Work in Progress

• Kogan, L., A. Lo, Q. Xu, and R. Zhang "Optimizing a Portfolio of R&D Projects: A Real Options Approach"

  We propose real options dynamic programming (RODP), a sequential strategy to optimize a portfolio of research and development (R&D) projects with correlated binary outcomes. The key innovation is to utilize correlation as a knowledge discovery mechanism and exercise the real options to dynamically adjust future R&D plans based on information learned from previous outcomes. We focus on a class of R&D projects, known as long shots, that are difficult to manage using the standard approach. We derive the RODP-optimal strategy and its corresponding financial value under batch testing and block correlation. RODP generates an improved efficient frontier with higher expected payoff and lower volatility than parallel development. Depending on investor preferences, the financial value of the investment portfolio is maximized when corre- lation is either very low or very high, which reflects the tradeoff between diversification from low correlations and information value from high correlations. Our results have important implications for managing a port- folio of R&D projects with high correlations that cannot be effectively reduced via diversification.

• Kogan, L., J. Li, H. Zhang, and Y. Zhu, "Operating Leverage and Asset Pricing Puzzles."

  Winner, 2023 Pacific-Basin Finance Journal Research Excellence Award.

  We investigate the joint asset pricing effects of variable costs and fixed costs in a firm's production process. While the latter such as SG&A expenses create an operating leverage effect, the variable costs allow firms to hedge against aggregate profitability shocks. Taking into account both types of production costs explains the empirical patterns in the cross-section asset returns in portfolios sorted by the gross profitability and operating leverage. Our model reconciles the seemingly contradictory phenomena that higher productivity firms earn lower returns (Imrohorouglu and Tuzel, 2014), whereas more profitable, often more productive, firms earn higher returns (Novy-Marx, 2013). It also offers a novel explanation for the negative idiosyncratic volatility premium (Ang, Hodrick, Xing, and Zhang, 2006) based on production costs.

• Kogan, L., D. Papanikolaou, L. Schmidt, and B. Seegmiller, "Technological Change and Occupations over the Long Run."

  We construct occupation-specific indicators of technological change that span two centuries (1850-2010) using textual analysis of patent documents and occupation task descriptions. We find strong evidence that much of technical change has been displacive of labor during this period.

Working Papers

• Cen, X., W. Dou, L. Kogan, and W. Wu, 2023, "Fund Flows and Income Risk of Fund Managers." Download. SSRN.

  Investment fund managers, with their specialized skills, make daily trading and asset allocation decisions in financial markets for a major portion of U.S. households. Their role is unique and pivotal in shaping capital market valuations and building wealth for households. To fully grasp their impact on capital markets and the broader economy, it’s imperative to examine their incentives and the income and career risk they confront. To achieve this objective, this paper creates a unique and novel dataset detailing the compensation and employment history of managers in U.S. active equity mutual funds. Specifically, we integrate data from CRSP, Morningstar, and U.S. Census LEHD, leveraging various "big" textual data sources, including mutual fund prospectus, LexisNexis, and CoreLogic. We find that, contrary to their self-disclosures, funds’ AUMs are the primary driver of their managers’ compensation, with both fund flows and performance influencing compensation via AUM. Fund flows – outside fund clients’ interests – exert significant influence on managers’ compensation. Specifically, a one-standard-deviation surge in fund flows is associated with a statistically significant increase in compensation by about 6%. These fund flows, when broken down, show that their systematic components affect the base pay, while idiosyncratic elements influence bonuses. Importantly, fund flows, as opposed to fund performance, exert a strong impact on the career outcomes of fund managers, especially concerning their downside career risk. For instance, large fund outflows elevate a manager’s likelihood of job turnover (with a substantial decline in income) by 4 percentage points.

• Huang, Q., D. Papanikolaou, and L. Kogan, 2024, "Productivity Shocks and Inflation in Incomplete Markets." Download.

