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AFA Ph.D. Student Poster Session

Poster Session

Saturday, Jan. 4, 2020 8:00 AM - 8:30 PM (PST)

Manchester Grand Hyatt, Seaport & Palm Foyers
Hosted By: American Finance Association
  • Chair: John Graham, Duke University

A Sustainable Capital Asset Pricing Model (S-CAPM): Evidence from Green Investing and Sin Stock Exclusion

Olivier David Zerbib
,
Tilburg University

Abstract

I demonstrate how the asset pricing formula deviates from the CAPM when a group of investors adopts sustainable investment practices involving financial exclusion and ESG screening. I characterize three premia: two exclusion premia, generalizing Merton (1987)'s [Journal of Finance, 42:483-510 (1987)] premium on neglected stocks, and a taste premium that disentangles the link between ESG and financial performance. By constructing an instrument that captures sustainable investors' revealed tastes for green stocks, I apply this model to green investing and sin stock exclusion and show that it significantly explains the cross-section of stock returns and outperforms the four-factor CAPM in several cases.

A Tool Kit for Factor-Mimicking Portfolios

Tengfei Zhang
,
Louisiana State University
Junbo Wang
,
Louisiana State University
Kuntara Pukthuanthong
,
University of Missouri
Richard Roll
,
California Institute of Technology

Abstract

We relate Factor-Mimicking Portfolios (FMP) to the beta-pricing model and propose that each FMP should minimize the mispricing component of its underlying factor. We also examine FMP construction when the underlying factor contains noise and offer a new method to resolve this issue. For both classical and our newly proposed method, we recommend enhanced necessary criteria. FMPs of several macroeconomic factors constructed by our method satisfy this criterion. We find that equity returns are priced by consumption growth, inflation, and the unemployment rate; and corporate bond returns are priced by consumption growth, industrial production, and the default spread.

Acquisitions and Technology Value Revision

Xiangshang Cai
,
University of Manchester
Amedeo De Desari
,
University of Manchester
Ning Gao
,
University of Manchester
Ni Peng
,
Queen Mary University of London

Abstract

Acquisition announcements cause upward revisions in the market value of target firms' technology peers, whether targets and their peers belong to the same industry or not. Firms having deeper technology overlaps with the targets experience more dramatic price revisions. Consistent with the acquisition probability theory, a firm is more likely to be taken over if at least one of its technology peers has been acquired recently; and peers more vulnerable to acquisitions have greater upward price revisions. Our findings demonstrate that information diffusion along the technology links is essential for technology valuation.

Alternative Facts in Peer-to-Peer Loans? Borrower Misreporting Dynamics and Implications

Vesa Pursiainen
,
Imperial College London and University of Hong Kong

Abstract

I study the implications and determinants of borrower misreporting in peer-to-peer (P2P) loans for credit card debt repayment and consolidation. I identify potential misreporting based on three behavior-based indicators: consistency of loan amount with outstanding credit balance, roundness of reported income, and roundness of chosen loan amount. A Misreporting Index constructed from these indicators has significant predictive power over the likelihood of default, and the additional default risk does not get compensated in the form of higher interest. I find evidence consistent with both intentional as well as innocent misreporting. Supporting the former, misreporting is more prevalent in areas with lower social capital, implying weaker social norms, and among borrowers whose professions are considered less honest, while borrowers with higher genuine income uncertainty are also more prone to misreport. Misreporting increases notably from Q2 2017 onwards, and the increase is larger among low-income and low-credit-grade borrowers.

Ambiguous Text

Eric Tham
,
EDHEC

Abstract

Text is inherently ambiguous. Yet investors read textual news as the primary
source of financial information from the financial news and social media. I used Natural
Language Processing on social and financial media text to construct a natural
event and Big Data ambiguity measurement. The ambiguity measurement is derived
from a mixture of distributions model that distinguishes from disagreement between
the two sources. A binomial model based on smooth ambiguity preferences is then
proposed that explains salient points of ambiguity on asset pricing in empirical tests
in this paper and in Brenner and Izhakian (2018). The paper finds that the financial
news media have a bigger influence on asset prices than social media except during
the last recession from Jun 2009 to Nov 2016. The paper provides a market-wide and
natural event evidence of agents’ maxmin utility optimisation behavior in Gilboa and
Schmeidler (1989).

An Empirical Investigation of Short-Termist Investment: The Case of Corporate Investment Horizons

Andreas Knetsch
,
RWTH Aachen University

Abstract

This paper proposes an empirical approach that tries to capture investment horizons ex post. It is based on the intuition that future short-term profits have high predictive power over current investments levels, if current investments are short-term oriented. I utilize this method to analyze short-termist investment. Previous empirical work on short-termist investment has analyzed investment levels and concluded that investment policies are short-termist in case of underinvestment. Due to the nature of short-termism as an agency problem under asymmetric information, this approach relies on assumptions about the unobservability of investment levels to investors or about distinct investor irrationalities. My suggested method does not require these assumptions. Contrary to other measures of investment horizons, it relies on accounting information which is not observable to investors in the period of investment. It thus considers the necessity for asymmetric information highlighted by theoretical models. The empirical findings in this paper establish the validity of the introduced approach by relating it to an existing measure of investment horizons as well as multiple firm characteristics which are theorized to determine the level of short-termism plaguing firms. I observe that investment horizons are shorter for firms that inflate their reported income through real or accrual-based earnings management and for firms whose stock prices are more sensitive to earnings surprises. I also investigate which governance mechanisms are effective in curtailing short-termism. Managerial entrenchment, analyst coverage, institutional ownership, the effectiveness of the board of directors, and managerial long-term compensation all relate to longer investment horizons and thus reduce short-termism.

