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A Study of Investment Capacity and an Essay about Interest Rates


In Chapter 1, I find increases in investor exposure to prominent systematic trading strategies, such as momentum, correlate with lower returns to these strategies. A 1 percentage point increase in gross momentum exposure as a percentage of market capitalization corresponds with a permanent 1.1 percentage point decline in future annual momentum returns. The result is based on a new measure of total investment in a strategy that distills aggregate dollar exposure levels from stock trading volumes. The approach circumvents market clearing for zero cost strategies by defining aggregate exposure as the absolute sum of long plus short exposure. Estimating aggregate investment in momentum over time reveals a nearly 10-fold increase in momentum exposure as a percentage of market capitalization from 1980 to 2010. The association of a permanent decline in returns with increases in exposure extends to other strategies, including long-run reversal and idiosyncratic volatility.

In Chapter 2 (with Daniel Feenberg and Ivo Welch), I discuss how contrary to common perception, many fixed-income investors have not suffered unusually low real interest rates in and after the Great Recession of 2008. This is because taxable investors must first pay taxes on nominal interest returns, before inflation further reduces their earned real interest rates. To obtain the same real after-tax yield, investors need more than one-to-one compensation for inflation. As a result, long-term Treasury bonds have been no less attractive for taxable investors in 2016 (with a 0.5% post-tax real yield) than they were in 2006 (0.5%) and 1976 (-1.7%), and only moderately lower than yields in 1966 (0.9%), and 1956 (0.8%), although they are much less attractive than they were in 1996 (2.4%) and 1986 (2.9%). Short-term Treasury bond yields have been on the low side but have also not been particularly unusual.

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