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AFA Ph.D. Student Poster Session

Poster Session

Friday, Jan. 4, 2019 7:30 AM - 6:00 PM

Hilton Atlanta, Grand Ballroom Pre-Function North
Hosted By: American Finance Association
  • Chair: Kenneth Singleton, Stanford University

A High Frequency Analysis of the Information Content of Trading Volume

Khaladdin Rzayev
,
The University of Edinburgh
Gbenga Ibikunle
,
University of Edinburgh

Abstract

We propose a state space modelling approach for decomposing high frequency
trading volume into liquidity-driven and information-driven components. Using a set of high
frequency S&P 500 stocks data, we show that informed trading increases pricing efficiency by
reducing volatility, illiquidity and toxicity/adverse selection during periods of non-aggressive
trading. We observe that our estimated informed trading component of volume is a statistically
significant predictor for one-second stock returns; however, it is not a significant predictor for
one-minute stock returns. We show that this disparity is explained by high frequency trading
activity, which eliminates pricing inefficiencies at high frequencies.

A Rationale for the Clientele Effect in Money Management

Qiaozhi Hu
,
Boston University
Marcel Rindisbacher
,
Boston University

Abstract

This paper proposes a rational explanation for the existence of clientele effects under commonly used portfolio management contracts. Contrary to the common view that investors always benefit from a manager’s market timing skill (private information about future market returns), we show that the value of a manager’s private information to an investor can be negative when the investor is sufficiently more risk-averse than the manager. This suggests different clienteles for skilled and unskilled funds. Investors in skilled funds are uniformly more risk-tolerant than investors in unskilled funds. We examine the effects of the manager’s skill level, contract parameters, and market conditions on an investor’s fund choice. Our results suggest that the investors who are sufficiently more risk-averse than the manager should include fulcrum fees in the contract to benefit from the skilled manager’s information advantage.

A Theory of the Market Response to Macroeconomic News under Bounded Rationality

Yu Wang
,
Boston College

Abstract

I develop a model of prescheduled macroeconomic announcements. My model analyzes the optimal allocation of attention between systematic and idiosyncratic risk factors when a macroeconomic announcement is anticipated. Skilled investors, when producing information under bounded rationality, allocate more of their attention to analyzing the idiosyncratic risk factor when they anticipate more precise public information about the systematic risk factor from the macroeconomic announcement. Consequently, my model predicts that, the more informative (precise) the macroeconomic announcement is expected to be about the underlying sources of risk, ceteris paribus, the more uncertainty pre-announcement, the more resolution of uncertainty post-announcement, and the higher the trading volume around the announcement on the market index. My model is consistent with patterns of abnormal returns, volatility, and trading volume documented in the empirical literature on macroeconomic announcements.

Acquisitions, Common Ownership, and the Cournot Merger Paradox

Miguel Anton
,
IESE Business School
José Azar
,
IESE Business School
Mireia Gine
,
University of Navarra & Wharton WRDS
Luca Xianran Lin
,
IESE Business School

Abstract

The “Cournot merger paradox” states that, in a symmetric Cournot game, all the gains from a merger between two firms are captured by non-merging rivals in the same industry. We extend the model to allow for overlapping ownership. We find that common ownership increases the profitability of mergers for diversified shareholders not only due to their ownership stakes in the target, but also due to their stakes in non-merging rival firms. Empirically we find that the adjusted CARs for acquiring shareholders are not negative when incorporating the effects of non-merging rivals in their portfolio. This results may explain why a high-common ownership environment can lead to higher merger activity.

Aggregating Information for Optimal Portfolio Weights

Xiao Li
,
University of Arizona

Abstract

I develop an approach that aggregates information from various sources for optimal portfolio weights. In particular, my approach uses the weights implied by extant allocation rules as instruments and decides the relative contribution from each rule through regularized regression (Elastic Net). Out-of-sample tests suggest that, by aggregating information from twelve allocation rules, my approach consistently achieves good performance across a variety of asset samples whereas none of the twelve rules can match the consistency. My paper also emphasizes the relevancy of allocation rules developed in prior studies. Even though they might not deliver satisfactory performance individually, their weights still contain valuable information and serve well as instruments.

Allocation Incentives of Marketplace Lending Platforms during the IPO of Debt Securities

Li Ting Chiu
,
University at Buffalo-SUNY
Brian Wolfe
,
University at Buffalo
Woongsun Yoo
,
Saginaw Valley State University

Abstract

When marketplace lending platforms create new (debt) securities, they play a similar role as underwriters in an IPO. For both intermediaries, revenue generation is proportional to the volume of securities created. Yet, when it comes to the allocation of these newly issued securities, marketplace lending platforms claim to randomly allocate securities among investors while IPO underwriters preferentially allocate. We provide evidence that the allocation behavior of marketplace lending platforms is not random and favors certain investors at the expense of others. Motivated by the underwriter literature and originate-to-distribute models of intermediation, we explore channels to explain why marketplace lending platforms might preferentially allocate securities to particular investors. Our results suggest a tension between adverse selection issues within the institutional market that force platforms to preferentially allocate and an opposing channel caused by heavy securitization activity of the marketplace lending notes which reduces the platforms’ preferential allocation of loans to institutional investors.

An Alternative Behavioral Explanation for the MAX Effect

Hannes Mohrschladt
,
University of Muenster
Maren Baars
,
University of Muenster

Abstract

Stocks with high maximum daily returns in the previous month (MAX) yield low future returns. We examine the underlying sources of this MAX effect and present three empirical arguments that question the common presumption that investors with lottery preferences cause an overvaluation of high-MAX stocks. First, high-MAX stocks are comparably unattractive for investors with cumulative prospect theory preferences. Second, we find no price pressure from lottery investors after high-MAX observations but immediate price reversals. Hence, the MAX return itself seems to be the source of the overvaluation. Third, the MAX effect reverses if the MAX return can be linked to an earnings announcement. These findings are perfectly in line with a behavioral phenomenon called strength-weight bias: Investors usually overreact towards extreme high-strength news such that high-MAX stocks tend to be overvalued. However, they underreact if the MAX return is accompanied by reliable high-weight news such as earnings announcements.

An Equilibrium Model of Blockchain-Based Cryptocurrencies

Engin Iyidogan
,
Imperial College Business School

Abstract

This paper develops an equilibrium model of proof-of-work cryptocurrencies. Equilibrium behaviour of miners and users are characterized for exogenous blockchain protocol metrics. This paper shows that an equilibrium can be achieved in the long run. High fixed mining reward is the reason of instability in current cryptocurrency designs. The equilibrium model has two main implications. First, decentralization and technological improvement in mining are the drivers of low transaction fees and low mining costs. Second, limited block size and mining difficulty, which is endogenously determined, create an incentive mechanism that achieves the sustainability of cryptocurrency in the long run.

Keywords: Cryptocurrency, Bitcoin, General Equilibrium

Are Financial Information Technologies Making the Rich Richer?

Roxana Mihet
,
New York University

Abstract

The recent financial information technology revolution has made information acquisition cheaper than ever before and has promised to completely restructure capital markets. The internet of things, machine learning, AI algorithms trained on big data sets, and so on, have started a revolution in global access to knowledge and lowered many different costs of trading (ie. commission fees, research fees, delegation fees, etc.). I build a noisy rational expectations model of the stock-market in order to understand how these developments affect who, what, and how investors trade. I show that improvements in financial information technologies explain the large rise in passive investing and the retrenchment of small investors from stock-markets. Moreover, contrary to mainstream beliefs, new financial information technologies do not automatically translate into more equal outcomes.

Cross-border spillovers from reducing non-performing loans

Alexander Plekhanov
,
European Bank for Reconstruction and Development
Marta Skrzypinska
,
University of Bristol

Abstract

Authorities in many countries recently deployed policies to reduce non-performing loans (NPL). This paper investigates whether such policies have cross-border spillovers, in particular, whether they affect foreign affiliates of banks. It uses a novel dataset on policies deployed to address high levels of NPLs in a large number of countries over the period 1990-2015 and bank-level data from Bankscope database. A combination of establishment of asset management companies with the view to develop a secondary market for impaired loans and availability of public funds for bank recapitalisations is found to have sizeable impact on foreign affiliates of banks. This finding is insightful in two ways. First, it suggests that the welfare benefits of policies to reduce NPLs are larger than previously thought -- on account of positive cross-border spillovers. Second, estimates can be seen as the lower bound of the effectiveness of such policies in the jurisdiction where policies are adopted. Such estimates have the benefit of exploiting arguably exogenous variation in deployment of policies and their timing. The cross-border effects of policies targeting NPLs are driven primarily by application of consolidated supervision and, to some extent, by the exchange of knowledge within banking groups and the workings on internal capital markets.

Avoiding the Fall into the Loop: Isolating the Transmission of Bank-to-Sovereign Distress in the Euro Area and its Drivers

Hannes Boehm
,
Halle Institute for Economic Research
Stefan Eichler
,
Technische Universitaet Dresden

Abstract

We isolate the direct bank-to-sovereign distress channel within the Eurozone's sovereign-bank-loop by exploiting the global, non-Eurozone related variation in stock prices. We instrument banking sector stock returns in the Eurozone with exposure-weighted stock market returns from non-Eurozone countries and take further precautions to remove any Eurozone crisis-related variation.
We find that the transmission of instrumented bank distress, while economically relevant, is significantly smaller than the corresponding coefficient in the unadjusted OLS framework, confirming concerns on reverse causality and omitted variables in previous studies.
Furthermore, we show that the spillover of bank distress is significantly stronger for countries with poorer macroeconomic performances, weaker financial sectors and financial regulation and during times of elevated political uncertainty.

