Andrei Simonov

I try to update those pages often, but you might be better off checking my page at SSRN

Individual Investors' behavior.

Role of social interaction in portfolio choice.

Financial Intermediation 

Economics of Asymmetric Information.
Asset pricing.
Market Microstructure, links between Market Microstructure and Asset Pricing.
Information asymmetries in rational expectations, equilibrium models
Decision theory 

 
Abstract

Competition among sellers of information in a noisy rational expectation equilibrium is considered.  Trader's preferences for information are explicitly characterized. It is shown that the competition on market for information makes providers of financial information to price their products in a way that leads traders to purchase all signals available. If signals are substitutes, competition pushes the price of information lower than that in monopolistic settings. However, if signals are complements, the price of an individual signal in duopoly actually exceeds the one in monopolistic settings, and information producers are involved in tacit collusion. Externalities of information lead to counterintuitive results that (a) efficiency of the competitive market for information (as measured by quality of signals offered for sale) is no better than in monopolistic setting, and (b) competition leads to no improvement on the part of the traders as providers of financial information are still able to appropriate all of the consumer surplus.

          

 
Abstract

We study the behavior of market makers in the Treasury bond market, by using an unique dataset that allows us to observe market makers' strategies jointly on the primary and secondary markets. We show that market makers actively learn from the dealers they are trading with. This allows them to react strategically to the information content of the orders they receive. Unlike the standard inventory or asymmetric information models, we allow market makers to directly place orders with other market makers.\ We identify two main types of strategic reaction to the informational content of trade: ``hiding'' and ``experimenting''. We show that all the market makers can be grouped into three classes (the sneakies, the sleepies and the sceptics), depending on their strategies. In particular, some market makers selectively choose the other market makers they place orders with in order to minimize the price impact of their trade. Others, on the contrary, choose their counterparts so as to learn the true quality of their information by observing the way they react to their trade. The choice of the type of strategy depends on market makers' priors regarding the degree of informativeness of the other market makers they are dealing with. We also show that the information acquired by trading in the secondary market affects market makers' behavior in the primary market. Bidding aggressiveness and dispersion of bids are a function of market makers' learning.

          

 
Abstract

How much of asset volume and volatility can be explained in terms of market makers's strategic interaction and through which channel does this effect take place? In the present paper we address these issues by using an unique dataset on the Treasury bond market.  We show that the same type of trade, on the same asset, in the same market can generate different volume and volatility patterns, depending on the type of market makers who are intermediating it. We identify the ''marginal traders'' as the class of traders that affects market conditions. We show that the marginal traders who have the greatest impact in the short run differ from those who have the greatest impact in the long run. We also show that the class of marginal traders is never most numerous nor does it generate the highest volume of trade.  The main implication is that it is not the trade per se that generates volatility, but the informed trade of a particular class of agents. We argue that these results have strong implications in terms of forecastability of future returns and volatility, by showing that most of the explanatory power of trades is due to the ''marginal traders''. Finally, we show how market volatility is influenced not only by traders' actual behavior, but also by their perception of the degree of informativeness and dispersion of beliefs of the other traders they are dealing with.

         

(with  Massimo Massa)

Abstract


We use a new and unique dataset to investigate the way investors react to prior gains/losses and the so called ''familiarity'' bias. We distinguish between different behavioral theories (loss aversion, house-money effect) and between behavioral and rational hypotheses (pure familiarity and information-based familiarity). We show that, on an yearly horizon, investors react to previous gains/losses according to the house-money effect. In terms of individual stock picking, we provide evidence in favor of the information-based theory and show that familiarity can be considered as a proxy for the availability of information as opposed to a behavioral heuristics.

Does prestige matter more than profits? Evidence from entrepreneurial choices

(with Mariassunta Giannetti)

Abstract

This paper studies whether social interactions affect the decision to become an entrepreneur. We find that in municipalities where entrepreneurship is more widespread individuals are more likely to become entrepreneurs even after controlling for individual characteristics, and local economic conditions. We also find that the effect is stronger within groups of individuals who belong to the same social group and are likely to have more frequent interactions. Moreover, the potential economic determinants of cross-municipalities differences in the rate of entrepreneurship, such as differences in income, wealth, or transport costs are unimportant for the individual occupational choice. What seems to matter, instead, are differences in cultural values across communities, which we proxy with indicators of religious, voting and household behavior. These findings support the importance of social interactions and peer group effects for entrepreneurial choices. We also evaluate alternative explanations, like the existence of agglomeration economies, using moving decisions and the success of entrepreneurial activity. However, they do not seem to find support in the data.

