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Three Essays on the Behavior of Financial Market Participants

Rossi, Andrea
http://rave.ohiolink.edu/etdc/view?acc_num=osu1534392734633895

Abstract Details

2018, Doctor of Philosophy, Ohio State University, Business Administration.
In this dissertation, I explore different aspects of the behavior of financial markets participants, specifically, private equity fund managers, hedge fund investors, and corporate insiders. In the first chapter, I try to understand why in private equity fund data there exists an economically large negative association between fund growth and performance at the partnership level. This empirical relation is usually interpreted as evidence of decreasing returns to scale. I argue that this inference is unwarranted. In essence, Bayesian-informed expectations reveal that the partnerships whose funds have grown the most were on average lucky in the past; as that luck reverts to zero, a spurious negative association between growth and returns is generated in the data. Controlling for this bias, the effect of growth on performance is about 80% smaller and statistically insignificant for both buyout and venture capital funds. Furthermore, I show that, historically, decreasing returns do not seem to have played a major role in the erosion of performance persistence in private equity. These results have implications for fund managers’ and investors’ decisions, and for our understanding of the private equity industry. In the second chapter, I focus on an important, yet overlooked, implication of the compensation structure of hedge funds. Hedge fund managers are usually compensated with an incentive fee equal to 20% of profits, often defined as returns in excess of a high-water mark. This compensation scheme is asymmetric: hedge funds don’t pay their investors when performance deteriorates, nor they return fees already earned. This means that, ex-post, incentive fees paid on a portfolio of hedge fund investments can amount to more than 20% of profits. I show that, historically, the effective percentage of aggregate profits paid as incentive fees has been more than twice as large as the nominal percentage. As a result, over the last two decades, investors have paid fees for one third of a trillion dollars more than they would have if incentive fees had been symmetric. These results are attributable to two main factors, i.e., ill-advised investment timing by investors and poor fund performance. In the third chapter, coauthored with Itzhak Ben-David and Justin Birru, we study whether industry familiarity is an advantage in stock trading by exploring the trading patterns of industry insiders in their own personal portfolios. To do so, we identify accounts of industry insiders in a large data set provided by a retail discount broker. We find that insiders trade firms from their own industry more frequently. Furthermore, they earn abnormal returns exclusively when trading own-industry stocks, especially obscure stocks (small, low analyst coverage, high volatility). In a battery of tests, we find no evidence of the use of private information. The results are most consistent with the interpretation that industry familiarity is an advantage in stock trading.
Michael Weisbach (Committee Chair)
Itzhak Ben-David (Committee Member)
Justin Birru (Committee Member)
Berk Sensoy (Committee Member)
200 p.
Finance
Financial Markets, Private Equity

Recommended Citations

Citations

  • Rossi, A. (2018). Three Essays on the Behavior of Financial Market Participants [Doctoral dissertation, Ohio State University]. OhioLINK Electronic Theses and Dissertations Center. http://rave.ohiolink.edu/etdc/view?acc_num=osu1534392734633895

    APA Style (7th edition)

  • Rossi, Andrea. Three Essays on the Behavior of Financial Market Participants. 2018. Ohio State University, Doctoral dissertation. OhioLINK Electronic Theses and Dissertations Center, http://rave.ohiolink.edu/etdc/view?acc_num=osu1534392734633895.

    MLA Style (8th edition)

  • Rossi, Andrea. "Three Essays on the Behavior of Financial Market Participants." Doctoral dissertation, Ohio State University, 2018. http://rave.ohiolink.edu/etdc/view?acc_num=osu1534392734633895

    Chicago Manual of Style (17th edition)

osu1534392734633895
452
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This open access ETD is published by The Ohio State University and OhioLINK.