Frontenac Foyer and Macdonald Foyer Wednesday, June 28, 2017, 10:00 am – 10:30 am
The Western Finance Association gratefully acknowledges the sponsors of our 2017 conference, receptions, lunches, coffee breaks, best paper awards, and Phd student awards.
Vincent Bogousslavsky, École Polytechnique Fédérale de Lausanne Pierre Collin-Dufresne, Swiss Finance Institute Mehmet Saglam, University of Cincinnati
Discussants:
Christopher Hrdlicka, University of Washington Richard Thakor, University of Minnesota Shomesh Chaudhuri, Massachusetts Institute of Technology
Financial Crisis and Monetary Policy –
Frontenac C Monday, June 26, 2017, 8:15 am – 10:00 am
Annette Vissing-Jorgensen, University of California-Berkeley
Viral Acharya, New York University Tim Eisert, Erasmus University Christian Eufinger, University of Navarra Christian Hirsch, Goethe University Frankfurt
Anusha Chari, University of North Carolina-Chapel Hill Karlye Dilts Stedman, University of North Carolina Christian Lundblad, University of North Carolina-Chapel Hill
Discussants:
Manuel Adelino, Duke University Matteo Crosignani, Federal Reserve Board of Governors Winston Dou, University of Pennsylvania
Household Finance and Credit –
Empress A&B Monday, June 26, 2017, 8:15 am – 10:00 am
Jialan Wang, University of Illinois-Urbana-Champaign
Nicole Branger, University of Muenster Patrick Konermann, BI Norwegian Business School Christoph Meinerding, Deutsche Bundesbank Christian Schlag, Goethe University Frankfurt
Hengjie Ai, University of Minnesota Anmol Bhandari, University of Minnesota
Discussants:
Stavros Panageas, University of California-Los Angeles Bernard Herskovic, University of California-Los Angeles Barney Hartman-Glaser, University of California-Los Angeles
Journal of Financial and Quantitative Analysis Coffee Break –
Frontenac Foyer and Macdonald Foyer Monday, June 26, 2017, 10:00 am – 10:30 am
TBA
Discussants:
Housing and Mortgage Markets –
Frontenac A Monday, June 26, 2017, 10:30 am – 12:15 pm
Shuo Cao, Shenzhen Stock Exchange Richard Crump, Federal Reserve Bank of New York Stefano Eusepi, Federal Reserve Bank of New York Emanuel Moench, Deutsche Bundesbank
Discussants:
Francisco Palomino, Federal Reserve Board of Governors Tetiana Davydiuk, University of Pennsylvania Michael Gallmeyer, University of Virginia
Asset Pricing Models with Frictions –
Empress A&B Monday, June 26, 2017, 10:30 am – 12:15 pm
John Bizjak, Texas Christian University Swami Kalpathy, Texas Christian University Zhichuan Li, University of Western Ontario Brian Young, Southern Methodist University
Ian Gow, Harvard University Steve Kaplan, University of Chicago David Larcker, Stanford University Anastasia Zakolyukina, University of Chicago
Discussants:
Dirk Jenter, London School of Economics and Political Science Gustavo Manso, University of California-Berkeley Daniel Metzger, Stockholm School of Economics
Jean Noel Barrot, Massachusetts Institute of Technology Erik Loualiche, Massachusetts Institute of Technology Matthew Plosser, Federal Reserve Bank of New York Julien Sauvagnat, Università Bocconi
Rodney Ramcharan, University of Southern California Amir Kermani, University of California-Berkeley Marco Di Maggio, Harvard University Edison Yu, Federal Reserve Bank of Philadelphia
Lorenzo Bretscher, London School of Economics and Political Science Alex Hsu, Georgia Institute of Technology Andrea Tamoni, London School of Economics and Political Science
Hendrik Bessembinder, Arizona State University Stacey Jacobsen, Southern Methodist University William Maxwell, Southern Methodist University Kumar Venkataraman, Southern Methodist University
Discussants:
Joel Hasbrouck, New York University Charles Jones, Columbia University Erik Sirri, Babson College
WFA Executive Committee and Board of Directors Meeting (Invitation Only) –
Beausejour Monday, June 26, 2017, 5:00 pm – 7:00 pm
Charlotte Ostergaard, BI Norwegian Business School Mike Burkart, London School of Economics and Political Science Salvatore Miglietta, BI Norwegian Business School
Discussants:
Nadya Malenko, Boston College Daniel Bergstresser, Brandeis University Peter Koudijs, Stanford University
Market Microstructure Theory –
Frontenac B Tuesday, June 27, 2017, 8:15 am – 10:00 am
Bradyn Breon-Drish, University of California-San Diego
Hui Chen, Massachusetts Institute of Technology Anton Petukhov, Massachusetts Institute of Technology Jiang Wang, Massachusetts Institute of Technology
Thomas Eisenbach, Federal Reserve Bank of New York David Lucca, Federal Reserve Bank of New York Robert Townsend, Massachusetts Institute of Technology
Mariassunta Giannetti, Stockholm School of Economics Farzad Saidi, Stockholm School of Economics
Discussants:
Christoph Herpfer, École Polytechnique Fédérale de Lausanne Hoai-Luu Nguyen, University of California-Berkeley Rustom Irani, University of Illinois-Urbana-Champaign
WFA Annual Luncheon Sponsored by Navigant Economics –
Marco Di Maggio, Harvard University Francesco Franzoni, Swiss Finance Institute Amir Kermani, University of California-Berkeley Carlo Sommavilla, Università della Svizzera Italiana
Discussants:
Artem Neklyudov, University of Lausanne Joel Hasbrouck, New York University Burton Hollifield, Carnegie Mellon University
Mariano Croce, University of North Carolina-Chapel Hill Thien Nguyen, Ohio State University Steve Raymond, University of North Carolina-Chapel Hill Lukas Schmid, Duke University
Andres Donangelo, University of Texas-Austin Francois Gourio, Federal Reserve Bank of Chicago Matthias Kehrig, Duke University Miguel Palacios, Vanderbilt University
Discussants:
Indrajit Mitra, University of Michigan Stephen Terry, Boston University Jack Favilukis, University of British Columbia
Household Financial Decisions –
Frontenac B Wednesday, June 28, 2017, 8:15 am – 10:00 am
Bruce Carlin, University of California-Los Angeles
Shai Bernstein, Stanford University Emanuele Colonnelli, Stanford University Xavier Giroud, Massachusetts Institute of Technology Benjamin Iverson, Northwestern University
Discussants:
Jarrad Harford, University of Washington Andras Danis, Georgia Institute of Technology Katherine Waldock, New York University
Real Effects of Corporate Finance –
Macdonald E Wednesday, June 28, 2017, 8:15 am – 10:00 am
Wenting Ma, University of North Carolina-Chapel Hill Paige Ouimet, University of North Carolina-Chapel Hill Elena Simintzi, University of British Columbia
Yang Liu, University of Pennsylvania Riccardo Colacito, University of North Carolina-Chapel Hill Mariano Croce, University of North Carolina-Chapel Hill Ivan Shaliastovich, University of Wisconsin-Madison
Discussants:
Jules Van Binsbergen, University of Pennsylvania Carolin Pflueger, University of British Columbia David Schreindorfer, Arizona State University
Does Private Equity Add Value? –
Empress A&B Wednesday, June 28, 2017, 10:30 am – 12:15 pm
Sophie Moinas, University of Toulouse Minh Nguyen, Newcastle University Business School Giorgio Valente, Hong Kong Institute for Monetary Research
Abstract:
Theoretical studies show that shocks to funding constraints should affect and be affected by market illiquidity. However, little is known about the empirical magnitude of such responses because of the intrinsic endogeneity of illiquidity shocks. This paper adopts an identification technique based on the heteroskedasticity of illiquidity proxies to infer the reaction of one measure to shocks affecting the other. Using data for the European Treasury bond market, we find evidence that funding illiquidity shocks affect bond market illiquidity and of a weaker simultaneous feedback reverse. We also investigate the determinants of the magnitude of these effects in the cross-section of bonds and find that the responses of individual bonds market illiquidity to funding illiquidity shocks increase with bond duration, with the credit risk of the issuer, and with haircuts.
Kevin Pan, Harvard University Yao Zeng, University of Washington
Abstract:
A natural liquidity mismatch emerges when liquid exchange traded funds (ETFs) hold relatively illiquid assets. We provide a theory and empirical evidence showing that this liquidity mismatch can reduce market efficiency and increase the fragility of these ETFs. We focus on corporate bond ETFs and examine the role of authorized participants (APs) in ETF arbitrage. In addition to their role as dealers in the underlying bond market, APs also play a unique role in arbitrage between the bond and ETF markets since they are the only market participants that can trade directly with ETF issuers. Using novel and granular AP-level data, we identify a conflict between APs dual roles as bond dealers and as ETF arbitrageurs. When this conflict is small, liquidity mismatch reduces the arbitrage capacity of ETFs; as the conflict increases, an inventory management motive arises that may even distort ETF arbitrage, leading to large relative mispricing. These findings suggest an important risk in ETF arbitrage.
Ayan Bhattacharya, Baruch College Maureen O'Hara, Cornell University
Abstract:
We show how inter-market information linkages in ETFs can lead to market instability and herding. When underlying assets are hard-to-trade, informed trading may take place in the ETF. Underlying market makers, then, have an incentive to learn from ETF price when setting prices in their respective markets. We demonstrate that this learning is imperfect: market makers pick up information unrelated to asset value along with pertinent information. This leads to propagation of shocks unrelated to fundamentals and causes market instability. Further, if market makers cannot instantaneously synchronize their prices, inter-market learning can lead to herding, where speculators across markets trade in the same direction using similar signals, unhinged from fundamentals.
Sohnke Bartram, University of Warwick Mark Grinblatt, University of California-Los Angeles
Abstract:
To assess stock market informational efficiency with minimal data snooping, we take the view of a statistician with little knowledge of finance. The statistician uses techniques like least squares to estimate peer-implied fair values from the market values of replicating portfolios with the same accounting statements as the company being valued. Divergence of a companys peer-implied value estimate from its market value represents mispricing, motivating a convergence trade that earns risk-adjusted returns of up to 10% per year and is economically significant for both large and small cap firms. The rate of convergence decays to zero over the subsequent 34 months.
Evgeny Lyandres, Boston University Egor Matveyev, University of Alberta Alexei Zhdanov, Pennsylvania State University
Abstract:
We study whether investment options are fairly priced by market participants. For this purpose, we build and estimate a real options model of optimal investment in the presence of demand uncertainty. We then classify stocks into undervalued and overvalued based on the difference between observed and model-implied firm values. A long-short strategy that buys stocks classified as the most undervalued by the model and shorts the most overvalued stocks generates annualized alphas from major asset pricing models that range between 10% and 17% for value-weighted portfolios. This relation between estimated misvaluation and future returns is only present within subsamples of firms with relatively high fractions of investment options to existing assets. We interpret these findings as evidence of investors having difficulties in valuing investment options, leading to mispricing in equity markets that is gradually corrected over time.
Vincent Bogousslavsky, École Polytechnique Fédérale de Lausanne Pierre Collin-Dufresne, Swiss Finance Institute Mehmet Saglam, University of Cincinnati
Abstract:
We investigate the impact of an exogenous trading glitch at a high-frequency market-makingfirm on standard measures of stock liquidity (effective and realized spreads) as well as on institutionaltrading costs (Implementation Shortfall and VWAP slippage) obtained from a proprietarydata set. We find that stocks in which the firm accumulated large positions as a result of thetrading glitch become substantially more illiquid on the day of the glitch. Effective spreadsrevert very quickly suggesting that market liquidity is resilient. Instead, institutional tradingcosts remain significantly higher for more than one week. We further document that all stocksfor which the firm was a designated market maker become more illiquid, even if they were notheavily traded during the glitch, in the two days prior to being reassigned to another marketmaker. These findings are broadly consistent with slow-moving capital theories and suggestthat high-frequency trading flash crashes may be associated with significant costs that aredifficult to detect using standard liquidity measures.
Discussant:
Shomesh Chaudhuri, Massachusetts Institute of Technology
I use a fuzzy regression discontinuity design to study the impact of auction-based emergency liquidity at the onset of the 2007-09 crisis. My empirical design uses the presence of binding capacity constraints in the Federal Reserves Term Auction Facility to isolate variation in short-term borrowing through this program. I find that the growth in marginal winners outstanding loan commitments is about 15% higher than marginal losers. This effect stems through more lending: marginal winners loan growth was about 8% higher than that of marginal losers. These effects arise despite the ability to replicate this auction-based liquiditys funding structure through the discount window. They highlight that banks would have relied considerably less on the Federal Reserve had only the discount window been in place during the crisis. I discuss the role of discount window stigma in partly explaining these results.
Viral Acharya, New York University Tim Eisert, Erasmus University Christian Eufinger, University of Navarra Christian Hirsch, Goethe University Frankfurt
Abstract:
Launched in Summer 2012, the European Central Bank (ECB)'s Outright Monetary Transactions (OMT) program indirectly recapitalized European banks through its positive impact on periphery sovereign bonds. However, the stability reestablished in the banking sector did not fully translate into economic growth. We document zombie lending by banks that remained undercapitalized even post-OMT. In turn, firms receiving loans used these funds not to undertake real economic activity such as employment and investment but to build up cash reserves. Creditworthy firms in industries with a high zombie firm prevalence suffered significantly from this credit misallocation, which further slowed down the economic recovery.