Bank Leverage, Capital Requirements and Bank's Implied Cost of (Equity) Capital

Christian Schmidt
,
University of Mannheim

Abstract

Do heightened capital requirements impose private costs on banks by adversely affecting their cost of capital? And if so, does the effect differ across different groups of banks? Using an international sample of listed banks over the period from 1990 to 2017, I find that equity investors adjust their expected return weakly in accordance with the Modigliani and Miller (1958) Theorem when banks decrease their leverage. The adjustment is stronger for smaller banks, banks that rely more on deposit financing and when debt is reduced rather than deposits, which never triggers a statistically significant adjustment. In any cases, the adjustment is not strong enough to keep banks' cost of capital constant which is estimated to increase by 10 to 40bps, representing a relative increase of 2.8% to 12.6%, when shifting equity from 8% to 16%. When using the 2011 EBA capital exercise as a quasi-natural experiment to identify the impact of capital regulation on bank's cost of capital, results indicate a strong reduction in required returns for the treated banks. However, the reduction is mainly caused by shifts in asset risk, highlighting the importance of differentiating between short-run and long-run effects.

Bank Liquidity Supply and Corporate Investment during the 2008-2009 Financial Crisis

Wei Zhang
,
University of Minnesota

Abstract

I document a line of credit channel through which bank liquidity supply shocks affect corporate investment during the 2008–2009 financial crisis. By exploiting the predetermined variation in the maturity structure of lines of credit, I find that firms whose last pre-crisis lines of credit become due at the time of the crisis (treated firms) cut investment by more than similar firms whose lines of credit mature after the crisis. Moreover, this effect is stronger for financially constrained firms, bank-dependent firms, and firms whose pre-crisis banks are unhealthy. Within the treated group, firms with unhealthy banks are less likely to obtain lines of credit in the crisis than those with healthy banks. Finally, in the sample of firms with lines of credit before the crisis, I find that those with unhealthy banks experience lower growth in lines of credit and investment, but this effect is restricted only to unrated firms.

Beta Ambiguity and Security Return Characteristics

Zhe Geng
,
Shanghai Jiao Tong University
Tan Wang
,
Shanghai Jiao Tong University

Abstract

We develop a model to study the cross-sectional properties of asset returns in the presence of ambiguity in the distribution of asset returns. In our model, the cross-sectional expected returns can be described by a three-factor model, capturing risk, mean ambiguity and variance-covariance ambiguity, respectively. Expected returns include a mean ambiguity premium, a variance-covariance ambiguity premium, as well as the standard risk premium. The expected returns exhibit cross-sectional characteristics consistent with the empirical fact that the overall beta-return relation and IVOL-return relation are both negative, but the beta-return relation is negative and stronger among overpriced stocks while positive and weaker among underpriced stocks, and the IVOL-return relation is negative and stronger among overpriced stocks but positive and weaker among underpriced stocks.

Beyond Distress Risk

Altan Pazarbasi
,
Frankfurt School of Finance and Management

Abstract

I identify a systematic credit risk factor in the Credit Default Swaps (CDS) market. This factor accounts for most of the cross-sectional variation in individual stock returns during 2003–2014. In the cross-section, distressed firms have larger exposures to the systematic credit risk factor, which shrinks positive distress alphas found in recent literature. The systematic credit risk also captures the time-series variation in equity returns, cash flow growth and state of the macroeconomy. A no-arbitrage, dynamic asset-pricing model delivers a structural interpretation for the empirical findings: By investing in distressed firms, investors are exposed to macroeconomic credit shocks beyond firm-specific financial distress risk

Bond Mutual Fund Winners and Losers: an Examination of Manager Risk-Shifting

Matthew Faulkner
,
Florida Atlantic University

Abstract

Do bond mutual fund managers shift risk once they become mid-year ‘losers’ or mid-year ‘winners’? In an annual tournament setting whereby managers compete for best performance, I find support that bond mutual fund managers increase risk in the second half of the year in an apparent attempt to increase returns and their relative position in the ‘tournament’ for the year. Fund managers have an incentive to shift risk to attract inflows, reduce outflows, and ultimately increase compensation which has been shown for equity mutual funds. The concave relationship associated with fund flow-performance in bond mutual funds (outflow sensitivity to poor performance is greater than inflow sensitivity to good performance), as opposed to convex for equity mutual funds, should be an extreme incentive for these bond mutual fund managers to avoid being ‘losers’ at the end of the year. This effect is most supported for high-yield bond mutual funds. This paper ultimately provides insight on how managers of bond mutual funds behave in consideration of a tournament setting.

But Wait, There’s More... Debt: The Effects of Pension Overhang on Corporate Policies

Emmanuel Alanis
,
Texas State University
Sudheer Chava
,
Georgia Institute of Technology
Peter Simasek
,
Georgia Institute of Technology

Abstract

We find a reduction in corporate pension liabilities leads to an increase in firm investment
through an overhang channel. We exploit an exogenous, universal increase (decrease) in
discount rates (pension liability) mandated by the Moving Ahead for Progress in the 21st
Century Act (MAP-21) to identify the impact of pension overhang on investment. Control-
ling for investment opportunity, cash flow, and annual pension obligations, we find firms with
large unfunded pension liabilities increase investment by 13% after the imposition of higher
rates. The effects are strongest for firms most likely to suffer from financial constraints,
while pension-related cash flows have minimal impact on investment policy. Our results are
consistent with, and incremental to, the effects of existing measures of debt overhang on
investment.

Capital Adjustment Costs And The Value Premium: A General Equilibrium Perspective

Hengjie Ai
,
University of Minnesota
Anmol Bhandari
,
University of Minnesota
Jincheng Tong
,
University of Minnesota
Chao Ying
,
University of Minnesota

Abstract

We develop a general equilibrium business cycle model that features firm entry and exit to study the implication of capital adjustment costs on the cross-section of equity returns. We show that adjustment cost can lead to a value or a growth premium depending on the relative importance of the two competing economic mechanisms: the cash flow beta channel and the duration channel. We demonstrate the importance of the adjustment cost at the extensive margin of investment in affecting the expected returns of all firms through a general equilibrium effect. When calibrated to the aggregate macroeconomic moments and cyclical properties of firm entry, our model matches well the time-series properties of asset prices at the aggregate level as well as the value premium in the cross section.

Capital Structure under Foreign Competition

Rachel Szymanski
,
Carnegie Mellon University

Abstract

Abstract I investigate how foreign competition influences domestic firm leverage. Empirical work connecting the two is sparse and inconsistent. It is surprising that although the results for how foreign competition influences profitability are unanimously negative, the results for leverage can be positive or negative. To better understand the discrepancy, I build a dynamic capital structure model in industry equilibrium with a trade-off theory leverage decision and foreign competition. Particularly, the model differentiates among two channels underlying foreign competition, increases in foreign competitiveness and reductions in trade policy uncertainty. The first channel implies decreased domestic leverage, so cannot alone match the empirics. However, the second channel can, implying both decreased profitability and increased leverage. Finally, using a new empirical strategy, I find support for the model's predictions on how both channels influence leverage.

CDS Central Counterparty Clearing Liquidation: Road to Recovery or Invitation to Predation?

Magdalena Tywoniuk
,
University of Geneva and Swiss Finance Institute

Abstract

Recent regulation, mandating the clearing of credit default swaps (CDS) by a Central Clearing Counterparties (CCP), has rendered it’s possible failure a serious threat to global financial stability. This work investigates the potential failure of a CCP initiated by the default of a large dealer bank and the unwinding of its positions. The theoretical model examines variation margin exchange be- tween dealer banks and the price impact of liquidation and predatory selling. It provides a measure of covariance between assets in banks’ portfolios; price impact affects assets to varying degrees, based on their relative distance to defaulted assets. Key results show that liquidation lowers CCP profits, and how predation decreases the profits of all members, pushing banks to default. Furthermore, a hybrid CCP (vs. current) structure provides a natural disciplinary mechanism for predation. Also, it is more incentive compatible for the CCP, in expectation of a large loss. A multi-period, dynamic simulation, calibrated to OTC market data, provides parameter sensitivities concerning the magnitude of CCP and predatory bank gains/losses, specifically, the minimisation of those losses with a hybrid fund structure. Furthermore, regulatory implications concerning the timing of liquidity injection for a Lender of Last Resort (LoL) are determined for various liquidity scenarios; stable and decreasing market liquidity, as well as, a liquidity dry-up at the bottom of a financial crisis.

Clustered IPOs as a Commitment Device

Matthias Lassak
,
Frankfurt School of Finance and Management

Abstract

I model the strategic interaction of two underwriters' decisions of accepting IPO mandates of firms with correlated values. Underwriters act as certifiers and increase the perceived value of issuing firms. Investors, however, take the agency conflict associated with the fee paying structure of IPOs into account and discount the offer price accordingly. By timely clustering of related IPOs across different underwriters, investment banks expose themselves to the outcome of other concurrent IPOs which results in a mutual disciplining effect. In this way, underwriters can credibly commit themselves to the marketing of high-value firms only. The model suggests that underpricing levels might be a function of underwriter syndicate composition and provides an agency based rational for the observed cyclicality in IPOs.

Collateral and Asymmetric Information in Lending Markets

Vasso Ioannidou
,
Lancaster University
Nicola Pavanini
,
Tilburg University
Yushi Peng
,
University of Zürich, Swiss Finance Institute

Abstract

We study the benefits and costs of collateral requirements in bank lending markets with asymmetric information. We estimate a structural model of firms' credit demand for secured and unsecured loans, banks' contract offering and pricing, and firm default using detailed credit registry data from Bolivia - a country where asymmetric information problems in credit markets are pervasive. We provide evidence that collateral mitigates adverse selection and moral hazard. With counterfactual experiments, we quantify how an adverse shock to collateral values propagates to credit supply, credit allocation, interest rates, default, and bank profits and how the severity of adverse selection influences this propagation.

Collateral Value and Strategic Default: Evidence from Auto Loans

Dimuthu Ratnadiwakara
,
University of Houston

Abstract

I analyze the impact of changes to collateral value on borrowers' default decision on auto loans using two types of natural experiments in Sri Lanka. Changes in vehicle import tax rates and loan-to-value ratio caps on auto loans generated plausibly exogenous variation in the resale value of vehicles already pledged as collateral. Using proprietary auto loan performance data, I estimate that a 10% drop in the collateral value corresponds to a 44% increase in the default rate. I also find that collateral value is more important for borrowers with higher outstanding loan balances.