  Innovation leads to higher productivity, yet it can lead to higher inflation if markets are incomplete. We establish a positive and economically significant relationship between innovation activity and local consumption-good prices at the state level. We rationalize this finding in a multi-region model of a monetary union where regions can experience displacive shocks that reallocate output among agents. Because benefits of economic growth accrue asymmetrically across all agents, prices of non-tradable goods can rise even as regional output increases. Local stock markets provide evidence consistent with model predictions.

• Kogan, L., J. Li, and X. Qiao, 2023, "Asset Growth Effect and Q Theory of Investment." SSRN.

  We extend the standard q theory of investment into a two-capital setup in which firms use both physical capital (long-term asset) and short-term capital (current asset) as production inputs. We find this simple extension is capable of explaining the stronger return predictive power of total asset growth than current and long-term asset growths. A novel asset imbalance channel creates negatively correlated comovement between current and long-term asset growths that are unrelated to the discount rate effect. Part of this comovement is cancelled out in the total asset growth, giving rise to its stronger return predictive power. Empirically, once controlling for this comovement, the return predictive power of current and long-term asset growths substantially improves. Furthermore, we document compelling evidences for the model's prediction that the asset growth effects are more prominent among firms with low asset imbalance. Our results support the q-theory based explanation for the asset growth effect.

• Dou, W., L. Kogan, and W. Wu, 2023, "Common Fund Flows: Flow Hedging and Factor Pricing." 2020 NASDAQ award for the best paper on asset pricing at the WFA Conference. Working Paper with Online Appendix

  Active mutual funds care about fund size, affected by common fund flows driven by primitive shocks. Funds hedge against common-flow shocks by tilting their portfolios toward low-flow-beta stocks. In equilibrium, common fund flows earn a risk premium, leading to a multi-factor asset-pricing model similar to the ICAPM, even with all agents behaving myopically and using naive asset-pricing models. Empirically, fund flows obey a strong factor structure with the common component earning a risk premium, and fund portfolios are, on average, tilted toward low-flow-beta stocks. This tilt increases in magnitude when flow-hedging motives strengthen following natural disasters and unexpected trade-war announcements.

• Kogan, L., D. Papanikolaou, L. Schmidt, and B. Seegmiller, 2024, "Technology and Labor Displacement: Evidence from Linking Patents with Worker-Level Data." Download.

  We develop measures of labor-saving and labor-augmenting technology exposure using textual analysis of patents and job tasks. Using US administrative data, we show that both measures negatively predict earnings growth of individual incumbent workers. While labor-saving technologies predict earnings declines and higher likelihood of job loss for all workers, labor-augmenting technologies primarily predict losses for older or highly-paid workers. However, we find positive effects of labor-augmenting technologies on occupation-level employment and wage bills. A model featuring labor-saving and labor-augmenting technologies with vintage-specific human capital quantitatively matches these patterns. We extend our analysis to predict the effect of AI on earnings.

• Kogan, L., D. Papanikolaou, L. Schmidt, and J. Song, 2022, "Technological Innovation and the Distribution of Labor Income Growth." Download.

  We examine the relation between technological progress and labor income risk using administrative data from the US. Motivated by a simple model of creative destruction and human capital specificity, we draw a distinction between technological advanced by the firm, or its competitors. We find that own firm innovation is associated with a modest increase in worker earnings growth, while innovation by competing firms is related to lower future worker earnings. Importantly, these earnings changes are asymmetrically distributed across workers: both gains and losses are concentrated on a subset of workers, which implies that the distribution of worker earnings growth rates becomes more right- or left-skewed following innovation by the firm, or its competitors, respectively. These effects are particularly strong for the highest-paid workers. Our results suggest innovation is associated with a substantial increase in the labor income risk, especially for workers at the top of the earnings distribution. Our simulations reveal that the increased disparity in innovation outcomes across firms in the 1990s can account for a significant part of the rise in income inequality.

