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Did Pandemic Stimulus Funds Spur the Rise of 'Meme Stocks'?

by Rachel Layne

Remember the GameStop stock frenzy? Research by Robin Greenwood and colleagues shows how market speculation can flare up when you combine stimulus funds, trading platforms, and plain old boredom.

Financial Meltdowns Are More Predictable Than We Thought

by Danielle Kost

Robin Greenwood and Samuel G. Hanson discuss new research that shows economic crises follow predictable patterns. Open for comment; 0 Comments.

Predictable Financial Crises

by Robin Greenwood, Samuel G. Hanson, Andrei Shleifer, and Jakob Ahm Sørensen

One central issue in the study of macroeconomic stability is financial crisis predictability. This paper estimates the probability of financial crises as a function of past credit and asset price growth.

Reflexivity in Credit Markets

by Robin Greenwood, Samuel G. Hanson, and Lawrence J. Jin

Investors’ biases and market outcomes affect each other in a two-way feedback loop. This study develops a model of a credit market feedback loop, finding that when investors become more bullish this can predict positive returns in the short run, even if expected returns become more negative at longer horizons.

The Impact of Pensions and Insurance on Global Yield Curves

by Robin Greenwood and Annette Vissing-Jorgensen

The global financial crisis and its aftermath had a dramatic impact on the solvency of pension funds and insurance companies. Drawing on a large cross-section of countries, this paper shows the importance of pension and insurance companies in determining the yields on long maturity bonds around the world.

First Look at New Research and Ideas, June 20

Sean Silverthorne

Should governments nudge? ... A new model for describing bubbles ... Exceptional management practices in India.

Bubbles for Fama

by Robin Greenwood, Andrei Shleifer, and Yang You

Nobel laureate Eugene F. Fama has famously claimed that there is no such thing as a bubble, which he defines as a large price run-up that predictably crashes. Analyzing industry data for the US and internationally, the authors find that Fama is mostly right that a sharp price increase of an industry portfolio does not, on average, predict unusually low returns going forward. Yet the authors show that there is much more to a bubble than merely increases in prices; they show a number of characteristics that predict an end to the bubble.

Rainy Day Stocks

by Niels Gormsen and Robin Greenwood

Niels Gormsen and Robin Greenwood identify characteristics of stocks that an investor who is worried about bad times should buy— a “rainy day” portfolio. They also propose a simple methodology that places greater weight on performance achieved during bad times than performance achieved during good times, essentially evaluating returns under a risk-neutral probability measure.

A Model of Credit Market Sentiment

by Robin Greenwood, Samuel G. Hanson, and Lawrence J. Jin

Recent empirical research in finance and economics has revived the idea that investor sentiment drives credit booms and busts. To explore the drivers of sentiment in credit markets, the authors model the two-way feedback between credit market sentiment and credit market outcomes. In their model the propagation of credit cycles is driven by the interplay between expectations and the refinancing nature of credit markets.

Extrapolation and Bubbles

by Nicholas Barberis, Robin Greenwood, Lawrence Jin, and Andrei Shleifer

Bubble episodes have fascinated economists and historians for centuries, in part because human behavior in bubbles is so hard to explain, and in part because of the devastating side effects of the crash. At the heart of the standard historical narratives of bubbles is the concept of extrapolation—the formation of expected returns by investors based on past returns. This paper presents a simple model of extrapolative bubbles that explains a lot of evidence and makes new predictions.

Forward Guidance in the Yield Curve: Short Rates versus Bond Supply

by Robin Greenwood, Samuel G. Hanson, and Dimitri Vayanos

Since late 2008, central banks have been conducting monetary policy through two primary instruments: quantitative easing (QE), in which they buy long-term government bonds and other long-term securities, and “forward guidance,” in which they guide market expectations about the path of future short rates. This paper analyzes the effects of forward guidance on both short rates and QE. Results show that forward guidance on QE tends to impact longer maturities than forward guidance on short rates, even when expectations about bond purchases by the central bank concern a shorter horizon than expectations about future short rates.