Discussant:
Matteo Crosignani, Federal Reserve Board of Governors
Anusha Chari, University of North Carolina-Chapel Hill Karlye Dilts Stedman, University of North Carolina Christian Lundblad, University of North Carolina-Chapel Hill
Abstract:
This paper examines the implications of unconventional monetary policy (UMP) and its continued unwinding for emerging market capital flows and asset prices with an emphasis on quantifying the magnitude of these effects. We combine U.S. Treasury data on emerging market flows and prices with Fed Funds Futures data to estimate the surprise component of Fed announcements. Results from a commonly employed affine term structure model indicate that monetary policy shocks represent, in small part, revisions in market participants expectations about the path of short term interest rates and, even more significantly, changes in their required risk compensation. The importance of revisions in risk compensation is true despite the fact that these shocks are extracted from relatively short-maturity futures contracts. While this interpretation characterizes the conventional (pre-crisis) period, the risk compensation effects are even more pronounced in the later unconventional monetary policy period. Controlling for a range of pull and push factors, panel regression results then suggest that the global impact of alternative monetary surprise measures varies significantly across the pre-crisis, Quantitative Easing (QE) and policy tapering periods. In particular, the effect of monetary policy shocks on global asset values is larger than that for physical capital flows. Relative to debt, emerging market equity positions and valuations are more sensitive to monetary policy shocks during the QE and normalization periods. There is an order-of-magnitude difference between the QE and the tapering periods for the effects of monetary policy on all types of emerging-market portfolio flows. Finally, the primary advantage of extracting the monetary surprise magnitude is that we can directly estimate a dollar amount in terms of U.S. investor position and flow changes to emerging markets. The quantification exercise suggests that the impact of U.S. monetary policy on emerging market capital flows depends critically on the size, sign and dispersion of the policy surprises.
Claire Celerier, University of Toronto Adrien Matray, HEC Paris
Abstract:
An exogenous increase in the density of bank branches reduces the share of unbanked households among low-income households. This finding is established using US interstate branching deregulation between 1994 and 2010 as an exogenous shock to the entry of new branches in poor counties. We exploit household level data, and show that the effect is stronger for populations that are more likely to be rationed by banks, such as black households living in ''high racially-bias" states, or for households living in rural areas where branch density is initially low. We then use deregulation to instrument the likelihood of holding a bank account and subsequently explore the effect on wealth accumulation. Holding a bank account helps poor household to accumulate wealth.
Discussant:
Hoai-Luu Nguyen, University of California-Berkeley
Ian Appel, Boston College Jordan Nickerson, Boston College
Abstract:
This paper studies the long-term effects of redlining policies that restricted access to credit in urban communities. For empirical identification, we use a regression discontinuity design that exploits boundaries from maps created by the Home Owners Loan Corporation (HOLC) in 1940. We find that ``redlined" neighborhoods have 4.8\% lower home prices in 1990 relative to adjacent areas. This finding is robust to the exclusion of boundaries that coincide with the physical features of cities (e.g., rivers, landmarks). Moreover, we show that housing characteristics varied smoothly at the boundaries when the maps were created. Evidence suggests lower property values may be driven by negative externalities associated with fewer owner-occupied homes and more vacant structures. Overall, our results indicate the effects of discriminatory credit rationing can persist decades after such practices are formally discontinued.
Bronson Argyle, Brigham Young University Taylor Nadauld, Brigham Young University Christopher Palmer, University of California-Berkeley
Abstract:
We document significant price dispersion in the market for car loans, provide direct evidence that it persists in part because of search frictions, and document how search frictions in credit markets impact consumption. Using rich microdata from millions of auto loan applications and originations by hundreds of financial providers, we isolate plausibly exogenous variation in interest rates due to institution-specific rule-of-thumb pricing rules. These discontinuities lead to substantial variation in the benefits of search, which we find directly affect physical search behavior and distort extensive- and intensive-margin loan and car choices by effectively constraining credit access. We further show that these discontinuities are more consequential in areas we measure as having high search costs. Overall, our results provide evidence of the real effects of the costliness of shopping around for credit, the continued importance of proximate bank branches, and the inhibition of monetary policy transmission to durable good purchases.
Plan sponsors rely on investment consultants' recommendations for hiring money managers to manage their plan funds. Often these investment consultants have their own investment management firms, or have business connections with investment managers, creating a conflict of interest. I find strong evidence that consultants bias hiring decisions towards their connected managers: a direct connection to a consultant increases a manager's odds of being hired by 637%, while an indirect connection increases the odds by 301%. The hiring decisions are less sensitive to past performance and management fee when connected managers are hired. I further find that, post hiring, the funds managed by the connected managers underperform significantly relative to the funds managed by the unconnected managers.
Mark Egan, Harvard University Gregor Matvos, University of Chicago Amit Seru, Stanford University
Abstract:
We construct a novel database containing the universe of financial advisers in the United States from 2005 to 2015, representing approximately 10% of employment of the finance and insurance sector. Roughly 7% of advisers have misconduct records. At some of the largest financial advisory firms in the United States, more than 15% of advisers have misconduct records. Prior offenders are five times as likely to engage in new misconduct as the average financial adviser. Firms discipline misconduct: approximately half of financial advisers lose their job after misconduct. The labor market partially undoes firm-level discipline: of these advisers, 44% are reemployed in the financial services industry within a year. Reemployment is not costless. Following misconduct, advisers face longer unemployment spells, and move to less reputable firms, with a 10% reduction in compensation. Additionally, firms that hire these advisers also have higher rates of prior misconduct themselves. We find similar results for advisers of dissolved firms, in which all advisers are forced to find new employment, independent of past misconduct or performance. Firms that persistently engage in misconduct coexist with firms that have clean records. We show that differences in consumer sophistication may be partially responsible for this phenomenon: misconduct is concentrated in firms with retail customers and in counties with low education, elderly populations, and high incomes. Our findings are consistent with some firms specializing in misconduct and catering to unsophisticated consumers, while others using their clean reputation to attract sophisticated consumers.
Discussant:
Christopher Parsons, University of California-San Diego
Andrey Malenko, Massachusetts Institute of Technology Anton Tsoy, Einaudi Institute for Economics and Finance
Abstract:
In many cases, buyers are not fully informed about their valuations and rely on the advice of biased experts. For example, the board of the bidder relies on the advice of managers when bidding for a target in a takeover contest. We study the design of sale mechanisms to such "advised buyers". In static mechanisms, such as first- and second-price auctions, advisors communicate a coarsening of information, and therevenue equivalence theorem holds. In contrast, in dynamic mechanisms, advisors can communicate information gradually as the auction proceeds, which leads to more efficient allocations. Whether this leads to higher revenues depends on the bias. If advisors are biased for overbidding, an ascending-price auction dominates static formats in both efficiency and expected revenues. If advisors are biased for underbidding, adescending-price auction dominates static mechanisms in efficiency but often results in lower revenues.
James Dow, London Business School Philip Bond, University of Washington
Abstract:
We analyze the allocation of trading talent across di¤erent types of assets, taking intoaccount equilibrium considerations in both labor and financial markets. We identify a strongeconomic force that leads the highest-skill traders to focus on trading "common event" assetsthat pay o¤ frequently. Less talented traders instead trade "rare event"assets that pay o¤only rarely, so that short positions pay o¤ with high probability, i.e., "nickels in front of asteamroller" strategies. This allocation of talent across assets reduces the ability of financialmarkets to predict rare events.
Discussant:
Stavros Panageas, University of California-Los Angeles
Nicole Branger, University of Muenster Patrick Konermann, BI Norwegian Business School Christoph Meinerding, Deutsche Bundesbank Christian Schlag, Goethe University Frankfurt
Abstract:
We analyze the implications of network structures for equilibrium asset prices, where networks are represented via mutually exciting jump processes for dividends. Our approach provides a flexible and tractable framework for asset pricing when the direction of shock propagation is relevant. We document that this directedness matters, e.g., for return volatilities, and taking it into account can lead to a substantially different interpretation of empirical findings, e.g., concerning a flight-to-quality effect. The model generates the positive centrality premium documented empirically in Ahern (2013), and we show that this premium is distinctly different from a standard CAPM-like premium for market risk.
Discussant:
Bernard Herskovic, University of California-Los Angeles
Hengjie Ai, University of Minnesota Anmol Bhandari, University of Minnesota
Abstract:
This paper studies asset pricing implications of idiosyncratic risks in labor productivities in a setting where markets are endogenously incomplete. Well-diversified owners of firms provide insurance to workers using long-term compensation contracts but cannot commit to ventures that yield a negative net present value of dividends. We show that under the optimal contract, workers are uninsured against tail risks in idiosyncratic productivities. Limited commitment makes risk premia higher due to a more volatile stochastic discount factor and a higher exposure of firms' cash-flow to aggregate shocks. Besidessalient features of equity and bond markets, the model is consistent with other empirical facts such as the cyclicality of factor shares and limited stock market participation.
Discussant:
Barney Hartman-Glaser, University of California-Los Angeles
Tomasz Piskorski, Columbia University Alexei Tchistyi, University of Illinois-Urbana-Champaign
Abstract:
We develop a tractable general equilibrium framework of housing and mortgage markets with aggregate and idiosyncratic risks, costly liquidity and strategic defaults, empirically relevant informational asymmetries, and endogenous mortgage design. We show that adverse selection plays an important role in shaping the form of an equilibrium contract. If borrowers? homeownership values are known, aggregate wages and house prices determine the optimal state-contingent mortgage payments, which efficiently reduces the costs of liquidity default. However, when lenders are uncertain about homeownership values, the equilibrium contract only depends on house prices and takes the form of a home equity insurance mortgage (HEIM) that eliminates the strategic default option and insures the borrower?s equity position. Interestingly, we show that widespread adoption of such loans has ambiguous e¤ects on the homeownership rateand household welfare. In economies in which recessions are expected to be severe, the HEIM equilibrium Pareto dominates the equilibrium with ?xed-rate mortgages. However, if economic downturns are not severe, HEIMs can lower the homeownership rate and make some marginal home buyers worse-o¤. We also note that adjustable-rate mortgages (ARMs) may share some benefits with HEIMs, which may help explain ARM popularity among riskier borrowers.
Anthony DeFusco, Northwestern University Stephanie Johnson, Northwestern University John Mondragon, Northwestern University
Abstract:
This paper studies how credit markets respond to policy constraints on household leverage. Using a research design that exploits a sharp policy-induced discontinuity in the cost of originating certain high-leverage mortgages, we study how the Dodd-Frank Ability-to-Repay rule affected the price and availability of credit in the U.S. mortgage market. Our estimates show that the policy had only moderate effects on prices, increasing interest rates on affected loans by roughly 1015 basis points. The effect on quantities, however, was significantly larger; we estimate that the policy eliminated 15 percent of the affected market completely and reduced leverage for another 20 percent of the remaining borrowers. This reduction in quantities is much greater than what would be implied by plausible demand elasticities and suggests that lenders responded to the policy primarily by rationing credit. Finally, while the policy succeeded in reducing leverage, our estimates suggest that this effect would have only slightly reduced the aggregate default rate during the housing crisis. Taken together, our results caution that policies seeking to constrain household leverage must be carefully targeted, as they can have large quantity effects even in cases where their market-priced costs are relatively small and their effectiveness in improving loan performance is limited.
Discussant:
Barney Hartman-Glaser, University of California-Los Angeles
I show that rules designed to prevent unaffordable mortgage lendingrestrict self-employed households' access to credit and reduce entrepreneurship. I use eligibility criteria for exemptions from the Ability-to-Repay rule -- a key part of the U.S. policy response to the subprime mortgage crisis -- to take a difference-in-differences approach. Comparing exempt and non-exempt bank lending behavior I find that the rule reduced access to mortgage credit in high self-employment census tracts. I then use geographic variation in access to banks receiving an exemption to identify broader economic effects. Growth in self-employment was lower in areas where exempt banks had a smaller market share. Locations farther from exempt branches experienced a relative reduction in new small business employment as a percentage of total employment.
Ian Martin, London School of Economics and Political Science Christian Wagner, Copenhagen Business School
Abstract:
We derive a formula that expresses the expected return on a stock in terms of the risk-neutral variance of the market and the stock's excess risk-neutral variance relative to the average stock. These components can be computed from index and stock option prices; the formula has no free parameters. We test the theory in-sample by running panel regressions of stock returns onto risk-neutral variances. The formula performs well at 6-month and 1-year forecasting horizons, and our predictors drive out beta, size, book-to-market, and momentum. Out-of-sample, we find that the formula outperforms a range of competitors in forecasting individual stock returns. Our results suggest that there is considerably more variation in expected returns, both over time and across stocks, than has previously been acknowledged.
Discussant:
Binying Liu, Hong Kong University of Science & Technology
Shomesh Chaudhuri, Massachusetts Institute of Technology Andrew Lo, Massachusetts Institute of Technology
Abstract:
Economic shocks can have diverse effects on financial market dynamics at different time horizons, yet traditional portfolio management tools do not distinguish between short- and long-term components in alpha, beta, and covariance estimators. In this paper, we apply spectral analysis techniques to quantify stock-return dynamics across multiple time horizons. Using the Fourier transform, we decompose asset-return variances, correlations, alphas, and betas into distinct frequency components. These decompositions allow us to identify the relative importance of specific time horizons in determining each of these quantities, as well as to construct mean-variance-frequency optimal portfolios. Our approach can be applied to any portfolio, and is particularly useful for comparing the forecast power of multiple investment strategies. We provide several numerical and empirical examples to illustrate the practical relevance of these techniques.
Jiangmin Xu, Peking University Harrison Hong, Columbia University Ioannis Branikas, Princeton University
Abstract:
Households hold under-diversified stock portfolios concentrated in firms headquartered near the city where they reside. Theories for this local-bias puzzle assign a causal role for proximity, be it generating an informational advantage or a familiarity bias. These explanations assume that households locate randomly. But in location choice models, a household optimally selects a city depending on many factors. This selection is important since latent location factors might be correlated with latent demand for local stocks. We develop a Heckman (1977)-style model to account for the effect of location choices on portfolio choices. Adjusting for this selection effect drastically reduces the impact of distance on household portfolios and the performance of local stock picks. We point to the importance of accounting for location choices on portfolio choices more generally.
Nina Boyarchenko, Federal Reserve Bank of New York Valentin Haddad, Princeton University Matthew Plosser, Federal Reserve Bank of New York
Abstract:
We discover a novel monetary policy shock that has a widespread impact on aggregate financial conditions. Our shock can be summarized by the response of long-horizon yields to FOMC announcements; not only is it orthogonal to changes in the near-term path of policy rates, but it also explains more than half of the abnormal variation in the yield curve on announcement days. We find that our long-rate shock is positively related to changes in real interest rates and market volatility, and negatively related to market returns and mortgage demand, consistent with policy announcements affecting market condence. Our results demonstrate that Federal Reserve pronouncements influence markets independent of changes in the stance of conventional monetary policy.
