Recent Academic Research
Luxury watches as an asset class, natural disasters' affect on GDP growth, CEO characteristics and default risk, and investor bias in forecasting volatility
Welcome back to another issue of Recent Academic Research! Today, I have some great papers on economics and unique asset classes. Don’t forget to fill out the poll at the bottom of the post to let me know which paper was the most interesting!
Let’s get into it.
Bias In Volatility Expectations
Investors exhibit return extrapolation behavior, meaning they form expectations about future volatility based on recent past returns. This paper presents empirical evidence that lower past returns lead to higher volatility expectations across physical, risk-neutral, and survey-based measures. Unlike models that simply extrapolate past realized volatility, this bias is primarily driven by negative returns and leads investors to overpay for protection against expected volatility increases.
The study employs MIDAS regressions to analyze the relationship between past returns and volatility expectations. It uses a comprehensive set of volatility expectation proxies, including GARCH models, the VIX index, Black-Scholes implied volatilities, and survey-based measures. The methodology controls for market volatility persistence and sentiment effects.
Findings:
Recent past returns have a stronger impact on volatility expectations than distant returns, a hallmark of extrapolative beliefs.
Negative past returns increase expected volatility under all three measures (physical, risk-neutral, and survey).
Investors demand higher variance risk premiums and exhibit higher implied volatility for out-of-the-money put options after experiencing losses.
Stocks with higher liquidity and analyst coverage show stronger extrapolation effects, suggesting that greater information availability does not mitigate the bias.
The negative correlation between return and volatility expectations aligns with behavioral finance theories, diverging from traditional risk-return trade-offs.
This is a great example of recency bias in the financial markets, as the authors find that recent past returns have a larger impact than distant past returns on volatility expectations. When recent returns have been low, the market prices in higher future volatility, suggesting that investors are willing to pay more to insure against the perceived higher expected volatility.
Chordia, Tarun and Lin, Tse-Chun and Xiang, Vincent, Return Extrapolation and Volatility Expectations(January 23, 2025). Available at SSRN: https://ssrn.com/abstract=5108745 or http://dx.doi.org/10.2139/ssrn.5108745
Generalist CEOs Reduce Default Risk
Firms led by generalist CEOs, who possess broad managerial experience across multiple firms and industries, exhibit lower corporate default risk. This study builds on prior literature that highlights the benefits of generalist CEOs, such as their ability to innovate and manage complex organizations, but also considers concerns about their lack of industry-specific expertise. The authors examine whether these CEOs mitigate or exacerbate default risk by leveraging their diverse skill sets.
Using a large panel dataset of 21,199 firm-year observations from 2,087 US firms (1993–2016), the study constructs a General Ability Index (GAI) to classify CEOs as generalists or specialists. It employs expected default frequency (EDF), credit default swap (CDS) spreads, and a hazard model as proxies for corporate default risk. Fixed effects, propensity score matching, and a difference-in-differences (DiD) approach are used to address endogeneity concerns.
Findings:
Generalist CEOs significantly reduce corporate default risk, with effects persisting across different measures of default risk.
The impact is strongest for firms operating in volatile industries, suggesting these CEOs are particularly valuable in uncertain environments.
The risk reduction effect is mediated through lower stock return volatility and reduced return on assets (ROA) volatility.
CEO career breadth within the same industry matters more than experience across different industries, indicating the importance of industry-specific knowledge.
Results remain robust after controlling for firm characteristics, CEO incentives, and governance factors.
This reminds me of the use of emergency CEOs for firms that distressed or going through bankruptcy. This study shows that there is a benefit in hiring these CEOs that have broad managerial and industry experience. For example, John J. Ray III became the CEO for both Enron and FTX after their respective collapses, and returned nearly 52 cents on the dollar to Enron creditors.
