Working Papers
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The Private Capital Alpha (with Gregory Brown and Wendy Hu)
* Conferences: 2024 Inquire Europe; 2023 IPC & PERC Private Equity Research Symposium
Abstract: The alpha of an investment reflects its ability to increase the Sharpe ratio of a benchmark portfolio allocation based on tradable factors. We argue that, in the context of private capital, the usual approach to estimate alpha is misleading because it ignores the economic realities of investing in private markets. We then combine a large sample of 5,028 U.S. buyout, venture capital, and real estate funds from 1987 to 2022 to estimate the alphas of private capital asset classes under realistic simulations that account for the illiquidity and underdiversification in private markets as well as the portfolio allocation of typical limited partners. We find that buyout as an asset class provided a positive and statistically significant alpha during our sample period. In contrast, over our sample period, the venture capital alpha was large and positive but statistically unreliable whereas the real estate alpha was very close to zero.
Institutional Investors’ Subjective Risk Premia: Time Variation and Disagreement (with Spencer Couts, Yicheng Liu, and Johnathan Loudis)
* Conferences: 2024 Annual Valuation Workshop at Wharton and 2024 Wabash River Conference at Purdue
Abstract: In this paper, we study the role of subjective risk premia in explaining subjective expected return time variation and disagreement using the long-term Capital Market Assumptions of major asset managers and investment consultants from 1987 to 2022. We find that market risk premia explain most of the expected return time variation, with the rest explained by alphas. The risk premia effect is almost entirely driven by time variation in risk quantities as opposed to risk price. Nevertheless, risk price explains about half of the transitory effect of risk premia on expected returns. Market risk premia also explain most of the expected return disagreement, but in this case alphas have a quantitatively significant effect, and risk price and risk quantities are roughly equally responsible for the risk premia effect. Our results provide benchmark moments that asset pricing models should match to be consistent with institutional investors’ beliefs.
A First Look at the Historical Performance of the New NAV REITs (with Spencer Couts)
* Conferences: 2024 IPC Real Assets Research Symposium, 2024 AREUEA National Conference, 2024 IPA Research Conference
Abstract: Private Commercial Real Estate (CRE) funds provide institutional investors an opportunity to access the CRE market, but most of them are inaccessible to typical individual (retail) investors. In this paper, we study the early performance (2016 to 2023) of a special and emerging class of non-listed CRE funds that are accessible to individual investors. These funds, referred to as Net Asset Value (NAV) Real Estate Investment Trusts (REITs), have grown in importance over the last decade. They now represent a major alternative to publicly traded REITs in providing individual investors a way to access CRE investments without direct ownership. We find that the observed returns from these NAV REITs suffer from smoothness due to lagged pricing updates, and thus unsmoothing returns is important for studying their risk-adjusted performance. We then show that NAV REITs have delivered large alphas relative to public indices over our sample period. Finally, we highlight that traditional alpha analysis may not be adequate for a short sample like ours and provide an alternative alpha analysis that indicates the alphas of NAV REITs over our sample period were economically meaningful, albeit substantially lower than traditional alpha analysis suggests.
Payout-Based Asset Pricing (with Andreas Stathopoulos)
* Conferences: 2024 Workshop on Investment and Production-Based Asset Pricing, 2024 UW Foster Summer Conference, 2024 U of Michigan New Frontiers in Asset Pricing Mitsui Symposium, 2024 World Symposium on Investment Research, 2024 MFA Meeting
Abstract: Firms’ payout decisions respond to expected returns: everything else equal, firms invest less and pay out more when their cost of capital increases. Given investors’ demand for firm payout, market clearing implies that productivity and payout demand dynamics fully determine equilibrium asset prices and returns. Using this logic, we propose a payout-based asset pricing framework. To operationalize it, we introduce a quantitative model, calibrating the productivity and payout demand processes to match aggregate U.S. corporate output and payout moments. Model-implied payout yields and firm returns match key empirical moments, and model-implied expected returns predict future firm returns in the data.
The Subjective Risk and Return Expectations of Institutional Investors (with Spencer Couts and Johnathan Loudis)
* Conferences: 2024 AFA Meeting, 2024 EFA Meeting, 2024 FIRS Meeting, 2024 NFA Meeting, 2024 Adam Smith Workshop, 2024 Annual Finance Conference at WashU, 2024 UW Foster Summer Conference, 2024 Helsinki Finance Summit on Investor Behavior, 2024 Alpine Finance Summit, 2023 Paris December Finance Meeting, 2023 Tel Aviv University Finance Conference, 2023 INSEAD Finance Symposium, 2023 Annual Valuation Workshop at USC, 2023 Brazilian Finance Society Meeting
Abstract: We use the long-term Capital Market Assumptions of major asset managers and institutional investor consultants from 1987 to 2022 to provide three stylized facts about their subjective risk and return expectations on 19 asset classes. First, there is a strong and positive subjective risk-return tradeoff, with most of the variability in subjective expected returns due to variability in subjective risk premia (compensation for market beta) as opposed to subjective alphas. Second, belief variation and the positive risk-return tradeoff are both stronger across asset classes than across institutions. And third, the subjective expected returns of these institutions predict subsequent realized returns across asset classes and over time. Taken together, our findings imply that models with subjective beliefs should reflect a risk-return tradeoff. Additionally, accounting for this subjective risk-return tradeoff when modeling multiple asset classes is even more important than incorporating average belief distortions or belief heterogeneity in our setting.
The Bond, Equity, and Real Estate Term Structures (with Spencer Andrews)
* Conferences: 2022 Finance Down Under; 2021 CFEA, 2021 MFA Meeting, 2021 SBFin Workshop
Abstract: We construct a Stochastic Discount Factor (SDF) that prices bond, equity, and real estate portfolios sorted on cash flow duration. Using this SDF and the dynamics of cash flow yields in these three asset classes, we estimate the bond, equity, and real estate term structures monthly from 1974 to 2019. We find that while (nominally) safe and risky cash flows have risk premia term structures that are upward sloping on average and move together over time, the term structure dynamics are fundamentally different after we remove the safe component of the risky cash flows. Specifically, equity and real estate maturity-matched risk premia, on average, increase over short maturities but decline over long maturities. Moreover, their term structures comove positively with each other but negatively with the bond term structure.
What Moves Equity Markets? A Term Structure Decomposition for Stock Returns
* Conferences: 2023 AFA, 2022 MFA Meeting, 2022 European Winter Finance Summit, 2022 Craig Holden Memorial Finance Conference at Indiana University; 2020 NFA
* Best Paper Award, European Winter Finance Summit (Sudipto Bhattacharya Memorial Prize)
Abstract: Several papers decompose stock returns into cash flow and discount rate news to study equity market fluctuations. This paper develops an alternative return decomposition based on the fact that equity movements originate from variation in the present values of dividends with different maturities. I find that roughly 60% of equity volatility comes from the present value of dividends with maturities beyond 20 years and that cash flow shocks drive volatility in short-term present values whereas discount rate news are responsible for volatility in long-term present values. I also provide three further empirical applications of this new equity term structure decomposition.