• Fanti, G., L. Kogan, P. Viswanath, 2022, "Economics of Proof-of-Stake Payment Systems." Download

  In this paper we develop a valuation framework for a Proof-of-Stake (PoS) payment system. Active network participants (proposers and validators) are required to stake tokens, and receive payments in return for their services. This property of the PoS system connects cash flows to token holdings, and allows for valuation using conventional methods. As an application of our framework, we analyze security properties of the PoS system. We show that while high token valuation relative to the flow of transactions is central to network security, valuation bubbles have adverse security implications. State-contingent monetary policies can be used to alleviate this problem.

• Kogan, L., I. Mitra, 2024, "Near-Rational Equilibria in Heterogeneous-Agent Models: A Verification Method." Download

  We propose a general simulation-based procedure for estimating bounds on welfare losses under approximate policies in heterogeneous-agent equilibrium models, which allows to verify that such approximate solutions describe a near-rational equilibrium. Our procedure endows agents with superior knowledge of the future path of the economy, while imposing a suitable penalty for such foresight. The relaxed problem is more tractable than the original, and results in an upper bound on agents' welfare. Our method is general, straightforward to implement, and can be used in conjunction with various solution algorithms. We illustrate our approach in two applications: the incomplete-markets model of Krusell and Smith (1998) and the heterogeneous firm model of Khan and Thomas (2008).

Permanent Working Papers

• Kogan, L., M. Tian, 2015, "Firm Characteristics and Empirical Factor Models: a Model-Mining Experiment." Working Paper, MIT. Download. Internet Appendix.

"A three-factor model using momentum and cashflow-to-price factors explains 14 asset pricing anomalies." Our model-mining experiment provides a backdrop to evaluate such claims. We construct three-factor linear pricing models that match return spreads associated with as many as 14 out of 27 commonly used firm characteristics over the 1971-2011 sample. 71% and 48% of the factor models match a larger fraction of target return cross-sections than the CAPM or Fama-French three-factor model, respectively. The relative performance of factor models is highly sensitive to sample choice and factor construction methodology. Simulation analysis indicates that the empirical performance across the mined models provides virtually no evidence in support of the underlying risk-return relations.

• Haugh, M., L. Kogan, Z. Wu, 2006, "Portfolio Optimization with Position Constraints: an Approximate Dynamic Programming Approach." Working Paper, MIT. Download.

  We analyze dynamic portfolio choice problems using an approximate dynamic program- ming (ADP) algorithm. We extend the algorithm to the case of constraints on borrowing and implement a duality-based simulation procedure for estimating bounds on the true value function. We demonstrate that the ADP solution exhibits a high degree of accu- racy in the considered examples, indicating that this is a promising approach to tackling challenging practical problems in the area of asset allocation and portfolio choice. We present additional evidence on the performance of the duality-based method for esti- mating performance of approximate portfolio rules, showing that it provides a valuable tool in conjunction with ADP-style algorithms.

• Kogan, L., T. Wang, 2003, "A Simple Theory of Asset Pricing under Model Uncertainty." Working Paper, MIT. Download.

  The focus of our paper is on the implications of model uncertainty for the cross-sectional properties of returns. We perform our analysis in the context of a tractable single-period mean-variance framework. We show that there is an uncertainty premium in equilibrium expected returns on financial assets and study how the premium varies across the assets. In particular, the cross-sectional distribution of expected returns can be formally described by a two-factor model, where expected returns are derived as compensation for the asset’s contribution to the equilibrium risk and uncertainty of the market portfolio. In light of the large empirical literature on the cross-sectional characteristics of asset returns, understanding the implications of model uncertainty even in such a simple setting would be of significant value. By characterizing the cross-section of returns we are also able to address some of the observational equivalence issues raised in the literature. That is, whether model uncertainty in financial markets can be distinguished from risk, and whether uncertainty aversion at an individual level can be distinguished from risk aversion.

• Kogan, L., R. Uppal, 2001, "Risk Aversion and Optimal Portfolio Policies in Partial and General Equilibrium Economies." Working Paper, MIT. Download.

