Finance

Finance is a featured research topic at Harvard Business School.

Our intellectual roots are based in a long line of scholars from Robert Merton whose collaborative work on risk management and option pricing won him the Nobel Prize in Economics in 1997, to John Lintner who co-created the Capital Asset Pricing Model and made significant contributions to dividend policy, and Gordon Donaldson whose work helped shape the field of corporate finance. We strive to understand how managers and firms make value-enhancing decisions; and how financial institutions, markets, and instruments contribute to this process. Our approach to research is distinguished by its unique combination of theory, empirical analysis, mathematical modeling, and field observations at companies.

Featured Works

Working Paper | HBS Working Paper Series | 2018
Macroeconomic Drivers of Bond and Equity Risks
John Y. Campbell, Carolin E. Pflueger and Luis M. Viceira
Our new model of consumption-based habit formation preferences generates loglinear, homoscedastic macroeconomic dynamics and time-varying risk premia on bonds and stocks. Consumers' first-order condition for the real risk-free interest rate takes the form of an exactly loglinear consumption Euler equation, commonly assumed in New Keynesian models. Estimating the model separately for 1979–2001 and 2001–2011 explains why the exposure of U.S. Treasury bonds to the stock market changed from positive to negative. A change in the comovement between inflation and the output gap explains changing bond risks but only when risk premia change endogenously as predicted by the model.
Keywords: Risk and Uncertainty; Bonds; Central Banking; System Shocks; Policy; Macroeconomics;

Citation:
Campbell, John Y., Carolin E. Pflueger, and Luis M. Viceira. "Macroeconomic Drivers of Bond and Equity Risks." Harvard Business School Working Paper, No. 14-031, September 2013. (Revised August 2018.) View Details
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Working Paper | 2016
Playing Favorites: How Firms Prevent the Revelation of Bad News
Lauren Cohen, Dong Lou and Christopher J. Malloy
We explore a subtle but important mechanism through which firms can control information flow to the markets. We find that firms that “cast” their conference calls by disproportionately calling on bullish analysts tend to underperform in the future. Firms that call on more favorable analysts experience more negative future earnings surprises and more future earnings restatements. A long-short portfolio that exploits this differential firm behavior earns abnormal returns of up to 149 basis points per month, or almost 18 percent per year. We find similar evidence in an international sample of earnings call transcripts from the UK, Canada, France, and Japan. Firms with higher discretionary accruals, firms that barely meet/exceed earnings expectations, and firms (and their executives) that are about to issue equity, sell shares, and exercise options, are all significantly more likely to cast their earnings calls.
Keywords: Information; Strategy; Ethics;

Citation:
Cohen, Lauren, Dong Lou, and Christopher J. Malloy. "Playing Favorites: How Firms Prevent the Revelation of Bad News." Working Paper, October 2016. (Winner of 2014 Crowell Memorial Prize For the best paper on quantitative investing, PanAgora Asset Management, Inc. 2014.) View Details
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Article | American Economic Review: Papers and Proceedings | May 2014
Dynamics of Demand for Index Insurance: Evidence from a Long-Run Field Experiment
Shawn A. Cole, Daniel Stein and Jeremy Tobacman
This paper estimates how experimentally-manipulated experiences with a novel financial product, rainfall index insurance, affect subsequent insurance demand. Using a seven-year panel, we develop three main findings. First, recent experience matters for demand, consistent with overinference from small samples. Second, spillovers also matter, in the sense that the recent payout experience of village co-residents affects insurance demand about as much as one's own recent payout experience. Third, the spillover effect decays as time passes while the effect of one's own experience does not. We discuss implications of this analysis for commercial sustainability of this complicated but promising risk management technology.