Bank Capital Requirements and Asset Prices: Evidence from the Swiss Real Estate Market

Olga Briukhova
,
University of Zurich and Swiss Finance Institute
Michele Pelli
,
University of Zurich and Swiss Finance Institute
Christoph Basten
,
University of Zurich

Abstract

In this paper we empirically study the effects of bank capital requirements on assets prices. In particular, we analyze the globally first activation of the Basel III countercyclical capital buffer (CCyB) by the Swiss National Bank in 2013. Since the Swiss sectoral implementation of the CCyB applies to residential mortgage lending only, we investigate the consequences of the intervention for the Swiss real estate market. As an identification strategy, we exploit the heterogeneity in treatment intensity across cantons, using data on the composition of mortgage suppliers in each canton. Our results suggest that the CCyB’s effectiveness in stabilizing asset prices crucially depends on the underlying financing structure of the market. We find that, being to a large extent financed by less mortgage-specialized universal or wealth management oriented banks, the cantons with a more overheated real estate market were less affected by the intervention. Additionally, we show that cantons with higher exposure to the CCyB treatment experienced mitigated price growth for single-family houses. However, the effect is not observed for condominiums, which are less dependent on mortgage loans and are more considerably financed by “deep-pocketed” institutional investors seeking positive yields. Our work raises important policy implications by shedding light on the intended and unintended effects of a novel macroprudential tool. For instance, in the presence of heterogeneous developments of real estate prices across regions, the CCyB requirements could be calibrated accordingly.

Global Demand Spillovers in Corporate Bond Issuance: The Effect of Underwriter Networks

Kerry Siani
,
Columbia University

Abstract

This paper studies how monetary policy shocks propagate across borders through bond issuance networks of firms, underwriters and investors. Using a difference-in-differences strategy, I find that the European Central Bank's quantitative easing program in 2016 spilled over to the U.S. corporate bond issuance market via an underwriting channel. U.S. firms connected to underwriters with more Eurozone investor clients faced greater orders for their bonds, achieved a lower cost of capital, and ended up issuing more bonds. The underlying mechanism is likely driven by costly search that underwriters face in locating potential investors, which incentivizes maintaining investor relationships for repeated business. As such, investor demand shocks transmitted through underwriters affect issuers heterogeneously based on preexisting issuer-underwriter-investor networks.

Banking on Demography: Population Aging and Financial Integration

Gazi Kabas
,
University of Zurich and Swiss Finance Institute
Sebastian Doerr
,
University of Zurich

Abstract

This paper argues that an integrated financial sector mitigates negative effects of population aging. We show that U.S. counties with an aging population see an increase in local deposits, reflecting higher saving rates of seniors. Banks use these deposits to increase credit supply. Using detailed data on mortgage lending, we find that banks channel deposits from aging ounties towards counties with a younger population. We find no evidence that banks engage in risky lending: they lend less to counties with a high share of sub-prime borrowers or low incomes, and do not lend disproportionately to low-income borrowers. The increase in credit supply has real effects. Counties with a higher market share of aging-exposed banks see an increase in house prices and building permits, as well as in firm formation. Results are robust to controlling for bank and county characteristics through granular fixed effects and an instrumental variable strategy.

Central Counterparty Exposure in Stressed Markets

Wenqian Huang
,
Bank for International Settlements
Albert Menkveld
,
VU University Amsterdam
Shihao Yu
,
VU University Amsterdam

Abstract

Time is valuable, particularly in stressed markets. As central counterparties (CCPs) have become systemically important, we need to understand the dynamics of their exposure towards clearing members at high frequencies. We track such exposure and decompose it which leads to the following insights. The composition of CCP exposure is fundamentally different in the tails. At extreme levels or during rapid increases, there is elevated crowding. This is the result of clearing members all concentrating their positions on a single security or a particular portfolio, desirable if motivated by hedging, worrying if due to speculation.

Do Commissions Cause Investment Adviser Misconduct?

Tarun Patel
,
University of Washington

Abstract

Sales commissions may present a conflict of interest that allows investment advisers to obtain rents from uninformed clients. Alternatively, commissions might be a contracting solution to motivate information provision. To analyze the relation between commissions and adviser misconduct, I exploit quasi-exogenous changes in individual investment advisers' compensation arrangements caused by mergers between large registered investment advisory firms. The opportunity to earn sales commissions increases the probability that an adviser engages in misconduct, but competition is an important mediator. In regions with greater competition, sales commissions decrease misconduct claims. Increased misconduct from commissions is concentrated among low-experience advisers and male advisers. Damages paid out
in claims involving commission-motivated advisers are $25,013 (36%) greater than other claims. The experimental design rules out latent firm and market explanations. Overall, I find that the connection between conflicts of interest and information provision depends on the competitive environment.

Common-Ownership and Portfolio Rebalancing

Eyub Yegen
,
University of Toronto

Abstract

The empirical literature on the potential anti-competitive effects of common-ownership relies heavily on financial institution mergers to make causal inferences. I find that more than 85% of newly-formed common-ownership relationships due to such financial institution mergers are no longer commonly-held by the acquiring institution during the post-merger period (with most being liquidated in the first quarter following the merger). Firms that are no longer commonly-held by the merged institution drive the anti-competitive results found in previous studies. The fact that portfolio firms are so quickly rebalanced casts doubt on the utility of financial institution mergers as a natural experiment. I also find evidence that portfolio rebalancing post-merger is driven by other factors, such as portfolio diversification or index tracking. Further, I find no significant positive risk-adjusted returns for a common-ownership based portfolio strategy, suggesting that investors do not make a profit from commonly-held stocks. Taken together, these findings suggest that empirical basis for claiming collusive effects of common-ownership is weaker than it appears and there is no strong evidence that provides a basis for policy concerns about institutional common-ownership.

Competition and Product Development Innovation: The Case of Newly Launched Trademarks

Qianqian Huang
,
City University of Hong Kong
Bin Yang
,
City University of Hong Kong

Abstract

This paper examines the relationship between competition and product development innovation using the U.S. trademark database. We find that greater import competition spurs corporate product innovation measured by newly launched trademarks. However, such increase in foreign competition is associated with lower survival rate of new product trademarks. Moreover, firms tend to launch new trademarks in old and familiar areas in response to intensified import competition. We find similar results when using common domestic competition measures. Overall, our results suggest that competitive markets can promote product innovation.

Competition, Non-Patented Innovation, and Firm Value

Scott Guernsey
,
University of Cambridge

Abstract

This paper studies how competition impacts non-patented corporate innovation and firm value by exploiting adoptions of state anti-plug molding laws – laws that prohibit “unscrupulous” reverse engineering by competitors – and their subsequent invalidation by the U.S. Supreme Court. Firms decrease patenting activity following the laws’ adoptions while also showing increasing investment spending, profitability, and value. Value gains are larger for firms at greater risk of imitation, and that are more innovative. After the laws are overturned, firms reinitiate patenting whereas prior investment spending, profitability, and value gains dissipate. These results suggest that more intense product market competition disincentivizes value-enhancing corporate innovation.