Discussant:
Francisco Palomino, Federal Reserve Board of Governors
This paper documents a new channel of monetary policy transmission through the shadow banking system. Analyzing U.S. money supply data from 1987 to 2012, I find that shadow bank deposits expand significantly when the Federal Reserve tightens monetary policy. This channel partially offsets the reduction of commercial bank deposits and dampens the impact of monetary tightening. I construct a structural model of bank competition and show that this new channel is a result of deposit competition between commercial and shadow banks in a market with heterogeneous depositors. Facing more yield-sensitive clientele, shadow banks pass through more rate hikes to depositors during periods of monetary tightening, thereby poaching deposits from commercial banks. Fitting my model to institution-level data from both commercial banks and money market funds, I show that the shadow bank channel reduces the impact of monetary policy on money supply by 40 percent. My results suggest a cautious stance towards the use of monetary tightening as a tool for promoting financial stability, because monetary tightening may unintentionally drive more deposits into the uninsured shadow banking sector, thereby amplifying the risk of bank runs.
Shuo Cao, Shenzhen Stock Exchange Richard Crump, Federal Reserve Bank of New York Stefano Eusepi, Federal Reserve Bank of New York Emanuel Moench, Deutsche Bundesbank
Abstract:
Forecasters disagree about the future path of monetary policy, particularly in the long-run. We propose an affine term structure model in which investors hold heterogeneous beliefs about the long-run level of rates. As they trade government bonds at equilibrium prices, they implicitly disagree about their risk-return tradeoff and engage in speculative trading. Our model fits U.S. Treasury yields and the short rate paths predicted by different groups of professional forecasters very well. We show that 1) a perceived slow-moving drift in the long-run level of the short rate is important in generating long-run disagreement about the policy rate; 2) almost half of the variation in term premiums is driven by disagreement about the policy rate; 3) disagreement affects term premiums through investors' heterogeneous responses to asymmetric signals as well as through endogenous wealth fluctuations.
Alexandre Corhay, University of Toronto Howard Kung, London Business School Lukas Schmid, Duke University
Abstract:
Imperfect competition is an important channel for time-varying risk premia in asset markets. We build a general equilibrium model with monopolistic competition and endogenous firm entry and exit. Endogenous variation in industry concentration generates countercyclical markups, which amplifies macroeconomic risk. The nonlinear relation between the measure of firms and markups endogenously generates countercyclical macroeconomic volatility. With recursive preferences, the volatility dynamics lead to countercyclical risk premia forecastable with measures of competition. Also, the model produces a U-shaped term structure of equity returns.
Nicolae Garleanu, University of California-Berkeley Stavros Panageas, University of California-Los Angeles
Abstract:
We construct equilibria of continuous-time overlapping-generations economies with imperfect risk sharing that can jointly account for volatile asset prices and high risk premiums in an economy with deterministic aggregate growth and non-volatile changes in cross-sectional consumption and wealth inequality. To emphasize the ability of the model to account for arbitrary asset-price volatility, we build our desired equilibrium by exploiting the existence of multiple self-fulfilling equilibria. We also provide an observationally equivalent version of the model with a unique equilibrium and appropriately constructed real shocks.
Mara Faccio, Purdue University William O'Brien, University of Illinois-Chicago
Abstract:
Using a newly assembled 50 country firm-level database spanning 19 years, we document that business group affiliated firms display less pronounced fluctuations in employment than unaffiliated firms in response to economic shocks. Consistent with cost-reducing internal labor markets, results are concentrated in single-country (rather than cross-country) groups. Within groups, employment declines in poorly performing firms and increases in better performing firms, suggesting efficient labor dynamics. We find no evidence that internal capital markets, agency problems, or a different performance sensitivity to economic shocks in groups are responsible for these results. Altogether, we highlight a new bright side of business groups.
Ian Appel, Boston College Joan Farre-Mensa, Harvard University Elena Simintzi, University of British Columbia
Abstract:
We analyze how frivolous patent-infringement claims made by non-practicing entities (NPEs, or patent trolls) affect small firms' ability to create jobs, raise capital, and survive. Our identification strategy exploits the passage of anti-troll laws in 31 US states. We find the passage of these laws leads to a 2% increase in employment at small high-tech firms an increase driven by IT firms, a frequent target of NPEs. By contrast, the laws have no significant impact on employment at larger or non-high-tech firms. Financing is a key channel driving our findings: In states with an established VC presence, anti-troll laws increase the number of firms receiving VC funding by 14%. Our findings suggest measures aimed at curbing the NPE litigation threat can help reduce both the real and financing frictions faced by small firms.
Yue Qiu, University of Minnesota Tracy Wang, University of Minnesota
Abstract:
Many U.S. publicly traded companies discuss potential failure in attracting and retaining skilled labor as a risk factor in their 10-K filings. In this study, we measure firms exposures to skilled labor risk by the intensity of such discussions in their 10-Ks. We find that this measure strongly and consistently correlates with various proxies for skilled labors outside options and mobility, while the existing related measures do not. We then examine the impact of skilled labor risk on firms compensation policy for key talents. Consistent with theories on optimal compensation design in the presence of mobile talents, we find that firms facing higher skilled labor risk use more incentive pay and longer pay duration. However, those firms do not offer higher total pay for key talents, suggesting that it is the pay structure rather than the pay level that plays a crucial role in attracting and retaining skilled labor.
John Bizjak, Texas Christian University Swami Kalpathy, Texas Christian University Zhichuan Li, University of Western Ontario Brian Young, Southern Methodist University
Abstract:
One of the most significant trends in executive compensation in the U.S. over the last decade is the use of explicit relative performance evaluation (RPE) awards. The peer group used to measure relative firm performance is vital in determining both the payout and efficacy of these awards. Since the board of directors along with corporate executives determine the selection of peers, we study whether there is any bias in peer selection and measure the economic magnitude of any potential bias. For firms that use a custom peer group, we find little evidence that peer firms are selected in a manner that increases award payouts. On the other hand, we do find evidence that firms select a broad market index as a peer group over a custom peer group to increase award value. Additional analysis indicates that the overlap between peers used for RPE and peers used for compensation benchmarking constrains a firm from biasing pay upwards. Contrary to prior evidence, we do not find any compensation benchmarking bias for firms that use RPE awards.
Discussant:
Dirk Jenter, London School of Economics and Political Science
Ivan Marinovic, Stanford University Felipe Varas, Duke University
Abstract:
This paper studiesoptimal CEO contracts when managers can manipulate their performance measure, sometimes at the expense of firm value. Optimal contracts defer compensation. The manager's incentives vest over time at an increasing rate and compensation becomes increasingly sensitive to short-term performance. This process generates an endogenous \textit{CEO horizon problem} whereby managers intensify performance manipulation in the final years in office. Contracts are designed to foster effort while minimizing the adverse effects of manipulation. We characterize the optimal mix of short and long-term compensation along the manager's tenure, the optimal vesting period of incentive pay, and the resulting dynamics of managerial short-termism over the CEO's tenure.
Ian Gow, Harvard University Steve Kaplan, University of Chicago David Larcker, Stanford University Anastasia Zakolyukina, University of Chicago
Abstract:
Based on two samples of high quality personality data for chief executive officers (CEOs), we use linguistic features extracted from conferences calls and statistical learning techniques to develop a measure of CEO personality in terms of the Big Five traits: agreeableness, conscientiousness, extraversion, neuroticism, and openness to experience. These personality measures have strong out-of-sample predictive performance and are stable over time. Our measures of the Big Five personality traits are associated with financing choices, investment choices and firm operating performance.
Economic recoveries can be slow, fast, or involve double dips. This paper provides an explanation based on the dynamic interactions between bank lending standards and firm entry selection. Recoveries are slower when high-quality borrowers postpone their investments, which occurs if the borrower pool has lower quality on average. Double dips can occur when banks endogenously produce information, which increases waiting benefits discontinuously. The model is consistent with both aggregate- and industry-level data.
Barney Hartman-Glaser, University of California-Los Angeles Hanno Lustig, Stanford University Mindy X. Zhang, University of Texas-Austin
Abstract:
Among U.S. publicly traded firms, the average firm's capital share has declined, even though the aggregate capital share has increased. We attribute the secular increase in the aggregate capital share among these firms to an increase in firm size inequality that is only partially mitigated by an increase in inter-firm labor compensation inequality. The largest firms in the right tail now account for a larger share of output, but the compensation of workers at these firms has not kept up. We develop a model in which firms optimally provide managers with insurance against firm-specific shocks. Consequently, larger, more productive firms return a larger share of rents to shareholders, while less productive firms endogenously exit. An increase in firm-level risk lowers the threshold at which firms exit and increases the measure of firms in the right tail of the size distribution. As a result, such an increase always increases the aggregate capital share in the economy, but may lower the average firm's capital share.
Viral Acharya, New York University Jun Qian, Shanghai Jiao Tong University Zhishu Yang, Tsinghua University
Abstract:
To support Chinas massive stimulus plan in response to the global financial crisis in 2008, large state-owned banks pumped huge volume of new loans into the economy and also grew more aggressive in the deposit markets. The extent of supporting the plan was different across the Big Four banks, creating a plausibly exogenous shock in the local deposit market to small and medium-sized banks (SMBs) facing differential competition from the 'Big Four' banks. We find that SMBs significantly increased shadow banking activities after 2008, most notably by issuing wealth management products (WMPs). The scale of issuance is greater for banks that are more constrained by on-balance sheet lending and face greater competition in the deposit market from local branches of the most rapidly expanding big bank. The WMPs impose a substantial rollover risk for issuers when they mature, as reflected by the yields on new products, the issuers' behavior in the inter-bank market, and the adverse effect on stock prices following a credit crunch. Overall, the swift rise of shadow banking in China seems to be triggered by the stimulus plan and has contributed to the greater fragility of the banking system.
This paper studies connections and information flows between activist hedge funds and other institutional investors and shows them as prominent factors in the success of activist campaigns. Using manager turnovers in connected mutual funds as exogenous shocks to activists connectivity, I identify a positive causal effect of connections with other investors on the short-run and long-run performance of activists campaigns and campaign characteristics. I also show that the two likely mechanisms through which activists benefit from their relationships with other institutions are information flows between institutional shareholders and well-connected activists before campaign announcements and higher support from other shareholders during the campaign. Overall, these results highlight that connections to other institutional investors benefit institutional asset managers.
Campbell Harvey, Duke University Yan Liu, Texas A&M University
Abstract:
Theoretical models imply fund size and performance should be negatively linked. However, empirical research has failed to uncover consistent support for this negative relation. Using a new econometric framework which includes fund-speci?c sensitivities to decreasing returns to scale, we ?nd a both economically and statistically signi?cant negative relation between fund size and performance. Exploiting fund heterogeneity to decreasing returns to scale, we show that investors direct ?ows to those funds with low sensitivity to decreasing returns to scale. Interestingly, investors appear to over-allocate capital to these low sensitivity funds leading to signi?cantly negative excess performance.
Francesco Franzoni, Swiss Finance Institute Mariassunta Giannetti, Stockholm School of Economics
Abstract:
This paper explores how affiliation to financial conglomerates relates to hedge funds funding and risk taking. We find that financial-conglomerate-affiliated hedge funds (FCAHFs) have more stable funding than other hedge funds. This may explain our finding that FCAHFs are able to take more risk and to purchase less liquid and more volatile stocks than other hedge funds during financial turmoil. In good times, instead, FCAHFs expand their assets less than other funds and are less exposed to systematic risk. Thus, FCAHFs perform a stabilizing function for the financial system, even though they do not generate higher returns for their investors.
Markus Brunnermeier, Princeton University Michael Sockin, University of Texas-Austin Wei Xiong, Princeton University
Abstract:
China's economic model involves active government intervention in financial markets. It relaxes/tightens market regulations and even directs asset trading with the objective to maintain market stability. We develop a theoretical framework that anchors government intervention on a mission to prevent market breakdown and the explosion of volatility caused by the reluctance of short-term investors to trade against noise traders when the risk of trading against them is sufficiently large. In the presence of realistic information frictions about unobservable asset fundamentals, our framework shows that the government can alter market dynamics by making noise in its intervention program an additional factor driving asset prices, and can divert investor attention toward acquiring information about this noise rather than fundamentals. Through this latter channel, the widely-adopted objective of government intervention to reduce asset price volatility may exacerbate, rather than improve, the information efficiency of asset prices.
Discussant:
Mariano Croce, University of North Carolina-Chapel Hill
Frederic Malherbe, London Business School Michael McMahon, University of Warwick
Abstract:
After financial crises, GDP is typically persistently weak compared to pre-crisis trends. We build a simple competitive general equilibrium model to highlight the role that the financial sector may have in boosting GDP to unsustainable, undesirable levels before financial crises. We show that the implicit subsidy from government guarantees to financial institutions boosts investment, which inflates GDP. However, using more appropriate consumption-based definitions, this mechanism decreases welfare. Allowing banks to freely trade in financial securities exacerbates the problem. Because loans generate collateral, banks are willing to make lending losses in equilibrium in order to generate trading profit. Our analysis suggests that economists that forecast growth on the basis of time-series trends could be deluded into thinking that the inefficient boost to GDP that derives from financial incentives is sustainable potential output capacity.
Yaron Leitner, Federal Reserve Bank of Philadelphia Bilge Yilmaz, University of Pennsylvania
Abstract:
We study a situation in which a regulator relies on models produced by banks in order to regulate them. A bank can generate more than one model and choose which models to reveal to the regulator. The regulator can find out the other models by monitoring the bank, but in equilibrium, monitoring induces the bank to produce less information. We show that a high level of monitoring is desirable when the bank's private gain from producing more information is either sufficiently high or sufficiently low (e.g., when the bank has very little or very large amount of debt). When public models are more precise, banks produce more information, but the regulator may end up monitoring more.
