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We show that eurozone bank risks during 2007-2013 can be understood as “carry trade” behavior. Bank equity returns load positively on peripheral (Greece, Italy, Ireland, Portugal, Spain, or GIIPS) bond returns and negatively on German government bond returns, which generated “carry” until the deteriorating GIIPS bond returns adversely affected bank balance sheets. We find support for risk-shifting and regulatory arbitrage motives at banks in that carry trade behavior is stronger for large banks and banks with low capital ratios and high risk-weighted assets. We also find evidence for home bias and moral suasion in the subsample of GIIPS banks.

With permission of Elsevier

We examine the relative weights hedge fund investors attach to past information in the fund selection process. The weighting scheme appears inconsistent with econometric forecasting models that predict fund returns, alphas or Sharpe ratios. In particular, investor flows are highly sensitive to performance streaks despite their limited predictive power regarding fund performance. Further, allocations based on forecast models’ out-of-sample predictions beat investor allocations by a significant margin, which suggests that the latter are suboptimal and reflect overreaction to certain types of information. Our findings do not support the notion that sophisticated investors have superior information or superior information processing abilities.

 

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