Professor Patrick Augustin will present the paper “Reaching for Yield in Decentralized Financial Markets”.
Among the ecosystem of decentralized financial services, yield farming is a complex investment strategy with hidden downside risks providing opportunities for passively earning income. We characterize the risk and return characteristics of yield farming and show that yield farms dynamically compete for liquidity by offering high yields that are advertised as salient headline rates. Levering the full history of transactions available through blockchain data, we show that investors chase farms with high yields and that those farms with the highest headline rates record the most negative risk-adjusted returns. That underperformance
is amplified by small investment stakes and investor mistakes. Overall, our evidence is consistent with salience theory that may underpin reaching for yield behavior. We exploit heterogeneity in shocks to the information set of yield farmers to show that improved information disclosure and reduction in product complexity reduces yield chasing and improves investor performance. Since yield farming is easily accessible to retail investors, our analysis has important implications for the regulation of decentralized finance.