Jean Noel Barrot, Massachusetts Institute of Technology Erik Loualiche, Massachusetts Institute of Technology Matthew Plosser, Federal Reserve Bank of New York Julien Sauvagnat, Università Bocconi
Abstract:
We analyze the effect of import competition on household balance sheets from 2000 to 2007 using individual-level data on leverage and defaults. We exploit cross-regional variation in exposure to foreign import competition using industry level shipping costs and initial differences in regions' industry specialization. We confirm the adverse effect of import competition on local labor markets during this period (Autor et al., 2013). Wevthen show that household debt increased significantly in regions where manufacturing industries are more exposed to import competition. A one standard deviation increase in exposure to import competition explains 30% of the cross-regional variation in the growth in household leverage over the period. Our results highlight the interaction of credit supply and demand as a driver of increased mortgage borrowing in the run-up to the financial crisis.
Discussant:
Jialan Wang, University of Illinois-Urbana-Champaign
Rodney Ramcharan, University of Southern California Amir Kermani, University of California-Berkeley Marco Di Maggio, Harvard University Edison Yu, Federal Reserve Bank of Philadelphia
Abstract:
This paper investigates the impact of uncertainty on consumer credit outcomes. Individual-level data on credit-card balances and mortgages reveal strong borrower-specific heterogeneity in response to changes in an equity-based measure of county-level economic uncertainty. Low-risk borrowers reduce their credit-card balances and use of mortgage credit in response to increased localized uncertainty, while lenders expand the availability of credit to these borrowers. The opposite is obtained for high-risk borrowers. The economic magnitudes are especially large during the recent financial crisis. This evidence suggests that localized uncertainty about economic conditions might independently affect aggregate economic activity through consumer credit markets.
Severino Felipe, Dartmouth College Meta Brown, Federal Reserve Bank of New York
Abstract:
Increasing personal bankruptcy protection can increase credit demand while reducing borrowers access to credit. Using changes in bankruptcy protection across US states over time, we show that these laws increase borrowers holdings of unsecured credit, but not secured debt. We also find an increased interest rate for unsecured credit only. These effects are driven by home owners in lower-income areas. We find on average no measurable increase in delinquency rates of households in the subsequent three years. These results suggest that increased bankruptcy protections did not reduce the aggregate level of household debt, but affected the composition of borrowing.
Lorenzo Bretscher, London School of Economics and Political Science Alex Hsu, Georgia Institute of Technology Andrea Tamoni, London School of Economics and Political Science
Abstract:
We build and estimate a New-Keynesian model with heterogeneous agents to study the impact of level and volatility shocks to fiscal policy on the term structure of interest rates and bond risk premia. We derive three key insights from the estimated theoretical model. First, government spending level shocks generate positive covariance between marginal utility to consume and inflation, making nominal bonds poor hedges against consumption risk. Therefore, investors demand positive risk premium for holding inflation risk. Second, government spending volatility shocks generate negative inflation risk premium as inflation declines when the marginal utility to consume is high. Increased uncertainty in government spending causes savings to go down while investment to go up, which in turn lowers the marginal cost of production and inflation. Third, variability in the nominal term premium is driven by variation in the real term premium while inflation risk premium is remarkably stable over time. We find that fluctuation of the real term premium is entirely driven by government spending volatility shocks.
Jens Hilscher, University of California-Davis Alon Raviv, Bar-Ilan University Ricardo Reis, London School of Economics and Political Science
Abstract:
This paper proposes and implements a method to measure the impact of future inflation on the real value of outstanding public debt. Taking a present-value approach, we can produce a probability distribution for levels of inflationary debt debasement and construct inflation counterfactuals that are disciplined by data. Our analysis requires data on debt maturity, debt holders, and risk-adjusted inflation densities. Using data for the United States, we find that it is unlikely that inflation will lower the US fiscal burden significantly, and that the effect of higher inflation is modest for plausible counterfactuals. If instead inflation is combined with financial repression, the interaction of the two can substantially increase debt debasement.
Michael Fleming, Federal Reserve Bank of New York Giang Nguyen, Pennsylvania State University
Abstract:
This paper studies the workup protocol, a distinctive trading feature of the U.S.Treasury securities market that resembles a mechanism for discovering dark liquidity. We quantify its role in the price formation process and find that the dark order flow generally contains less information than its transparent counterpart. We also show that the workup protocol is used more often around volatile times, but that workup trades become less informative relative to transparent trades. Overall, the evidence suggests that the workup protocol provides a useful mechanism for liquidity trading and avoiding market volatility, rather than a channel to hide private information.
Hendrik Bessembinder, Arizona State University Stacey Jacobsen, Southern Methodist University William Maxwell, Southern Methodist University Kumar Venkataraman, Southern Methodist University
Abstract:
We study trading costs and dealer behavior in U.S. corporate bond markets from 2006 to 2016.Despite a temporary spike during the financial crisis, trade execution costs have not increasednotably over time. However, alternative measures, including dealer capital commitment overvarious time horizons, turnover, block trade frequency, and average trade size not only decreasedduring the financial crisis, but continued to decline afterward. These declines are attributable tobank-affiliated dealers, as non-bank dealers have increased their market commitment. Theevidence supports that liquidity provision in the corporate bond markets is evolving away fromthe traditional commitment of dealer capital to absorb customer imbalances and toward dealersplaying more of a matching role, and that post-crisis regulations focused on banking contributed.
Daniel Metzger, Stockholm School of Economics Laurent Bach, Stockholm School of Economics
Abstract:
We show that management holds extraordinary power over the voting process at U.S. corporations, allowing it to block improvements to corporate governance. Using a sample of shareholder proposals from 2003 to 2016, we uncover a large and discontinuous drop in the density of voting results at the 50% threshold. Counterfactual distributions reveal that 11% of closely-contested proposals that were eventually rejected by voters were defeated because management was able to alter the voting results very precisely. These findings imply that one cannot routinely use RDD to identify the causal effects of changes in corporate governance generated by shareholder votes.
Tara Bhandari, U.S. Securities and Exchange Commission Peter Iliev, Pennsylvania State University Jonathan Kalodimos, Oregon State University
Abstract:
A regulatory change permitting shareholder resolutions for proxy access generated a large wave of such proposals. Using a surprise SEC announcement to identify the substantial variation in the expected benefits of proxy access at different firms, we document that the extent to which the market reacts positively to a firm being targeted with a shareholder proposal for proxy access is strongly related to these expected benefits. However, we find that proponents are just as likely to target the firms that were not expected to benefit from proxy access as those that would benefit the most. We also find that management resists proposals more intensely at firms that stand to benefit more, and that coordination problems and conflicting shareholder interests confound the process of voting for the proposals. Hence, this primary channel for market-driven governance reform faces key limitations.
Charlotte Ostergaard, BI Norwegian Business School Mike Burkart, London School of Economics and Political Science Salvatore Miglietta, BI Norwegian Business School
Abstract:
We study how owners trade off costs and benefits ofestablishing a board in a historical setting, where boards are optional and authority over corporate decisions can freely be allocated across the general meeting, the board, and management.We find that large owners and boards are substitutes, and that boards existin firms most prone to have collective action problems.Boards monitor and advice management, mediate among shareholders, and these different roles entail different allocations of authority.Boards also arise to balance the need for small shareholder protection with the need to curb managerial discretion.
Kerry Back, Rice University Ruomeng Liu, Rice University Alberto Teguia, Rice University
Abstract:
Dealers who acquire inventory in one transaction usually seek to dispose of it in a second transaction. If the terms of the first transaction are disclosed, then dealers will engage in costly signaling, offering unduly favorable prices in the first transaction to signal asset quality to the second counterparty. Costly signaling lowers spreads and increases volume, market liquidity, and investor welfare. Aggregate welfare is higher in transparent markets, but dealers prefer opacity when potential gains from trade are large and/or adverse selection is low.
Hui Chen, Massachusetts Institute of Technology Anton Petukhov, Massachusetts Institute of Technology Jiang Wang, Massachusetts Institute of Technology
Abstract:
We build a dynamic model to examine the mechanism through which market-wide circuit breakers affect trading and price dynamics in the stock market. We show that the presence of downside circuit breakers tends to lower the price-dividend ratio, reduce daily price ranges, but increase conditional and realized volatilities. They also raise the probability of the stock price reaching the circuit breaker limit as the price approaches the threshold (a "magnet" effect). The effects of circuit breakers can be further amplified when some agents' willingness to hold the stock is sensitive to recent shocks to fundamentals, which can be due to behavioral biases, institutional constraints, etc. Surprisingly, the volatility amplification effect of circuit breakers is the strongest when the initial wealth share for the irrational agent is the smallest. Finally, using historical data from a period when circuit breakers have not been implemented can lead one to underestimate the likelihood of triggering a circuit breaker, especially when the threshold is relatively tight.
Discussant:
Daniel Andrei, University of California-Los Angeles
Vincent Glode, University of Pennsylvania Christian Opp, University of Pennsylvania Xingtan Zhang, University of Pennsylvania
Abstract:
We analyze optimal voluntary disclosure by a privately informed agent who faces a counterparty endowed with market power in a bilateral transaction. While disclosures reduce the agent's informational advantage, they may increase his information rents by mitigating the counterparty's incentives to resort to inefficient screening. We show that when disclosures are restricted to be ex post verifiable, the privately informed agent always finds it optimal to design a partial disclosure plan that implements socially efficient trade in equilibrium. Our results have important implications for understanding the conditions under which asymmetric information impedes trade and for regulating information disclosure.
Kandarp Srinivasan, Washington University-St. Louis
Abstract:
What caused the flood of securitized products in the years immediately preceding the crisis? This paper presents evidence that demand for safe collateral in repo markets made it attractive for financial institutions to issue securitized products. Using the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) as a natural experiment that shocked the demand for collateral in repo markets, this paper establishes collateralized borrowing in short-term debt markets as a contributing factor to the rise of mortgage securitization. Hand-collected data on over 900 repurchase contracts from S.E.C N-Q filings reveals underwriters of securitized products increased use of mortgage-based repos in the months following the law change. The evidence provides a direct test of liability-centric theories of banking that link the money creation function of financial intermediaries to the balance sheet holdings of liquid assets (Hanson et al. (2015)).
Will Cong, University of Chicago Jacopo Ponticelli, University of Chicago
Abstract:
We study the effects of credit supply shocks on credit allocation in economies with severe financial frictions. We find that, in the presence of such frictions, credit expansions can reverse the gradual reallocation of resources from low to high productivity firms. We test the empirical predictions of the model using China's economic stimulus plan introduced in 2008, which triggered a large policy-driven credit expansion. Using private firm-level data we show evidence of reallocation reversal. That is, differently from the pre-stimulus years, new credit was allocated relatively more towards state-owned, low-productivity firms than to privately-owned, high-productivity firms
Jin Cao, Norges Bank Valeriya Dinger, University of Osnabrück
Abstract:
We empirically analyze how bank lending reacts to monetary policy in the presence of global financial flows. Employing a unique and novel dataset of the funding modes and currency composition of the full population of Norwegian banks in structurally identified regressions, we show that the efficiency of the bank lending channel is affected when banks can shift to international funding and thus insulate their costs of funding from domestic monetary policy. We isolate the effect of global factors from domestic monetary policy by focusing on the deviation of exchange rates from the prediction of (uncovered and covered) interest rate parity. The Norwegian banking sectors represents an ideal laboratory since the exogenous exchange rate dynamics allows for a convincing identification of the relation between lending and global factors.
Martin Puhl, Vienna University of Technology Pavel Savor, Temple University Mungo Wilson, University of Oxford
Abstract:
We identify an ambiguity premium for U.S. stocks from increases in the option-implied concavity of preferences immediately before scheduled macroeconomic announcements. Our methodology relies on Skiadas' (2013) critique of smooth ambiguity aversion models, which shows that ambiguity aversion has a negligible effect on small risks, defined as risks that are proportional to the holding period. We show that the same critique implies that the effect of smooth ambiguity aversion on large risks, those that are independent of the holding period, should be of first-order importance. We test for the difference in the effect of ambiguity aversion on the two types of risk by studying the implied concavity of preferences for a representative agent, and confirm that such concavity indeed increases significantly ahead of scheduled announcements, which represent large risks. Except for smooth ambiguity aversion, no other representative agent model predicts such an increase. Our results suggest that a fundamental benefit of securities markets is that they break large risks into small ones by allowing frequent trading and providing liquidity, thereby reducing discount rates.
Paul Schneider, Swiss Finance Institute Fabio Trojani, Swiss Finance Institute
Abstract:
Under mild assumptions, we recover the conditional moments of market returns from a model-free pricing kernel projection on tradeable realized moments that minimizes dispersion. Recovered moments predict realized moments and reveal the time-varying properties of horizon-dependent equity premia, variance risk premia and market Sharpe ratios. Projected kernels tend to be monotonic at short horizons and U?shaped at long horizons. They induce optimal trading strategies with counter-cyclical Sharpe ratios and plausible nonlinear market timing properties.
Stefanos Delikouras, University of Miami Alex Kostakis, University of Manchester
Abstract:
We propose a single-factor asset pricing model based on an indicator function of consumption growth being less than its endogenous certainty equivalent. This certainty equivalent is derived from generalized disappointment aversion preferences, and it is located approximately one standard deviation below the conditional mean of consumption growth. Our single-factor model can explain the cross-section of expected returns for size, value, reversal, profitability, and investment portfolios at least as well as the Fama-French multi-factor models. Our results show strong empirical support for asymmetric preferences, and question the effectiveness of the smooth utility framework, which is traditionally used in consumption-based asset pricing.
Bo Bian, London Business School Rainer Haselmann, Goethe University Frankfurt Thomas Kick, Deutsche Bundesbank Vikrant Vig, London Business School
Abstract:
In this paper, we examine how the regulatory design of bailout institutions affects the outcome of bank bailout decisions. In the German savings bank sector, distress events can be resolved by local politicians (decentralized) or a state-level association (centralized). We show that decisions by local politicians with close links to the bank are distorted by personal considerations: while distress events per se are not related to the electoral cycle, the probability of local politicians injecting taxpayers' money into a bank in distress is 30\% lower in the year directly preceding an election. Using the timing of the distress event in the electoral cycle as an instrument, we show that a decentralized local bailout results in worse future performance and inefficiently allocated, politically targeted lending in affected banks. We also observe a significantly worse real sector performance of localities under decentralized bailouts as compared with those under centralized ones. Our findings illustrate that centralization reduces distortions in the decision making process and has implications for the design of regulatory architecture.
