The IMF potentially creates moral hazard when it provides bailouts to countries in a financial crisis. We ask whether a creditor moral hazard is observable in the data. We test the hypothesis that recent unprecedented bailouts – starting with the 1994 Mexican crisis – changed international investors’ perception of default risk on international borrowing. Our events-study approach identifies imp...

In an asset-pricing model, risk-averse agents need to forecast the conditional variance of a stock’s return. A near-rational restricted perceptions equilibrium exists in which agents believe prices follow a random walk with a conditional variance that is self-fulfilling. When agents estimate risk in real-time, recurrent bubbles and crashes can arise. These effect are stronger when agents allow ...

Markets for Reputation: Evidence on Quality and Quantity in Academe We develop a theory of the market for individual reputation, an indicator of regard by one’s peers and others. The central questions are: 1) Does the quantity of exposures raise reputation independent of their quality? and 2) Assuming that overall quality matters for reputation, does the quality of an individual’s most importan...

Unlike in small communities where one can strategically interact with another according to the latter’s individual reputation, players in complex societies often have to interact with strangers whose individual reputations cannot be easily acquired. They often have to infer their counterparts’ characteristics from the latters’ group reputation to simplify decision making. We provide a game theo...

This paper examines the role of the federal government in the market for terrorism reinsurance. We investigate the stock price response of affected industries to a sequence of 13 events culminating in the enactment of the Terrorism Risk Insurance Act (TRIA) of 2002. In the industries most likely to be affected by TRIA—banking, construction, insurance, real estate investment trusts, transportati...

I develop a noisy rational expectations equilibrium model with a continuum of states and a full set of options that render the market complete. I show a major difference in equilibrium behavior between models with constant absolute risk aversion (CARA) and non-CARA preferences. First, when informed traders have non-CARA preferences, all equilibria are fully revealing, independent of the amount ...

This paper presents a Heterogeneous Agent Model of a financial market with chartist and fundamentalist traders that exhibit bounded rationality and short-term thinking to explain the effect of under and overreaction to news. The existence of the Market Maker’s finite price adjustment speed and the presence of risk aversion lead to the fact that prices do not adjust instantaneously to new inform...

We outline a systematic approach to incorporate macroeconomic information into firm level forecasting from the perspective of an equity investor. Using a global sample of 324,982 firm-years over the 1998-2010 time period, we find that combining firm level exposures to countries (via geographic segment data) with forecasts of country level performance, is able to generate superior out of sample ...

This paper establishes a strong link between the dispersion in beliefs among active mutual funds, as revealed through their active holdings (i.e., deviations from benchmarks), and future stock returns. We find that after standard risk adjustments, stocks in the top decile portfolio with large increases in dispersion outperform those in the bottom decile by more than 1% per month. This effect of...

We exploit the restrictions of intertemporal portfolio choice in the presence of nonfinancial income risk to design and implement tests of hedging that use the information contained in the actual portfolio of the investor. We use a unique dataset of Swedish investors with information broken down at the investor level and into various components of wealth, investor income, tax positions and inve...