Final Report Summary - FRICTIONS (Financial Frictions) My research project set out to contribute to the knowledge of financial frictions and what to do about them. Whereas economists have traditionally focused on the assumption of perfect markets, a growing body of evidence is leading to a widespread recognition that markets are plagued by significant financial frictions. My project has explored how financial frictions affect asset prices and the economy.The project has been successfully completed and the output has been significant. Indeed, 9 papers have already been accepted in the top finance and economics journals. In addition, several other promising papers are under review at different journals at various stages. This collection of papers addresses the questions that I set out to answer as part of this ERC project on financial frictions. Further, in connection with this project, I have co-organized 5 major conferences on financial frictions that have attracted some of the leading researchers from around the world, including several Nobel Prize winners.Several of the papers that have been published as part of this project have already made an impact. Indeed, they are well cited by academics, they have been mentioned in the media, and discussed by practitioners at central banks and financial institutions. Two papers have won prestigious awards. In particular, the paper “Betting Against Beta” won the “Fama/DFA First Prize for best paper in the Journal of Financial Economics,” 2014, which is one of the most selective prizes in financial economics (first prize among the papers published in one of the top three journals). Also, the paper “Efficiently Inefficient Markets for Assets and Asset Management” won the “AIM Investment Center Best Paper Award,” 2016. Three papers are published as the lead paper. According to Google Scholar, “Measuring Systemic Risk” is already cited by 1526 papers, more than any other paper published in The Review of Financial Studies during the project period, i.e. since 2012 (again according to Google Scholar). Also, these papers have been downloaded well more than 25,000 times according to SSRN.The main research achievements are to develop a method to measure and manage systemic risk (“Measuring Systemic Risk”), to show how to measure the risk of global securities and the value of a risk model (“Risk Everywhere: Modeling and Managing Volatility”), to show theoretically and empirically how funding constraints affect the trade-off between risk and expected return (“Betting Against Beta”), to derive and solve a framework for how to dynamically choose your portfolio in light of transaction costs and other frictions (“Dynamic Trading with Predictable Returns and Transaction Costs” and “Dynamic Portfolio Choice with Frictions”), to show how options are affected by frictions (“Early Option Exercise: Never Say Never”), to show the effect of carry in financial markets (“Carry”), and to derive a generalized recovery theorem (“Generalized Recovery”).List of published and forthcoming papers1. “Efficiently Inefficient Markets for Assets and Asset Management,” (with Nicolae Garleanu)The Journal of Finance, forthcoming.AIM Investment Center Best Paper Award, 2016.2. “Generalized Recovery,” (with Christian Skov Jensen and David Lando)Journal of Financial Economics, forthcoming.3. “Risk Everywhere: Modeling and Managing Volatility,” (Tim Bollerslev, Benjamin Hood, John Huss)The Review of Financial Studies, forthcoming.4. “Carry,” (with Ralph Koijen Tobias Moskowitz and Evert Vrugt)Journal of Financial Economics, 127 (2), 197-225. Lead paper.5. “Measuring Systemic Risk,” (with V. Acharya, T. Philippon, and M. Richardson)The Review of Financial Studies, 2017, vol. 30 (1), 2-47. Editor’s Choice (lead paper). Associated systemic risk rankings, real time on the web.6. “Early Option Exercise: Never Say Never,” (with Mads Vestergaard Jensen)Journal of Financial Economics, 2016, vol. 121 (2), 278-299.7. “Dynamic Portfolio Choice with Frictions,” (with Nicolae Garleanu)Journal of Economic Theory, 2016, vol. 165, 487–516.8. “Betting Against Beta,” (with Andrea Frazzini) Journal of Financial Economics, 2014, vol. 111 (1), 1-25. Lead paper. Fama/DFA First Prize for best paper on capital markets and asset pricing in the JFE 2014.9. “Dynamic Trading with Predictable Returns and Transaction Costs,” (with Nicolae Garleanu)The Journal of Finance, 2013, vol. 68 (6), 2309-2340.