I investigate how political incentives affect the policies of public-sector defined benefit (DB) pension plans in the United States. I document that \pension deficits"|the difference between liability accrual rates and asset accumulation rates|are systematically higher in gubernatorial election years relative to non-election years. This electoral cycle pattern is explained by systematic election year dips in governmental contributions over which Governors have significant discretion. Subsequent findings suggest incumbent Governors conduct \hidden" borrowing on behalf of taxpayers in election years in order to increase his/her election chances. Specifically, electoral cycles are more pronounced for states in which taxpayers bear the burden of underfunded public plans and for states with less transparent pension systems, and pension deficits are larger during elections that are more closely contested and during gubernatorial terms in which the incumbent is eligible to run for reelection. Additional results suggest that systematic pension deficit electoral cycles have real consequences: plans exhibiting larger electoral cycles in pension deficits are associated with larger deterioration in funding levels, and states containing such plans are associated with lower economic growth. I conduct falsification tests, including analysis of private-sector DB pension plans and of unexpected Governor transitions, in order to rule out alternative explanations for my findings.
Discussant:
Irina Stefanescu, Federal Reserve Board of Governors
This paper investigates the effect of credit availability on consumer borrowing and spend- ing decisions using a test-tube exogenous shock to credit availability. I design and implement a randomized trial at a European retail bank where credit lines are deliberately varied to 54,522 pre-existing consumer and small business cardholders. I find that credit availability has a pre- cisely measured and economically large effect on spending and the use of credit. Contrary to conventional wisdom, the effect of credit is not confined to a small set of credit constrained con- sumers who are up against their limits. The spending response of the unconstrained consumers are concentrated in goods with investment features, and are made in the wake of positive in- come shocks. Moreover, I find that credit line utilization displays mean-reverting dynamics, i.e. strict credit constraints are transitory. I then show how these novel findings can be used to per- form non-parametric acid tests of competing models of intertemporal behavior (e.g., complete markets, PIH, rule-of-thumb, buffer-stock, myopic). Indeed, many aspects of the experimen- tal findings can quantitatively be predicted by a buffer-stock model with illiquid durables and one-sided adjustment costs. I discuss the implications of this model on the linkages between the financial sector and the real economy; formulating fiscal, monetary and macroprudential policy; and evaluating welfare in the credit market.
This paper studies the content of financial news as a function of past market returns. As a proxy for media content we use positive and negative word counts from general financial news columns from the Wall Street Journal and the New York Times. Our empirical analysis allows us to discriminate between theories that predict hyping good stock performance to those that emphasize negative news. The evidence is conclusive: negative market returns taint the ink of typewriters, while positive returns barely do. Given how pervasive our estimates are across multiple time periods, subject to different competitive pressures in the market for news, we conclude our results are driven by demand considerations.
This paper estimates the effect of attention to news on financial markets, using quasi-random variation in positioning of news articles on the Bloomberg terminal. I focus on a category of news articles, some of which are pinned to the prominent "front page" positions at the top of the news screen in a process independent of their content. This offers a natural experiment in positioning between the articles that are pinned and those that are not. The front page and non-front page articles are indistinguishable by either algorithmic analysis, or by the target audience of active finance professionals. I find that pinning a news article to the front page leads to 280% higher trading volumes and 180% larger price changes within the first ten minutes after publication. These articles also see a much stronger short-term price drift, with 30% higher continuation in returns at the five-minute level. The effect is strongest during the first 30-45 minutes after the news, and partially reverses over subsequent hours. A comparison against differential reactions following news articles of varying editorial importance indicates that news positioning plays an even stronger role in driving market activity than editorial markings of news importance.
Antonio Gargano, University of Melbourne Alberto Rossi, University of Maryland
Abstract:
We employ a novel brokerage account dataset to investigate the relation between individual investor attention and performance. Attention is positively related to investment performance, both at the portfolio return level and the individual trades level. We establish causality using an identification strategy that instruments investors attention using local weather conditions and provide evidence that the superior performance of high-attention investors arises because they behave as momentum traders that purchase stocks early in their momentum cycle. Finally, we show that paying attention is particularly profitable when trading stocks with high uncertainty, but for which a lot of public information is available.
I analyze a market with large and small traders with different values. I show that illiquidity and information efficiency are complements. Policy measures promoting liquidity might be harmful for information efficiency and vice versa. An increase in risk-bearing capacity may harm liquidity. An increase in the precision of information may harm information efficiency. Increasing market power or breaking up a centralized market into two separate exchanges might improve welfare. Multiple equilibria, in which higher liquidity is associated with lower information efficiency, are possible. Applied to crude oil market the model highlights (1) informational frictions and (2) market power of producers amplified by (1) as possible drivers of recent sharp price changes.
I develop a tractable model of information aggregation in the market for lending between financial intermediaries and firms when both the aggregate health of the financial sector and the strength of the real economy are unobservable. In the presence of informational frictions, credit spreads and other measures of borrowing costs aggregate the private information of real and financial investors through the demand and supply for credit, respectively, and serve as useful signals about both real and financial fundamentals. In such a setting, I show that increasing transparency in the financial sector lowers credit spreads, raises leverage and the level of real investment by firms, but can have a non-monotonic impact on welfare. I then discuss several empirical and policy implications of my work.
Discussant:
Haoxiang Zhu, Massachusetts Institute of Technology
Anisha Ghosh, Carnegie Mellon University George Constantinides, University of Chicago
Abstract:
The market price-dividend ratio is highly correlated with several macroeconomic variables but not with aggregate consumption growth. We incorporate this observation in an exchange economy with learning about the economic regime from consumption history and a latent signal. The estimated model rationalizes the moments of consumption and dividend growth, stock market return, price-dividend ratio, and the real and nominal term structures and performs well in predictive regressions while a nested model with learning from consumption history alone does not. The intuition is that the beliefs process has high persistence and low variance because beliefs depend on consumption growth and the signal. The model fit remains largely intact when we replace the latent signal with the innovation in the CPI or a combination of macroeconomic variables highly correlated with the price-dividend ratio. The results highlight the informational role of macroeconomic variables and suggests that just one macroeconomic variable, along with consumption growth, goes a long way towards proxying for the investors relevant information set.
Recent studies show that the standard test portfolios do not contain sufficient information to discriminate between asset pricing models. To address this issue, we develop a novel approach that expands the cross-section to several thousand portfolios. Our large-scale approach is simple, widely applicable, and allows for formal comparison tests. Its ability to improve performance evaluation is confirmed by our empirical results---while the tested models are all misspecified, they exhibit striking performance differences. In particular, the human capital and conditional CAPMs produce lower pricing errors which suggests that labor income and recession risk are important concerns for investors.
Peter Diep, AQR Capital Management Andrea Eisfeldt, University of California-Los Angeles Scott Richardson, London Business School
Abstract:
We present a simple, linear asset pricing model of the cross section of Mortgage-Backed Security (MBS) returns. We measure prepayment risk and estimate security risk loadings using real data on prepayment forecasts vs. realizations. Estimated loadings are monotonic in securities' coupons relative to the par coupon, as predicted by the model. Prepayment risks appear to be priced by specialized MBS investors. In particular, we find convincing evidence that prepayment risk prices change sign over time with the sign of a representative MBS investor's exposure to prepayment risk.
Discussant:
Nina Boyarchenko, Federal Reserve Bank of New York
Rui Albuquerque, Boston College Jose Guedes, Universidade Católica Portuguesa
Abstract:
We show that, in the presence of correlated investment opportunities across banks, risk sharing between bank shareholders and bank managers leads to (a) compensation contracts that include relative performance evaluation; and (b) investment decisions that are biased toward such correlated opportunities, thus creating systemic risk. We analyze various policy recommendations regarding bank managerial pay and show how shareholders optimally undo the policies intended risk-reducing effects. We discuss alternative measures that can effectively decrease the systemic risk arising from pay packages.
Thomas Eisenbach, Federal Reserve Bank of New York David Lucca, Federal Reserve Bank of New York Robert Townsend, Massachusetts Institute of Technology
Abstract:
We study bank supervision by combining a theoretical model of asymmetric information and a novel dataset on work hours of Federal Reserve supervisors. We highlight the trade-offs between the benefits and costs of supervision and use the model to interpret the relation between supervisory efforts and bank characteristics observed in the data. More supervisory hours are spent on larger, more complex, and riskier banks. However, hours increase less than proportionally with bank size, suggesting technological scale economies in supervision. We provide evidence of constraints on supervisory resources, documenting reallocation of hours at times of stress and in the post-2008 period. Using variation implied by this resource reallocation, we find evidence that supervision lowers risk.
Jason Donaldson, Washington University-St. Louis Giorgia Piacentino, Washington University-St. Louis
Abstract:
We present a banking model in which bank debt circulates in secondary markets, facilitating trade. The key friction is that secondary market trade is decentralized, i.e. bank debt is traded over the counter like banknotes were in the nineteenth century and repos are today. We find that bank debt is susceptible to runs because secondary market liquidity is fragile, and subject to sudden, self-fulfilling dry-ups. When debt fails to circulate it is redeemed on demand in a "money run." Even though demandable debt exposes banks to costly runs, banks still choose to issue it because it increases their debt capacity: the option to demand increases the price of debt in the secondary market and hence allows banks to borrow more in the primary market--unlike in existing models, demandability and tradeability are complements.
Thomas Mertens, Federal Reserve Bank of San Francisco Tarek Hassan, University of Chicago Tony Zhang, University of Chicago
Abstract:
We propose a novel, risk-based transmission mechanism for the effects of currency manipulation: policies that systematically induce a countrys currency to appreciate in bad times lower its risk premium in international markets and, as a result, lower the countrys risk-free interest rate and increase domestic capital accumulation and wages. Currency manipulations by large countries also have external effects on foreign interest rates and capital accumulation. Applying this logic to policies that lower the variance of the bilateral exchange rate relative to some target country (currency stabilization), we find that a small economy stabilizing its exchange rate relative to a large economy increases domestic capital accumulation and wages. The size of this effect increases with the size of the target economy, offering a potential explanation why the vast majority of currency stabilization in the data are to the U.S. dollar, the currency of the largest economy in the world. A large economy (such as China) stabilizing its exchange rate relative to a larger economy (such as the U.S.) diverts capital accumulation from the target country to itself, increasing domestic wages, while decreasing wages in the target country.
Magnus Dahlquist, Stockholm School of Economics Julien Penasse, University of Luxembourg
Abstract:
It is well known that the interest rate differential (the forward premium) predicts currency returns. However, we nd that the real exchange rate, not the interest rate differential, is the main predictor of currency returns at longer horizons. We relate this finding to other puzzling features of currency markets, namely that the real exchange rate contemporaneously appreciates with the interest rate differential and that the positive relationship between currency risk premia and the interest rate differential reverses over longer horizons. Models in which the currency risk premium depends on the interest rate differential and a missing risk premium, capturing deviations from the purchasing power parity, can rationalize these observations.
John Cotter, University College Dublin Stuart Gabriel, University of California-Los Angeles Richard Roll, California Institute of Technology
Abstract:
We present new international diversification indexes across equity, sovereign This paper presents new indexes of investment diversification potential within and among equity, sovereign debt, and real estate asset classes and countries. The diversification indexes derive from estimates of asset return integration based on common global factors. The indexes reveal a marked and near ubiquitous decline in diversification potential across asset classes and markets for the post-2000 period. Analysis of panel data suggests that the decline is related to higher levels of market credit risk and volatility as well as to technological and communications innovation as proxied by internet diffusion. The decline in diversification opportunity is associated with sharply higher levels of investment risk.
Samuel Kruger, University of Texas-Austin John Griffin, University of Texas-Austin Gonzalo Maturana, Emory University
Abstract:
In the aftermath of the financial crisis, banks paid record fines for their role in fraudulent RMBS underwriting prior to the financial crisis. These civil actions at the corporate level are predicated on economic theory predicting that firms and labor markets create proper incentives through diminished internal and external job prospects. We find no evidence that senior RMBS bankers at top banks suffered from lower job retention, fewer promotions, or worse job opportunities at other firms compared to their counterparts in other areas of structured finance that experienced no fraud. This result holds for every major RMBS underwriter. Outside of the top underwriters there is some evidence that RMBS employees did relatively worse, potentially due to poor firm performance. We then ask why firms and labor markets did not discipline RMBS bankers. We examine whether banks: (a) disciplined the most culpable employees who directly signed deal documents associated with large amounts of fraud or listed in government settlements, (b) kept RMBS employees only to avoid litigation, (c) disciplined RMBS employees after the fraud was publicly disclosed, or (d) disciplined RMBS employees to a greater extent at banks with larger civil penalties. We find evidence against these hypotheses as complete explanations, and evidence consistent with implicit upper-management approval of RMBS activities. Overall, our findings imply that the record-breaking civil penalties are unlikely to transform bank corporate culture or significantly change perceived individual incentives.
Using a hand-matched data set on 27,284 union contracts, I provide novel evidence on the strategic use of corporate liquidity in contract negotiations with unions. I focus on the idea that firms have incentives to hold low levels of liquid assets during union negotiations, because high liquidity can encourage unions to raise their wage demands. The main finding is that firms reduce liquidity before contract negotiations primarily through increased asset purchases. Firms increase asset purchases as a fraction of total assets by one-third before contract negotiations, and finance those purchases by a reduction in cash balances and an increase in leverage. Firms do not increase investments, R&D, dividends, or repurchases before contract negotiations. Strategic liquidity management is associated with lower wages. The evidence indicates that firms reduce liquidity to gain strategic advantages in contract negotiations with unions in ways that simultaneously allow managers to maintain the level of resources under their control.