Safiullah, Md and Baghdadi, Ghasan and Goergen, Marc, Do Generalist CEOs Reduce Corporate Default Risk? (February 13, 2025). European Corporate Governance Institute – Finance Working Paper No. 1037/2025, Available at SSRN: https://ssrn.com/abstract=5150757 or http://dx.doi.org/10.2139/ssrn.5150757
Natural Disasters and Subsequent GDP Growth
Natural disasters significantly impact economic growth, particularly in emerging markets and developing economies (EMDEs). While advanced economies (AEs) experience minimal long-term effects due to rapid increases in government spending, EMDEs face prolonged economic disruptions. Prior research has examined the overall macroeconomic effects of disasters, but this study contributes by analyzing how different components of GDP—investment, consumption, exports, and imports—respond across various country groups.
The study by IMF and Princeton authors uses panel data from 1980 to 2019, focusing on large, single-year, non-overlapping natural disasters where damage exceeds 1% of GDP. It employs local projection methods to estimate the short-term and medium-term effects on economic growth. Country characteristics, such as fiscal space, adaptive capacity, and disaster magnitude, are also examined.
Findings:
Output growth declines by an average of 1.3% in the disaster year and partially recovers in the following year, but GDP levels remain permanently lower.
Advanced economies offset losses through immediate government spending, preventing significant output declines.
Non-small-island EMDEs experience sharp drops in investment, contributing to slower recovery.
Small-island EMDEs face the largest declines in output growth, driven primarily by disruptions in exports and tourism.
Countries with greater fiscal space pre-disaster are more resilient, as they can increase spending to counteract economic losses.
The findings from this paper suggest that governments of advanced economies are better suited to respond to natural disasters and offset their economic damage. This is likely due to government efficiency and the resources available to the government. It makes sense that small-island EMDE countries that derive a large portion of GDP from exports and tourism would be disproportionately affected by natural disasters.
Nguyen, Ha and Feng, Alan and García-Escribano, Mercedes, Understanding the Macroeconomic Effects of Natural Disasters. IMF Working Paper No. 2025/046, Available at SSRN: https://ssrn.com/abstract=5155758 or http://dx.doi.org/10.5089/9798229002677.001
Luxury Watch Asset Class Characteristics
Luxury watches have emerged as an alternative asset class, offering lower returns than equities but lower risk and a low correlation with traditional financial markets. While academic research has extensively examined other collectables like art, wine, and classic cars, the investment potential of luxury watches remains underexplored. This study analyzes the risk-return profile, illiquidity concerns, and diversification benefits of investing in high-end timepieces.
The study uses Chrono24 price data from January 2019 to September 2024, covering the overall luxury watch market and 13 major brands. It compares watch returns to equities, fixed income, commodities, and real estate, applying mean-variance spanning tests and portfolio simulations to assess diversification benefits.
Findings:
Luxury watches underperform equities but outperform fixed income and real estate in risk-adjusted terms.
Audemars Piguet, Patek Philippe, and Rolex dominate returns, while other brands show weaker performance.
Luxury watches exhibit low volatility and low correlations with financial assets, making them a strong diversification tool.
Illiquidity significantly impacts pricing, with price smoothing effects and delayed volatility recognition.
Physical watch investments differ from investing in watch manufacturer stocks, as the latter are more correlated with equities and lack direct exposure to timepiece valuations.
Through my research, I find that there is generally a positive correlation between the number of academic studies on an asset and the information availability on that asset class. Because of this, I generally highlight studies on equities and fixed income. However, other asset classes (like luxury watches) can be utilized to increase portfolio risk-adjusted returns. Affluent investors may want to consider implementing luxury watches in a portfolio given their low correlation with other asset classes.
Weisskopf, Jean-Philippe and Masset, Philippe, Time is Money: An Investment in Luxury Watches (January 30, 2025). Available at SSRN: https://ssrn.com/abstract=5119075 or http://dx.doi.org/10.2139/ssrn.5119075
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I hold a PhD in financial economics from Penn/Wharton & was in the institutional investment business for nearly 40 years. The watches as an asset class paper is idiotic. There is not enough supply to create broad availability, construct index funds, or from which to build viable derivative securities. Watches could be an asset but no significant institutional investor could hold them in enough quantity to affect the performance of their funds. They're a curiosity at maximum. The authors obviously have no experience in institutional investing or in the necessary conditions for assets to be widely held across portfolios - namely in the characteristics of an asset class.