David Musto

David K. Musto is the Ronald O. Perelman Professor in Finance and faculty director of the Stevens Center for Innovation in Finance at the Wharton School, where he has been on the faculty since 1995. He also served as Senior Financial Economist at the Securities Exchange Commission from 2005 to 2007. He has a BA from Yale University and a PhD from the University of Chicago, and between college and graduate school he worked for Roll and Ross Asset Management in Culver City, CA. Most of his work, both theoretical and empirical, is in the area of consumer financial services, mutual funds and consumer credit in particular. He has also published work on corporate and political voting, option pricing, short selling, and cross-border taxation.

Education

PhD, University of Chicago, 1995; BA, Yale University, 1987

Academic Positions Held

Wharton: 1995present(named Ronald O. Perelman Associate Professor in Finance, 2007; Professor, 2008)

Other Positions

Programmer, Trout Trading Company, 1993; Systems Consultant, Roll & Ross Asset Management, 198789

David Musto, Gregory Nini, Krista Schwarz (Working), Notes on Bonds: Liquidity at all Costs in the Great Recession.

Abstract: We relate market stress to asset pricing by analyzing a large and systematic discrepancy among offtherun Treasury securities:  bond prices traded as much as five percent below otherwise identical notes, orders of magnitude more than we find concurrent special repo rates to explain.  The relatively low lending revenue from holding the note begs the question of why its current holders would not trade it for cheaper yet identical cash flows.  The pricing discrepancy persisted for months.  We find that liquidity characteristics of Treasury securities explain a large share of the Treasury pricing anomaly.  We relate insurers’ transactions in Treasuries to their characteristics.  We find that the most highly levered insurers and those that transact most frequently tended to demand notes over bonds during the crisis, contributing to the anomaly.   

David Erickson and David Musto Alcoa Deals with the Financial Crisis Wharton Case 98.

Description: Alcoa, Inc. (Alcoa), an S&P 500 Index constituent and Dow Jones Industrial Average (DJIA) component, has just announced its fourth quarter 2008 earnings. In the midst of the Global Financial Crisis, Alcoa reported a net loss of US$1.19 billion for the quarter. With aluminum prices off by 56 percent in the last five months and a sharp drop in demand from its end markets, Alcoa announced a major restructuring including a workforce reduction of 15,000 jobs. Joan Davidson, a managing director at Pinnacle Capital (a fictitious investment bank), is scheduled to meet with Alcoa management and needs to strategize to give the company her recommendations on what actions Alcoa should take. The case examines Alcoa's history, current situation, and the potential alternatives it can take.   To use this case, please contact coursematerials@wharton.upenn.edu.  

David Erickson and David Musto Elliott Management Goes After Riverbed Technology Wharton Case 97.

Description: The case follows Elliott Management, one of the world’s largest activist investors, in its campaign in 2014 to buy out Riverbed Technology, a formerly highflying technology firm.  The campaign involves a sequence of moves by Elliott and countermoves by Riverbed.  The narrative includes communications between the parties; Riverbed’s earnings announcements and other corporate actions; and the impact on Riverbed’s stock price. To use this case, please contact coursematerials@wharton.upenn.edu.

David Erickson and David Musto The Alibaba IPO Wharton Case 96.

Description: Alibaba Group Holding Limited (Alibaba) is finishing up its IPO roadshow. James Miller, an associate at Dragon Fund (a fictitious financial institution), is asked to prepare a recommendation on Alibaba for its upcoming Investment Committee meeting. The case examines Alibaba's history; business model; opportunity in China (and globally); governance structure; valuation (versus potential comparable companies); and the forms of securities it is offering. To use this case, please contact coursematerials@wharton.upenn.edu. 

David Erickson and David Musto EMC: The Carveout of VMware Wharton Case 95.

Description: This case focuses on the strategic decision EMC made to carve out its highgrowth subsidiary, VMware. The case examines some of the factors companies use to determine whether or not to carve out a subsidiary and the potential implications. It also examines the valuation impact on both EMC and VMware at IPO. To use this case, please contact coursematerials@wharton.upenn.edu.

Rich Evans, Christopher Geczy, David Musto, Adam V. Reed (2009), Failure is an Option: Impediments to Short Selling and Options Prices, Review of Financial Studies, Forthcoming.

Abstract: Regulations allow market makers to short sell without borrowing stock, and the transactions of a major options market maker show that in most hardtoborrow situations, it chooses not to borrow and instead fails to deliver stock to its buyers. Some of the value of failing passes through to option prices: when failing is cheaper than borrowing, the relation between borrowing costs and option prices is significantly weaker. The remaining value is profit to the market maker, and its ability to profit despite the usual competition between market makers appears to result from a cost advantage of larger market makers at failing.