Discussant:
Paige Ouimet, University of North Carolina-Chapel Hill
This paper studies the strategic role of debt structure in improving the bargaining position of a firm's management relative to its non-financial stakeholders. Debt structure is essential for strategic bargaining because it affects the ease of renegotiating debt contracts and thus the credibility of bankruptcy threats. Using the airline industry as an empirical setting, we first show that the degree of wage concessions is strongly related to a firm's debt structure. Debt structure is further shown to be adjusted as a response to an increase in non-financial stakeholders' negotiation power. Using NLRB labor union election as a laboratory setting and employing a regression discontinuity design, we find that passing a labor union election leads to an increase in the ratio of public debt to total assets and a decrease in the ratio of bank debt to total assets in the following three years after elections, whereas there is no significant change in the level of total debt. The syndication size of newly issued bank loans increases while creditor ownership concentration decreases once the vote share for unions passes the winning threshold. Further analyses confirm that the debt structure adjustments after union certification are more likely driven by the strategic concerns of management rather than more constrained access to bank loans.
Janet Gao, Indiana University Xiumin Marin, Washington University-St. Louis Joseph Pacelli, Indiana University
Abstract:
We examine the role of loan officers in the private debt market. We construct a comprehensive database that allows us to track the employment history, performance and lending terms related to over 7,000 loan officers employed by major U.S. corporate lending departments from the period spanning 1994 to 2012. We find evidence consistent with loan officers having a substantial impact on ex-post loan performance, after controlling for observable lending terms, borrower, bank, and industry characteristics. Moreover, loan officers also appear to be more important than banks in explaining the variation of loan performance. We further show that loan officers exhibit heterogeneous loan origination styles as reflected in their lending terms and these styles appear to be associated with loan performance. Finally, we find that loan officers play an equally important role in both large banks and small banks and that their future lending performance is highly influenced by early employment choices. Overall, our study highlights the importance of human capital in the corporate lending market.
Discussant:
Christoph Herpfer, École Polytechnique Fédérale de Lausanne
This paper introduces a novel empirical approach to estimate the effects of an informational friction limiting the reallocation of credit after a shock to banks. Because lenders rely on private information when deciding which relationship to end, borrowers looking for a new lender are adversely selected. I show how to identify private information separately from information common to all lenders, but unobservable to the econometrician, by using bank shocks within a discrete-choice model of relationships. Applying this approach to the U.S. corporate loan market during the crisis, this informational friction cannot explain more than 10% of the fall in lending.
Discussant:
Hoai-Luu Nguyen, University of California-Berkeley
Mariassunta Giannetti, Stockholm School of Economics Farzad Saidi, Stockholm School of Economics
Abstract:
We conjecture that lenders' decisions to provide liquidity are affected by the extent to which they internalize any spillover effects of negative shocks. We show that lenders with a large share of loans outstanding in an industry are more likely to provide liquidity to industries in distress. High-market-share lenders' propensity to provide liquidity is higher when negative spillovers are expected to be stronger, such as in industries in which fire sales are more likely to ensue. Lenders with a large share of outstanding loans are also more likely to provide liquidity to customers and suppliers of industries in distress, especially when the disruption of supply chains is expected to be more costly. Our results provide a novel channel, unrelated to market power, explaining why concentration in the credit market may favor financial stability.
Discussant:
Rustom Irani, University of Illinois-Urbana-Champaign
Using U.S. Census employer-employee matched data, I show that employer financial distress accelerates the exit of employees to found start-ups. This effect is particularly evident when distressed firms are less able to enforce contracts restricting employee mobility into competing firms. Entrepreneurs exiting financially distressed employers earn higher wages prior to the exit and after founding start-ups, compared to entrepreneurs exiting non-distressed firms. Consistent with distressed firms losing higher-quality workers, their start-ups have higher average employment and payroll growth. The results suggest that the social costs of distress might be lower than the private costs to financially distressed firms.
Shai Bernstein, Stanford University Timothy McQuade, Stanford University Richard Townsend, University of California-San Diego
Abstract:
This paper investigates whether household level shocks impact employee project se- lection and risk taking within firms. To study this question, we construct a unique dataset that links employee patenting with employee housing transactions. We find that employees who experience a negative shock to housing wealth during the financial crisis produce fewer patents and patents of lower quality relative to others in the same firm and in the same metropolitan area. They are also less likely to patent in technologies that are new to their firm or more generally to draw on information from outside of their firms existing knowledge base. Similarly, their patents combine information from fewer disparate fields and are used by a narrower set of technologies. The results are consistent with a career concerns model in which negative housing shocks lead to lower failure tolerance and therefore reduced risk taking and exploratory projects within the firm. In contrast to the view that innovation is determined by firm level factors and the strategy set by top executives, this evidence suggests that shocks to individual inventors also affect the types of projects a firm pursues.
Gustaf Bellstam, University of Colorado-Boulder Sanjai Bhagat, University of Colorado-Boulder J. Anthony Cookson, University of Colorado-Boulder
Abstract:
We construct a new text-based measure of innovation using the content of analyst reports of S&P 500 firms. Our text-based measure captures innovation that is not measured by existing proxies, which is the case when innovation is not financed by R&D and is not patented. The text-based innovation measure is useful even within the set of patenting firms because it strongly correlates with valuable patents, which likely capture true innovation. Indeed, the text-based innovation measure is robustly related to greater firm performance and growth opportunities for up to four years, and these value implications hold just as strongly for non-patenting firms. Digging deeper, highly-innovative firms according to our text-based measure become innovative by producing innovative systems (e.g., Walmarts cross-geography logistics). Consistent with this interpretation, we find that highly-innovative firms are more acquisitive, using acquisitions of relatively smaller firms to augment their innovative systems. Taken together, these findings provide deeper insight into the value of innovation more broadly, not just innovation that can be patented.
Jianan Liu, University of Pennsylvania Robert Stambaugh, University of Pennsylvania Yu Yuan, Shanghai Jiao Tong University
Abstract:
The beta anomaly--negative (positive) alpha on stocks with high (low) beta---arises from beta's positive correlation with idiosyncratic volatility (IVOL). The relation between IVOL and alpha is positive among underpriced stocks but negative and stronger among overpriced stocks (Stambaugh, Yu, and Yuan, 2015). That stronger negative relation combines with the positive IVOL-beta correlation to produce the beta anomaly. The anomaly is significant only within overpriced stocks and only in periods when the beta-IVOL correlation and the likelihood of overpricing are simultaneously high. Either controlling for IVOL or simply excluding overpriced stocks with high IVOL renders the beta anomaly insignificant.
Yasser Boualam, University of North Carolina-Chapel Hill Joao Gomes, University of Pennsylvania Colin Ward, University of Minnesota
Abstract:
This paper argues that the seemingly lower returns on distressed stocks are the result of estimation bias and proposes a simple theoretical correction that can be applied in practice. The bias emerges because highly distressed stocks possess equity betas that display countercyclical nonlinear movements that are not well captured by simple linear factor pricing models. Empirically, we find that these biases can be quite large for abnormal excess returns and that after implementing our proposed correction we see little evidence of underperformance for portfolios of distressed stocks in the data.
Rawley Heimer, Federal Reserve Bank of Cleveland Kristian Myrseth, University of Dublin Raphael Schoenle, Brandeis University
Abstract:
Abstract Subjective mortality beliefs contribute to contradictory savings rate puzzles at opposite ends of the life-cycle the young under-save, and retirees dis-save too slowly. We calibrate a canonical life-cycle model to new data from a large survey on subjective survival beliefs. Relative to a benchmark calibration using actuarial transition probabilities, the young under-save by 30%, and retirees draw down their assets 15% more slowly. The data supports the models predictions: distorted mortality beliefs correlate with savings behavior, even after controlling for risk preferences, cognitive, and socioeconomic factors. The salience of causes-of-death is a pivotal source of mortality belief distortions over the life-cycle.
Francois Gourio, Federal Reserve Bank of Chicago Phuong Ngo, Cleveland State University
Abstract:
Historically, inflation is associated with low stock returns, leading investors to fear inflation. We document that this correlation changes after 2008: inflation are now associated with high stock returns. We interpret this as a change in the conditional covariance of (news about) economic activity and inflation. We then show how the zero lower bound (ZLB) on nominal interest rates can explain this change of covariance owing to the changing propagation mechanisms at the ZLB. This has important implications for asset prices since covariances determine risk premia. A fairly standard New Keynesian macroeconomic model can generates positive term premia and inflation risk in normal times (far from the zero lower bound), but these premia fall as the economy becomes closer to the ZLB.
Mariano Croce, University of North Carolina-Chapel Hill Tatyana Marchuk, Goethe University Frankfurt Christian Schlag, Goethe University Frankfurt
Abstract:
In this paper, we compute conditional measures of lead-lag relationships between GDP growth and industry-level cash-flow growth in the US. Results show that firms in leading industries pay an average annualized return 4% higher than that of firms in lagging industries. The difference in the returns of leading and lagging firms is priced in the cross section of equity returns, even after we adjust for the Fama-French three-factor model. This finding can be rationalized in a model in which (a) agents price growth news shocks, and (b) leading industries provide valuable resolution of uncertainty about the growth prospects of lagging industries.
Peter DeMarzo, Stanford University Zhiguo He, University of Chicago
Abstract:
We analyze equilibrium leverage dynamics in a dynamic tradeoff model when the firm is unable to commit to a leverage policy ex ante. We develop a methodology to characterize equilibrium equity and debt prices in a general jump-diffusion framework, and apply our approach to the standard Leland (1998) setting. Absent commitment, the leverage ratchet effect (Admati et al. 2015) distorts capital structure decisions, leading shareholders to take on debt gradually over time and never voluntarily reduce debt. On the other hand, countervailing effects of asset growth and debt maturity cause leverage to mean-revert towards a long run target. In equilibrium, bond investors anticipate future leverage increases and require significant credit spreads even for firms with currently large distance-to-default. As a result, the tax benefits of future debt increases are fully dissipated, and equilibrium equity values match those in a model where the firm commits not to issue new debt.In our model, leverage is dependent on the full history of the firms earnings. Despite the absence of transactions costs, an increase in profitability causes leverage to decline in the short-run, but the rate of new debt issuance endogenously increases so that leverage ultimately mean-reverts. The target level of leverage, and the speed of adjustment depends critically on debt maturity; nonetheless, in equilibrium shareholders are indifferent toward the debt maturity structure.
Discussant:
Josef Zechner, Vienna University of Economics and Business
When a group of investors with dispersed private information jointly invest in a risky project, how should they divide up the project payoff? A typical common stock contract rewards investors in proportion to their initial investment, but is it really optimal for harnessing all investors wisdom of the crowd? By showing that a simple profit-sharing contract with decentralized decision making could first best coordinate individuals investment choices, this paper studies as a general contracting problem the role of profit sharing in harnessing the crowd wisdom, and discusses implications for the security design of investment crowdfunding. Our result connects the traditional diversification insight underpinning portfolio theory with contracting and investment under private information.
Christian Hilpert, University of Hamburg Stefan Hirth, Aarhus University Alexander Szimayer, University of Hamburg
Abstract:
We analyze how a firms reputation and track record affect its rating and cost of debt. We model a setting in which outsiders such as a rating agency and the firm's creditors continuously update their assessment of the firm's true state described by its cash flow. They observe the latter only imperfectly due to asymmetric information. Other things equal, the rating agency optimally rates a firm with the same observed cash flow higher, if the historical minimum is sufficiently low. Thus, the rating is not only driven by the most recent information, but history matters. The rating agency refines its unbiased cash flow estimate by ruling out the most overestimated types, leading to an overestimation at default. In response, the firm delays default and lower asset values are available to creditors upon default.
Rick Harbaugh, Indiana University John Maxwell, Indiana University Kelly Shue, University of Chicago
Abstract:
If a biased sender can distort some of the news, is it more persuasive to make relatively good news look even better, or to make relatively bad news look less bad? We show that when the news is mostly good, shoring up relatively bad news is most persuasive since it makes the good news appear more consistent and hence more credible. But when the news is mostly bad, exaggerating relatively good news is most effective since it makes the bad news appear less consistent and hence less damaging. We test for such selective news distortion by examining the consistency of reported segment earnings across different units in firms. As predicted by the model, managers appear to manipulate segment earnings to boost underperforming segments when firm earnings are above expectations and to boost overperforming segments when firm earnings are below expectations. More generally, we show how Bayesian updating leads managers and other biased senders to have mean-variance news preferences that differ from traditional mean-variance preferences in that more variance sometimes helps and a higher mean sometimes hurts.
Andrey Malenko, Massachusetts Institute of Technology Nadya Malenko, Boston College
Abstract:
We analyze how proxy advisors, which sell voting recommendations to shareholders, affect corporate decision-making. If the quality of the advisor's information is low, there is overreliance on its recommendations and insufficient private information production. In contrast, if the advisor's information is precise, it may be underused because the advisor rations its recommendations to maximize profits. Overall, the advisor's presence leads to more informative voting only if its information is sufficiently precise. We evaluate several proposals on regulating proxy advisors and show that some suggested policies, such as reducing proxy advisors' market power or decreasing litigation pressure, can have negative effects.
Juliane Begenau, Harvard University Berardino Palazzo, Boston University
Abstract:
The gradual replacement of traditional U.S. public companies by more R&D-intensive firms is key to understanding the secular trend in average cash-holdings. Over the last 35 years, an increasing share of R&Dintensive firms has entered the stock market with progressively higher cash-balances. This positive entry-effect dominates the negative within-firm effect post IPO. We build a firm industry model with endogenous entry to quantify the importance of two competing selection mechanisms: an increasing share of R&Dintensive firms in the overall economy and more favorable IPO conditions. Only the combination of both mechanisms successfully generates a sizable secular increase.
Discussant:
Antonio Falato, Federal Reserve Board of Governors
Core-periphery trading networks arise endogenously in over-the-counter markets as an equilibrium balance between trade competition and inventory efficiency. A small number of firms emerge as core dealers to intermediate trades among a large number of peripheral firms. The equilibrium number of dealers depends on two countervailing forces: (i) competition among dealers in their pricing of immediacy to peripheral firms, and (ii) the benefits of concentrated intermediation for lowering dealer inventory risk through dealers' ability to quickly net purchases against sales. For an asset with a lower frequency of trade demand, intermediation is concentrated among fewer dealers, and interdealer trades account for a greater fraction of total trade volume. These two predictions are strongly supported by evidence from the Bund and U.S. corporate bond markets. From a welfare viewpoint, I show that there are too few dealers for assets with frequent trade demands, and too many for assets with infrequent trade demands.