Consuming Dividends

Konstantin Bräuer
,
Goethe University Frankfurt
Andreas Hackethal
,
Goethe University Frankfurt
Tobin Hanspal
,
Goethe University Frankfurt

Abstract

This paper studies why investors buy dividend-paying assets and how they time their consumption accordingly to anticipated income. We combine administrative data on bank customers linking detailed portfolio and trading data, categorized consumption transactions and income, and survey responses on financial behavior. We find that private consumption is excessively sensitive to dividend income. Investors across wealth, income and age distributions increase spending precisely around dividend receipt. Importantly, we find that consumption responses are driven by financially sophisticated investors who select dividend portfolios, anticipate dividend income, and plan consumption accordingly. Our results contribute to the literature on a dividend clientele and provide evidence of ‘planned’ excess sensitivity.

Costly Information Acquisition and Investment Decisions: Quasi-Experimental Evidence

David Xiaoyu Xu
,
University of Texas

Abstract

This paper analyzes how information costs causally affect the acquisition of private information and investment decisions. Using data on Chinese mutual fund managers' visits to geographically dispersed firm headquarters, I exploit the introduction of high-speed rail lines as a source of quasi-experimental variation in information costs. I show that exogenous travel time reductions substantially increase the frequency of visits and trading profits at the fund family--firm pair level. These effects are stronger for pairs with larger travel time reductions and persist over multiple years. Overall, my findings provide evidence for investors’ trade-off between the costs and benefits of private information.

Ambiguous Credit Information and Corporate Bond Prices

Hwagyun (Hagen) Kim
,
Texas A&M University
Ju Hyun Kim
,
Sungkyunkwan University, Texas A&M University
Heungju Park
,
Sungkyunkwan University

Abstract

This paper connects credit information ambiguity to corporate bond prices. If investors dislike uncertain quality of credit information, theory implies that bond prices respond more to bad than to good news, and investors require higher premia for holding corporate bonds. Empirical results support the theory. Bond returns are predictable using the proposed ambiguity measures based on both time-series and cross-sectional variations in credit rating distributions. Credit information ambiguity explains up to 35% of corporate bond return premia and remains highly significant in various specifications that contain a battery of controls. Proposed credit ambiguity measures maintain predictability in multiple hypothesis testing.

Credit Supply Decomposition and Real Activity

Maximillian Littlejohn
,
University of California, Irvine

Abstract

This paper investigates the implications of sector-specific credit supply shocks on real economic activity in the United States during the past 66 years. These sectors include private households, non-financial corporations, and banks. Within a structural vector autoregression (SVAR) framework, I employ a unique sign-restriction strategy to identify one monetary policy shock, two aggregate macroeconomic shocks, and three credit supply shocks. I find evidence that credit supply shocks not only vary by the sectors in which they arise, but also by their consequences for business cycle dynamics. Credit shocks originating in the banking sector can explain up to 25% of output fluctuations while those arising in the household and corporate sectors can explain up to 15%. In addition, household and bank credit shocks may hold long-run consequences for inflation explaining up to 15% of its fluctuations. Within a historical context, the model identifies several periods where credit supply has been a significant driver of GDP. With respect to the recent financial crisis, the model uncovers a smaller role for credit shocks relative to aggregate supply shocks than is typically found in the literature. This supports recent empirical evidence suggesting that the early stages of the crisis were more reminiscent of an oil price shock recession.

Credit Variance Risk Premiums

Manuel Ammann
,
University of St. Gallen
Mathis Moerke
,
University of St. Gallen

Abstract

This paper studies variance risk premiums in the credit market. Using a novel data set of swaptions quotes on the CDX North America Investment Grade index, we nd that returns of credit variance swaps are negative and economically large. Shorting variance swaps yields an annualized Sharpe ratio of almost six, eclipsing its counterpart in xed income or equity markets. The returns remain highly statistically signicant when accounting for transaction costs, cannot be explained by established risk-factors, and hold for various investment horizons. We also dissect the overall variance risk premium into payer and receiver variance risk premiums. We nd that exposure to both parts is priced. However, the returns for payer variance, associated with bad economic states, are roughly twice as high in absolute terms.

Creditor Rights, Debt Capacity and Securities Issuance: Evidence from Anti-recharacterization Laws

Daniel Tut
,
Schulich School of Business- York University

Abstract

This paper examines the effects of improvement in creditors' rights protection on firms' financing choices and securities issuance. To address these issues, I exploit exogenous variation in creditors' rights protection induced by the staggered adoption of anti-recharacterization laws by some U.S. states. The laws enhance the ability of creditors to repossess collateral during bankruptcy. Using a difference-in-difference methodology to estimate the causal impacts; I find that: [1] the laws are positively related to debt capacity and debt maturity. Firms increase market leverage and substitute away from costly short-term debt financing into long-term debt financing [2] the laws are positively related to debt issuance [3] The laws are negatively related to equity issuance. My analysis further demonstrates that proactive securities issuers are significantly more responsive to the adoption of anti-recharacterization laws than passive securities issuers.

Intra-household Dynamics and CEO Corporate Risk-taking

Constantinos Antoniou
,
University of Warwick
Carina Cuculiza
,
University of Miami
Alok Kumar
,
University of Miami
Lizhengbo Yang
,
University of Warwick

Abstract

Household finance literature suggests that intra-household dynamics between couples can affect their household financial decisions Risk-sharing between husband and wife jointly decide their savings and stock investment choices. Does the effect of household dynamics extend beyond household settings? Do the household dynamics in inherited cultural distance between CEOs and CEO spouses affect CEOs’ decision-making? Cultural distance in personalities, lifestyles, and beliefs affects couples’ personal concept imperceptible through cultural transmission. We examine whether intra-household dynamics in the distance of one Hofstede’s cultural dimension, that is, the attitude toward uncertainty, between CEOs and CEO spouses affect corporate risk-taking. We document that the high uncertainty avoidance of CEO spouses will influence CEOs’ personal uncertainty avoidance, and then lead to less corporate risk-taking, reflected in standard deviation of return on assets and Research and Development (R&D) expenditure. We extend intra-household dynamics beyond household settings into corporate finance settings. Our study contributes to the research on how culture heritage and cultural transmission affect financial outcomes.