Countercyclical Risks and Portfolio Choice over the Life Cycle: Evidence and Theory

Jialu Shen
,
Imperial College Business School

Abstract

I show that countercyclical earnings risk alone can generate moderate stock holdings for young households, while the standard lifecycle models struggle to predict such a realistic age profile of risky share. Moreover, countercyclical earnings risk has quantitatively important effects on saving and portfolio choice decisions over the business cycle. During expansions when expected future earnings growth is high, households save less and also invest a higher share of their financial wealth in the stock market. The opposite holds during recessions. Further negative skewness in the earnings process during recessions additionally reduces households' stock market exposure and consumption. These quantitative predictions are consistent with microeconometric evidence from the Panel Study of Income Dynamics and macroeconometric evidence from the Flow of Funds. Counterfactual simulations using the calibrated model generate wealth inequality dynamics similar to their empirical counterparts.

Credit-Induced Moral Hazard in Insurance

Francis Annan
,
Columbia University

Abstract

I explore the possibility that bundling credit with insurance contracts may amplify moral hazard, with implications for welfare. I evaluate these effects by exploiting unique administrative data on contracts and an insurance policy experiment in Ghana that made it illegal to buy car insurance on credit, creating an exogenous variation in contract choice: consumers responded by switching to contracts with less coverage. Using a model that allows for selection and moral hazard, I show that if contracts with higher coverage only increase claims, a simple difference estimator gives a lower bound on the effect of moral hazard. I combine this result with the contracts data to document evidence of substantial moral hazard effects of bundling and explore some of its implications. For example, I show that, at least in my context, (i) the welfare gains from bundling do not outweigh the losses, and (ii) abstracting from selection while learning about moral hazard leads one to substantially over-estimate its effect.

Currency Carry, Momentum, and Global Interest Rate Uncertainty

Ming Zeng
,
Singapore Management University

Abstract

Currency carry and momentum are among the most popular investment strategies in the foreign exchange market. The carry (momentum) trade buys currencies with high-interest rates (recent returns) and sells those with low-interest rates (recent returns). Both strategies are highly profitable, but little is known on their common risk sources. This paper finds that their high returns are compensations for the risk of global interest rate uncertainty (IRU), with risk exposures explaining 92% of their cross-sectional return variations. Profitability of two strategies also weakens substantially when the global IRU risk is high. The unified explanation stems from its superior power of capturing the crashes of carry and momentum, which usually occur during bad and good market states. An intermediary-based exchange rate model confirms the negative price for the global IRU risk. Higher uncertainty tightens intermediary's financial constraints and triggers unwinding on long and short positions. High (low) carry and momentum currencies then realize low (high) returns as they are on the long (short) side of intermediary's holdings. Further empirical evidence indicates that the explanatory power for momentum extends to other asset classes, suggesting a risk-based explanation for the commonality of momentum returns.

Debt Holder Monitoring and Implicit Guarantees: Did the BRRD Improve Market Discipline?

Jannic Alexander Cutura
,
Goethe University

Abstract

This paper argues that the introduction of the Banking Recovery and Resolution Directive (BRRD) improved market discipline in the European bank market for unsecured debt. The different impact of the BRRD on bank bonds provides a quasi-natural experiment that allows to study the effect of the BRRD within banks using a difference-in-difference approach. Identification is based on the fact that (otherwise identical) bonds of a given bank maturing before 2016 are explicitly rotected from BRRD bail-in. The empirical results are consistent with the hypothesis that debt holders actively monitor banks and that the BRRD diminished bail-out expectations. Bank bonds subject to BRRD bail-in carry a 0.1 percentage point bail-in premium in terms of the yield pread. This bailin premium is more pronounced for non-GSIB banks and weaker capitalized banks.

Depositors Disciplining Banks: The Impact of Scandals

Mikael Homanen
,
Cass Business School

Abstract

Do depositors react to negative non-financial information about their banks? By using branch level data for the U.S., I show that banks, that financed the highly controversial Dakota Access Pipeline, experienced significant decreases in deposit growth, especially in branches located closest to the pipeline. These effects were greater for branches located in environmentally or socially conscious counties and data suggests that savings banks were among the main beneficiaries of this depositor movement. Using a global hand-collected dataset on tax evasion, corruption and environmental scandals related to banks, I show that negative deposit growth as a reaction to scandals is a more widespread phenomenon.

Disaster Risk and International Capital Flows

Mihir Gandhi
,
University of Chicago

Abstract

What drives the flow of capital between countries? In this paper, I argue that gross and bilateral international capital flows are driven by disaster risk. I hypothesize that capital flows move from more to less risky countries and find strong empirical support for this prediction in the data. I use options on country indexes to measure country-specific disaster risk. I find that an increase in country-specific disaster risk predicts an increase in gross outflows and a decrease in gross inflows. This predictability is largely driven by debt-based flows and non-U.S. countries, which is consistent with the large literature on the special role of the U.S. in the global economy. Regressions with bilateral banking flows largely tell a similar story. The effect remains robust to inclusion of a variety of other proxies for global and country-specific risk.

Asset purchase programs, leveraged firms and spillovers to competitors

Talina Sondershaus
,
Halle Institute for Economic Research

Abstract

Large scale asset purchase programs might have unintended side-effects on small and medium enterprises (SMEs). By exploiting the first large scale asset purchase program of the ECB, this paper links asset purchases and bank lending as well as spill-over effects on German firms. Estimations show that medium and highly leveraged firms connected to weak banks show larger borrowings. I find spill-over effects to competitors: Highly leveraged firms which do not benefit from the program and operate in the same region show lower investment activities. The asset purchases seem to contribute to a cleansing effect. However, these results do not hold for regions with low unemployment rate, where competition for resources is high between firms. Here, the lowly leveraged firms show lower investment activities as a response.

Does Public News Mitigate The Markets' Underreaction to Liquidity Shocks_Dong

Mengming Dong
,
Rice University

Abstract

There is evidence that equity markets underreact to liquidity shocks. In this paper, I examine whether the presence of firm-level public news mitigates such underreaction. I use comprehensive news data and find that when there is important public news released in the same months of the liquidity shocks, the price discovery process of liquidity shocks does not get any faster. In certain tests, the drift is actually significantly larger. This shows that even though public news reveals more information to investors and draws more investor attention, it does not help investors incorporate liquidity shocks into prices. If anything, public news only aggravates the market’s underreaction to liquidity shocks. This provides evidence that liquidity level overall is difficult for average investors to grasp.

Effectiveness and (In)Efficiencies of Compensation Regulation: Evidence from the EU Banker Bonus Cap

Stefano Colonnello
,
Halle Institute for Economic Research
Michael Koetter
,
Halle Institute for Economic Research
Konstantin Wagner
,
Halle Institute for Economic Research

Abstract

We investigate the (unintended) effects of bank executive compensation regulation. Capping the share of variable compensation did not induce an executive director exodus from EU banking because banks raised fixed compensation sufficiently to retain executives. However, risk-adjusted bank performance deteriorated, consistent with reduced incentives to exert effort and insurance effects associated with fixed compensation components. We also find that banks with directors that are more affected by the bonus cap exhibit more systemic as well as systematic risk. This result casts doubts on the effectiveness of the policy to achieve its aim to enhance financial stability.

Explaining the Pre-Announcement Drift

Paula Cocoma
,
INSEAD

Abstract

I propose a theoretical explanation for the puzzling positive pre-announcement drift that has been empirically documented to occur before scheduled announcements, using as main example the drift before the Federal Open Market Committee (FOMC) meetings. I construct a general equilibrium model of disagreement (difference-of-opinion) where two groups of agents react differently to the information released at the announcement and also to signals regarding this information available between two announcement dates. In contrast to traditional asset pricing explanations, this model matches consistently key empirical facts such as (1) the upward drift in prices just before the announcement, (2) lower risk (price volatility) before the announcement, followed by higher risk after the announcement, and (3) low (high) trading volume before (after) the announcement.

Flight to “Futures” During the Financial Crisis: Deliverability Through Central Counterparties

Takahiro Hattori
,
Ministry of Finance Japan, Hitotsubashi University

Abstract

This is the first paper to empirically evaluate the role of central counterparties (CCPs) in the over-the-counter market during the 2008–2009 financial crisis. Taking advantage of the physical settlement of Japanese government bond (JGB) futures, we focus on the institutional linkage between 7-year JGBs and JGB futures, which enables investors to clear their cash bonds through CCPs. To identify the premium on the settlements through CCPs, we compare 7- and 6-year JGBs, which generate almost the same cash flow except in their linkage to JGB futures, and empirically show that the special premium on the linkage clearly emerged only during the crisis and is significantly related to physical settlements through CCPs.

Founder CEO Effect Under Macro-uncertainty

Masud Karim
,
Temple University

Abstract

This paper examines how do founder CEOs react differently under high uncertainty and how does that affect firm performance. Using data of Russell 3000 firms for the period 2001-2015, I document that on an average founder-CEO led firms perform inferior to professional-CEO led firms; however, founder-CEO leadership has strong positive impact under high macro-uncertainty. Lower private rent extraction and increased value of information advantage during high uncertainty are two main channels through which founder leadership enhance firm value. Exploiting an instrumental variable approach based on fraction of founders' death prior the sample period, my results are robust to endogeneity concerns. The findings highlight that the implications of top management mismatch or misalignment is critical, and especially at bad times.

FX Premia Around The Clock

Ingomar Krohn
,
Copenhagen Business School
Philippe Mueller
,
University of Warwick
Paul Whelan
,
Copenhagen Business School

Abstract

We dissect return dynamics in the foreign exchange market into high-frequency components over the 24-hour day. Using twenty-four years of data on G10 currencies we unveil a distinct `W' intraday pattern of returns to the dollar portfolio. We show that positive average returns for going long foreign currencies are almost entirely generated during U.S. main trading hours, whereas currencies collectively depreciate against the U.S. dollar overnight. Moreover, we document that 75% of the HML portfolio returns from a standard carry trade strategy and almost 80% of dollar carry returns are generated during the U.S. trading day. Finally, we show that our main result may be exploitable by investors that are able to benefit from lower than average transaction costs.