Björn Hagströmer, Stockholm University Albert Menkveld, VU University Amsterdam
Abstract:
We measure information percolation in securities markets for a one security-many markets setting. Applications range from over-the-counter dealer markets to trading in multiple electronic venues. The outcome is a network map with markets as vertices and information flows as directional edges. The approach first removes pricing errors due to, for example, liquidity trades. It then measures the information flow from A to B by the strength of B's immediate response to A. To illustrate, we analyze information percolation in foreign exchange during normal times and after the Swiss franc crash, where price discovery is suddenly left to the market.
Marco Di Maggio, Harvard University Francesco Franzoni, Swiss Finance Institute Amir Kermani, University of California-Berkeley Carlo Sommavilla, Università della Svizzera Italiana
Abstract:
This paper shows that the network of relationships between brokers and institutional investors shapes the information diffusion in the stock market. We exploit trade-level data to show that central brokers gather information by executing informed trades, which is then leaked to their best clients. We show that after large informed trades, a significantly higher volume of other institutional investors execute similar trades through the same broker, allowing them to capture higher returns in the first few days after the initial trade. In contrast, we find that when the informed asset manager is affiliated with the broker, such imitation does not occur. Similarly, we show that the clients of the broker employed by activist investors to execute their trades tend to buy the same stocks just before the filing of the 13D. This evidence also suggests that an important source of alpha for fund managers is the access to better connections rather than superior skill.
Mariano Croce, University of North Carolina-Chapel Hill Thien Nguyen, Ohio State University Steve Raymond, University of North Carolina-Chapel Hill Lukas Schmid, Duke University
Abstract:
Elevated levels of government debt raise concerns about their effects on long-term growth prospects. Using the cross section of US stock returns, we show that (i) high-R\&D firms are more exposed to government debt and pay higher expected returns than low-R\&D firms; and (ii) higher levels of the debt-to-GDP ratio predict higher risk premia for high-R\&D firms. Furthermore, rises in the cost of capital for innovation-intensive firms predict declines in subsequent R\&D activity and economic growth. We study these findings in a production-based asset pricing model with endogenous innovation. By accounting for fiscal and political risk, our model reproduces several aspects of the empirical evidence.
David Schreindorfer, Arizona State University Lars-Alexander Kuehn, Carnegie Mellon University
Abstract:
The goal of this paper is to quantify the cyclical variation in firm-specific risk and study its aggregate consequences via the allocative efficiency of capital resources across firms. To this end, we estimate a general equilibrium model with firm heterogeneity and a representative household with Epstein-Zin preferences. Firms face investment frictions and permanent shocks, which feature time-variation in common idiosyncratic skewness. Quantitatively, the model replicates well the cyclical dynamics of the cross-sectional output growth and investment rate distributions. Economically, the model generates business cycles through inefficiencies in the allocation of capital across firms, which amounts to an average output gap of 4.5% relative to a frictionless model. These cycles arise because i) permanent Gaussian shocks give rise to a power law distribution in firm size and (ii) rare negative Poisson shocks cause time-variation in common idiosyncratic skewness. Despite the absence of firm-level granularity, a power law in the firm size distribution implies that large inefficient firms dominate the economy, which hinders the household's ability to smooth consumption.
Andres Donangelo, University of Texas-Austin Francois Gourio, Federal Reserve Bank of Chicago Matthias Kehrig, Duke University Miguel Palacios, Vanderbilt University
Abstract:
Using a standard production model, we demonstrate theoretically that, even if labor is fully flexible, it generates a form of operating leverage if (a) wages are smoother than productivity and (b) the capital-labor elasticity of substitution is strictly less than one. Our model supports using labor share--the ratio of labor expenses to value added--as a proxy for labor leverage. We show evidence for conditions (a) and (b), and we demonstrate the economic significance of labor leverage: High labor-share firms have operating profits that are more sensitive to shocks, and they have higher expected asset returns.
Most US households invest a substantial fraction of their wealth in an individual asset: their family home. This paper studies the empirical properties of idiosyncratic house price risk using a novel micro-dataset of house sales and remodeling permits from the metropolitan areas of Los Angeles, San Diego, and San Francisco. Unlike what is usually assumed in the literature, I find that idiosyncratic housing risk does not scale with time. Moreover, the fraction of capital gains variance determined by the idiosyncratic component decreases over a house holding period. I analyze the effects of idiosyncratic risk on household welfare, using a quantitative portfolio model. Exposure to idiosyncratic shocks has substantial effects on the trade-off between owning and renting, especially for short holding periods.
Discussant:
William Mann, University of California-Los Angeles
Laurent Bach, Stockholm School of Economics Laurent Calvet, EDHEC Business School Paolo Sodini, Stockholm School of Economics
Abstract:
This paper investigates the risk and return characteristics of household wealth. The analysis relies on an administrative panel that reports the financial assets, real estate, private equity, and debt of Swedish residents. We find that the expected return on net wealth is U-shaped in net worth: the middle class hold levered positions in real estate while the wealthiest households bear high systematic risk through equity holdings. The wealthy also bear more idiosyncratic risk but do not earn abnormally high returns as compensation. Finally, we show that the heterogeneity of wealth returns largely explains inequality dynamics at the top.
This paper examines the effect of restricting payday credit to payday users. Using administrative banking data from over fifteen thousand online payday borrowers, I exploit a natural experiment surrounding a 2013 U.S. Department of Justice initiative known as Operation Choke Point (OCP) that unexpectedly shut down dozens of unlicensed online payday lenders. Using a difference in differences framework, I find a persistent reduction in payday borrowing of treated households, those with a pre-existing relationship with a lender that is shut down. Relative to control households, treated households reduce borrowing by $136 per month, reduce the number of bounced checks by 17%, and increase consumption by 3%. These effects are persistent and observable six quarters after treatment. A cross-sectional analysis reveals that the positive outcomes following restricted payday loan access are concentrated among the heaviest pre-treatment borrowers. I conclude by analyzing what types of purchases payday loans are financing and find that about half of abnormal spending occurs in predictable categories such as mortgages, car loans, and insurance. Surprisingly, I find evidence of abnormal gambling activity the week following payday borrowing.
Chen Lian, Massachusetts Institute of Technology Yueran Ma, Harvard University Carmen Wang, Harvard University
Abstract:
In recent years, interest rates reached historic lows in many countries. We document that individual investors "reach for yield," that is, have a greater appetite for risk taking when interest rates are low. Using an investment experiment holding fixed risk premia and risks, we show that low interest rates lead to significantly higher allocations to risky assets, among MTurk subjects and HBS MBAs. This behavior cannot be easily explained by conventional portfolio choice theory or by institutional frictions. We then propose and test explanations related to investor psychology. We also present complementary evidence using historical data on household investment decisions.
Jennifer Carpenter, New York University Richard Stanton, University of California-Berkeley Nancy Wallace, University of California-Berkeley
Abstract:
We develop the first empirical model of employee-stock-option exercise that is suitable for valuation and allows for behavioral channels in the determination of employee option cost. We estimate exercise rates as functions of option, stock and employee characteristics in a sample of all employee exercises at 102 firms. Increasing vesting date frequency from annual to monthly reduces option value by 20%. Men exercise faster than women, reducing option value by 2-3%. Top employees exercise faster than lower-ranked, reducing value by 3-4%. Finally, we develop an analytic valuation approximation that is much more accurate than methods used in practice.
Jeffrey Brown , University of Illinois-Urbana-Champaign Alessandro Previtero, Indiana University
Abstract:
We provide evidence that procrastinators exhibit different financial behaviors than non-procrastinators. We define a procrastinator as one who waits until the last day of their health care open enrollment period to make a plan election. We show that procrastinators take longer to sign up for 401(k) plans, contribute less, are more likely to stick with default portfolio allocations, and are more likely to choose a lump sum over an annuity as a payout option, especially when the lump sum is more salient. Further evidence indicates that our findings are best explained by procrastination being the outcome of present-biased preferences.
Jie He, University of Georgia Jiekun Huang, University of Illinois-Urbana-Champaign Shan Zhao, Grenoble School of Management
Abstract:
We analyze the role of institutional cross-ownership in internalizing corporate governance externalities using data on mutual fund proxy voting. Exploiting the variation in cross-ownership across institutions for the same firm at the same time as well as the variation in cross-ownership across firms within the same institutions portfolio, we show that an institutions holdings in peer firms increase the likelihood that the institution votes against management in shareholder-sponsored governance proposals. This effect is stronger for firms whose managers are likely to have more outside opportunities and industries with fewer analysts following. We further show that high aggregate cross-ownership positively predicts management losing a vote. Overall, our evidence suggests that institutional cross-ownership improves governance by alleviating the inefficiency resulting from corporate governance externalities.
Ryan Lewis, University of Colorado Cem Demiroglu, Koç University Julian Franks, London Business School
Abstract:
This paper shows that public dissemination of trading information for registered corporate bonds reduces valuation errors in Chapter 11 bankruptcy reorganizations by about half, virtually eliminating unintended wealth transfers between claimants and consequent violations of the absolute priority rule. The impact of dissemination is significantly greater where alternative market-based indicators of firm valuation, such as analyst estimates or outside bids for the companys assets are lacking, and significantly lower where hedge funds are among the debtor's largest unsecured claimants. The results suggest that the transparency of market prices helps improve the distributional efficiency of Chapter 11 bankruptcy and provide support for proposals to increase the availability of market-based signals to aid the valuation process.
Shai Bernstein, Stanford University Emanuele Colonnelli, Stanford University Xavier Giroud, Massachusetts Institute of Technology Benjamin Iverson, Northwestern University
Abstract:
How do different bankruptcy approaches affect the local economy? Using U.S. Census microdata at the establishment level, we explore the spillover effects of reorganization and liquidation on geographically proximate firms. We exploit the random assignment of bankruptcy judges as a source of exogenous variation in the probability of liquidation. We find that within a five-year period, employment declines substantially in the immediate neighborhood of the liquidated establishments, relative to reorganized establishments. Most of the decline is due to lower growth of existing plants, with some reduced entry into the nearby area as well. The spillover effects are highly localized and concentrate in the non-tradable sector, particularly when the bankrupt firm is in the non-tradable sector as well. The results are consistent with liquidation leading to a reduction in consumer traffic to the local area or reducing knowledge spillovers between firms.
Qiping Xu, University of Notre Dame Eric Zwick, University of Chicago
Abstract:
This paper studies tax minimizing investment, in which firms increase capital expenditure (CAPEX) sharply near fiscal year-end to reduce tax payments. During the period of 1984-2013, fiscal Q4 CAPEX is on average 37% higher than the average of the first three fiscal quarters. We exploit firms' taxable income status and the Tax Reform Act of 1986 to establish the causal link between fiscal Q4 investment spikes and tax minimization. The Q4 CAPEX spike represents a higher CAPEX level instead of a mere shifting over time. Firms that are more financially constrained, have higher loss carryforward, and meet or beat earnings forecasts are more inclined to backload investment. Cross-country data shows that tax minimizing investment exists internationally.
Wenting Ma, University of North Carolina-Chapel Hill Paige Ouimet, University of North Carolina-Chapel Hill Elena Simintzi, University of British Columbia
Abstract:
This paper documents important shifts in the occupational composition of industries following high merger and acquisition (M&A) activity as well as accompanying increases in mean wages and wage inequality. We propose mergers and acquisitions act as a catalyst for skill-biased and routine-biased technological change. We argue that due to an increase in scale, improved efficiency or lower financial constraints, M&As facilitate technology adoption and automation, disproportionately increasing the productivity of high-skill workers and enabling the displacement of occupations involved in routine-tasks, typically mid-income occupations. An increase in M&A intensity of 10% is associated with a 24% (27%) reduction in industry (local labor market) routine share intensity and an eight (sixteen) percentage point increase in the share of high skill workers. These results have important implications on wage inequality: An increase in M\&A activity by 10% is associated with a 24% (43%) increase in the mean industry (local labor market) hourly wage and an 20% (48%) increase in industry (local labor market) wage polarization. Our results are robust to several robustness tests which further support the notion that firm reorganizations through M\&As are a first-order driving force of job polarization and inequality.
Juanita Gonzalez-Uribe, London School of Economics and Political Science Daniel Paravisini, London School of Economics and Political Science
Abstract:
We estimate the sensitivity of investment to the cost of outside equity for young firms. For estimation, we exploit differences across firms in eligibility to a new tax relief program for individual outside equity investors in the UK. On average, investment increases 1.6% in response to a 10% drop in the cost of outside equity. This average conceals substantial heterogeneity: 1% of eligible firms issue equity in response to a subsidy that would have doubled investors returns, implying large fixed issuance costs for the majority of firms. Conditional on issuing new equity, however, firms invest eight times the issued amount. The results imply a large complementarity between outside equity and other funding sources.
Elisabeth Kempf, University of Chicago Alberto Manconi, Università Bocconi Massimo Massa, INSEAD
Abstract:
We study the information content of the cash-driven side of the securities lending market. We focus on the structured finance products (securitized bonds) segment, where confounding effects from short selling are less likely. We document that changes in lendable amounts, proxying for the amount of a security used as collateral in a cash loan, predict future performance (delinquencies, foreclosure rates, and deal losses). Decreases in lendable amounts act like the proverbial canary in a coalmine, predicting a worsening performance. In contrast, we do not find any evidence of predictability from changes in the on loan amounts. This evidence is consistent with securities lenders/cash borrowers and/or lending intermediaries possessing information about the future value of the securities.
Discussant:
Adam Reed, University of North Carolina-Chapel Hill
Matthew Spiegel, Yale University Laura Starks, University of Texas-Austin
Abstract:
Corporate bonds face institutional rigidities from the division between investment grade and non-investment grade clientele. The effects of these rigidities are exacerbated by infrequent trading in individual bonds, averaging only 5% of all trading days and generally declining as bonds age. Examining how rigidities affect returns requires a methodology that takes the infrequent trading into account. Using a novel methodology that modifies the repeat sales method by incorporating bond characteristics, subsequent to a bond rating crossing the investment/non-investment boundary, we find that transaction prices for bonds show significant negative (or positive) abnormal returns over time, followed by a partial recovery.
