Research - Wentao Li

Job Market Paper

Beating the Index with ETFs

ABSTRACT

ETFs have been well-known for tax efficiency. With in-kind redemption, ETFs distribute almost no capital gain to investors, allowing them to track indices closely after tax. On top of the existing knowledge, this paper finds evidence that highly correlated ETFs are used to harvest capital loss without triggering the wash-sale rule. The average monthly tax-loss trading volume is 9.1% of the asset under management, representing 20.7% of total trading volume. Tax-loss harvesting is negatively associated with past returns and positively associated with realised volatility. The connection is more substantial for recent and negative returns. ETFs with larger sizes and bid-ask spreads have lower tax-loss trading volumes relative to their assets under management. This paper builds a parsimonious model to explain the connection between tax-loss harvesting and past price movements.

Tax-loss trading volume in response to past returns

Working Papers

Short-Duration Equity Return Puzzle

Link

ABSTRACT

Short-duration dividend strips have high conditional Sharpe ratios during crises, which are far beyond the theoretical upper bound. The finding is called the short-duration equity return puzzle. Using dividend prices and dividend forecasts, this paper constructs the required rate of return and the conditional Sharpe ratio for dividend strips over the period between 2002 and 2021. During the crisis period in the sample, the required rate of return of 1-year dividend peaks at 55% and its conditional Sharpe ratio rises to above 14, 2 to 17 times higher than the theoretical upper bounds predicted by mainstream macrofinance models. Returns and Sharpe ratios for other horizons are also too high to be explained. The finding is robust to measurement errors and transaction costs.

Conditional Sharpe Ratios for S&P 500 dividend strips

Term Structure of Equity Return Volatility

Link

ABSTRACT

The term structure of equity return volatility fluctuates across time. It affects the term structure of equity returns through the volatility feedback effect and explains the cyclicality of equity return term structure. By analysing the dividend strip futures, this paper finds that volatility feedback effects of dividend strips exist and decrease with the horizon. Using realised and implied volatilities as business cycle indicators, this paper confirms that the term structure of equity returns is pro-cyclical. Decomposition of cyclicality shows that the pro-cyclical term structure of equity returns comes from the high relative sensitivity of short-duration volatility. The predictability of cyclicality by the term structure of volatility is a novel feature that can be used to test macro-finance models. The rare disaster model proposed by Gabaix (2012) is rejected by the test.

Return Predictability from Industry Network Effects: Evidence from Rolling Window Adaptive Lasso

Link

ABSTRACT

The literature argues that industry network effects imply the predictability of industry returns, while the return predictability can estimate the industry network in reverse. The paper employs rolling window adaptive lasso regressions to test the robustness of return predictions, showing the inherent model instability of the industry network and raising caveats for using the adaptive lasso method to estimate the industry network with a long time series. The out-of-sample predictability is examined by creating long-short trading portfolios based on the predictions. With non-parametric tests, the paper discovers that the out-of-sample predictability exists but is primarily due to the momentum effect. The adaptive lasso portfolios perform significantly worse than the momentum portfolio before the adjustment of risks. Based on the multifactor models, the trading portfolios also fail to continuously generate significant alphas for risk-averse investors.

Published Papers

Balance-of-Payments Constrained Growth in UK: A Comment on Extensions of Thirlwall's Law

Applied Economics, 2021

ABSTRACT

We apply Thirlwall's law (Thirlwall 1979) to estimate long run growth in the UK. In particular, we develop a new test allowing for potential structural breaks based on 2SLS to remedy potential weaknesses that existed in previous methods. Our results show the UK had different balance of payments positions in different time periods, and its growth has been constrained in the past two decades. We further elaborate on pound's changing role as a reserve currency and how this has affected the UK's external constraint and growth.

A comparison of BOP contrained growth rate and real growth rate in the UK.