  In this article, we show how to analyze analytically the equilibrium policies and prices in an economy with a stochastic investment opportunity set and incomplete financial markets, when agents have power utility over both intermediate consumption and terminal wealth, and face portfolio constraints. The exact local comparative statics and approximate but analytical expression for the portfolio policy and asset prices are obtained by developing a method based on perturbation analysis to expand around the solution for an investor with log utility. We then use this method to study a general equilibrium exchange economy with multiple agents who differ in their degree of risk aversion and face borrowing constraints. We characterize explicitly the consumption and portfolio policies and also the properties of asset returns. We find that the volatility of stock returns increases with the cross-sectional dispersion of risk aversion, with the cross-sectional dispersion in portfolio holdings, and with the relaxation of the constraint on borrowing. Moreover, tightening the borrowing constraint lowers the risk-free interest rate and raises the equity premium in equilibrium.

Publications

• Kogan, L., I. Mitra, 2024, "Near-Rational Equilibria in Heterogeneous-Agent Models: A Verification Method." Download. Conditionally accepted, Review of Financial Studies.
• John, K., L. Kogan, and S. Fahad, 2023, "Smart Contracts and Decentralized Finance." Download. Annual Review of Financial Economics,15, 523-542.
• Kogan, L., J. Li, and H. Zhang, 2023, "Operating Hedge and Gross Profitability Premium." Download, Preprint, Internet Appendix Journal of Finance, forthcoming.
• Dou, W., L. Kogan, and W. Wu, 2023, "Common Fund Flows: Flow Hedging and Factor Pricing." Download, Internet Appendix Journal of Finance, forthcoming. 2020 NASDAQ award for the best paper on asset pricing at the WFA Conference.
• Chen, H., W. Dou, L. Kogan, 2023, "Measuring the "Dark Matter" in Asset Pricing Models." Journal of Finance, 79, 843-902. Download, Internet Appendix. Best paper award at the 2013 Red Rock Finance Conference.
• Chen, W., M. Khan, L. Kogan, and G. Serafeim, 2020, "Cross-firm return predictability and accounting quality." Journal of Business Finance & Accounting, 48, 70–101. Preprint
• Kogan, L., D. Papanikolaou, A. Seru, N. Stoffman, 2020, "Left Behind: Creative Destruction, Inequality, and the Stock Market." Journal of Political Economy, 128, 855-906. Download, Internet Appendix
• Kogan, L., D. Papanikolaou, A., 2019, "Technological Innovation, Intangible Capital, and Asset Prices." Annual Review of Financial Economics, 11, 221-242. Download
• Fanti G., Kogan L., Oh S., Ruan K., Viswanath P., Wang G. (2019) "Compounding of Wealth in Proof-of-Stake Cryptocurrencies." In: Goldberg I., Moore T. (eds) Financial Cryptography and Data Security. FC 2019. Lecture Notes in Computer Science, vol 11598. Springer, Cham. Download
• Kogan, L., D. Papanikolaou, 2018, "Equilibrium Analysis of Asset Prices: Lessons from CIR and APT." Journal of Portfolio Management, 44, 59-69. Download
• Kogan, L., D. Papanikolaou, A. Seru, N. Stoffman, 2017, "Technological Innovation, Resource Allocation, and Growth." Quarterly Journal of Economics, 132, 665–712. Crowell Memorial Prize (second prize), PanAgora Asset Management. Download, Internet Appendix Replication Kit Data
• Kogan, L., S. Ross, J. Wang, and M. Westerfield, 2017, "Market Selection." Journal of Economic Theory, 168, 209-236. Download
• Huynh, V.A., L. Kogan, and E. Frazzoli, 2014, "A martingale approach and time-consistent sampling-based algorithms for risk management in stochastic optimal control." Decision and Control (CDC), IEEE 53rd Annual Conference, 1858-1865. Download
