Fundamentally, stocks are a good hedge against inflation if corporate profitability keeps up with inflation. Using monthly stock-market data covering over 151 years, from 1871 to 2022, this article analyzes the relationship between inflation and corporate profitability, measured by dividend-equivalent earnings discounted at the risk-free rate. The relation between corporate profitability and inflation varies across sample periods, time horizons, and ranges of inflation. Corporate profitability tends to be positively related with demand-pull inflation, and negatively related with cost-push inflation. More interestingly, corporate profitability is the highest when inflation is modest (0%–4%), and it is very low when inflation is very low (deflation) or very high (over 10%). Based on this finding, what really matters for corporate profitability seems to be long-term economic stability, as opposed to a temporary setback. High inflation, itself, may not lower corporate profitability, although it can signal lower corporate profitability. Negative stock market reactions to high inflation itself may create buying opportunities.
{"title":"Stocks as a Hedge against Inflation: Does Corporate Profitability Keep Up with Inflation?","authors":"Sangkyu Park","doi":"10.2139/ssrn.4237040","DOIUrl":"https://doi.org/10.2139/ssrn.4237040","url":null,"abstract":"Fundamentally, stocks are a good hedge against inflation if corporate profitability keeps up with inflation. Using monthly stock-market data covering over 151 years, from 1871 to 2022, this article analyzes the relationship between inflation and corporate profitability, measured by dividend-equivalent earnings discounted at the risk-free rate. The relation between corporate profitability and inflation varies across sample periods, time horizons, and ranges of inflation. Corporate profitability tends to be positively related with demand-pull inflation, and negatively related with cost-push inflation. More interestingly, corporate profitability is the highest when inflation is modest (0%–4%), and it is very low when inflation is very low (deflation) or very high (over 10%). Based on this finding, what really matters for corporate profitability seems to be long-term economic stability, as opposed to a temporary setback. High inflation, itself, may not lower corporate profitability, although it can signal lower corporate profitability. Negative stock market reactions to high inflation itself may create buying opportunities.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"32 1","pages":"43 - 60"},"PeriodicalIF":0.0,"publicationDate":"2023-08-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"43517874","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Many funds have “ESG” in their names, suggesting they hold a portfolio of stocks or other assets issued by firms that rank highly on ESG criteria. However, names may be misleading and actual portfolio holdings often do not reflect ESG investing criteria so that investors in such funds end up with a “brown” portfolio instead of the “green” portfolio they desired. The authors study the prospectuses of funds with ESG in their names and find that prospectus language is not useful in identifying true ESG funds from “greenwashing” funds that do not invest according to ESG principles.
{"title":"How Useful Is a Prospectus in Identifying Greenwashing versus True ESG Funds?","authors":"Min Li, Michael Melvin","doi":"10.2139/ssrn.4503729","DOIUrl":"https://doi.org/10.2139/ssrn.4503729","url":null,"abstract":"Many funds have “ESG” in their names, suggesting they hold a portfolio of stocks or other assets issued by firms that rank highly on ESG criteria. However, names may be misleading and actual portfolio holdings often do not reflect ESG investing criteria so that investors in such funds end up with a “brown” portfolio instead of the “green” portfolio they desired. The authors study the prospectuses of funds with ESG in their names and find that prospectus language is not useful in identifying true ESG funds from “greenwashing” funds that do not invest according to ESG principles.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"4 1","pages":"109 - 127"},"PeriodicalIF":0.0,"publicationDate":"2023-08-07","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"44408860","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Joseph Liberman, Stanley Krasner, Nathan Sosner, Pedro Freitas
On average, net losses realized by direct indexing loss-harvesting strategies taper off within the first few years after their inception. In our historical simulations, they reach a maximum average cumulative level of about 30% of the initially invested capital. In addition, direct indexing strategies exhibit a high dispersion of net loss outcomes. Long-short strategies motivated by factor investing can significantly outperform direct indexing strategies from both a pre-tax and tax perspective. We model two types of long-short factor-based strategies: relaxed-constraint and composite long-short. Both types of strategies, if implemented with a sufficiently high level of leverage and tracking error, can realize a cumulative net capital loss of 100% of the invested capital within a few years and, at the same time, substantially outperform the benchmark index before tax, net of implementation costs. We further show that leverage and tracking error of long-short strategies can be managed dynamically in a highly tax-efficient manner. For example, an investor who becomes less optimistic about the prospects of factor investing can reduce the leverage and tracking error substantially, albeit not all the way to zero, without recognizing net capital gains. We find that a full liquidation of the long and short extensions results in realization of most of the previously deferred gains.