Read a commentary by Bob Shiller referencing this paper: “The Culture of Entrepreneurship”

Portfolio diversification and city agglomeration

(with William. N. Goetzmann and  Massimo Massa)

Abstract

We study portfolio under-diversification from a novel perspective, linking it to the process of professional specialization and knowledge spillover that drive city agglomeration. We show these factors, on the one hand, limit the capacity to elaborate financial information, induce them to invest in familiar stocks and reduce portfolio diversification. On the other hand, by increasing prosperity raise the relative information and increase portfolio diversification. We use a new and unique dataset that contains that contains information on individual investors, traced over time. We have available information on investors' wealth, broken down into their components (cash, stocks and mutual funds, real estate, loans, bonds and other assets), their income and tax position as well as their demographic characteristics. We compare our theory based on city agglomeration to the other existing theories of portfolio diversification, such as background risk, district risk and familiarity/limited information. We provide evidence in favor of the city agglomeration theory and the limited information theory, while we reject the ones based on background risk and district risk.

Portfolio choice and menu exposure

(with Anders Karlsson and  Massimo Massa)

Abstract 

We study the impact of the menu representation on portfolio choice and we show that investors choose assets as a function of the way they are represented in the menu available to them. We use the choices of mutual funds for retirement accounts of the Swedish population. We show that investors prefer the funds that belong to categories that are more represented in the menu. More numerous categories attract more investment, regardless of their weight in the optimal or world market portfolio. Moreover, an exogenous change in the menu changes investor demand. An increase in the representation of a category in the menu increases investment in all the funds belonging to the same category, including the already existing ones. By using information on the performance of the funds that investors choose, we show that there is a consistent positive correlation between the investor’s sensitivity to the menu exposure and his inability to select over-performing funds. This suggests that the menu exposure represents a rational way of coping with limited (private) information that decreases as information improves. Also, the higher the exposure, the lower degree of portfolio concentration. Our findings shed light on the home exposure puzzle and insight of the determinants of style investing. They also have direct normative implications in terms of Social Security reform

Shareholder homogeneity and firm value

(with  Massimo Massa)

Abstract 

We study how the shareholding structure of a firm affects its stock price and profitability. We argue that the degree of shareholder homogeneity affects firm value. Homogeneous shareholders act as a disciplining device on managers, inducing them to be more transparent and to engage less in value destroying activities. This leads to higher firm profitability, higher stock price and lower volatility. Shareholder homogeneity represents an alternative and indirect source of corporate governance based on the stock market. We test this hypothesis by using a dataset containing information on all the shareholders for each firm in Sweden from 1995 to 2001. We construct two proxies for shareholder homogeneity: the first is based on the age cohort of the shareholders, and the second on their degree of college interaction. For each firm, we measure the degree of homogeneity of all shareholders. Using this proxy, we show that greater homogeneity increases firm profitability and returns, and reduces analysts’ forecasting errors and dispersion, and stock volatility.

Stock market participation and pension reform

(with Anders Karlsson and  Massimo Massa)

Abstract

We study how the introduction of a defined contribution market based retirement system affects the propensity of the investor to participate in the stock market. By using data on the “Swedish experiment”, we focus on the decision to invest directly in stocks and we see how it changes once the households are allowed to participate to the new pension system. We show that, the introduction of the possibility to invest in retirement funds increases the probability of stock market participation. That is, an individual that did not participate in the stock market has a higher probability of entering it once he has been presented with the new pension scheme. Moreover, the individuals who are more likely to enter the stock market are the ones who make a deliberate portfolio choice for the retirement money. This finding is not consistent with investors perceiving the investment in retirement accounts as a close substitute to investment in equity. Quite the contrary, it suggests that being induced to choose among different pension funds does “educate” the individual, inducing him to participate in the stock market.

The Dark Role of Investment Banks in the Market for Corporate Control

(joint with A. Bodnaruk, M. Massa)

read also WSJ front page article, Jan. 14th, 2008