Research that stunned the bond market wins Fama-DFA prize

Two Warwick Business School academics are celebrating after winning a prestigious prize for their research which found serious mistakes in a seminal finance paper on corporate bonds. 

Phillippe Mueller, and Cesare Robotti, both Professors of Finance, have won the Fama-DFA Prize for the best capital markets and asset pricing research papers published in the Journal of Financial Economics, one of premier journals in finance. 

Their paper, Priced risk in corporate bonds, was written alongside Alex Dickerson as he did his PhD at WBS. It stunned the finance world as it unearthed that key data underlying a formula for predicting returns in the bond market and used religiously by quantitative investors were wrong. 

It led to the paper behind the data, written by academics at Georgetown University in 2019, being retracted – the only time the Journal of Financial Economics has ever done so - and authors Jennie Bai, Turan Bali and Quan Wen issuing an apology. 

The editors of the Journal of Financial Economics have now rewarded the WBS trio’s detective work with the prestigious award. 

Professor Robotti said: “This is a great honour; it is one of the most prestigious awards in the finance profession. 

“The paper made big waves not just in academia but in the investing profession, with plenty of media interest, so it is very pleasing the editors have recognised its importance. 

“Using factors based on a bond’s downside risk, illiquidity risk and credit risk had become part of the investing industry’s practices, so it was surprising to find it was based on data that contained fundamental errors. Once we corrected these errors, we found the formula provided no investment advantage at all. It has had big implications for quantitative investors.”

The research found two big errors in the 2019 data, which had claimed to find three factors that influenced bond returns. But the WBS team discovered two of the factors had a ‘lead error’, that is the researchers gave the returns a month after they should have done.   

And they found the third factor had a ‘lag error’ where the returns were given the month before they should have been. Plus, they found the 2019 paper removed extreme losses for some bonds, so the factors looked less volatile and more plausible to unsuspecting readers. 

Professor Mueller added: “It is fundamental to science that research can be replicated, so our paper is part of that process, and unfortunately, we found that a significant paper was not actually repeatable. 

“The paper has had a great impact; it is important work. It is great that research which tries to replicate other studies is rewarded with this prestigious prize.” 

The award is named after Eugene Fama, the 2013 Nobel Laureate in Economics and a co-founding advisory editor of the Journal of Financial Economics, who is renowned for developing the efficient-market hypothesis in asset pricing.

Further reading:

The flaw in the data that led corporate bond investors astray