{"title":"Beyond Direct Indexing: Dynamic Direct Long-Short Investing","authors":"Joseph Liberman, Stanley Krasner, Nathan Sosner, Pedro Freitas","doi":"10.2139/ssrn.4437402","DOIUrl":"https://doi.org/10.2139/ssrn.4437402","url":null,"abstract":"On average, net losses realized by direct indexing loss-harvesting strategies taper off within the first few years after their inception. In our historical simulations, they reach a maximum average cumulative level of about 30% of the initially invested capital. In addition, direct indexing strategies exhibit a high dispersion of net loss outcomes. Long-short strategies motivated by factor investing can significantly outperform direct indexing strategies from both a pre-tax and tax perspective. We model two types of long-short factor-based strategies: relaxed-constraint and composite long-short. Both types of strategies, if implemented with a sufficiently high level of leverage and tracking error, can realize a cumulative net capital loss of 100% of the invested capital within a few years and, at the same time, substantially outperform the benchmark index before tax, net of implementation costs. We further show that leverage and tracking error of long-short strategies can be managed dynamically in a highly tax-efficient manner. For example, an investor who becomes less optimistic about the prospects of factor investing can reduce the leverage and tracking error substantially, albeit not all the way to zero, without recognizing net capital gains. We find that a full liquidation of the long and short extensions results in realization of most of the previously deferred gains.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"14 1","pages":"10 - 41"},"PeriodicalIF":0.0,"publicationDate":"2023-08-05","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42928960","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Steven Braun, Corey Hoffstein, R. Israelov, David Nze Ndong
Prior research and empirical investment results demonstrate that strategy performance can be highly sensitive to rebalance schedules, an effect called rebalance timing luck (“RTL”). In this article, the authors extend the empirical analysis to option-based strategies. As a case study, they replicate a popular strategy—the self-financing, three-month put-spread collar—with three implementations that vary only in their rebalance schedule. They find that the annualized tracking error between any two implementations is in excess of 400 basis points. They also decompose the empirically derived rebalance timing luck for this strategy into its linear and non-linear components. Finally, they provide intuition for the driving causes of rebalance timing luck in option-based strategies.
{"title":"The Hidden Cost in Costless Put-Spread Collars: Rebalance Timing Luck","authors":"Steven Braun, Corey Hoffstein, R. Israelov, David Nze Ndong","doi":"10.2139/ssrn.4336419","DOIUrl":"https://doi.org/10.2139/ssrn.4336419","url":null,"abstract":"Prior research and empirical investment results demonstrate that strategy performance can be highly sensitive to rebalance schedules, an effect called rebalance timing luck (“RTL”). In this article, the authors extend the empirical analysis to option-based strategies. As a case study, they replicate a popular strategy—the self-financing, three-month put-spread collar—with three implementations that vary only in their rebalance schedule. They find that the annualized tracking error between any two implementations is in excess of 400 basis points. They also decompose the empirically derived rebalance timing luck for this strategy into its linear and non-linear components. Finally, they provide intuition for the driving causes of rebalance timing luck in option-based strategies.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"26 1","pages":"60 - 74"},"PeriodicalIF":0.0,"publicationDate":"2023-08-04","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"41907082","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Compliance carbon allowances are an important tool to reduce carbon emissions and align production and consumption with the Paris Agreement. The four sizable compliance carbon allowance markets accessible to investors are those of the European Union, the United Kingdom, California, and the Regional Greenhouse Gas Initiative in the United States. The authors document the liquidity of futures traded on the carbon allowances of these four markets. Return correlation between markets is limited, leading to diversification benefits for global carbon investors. Global carbon market returns also provide diversification opportunities for investors in conventional asset classes such as stocks, bonds, and commodities.