Philip Bond, David Musto, Bilge Yilmaz (2008), Predatory Mortgage Lending, Journal of Financial Economics, (2009), 94, 412427.

Abstract: Regulators express growing concern over predatory loans, which the authors take to mean loans that borrowers should decline. Using a model of consumer credit in which such lending is possible, they identify the circumstances in which it arises both with and without competition. The authors find that predatory lending is associated with highly collateralized loans, inefficient refinancing of subprime loans, lending without due regard to ability to pay, prepayment penalties, balloon payments, and poorly informed borrowers. Under most circumstances competition among lenders attenuates predatory lending. They use their model to analyze the effects of legislative interventions.

Susan E. K. Christoffersen, Donald B. Keim, David Musto (Working), Valuable Information and Costly Liquidity: Evidence from Individual Mutual Fund Trades.

Abstract: Until recently, all Canadian mutual funds were required to disclose all their individual trades, offering a unique and ideal opportunity to measure and analyze the cost and performance of mutual funds’ trades. We find that active management delivers both cheaper trades and better subsequent performance, and that the dissipative effect of flowdriven transactions costs is primarily through forced sales. Fund size associates with both cheaper trades and better subsequent performance, and a series of trades predicts more price movement in the predicted direction, indicating the value to funds of keeping their trading anonymous.

Christopher Geczy, Susan Christoffersen, David Musto, Adam Reed (2007), Vote Trading and Information Aggregation, Journal of Finance.

Abstract: The standard analysis of corporate governance assumes that shareholders vote in ratios that firms choose, such as one shareone vote. However, if the cost of unbundling and trading votes is sufficiently low, then shareholders choose the ratios. We document an active market for votes within the U.S. equity loan market, where the average vote sells for zero. We hypothesize that asymmetric information motivates the vote trade and find support in the cross section. More trading occurs for higherspread and worseperforming firms, especially when voting is close. Vote trading corresponds to support for shareholder proposals and opposition to management proposals.

David Musto and Nicholas S. Souleles (2006), A Portfolio View of Consumer Credit, Journal of Monetary Economics, 53(1), January 2006, 5984.

Abstract: This paper takes a portfolio view of consumer credit. Default models (creditrisk scores) estimate the probability of default of individual loans. But to compute riskadjusted returns, lenders also need to know the covariances of the returns on their loans with aggregate returns. Covariances are independently relevant for lenders who care directly about the volatility of their portfolios, e.g. because of ValueatRisk considerations or the structure of the securitization market. Crosssectional differences in these covariances also provide insight into the nature of the shocks hitting different types of consumers. We use a unique panel dataset of credit bureau records to measure the ‘covariance risk’ of individual consumers, i.e., the covariance of their default risk with aggregate consumer default rates, and more generally to analyze the crosssectional distribution of credit, including the effects of credit scores. We obtain two key sets of results. First, there is significant systematic heterogeneity in covariance risk across consumers with different characteristics. Consumers with high covariance risk tend to also have low credit scores (high default probabilities). Second, the amount of credit obtained by consumers significantly increases with their credit scores, and significantly decreases with their covariance risk (especially revolving credit), though the effect of covariance risk is smaller in magnitude. It appears that some lenders take covariance risk into account, at least in part, in determining the amount of credit they provide.

Past Courses

FNCE238 CAPITAL MARKETS

The objective of this course is to give you a broad understanding of the framework and evolution of U.S. capital markets, the instruments that are traded, the mechanisms that facilitate their trading and issuance, and the motivations of issuers and investors across different asset classes. The course will highlight the problems that capital market participants are seeking to solve, which you can use in your postWharton careers to evaluate future market innovations. We will consider design, issuance, and pricing of financial instruments, the arbitrage strategies which keep their prices inline with one another,and the associated economic and financial stability issues. We will draw from events in the aftermath of the recent financial crisis, which illustrate financing innovations and associated risks, as well as policy responses that can change the nature of these markets.

FNCE383 STRATEGIC EQUITY FINANCE

This course combines lectures and cases, and will go through actual situations where companies need to make strategic decisions on raising equity capital. We will address different phases of a company's life cycle. Through these cases, from the decisionmakers perspective, we will explore the different paths that can be taken and consider issues such as investor activism, governance and regulatory and valuation impact. FNCE 383 is a half semester course offered in Q3 during the spring semester.

