Morningstar - Summer 2019 - 79

are Thomas Idzorek, CFA, chief investment
officer, retirement, with Morningstar Investment
Management; Paul D. Kaplan, Ph.D., CFA,
director of research with Morningstar Canada; and
James X. Xiong, Ph.D., CFA, head of scientific
investment management research with
Morningstar Investment Management. They
recently joined me to discuss their effort
and its applications. Our conversation has been
edited for length and clarity.

Thomas Idzorek: We'd all kind of lost sight of
the "New Equilibrium Theory" paper. Then, Roger,
James, and I noticed the liquidity factor
within mutual funds and published a paper2 that
came out in the FAJ before Roger's more
foundational work on liquidity within stocks.3
After those two papers, we began thinking:
Is there a broader encompassing idea or rationale
behind what we were seeing? In 2014, we
published "Dimensions of Popularity"4 and coined
popularity as the umbrella term.

John Rekenthaler: Tell me about the genesis of

this work.

Roger Ibbotson: I can take this all the way back
to the 1980s when Larry Siegel, Jeff Diermeier,
and I wrote an article for the Financial Analysts
Journal called "A New Equilibrium Theory."1 It was
based on the idea that lots of things impact
the price of an asset, not just risk-how liquid
an asset was, how it was taxed, and so
forth. All these sorts of things were involved
in an equilibrium. This idea has been around now
for 30 years or so.

Ibbotson: The key thing about liquidity is it's
something you like, and less liquidity is something
you do not like. The general paradigm in
classic finance is risk: Risk is something you don't
like, and less risk is something you like. So, liking
or disliking something has to do with how
it's going to be priced. That was the key to the
whole perspective here.

Once we're looking more generally at how
things are going to be priced, we don't have

to stick with the idea of liquidity or risk. We can
have many other variables, and they don't
even have to be classical. They could be behavioral,
as well.
Idzorek: After "Dimensions of Popularity,"
I wanted to write more of an academic article
rather than something for practitioners.
That led me to do a relatively extensive literature
review. As I was rereading "A New Equilibrium
Theory," I was astonished to read that many
of the ideas that I had written out had been almost
identically expressed, only decades earlier.
Rekenthaler: You invented something that others
had already invented. I've been there and done that
myself, Tom.

Idzorek: As I was working on this with James and
Roger, struggling to make it an academicoriented paper, Roger and I were invited to submit
a paper to the Journal of Investing for one
of their anniversary editions. We ended up using
some of the work for that article.5 Meanwhile,
Paul wrote a formal theory for the popularity asset
pricing model and called it the PAPM.
Paul Kaplan: I was first exposed to the
"New Equilibrium Theory" paper by Larry Siegel
himself back when I worked at Ibbotson
Associates, the firm that Roger had started back
in the 1970s. Larry is the director of research
for the CFA Institute Research Foundation, and he
is the author of the foreword of our new
book. As he relates in the foreword, one of the
criticisms of the new equilibrium theory
was that it was neither new nor equilibrium nor
a theory.

Paul Kaplan, director of research for
Morningstar Canada.

James Xiong, head of scientific investment
management research for Morningstar
Investment Management.

1 Ibbotson, R.G., Diermeier, J.J., & Siegel, L. 1984. "The
Demand for Capital Market Returns: A New Equilibrium
Theory." Financial Analysts Journal, Vol. 40, No. 1,
PP. 22-33.
2 Ibbotson, R.G., Idzorek, T.M., & Xiong, J.X. 2012.
"The Liquidity Style of Mutual Funds." Financial Analysts
Journal, Vol. 68, No. 6, PP. 38-53.
3 Ibbotson, R.G., Chen, Z., Kim, D. Y.-J., & Hu, W.Y.
2013. "Liquidity as an Investment Style." Financial Analysts
Journal, Vol. 69, No. 3, PP. 30-44.
4 Ibbotson, R.G. & Idzorek, T.M. 2014. "Dimensions of
Popularity." Journal of Portfolio Management, Vol. 40, No. 5,
PP. 68-74.
5 Idzorek, T.M. & Ibbotson, R.G. 2017. "Popularity and Asset
Pricing." The Journal of Investing, Vol. 26, No. 1, PP. 46-56.

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