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Using a sample of equity closed-end funds, we document significant portfolio holdings disclosure valuation effects and strategic disclosure timing by portfolio managers. An event study analysis reveals statistically significant positive (negative) abnormal returns associated with early (late) disclosure. We find that the returns of a long-short arbitrage strategy portfolio become statistically significant exactly when the implementation of such a strategy is facilitated by the timely disclosure of portfolio holdings. Our findings support the argument that managers of funds trading at high discounts are more likely to disclose earlier in order to reduce discounts and protect themselves from activist investor attacks. This is despite the documented strong motives for late disclosure stemming from copycatting and front running threats shared with open-end fund managers.

This paper models a market microstructure bias, driven by the bid-ask spread, that is evident in the aggregate firm-level risk embodied by the stock return variance estimates of Goyal and Santa-Clara (2003) and Campbell, Lettau, Malkiel, and Xu (2001). Controlling for this bias, we find that there is a significant liquidity channel through which most of macroeconomic policy and activity initially demonstrates an effect. Market microstructure also explains the time-trend of aggregate firm-level volatility observed from 1962 to 1997 (Campbell et al., 2001), and subsumes any relation between retail trading and future idiosyncratic volatility from 1983 to 1999 (Brandt, Brav, Graham, and Kumar, 2010). We conclude that the aggregate firm-level bid-ask spread better predicts future market volatility rather than any measure of economic activity and that the bid-ask spread is the primary driver in trends observed in aggregate volatility measures from 1927 to 2012.

We introduce a novel methodology to identify copycat behavior in mutual funds. We find that imitation is pervasive in the mutual fund industry. While most copycats underperform, a small number are 'smart imitators'. We find that funds at the high and low ends of the Copycat Score range outperform other funds in the sample by 1.92% and 3.24% per year, respectively. We show that the Copycat Score is persistent in time, related to other measures of skill, and is a good predictor of fund performance. We conclude that smart copycatting is another skill in the toolkit of successful fund managers.

We examine the cross-sectional relation between idiosyncratic volatility and stock returns and propose that the joint effect of the percentage of zero returns, that affects the loading on the systematic risk factors, and the bid-ask spread, that inflates the variance of the returns, biases the estimate of idiosyncratic volatility and the resulting pricing ability of idiosyncratic volatility. We model the microstructure influence on returns and derive a closed-form solution for the bias in the estimated idiosyncratic volatility. Motivated by this theory, our empirical results show that controlling for the liquidity costs on the estimation of idiosyncratic volatility diminishes to insignificance the ability of idiosyncratic volatility estimates to predict future returns. We confirm our findings by examining external shocks to liquidity, due to reductions in the stated quotes after 1997 and the decimalization of quotes in 2001, and find a significant reduction in the pricing ability of idiosyncratic volatility. Finally, minimizing liquidity’s influence on the estimated idiosyncratic volatility, by orthogonalizing the percentage of zero return and spread effects on the estimated idiosyncratic volatility, demonstrates that the resulting idiosyncratic volatility estimate has little pricing ability.

We examine whether liquidity is priced in corporate yield spreads. Using a battery of liquidity measures covering over 4000 corporate bonds and spanning investment grade and speculative grade categories, we find that more illiquid bonds earn higher yield spreads; and that an improvement of liquidity causes a significant reduction in yield spreads. These results hold after controlling for common bond-specific, firm-specific, and macroeconomic variables, and are robust to issuers' fixed effect and potential endogeneity bias. Our finding mitigates the concern in the default risk literature that neither the level nor the dynamic of yield spreads can be fully explained by default risk determinants, and suggests that liquidity plays an important role in corporate bond valuation.