Data Economy and M&A

Daniela Schoch
,
LMU Munich

Abstract

In research, public, and policy debate, there is increasing interest in data accumulating firms like Google, Facebook, and Amazon. Discussions about whether the power of firms in terms of personal data concentration might harm consumers are prevalent. Since theory predicts mixed results regarding the impact of such firms' data access on social welfare and oftentimes business models with zero prices for consumers, competition authorities rarely intervene. Meanwhile, due to high scale economies and network externalities, data firms have a particularly large incentive to grow, among others through mergers and acquisitions (M&A). Adding to the up to now mainly theoretical or anecdotal discussion on data intensive firms, this paper (1) identifies data-rich firms in a systematic approach using textual analysis and (2) analyzes the relationship between firms' M&A activity and data intensity. I show that the proposed measure reflects expected characteristics of data intensive firms. I find that higher data intensity of firms corresponds to a higher probability of being acquirer or target in an M&A transaction. Controlling for market to book ratio, life cycle stage, and competition intensity does not alter the relationship. There is some indication for lower attention by competition authorities for data intensive acquirers if the target is small, but even higher attention if the target is large or public.

Disastrous Selling Decisions: The Disposition Effect and Natural Disasters

Matthew Henriksson
,
University of South Florida

Abstract

Combining county-level natural disaster data with individual investor transactions, I document an increased disposition effect for investors impacted by a natural disaster. This effect is increasing in disaster severity and decreasing in the length of time following the event, suggesting that extreme natural disasters can significantly influence investor behavior, especially in the short term. These findings are not explained by liquidity constraints, tax incentives, or informed trading. The effect strengthens with local stocks and investors’ duration at their residence. Moreover, the increased disposition effect of disaster-affected investors is consistent with investors deriving utility from environmental damages and realized gains/losses.

Distance Effects in CMBS Loan Pricing: Banks versus NonBanks

Nagihan Mimiroglu
,
Maastricht University

Abstract

We investigate whether the geographical distances between lenders, borrowers and their properties are priced in the loans underlying US Commercial Mortgage Backed Securities during the 2000 to 2017 period. We find that, a doubling in the bank-borrower distance is associated with a 2.5 basis points increase in the spread, and that this effect is more pronounced if the loan is collateralized by riskier property types. Geographic distance does not seem to have any effect on the loan spread for non-bank lenders. The difference in loan pricing across originator types (even after controlling for key mortgage and property characteristics) suggests banks and non-bank lenders have different incentives, lending technologies, and/or different types of borrowers.

Distinct Roles of Risk and Uncertainty: Evidence from Trading around U.S. Macro News

Bao Doan
,
University of New South Wales

Abstract

We provide evidence on distinct roles of risk and uncertainty in financial markets by examining trading activity around the U.S. macro news releases. We document a sustained increase in stock and option trading activity coupled with a rise in risk and a dramatic drop in uncertainty after the release of Federal Open Market Committee (FOMC) statements. Following non-FOMC macro news, we find little change in uncertainty and moderate increase in equity trading, even though risk increases. Our results suggest FOMC news helps resolve uncertainty. This resolution of uncertainty encourages more trading activity than increased risk. We also compare trading prior to news releases on event days with that on non-event days and find a significant reduction in both stock and option trades for FOMC news. For non-FOMC macro news, we find a surge in trading options only. Our results confirm that investors are willing to wait to trade in anticipation of resolution in uncertainty after the FOMC news. Knowing that uncertainty in the post-announcement of non-FOMC news does not change much, investors actively exploit their insights in options market prior to the news releases.

Do Banks Assist Corporate Tax Avoidance? Evidence from Simultaneous Debt-Equity Holding

Shuyi Cheng
,
City University of Hong Kong

Abstract

This paper analyzes how banks’ simultaneous holding of both debt and equity claim of the same firm (dual holding) affect the firm’s tax avoidance activities. Using bank mergers as an exogenous shock, we employ difference-in-differences methods to establish the causal effect. The presence of bank dual holder is associated with a significant increase in corporate tax avoidance. The effect is stronger when banks have higher equity stake or lender stake and when banks have higher market share of the related industry.

Do Boards Have Style? Evidence from Director Style Divergence and Board Turnover

Robert Bird
,
University of Connecticut
Paul Borochin
,
University of Miami
John Knopf
,
University of Connecticut
Luchun Ma
,
University of Connecticut

Abstract

We identify persistent director style effects on corporate policies. Director style explains a significant amount of cross-sectional variation in firm policy variables for financing, investment, operations, and corporate governance, among others. The results are significantly different from counterfactual random assignments of directors to firms, confirming the validity of director style measures. We also aggregate director effects at the firm level to create a median board style. Directors with effects that deviate from the board's overall style on acquisition, advertising, and compensation policies are significantly more likely to leave the board or leave their appointment to key board committees. Style divergent directors are also more likely to leave the board as the CEO's total compensation increases. Board style has predictive power for future firm performance.

Do Creditor Rights affect Financial Contracts? Evidence from the Anti-Recharacterization Statute

Negar Ghanbari
,
Norwegian School of Economics

Abstract

This paper examines the effect of creditor rights on bank loan contract design. Focusing on the conflict of interest between creditors, I study how bank lenders respond to a legal change that strengthens the rights of securitization creditors. Improving the power of securitization creditors to seize their collateral in bankruptcy reduces their incentives to maximize recoveries in chapter 11, increasing the risk of other competing creditors, such as banks. I find that loans granted to firms using asset securitization have higher interest rates, higher fees, smaller size, and more covenant restrictions after the law change. These effects are stronger for firms with higher default risk, for which the legal change may have a bigger impact. My findings thus highlight how increasing the power of some corporate creditors affects financial contracts of the other creditors.