Citation:
Cole, Shawn A., Daniel Stein, and Jeremy Tobacman. "Dynamics of Demand for Index Insurance: Evidence from a Long-Run Field Experiment." American Economic Review: Papers and Proceedings 104, no. 5 (May 2014): 284–290. View Details
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Article | Review of Financial Studies | 2014
Expectations of Returns and Expected Returns
Robin Greenwood and Andrei Shleifer
We analyze time-series of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated with model-based expected returns. The evidence is not consistent with rational expectations representative investor models of returns.
Keywords: Performance Expectations; Investment Return;

Citation:
Greenwood, Robin, and Andrei Shleifer. "Expectations of Returns and Expected Returns." Review of Financial Studies 27, no. 3 (March 2014): 714–746. (Internet Appendix Here.) View Details
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Article | Journal of Financial Economics | August 2014
Mortgage Convexity
Samuel G. Hanson
Most home mortgages in the United States are fixed-rate loans with an embedded prepayment option. When long-term rates decline, the effective duration of mortgage-backed securities (MBS) falls due to heightened refinancing expectations. I show that these changes in MBS duration function as large-scale shocks to the quantity of interest rate risk that must be borne by professional bond investors. I develop a simple model in which the risk tolerance of bond investors is limited in the short run, so these fluctuations in MBS duration generate significant variation in bond risk premia. Specifically, bond risk premia are high when aggregate MBS duration is high. The model offers an explanation for why long-term rates could appear to be excessively sensitive to movements in short rates and explains how changes in MBS duration act as a positive-feedback mechanism that amplifies interest rate volatility. I find strong support for these predictions in the time series of US government bond returns.
Keywords: Mortgages; Interest Rates; Volatility;

Citation:
Hanson, Samuel G. "Mortgage Convexity." Journal of Financial Economics 113, no. 2 (August 2014): 270–299. (Internet Appendix Here.) View Details
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Working Paper | 2014
Financial Repression in the European Sovereign Debt Crisis
Bo Becker and Victoria Ivashina
By the end of 2013, the share of government debt held by the domestic banking sectors of Eurozone countries was more than twice its 2007 level. We show that this type of increasing reliance on the domestic banking sector for absorbing government bonds generates a crowding out of corporate lending. For a given domestic firm, new debt is less likely to be a loan—i.e., the loan supply contracts—when local banks have purchased more domestic sovereign debt and when that debt is risky (as measured by CDS spreads). These effects are most pronounced in the period following the second Greek bailout in early 2010.
Keywords: Credit Cycles; Sovereign debt; Financial Repression; Sovereign Finance; Greece;

Citation:
Becker, Bo, and Victoria Ivashina. "Financial Repression in the European Sovereign Debt Crisis." Working Paper, April 2014. View Details
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Recent Publications

Working Paper | HBS Working Paper Series | 2018
Arbitration with Uninformed Consumers
Mark Egan, Gregor Matvos and Amit Seru
We examine whether firms have an informational advantage in selecting arbitrators in consumer arbitration as well as the impact of the arbitrator selection process on outcomes. We collect data containing roughly 9,000 arbitration cases in securities arbitration. Securities disputes present a good laboratory: the selection mechanism is similar to other major arbitration forums; arbitration is mandatory for all disputes, eliminating selection concerns; and the parties choose arbitrators from a randomly generated list. We first document that some arbitrators are systematically industry friendly while others are consumer friendly. Firms appear to utilize this information in the arbitrator selection process. Despite a randomly generated list of potential arbitrators, industry friendly arbitrators are 40% more likely to be selected than their consumer friendly counterparts. Better informed firms and consumers choose more favorable arbitrators. We develop and calibrate a model of arbitrator selection in which, like the current process, both the informed firms and uninformed consumers have control over the selection process. Arbitrators compete against each other for the attention of claimants and respondents. The model allows us to interpret our empirical facts in equilibrium and to quantify the effects of changes to the current arbitrator selection process on consumer outcomes. Competition between arbitrators exacerbates the informational advantage of firms in equilibrium resulting in all arbitrators slanting towards being industry friendly. Evidence suggests that limiting the respondents' and claimants' inputs over the arbitrator selection process could significantly improve outcomes for consumers.
Keywords: Arbitration; Financial Advisers; Financial Advisors; Brokers; consumer finance; Financial Misconduct; Personal Finance; Conflict and Resolution; Information; Fairness;

