Research

Price-based risk rules map sampled transaction prices into measured risk and then into binding requirements. We prove a local impossibility theorem: in reachable binding states with sufficiently strong amplification, no such rule can simultaneously remain (i) risk-sensitive, (ii) preserve liquidity continuity, and (iii) eliminate profitable round-trip manipulation. Unlike classic manipulation, the mechanism does not require large trades, large price moves, or making a slack constraint bind. A small trade can alter the prices used by the rule, tighten requirements, induce predictable forced selling, and then be reversed profitably. The result holds with continuous trading between discrete measurement and reset dates and survives strategic responses by constrained investors. Fragility is greatest when realized risk is low.

Under classic no-manipulation conditions on market impact, price-based risk constraints (margins, haircuts, leverage limits, volatility targets, mandates) can still generate dynamic arbitrage. We develop a refined no-dynamic-arbitrage test for such environments; it requires only the constraint rule and an estimate of market impact. The test also yields an upper bound on the size of the constrained sector consistent with non-manipulability. We apply it to volatility-managed portfolios: admissible scale is well below one day of average daily volume, and vulnerability increases sharply once linked notional reaches roughly one to two days of daily volume. Manipulation incentives are strongest in low-volatility states, driven by feedback between measured risk and rule-induced trading.

Collateralized Loan Obligations (CLOs) spread shocks in the market for leveraged loans. I document that, in order to satisfy constraints based on the par value of their assets, CLOs become forced sellers of high quality securities when hit by negative shocks to otherwise unrelated securities. Loans sold for non fundamental reasons trade at depressed prices for up to nine months after the shock. The effect cannot be explained by selection on ex-ante or ex-post loan characteristics. A large fraction of the dislocation in secondary markets is transmitted to the market of issuance: shocked companies due to refinance their loans substitute away from institutional tranches towards other types of securities. The substitution is imperfect causing an increase in the cost of borrowing.

Understanding the determinants of overcrowding behaviour is challenging due to the difficulty in measuring investor beliefs and preferences. This paper addresses this challenge by exploring the dynamics of investor behaviour within the leveraged loan market. Our major findings reveal that overcrowding among institutional investors in this market is driven by incorrect beliefs about their peers’ actions rather than unobservable asset characteristics or positive spillovers across investors. Using a structural model of entry, along with exclusion restrictions and instrumental variables, we assess the accuracy of investor beliefs regarding their peers’ investment decisions. Our findings refute the hypothesis of unbiased beliefs, indicating that overcrowding is driven by investors’ incorrect assumptions about peer behaviour. Additionally, we recover the out-of-equilibrium beliefs of investors, providing insights into the determinants of their investment choices. These insights have significant implications for understanding market dynamics and quantifying the effect of overcrowding on asset prices.

By inverting the optimal portfolios of mutual fund managers in a fairly general setting, which allows us to partial out the effect of risk aversion and hedging demands, we provide an estimate of perceived expected excess returns and show that they are significantly affected by experienced returns. The effect of past returns is non-monotone: we provide reduced-form and structural evidence of managers displaying recency and primacy bias. Finally, we estimate an average coefficient of relative risk aversion close to unity.

Taxes that happen concurrently with the purchase are more salient than deferred taxes. Using a sharp geographical discontinuity between London Boroughs, we show that the incidence of property taxes deferred to the future is too small compared to the incidence of stamp duty taxes happening at the moment of buying the property. The difference in incidence implies very large discount rates that cannot be easily rationalized even after accounting for liquidity constraints. The lack of salience at the moment of purchase implies that the burden of the tax will be borne in the future to meet the budget constraint. This implies that there is an optimal tax mix, even though one of the two taxes is more distortionary than the other.