Hedge Fund Activism and Capital Structure

Lin Ge
,
University of Mississippi
Abhishek Ganguly
,
Indiana University

Abstract

Using a comprehensive pooled sample of hedge fund activism spanning over two decades (1994-2014) in the U.S., and firms matched on observable characteristics by closest propensity scores, we study whether hedge fund activists influence the capital structures of targeted firms to create value. We find that over-levered firms are more likely to be targeted. We further document that there is a significant positive association between firms’ distance away from the target leverage and their likelihood of being targeted by an activist hedge fund when the firm is over-levered. However, when the firm is under-levered, such relation is negative, indicating that activists also value financial flexibility. Moreover, in a difference-in-differences set-up, when compared to a propensity score-matched cohort, we find that the firms reduce the distance from their long-run target capital structure post-hedge fund activist intervention when the firm is over-levered but not when they are under-levered. Our findings are broadly consistent with the dynamic trade-off models of capital structure, where adjustment costs and financial flexibility considerations play a key role and provide empirical evidence on the positive impact of hedge fund activists on their investee firms’ capital structures. Such findings are not driven by asset sales, wealth transfer from bondholders to stockholders, enhancing dividends via leverage and are robust to alternative explanations such as mechanical mean reversion of leverage and hedge funds’ stock picking skills.

Heterogeneous Intermediary Capital and the Cross-Section of Stock Returns

Sang-Ook (Simon) Shin
,
Texas A&M University

Abstract

This paper examines how heterogeneity in intermediary capital - the equity capital ratio of the largest financial intermediaries in the U.S. - affects the cross-section of stock returns. I estimate the exposure (i.e., beta) of individual stocks to a shock in the dispersion of intermediary capital and find that stocks in the lowest beta decile generate an additional 6.8% - 8.2% annual return relative to stocks in the highest beta decile. Using data from Institutional (13F) Holdings, I also find evidence that low-capital intermediaries, who hold riskier assets than high-capital intermediaries, face leverage-induced fire sales during bad times. I propose a model of heterogeneous intermediary capital in which heterogeneous risk preference between high- and low-capital intermediaries leads to a countercyclical variation in aggregate risk aversion and a risk premium. The model states that the dispersion of intermediary capital is priced in the cross-section of asset prices, which supports the empirical findings.

Heterogeneous Information Content of Global FX Trading

Angelo Ranaldo
,
University of St. Gallen
Fabricius Somogyi
,
University of St. Gallen

Abstract

This paper studies the information content of trades in the world's largest over-the-counter market, the foreign exchange (FX) market. The results are derived from a comprehensive order flow dataset distinguishing between different groups of market participants and covering a broad cross-section of currency pairs. Our findings show that both the contemporary and permanent price impact are heterogeneous across agents, time, and currency pairs, supporting the asymmetric information theory. A trading strategy based on the permanent price impact capturing superior information generates high returns even after accounting for risk, transaction costs, and other common risk factors documented in the FX literature.

Hidden Predictability

Tomas Fiala
,
University of Lugano (USI), Swiss Finance Institute

Abstract

I decompose stock market return into return on a portfolio of dividend futures and a portfolio of bonds to study predictability. Stock market return predictability is weakened by presence of the portfolio of bonds and is driven by the portfolio of dividend futures. Returns on the dividend futures portfolio can be predicted with higher statistical and economic significance than the stock market returns. This is because predictability of the dividend futures portfolio is partially cancelled out by the portfolio of bonds that loads on dividend-price ratio with the opposing sign. Moreover, the dividend futures and bond portfolios respond to different sources of risk. Therefore, instead of asking whether stock market returns predictable, we should ask which component of the returns is predictable and what is the relevant source of risk.

Risk Management and Capital Budgeting: Evidence from Project-Level Discount Rate

Paul Decaire
,
University of Pennsylvania

Abstract

I use a detailed and comprehensive project-level dataset to investigate how managers assess project risks. Exploiting a revealed preference strategy, I extract firms' project-specific implied discount rate and examine if their behavior is consistent with core corporate finance predictions. Using variation in the level of their potential projects' idiosyncratic risk, I document that, on average, firms inflate their discount rate in projects facing a high level of idiosyncratic risk. In a second step, I document a channel - firm hierarchical structure - that affects how managers price idiosyncratic risk.

How Reverse Merger Firms Raise Capital in PIPEs: The Role of Placement Agent Reputation and Stage Financing

Yini Liu
,
University of Texas at San Antonio

Abstract

We analyze private investments in public equity (PIPE) deals of private firms that went public via a reverse merger (RM) between 2008 and 2016. We examine the effect of placement agent reputation on PIPE contract design and PIPE stage financing. Our findings imply that RM firms advised by expert placement agents offer more investor-friendly PIPE contract terms. However, different from the prior literature based on the PIPEs of mostly mature public firms, RM issuers are not able to negotiate higher offer prices when they agree to more investor-friendly contract terms. Our results are consistent with the hypothesis that expert agents exercise more bargaining power relative to PIPE issuers than non-expert agents. Further, we find that the expertise of placement agents in RM firms’ PIPEs is negatively related to stage financing, which suggests a substitution effect between placement agent certification and monitoring by PIPE investors. Finally, we find that the PIPEs of RM firms offer more investor-friendly contract terms, are more likely to involve stage financing, and have greater offer price discounts than those of matched IPO firms. This suggests that raising new equity capital in PIPEs entails significantly higher costs for RM firms than IPO firms.

Immigration Policy and Equity Returns: Evidence from the H-1B Visa Program

Ali Sharifkhani
,
University of Toronto

Abstract

I show that firms' access to skilled immigrant labor is an important determinant of the cross-section of equity returns. Using a comprehensive set of data on H-1B visa petitions, I construct an occupation-level measure of labor market competition between skilled immigrant and local workers. I find that stocks of firms in high-competition industries - those with a high share of labor for which skilled immigrants are close substitutes - outperform their peers with a low share. I show that this premium is explained by firms' differential exposures to priced immigration policy shocks that shift the supply of skilled immigrant labor. Based on evidence from the 2003 H-1B legislative cap reduction as a natural experiment, I show that these shocks differentially impact wages at the occupation-level, leading to an asymmetric effect on firms' cash flows through labor expenditure.

Implied Volatility Spread, Options’ Greeks and the Cross-Section of Stock Returns

Boris Fays
,
HEC Liège

Abstract

This paper examines the relation between the information contained in the two first Greeks of options - Delta and Gamma - and the pricing of stocks. More precisely, I sort the cross section of US equity stocks on a Probability Adjusted Implied Volatility Spread (PAVS), defined as the difference between the ratio Delta/Gamma of a zero-beta straddle strategy. I show that a zero-cost trading strategy on this simple measure provides statistically significant average monthly returns. This measure improves the spread from the deviation of the Put-Call parity of Cremers and Weinbaum (2010) as it implicitly retrieves the probability distribution of a stock return, contained in the Black-Scholes model, to get the views of market participants about future stocks prices.

Information Choice, Uncertainty, and Expected Returns

David Gempesaw
,
Pennsylvania State University

Abstract

In this paper, I test the rational expectations equilibrium model of information choice and investment choice developed by Van Nieuwerburgh and Veldkamp (2010). By estimating a variable from the model called the learning index, I introduce a new approach to empirically measure investors’ information choices and assess the effects of these choices. I find negative cross-sectional relationships between the learning index and expected stock returns and volatility. In addition, the learning index is associated with proxies for information demand and the amount of information in prices. Taken together, my findings provide evidence in support of the model’s predictions.

(In)frequently Traded Corporate Bonds

Alexey Ivashchenko
,
University of Lausanne, Swiss Finance Institute
Artem Neklyudov
,
University of Lausanne and Swiss Finance Institute

Abstract

We study a large group of bonds that experience substantial and long-lasting swings in trading activity. We call these bonds (in)frequently traded. They are similar to other bonds in primary bond characteristics, and publicly observed changes in these characteristics do not explain the swings in trading activity. We link jumps in trading activity of (in)frequently traded bonds to mutual fund rebalancing and document that more active trading in these bonds is associated with positive abnormal returns, but only after the 2008 crisis. Our results suggest that returns are due to growing mutual fund demand for (in)frequently traded bonds amid limited post-crisis secondary market supply, but the exact forces behind abnormal returns largely remain a puzzle.

Innovation Awards, Product Segmentation, and Stock Returns

Po-Hsuan Hsu
,
The University of Hong Kong
Yiming Yang
,
The University of Hong Kong
Tong Zhou
,
Sun Yat-Sen University

Abstract

This paper connects technological innovation to product market segmentation using a prestigious award for technology breakthroughs in product inventions: the R&D 100 Award. We argue that award-winning outcomes have asset pricing implications because awarded firms have the growth opportunities to promote their products to high-end markets, which increases revenue procyclical to aggregate consumption and results in higher systematic risks. We find that, compared with their matched industry counterparts, awarded firms are associated with lower product similarity, lower product fluidity, and higher profitability over the future five years. Moreover, these firms outperform their comparable peers by 3% in annual returns and have both significantly higher procyclicality of sales growth and market betas. Moreover, the award-return relation is more pronounced in periods of higher aggregate consumption growth and among firms with higher R&D investments.

Institutional Investors and the Time-Variation in Expected Stock Returns

Rüdiger Weber
,
University of Michigan

Abstract

I document a new stylized fact: the higher the share of institutional ownership in a stock, the more its price-dividend ratio is driven by discount rate variation rather than by changes in dividend growth expectations. Hence, the dividend-price ratio of stocks with high institutional ownership predicts returns. Conversely, for stocks held mostly by individual investors, returns are not predictable. As a general equilibrium outcome, return predictability crucially depends on the properties of the marginal investor. More strongly time-varying volatility in the marginal utility of institutions acting as marginal investors in the respective stocks provides a natural explanation for the observed pattern. In an equilibrium model, time-varying redemption risks generate the observed predictability patterns among a priori identical stocks. My findings help explain the weak return predictability of small and value stocks, the postwar predictability reversal, and the fact that dividend smoothing cannot explain that reversal.

