of the time.
Overconfidence (i.e., having a narrow confidence interval) is correlated with personal
characteristics and is also stronger following periods of high returns in the market and in their
firms. Firms with overconfident CFOs invest more, pay out fewer dividends, use debt more
aggressively, engage in market timing, provide more managerial forecasts, and tilt executive
compensation towards performance.
at 7:32 AM


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