Do Digital Coins Have Fundamental Values? Evidence from Machine Learning

Jinfei Sheng
,
University of California-Irvine
Yukun Liu
,
University of Rochester
Wanyi Wang
,
University of California-Irvine

Abstract

The rapid development of digital coins has raised questions about whether it is driven by technology innovations or investor speculations. Using machine learning techniques, we construct a novel technology index (Tech) of individual digital coin from their Initial Coin Offering (ICO) whitepapers. We find that the ICOs with high Tech Indexes are more likely to succeed and less likely to be delisted. Moreover, the Tech Index strongly and positively predicts ICOs’ long-run performance. Overall, the results suggest that fundamentals are an important driving force for the valuation of ICOs.

Do Firms Leave Workers in the Dark Before Wage Negotiations?

Sunny (Seung Yeon) Yoo
,
University of Southern California

Abstract

This paper examines managers' strategic use of financial disclosure in labor negotiations. Using the exogenous expiration date of collective bargaining contracts, I find that when wage negotiations are imminent, firms strategically redact information about material agreements. Strategic redaction is pronounced when unions cannot accurately predict firms' prospects, when firms have low growth opportunities, when liquidity is less constrained, and when the estimated cost of a work stoppage is low. These results suggest that firms strategically withhold information to balance the costs and benefits of information asymmetry. Consistent with this interpretation, strategic disclosure is statistically uncorrelated to ex post performance.

Do Natural Disasters Bias Creditors?

Balbinder Singh Gill
,
Temple University

Abstract

This paper uses global data from 67 countries to investigate whether a natural disaster event cause creditor’s lending decision-making process to be affected by behavioral biases. To test this empirically, I construct a sample of 40,278 firms with 292,716 firm-year observations in 67 countries during the 14-year period from 2002 to 2015. Notably, this paper introduces a novel empirical approach that allows me to investigate if the attributes of a natural disaster event cause creditors to act suboptimal in their lending decision-making process. Specifically, I define two different empirical approaches: the uninformed and the fully informed approach. The uninformed approach assumes that creditors only uses the natural disaster event as their lexicographic heuristic in their business lending decision-making process. Creditors do not use detailed information about the natural disaster risk in their business lending decision-making process because of the high cost of data collection. The fully informed approach assumes that creditors use, in addition to the natural disaster event (the lexicographic heuristic), detailed information about natural disaster risk in their business lending decision-making process. This paper documents that the impact of a natural disaster on leverage depends on the used attribute of a natural disaster event. The results of this paper show that using attributes of a natural disaster event in combination with the lexicographic heuristic (the natural disaster event) causes creditors to make sub-optimal lending decisions. This finding also implies that a natural disaster event tend to bias the behavior of creditors, and that this bias tends to continue to exist even after considering the different types of natural disasters, and the cross-country differences in country specific factors such as the legal environment of a country and the level of financial development of a country.

Does Economic Policy Uncertainty Affect Analyst Forecast Accuracy?

Rumpa Biswas
,
University of New Orleans

Abstract

I investigate the dynamics of analyst forecast errors relative to economic policy uncertainty (EPU) and find a significantly positive relation between EPU and analyst forecast errors. EPU’s contribution to augment information asymmetry inhibits analysts’ ability to forecast leading to aggravated forecast errors. A doubling of EPU increases earnings forecast errors by 4.29 percentage points, and the volatility and dispersion in forecast errors are positively related to the EPU. This effect of EPU on forecast errors persists for 13 months with a gradually declining effect that is aligned with Oi–Hartman–Abel effect, a channel through which uncertainty can affect firms' financial activities, performance, and growth. Forecast errors are higher for firms with higher sensitivity to the EPU, and the uncertainty factor retains its significance when compared to the other risk factors. Additionally, firms with higher idiosyncratic risks show a higher sensitivity to the EPU.

Doing Safe by Doing Good: Risk and Return of ESG Investing in the U.S. and Europe

Christina E. Bannier
,
Justus Liebig University Giessen
Yannik Bofinger
,
Justus Liebig University Giessen
Bjoern Rock
,
Justus Liebig University Giessen

Abstract

We examine the protability of investing along environmental, social and governance (ESG) criteria. A four-factor model shows that a long-short portfolio in stocks with the highest respectively lowest ESG scores yields a signicantly negative alpha, hinting at an insurance-like character of corporate social responsibility. Indeed, we demonstrate that ESG activity reduces rm risk, with a positively moderating role of market volatil- ity. ESG-inactive rms are nevertheless shown to deliver the highest contemporaneous return per unit of risk. Corporate social responsibility rather reveals its benet only gradually: Value-increasing eects signicantly lag ESG scores by several years.

Will Fund Managers Survive to the Advent of Robots? An Optimal Contracting Approach

Vincent Tena
,
Toulouse School of Management

Abstract

This paper investigates the microfundation of the automation of fund managers in a continuous-time principal-agent framework. In this model, a representative investor delegates the management of a fund either to an agent or to an unsupervised robot that can substitute to the agent and that arises randomly. To capture the trade-off between the delegation to an agent and automation, we assume that while the fund manager is inherently subject to an agency friction, he may perform better than the robot by adopting an active management strategy. We derive an optimal long-term contract that distorts the provision of incentives over time. At first, it boosts the fund manager's value and secures the contractual relationship, and then at the advent of robots it lets the principal reassess the agent's value to account for the presence of this new alternative. In line with empirical evidence, we predict that the advent of robots (i) has a skimming effect as it leads to the instantaneous automation of the less successful fund managers, and (ii) it mitigates the agency friction as the fund managers that remain active extract a smaller agency rent. Combined, these factors make the delegation to fund managers more attractive from the perspective of the representative investor after the advent of robots.

Platform Enterprises: Financing, Investment, and Network Growth

Joanne Juan Chen
,
London School of Economics

Abstract

This paper develops a tractable micro-founded dynamic platform model
featuring cross-group network e ects. Networks are analogous to capital-assets,
and the platform enterprise invests in the networks by making subsidies to
users. The paper solves for the entrepreneur's optimal nancing and investment
strategies, with limited enforcement as the major nancial friction. The main
results are: 1) making highly aggressive subsidies by using up available funds
is constrained-optimal; 2) per-transaction subsidies decrease over time and
are followed by increasing fees; 3) the platform with stronger network e ects
has a propensity to make more subsidies at initial stages and enjoys a higher
valuation; 4) staged nancing mitigates the limited enforcement problem, and
ceteris paribus, the number of funding rounds decreases with pro tability of
the platform and increases with required pro ts by nanciers; 5) the value of
funds raised each round increases and the nancing frequency decreases over
time.