Emerging markets are characterized by volatile, but substantial returns that can easily exceed 75% per annum. Balancing these lofty returns are liquidity costs that, using the bid–ask spread as a basis, range from 1% for the Taiwanese market to over 47% for the Russian market. However, the paucity of bid–ask spread information across countries and time requires the use of liquidity estimates in emerging markets even though little is known about the efficacy of these estimates in measuring bid–ask spread costs. Using firm-level quoted bid–ask spreads as a basis, I find that price-based liquidity measures of Lesmond et al. [Review of Financial Studies 12 (1999) 1113] and Roll [Journal of Finance 39 (1984) 1127] perform better at representing cross-country liquidity effects than do volume based liquidity measures. Within-country liquidity is best measured with the liquidity estimates of either Lesmond, Ogden, and Trzcinka or, to a lesser extent, Amihud (2002). Examining the impact of legal origin and political institutions on liquidity levels shows that countries with weak political and legal institutions have significantly higher liquidity costs than do countries with strong political and legal systems, even to the exclusion of legal origin or insider trading enforcement. Higher incremental political risk is associated with a 10 basis point increase in transaction costs, using the Lesmond, Ogden, and Trzcinka estimate, or a 1.9% increase in price impact costs, using the Amihud estimate.

Recent work suggests that investor sentiment drives the behavior of closed-end fund premiums. We develop a microstructure model that links the observed closed-end fund premiums to the interplay between the bid-ask spread of the fund with that of the fund's holdings. Employing a battery of investor sentiment measures, we find inconsistent evidence in support of an investor sentiment hypothesis, but robust support for the liquidity based explanation in explaining the closed-end fund premium. The importance of the microstructure explanation extends to pricing of the closed-end funds whereby significant cross-sectional pricing ability for the bid-ask spreads is found, but no significant pricing ability for either investor sentiment or closed-end fund premiums.

This paper models a market microstructure bias, driven by the bid-ask spread, that is evident in the pricing of aggregate firm-level risk embodied by the stock return variance estimates of Goyal and Santa-Clara (2003). Controlling for this bias, we find no pricing ability for aggregate firm-level variance for the period 1927 to 2012 or for any sub-period tested. Market microstructure also explains the time-trend of aggregate firm-level volatility observed from 1962 to 1997 (Campbell, Lettau, Malkiel, and Xu, 2001), and subsumes any relation between retail trading and future idiosyncratic volatility from 1983 to 1999 (Brandt, Brav, Graham, and Kumar, 2010). We conclude that the aggregate firm-level bid-ask spread is priced with future market returns rather than any of the aggregate firm-level risk measures.

Transaction costs are important for a host of empirical analyses from market efficiency to international market research. But transaction costs estimates are not always available, or where available, are cumbersome to use and expensive to purchase. We present a model that requires only the time series of daily security returns to endogenously estimate the effective transaction costs for any firm, exchange, or time period. The feature of the data that allows for the estimation of transaction costs is the incidence of zero returns. Incorporating zero returns in the return-generating process, the model provides continuous estimates of average round-trip transaction costs from 1963 to 1990 that are 1.2% and 10.3% for large and small decile firms, respectively. These estimates are highly correlated (85%), with the most commonly used transaction cost estimators. How much does it cost to trade common stock? The Plexus Group (1996) estimated that trading costs are at least 1.0-2.0% of market value for institutions trading the largest NYSE/AMEX firms. Such trades account for more than 20% of reported trading volume. Stoll and Whaley (1983) reported quoted spread and commission costs of 2.0% for the largest NYSE size decile to 9.0% for the small decile. Bwardwaj and Brooks (1992) reported median quoted spread and commission costs between 2.0% for NYSE securities with prices greater than $20.00 and 12.5% for securities priced less than $5.00. These costs are important in determining investment performance and "can substantially reduce or possibly outweigh the expected value created by an investment strategy" [Keim and Madhavan (1995)]. This article is based on a portion of the first chapter of David A. Lesmond's dissertation entitled: "Trans

This paper investigates the hypothesis that market microstructure is an important determinant of stock-return kurtosis. We first develop a simple model where an informed investor has private information about the firm's fundamentals and marketmaker has private information about the non-fundamentals, particularly concerning the structure of noise-traders' demand. The model shows that these market frictions can generate significant kurtosis in asset return distribution. Consistently, findings in our empirical analyses support this conjecture. We find a positive and causal association between liquidity cost in stock market and kurtosis in stock return. This association is robust to various specifications, and different proxies for liquidity cost and return kurtosis. It is even present when we control for the endogeneity and reverse causality concerns. Our findings have implications for research in asset pricing and corporate finance, and also add to the knowledge of practitioners, especially from risk management perspective.

