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Smalling, David

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    Essays in Financial Economics
    (2015-05-18) Smalling, David; Stein, Jeremy C.; Campbell, John Y.; Cohen, Lauren; Malloy, Christopher
    This dissertation addresses the central issue of understanding how frictions to information flow distort the ability for prices to incorporate new information. In chapter 1, “Forgotten Portfolios”, I illustrate how the ability of a stock’s price to impound information can rely on the portfolios of its owners. I show that, in the presence of limited attention, investors rationally allocate their attention towards processing information that has a greater impact on their wealth. Chapter 2, “The Social Elite” (based on joint work with Alexander Chernyakov), examines how casual social interactions impact asset prices. Social networks play a vital role in the diffusion of information. I focus on fund managers and corporate officers of publicly traded firms and present evidence of information transfer at exclusive social gatherings. I find that when executives attend social gatherings their stock prices' subsequent behavior directionally predicts upcoming earnings surprises. I show that fund managers who attend events that corporate officers from a particular firm also attend are more likely to purchase stock in that firm. I explore potential reasons for this tendency and find that fund managers demonstrably outperform when they decide to trade these socially-connected stocks. Further, socially-connected stocks that fund managers do not purchase subsequently underperform. In chapter 3, “Mean Reversion”, I propose a mechanism whereby learning from news jointly explains the patterns of short horizon momentum and long horizon reversals observed in equity prices. The model's key departure from rationality is its assumption that investors underestimate the relative precision of news. Under mild assumptions, investors will exhibit a rational but perverse tendency to increase their belief in other private signals, regardless of whether or not the private signal is true.