Education and Innovation: The Long Shadow of the Cultural Revolution

Zhangkai Huang
,
Tsinghua University
Gordon Phillips
,
Dartmouth College
Jialun Yang
,
Tsinghua University

Abstract

The Cultural Revolution deprived Chinese students their opportunity to receive higher education for 10 years when colleges and universities were closed. We examine the human capital cost of this loss of education on subsequent innovation by firms. We examine the innovation of firms that have CEOs who turn 18 during the Cultural Revolution thus sharply reducing their chances of attending college. Using multiple approaches to control for selection and endogenity, including an instrument based on a CEO’s Cultural Revolution exposure, we show that Chinese firms led by CEOs without college degrees spend less on R&D, generate fewer patents and receive fewer citations to these patents.

Electronic Trading and Traders

Pedro Tremacoldi-Rossi
,
University of Illinois at Urbana-Champaign

Abstract

How did trading automation impact broker-dealer firms and workers? I leverage the high degree of financial regulation in the US to construct a linked employer-employee panel of traders, analysts, and brokerage firms and analyze the consequences of electronic stock trading on broker-dealer employment during the 2000s. These data provide rich information on workers’ employment history, experience, professional licenses and firms’ financial and operating condition and leverage, enabling to quantify how trading automation affected financial intermediation in the securities industry. Exploiting a regulatory change in stock markets that fostered speed-driven competition and local variation in IT stock, I show that electronic trading lead to substantial broker-dealer employment losses. Automation eliminated 100 trading jobs on average during 2007-2009 for each additional computer per worker existing before Regulation National Market System became effective. Through a series of tests, I show that these results are unlikely to be driven by the Great Recession or the rise in online brokerage services.

Ensemble Machine Learning and Stock Return Predictability

Hongwei Zhang
,
Tilburg University and Central University of Finance and Economics

Abstract

Many, even sophisticated, models cannot beat a simple mean combination of univariate stock market return forecasts. We introduce an ensemble machine learning method, which averages forecasts from sophisticated models (like BMA, WALS and LASSO) based on random subsamples and which learns from its mistakes by adaptively changing sampling distributions. Empirically, our novel method improves the simple mean forecast with statistically significant monthly out-of-sample R2 of around 2-3% and annual utility gains around 3%. Our approach benefits from predicting well in volatile periods and especially from extreme market drops. The forecasting gains of our new method stem from improved diversity among individual forecasts. We obtain similar gains in forecasting accuracy when we use our method to predict macro economic variables.

ESG Preference, Institutional Trading, and Stock Return Patterns

Jie Cao
,
Chinese University of Hong Kong
Sheridan Titman
,
University of Texas at Austin
Xintong Zhan
,
Chinese University of Hong Kong
Weiming Zhang
,
Chinese University of Hong Kong

Abstract

We explore how the trend towards socially responsible investing affects the predictability of stock returns. We look at a composite of 11 mispricing signals and find that they more reliably predict returns of stocks held by more socially responsible (SR) institutions. We conjecture that this is related to our observation that SR institutions are less likely to buy underpriced stocks with poor ESG scores or sell overpriced stocks with high ESG scores. We find that these patterns only emerge in recent years with the rise of ESG investing, and are not fully offset by ESG-neutral arbitrageurs due to funding liquidity constraints.

Falling Behind: Has Rising Inequality Fueled the American Debt Boom 1980–2007?

Moritz Drechsel-Grau
,
University of Mannheim
Fabian Greimel
,
University of Mannheim

Abstract

The household debt boom since 1980 is considered one of the main drivers of the Great Recession of 2007–9. In lockstep with household debt, income inequality has risen to new extremes. We build a model that links rising inequality to the mortgage debt boom. It builds on the old idea that people care about their social status. In an attempt to keep up with ever richer Joneses, the middle class substitutes status-enhancing houses for status-neutral consumption. These houses are mortgage- financed, creating a debt boom across the income distribution. Our mechanism is consistent with the following stylized facts: (i) Real mortgage debt, (ii) debt-service-to-income ratios and (iii) house sizes (in sqft) have increased since the 1980 across all income quintiles. This happened despite (iv) stagnating real incomes for the bottom 50% since the 1980s. We build a tractable dynamic network model with housing to illustrate how our mechanism generates these facts. We extend it to a quantitative general equilibrium life-cycle model to show how status concerns and rising inequality amplify previously studied origins of the debt boom: the saving glut, the banking glut and financial innovation. Preliminary results suggest that social comparisons boost the debt boom and the house price boom by about 25%.

Family Comes First: Reproductive Health and the Gender Gap in Entrepreneurship

Jonathan Zandberg
,
Boston College

Abstract

Better access to reproductive healthcare increases women's propensity to become entrepreneurs. Access correlates positively with female entrepreneurial activity and negatively with female entrepreneurial age. Examining firm size and personal income suggests it also improves survival and success of female-led businesses. None of these results hold when tested on men, women above 40, or other placebo professions. To establish causality, I exploit the Roe v. Wade landmark decision, the staggered enactment of state laws restricting abortion providers, and an index tracking state-level regulation of reproductive care. All three analyses suggest that policies securing better reproductive care enable more women to become entrepreneurs.

Family Ties and Insider Trading: A Closer Look at Family Firms

Stefan Morkoetter
,
University of St Gallen
Tobias Schori
,
University of St. Gallen
Thomas Zellweger
,
University of St. Gallen

Abstract

We study insider trading in family firms and compare the profitability of insider purchases and sales of family insiders, i.e. insiders who are related to the founding family, to those of nonfamily insiders, i.e. insiders without such family ties. Probing a sample of 37,012 insider trades from 241 family firms, we find that family insiders generate higher abnormal returns compared to nonfamily insiders for insider purchases. For insider sales, transactions that imply significant litigation and reputational risks, the profitability is significantly lower for family insiders compared to nonfamily insiders. We also distinguish between family insiders who are actively involved in the firm and family insiders who are significant shareholders but not otherwise involved in the firm. The profitability of insider sales is significantly higher for family insiders without management involvement, who are thereby under less regulatory scrutiny, compared to insider sales by family insiders with an active management role.