Previous literature analyzes copycat funds, whose managers invest by imitating the disclosed positions of other funds, using simulation only. I introduce a measure to identify real copycat and leader funds, and analyze samples of U.S. equity funds that fall into each category. Unlike previously reported results, real copycat funds do not outperform the average mutual fund. However, leader funds, identified with this measure as those which are most followed by others, do outperform the market and their peers. A simulated investment strategy that follows these leader funds’ portfolio disclosures obtains higher returns than those previously reported, even delivering positive and significant alpha. Further tests show that this performance is not the result of simple momentum or other previously reported anomaly. This hints at the possibility of a different form of fund management skill: that of identifying peer managers whose portfolio holdings disclosures contain valuable information and are worth imitating.

We examine the cross-sectional relation between idiosyncratic volatility (IV) and stock returns and propose that the percentage of zero returns and its effect on IV measurement is a missing component in the ongoing analysis of the pricing of IV. We find the results of Spiegel and Wang (2005) and Ang, Hodrick, Xing, and Zhang (2006) are critically dependent on the occurrence of zero returns, yet because these studies do not specifically account for the occurrence of zero returns, measurements of IV are inflated. We examine external shocks to liquidity due to reductions in the stated quotes after 1997 and 2001 and find that a significant reduction in the occurrence of zero returns accompanies a significant reduction in the pricing ability of IV. Restricting our analysis to those firms that experience less than 5% zero returns during the period 1983 to 1996, when the overall pricing ability of IV peaks, we find no ability of IV to predict returns. Controlling for the liquidity costs engendered in both the percentage of zero returns and the more direct bid-ask spread removes the ability of IV to predict future returns.

This paper investigates the relationship between capital structure and stock liquidity surrounding pure leverage recapitalizations. A substitution of debt for equity in the firm's capital structure concentrates private information in the remaining equity, increasing the informational asymmetry of the firm's equity, leading to increases in the firm's equity liquidity costs. Changes in the firm's leverage are associated with both changes in the probability of informed trading in the firm's stock and with changes in the firm's underlying equity liquidity even after controlling for changes in the commonly used liquidity, equity volatility, or capital structure choice control variables. In aggregate, leverage increasing firms experience an increase of 1% in the bid-ask spread and leverage decreasing firms experience a decrease of 2% in the bid-ask spread. We argue that leverage's effect on equity liquidity costs represents an economically relevant cost to debt usage, and this cost potentially reduces firm value relative to a zero transaction costs environment.

Liquidity risk is an important component of the yield spread on both corporate and sovereign bonds in emerging markets, explaining about half as much of the yield spread as credit risk specific variables. Using three measures of liquidity, including estimates from a model extension of the limited dependent variable model of Lesmond, Ogden, and Trzincka (1999)) on a dataset of over 1600 bond-years spanning both crisis and boom periods in 16 countries, we provide valuable evidence on the magnitude of these effects and the differences in liquidity across sovereign and corporate issuers. In particular, we document that liquidity components increase as credit quality deteriorates for sovereign debt, while the reverse is true for corporate debt, and are the first study to examine the determinants of the rapidly expanding emerging market corporate debt sector. Liquidity is highly significant in explaining cross-sectional variation in yield levels and changes across rated and unrated categories, for both corporate and sovereign issuers, and appears to dominate credit risk in explaining cross-sectional variations in yield spreads for both corporate and sovereign debt instruments across all of the emerging markets examined.

In markets with trading friction, the incorporation of information into market prices can be substantially delayed through a weakening of the arbitrage process. We re-examine the profitability of relative-strength, or momentum, trading strategies (buying past strong performers and selling past weak performers). We find that standard relative-strength strategies require frequent trading in disproportionately high-cost securities so that trading costs prevent profitable strategy execution. In the cross section, we find that those stocks that generate large momentum returns are precisely those stocks with high trading costs. We conclude that the magnitude of the abnormal returns associated with these trading strategies creates an illusion of profit opportunity when, in fact, none exists.