Interdealer Networks in Corporate Bond Trading and Market Liquidity

Monica Petrescu
,
University of Cambridge

Abstract

This paper considers the role of the interdealer network as a potential channel for the transmission and amplification of the effect of changes in microstructure on liquidity available for customers; changes in the number and type of active dealers affect the dynamics of the interdealer network and thus intermediation costs for market makers. Using transaction-level data for US corporate bond trading with dealer identifiers, we characterize market liquidity and the network topology of the interdealer market from before the 2008 financial crisis to today. Lower prevalence of block trades, decrease in trade size, and higher bid-ask spreads indicate a decrease in customers' ability to transact large amounts quickly. A 50% increase in the number of small dealers and decreased reliance on core dealers drive the evolution of intermediation patterns in the interdealer market. We find that the placement of a dealer in the interdealer network -- quantified by indicators of fragmentation, neighbor quality, influence, and connectivity -- affects her liquidity supply to customers. Fragmentation leads to lower trade sizes and fewer block trades, but lower bid-ask spreads for retail trades. Neighbor quality is an important determinant of the quality of customer liquidity supplied by peripheral dealers. There is some evidence that dealers with a higher influence over their neighbors charge lower bid-ask spreads to customers.

Investment Tax Credits and Innovation

Yao Lu
,
Tsinghua University
Xinzheng Shi
,
Tsinghua University
Yeqing Zhang
,
Tsinghua University

Abstract

We study the effects of the reform on value-added tax credit on investment in China in 2004, which reduces the relative price of fixed investment of the eligible firms. The difference-in-difference-in-differences (DDD) estimation results show that the reform significantly increases firms’ capital expenditures on fixed assets, but decreases R&D investment, resulting in lower innovation. More importantly, the results show that the impacts of the reform on innovation are stronger for financially more constrained firms, non-SOE firms, and domestic firms. These findings suggest that financial constraints can affect the impacts of investment tax credits on innovation, and there might be some unintended consequences of enhancing investment tax credit.

Investor Behavior at the 52 Week High

Josh Della Vedova
,
University of Sydney Business School
Andrew Grant
,
University of Sydney Business School
P. Joakim Westerholm
,
Discipline of Finance

Abstract

We extend upon the previous studies of the 52 week high and explain how household disposition effect and anchoring behavior is responsible for both the volume spikes at the 52 week high and the return continuation following it. Our data set allows recognition of household and institutional stock trading, from which we show households strongly sell with latent limit orders placed at the 52 week high price. This behavior is strengthened when the high is more salient and with market wide uncertainty. This household limit order selling provides the liquidity for the post event momentum style returns we see following the 52 week high. This anchoring behavior is very costly to households and fruitful to institutions who act as the counter-party to these trades.

The effect of pro-environmental preferences on bond prices: Evidence from green bonds

Olivier David Zerbib
,
Tilburg University

Abstract

We use green bonds as an instrument to identify the effect of non-pecuniary motives, specifically pro-environmental preferences, on bond market prices. We perform a matching method, followed by a two-step regression procedure, to estimate the yield differential between a green bond and a counterfactual conventional bond from July 2013 to December 2017. The results suggest a small negative premium: the yield of a green bond is lower than that of a conventional bond. On average, the premium is -2 basis points for the entire sample and for euro and USD bonds separately. We show that this negative premium is more pronounced for financial and low-rated bonds. The results emphasize the low impact of investors' pro-environmental preferences on bond prices, which does not represent, at this stage, a disincentive for investors to support the expansion of the green bond market.

Learning and the Capital Age Premium

Kai Li
,
Hong Kong University of Science and Technology
Chi-Yang Tsou
,
University of Hong Kong
Chenjie Xu
,
Hong Kong University of Science and Technology

Abstract

This paper studies the implications of parameter learning on the cross-section of stock returns. We propose a production-based general equilibrium model to study the link between capital age, timing of cash flows and expected returns in the cross-section of stocks. Our model features slow learning about firms' exposure to aggregate productivity shocks over time. Firms with old capital are assumed to have more information about their exposure than firms with young capital. Our framework provides a unified explanation of the following stylized empirical facts: old capital firms (1) have higher capital allocation efficiency; (2) are more exposed to aggregate productivity shocks and hence earn higher expected returns, which we call it the capital age premium; (3) have shorter cash-flow duration, as compared with young capital firms.

Managerial Short-Termism and Market Competition

Yan Xiong
,
University of Toronto

Abstract

This paper studies stock-based executive compensation in an entry game, where two publicly-traded firms, each run by a manager, simultaneously decide whether or not to enter a market. The paper shows that although short-term concerns induce managers to behave myopically, the two firms may find it optimal to reward their managers based on short-term stock performance. By emphasizing short-term stock prices in the compensation contract, a firm commits to an aggressive entry strategy and obtains a competitive advantage over its rival. However, such equilibrium is a Prisoner's Dilemma for the firms. Overall, this paper provides a new perspective of managerial short-termism with testable empirical implications.

Managers' Gender Norms and the Gender Gap

Maddalena Ronchi
,
Queen Mary University of London

Abstract

Do managers’ gender attitudes shape gender-gaps within firms? To answer this question, we build on sociological work showing that a child’s gender influences parental attitudes towards women, and we extend it to the context of human resource management. Using social-security data from Denmark on the population of establishments and managers, we show that in establishments where managers parent an additional daughter labor market outcomes of female employees improve. This result is driven only by male managers and it is stronger for those who are also owners of the establishments. Further, it holds both cross-sectionally and when we exploit birth events within manager-establishment spells. In particular, we find that the female share of the firm wage bill increases by 1.3 percentage points following the birth of a daughter, as opposed to a son. The estimated effect on the female wage bill share is explained both by a rise in the female employment share - in turn driven by a higher propensity to hire women - and an increase in female wages. Our next step is to test the effect of this exogenous improvement in female labor market outcomes - induced by fathering more daughters - on firm performance.

Media and Shareholder Activism

Abhishek Ganguly
,
Indiana University

Abstract

Using more than twenty-five million firm-level articles published in the media, I examine the role of media in shareholder activism events during the years 2002-2014. I find that conditioning on numerous observable firm-specific characteristics and unobservables, broader and negative ex-ante media coverage is positively associated with the probability of a firm being a shareholder activist’s target. The positive correlation between media coverage and the propensity for targeting by activists is robust to the use of instrumental variable (IV) approach indicating that the documented relation is plausibly causal. The association between negative media tone and activism is stronger during the times of greater divergence of opinion about the firm amongst analysts. However, during times of overall low sentiments, the shareholder activists become less sensitive to media tone. I further document that media coverage also plays a crucial role in determining the outcomes of activism events. Target firms with ex-ante positive media coverage not only have significantly lower announcement returns but also have a higher likelihood of management winning. Overall, the results provide empirical evidence for the linkage between shareholder activism and limited investor attention and investor opinion, as suggested by theories.

Monetary Policy and Corporate Bond Fund Fragility

Jinyuan Zhang
,
INSEAD

Abstract

This paper examines the effects of monetary policy on the fragility of U.S. corporate bond mutual funds.
We empirically show that, despite better funds' performance, loose monetary policy exacerbates the fragility of corporate bond funds, measured by the sensitivity of outflows to negative performance.
We rationalize this phenomenon through a global game model with an endogenous liquidity risk premium.
In the equilibrium, liquidity risk is compensated but strategic complementarity discount is not.
In a relatively liquid market where complementarity discount is modest, the discounted fund return decreases faster when lowering the interest rate, incentivizing investors to run from the fund.
Moreover, the model predicts that in a liquid (illiquid) market, the fund becomes more (less) fragile as monetary policy uncertainty increases.
Our empirical analysis supports these predictions. The results highlight the unintended impacts of monetary policy on the asset management sector.

Mutual Fund Redemptions in Kind

Honglin Ren
,
Georgia State University

Abstract

Open-end mutual funds can use redemptions in kind to meet investor redemption requests by delivering securities they hold in lieu of cash. Such a tool can mitigate the need of asset fire sales when a fund faces large redemption requests. I show that asset illiquidity is a factor associated with the likelihood of using redemptions in kind. Redemptions in kind reduces investors’ run-like behavior in illiquid funds. However, it also reduces investors’ sensitivity to good performance. Facing a large outflow, redemptions in kind helps mitigate price pressure on the stocks held by a fund and improves the fund’s performance. I further document that funds tend to deliver illiquid securities and securities with accumulated capital gains in redemptions in kind.

On the Stock Market Variance-Return or Price Relations: A Tale of Two Variances

Hui Guo
,
University of Cincinnati
Qian Lin
,
Wuhan University
Abby Pai
,
University of Cincinnati

Abstract

Stock market variance-return or price relations are sometimes negative and sometimes positive.
We explain these puzzling ndings using a model with two variances, "bad" and "good". In the
model, conditional equity premium depends positively on bad variance and negatively on good
variance. Market prices, which correlate negatively with discount rates, decrease with bad variance
and increase with good variance. Because market variance is the sum of bad and good variances,
its relation to conditional equity premium or market prices can be negative or positive, depending
on the relative importance of two variances. Our empirical results support the model's main implications.

On the Stock Return and Investment Return Correlation Puzzle

Yao Deng
,
University of Minnesota
Frederico Belo
,
INSEAD, University of Minnesota and NBER

Abstract

This paper addresses and tackles two issues in investment-based asset pricing: the stock return and investment return correlation puzzle and the structural estimation of the model. (i) Neoclassical Q theory of investment predicts the state by state equivalence between firm's investment return and stock return, thus perfect correlation. However, in the data, the correlation is slightly negative. We simulate firm characteristics and stock returns data from investment models and estimate the (misspecified) Q theory model. We study how time aggregation, portfolio aggregation and model misspecification impact stock and investment return correlation. (ii) We propose new portfolio aggregation methods that recover true structural parameters and generate more stable point estimates. (iii) More importantly, traditional test of investment-based asset pricing model using generalized method of moments is weak and we propose more powerful econometric tests.

