The AQR Insight Award, sponsored by AQR Capital Management, recognizes important, unpublished papers that provide the most significant, new practical insights for tax-exempt institutional or taxable investor portfolios. Up to three papers share a $100,000 prize.
Robert Ready, Nikolai Roussanov, and Colin WardPersistent differences in interest rates across countries account for much of the profitability of currency carry trade strategies. The high-interest rate "investment" currencies tend to be "commodity currencies," while low interest rate "funding" currencies tend to belong to countries that export finished goods and import most of their commodities. We develop a general equilibrium model of international trade and currency pricing in which countries have an advantage in producing either basic input goods or final consumable goods. The model's primary mechanism is that productivity shocks to final good producers are more important for global risk, and that these producer countries are forced to bear this risk, which in turn gives rise to differences in riskiness across currencies, and profitable carry trade strategies.
Matti Keloharju, Juhani T. Linnainmaa, and Peter Nyberg
A strategy that selects stocks based on their historical same-calendar-month returns earns an average return of 13% per year. We document similar return seasonalities in anomalies, commodities, international stock market indices, and at the daily frequency. The seasonalities overwhelm unconditional differences in expected returns. The correlations between different seasonality strategies are modest, suggesting that they emanate from different common factors. Our results suggest that seasonalities are not a distinct class of anomalies that requires an explanation of its own - rather, they are intertwined with other return anomalies through shared common factors. A theory that is able to explain the risks behind any common factor is thus likely able to explain a part of the seasonalities.READ THE PAPER
Salman Arif, Azi Ben-Rephael, and Charles M.C. Lee
Using high resolution data, we show that short-sellers (SSs) systematically profit from mutual fund (MF) flows. At the daily level, SSs trade strongly in the opposite direction to MFs. This negative relation is associated with the expected component of MF flows (based on prior days’ trading), as well as the unexpected component (based on same-day flows). The ability of SS trades to predict stock returns is up to 3 times greater when MF flows are in the opposite direction. The resulting wealth transfer from MFs to SSs is most pronounced for high-MF-held, low-liquidity firms, and is much larger during periods of high retail sentiment.
Oliver Boguth and Mikhail Simutin
Prior theory suggests that time variation in the degree to which leverage constraints bind affects the pricing kernel. We propose a demand-based measure for this leverage constraint tightness by inverting the argument that constrained investors tilt their portfolios to riskier assets. We show that the average market beta of actively managed mutual funds - intermediaries facing leverage restrictions - captures their borrowing demand and thus the tightness of leverage constraints. Consistent with theory, it strongly predicts returns of the betting-against-beta portfolio, and is a priced risk factor in the cross-section of mutual funds and stocks. Funds with low exposure to the factor outperform high-exposure funds by more than 5% annually, and for stocks this difference reaches 7%. Our results show that the tightness of leverage constraints has important implications for asset prices.
Christopher L. Culp, Yoshio Nozawa, and Pietro Veronesi
Theoretically, corporate debt is economically equivalent to safe debt minus a put option on the firm’s assets. We empirically show that indeed portfolios of long Treasuries and short traded put options (“pseudo bonds”) closely match the properties of traded corporate bonds. Pseudo bonds display a credit spread puzzle that is stronger at short horizons, unexplained by standard risk factors, and unlikely to be solely due to illiquidity. Our option-based approach offers a novel, model-free benchmark for credit risk analysis, which we use to run empirical experiments on credit spread biases, the impact of asset uncertainty, and bank-related rollover risk.