Government Debt Management at the Zero Lower Bound

by Robin Greenwood, Samuel G. Hanson, Joshua S. Rudolph & Lawrence H. Summers

At least since the 1980s, the three domains of United States monetary policy, fiscal and debt management policy, and the prudential regulation of financial intermediaries have been separate and distinct. However, with the onset of the financial crisis in 2007 and and subsequent easing of monetary policy, the lines between these domains have become blurred, and conventional monetary policies have lost their impact. This blurring of functions—and economists' observation that Federal Reserve and Treasury policies with regard to US government debt have been pushing in opposite directions—suggests the need to revisit the principles underlying government debt management policy. In this paper the authors quantify the extent to which the Fed and Treasury have been working at cross purposes. They also present a framework in which traditional debt management objectives can be considered in conjunction with managing aggregate demand and promoting financial stability. Overall, they argue for revised institutional arrangements to promote greater cooperation between the Treasury and the Federal Reserve in setting debt management policy. Key concepts include: Starting in 2008, US monetary policy and debt management dramatically changed course in response to the unfolding financial and economic crisis, pulling the government balance sheet in opposite directions. Debt management varies by time and has implications for aggregate demand. It therefore puts the Treasury into conflict with the Federal Reserve. Improved policy coordination could substantially reduce this conflict. Closed for comment; 0 Comments.

Missing the Wave in Ship Transport

by Kim Girard

Despite a repeating boom-bust cycle in the shipping industry, owners seem to make the same investment mistakes over time. Can other cyclical industries learn the lessons of the high seas? Research by Robin Greenwood and Samuel G. Hanson. Open for comment; 0 Comments.

X-CAPM: An Extrapolative Capital Asset Pricing Model

by Nicholas Barberis, Robin Greenwood, Lawrence Jin & Andrei Shleifer

Many investors assume that stock prices will continue rising after they have previously risen, and will continue falling after they have previous fallen. This evidence, however, does not mesh with the predictions of many of the models used to account for other facts about aggregate stock market prices. Indeed, in most traditional models, expected returns are low when stock prices are high: in these models, stock prices are high when investors are less risk averse or perceive less risk. In this paper, the authors present a new model of aggregate stock market prices which attempts to both incorporate expectations held by a significant subset of investors, and address the evidence that other models have sought to explain. The authors' model captures many features of actual returns and prices. Importantly, however, it is also consistent with survey evidence on investor expectations. This suggests that the survey evidence is consistent with the facts about prices and returns and may be the key to understanding them. Key concepts include: The model in this study can reconcile evidence on expectations with the evidence on volatility and predictability that has animated recent work in this area. A new model like this one is needed. Traditional models of financial markets have been able to address pieces of the existing evidence, but not the data on investor expectations. The same holds true for preference-based behavioral finance models as well as for the first generation belief-based behavioral models. Closed for comment; 0 Comments.

Waves in Ship Prices and Investment

by Robin Greenwood & Samuel Hanson

Dry bulk shipping is a highly volatile and cyclical industry in which earnings, investment, and returns on capital appear in waves. In this paper, the authors develop a model of industry capacity dynamics in which industry participants have trouble forecasting demand accurately and fail to fully anticipate the effect that endogenous supply responses will have on earnings. The authors estimate the model using data on earnings, secondhand prices, and investment in the dry bulk shipping industry between 1976 and 2011. Findings show that returns to owning and operating a ship are predictable and closely related to industry-wide investment in capacity. High current ship earnings are associated with higher ship prices and higher industry investment, but predict low future returns on capital. Conversely, high levels of ship demolitions-a measure of industry disinvestment-forecast high returns. Key concepts include: Real-world economic agents may repeatedly underestimate the power of long-run competitive forces, particularly in markets-such as industries with long time-to-build delays-where feedback is delayed and learning is slow. The annual realized returns to owning a ship vary enormously over time, from a low of -76% between December 2007 and December 2008 to a high of +86% between June 1978 and June 1979. Cycles in investment, lease rates, and secondhand prices are connected to predictable variation in the returns to ship owners. Heavy investment during booms predictably depresses future earnings and the price of capital, leading prices to overshoot their rational-expectations levels. Closed for comment; 0 Comments.

Expectations of Returns and Expected Returns

by Robin Greenwood & Andrei Shleifer

Much of modern asset pricing seeks to explain changes in stock market valuations using theories of investors' time-varying required returns. Although researchers have achieved considerable progress in developing proxies for expected returns, an important but often overlooked test of these theories is whether investors' expectations line up with these proxies. This paper shows that they do not. Key concepts include: Survey measures of investor expectations are not meaningless noise, but rather reflections of widely shared beliefs about future market returns, which tend to be extrapolative in nature. Future models of stock market fluctuations should embrace the large fraction of investors whose expectations are extrapolative. Closed for comment; 0 Comments.