Partial Moment Momentum

Yang Gao
,
University of Sydney Business School
Henry Leung
,
Sydney University
Stephen Satchell
,
University of Cambridge

Abstract

While momentum profits benefit from persistent trends of the market, which can be predicted by market volatility, such strategies are unable to distinguish between upside and downside risk and suffer consequently. We propose partial moments-based momentum trading strategies and find that they outperform plain momentum and volatility-adjusted momentum strategies. We find strong outperformance for them during states of market downturn. The outperformance is robust across different time periods. Furthermore, analysis, based on conventional factor risk, shows little to no exposure for our preferred portfolio.

Peer Information in the Cost of Debt

Yangming Bao
,
SAFE and Goethe Univsersity Frankfurt

Abstract

This paper studies how peer information impacts bank lending behavior and firms’ cost of debt. Using syndicated loan data, I find that firms obtain lower loan rates when borrowing from banks that lent to their peers in previous years. The benefit in loan rates increases with firm and peer group similarity and with firm opacity. To establish a causal interpretation of peer effects in loan pricing, I use class action litigation records and find the benefit diminishes when peers in bank portfolio committed financial mis- conduct, conditional on a wide cross-section of firm characteristics. The increased loan rates concentrate on firms that are harder to switch banks, indicating the possibility that banks take the advantage of peer information deterioration to extract rent.

Pension Funds Interconnections and Herd Behavior

Matteo Bonetti
,
Maastricht University

Abstract

We use a unique dataset on the governance structures of 191 Dutch pension funds to study the effect of interconnections on strategic investment decisions in alternative assets. The interconnections are determined through trustees, actuaries, or dominant asset managers who provide services to multiple pension funds. We use spatial econometrics and find that pension funds that are interconnected via actuaries or dominant asset managers change their strategic allocations in the same direction over time, which is in line with herding. The effect of interconnections can be sizable. A pension fund interconnected to two other pension funds through the same dominant asset manager will increase on average its allocation to alternative investments by 2.5 percent if both pension funds increase their allocation by 10 percent, all else being equal. Conversely, pension funds interconnected via trustees display independent strategic asset allocations. Interconnections facilitate the transfer of information. However, herding can lead pension funds to develop an alternative asset class portfolio that is not in line with their liability structure, size, or knowledge level.​

Policy Uncertainty and Household Credit Access: Evidence from Peer-to-Peer Crowdfunding

Xiang Li
,
Tsinghua University
Bibo Liu
,
Tsinghua University
Xuan Tian
,
Tsinghua University

Abstract

This paper studies how policy uncertainty affects household credit access. Using crowdfunding data from a major peer-to-peer (P2P) crowdfunding platform, Prosper.com, and a news-based policy uncertainty index developed by Baker, Bloom, and Davis (2016), we find that policy uncertainty negatively affects households’ access to small loans. Using an instrument variable approach and the difference-in-differences approach relying on plausibly exogenous variation in policy uncertainty generated by gubernatorial elections, we show that the relation is likely causal. Investors’ increased caution on deal selection and enhanced value of the “wait-and-see” option appear two plausible underlying channels through which policy uncertainty affects P2P crowdfunding. Further evidence suggests that policy uncertainty increases loan interest rates and default probabilities.

Predictable Downturns

Carter Davis
,
University of Chicago

Abstract

Eugene Fama stated in his Nobel Prize lecture that “there is no statistically reliable evidence that expected stock returns are sometimes negative” (2013). However, various theoretical models such as Barberis et al. (2015) and Barlevy and Veronesi (2003) imply that expected stock returns are sometimes negative. This paper provides evidence that expected excess aggregate stock market returns are sometimes negative, and that portfolios composed of the most liquid stocks have predictable downturns as well. This paper presents a forecasting model that relies exclusively on ex-ante information to predict stock market downturns only when the day-prior confidence of a downturn is relatively high, and shows that the average excess return on days which are predicted to be downturns by the forecasting model is -13.9 basis points. Volatility and classic factor return variables alone are sufficient to predict downturns in the sample and are the most powerful downturn predictors. A market timing portfolio using these ex-ante predictions generates a risk-adjusted return of 3.5 basis points per day, annualized to an average 8.8% risk-adjusted return.

Predicting the Equity Premium with Implied Volatility Spreads

Charles Cao
,
Pennsylvania State University
Tim Simin
,
Pennsylvania State University
Han Xiao
,
Pennsylvania State University

Abstract

This paper is an empirical investigation of the predictive ability of the call-put implied volatility spread (CPIVS). In out-of-sample tests, the CPIVS outperforms well-known predictors of equity premium such as the dividend yield, stock return variance, term spread, and Cay. Specifically, we find that (1) the CPIVS attracts most investors’ attention according to willing-to-pay for predictive information based on utility gains; (2) the prediction is robust and consistent with common risk factors and different portfolios, and (3) the CPIVS can survive in various specifications and is unbiased in finite samples. Furthermore, we attribute the powerful prediction to the forward-looking information within the CPIVS, in the channel of discount rate and cash flow, as well as the moment risk in the market returns.

Option-Implied Surplus Consumption

Alexander Kontoghiorghes
,
Queen Mary University of London

Abstract

I use index prices and options to estimate the pricing kernel's elasticity, which approximates the fundamental component of Campbell and Cochrane (1999), the surplus consumption ratio. The approximation relies on an empirically motivated, time-varying relationship between consumption growth and the expected returns on market wealth, therefore avoiding problematic consumption data. I show that my estimate of the surplus consumption ratio: predicts future excess market returns, is highly correlated to business cycle variables and the SVIX of Martin (2017), and is priced in a cross-sectional analysis of equity returns. The results provide new empirical support for consumption-based asset pricing models.

THE FAILURE OF THE BALANCED CONDITION IN THE NATURAL EXPERIMENT DESIGN

Chen Wang
,
Australian National University

Abstract

One important task in economics and finance studies is establishing causal inference. Given the obstacles of obtaining reliable instrumental variables, methodologies such as ordinary least squares (OLS) that fall under the umbrella of natural experiments by taking advantage of exogenous events are becoming prominent, without questioning on the balanced condition hypothesis. One empirical problem with these methodologies is that the treatment assignment is not random, which is characterized by non-balanced covariates across the treatment and control groups. This problem is often not obvious to researchers, and they may infer causality when in fact none may exist. By employing the examples from influential journals, we show that the causal inferences from the natural experiment studies may change after we deal with the imbalanced condition problem. We argue that the data quality will affect the estimates of the treatment effect: a better-balanced dataset will require fewer matching activities, in doing so, the estimation results after dealing with the imbalanced condition problem become less volatile compared with those from low quality dataset. Notwithstanding the popularity of nature experiment technique, according to our knowledge, such results are not available in the previous literature.

Product Market Competition and Corporate Governance: Substitutes or Complements? Evidence from CEO Duality

Haofei Zhang
,
University of Toronto

Abstract

This paper examines the phenomenon that firms in industries with high competition can benefit from good corporate governance. By analyzing the market reaction to CEO/chairman consolidation announcements, I find that the market reacts positively to consolidation events if the announcing firm has strong governance and is facing high product market competition. The benefit of CEO duality comes from the efficiency gain in the management, and is positively related to market competition. Only firms with strong governance can capture this benefit. Market reaction is negligible for firms with weak governance and for firms facing low competition. Overall, my results suggest that product market competition and corporate governance are complements for firms that want to gain managerial efficiency by granting the CEO additional power. A one-size-fits-all board structure is not appropriate for all firms. The board needs to carefully weigh the costs and benefits of CEO duality when making this decision.

Quantitative Easing, Bank Reserves, and Deposit Rates

Gursharan Bhue
,
University of Chicago

Abstract

Using cross-sectional heterogeneity in bank's exposure to large-scale asset purchases, as measured by the relative prevalence of mortgage-backed securities on their books, this paper finds that unconventional monetary policy shocks affect long-term deposit rates in the economy. Using a difference-in-differences identification strategy, this paper finds strong effects of the first round of quantitative easing (QE1) on the long-maturity (one to five year) certificate of deposit rates. Highly affected commercial banks decrease their CD rates by 30 to 75 basis points relative to their counterparts. Later rounds of QE (QE2 and QE3) does not seem to have a significant impact. Overall, the evidence is in support of the Reserve-induced balance-sheet channel of unconventional monetary policy transmission, as opposed to the other deposit demand-side factors. The paper highlights an important channel by which reserves affect deposit prices and has implications for monetary policymaking.

Non-bank loans, corporate investment, and firm performance

Junyang Yin
,
University of Bristol

Abstract

We examine the post-loan outcomes of firms borrowing from non-bank institutions in the US syndicated loan market. We compare non-bank borrowers with observably similar bank borrowers. For the sample of leveraged loans, non-bank borrowers have worse profitability and lower investments following loan origination. Non-banks are more likely to impose covenants restricting investments; if strict, these restrictions lead to lower profitability. Additionally, we exploit two exogenous shocks which affected the bank vis-à-vis non-bank lending environment in different ways. First, we show that the leveraged borrowers of non-banks are more severely affected than leveraged bank borrowers during the financial crisis. Second, we find that the leveraged lending guidance, which encouraged banks to reduce lending to leveraged borrowers, had an adverse effect on the profitability of the affected firms. Our findings are consistent with the view that, as the lenders of last resort, non-banks extract rents from borrowers with limited access to external finance.

Reference-Dependent Return Chasing

Fabian Brunner
,
University of Mannheim

Abstract

The performance-flow relation in mutual funds is mediated by the gains and losses investors hold a fund at. The chasing of past abnormal performance gets strongly attenuated and convexity is eliminated if the average investor holds the fund at a loss. Thus, fund investors distinctly react to an interaction between abnormal performance and gains and losses after controlling for the respective base effects. This interaction is not an artifact of omitted residual information or non-linearity. The empirical patterns support ambiguity induced by conflicting information and the social transmission of investment opportunities as explanations.

