Assessing Asset Pricing Models using Revealed

Note of the Relation between “Assessing Asset Pricing Models using Revealed Preference” and “What risk factors matter to investors? Evidence from mutual fund flows” Jonathan B. Berk Jules H. van Binsbergen April 29, 2014 This note describes the chronology of events that lead to the development of “Assessing Asset Pricing Models using Revealed Preference” by Jonathan Berk and Jules van Binsbergen and how they relate to a subsequent paper “What risk factors matter to investors? Evidence from mutual fund flows” by Brad Barber, Xing Huang and Terrance Odean. Chronology of Events February 2012 No later than February 2012, Berk and van Binsbergen (BvB), while working on an earlier paper (“Measuring Skill in the Mutual Fund Industry”), discover that managerial compensation much better predicts outperformance relative to the benchmark of available Vanguard funds than the Fama-‐French-‐Carhart risk factor specification (FFC). They also notice that net alpha is predictable when computed using FFC, while it is not using the Vanguard benchmark. What these results mean is that the mutual fund flows are not flowing to positive alpha investment opportunities as defined by FFC. They realize that this implies investors do not care about FFC and confirm this using flow data. Shortly after discovering these results Berk discusses them with Odean during one of their weekly meetings. Odean claims to have no recollection of any discussion of what mutual fund flows imply about FFC with Berk. He claims to have had this insight independently sometime in March 2012. September 27, 2013 Van Binsbergen goes to Michigan State and presents “Measuring Skill in the Mutual Fund Industry.” During his one-‐on-‐one meeting with Huang, she informs him of the project she is working on with Barber and Odean. Van Binsbergen informs her that he already has a paper on the subject and describes in detail the findings of his paper with Berk. Huang makes it clear to van Binsbergen that she does not yet have a paper and therefore does not give van Binsbergen a copy of the paper. The conversation ends at that point. Shortly thereafter Huang sends the following email to both of her coauthors informing them of the existence of the BvB paper: “Jules van Binsbergen (in Stanford, Berk's coauthor) is visiting our department today. During our meeting, I mentioned our project, and it seems that they have a very similar paper, using mutual fund flow to imply what risk model investors are using. So what do you think? what shall we do now?” Odean and Barber have not shared their reply to this email with us. When van Binsbergen returned to Stanford and informed Berk about the Huang conversation, Berk dismissed it believing that it was inconceivable that Odean would work on the project given the precedence of the Berk and van Binsbergen existing paper and the fact that Berk discussed the idea with Odean. October 17, 2013 “Assessing Asset Pricing Models using Revealed Preference” is posted on SSRN March 14, 2014 “What risk factors matter to investors? Evidence from mutual fund flows” is posted on SSRN The paper does not cite the BvB paper and contains the following sentence: “To sum up, to our knowledge, we are the first paper to explicitly address the following question: How do investors account for risk when allocating capital to actively managed mutual funds?” March 26, 2014 Berk and Van Binsbergen notice the BHO paper and immediately email Odean and Barber. Odean’s email reply begins with the following observation: “This is fourth or fifth time that I've independently worked on a project similar to one that other authors were working on.” Odean then acknowledges that BHO all knew about the existence of BvB more than five months prior to the date of their post, but chose to intentionally ignore the paper: “We decided not to read your paper so as not to be influenced by whatever methodological choices you made. We assumed that Jules had mentioned our paper to you. So far, none of the three of us has read your paper. I intend to do so in the next few days and, of course, we will cite you.” April 24, 2014 BHO post a new version of their paper to SSRN. This version removes the false sentence claiming to be first, cites BvB but includes the following footnote: “In April 2012, we derived the result that CAPM alphas better forecast fund flows than market-‐adjusted returns or 3or 4-‐factor alphas. Since then we have focused on establishing the robustness of this finding and attempting to understand the mechanism. In September 2013, Berk and Binsbergen and we became aware that both sets of authors had independently derived similar findings. Berk and Binsbergen posted a preliminary paper to SSRN in October 2013. We posted our paper to SSRN in March 2014 after presenting the paper and submitting it to conferences.” We can find no record of BHO presenting their paper prior to March 2014. April 29, 2014 BHO post a new version of their paper to SSRN that revises the footnote as follows: “In September 2013, Berk and van Binsbergen and we became aware that both sets of authors had independently derived similar findings. Berk and van Binsbergen first posted their paper to SSRN in October 2013. We posted our paper to SSRN in March 2014.” Comments Barber, Huang and Odean (BHO) insist that their work was independently executed. Because there is no way to verify that the conversation between Berk and Odean occurred in February 2012, there is no way to dispute the claim that the BHO work is independent. But the issue of whether the work is contemporaneous is not subject to dispute. It is a matter of public record. BHO became aware of the existence of the BvB paper over 5 months prior to when they posted their paper for the first time. That they chose to intentionally ignore the BvB paper once they became aware of its existence does not in any way change the chronology. Why BHO chose to intentionally ignore prior work and, in addition, inserted a sentence in the first version of their paper that they knew at the time they wrote it to be untrue is unclear.

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