Discussant:
Chotibhak Jotikasthira, Southern Methodist University
Mahdi Nezafat, Michigan State University Mark Schroder, Michigan State University
Abstract:
We analyze a model of costly private information acquisition and asset pricing under imperfect competition. We show that imperfect competition generally creates strategic complementarity in traders' information acquisition decisions. The source of strategic complementarity is the change in the liquidity of the risky asset that arises from a change in the precision of a private signal: when an uninformed trader becomes informed, the liquidity of the risky asset generally increases. The increase in liquidity encourages more private information acquisition by informed traders. We also show that imperfect competition can shut down private information acquisition, leading to significant illiquidity and volatility. This finding implies that excess return volatility can be observed in markets with low information asymmetry.
Liyan Yang, University of Toronto Haoxiang Zhu, Massachusetts Institute of Technology
Abstract:
We model the strategic interaction between fundamental informed trading and order-flow informed trading. Adding to a two-period Kyle (1985) model, a "back-runner" observes a signal of the fundamental informed investor's period-1 order after the order is filled. Learning from past order-flow information, the back-runner competes with the fundamental investor in period 2. If order-flow information is accurate, the fundamental investor hides her information by randomizing her period-1 trade, resulting in a mixed-strategy equilibrium. A pure-strategy equilibrium obtains if order-flow information is inaccurate. Back-running delays price discovery and reduces fundamental information acquisition. Recent evidence on high-frequency trading supports our theoretical predictions.
Discussant:
Dan Bernhardt, University of Illinois-Urbana-Champaign
Bradyn Breon-Drish, University of California-San Diego Snehal Banerjee, University of California-San Diego
Abstract:
We develop a continuous-time Kyle (1985) model where the strategic trader dynamically chooses when to acquire costly information about an assets payoff, instead of being endowed with this information. We show that whether the market maker observes the acquisition decision plays an important role. When information acquisition is observable, there exists an equilibrium in which the traders acquisition decision follows a pure strategy and delay, relative to a naive NPV rule, is optimal. In contrast, when the acquisition decision is not observable, we show that an equilibrium with smooth trading and a pure acquisition strategy cannot exist. We also rule out the existence of a class of equilibria with smooth trading in which the trader mixes between acquiring information and not. These results suggest that the standard Kyle trading equilibrium is difficult to reconcile with costly, dynamic information acquisition, when the acquisition decision is unobservable.
Dmitriy Muravyev, Boston College Xuechuan Ni, Boston College
Abstract:
Returns for S&P 500 index options are negative and large: -0.7% per day. Strikingly, when we decompose these delta-hedged option returns into intraday (open-to-close) and overnight (close-to-open) components, we find that average overnight returns are -1% while intraday returns are actually positive, 0.3% per day. A similar return pattern holds for all maturity and moneyness categories, equity and ETF options, and VIX futures. Rational theories struggle to explain positive intraday returns. We show that returns change sign and become positive because option prices fail to account for the well-known fact that stock volatility is substantially higher intraday than overnight. Thus, option market-makers, some of the most sophisticated investors, appear to completely ignore one of the strongest volatility seasonalities, which can be easily added to option pricing models. Finally, other option investors also appear unaware of this anomaly, which may explain its persistence.
Patrick Augustin, McGill University Menachem Brenner, New York University Gunnar Grass, HEC Montréal Marti Subrahmanyam, New York University
Abstract:
We analyze how informed investors trade in the options market ahead of corporate news, when they receive private information about (i) the timing of the announcement and (ii) its potential impact on stock prices. Our simple framework characterizes the optimal strategy in terms of option type, maturity, and strike price that yields the greatest leverage to informed investors and, hence, the most bang for the buck. Accounting for uncertainty in the private information signal, as well as market frictions including minimum prices and bid ask spreads, we can rank strategies without the need to model risk aversion or price impact. We demonstrate empirically that (i) heterogeneity in unusual options activity ahead of significant corporate news (SCNs) is consistent with the predictions of our framework and (ii) informed trading measures derived from our framework improve the predictability of significant corporate news events.
John Griffin, University of Texas-Austin Amin Shams, University of Texas-Austin
Abstract:
At the settlement time of the VIX Volatility Index, volume spikes on S&P 500 Index (SPX) options, but only in the out-of-the-money options that are used to calculate the VIX, and more so for options with a higher and discontinuous influence on VIX. We investigate alternative explanations of coordinated liquidity trading and hedging. Tests including those utilizing differences in put and call options, open interest around the settlement, and a similar volatility contract with an entirely different settlement procedure are inconsistent with these explanations, but consistent with market manipulation. Size and liquidity differences between the SPX and VIX markets may facilitate the sizeable settlement deviations.
David Berger, Northwestern University Ian Dew-Becker, Northwestern University Stefano Giglio, University of Chicago
Abstract:
There is substantial evidence that the volatility of the economy is countercyclical. This paper provides new empirical evidence on the relationship between aggregate volatility and the macroeconomy. We aim to test whether that relationship is causal. We measure volatility expectations using market-implied forecasts of future stock return volatility. According to both simple cross-correlations and a wide range of VAR specifications, shocks to realized volatility are contractionary, while shocks to expected volatility in the future have no significant effect on the economy. Furthermore, investors have historically paid large premia to hedge shocks to realized volatility, but the premia associated with shocks to volatility expectations have not been statistically different from zero. We argue that these facts are inconsistent with models in which uncertainty shocks cause contractions, but they are in line with the predictions of a simple model in which aggregate technology shocks are negatively skewed.
Xiang Fang, University of Pennsylvania Yang Liu, University of Pennsylvania
Abstract:
This paper studies how financial market volatility drives exchange rates through the riskmanagement practice of financial intermediaries. We build a model in which the major participantsin the international financial market are levered intermediaries subject to Value-at-Riskconstraints. Higher portfolio volatility translates into tighter funding conditions and increasedmarginal value of wealth. Thus, foreign currency is expected to appreciate. Our model can resolvethe Backus-Smith puzzle, the forward premium puzzle, and the exchange rate volatilitypuzzle quantitatively. Our empirical tests verify two implications of the model that measuresof both financial market volatility and funding condition have predictive power on exchangerates.
Yang Liu, University of Pennsylvania Riccardo Colacito, University of North Carolina-Chapel Hill Mariano Croce, University of North Carolina-Chapel Hill Ivan Shaliastovich, University of Wisconsin-Madison
Abstract:
We show novel empirical evidence on the significance of output volatility (vol) shocks for both currency and international quantity dynamics. Focusing on G-17 countries, we document that: (1) consumption and output vols are imperfectly correlated within countries; (2) across countries, consumption vol is more correlated than output vol; (3) the pass-through of relative output vol shocks onto relative consumption vol is significant, especially for small countries; and (4) consumption differentials vol and exchange rate vol are disconnected. We rationalize these findings in a frictionless model with multiple goods and recursive preferences featuring a novel and rich risk-sharing of vol shocks.
Jonathan Cohn, University of Texas-Austin Nicole Nestoriak, U.S. Bureau of Labor Statistics Malcolm Wardlaw, University of Texas-Dallas
Abstract:
This paper presents evidence that workplace injury rates decline substantially after private equity buyouts. The decline holds for buyouts of public firms but not private firms, and is greater for public firms likely facing more pressure pre-buyout to deliver short-term performance, suggesting that alleviating pressure on managers to make short-sighted decisions can improve workplace safety. There is some evidence that high levels of buyout debt lessen the decline in injury rate. Finally, employment after buyouts declines more at relatively safe establishments, though this effect is small relative to the injury rate decline within establishments.
Cesare Fracassi, University of Texas-Austin Alessandro Previtero, Indiana University Albert Sheen, University of Oregon
Abstract:
We investigate the effects of private equity on consumers using detailed price and sales data for an extensive number of consumer products. We find that firms acquired by private equity raise prices marginally---less than 1%---on existing products relative to matched control firms. Overall industry prices rise after buyouts, but again the price increase is on average very modest. More notably, target firms significantly increase sales due to more product additions and greater availability within and across cities. These results are stronger for private firm targets, suggesting that private equity could ease financial constraints and provide the expertise to manage growth. Contrary to the common view that private equity leads to substantial price increases, this evidence suggests that consumers could benefit from private equity deals through an increase in product variety.
Peter Iliev, Pennsylvania State University Michelle Lowry, Drexel University
Abstract:
Contrary to generally-held notions regarding the private firm focus of venture capital firms, we find that many VCs take an active investing role in firms after the IPO. Approximately 15% of VC-backed firms receive additional VC financing within the first five years after the IPO, in many cases from a VC that also funded the firm prior to the IPO. VCs concentrate their investments in firms that are most likely to find it prohibitively costly to raise public equity. Consistent with the added capital enabling the firm to undertake positive NPV projects, these post-IPO investments are associated with positive abnormal returns. Moreover, results indicate that the option to raise capital from a VC firm has positive value: the tendency of a firms pre-IPO VC to back firms after the IPO is positively related to post-IPO returns and to firm survival.
Mihir Mehta, University of Michigan Suraj Srinivasan, Harvard University Wanli Zhao, Southern Illinois University
Abstract:
We document that firms linked to powerful U.S. politicians that oversee merger antitrust regulators receive favorable mergers and acquisitions antitrust review outcomes. When acquirers are constituents of these politicians, mergers are likely to encounter a more favorable review process. In contrast, when targets are constituents, the merger antitrust review outcomes are dependent on the targets partiality towards the merger. To establish identification, we exploit a subset of politician turnover events that are plausibly exogenous as well as a falsification test using politicians with no jurisdiction over antitrust regulators. Politician incentives to influence merger antitrust review outcomes appear to be driven by lobbying, contributions, and prior business connections. Our findings suggest that merger antitrust reviews are not independent of self-serving political intervention.
Pat Akey, University of Toronto Rawley Heimer, Federal Reserve Bank of Cleveland Stefan Lewellen, London Business School
Abstract:
Using proprietary data on individual Americans' credit histories, we find that access to consumer credit decreases by 4.5% - 8% when the borrower's home-state U.S. Senator ascends to chair a powerful Senate committee. This contraction in credit availability is concentrated among historically credit-constrained borrower groups (poor borrowers, non-white borrowers, and borrowers with low credit scores), and is stronger in areas with fewer politically-active consumers and more politically-connected lenders. Our evidence is most consistent with a ``political protection'' hypothesis: banks view fair-lending regulatory guidelines as less binding when they have connections to powerful politicians. Our results highlight the distinction between political power and legislative outcomes, and provide a counterpoint to recent findings that government interventions improve consumers' access to credit.
Discussant:
Jiekun Huang, University of Illinois-Urbana-Champaign
Using subsidiary-level data for Indian firms and staggered elections across Indian states, I find that political uncertaintys impact on firm performance varies by organizational form. I find that the gap in leverage ratio between subsidiaries of conglomerate and stand-alone firms widen by 15% in states with elections vis-´a-vis other states. Periods of elevated political uncertainty is also associated with relatively lower investment and higher borrowing cost for the stand-alone firms. The results are consistent with the possibility of being driven largely by the (reduced) supply of capital than the (subdued) demand for it. This paper introduces political uncertainty as a new dimension in the long standing literature that compares diversified and single segment firms.
Lin Shen, University of Pennsylvania Junyuan Zou, University of Pennsylvania
Abstract:
We analyze a model with strategic complementarity in which coordination failure leads to welfare losses. We adopt global game techniques to pin down the unique threshold equilibrium and propose a stimulus program with voluntary participation for a policy maker to reduce coordination failure. The stimulus program is offered to agents who take the efficient action. If an agent accepts the offer, she receives upfront subsidies and needs to pay tax proportional to realized payoffs in the future. In fact, only a small mass of ``pivotal agents" receiving medium signals self-select to accept the offer and take the efficient action. Amplified by higher-order beliefs, the stimulus program significantly reduces coordination failures in equilibrium. In the limit of vanishing information frictions, our proposed program eliminates all coordination failures at zero cost. When the coordination problem interacts with moral hazard, we show our proposed program is better than other programs such as the lender of last resort or government guarantee in terms of cost and social efficiency. The results are robust to several generalizations including, investors' unobservable ex-ante heterogeneity, continuous payoff structure and a finite number of agents.
Oliver Boguth, Arizona State University Vincent Gregoire, University of Melbourne Charles Martineau, University of British Columbia
Abstract:
In an effort to increase transparency, the Chair of the Federal Reserve now holds a press conference following some, but not all, Federal Open Market Committee announcements. Press conferences are scheduled independently of economic conditions and communicate little information. Evidence from financial markets demonstrates that investors lower their expectations of important decisions on days without press conferences, and we show that they shift attention away from these announcements. Both channels prevent effective monetary policy, as the committee is averse to surprising markets and aims to coordinate market expectations. Correspondingly, we show that announcements without press conferences convey less price-relevant information.
Discussant:
Daniel Andrei, University of California-Los Angeles
Suresh Sundaresan, Columbia University Zhenyu Wang, Indiana University Wei Yang, Indiana University
Abstract:
The financial industry uses OIS as market expectations of the average overnight rates, but standard term structure models that ignore FOMC meeting schedules explain the short-term OIS curve by risk premiums. We build a database to track the public information on FOMC schedules and introduce models to incorporate the information. Our models explain the OIS curve by expectations and show that the OIS curve inversion before the financial crisis reflects the expectation of the Feds rate cuts. We present evidence that the Fed was behind the market expectation before the crisis but moved ahead of the expectation during the crisis.
Discussant:
Nina Boyarchenko, Federal Reserve Bank of New York
The USC Marshall School of Business Trefftz Award/For the Best Student Paper
If you have an iPhone, you can "Add to Home
Screen" and it looks just like an app (without paying the 99
cents)
Everything gets cached so this works off-line
or airplane mode (or more correctly, everything should get
cached so this should work off-line or airplane mode.)