Internal Models, Make Believe Prices, and Bond Market Cornering

Ishita Sen
,
Harvard University
Varun Sharma
,
London Business School

Abstract

We show that U.S. life insurers used internal models to over-report the value of a large fraction of corporate bonds during the financial crisis. Reported credit spreads of bonds valued using internal models were substantially lower by 220 bps, as compared to bonds that are otherwise similar but valued using external sources. Misreporting is higher for bonds that are likely to be impaired and negatively affect regulatory ratios, for insurers that are constrained by regulatory capital, and for bond positions that are held by few insurers. Using novel data on U.S. state regulators, we document that misreporting is negatively correlated with the degree of supervision at the state level, but only for bonds held by multiple insurers. Supervision has limited impact on bonds held by fewer insurer due to the lack of reference prices available with state regulators. Consistent with these incentives, we show that insurers “corner the market" by holding a large fraction of a bond's issue, as this allows them to bypass regulatory scrutiny and facilitates the use of internal models. Our findings have implications for the micro-structure of a segment of the corporate bond market and for properly assessing the fragility of financial institutions in bad times.

Financial Policies and Internal Governance with Heterogeneous Risk Preferences

Shiqi Chen
,
University of Cambridge
Bart Lambrecht
,
University of Cambridge

Abstract

We consider a group of investors with heterogeneous risk preferences that determines
a firm’s investment policy, and each investor’s compensation function. The optimal investment policy is a time-varying weighted average of investors’ optimal policies and converges to the policy of the least (most) risk averse investor in booms (busts), reconciling the diversification of opinions hypothesis and the group shift hypothesis. The most (least) risk averse investor receives a strictly concave (convex) claim on the firm’s net worth. For intermediate risk preferences investors’ claim is S-shaped, resembling
preferred stock. We endogenize investors’ utility weights absent wealth redistribution, and under social optimization.

Fire Sales, Fair Value Estimation, and Impairment Recognition of Downgraded Securities

Minjae Koo
,
University of Houston

Abstract

This paper explores the fire sales, valuation, and value recognition of downgraded bonds. I categorize downgrades as dual downgrades — where both credit ratings downgrade and regulatory risk designation downgrade (latter negatively affecting the risk-based capital ratio) occur, and single downgrades — where only credit ratings downgrade occurs. I find that insurers are more likely to dispose immediately of bonds that experience dual downgrades than single downgrades, but the association is weaker for riskier bonds, primarily because of illiquidity. Moreover, insurers are more likely to recognize other-than-temporary impairment (OTTI) and with greater magnitude upon a dual downgrade than a single downgrade, but the relation becomes weaker for riskier bonds. Additionally, cross-sectional analyses show that the likelihood of fire sales upon a dual downgrade for riskier bonds is higher in higher MTM (mark-to-market accounting) states and among securities that are more commonly held by insurers, and lower for securities that are subject to higher impairment risk. Impairment recognition (fair value estimation) upon a dual downgrade for riskier bonds is less likely or smaller (more favorable) in lower MTM states, for firms with poorer financial performance, and for securities that are less commonly held (for firms with poorer financial performance). In sum, findings suggest that insurers are less likely to dispose immediately of riskier bonds that experience dual downgrades. Nevertheless, they are more likely to engage in opportunistic valuations of such bonds, possibly providing stakeholders with a distorted picture of their financial performance.

Firm Reputation and the Cost of Bank Debt

Ye Wang
,
University of Arizona

Abstract

This paper examines whether firm reputation impacts borrowing costs and thus investment. Using unique data from Fortune’s Most Admired Companies surveys, I find that reputable borrowers enjoy lower borrowing costs and better loan contract terms: Relative to otherwise similar loans, loans initiated after a firm being recognized as Most Admired Companies are associated with 15% lower borrowing costs, 6% fewer financial covenants, and 7% lower likelihood of collateral requirements. My identification strategy is based on propensity score matching, a regression discontinuity design, and clean reputation measures removing the impact of prior financial performance. Further evidence suggests that banks reward reputable firms with better contract terms because this reputation proxy contains incremental information on borrower future performance and credit risk. Last, firms increase capital expenditures and R&D after receiving the Most Admired designation, consistent with reputable firms exploiting their lower cost of capital and with reputation having real effects on firms’ investment policies.

Forecasting Risk Measures Using Intraday Data in a Generalized Autoregressive Score (GAS) Framework

Emese Lazar
,
University of Reading
Xiaohan Xue
,
University of Reading

Abstract

A new framework for the joint estimation and forecasting of dynamic Value-at-Risk (VaR) and Expected Shortfall (ES) is proposed by incorporating intraday information into a generalized autoregressive score (GAS) model, introduced by Patton, Ziegel and Chen (2019) to estimate risk measures in a quantile regression setup. We consider four intraday measures: the realized volatility at 5-min and 10-min sampling frequencies, and the overnight return incorporated into these two realized volatilities. In a forecasting study, the set of newly proposed semiparametric models is applied to 4 international stock market indices: the S&P 500, the Dow Jones Industrial Average, the NIKKEI 225 and the FTSE 100, and is compared with a range of parametric, nonparametric and semiparametric models including historical simulations, GARCH and the original GAS models. VaR and ES forecasts are backtested individually, and the joint loss the function is used for comparisons. Our results show that GAS models, enhanced with the realized volatility measures, outperform the benchmark models consistently across all indices and various probability levels.

Foreign Sentiment

Azi Ben-Rephael
,
Rutgers University
Xi Dong
,
City University of New York-Baruch College
Massimo Massa
,
INSEAD
Changyun Zhou
,
Baruch College, CUNY and The Graduate Center, CUNY

Abstract

We construct a direct measure of U.S. based foreign sentiment using flow shifts between U.S. and international mutual funds. Foreign sentiment predicts return reversals in international markets, while local sentiments predict reversals in local markets. Exploring this segmentation, we find that foreign sentiment predictability is driven by overreaction to non-U.S. local negative news, which increases with the foreignness of a country to U.S. investors. In contrast, non-U.S. local sentiment predictability is not driven by overreaction to the same news. A complementary analysis of the U.S. provides consistent results, suggesting that the U.S. is also not immune to foreign sentiment from international markets. Our findings shed light on a new behavioral explanation for how foreign sentiment is generated, in the spirit of Dumas et al. (2017) “foreign sentiment” concept.