Regulatory Cliff Effects and Systemic Risk

Andreas Brøgger
,
Copenhagen Business School
Graeme Cokayne
,
Danmarks Nationalbank

Abstract

We identify systemic risks arising from regulatory cliff effects. Regulatory cliff effects lead to sudden discrete changes to asset properties, causing financial agents to act simultaneously in a homogeneous way, exacerbating systemic risk. We develop a model which quantifies these effects, and find that under certain circumstances, even small changes have drastic consequences. Taking the model to the data, we find that current market measures imply that the circumstances are satisfied for the Danish financial system. The model thus sheds light on the consequences of the regulation implemented since the Great Recession, given scenarios not yet empirically observable.

Reshaping the Financial Network: Externalities of Central Clearing and Systemic Risk

Olga Briukhova
,
University of Zurich, Swiss Finance Institute
Marco D'Errico
,
European Systemic Risk Board
Stefano Battiston
,
University of Zurich

Abstract

Meant to limit systemic risk and ensure transparency, the mandate to clear spe- cific transactions via central clearing counterparties (CCP) is at the heart of the following the crisis regulatory reforms and leads to the reshaping of the over-the- counter (OTC) network. This paper takes a network perspective to analyze how the transition from a bilateral to a fully centrally cleared market effects the expected value of a derivative contract, redistributes wealth among market participants of different size and credit quality, and thereby influences financial stability. We find that mar- ket frictions, such as non-zero probability of agents' default, costly collateral and inability to fully collateralize a deal, create distortions in the fair value of a contract which depend on the structure of the market. We show that due to mutualization of risks and funds, transition to a centrally cleared setting leads to externalities on three levels: i) credit quality distortions of netting, ii) funding costs, and iii) risk sharing. In particular, we nd that even though a CCP interposes itself between a buyer and a seller of a contract, the real insulation from the counterparty risk does not always hold. We derive a threshold value on a CCP's 'skin in the game' capital, below which expected exposures between members form a fully connected network. The threshold is hit exactly in times of distress, that might further increase systemic risk. Our work offers a simple network framework for further assessments of the policy implications of mandatory central clearing, including its impact on the relations between market participants, their incentives, and systemic risk. We discuss more general issues of netting and mutualisation of resources and risks.

Retirement Plan Conflicts of Interest in Mutual Fund Management

William Beggs
,
University of Arizona

Abstract

Form ADV regulatory disclosures made by mutual fund management firms indicate that nearly one-third of investment advisers to mutual funds offer pension consulting services to defined contribution plans. This practice presents inherent conflicts of interest and allows for the adviser’s mutual funds to be recommended by adviser personnel to defined contribution clients (e.g., 401(k) plans). I find that this conflict of interest materially affects the portfolio management of the conflicted adviser’s funds. Equity mutual funds managed by advisers with retirement plan conflicts of interest exhibit widespread underperformance and are actively managed to a significantly lesser extent. The magnitude of underperformance is more pronounced for target date mutual funds.

Rollover Risk and Bank Lending Behavior

Martina Jasova
,
Barnard College, Columbia University
Caterina Mendicino
,
European Central Bank
Dominik Supera
,
University of Pennsylvania

Abstract

How does a sudden extension of bank debt maturity affect bank lending in times of crisis? We use the provision of long-term funding by the 2011 European Central Bank's (ECB) very long-term refinancing operations (vLTRO) as a quasi-natural experiment to address this question. Our analysis employs a novel dataset that matches the ECB monetary policy and market operations data with the firm credit registry and banks' security holdings in Portugal. We show that lengthening of bank debt maturity in crisis times has a positive and economically sizable impact on bank lending and the real economy. The effects are stronger on the supply of credit to smaller, younger, riskier firms and firms with shorter lending relationships. We also find that loan-level results translate to real and credit effects at the firm level. Finally, we discuss policy side-effects and show how the unrestricted liquidity provision provided incentives to banks to purchase more securities and partially substituted away from lending to the real economy.

Skewed Servicing and Monitoring for Securitized Commercial Mortgages

Luis Lopez
,
Pennsylvania State University

Abstract

This paper empirically examines the role of trustees in financial markets within the framework of commercial mortgage-backed securities (CMBS). Using a natural experiment around mergers that result in servicers and trustees falling under the same institutional umbrella, I present evidence that an affiliation associates with excessive advances on delinquent loans, which throttles information to bondholders. Furthermore, I find that a servicer-trustee affiliation correlates with distortions to the cash flows to bondholders and invokes a decrease in the average recovery rate of a delinquent commercial mortgage by up to $0.07 per dollar of outstanding debt, accounting for an economic impact of about $4.53 billion in market-wide liquidation losses.

Stakeholder Orientation and Shareholders’ Required Rate of Return: Evidence from the Passage of Constituency Statutes

Zhihong Chen
,
Hong Kong University of Science and Technology
Sichen Shen
,
University of Hong Kong
Hong Zou
,
University of Hong Kong

Abstract

We contribute to the longstanding debate on the implications of stakeholder orientation for shareholders by studying shareholder’s responses to U.S. state-level adoption of Constituency Statues (CS laws) that authorize directors and officers to consider non-owner stakeholder interests in business decisions. Based on a difference-in-differences analysis, we find that firms have a significantly lower cost of equity after their incorporation state adopts a CS law. The effect is concentrated in firms that are subject to less managerial agency problems. Additional analyses suggest that CS law adoption reduces the cost of equity via improving financial reporting quality, reducing downside tail risks relating to environmental, social and governance (ESG) issues, and increasing firms’ ability to weather negative industry-wide shocks. Our findings show that the interests of shareholders and other stakeholders do not necessarily conflict.

The “15 Days” Debate: The Value of an Early Release of Information (Evidence from 10-K Submissions)

Khaled Alsabah
,
University of Colorado

Abstract

I analyze the effects of a SEC rule that accelerated the deadline for a 10-K submission by 15 days. The results have proven to be in the SEC’s favor, on the most part, against the opposing firms. Using regression discontinuity design, I document that investors value the early release of information, as demonstrated by a stronger market reaction around the 10-K release date. I find evidence supporting the position that the stronger market reaction toward the accelerated 10-K filers is due to the Grossman & Stiglitz (1980) model, since fewer traders choose to be informed, when a firms’ 10-K is required to be submitted earlier. I do not find that accelerated firms tend to make more mistakes relative to firms with a longer deadline, with the exception of newly large accelerated firms or constrained large accelerated firms.

The Costs of Better Lending Technology: the Decline of Small Businesses Lending

Haiyan Pang
,
Arizona State University

Abstract

Banks' lending to small businesses is declining. I evaluate how information technology improvements contribute to this decline with a quantitative, dynamic model. The model infers that banks' costs of assessing borrowers' hard information decrease by 50% and consequently, small business lending falls by 12% from 2002 to 2017. This technology improvement not only discourages banks to build relationships and lend to small businesses, but also increases the exit rates of small banks that have larger shares of small business loans. The model predicts that the first effect contributes to 51% of the decrease in small business lending and that policy should subsidize small business lending rather than small banks to encourage lending to small borrowers.

The Good The Bad and The Trending: Microblogging Sentiment and Short Term Momentum

Austin Hill-Kleespie
,
University of Utah

Abstract

Over the past ten years microblogging services such as StockTwits and Twitter have become a popular way for users to express thoughts, opinions, and reactions in real time. This study explores the mechanism that connects the content of these posts to stock returns and theories of momentum at both the individual security level and in portfolios. Specifically I construct firm level measures of StockTwits sentiment using data from the StockTwits microblogging website to test theories of momentum from Daniel, Hirshleifer, and Subrahmanyam (1998) and Hong and Stein (1999). I find that trailing measures of sentiment have predictive power over future stock returns. Portfolios formed using StockTwits data have strong explanatory power over the daily momentum factor of Carhart (1997). These findings are consistent with Hong and Stein (1999) and also demonstrate that microblogging services provide an important new data set for testing asset pricing theories.

The Impact of Equity Tail Risk on Bond Risk Premia: Evidence of Flight-to-Safety in the U.S. Term Structure

Dario Ruzzi
,
University of Bristol

Abstract

This paper quantifies the effects of equity tail risk on the term structure of U.S. government securities. We combine the downside jump intensity factors of international stock market indices into a single measure of equity tail risk and show that it is strongly priced in an affine term structure model for the U.S. interest rates. Consistent with the theory of flight-to-safety, we find that the response of Treasury bond yields and future excess returns to a contemporaneous shock to the equity tail factor is negative and opposite to what happens in the stock market. The significance of these results decreases with the maturity of the bonds, suggesting that the short end of the U.S. yield curve is more strongly affected by flight-to-safety than the long end.

The Information in Index Returns and the Cross-Section of Options

Yuguo Liu
,
University of Houston
Kris Jacobs
,
University of Houston

Abstract

The estimation of option valuation models is challenging due to the complexity of the models and the richness of the option data. Many existing studies limit the time-series and especially the cross-sectional dimension of the option data, which may complicate the identification of model parameters. We address these computational constraints by filtering the state variables using particle weights based on model-implied spot volatilities rather than model prices. Some of our estimates differ substantially from the existing literature. We show that samples restricted to at-the-money and especially short-maturity options may result in serious identification problems. The composition of the option sample also critically affects the relative importance of returns and options for parameter estimates when both are used in estimation.

The Pricing of Market and Idiosyncratic Jump and Volatility Risks

Frederik Middelhoff
,
University of Muenster

Abstract

This paper analyzes the basic risk-return relation of differnet volatility components in the cross-section of stock returns. Using option portfolio returns that have a constant exposure to either jump or diffusive risk, I decompose the total volatility risk into four components: market volatility risk, idiosyncratic volatility risk, market jump risk, and idiosyncratic jump risk. The analysis shows, that this decomposition helps in explaining contemporaneous and future returns. While all four components are at play when stocks earn contemporaneously negative returns, idiosyncratic jump and volatility risks are most impotent to explain the cross-sectional variation in positive returns. In addition, stocks that have higher idiosyncratic jump risk earn higher subsequent returns. This relation is robust to various stock characteristics and cannot be explained by the low beta anomaly.

