Episodic liquidity crises: cooperative and predatory trading,”

ABSTRACT We describe how episodic illiquidity arises from a breakdown in cooperation between market participants. We first solve a one-period trading game in continuous-time, using an asset pricing equation that accounts for the price impact of trading. Then, in a multi-period framework, we describe an equilibrium in which traders cooperate most of the time through repeated interaction and provide 'apparent liquidity' to each other. Cooperation breaks down when the stakes are high, leading to predatory trading and episodic illiquidity. Equilibrium strategies involving cooperation across markets lead to less frequent episodic illiquidity, but cause contagion when cooperation breaks down. * Bruce Ian Carlin, Miguel Sousa Lobo, and S. Viswanathan are from the Fuqua School of Business at Duke University. The authors would like to than

Predictability and the earnings-returns relation

This paper studies the effects of predictability on the earnings-returns relation for individual firms and for the aggregate. We demonstrate that prices better anticipate earnings growth at the aggregate level than at the firm level, which implies that random-walk models are inappropriate for gauging aggregate earnings expectations. Moreover, we show that the contemporaneous correlation of earnings growth and stock returns decreases with the ability to predict future earnings. Our results may therefore help explain the apparently conflicting recent evidence that the earnings-returns relation is negative at the aggregate level but positive at the firm level.Stock prices Aggregate earnings Discount rates Expected returns Expected earnings

Liquidity risk and the cross-section of hedge-fund returns

This paper demonstrates that liquidity risk as measured by the covariation of fund returns with unexpected changes in aggregate liquidity is an important determinant in the cross-section of hedge-fund returns. The results show that funds that significantly load on liquidity risk subsequently outperform low-loading funds by about 6% annually, on average, over the period 1994-2008, while negative performance is observed during liquidity crises. The returns are independent of the liquidity a fund provides to its investors as measured by lockup and redemption notice periods, and they are also robust to commonly used hedge-fund factors, none of which carries a significant premium during the sample period. These findings highlight the importance of understanding systematic liquidity variations in the evaluation of hedge-fund performance.Liquidity risk Hedge funds Price impact Asset pricing