We relate Schumpeter’s notion of creative destruction to asset pricing, thereby offering a novel explanation of size and value premia. We argue that small-value firms must offer higher expected returns to compensate for the risk posed by serendipitous invention activity, whereas large-growth stocks provide protection against creative destruction and receive expected return discounts. A 2-factor model that accounts for creative-destruction risk effectively explains the cross-sectional return variation of size- and book-to-market-sorted portfolios. The estimated risk compensations associated with creative destruction are substantial and statistically significant, indicating their relevance for asset pricing.

The literature documents heterogeneity in the delay of stock price reaction to systematic shocks, implying that asset risk depends on investment horizon. We study the pricing of risk factors across investment horizons. Value (liquidity) risk is priced over intermediate (short) horizons. Conditioning horizon-factor exposures on firm characteristics indicates that characteristics, with the exception of momentum, are not priced beyond their contribution to systematic risk. Long-horizon institutional investors overweight assets with high intermediate-horizon exposures to value risk and high short-horizon exposures to liquidity risk. The results highlight the importance of investment horizon in determining risk premia.

Recent empirical studies have shown that during the financial crisis of 2007–2008, banks that were more heavily exposed to liquidity risk contracted their supply of credit more sharply. I contribute to the identification of this effect by relying on the use of micro-level data on U.S. mortgage loan applications, which allows me to identify liquidity risk as an important determinant of the contraction of credit in the mortgage market but as separate from the precipitous fall in credit demand, disruptions in the securitization and subprime markets, shifts in asset risk, and changing risk aversion among loan officers.

We demonstrate theoretically and empirically that strategic considerations are important in shaping the cash policies of innovative firms. In our model, firms compete in product markets with uncertain structure using cash as a commitment device to invest in innovation. We show that firms’ equilibrium cash holdings are related to the expected intensity of competition. The sign and magnitude of this relation depends on firms’ financial constraints. Consistent with the strategic motive for hoarding cash, we show that firms’ cash holdings are negatively affected by their rivals’ cash-holding choices, even more so when competition is expected to be intense.

This paper provides a structural approach to testing investment equations based on the log-likelihood function of a nonlinear investment rule. The analysis integrates the predictions of the q-theory for the commonly studied active region of investment and provides new inferences on how real and financing frictions affect the probability that a firm invests. The empirical findings are consistent with the macro-finance literature suggesting that q-theory models with nonconvex investment frictions better explain the data. I also find that both real and financing costs of investment are related to the capital intensity of the industry in which firms operate.

A basic intuition is that arbitrage is easier when markets are most liquid. Surprisingly, we find that momentum profits are markedly larger in liquid market states. This finding is not explained by variation in liquidity risk, time-varying exposure to risk factors, or changes in macroeconomic condition, cross-sectional return dispersion, and investor sentiment. The predictive performance of aggregate market illiquidity for momentum profits uniformly exceeds that of market return and market volatility states. While momentum strategies have been unconditionally unprofitable in the United States, in Japan, and in the Eurozone countries in the last decade, they are substantial following liquid market states.

We examine the relation between the agglomeration of firms around big cities and chief executive officer (CEO) compensation. We find a positive relation among the metropolitan size of a firm’s headquarters, the total and equity portion of its CEO’s pay, and the quality of CEO educational attainment. We also find that CEOs gradually increase their human capital in major metropolitan areas and are rewarded for this upon relocation to smaller cities. Taken together, the results suggest that urban agglomeration reflects local network spillovers and faster learning of skilled individuals, for which firms are willing to pay a premium and which are therefore important factors in CEO compensation.

We document that suppliers to purely financially distressed companies that are highly likely to reorganize in bankruptcy incur little or no spillover costs. In contrast, suppliers to economically distressed firms experience large losses in market value that are linked to proxies for the cost of replacing the bankrupt customers. Suppliers experience increased selling, general, and administrative (SG&A) expenses and lower margins in the year following the bankruptcy of their trading partners, which we link to proxies for partner replacement costs. Suppliers continue to extend trade credit to firms that are healthier and in situations where the cost of replacing the partner is higher.

This article presents a unique test of the effectiveness of technical analysis in different sentiment environments by focusing on its usage by perhaps the most sophisticated and astute investors, namely, hedge fund managers. We document that during high-sentiment periods, hedge funds using technical analysis exhibit higher performance, lower risk, and superior market-timing ability than nonusers. The advantages of using technical analysis disappear or even reverse in low-sentiment periods. Our findings are consistent with the view that technical analysis is relatively more useful in high-sentiment periods with larger mispricing, which cannot be fully exploited by arbitrage activities because of short-sale impediments.

We study the return predictability of a measure of continuing overreaction based on the weighted average of signed volumes. We find that the strategies of buying stocks with upward continuing overreaction and selling stocks with downward continuing overreaction generate significant positive returns and that our measure of continuing overreaction is a better predictor of future returns than past returns. The results are stronger among stocks primarily held by investors more prone to biased self-attribution. Our results provide direct support for the model of return predictability based on overconfidence and biased self-attribution.