• Kogan, L., D. Papanikolaou, 2014, "Growth Opportunities, Technology Shocks, and Asset Prices." Journal of Finance, 69, 675-718. 2014 Amundi Smith Breeden Prize (first prize) for the best paper published in Journal of Finance. Download, Internet Appendix
• Kogan, L., D. Papanikolaou, 2013, "Firm Characteristics and Stock Returns: The Role of Investment-Specific Shocks." Review of Financial Studies, 26, 2718-2759. Download Internet Appendix
• Kogan, L., D. Papanikolaou, 2012, "Economic Activity of Firms and Asset Prices." Annual Review of Financial Economics 4, 361-384. Download
• Khan, M., L. Kogan, G. Serafeim, 2012, "Mutual Fund Trading Pressure: Firm-Level Stock Price Impact and Timing of SEOs." Runner up for the 2013 Whitebox Prize for Best Financial Research. Journal of Finance, 67, 1371-1395. Download, Internet Appendix
• Garleanu, N., L. Kogan, S. Panageas, 2012, "Displacement Risk and Asset Returns." Best paper award at the 2011 Utah Winter Finance Conference. Journal of Financial Economics, 105, 491-510. Download, Internet Appendix
• Kogan, L., D. Papanikolaou, 2010. "Growth Opportunities and Technology Shocks." American Economic Review, P&P, 100, 532-36. Download
• Gomes, J., Kogan, L., and M. Yogo, 2009, "Durability of Output and the Cross-Section of Stock Returns," Journal of Political Economy, 117, 941-986. 2007 Crowell Memorial Prize (first prize), PanAgora Asset Management. Download
• Kogan, L., D. Livdan, A. Yaron, 2008, "Oil Futures Prices in a Production Economy with Investment Constraints," Journal of Finance 64, 1345-1375. Download
• Kogan, L., 2008, "A Dynamic Default Correlation Model." Quantitative Credit Research Quarterly Q2/3, Lehman Brothers. Download
• Kogan, L., V. Konstantinovsky, 2008, "Commodity Futures and Inflation." Global Relative Value, Lehman Brothers. Download
• Kogan, L., M. Haugh, 2007, "Duality Theory and Approximate Dynamic Programming for Pricing American Options and Portfolio Optimization," in Handbooks in Operations Research and Management Science: Financial Engineering, 15, Ch. 23. (Eds.: J. Birge, V. Linetsky). Elsevier, North-Holland. Download
• Kogan, L., I. Makarov, and R. Uppal, 2007, "The Equity Risk Premium and the Riskfree Rate in an Economy with Borrowing Constraints." Mathematics and Financial Economics 1, 1-19. Lead article, inaugural issue. Download
• Kogan, L., S. Ross, J. Wang, and M. Westerfield, 2006, "The Price Impact and Survival of Irrational Traders." Journal of Finance 61, 195-229. 2006 Smith Breeden Prize (first prize) for the best paper published in Journal of Finance. 2004 FAME Research Prize, Swiss Finance Institute. Download
• Haugh, M., Kogan, L., J. Wang, 2004, "Evaluating Portfolio Policies: A Duality Approach," Operations Research 54, 405-418. Download
• Kogan, L., 2004, "Asset Prices and Real Investment," Journal of Financial Economics 73, 411-432. Lead article. Download
• Haugh, M., and L. Kogan, 2004, "Pricing American Options: A Duality Approach," Operations Research 52, 258-270. Download
• Gomes, J., L. Kogan, and L. Zhang, 2003, "Equilibrium Cross-Section of Returns," Journal of Political Economy 111, 693-732. Lead article. Download, Erratum
• Chan, Y., and L. Kogan, 2002, "Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices," Journal of Political Economy 110, 1255-1285 Download
• Kogan, L., 2001, "An Equilibrium Model of Irreversible Investment," Journal of Financial Economics 62, 201-245. Lead article. Download
• Bertsimas, D., L. Kogan, and A. Lo, 2001, "Hedging Derivative Securities and Incomplete Markets: An Epsilon-Arbitrage Approach," Operations Research 49, 372-397. Download
• Bertsimas, D., L. Kogan, and A. Lo, 2000, "When Is Time Continuous?" Journal of Financial Economics 55, 173-204. Download