Abstract In both corporate finance and asset pricing empirical work, researchers are often confronted with panel data. In these data sets, the residuals may be correlated across firms and across time, and OLS standard errors can be biased. Historically, the two literatures have used different solutions to this problem. Corporate finance has relied on clustered standard errors, while asset pricing has used the Fama-MacBeth procedure to estimate standard errors. This paper examines the different methods used in the literature and explains when the different methods yield the same (and correct) standard errors and when they diverge. The intent is to provide intuition as to why the different approaches sometimes give different answers and give researchers guidance for their use.

Abstract Stocks are short sale constrained when there is a strong demand to sell short and a limited supply of shares to borrow. Using data on both short interest, a proxy for demand, and institutional ownership, a proxy for supply, we find that constrained stocks underperform during 1988-2002 by a significant 215 basis points per month on an EW basis, although by only an insignificant 39 basis points per month on a VW basis. For the overwhelming majority of stocks, short interest and institutional ownership levels make short selling constraints unlikely. 2

This paper explores the determinants of corporate failure and the pricing of financially distressed stocks whose failure probability, estimated from a dynamic logit model using accounting and market variables, is high. Since 1981, financially distressed stocks have delivered anomalously low returns. They have lower returns but much higher standard deviations, market betas, and loadings on value and small-cap risk factors than stocks with low failure risk. These patterns are more pronounced for stocks with possible informational or arbitrage-related frictions. They are inconsistent with the conjecture that value and size e¤ects are compensation for the risk of financial distress.

Using a broad panel of NYSE-listed stocks between 1983 and 2004, we study the relation between institutional shareholdings and the relative informational efficiency of prices, measured as deviations from a random walk. Stocks with greater institutional ownership are priced more efficiently, and we show that variation in liquidity does not drive this result. One mechanism through which prices become more efficient is institutional trading activity, even when institutions trade passively. But efficiency is also directly related to institutional holdings, even after controlling for institutional trading, analyst coverage, short selling, variation in liquidity, and firm characteristics. (JEL G12, G14) Institutional shareholdings and trading have increased dramatically over the past several decades. In 1965, members of the Securities Industries Association held 16 % of U.S. equities; in 2001, they held 61 % according to the Securities Industry Association Fact Book (2002). Moreover, nonretail trading accounted for 96 % of New York Stock Exchange (NYSE) trading volume in 2002 (Jones and Lipson 2004). How this broadened scope of institutional ownership and trading affects the quality of equity markets, however, is an open question.

We examine short selling in US stocks based on new SEC-mandated data for 2005. There is a tremendous amount of short selling in our sample: short sales represent 24% of NYSE and 31% of Nasdaq share volume. Short sellers increase their trading following positive returns and they correctly predict future negative abnormal returns. These patterns are robust to controlling for voluntary liquidity provision and for opportunistic risk-bearing by short sellers. The results are consistent with short sellers trading on short-term overreaction of stock prices. A trading strategy based on daily short-selling activity generates significant positive returns during the sample period. (JEL G12, G14) There is currently tremendous interest in short selling not only from academics, but also from issuers, media representatives, the Securities and Exchange Commission (SEC), and Congress. Academics generally share the view that short sellers help markets correct short-term deviations of stock prices from fundamental value. This view is by no means universally held, and many issuers and media representatives instead characterize short sellers as immoral, unethical, and downright un-American.

Hedge funds have become important investors in public companies raising equity privately. Hedge funds tend to finance companies that have poor fundamentals and pronounced information asymmetries. To compensate for these shortcomings, hedge funds protect themselves by requiring substantial discounts, negotiating repricing rights, and entering into short positions of the underlying stocks. We find that companies that obtain financing from hedge funds significantly underperform companies that obtain financing from other investors during the following two years. We argue that hedge funds are investors of last resort and provide funding for companies that are otherwise constrained from raising equity capital. (JELG14, G23, G32) Hedge funds have recently become an important source of funding for pub-lic companies raising equity privately. Financing young companies with severe information asymmetries is an important investment strategy for some hedge funds. Since 1995, hedge funds have participated in more than 50 % of the private placements of equity securities and have contributed

We document a significant negative effect of idiosyncratic stock-return volatility on investment. We address the endogeneity problem of stock return volatility by instrumenting for volatility with a measure of a firm’s customer base concentration. We propose that the negative effect of idiosyncratic risk on investment is partly due to managerial risk aversion, and find that the negative relationship between idiosyncratic uncertainty and investment is stronger for firms with high levels of insider ownership. Several mechanisms can mitigate this effect namely the use of option-based compensation and shareholder monitoring. We find that the investment-idiosyncratic relationship is weaker for firms that make use of option-based compensation, and insider ownership does not matter for firms primarily held by institutional investors.

In this paper, we study how short-sale constraints affect asset price and market efficiency. We consider a fully rational expectations equilibrium model, in which investors trade to share risk and to speculate on private information in the presence of short-sale constraints. Short-sale constraints limit both types of trades, and thus reduce the allocational and informational efficiency of the market. Limiting short sales driven by risk-sharing simply shifts the demand for the asset upwards and consequently its price. However, limiting short sales driven by private information increases the uncertainty about the asset as perceived by less informed investors, which reduces their demand for the asset. When this information effect dominates, short-sale constraints actually cause asset prices to decrease and price volatility to increase. Moreover, we show that short-sale constraints can give rise to discrete price drops accompanied by a sharp rise in volatility when prices fail to be informative and the uncertainty perceived by uninformed investors surges.

Recent research establishes a negative relation between stock returns and dispersion of analysts earnings forecasts, arguing that, due to short-sale constraints in equity markets, asset prices more reflect the views of optimistic investors. In this article, we examine whether a similar effect prevails in corporate bond markets. After controlling for common bond-level, firm-level, and macroeconomic variables, we find evidence that bonds of firms with higher dispersion demand significantly higher credit spreads than otherwise similar bonds and that changes in dispersion reliably predict changes in credit spreads. We argue the dominating effect of dispersion is to proxy for future cash flow uncertainty due to the limited role of short-sale constraints in corporate bond markets.

A number of recent studies show that institutional herding positively predicts future returns on a two to four quarter horizon. These studies concentrate on relatively short-term herding behavior, typically measured over one or two quarters. Motivated by the theoretical herding literature, which emphasizes endogenous persistence in decisions over time, we focus on the temporal dimension of institutional trading behavior. We test the impact of multi-quarter persistent patterns of buying and selling by institutions on the cross-section of future stock returns. Using both regression and portfolio tests, we find that stocks that are persistently sold by institutions over three to five quarters outperform stocks that are persistently bought by them for a period of up to two years. The cross-sectional return predictability that is associated with persistent institutional trading is not subsumed by the well-known predictability associated with past returns and other stock characteristics. It is robust to using different measures of institutional trading and different definitions of institutional herding, and is not confined to small stocks. We also analyze how the persistent trading choices of institutions over several quarters affect institutional trade. We find that institutions, as an aggregate, tend to buy