Citation:
Egan, Mark, Gregor Matvos, and Amit Seru. "Arbitration with Uninformed Consumers." Harvard Business School Working Paper, No. 19-046, October 2018. (NBER Working Paper Series, No. 25150, October 2018.) View Details
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Working Paper | HBS Working Paper Series | 2018
When Harry Fired Sally: The Double Standard in Punishing Misconduct
Mark Egan, Gregor Matvos and Amit Seru
We examine gender differences in misconduct punishment in the financial advisory industry. We find evidence of a "gender punishment gap": following an incident of misconduct, female advisers are 20% more likely to lose their jobs and 30% less likely to find new jobs relative to male advisers. Females face harsher outcomes despite engaging in misconduct that is 20% less costly and having a substantially lower propensity towards repeat offenses. The gender punishment gap in hiring and firing dissipates at firms with a greater percentage of female managers at the firm or local branch level. The gender punishment gap is not driven by gender differences in occupation (type of job, firm, market, or financial products handled), productivity, misconduct, or recidivism. We extend our analysis to explore the differential treatment of ethnic minorities and find similar patterns of "in-group" tolerance. Our evidence is inconsistent with a simple Bayesian model and suggests instead that managers are more forgiving of missteps among members of their own gender/ethnic group.
Keywords: Financial Advisers; Brokers; Gender Discrimination; consumer finance; Financial Misconduct and Fraud; FINRA; Financial Institutions; Employees; Crime and Corruption; Gender; Prejudice and Bias; Outcome or Result; Personal Finance; Financial Services Industry;

Citation:
Egan, Mark, Gregor Matvos, and Amit Seru. "When Harry Fired Sally: The Double Standard in Punishing Misconduct." Harvard Business School Working Paper, No. 19-047, October 2018. (NBER Working Paper Series, No. 23242, March 2017.) View Details
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Case | HBS Case Collection | October 2018
African Bank Investments Limited (A)
Lynn S. Paine and Will Hurwitz
Less than a year after joining the board of African Bank Investments Limited (ABIL), the newest director finds himself in difficult discussions with other directors about removing the struggling company’s CEO. The case is set in South Africa in mid-2014 as shares in ABIL, which traded on the Johannesburg Stock Exchange, are declining precipitously. The case describes ABIL’s origins and evolution, including the acquisition and growth of its wholly owned subsidiary African Bank, a provider of unsecured loans to help individuals pay for expenses such as vehicle repairs, home renovations, funeral costs, medical bills, and education. As ABIL’s profits rose and share price soared, it became the darling of analysts. However, when the South African economy turned sour, customers started defaulting on their loans, and ABIL and African Bank began to struggle. As ABIL’s stock price dropped, the management team faced difficult questions about the company’s lending practices, risk management processes, and plans to turn the business around. By 2014, the situation was grim, and pressure mounted from shareholders and market regulators for the board to take action. The case details the history of unsecured lending in South Africa, describes the regulatory, social, and legal contexts for the company and its business model, and explores the company’s unique corporate structure and executive and director dynamics.
Keywords: Ethics; Personal Finance; Corporate Accountability; Governing and Advisory Boards; Corporate Governance; Crisis Management; Insurance; Leadership; Management; Risk Management; Banking Industry; Financial Services Industry; Insurance Industry; Africa; South Africa;

Citation:
Paine, Lynn S., and Will Hurwitz. "African Bank Investments Limited (A)." Harvard Business School Case 319-052, October 2018. View Details
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Article | Academy of Management Journal | March 2016
The Role of Investor Gut Feel in Managing Complexity and Extreme Risk
Laura Huang
Securing financial resources from investors is a key challenge for many early stage entrepreneurial ventures. Given the inherent uncertainty surrounding a decision to invest in these ventures, prior research has found that experienced investors rely heavily on their investor gut feel—dynamic expertise-based emotion-cognitions specific to the entrepreneurship context. In this paper, I inductively find that rather than based on rapid, nonconscious impulse, as much of prior literature would suggest, what investors call their "gut feel" is an elaborate "intuiting process." This process serves a distinct purpose: it emboldens investors to make investments that would otherwise be considered overly risky and likely to lead to failure. In the theoretical model I present, I delineate how investors are guided by a predisposed stance on risk and uncertainty, which dictates the approach investors take towards managing the complexity of an investment opportunity—and how they cognitively and emotionally reframe investment risk into a compelling narrative that transcends avoidance behavior and leads investors to invest. These findings expand our overall understanding of the complex ways in which investors contend with the risks and uncertainties in entrepreneurial finance.
Keywords: angel investors; gut feel; intuition; Entrepreneurship; Finance; Risk and Uncertainty; Complexity; Decision Making;