Vulnerable Banks

by Robin Greenwood, Augustin Landier & David Thesmar

Since the beginning of the US financial crisis in 2007, regulators in the United States and Europe have been frustrated by the difficulty in identifying the risk exposures at the largest and most levered financial institutions. Yet, at the time, it was unclear how such data might have been used to make the financial system safer. This paper is an attempt to show simple ways in which this information can be used to understand how deleveraging scenarios could play out. To do so the authors develop and test a model to analyze financial sector stability under different configurations of leverage and risk exposure across banks. They then apply the model to the largest financial institutions in Europe, focusing on banks' exposure to sovereign bonds and using the model to evaluate a number of policy proposals to reduce systemic risk. When analyzing the European banks in 2011, they show how a policy of targeted equity injections, if distributed appropriately across the most systemic banks, can significantly reduce systemic risk. The approach in this paper fits into, and contributes to, a growing literature on systemic risk. Key concepts include: This model can simulate the outcome of various policies to reduce fire sale spillovers in the midst of a crisis. Size caps, or forced mergers among the most exposed banks, do not reduce systemic risk very much. However, modest equity injections, if distributed appropriately between the most systemic banks, can cut the vulnerability of the banking sector to deleveraging by more than half. The model can be adapted to monitor vulnerability on a dynamic basis using factor exposures. Closed for comment; 0 Comments.

Issuer Quality and Corporate Bond Returns

by Robin Greenwood & Samuel G. Hanson

In research that could help regulators and policymakers tell if credit markets are becoming overheated, HBS professor Robin Greenwood and doctoral candidate Samuel G. Hanson suggest that measures of credit quality are just as important to monitor as the more traditional reviews of credit quantity. They also find that time-varying investor beliefs such as over-optimism, or tastes such as a heightened tolerance for risk, can contribute to fluctuations in credit quantity. Key concepts include: The researchers use measures of the quality of corporate debt issuers to forecast excess returns on corporate bonds. When issuer quality is low, corporate bonds subsequently underperform Treasuries. The work uncovers a striking degree of predictability and often forecasts significantly negative excess returns. The 2004-2007 credit boom and collapse was not unique, but rather part of a recurring historical pattern in which investors grant cheap credit to low quality borrowers during credit booms, and experience low returns when those borrowers ultimately default or spreads widen. The research results provide guidance on how we can tell if credit markets are becoming overheated, and suggests that looking at credit quantities alone may not be enough-policymakers might also want to consider the credit quality of debt market financing. Closed for comment; 0 Comments.

A Comparative-Advantage Approach to Government Debt Maturity

by Robin Greenwood, Samuel G. Hanson & Jeremy C. Stein

Can the government do anything to discourage short-term borrowing by the private sector? HBS Professor Robin Greenwood, Harvard University and Harvard Business School PhD candidate Samuel Hanson, and Harvard University Professor Jeremy C. Stein suggest the government could actively influence the corporate sector's borrowing decisions by shifting its own financing between T-bills and bonds. Key concepts include: Historically, there is a strong correlation between the maturity of government debt and the ratio of debt-to-GDP. There is effectively a regulatory dimension to the government's debt-maturity choice. The title of the paper refers to the idea that, in choosing the optimal maturity structure of its debt, the government balances the costs of rollover risk with the system-wide benefits of crowding out private sector money creation. In other words, the government should keep issuing short-term bills as long as it has a comparative advantage over the private sector in the production of riskless money-like securities. Treasury could both create valuable incremental monetary services, as well as have a potentially powerful crowding-out effect on the private sector, by issuing more in the way of, say, two and four-week bills. A simple calculation shows that this may be done without much of an increase in rollover risk. Closed for comment; 0 Comments.

How Government can Discourage Private Sector Reliance on Short-Term Debt

by Staff

Financial institutions have relied increasingly and excessively on short-term financing--putting the overall system at risk. Should government step in? Harvard researchers Robin Greenwood, Samuel Hanson, and Jeremy C. Stein propose a "comparative advantage approach" that allows government to actively influence the corporate sector's borrowing decisions. Key concepts include: There is general agreement that the financing of large financial intermediaries puts the larger financial system at risk. The government can dissuade firms from issuing short-term debt by simply making it less attractive to do so. The government could actively influence the corporate sector's borrowing decisions by shifting its own financing between T-bills and bonds. Closed for comment; 0 Comments.