{"title":"Investing in Carbon Credits","authors":"L. Swinkels, Jieun Yang","doi":"10.2139/ssrn.4225486","DOIUrl":"https://doi.org/10.2139/ssrn.4225486","url":null,"abstract":"Compliance carbon allowances are an important tool to reduce carbon emissions and align production and consumption with the Paris Agreement. The four sizable compliance carbon allowance markets accessible to investors are those of the European Union, the United Kingdom, California, and the Regional Greenhouse Gas Initiative in the United States. The authors document the liquidity of futures traded on the carbon allowances of these four markets. Return correlation between markets is limited, leading to diversification benefits for global carbon investors. Global carbon market returns also provide diversification opportunities for investors in conventional asset classes such as stocks, bonds, and commodities.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"26 1","pages":"28 - 59"},"PeriodicalIF":0.0,"publicationDate":"2023-08-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"45103449","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The value of direct indexing in enhancing overall after-tax returns has been well established. But where does direct indexing fit in an investor’s portfolio? In this article, we demonstrate the potential benefits of building a portfolio using a core–satellite approach. We consider multiple investment vehicles and approaches—passive ETFs, direct indexing, and active investment strategies—and create several possible implementation paths for investors to consider.
{"title":"Using a Direct Index in a Core–Satellite Portfolio","authors":"Paul Bouchey, Steve Edwards, Spencer Cavallo","doi":"10.2139/ssrn.4456236","DOIUrl":"https://doi.org/10.2139/ssrn.4456236","url":null,"abstract":"The value of direct indexing in enhancing overall after-tax returns has been well established. But where does direct indexing fit in an investor’s portfolio? In this article, we demonstrate the potential benefits of building a portfolio using a core–satellite approach. We consider multiple investment vehicles and approaches—passive ETFs, direct indexing, and active investment strategies—and create several possible implementation paths for investors to consider.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"14 1","pages":"58 - 68"},"PeriodicalIF":0.0,"publicationDate":"2023-07-27","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"46250321","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Investment strategies focused on environmental, social, and governance (ESG) issues have been receiving increased interest among defined contribution (DC) plan sponsors, consultants, and regulators. This article explores the allocation decisions of 9,324 newly enrolled DC participants who are self-directing their accounts in a DC plan that offers at least one ESG fund. The analysis suggests that demand for ESG funds is relatively low, with ESG fund allocations and holding levels being lower than random chance would suggest. While there are some clear demographic preferences for ESG funds (e.g., among younger participants with higher incomes), ESG allocations appear to be primarily a function of weak preferences, driven by naïve diversification, although ESG allocations are significantly higher in plans where general ESG usage is more elevated. ESG funds have the potential to drive participants away from professionally managed investment options, such as target-date funds, resulting in lower risk-adjusted returns for participants if they are simply added to core menus. Overall, this analysis suggests that plan sponsors should take a thoughtful and cautious approach when considering adding ESG funds to an existing core menu.
{"title":"ESG Fund Allocations among New, Do-It-Yourself Defined Contribution Plan Participants","authors":"David Blanchett, Zhikun Liu","doi":"10.2139/ssrn.4149885","DOIUrl":"https://doi.org/10.2139/ssrn.4149885","url":null,"abstract":"Investment strategies focused on environmental, social, and governance (ESG) issues have been receiving increased interest among defined contribution (DC) plan sponsors, consultants, and regulators. This article explores the allocation decisions of 9,324 newly enrolled DC participants who are self-directing their accounts in a DC plan that offers at least one ESG fund. The analysis suggests that demand for ESG funds is relatively low, with ESG fund allocations and holding levels being lower than random chance would suggest. While there are some clear demographic preferences for ESG funds (e.g., among younger participants with higher incomes), ESG allocations appear to be primarily a function of weak preferences, driven by naïve diversification, although ESG allocations are significantly higher in plans where general ESG usage is more elevated. ESG funds have the potential to drive participants away from professionally managed investment options, such as target-date funds, resulting in lower risk-adjusted returns for participants if they are simply added to core menus. Overall, this analysis suggests that plan sponsors should take a thoughtful and cautious approach when considering adding ESG funds to an existing core menu.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"11 1","pages":"56 - 73"},"PeriodicalIF":0.0,"publicationDate":"2023-07-12","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"49052425","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Recent progress in causal inference has opened a path, however difficult, for advancing financial economics beyond its current phenomenological stage. This article proposes a hierarchy of empirical evidence, recognizing that not all types of observations have the same scientific weight, in the sense of enabling the falsification of causal claims.