Citation:
Huang, Laura. "The Role of Investor Gut Feel in Managing Complexity and Extreme Risk." Academy of Management Journal 61, no. 5 (October 2018): 1821–1847. View Details
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Book | 2018
Varieties of Green Business: Industries, Nations and Time
G. Jones
Published at a time of ever-increasing warnings that the pace of climate change and other environmental changes risk making the Earth unsustainable within our own lifetimes, this book looks at the past of green business to identify lessons for the future. It provides rich new evidence and insights on green business as it examines its variation between industries and nations over time. It shows the deep historical origins of endeavors to create for-profit businesses that were more responsible and sustainable as well as how these strategies have faced constraints, trade-offs, and challenges of legitimacy. The industries covered range from sustainable finance and solar energy to organic food and wine, ecotourism, and outdoor clothing. Strategies pursued range from incremental shifts towards sustainability to abandoning for-profit business entirely and re-wilding and conserving millions of acres of lands in Latin America. The book's distinctiveness lies in the use of original empirical data and the willingness to engage with both successful and unsuccessful cases. The wide geographical coverage includes not only the United States and Europe but also less studied settings, including Chile, Costa Rica, New Zealand, and Japan. The book serves as a warning against facile beliefs in the potential of win/win solutions as business tries to reduce its environmental impact or even save the planet. The lesson of history is that making business sustainable is a hard journey, littered with system-wide roadblocks, but it is a journey that is possible and one that is urgently needed.
Keywords: Green Business; sustainability; business history; eco-tourism; organic wine; organic food; waste management; sustainable finance; Ethics; Finance; History; Entrepreneurship; Accommodations Industry; Agriculture and Agribusiness Industry; Banking Industry; Energy Industry; Food and Beverage Industry; Green Technology Industry; Tourism Industry; Europe; Asia; Latin America; North and Central America; New Zealand;

Citation:
Jones, G. Varieties of Green Business: Industries, Nations and Time. Northamption, MA: Edward Elgar Publishing, 2018. View Details
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Chapter | Handbook of Behavioral Economics | 2018
Behavioral Household Finance
John Beshears, James J. Choi, David Laibson and Brigitte C. Madrian
This chapter provides an overview of household finance. The first part summarizes key facts regarding household financial behavior, emphasizing empirical regularities that are inconsistent with the standard classical economic model and discussing extensions of the classical model and explanations grounded in behavioral economics that can account for the observed patterns. This part covers five topics: consumption and savings, borrowing, payments, asset allocation, and insurance. The second part addresses interventions that firms, governments, and other parties deploy to shape household financial outcomes: education and information, peer effects and social influence, product design, advice and disclosure, choice architecture, and interventions that directly target prices or quantities.
Keywords: Personal Finance; Global Range; Household; Behavior; Strategy; Governing Rules, Regulations, and Reforms; Product Design; Welfare or Wellbeing;

Citation:
Beshears, John, James J. Choi, David Laibson, and Brigitte C. Madrian. "Behavioral Household Finance." In Handbook of Behavioral Economics: Foundations and Applications 1, edited by B. Douglas Bernheim, Stefano DellaVigna, and David Laibson, 177–276. Amsterdam: Elsevier, 2018. View Details
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Article | Journal of the Economic and Social History of the Orient | 2018
Revenue Farming Reconsidered: Tenurial Rights and Tenurial Duties in Early Modern India, ca. 1556–1818
Sudev J Sheth
The meaning of land revenue farming in Indian history has eluded consensus. Some view it as an administrative aberration indicating weak state control, while others see it as a strategy for consolidating authority. This essay traces the historical development of iqṭāʻ and ijārah, two Perso-Arabic terms frequently translated from the sources as “revenue farming estate.” I then suggest that existing perspectives do not capture the broader structure and significance of various entitlements to land revenue. Instead, I suggest that entitlements be schematized according to how regularized the right was, whether it was permanent, and how duty-bound the right holder was. In this formulation, revenue farm refers to a complex of rights and duties secured by contract in which a sovereign transferred the temporary exploitation of a holding for rent in advance. It was one of four tenurial complexes under which entitlements fell, the others being estates from bureaucratic assignment, hereditary occupation or possession by grant/gift, and tributary or chieftaincy.
Keywords: iqṭāʻ; ijārah; revenue farming; financial agents; Mughal Empire; Business History; Business and Government Relations; Property; Finance; South Asia;