The Spillover Effect of Earnings Management

Yibin Liu
,
University of California-San Diego

Abstract

We propose and test the spillover effect of firms' earnings management on other firms' outcomes. We first document that China's de-listing policy creates a high earnings management segment and a low earnings management segment in the stock market. A large proportion of firms in the high earnings management segment are suspects of earning management which creates a spillover effect on other firms in the same segment. We show that investors can not identify which firms have managed their earnings in the high earnings management segment. Hence, investors distrust and react less to earnings announcement by all firms in the high earnings management segment. Moreover, firms in the high earnings management segment suffer from less stock price informativeness, higher risk factor loadings, along with real effects on firms' innovation. Lastly, we present causal evidence by studying firms listed in China that exogenously shift across high and low earnings management segments because of the U.S. 2007-08 financial crisis.

The Term Structure and Time-Series Variation of the Pricing Kernel

Joost Driessen
,
Tilburg University
Joren Koëter
,
Tilburg University
Ole Wilms
,
Tilburg University

Abstract

We estimate the pricing kernel from portfolios of options on the S&P 500 index for different horizons and over time. This allows us to compare short- and long-term pricing kernels and check its time-series variation. We document a U-shaped short-term pricing kernel for which the U-shape is more pronounced in good times, a finding that is at odds with leading asset pricing models. However, we find the U-shape to be a unique feature of the short-term pricing kernel and once we look at longer horizons, the pricing kernel is monotonically decreasing with only little time-series variation. We show that leading asset pricing models capture the level, shape and time-series variation of the long-term pricing kernel well.

The Value of ETF Liquidity

Marta Khomyn
,
University of Technology Sydney
Talis Putnins
,
University of Technology Sydney

Abstract

We investigate the apparent paradox of persistent fee differentials for exchange traded funds (ETFs) that track the same index, where counterintuitively more expensive ETFs often attract more investment. We show that this apparent paradox arises due to liquidity clienteles—investors with short holding horizons are attracted to the most liquid ETFs, thereby making them more liquid, and allowing the ETF issuers to charge a higher fee in equilibrium. Long horizon investors are more sensitive to the fee and therefore hold low-fee ETFs, which in turn are less liquid due to lower investor turnover. Liquidity clienteles also explain key features of ETFs competition, including the first-mover advantage and the ability for incumbent ETFs to maintain higher fees. We exploit the unique laboratory created by competing ETFs to measure the value of market liquidity to investors.

Trademarks in Entrepreneurial Finance: Empirical Evidence from Venture Capital Investments in Private Firms and Venture-Backed IPOs

Thomas Chemmanur
,
Boston College
Harshit Rajaiya
,
Boston College
Xuan Tian
,
Tsinghua University
Qianqian Yu
,
Lehigh University

Abstract

We analyze the role of trademarks in the financing, valuation, and performance of start-up firms. We conjecture that trademarks may play two economically important roles in entrepreneurial finance: first, granting start-up firms some monopoly power in the product market (a “protective” role) leading them to perform better in the future; and second, signaling better future financial performance and higher intrinsic value to private and public equity investors such as venture capitalists (VCs) and those in the IPO market (an “informational” role). We develop testable hypotheses regarding the relation between the number of trademarks held by a firm and various aspects of VC investment in it; its probability of successful exit; its IPO and secondary market valuation; institutional investor participation in its IPO; its post-IPO operating performance; and its post-IPO information asymmetry. We test these hypotheses using a large and unique dataset of trademarks held by VC-backed firms and data on VC investment in these firms, on their exit decisions, and on the IPO characteristics (of those firms going public). We find that the number of trademarks held by an entrepreneurial firm is associated with a greater VC investment amount spread over a smaller number of financing rounds; a greater probability of successful exit; higher IPO and secondary market valuations; greater institutional investor IPO participation; smaller post-IPO equity market information asymmetry; and better post-IPO operating performance. We establish using an instrumental variable analysis (using trademark application examiner leniency as the instrument) that the above results are causal.

The Predictive Power of Tail Risk Premia on Individual Stock Returns

K. Victor Chow
,
West Virginia University
Jingrui Li
,
West Virginia University
Ben Sopranzetti
,
Rutgers University

Abstract

The impact of tail events on returns is well documented at the aggregate market level, but not so much is known about its impact at the individual stock level. This paper introduces a novel, option-free, methodology to directly calculate the tail risk premium for individual stocks, and then examines the characteristics of this premium in the cross section of stock returns. The existence of a premium for bearing negative tail risk is significantly associated with negative returns up to one month in the future. The same cannot be said for the premium for bearing positive tail risk, which seems to have no predictive power at the monthly level. Further, the larger in magnitude is the premium for bearing negative tail risk, the greater and longer lasting is its impact on expected future returns.

Overpaying for Corporate Control: What Does the Value of Shareholder Votes Tell Us about Future Stock Returns?

In Ji Jang
,
Texas A&M University
Hwagyun (Hagen) Kim
,
Texas A&M University
Mahdi Mohseni
,
Texas A&M University

Abstract

Firms with higher (lower) vote values have significantly lower (higher) future returns. Constructing portfolios based on an option-based measure of the value of voting rights yields average return spreads of about 80 basis points per month, and the return differences persist up to ten months. Our results cannot be explained by models of informed trading, liquidity and other factors known to affect stock prices. An alternative measure of vote value based on dual class firms generates similar results. Our findings highlight the importance of the vote component of stock prices in understanding the cross section of stock returns.

When is the Price of Dispersion Risk Positive?

Alexander David
,
Haskayne School of Business
Amel Farhat
,
Haskayne School of Business

Abstract

This paper documents that the price of analysts’ dispersion risk in the cross-section of stock returns changes over time, and in particular turns positive in periods of high analyst dispersion. Our result holds using 100 test portfolios that are double-sorted on their betas and their coefficients on aggregate dispersion, as well as numerous test portfolios that have been used in the literature. We construct a general equilibrium model in the spirit of Merton’s ICAPM, in which analysts of different types have heterogeneous beliefs and provide different forecasts of a macroeconomic factor (aggregate earnings growth). The consumer does not trust either analyst fully, and dynamically adjusts the weight given to each analyst, given the history of their past forecast performance. In equilibrium, each asset’s risk premium depends on its exposure to three factors: (i) the market portfolio, (ii) the macroeconomic factor, and, (iii) a “flight-to-safety” factor, which is the variance of the market portfolio. The first term increases with dispersion, while the third term declines. The latter decline occurs because consumers shift into assets with lower cash flow betas during periods of high dispersion. The model provides a testable implication, that the changing sign of the price of risk is due to the flight-to-safety during periods of high dispersion. We find strong support for such a flight-to-safety in the data.

Who are the Bitcoin Investors? Evidence from Indirect Cryptocurrency Investments

Dominique Lammer
,
Goethe University Frankfurt
Tobin Hanspal
,
Goethe University Frankfurt
Andreas Hackethal
,
Goethe University

Abstract

Following price growth and volatility, cryptocurrencies have received increasing attention by individuals, the media, and regulators. However, surprisingly little is known about the type of investors and consumers these currencies attract. We use administrative data from a large online broker to describe the investment characteristics and behaviors of individu-als who invest in cryptocurrencies indirectly using structured retail products. We find that these investors are more likely to be male, have higher portfolio wealth, and are technolo-gy-savvy. We find that cryptocurrency-investors are more active investors and traders, even before they participate in these types of investments. They have riskier portfolios and are more prone to biases. Our results shed light on the types of investors most likely to adopt new financial technologies and products and can inform regulators on the vul-nerability of cryptocurrency investors.

Why Blockholdings Can Increase Cash Holdings?

Shaoting Pi
,
University of Utah

Abstract

We provide a theory to reveal that the rise of blockholders may explain the dramatic increase in cash holdings in recent decades.

First, we find that after a blockholder exits a firm by selling its holdings the firm’s stock price will have an adverse selection issue. The blockholder may exit either because its idiosyncratic liquidity shock or because its private negative signal about the firm's returns. However, all other investors are unable to distinguish between these two forces. Therefore, after the exit of blockholders, market has to allow for both possibilities and adjustments move towards a pooling stock price. We show this pooling stock price has an endogenous adverse selection issue: firms sold due to blockholders' problems will loss, while firms sold due their own profitability problems will gain.

Second, we demonstrate that the ex-ante cash reservoirs will go through two stages, an initial pooling stage and a further separating stage. The initial pooling stage explains why most of U.S industrial firms are holding excessive cash. The subsequent separation explains why not all cash holdings turn into dividends or stock repurchases and why not all cash-rich firms pay dividends although most of U.S firms are currently holdings excessive cash.

Third, we characterize the insurance effect of the excessive cash holdings. We demonstrate that excessive cash holdings can mitigate the risk incurred by blockholders’ irresponsible (self-liquidity shock motivated) exit. Exiting blockholders will have to give up the control right of cash to other investors who stay with firms. Moreover, the insurance effect not only helps to strengthen the loyalty of blockholders, but also motivates blockholders to monitor firms.

In the extension, we show that top managements’ compensation structure could also be influenced by the liquidity exit of blockholders, because the exit could exaggerate the myopia of individual investors who are a main composite of non-blockholders.

Why Don’t Issuers Get Upset about IPO Underpricing: Evidence from the Loan Market

Xiaoyu Zhang
,
Norwegian School of Economics
Xunhua Su
,
Norwegian School of Economics

Abstract

This paper links IPO underpricing with the benefit of going public from the loan market. We show that IPO underpricing is followed by significantly lower borrowing costs of the issuer after going public. The average reduction in the loan interest spread for firms with above-median IPO underpricing is about 24% of their pre-IPO loan spreads, which almost double the reduction for firms with below-median underpricing, after control for firm and loan characteristics, and important factors that affect IPO underpricing. This larger reduction in borrowing costs amounts to about U.S. $0.8 billion per year for our sample firms, which is substantial relative to the total amount of money left on the table due to higher underpricing (U.S. $21.06 billion). More importantly, neither price revision before IPO nor longer-term stock returns after IPO has a similar effect, suggesting a unique role of underpricing in driving issuers’ borrowing costs. Our findings provide a new rationale for why issuers don’t get upset about IPO underpricing, and are consistent with the argument that going public generates great publicity of the issuer, while IPO underpricing amplifies this effect and tends to make the issuer an “overnight celebrity.”
JEL Classifications
  • G0 - General