{"title":"The Hierarchy of Empirical Evidence in Finance","authors":"Marcos M. López de Prado","doi":"10.2139/ssrn.4425855","DOIUrl":"https://doi.org/10.2139/ssrn.4425855","url":null,"abstract":"Recent progress in causal inference has opened a path, however difficult, for advancing financial economics beyond its current phenomenological stage. This article proposes a hierarchy of empirical evidence, recognizing that not all types of observations have the same scientific weight, in the sense of enabling the falsification of causal claims.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"49 1","pages":"10 - 29"},"PeriodicalIF":0.0,"publicationDate":"2023-07-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"46510573","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We document that a theoretically founded, real-time, and easy-to-implement option-based measure, termed synthetic-stock difference (SSD), accurately estimates the part of a stock’s expected return arising from its transaction costs. We calculate SSD for US optionable stocks. SSD can be more than 10% per year, it can fluctuate significantly over time, and its cross-sectional dispersion widens over market crises periods. We confirm the accuracy of SSD by empirically verifying the predictions of a standard asset pricing setting with transaction costs. First, we document its predicted type of connection with various proxies of stocks’ transaction costs. Second, we conduct simple asset pricing tests that render further support. Our setting allows explaining the size of alphas reported by previous literature on the predictive ability of deviations from put-call parity.
{"title":"The Contribution of Transaction Costs to Expected Stock Returns: A Novel Measure","authors":"Kazuhiro Hiraki, G. Skiadopoulos","doi":"10.2139/ssrn.4318478","DOIUrl":"https://doi.org/10.2139/ssrn.4318478","url":null,"abstract":"We document that a theoretically founded, real-time, and easy-to-implement option-based measure, termed synthetic-stock difference (SSD), accurately estimates the part of a stock’s expected return arising from its transaction costs. We calculate SSD for US optionable stocks. SSD can be more than 10% per year, it can fluctuate significantly over time, and its cross-sectional dispersion widens over market crises periods. We confirm the accuracy of SSD by empirically verifying the predictions of a standard asset pricing setting with transaction costs. First, we document its predicted type of connection with various proxies of stocks’ transaction costs. Second, we conduct simple asset pricing tests that render further support. Our setting allows explaining the size of alphas reported by previous literature on the predictive ability of deviations from put-call parity.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"31 1","pages":"8 - 33"},"PeriodicalIF":0.0,"publicationDate":"2023-06-23","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42816661","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Investors take for granted that returns are recorded in units of time, such as days, months, and years. Yet some time periods include unusual events that reasonably cause asset prices to change, whereas other periods are relatively free of unusual events, in which case returns mostly reflect noise. Based on insights from information theory, the authors rescale time into event units so that each return is related to a common degree of event intensity. Their analysis reveals that when returns are measured in event units, their distributions are more normal and their co-occurrences are more stable, which enables analysts to form more reliable inferences.
{"title":"Event Time","authors":"M. Czasonis, M. Kritzman, D. Turkington","doi":"10.2139/ssrn.4101500","DOIUrl":"https://doi.org/10.2139/ssrn.4101500","url":null,"abstract":"Investors take for granted that returns are recorded in units of time, such as days, months, and years. Yet some time periods include unusual events that reasonably cause asset prices to change, whereas other periods are relatively free of unusual events, in which case returns mostly reflect noise. Based on insights from information theory, the authors rescale time into event units so that each return is related to a common degree of event intensity. Their analysis reveals that when returns are measured in event units, their distributions are more normal and their co-occurrences are more stable, which enables analysts to form more reliable inferences.","PeriodicalId":74863,"journal":{"name":"SSRN","volume":"49 1","pages":"81 - 92"},"PeriodicalIF":0.0,"publicationDate":"2023-05-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"41505960","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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