Citation:
Sheth, Sudev J. "Revenue Farming Reconsidered: Tenurial Rights and Tenurial Duties in Early Modern India, ca. 1556–1818." Art. 4. Special Issue on Repossessing Property in South Asia: Land, Rights, and Law across the Early Modern/Modern Divide edited by Faisal Chaudhury. Journal of the Economic and Social History of the Orient 61, nos. 5-6 (2018): 878–919. View Details
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Case | HBS Case Collection | July 2018 (Revised November 2018)
Hidrovias do Brasil: Navigating Unchartered Waters
Boris Groysberg and Sarah L. Abbott
Since its founding eight years earlier, Hidrovias do Brasil (“Hidrovias”), an integrated logistics provider serving corporate customers exporting products from South America via the Atlantic Ocean, had grown to 900 employees and $253 million in annual revenues. Hidrovias was founded by the Brazilian private equity firm, Pátria Investments, who had built the business from the ground up, forging and nurturing relationships with customers, investors, government entities, and suppliers. As Bruno Serapiao, Hidrovias’s CEO pondered next steps for the company, he considered the following questions: What had been the key drivers of Hidrovias’s success to date? What were the major challenges? And, what was the best path for the company going forward?
Keywords: growth and development; leadership; operations; human resources; private equity; Brazil; emerging markets; entrepreneurial organizations; operation management; strategy; general management; Entrepreneurship; Finance; Growth and Development; Leadership; Operations; Problems and Challenges; Transportation; Human Capital; Strategy; Emerging Markets; Brazil;

Citation:
Groysberg, Boris, and Sarah L. Abbott. "Hidrovias do Brasil: Navigating Unchartered Waters." Harvard Business School Case 419-007, July 2018. (Revised November 2018.) View Details
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Case | HBS Case Collection | July 2018 (Revised August 2018)
Project Helios: Harvesting the Sun
Mark Egan and E. Scott Mayfield
Aware of the impact that modern society was having on the environment, Ashley Telkes had always tried to be cognizant of her own impact on the environment and to take reasonable steps to mitigate her own effects. Having already implemented a number of passive measures to minimize her “carbon footprint,” Telkes must now confront the bigger decision of whether or not to invest in solar panels to generate electricity for her home. Although pre-disposed to pursue environmentally friendly alternatives, the project entailed significant up-front expenses and Telkes could not afford to make a poor financial decision. Telkes must assess the financial merits of the project, as well as understand the regulatory and technological risks associated with going forward or choosing to delay.
Keywords: Renewable Energy; Personal Finance; Decision Making; Environmental Sustainability;

Citation:
Egan, Mark, and E. Scott Mayfield. "Project Helios: Harvesting the Sun." Harvard Business School Case 219-009, July 2018. (Revised August 2018.) View Details
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Article | Harvard Business Review | July–August 2018
The Other Diversity Dividend
Paul Gompers and Silpa Kovvali
Researchers have struggled to establish a causal relationship between diversity and financial performance—especially at large companies, where decision rights and incentives can be murky, and the effects of any given choice can be tough to pin down. So the authors chose a “lab rat” with fewer barriers to understanding—the venture capital industry. VC firms are fairly flat: Every investor is a decision maker, and choices have clear business consequences. Using publicly available information, researchers can see how similar or different decision makers are and compare decision quality on the basis of investments’ performance. After examining tens of thousands of VC investments, Gompers has found that diversity significantly improves financial performance on measures such as profitable investments at the individual portfolio-company level and overall fund returns. And even though associating with similar people can have social benefits for those people, it can lead investors and firms to leave a lot of money on the table. In this article Gompers and Kovvali describe the research and provide recommendations for reaping the business benefits of diversity.
Keywords: Diversity; Decision Making; Finance; Performance Improvement; Venture Capital;

Citation:
Gompers, Paul, and Silpa Kovvali. "The Other Diversity Dividend." Harvard Business Review 96, no. 4 (July–August 2018): 72–77. View Details
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