FNCE399 INDEPENDENT STUDY

Integrates the work of the various courses and familiarizes the student with the tools and techniques of research.

FNCE738 CAPITAL MARKETS

The objective of this course is to give you a broad understanding of the instruments traded in modern financial markets, the mechanisms that facilitate their trading and issuance, as well as, the motivations of issuers and investors across different asset classes. The course will balance functional and institutional perspectives by highlighting the problems capital markets participants are seeking to solve, as well as, the existing assets and markets which have arisen to accomplish these goals. We will consider design, issuance, and pricing of financial instruments, the arbitrage strategies which keep their prices inline with one another,and the associated economic and financial stability issues. The course is taught in lecture format, and illustrates key concepts by drawing on a collection of case studies and visits from industry experts.

FNCE883 STRATEGIC EQUITY FINANCE

This course combines lectures and cases, and will go through actual situations where companies need to make strategic decisions on raising equity capital. We will address different phases of a comany's life cycle. Through these cases, from the decisionmakers perspective, we will explore the different paths that can be taken and consider issues such as investor activism, governance and regulatory and valuation impact. FNCE 883 is a half semester course offered in Q3 of the spring semester.

FNCE899 INDEPENDENT STUDY

Independent Study Projects require extensive independent work and a considerable amount of writing. ISP in Finance are intended to give students the opportunity to study a particular topic in Finance in greater depth than is covered in the curriculum. The application for ISP's should outline a plan of study that requires at least as much work as a typical course in the Finance Department that meets twice a week. At a minimum, we need a description of the methodology you intend to employ, a bibliography and description of the data that you will use as well as a list of interim deliverables and dates to ensure that you complete the project within the semester. Applications for FNCE 899 ISP's will not be accepted after the THIRD WEEK OF THE SEMESTER. You must submit your Finance ISP request using the Finance Department's ISP form located at https://fnce.wharton.upenn.edu under the Course ISP section

FNCE912 CORP FNCE AND FIN INSTIT

This course provides students with an overview of the basic contributions in the modern theory of corporate finance and financial institutions. The course is methodology oriented in that students are required to master necessary technical tools for each topic. The topics covered may include capital structure, distribution policy, financial intermediation, incomplete financial contracting, initial and seasoned public offerings, market for corporate control, product market corporate finance interactions, corporate reorganization and bankruptcy, financing in imperfect markets, security design under adverse selection and moral hazard, and some selected topics.

What is naked short selling?, CNNMoney.com 05/19/2010

Knowledge @ Wharton

• Are Credit Bureaus Poised to Fight for the Consumer?, Knowledge @ Wharton 03/12/2015
• Does Social Impact Demand Financial Sacrifice?, Knowledge @ Wharton 12/02/2014
• The ‘Social’ Credit Score: Separating the Data from the Noise, Knowledge @ Wharton 06/05/2013
• More Savings, Less Plastic: Consumer Credit after the Crisis, Knowledge @ Wharton 07/08/2009
• Victimizing the Borrowers: Predatory Lending’s Role in the Subprime Mortgage Crisis, Knowledge @ Wharton 02/20/2008
• What’s in Your Future(s)? The Merger of the Chicago Exchanges, Knowledge @ Wharton 11/01/2006
• Bad News Is Good News: ‘Distressed for Control’ Investing, Knowledge @ Wharton 04/26/2006
• The Next Chapter in Bankruptcy Law: What Does It Mean for Debtors and Creditors?, Knowledge @ Wharton 11/21/2005
• The Economic Outlook for 2005, Knowledge @ Wharton 01/12/2005
• Can We Trust the Mutual Fund Industry Yet, or Is Reform Illusory?, Knowledge @ Wharton 07/28/2004
• It’s Time to Curb Abuses in Mutual Funds, Knowledge @ Wharton 11/19/2003
• Mutual Fund Scandals: Once Again, Individual Investors Are the Losers, Knowledge @ Wharton 09/24/2003
• Ducking Foreign Taxes: How Much Can U.S. Investors Really Save?, Knowledge @ Wharton 07/02/2003
• You Could Have Shorted Dotcoms: You Just Didn’t, Knowledge @ Wharton 12/18/2002
• Equity Loans: How to Sell What You Do Not Own, Knowledge @ Wharton 08/01/2001
• When Fund Managers Leave Their Fund, Should Investors Follow?, Knowledge @ Wharton 10/16/2000
• Investors Beware: Some Mutual Fund Managers Inflate Yearend Returns, Knowledge @ Wharton 01/20/2000