Formal Institutions, Culture, and Initial Coin Offerings: A Cross-Country Analysis

Ozgur Arslan-Ayaydin
,
University of Illinois at Chicago
Prabal Shrestha
,
KU Leuven
James Thewissen
,
KU Leuven
Wouter Torsin
,
KU Leuven

Abstract

Investors and policymakers still have little knowledge of Initial Coin Offerings’ (ICOs) dynamics as a funding mechanism. It is unclear what factors determine their international diffusion, the amount of capital raised and even the market perception post-ICO. Based on 2,205 ICOs from 105 countries between 2015 and 2018, we draw on institutional theory to provide evidence that, in a context of high information asymmetry and regulatory uncertainty, a country’s institutional strength has a positive and significant effect on the number of ICOs, their probability of success, the amount raised and the token price volatility. We observe that this relationship is particularly relevant for countries with no or light regulations concerning ICOs. This indicates that, to some extent, institutions substitute for the regulatory void surrounding ICOs. The crux of our results is
that despite the decentralization and disintermediation features of ICOs, a country’s strong institutions support the development of ICOs, send a signal of trustworthiness to investors, and reduce the return volatility associated with ICOs. Furthermore, we also find some evidence showing that the positive relationship between institutional background and investors’ decision to contribute to an ICO project is moderated by cultural dimensions of uncertainty avoidance
and collectivism.

Friends with Threats: Credit Conditions Under Common Ownership

Luca X. Lin
,
IESE Business School, University of Navarra

Abstract

I show that firms are less likely to violate loan covenants as their shareholders hold more shares in their industry peers. This link is more pronounced for firms with higher financial risks and a stronger tendency to overinvest. When violations do occur, creditors pressure for smaller cuts in capital investments in firms with more such common owners. These results support the hypothesis that creditors benefit from better governance under common ownership. However, creditors pressure for substantially larger payout cuts in firms with high common ownership after violations. Shareholders with more common ownership are also more likely to exit in the quarters after violations. Such evidence suggests that better governance by common owners can come at the expense of heightened shareholder-creditor conflict when the firm approaches financial distress.

Golfing for Information: Social Interactions and Economic Consequences

Sumit Agarwal
,
National University of Singapore
Yu Qin
,
National University of Singapore
Tien Foo Sing
,
National University of Singapore
Xiaoyu Zhang
,
National University of Singapore

Abstract

This paper studies how company top managers acquire information through social interactions at golf courses to subsequently acquire land parcels at lower prices. Developers play golf together more often after the government makes a land sale schedule announcement. We find evidence rejecting the collusion hypothesis. The winning bids are 6% lower after interacting with top managers from other companies, while the subsequent property selling price is not significantly different. However, the lower land prices by informed bidders generate negative spillovers on neighboring properties. Our results imply that social interactions enable developers to realize higher profits, while the government loses land sale revenues.

High-Frequency Trading, Endogenous Capital Commitment and Market Quality

Yenan Wang
,
Duke University

Abstract

I study market quality implications of the competition between traditional market making and high-frequency trading. A long-run traditional market maker responds to the competition from high-frequency traders by reducing both the spread and the amount of capital committed in market making. While a lower spread level is beneficial, less capital commitment deteriorates market quality. Specifically, the market's capacity to satisfy large demand is impaired. My model integrates price and quantity effects of high-frequency trading to better characterize its implications for market quality. I argue that focusing on spread alone is not always effective in measuring market quality. I further use this framework to analyze market quality implications of different high-frequency trading regulatory measures.

House Price Risks and Mortgage Choice

Lu Liu
,
Imperial College London

Abstract

The paper proposes a novel dimension of optimal mortgage choice, the length of the fixation period. Absent long-term fixed-rate products in most countries outside of the US, households are exposed to reclassification risk such as house price declines when they refinance at the end of the fixation expiry date, introducing uncertainty to the cost of life-time mortgage payments. In UK administrative data on mortgage originationd, I find that households' choice of fixation length reflects possibly competing hedging and affordability motives. Preliminary evidence further suggests that this leads to both adverse and ''advantageous'' selection into longer fixed rate mortgages from the perspective of a lender, with relevance for mortgage market design and macroeconomic policy.

How do Financial Contracts Evolve for New Ventures?

Danying Fu
,
University of Oxford
Tim Jenkinson
,
University of Oxford
Christian Rauch
,
Goethe University Frankfurt

Abstract

While previous papers have characterized various features of the financial contracts between entrepreneurs and venture capitalists, little is known about how the equity contracts evolve over the life of new ventures. Using the novel data set containing financial contract terms applying to different classes of stock, this paper is the first to focus on exploring the how the equity contract terms granted by the same investee private firms may vary across time, and determining the possible influencing factors. We find that there exists a default contract, for the terms adopt by different companies or used by the same companies in different funding rounds are surprisingly similar. Further, we notice, by analyzing the evolution patterns, that equity contracts change asymmetrically across different terms and at different stages of the investee firms. We also provide insights into the discussion on whether employing post-money valuation will definitely result in the over-valuation of start-ups. Our preliminary regression results show that the headroom, the new measure we developed as a proxy for the company’s financial flexibility, be negatively related to the dilution of common stockholders’ ownership of the company.

How Have Stock Markets Responded to 35 Years of Analyst Reports? Evidence from Machine Learning and Textual Analysis

Abena Owusu
,
Rensselaer Polytechnic Institute

Abstract

Using machine learning (ML) and contrasting with simple textual sentiment score and principal components analysis (PCA) methods, we examine the time series of content within over 700,000 sell-side analyst research reports from 1983 to 2017. We find that analyst reports have significantly changed across a variety of dimensions including length and content of four existing and two new dictionaries related to valuation and alternative metrics. We find that the naive net tone of reports only explains contemporaneous, not future, equity returns. On the other hand, we find that ML methods provide substantially different results from naive sentiment and PCA approaches on determining the impact of analyst reports on financial markets. We also examine the ability of reports to predict changes in firm short interest and volatility. Overall, we find that sell-side analyst reports have stronger impact on smaller cap stocks.

Identifying Empty Creditors with a Shock and Micro-Data

Hans Degryse
,
KU Leuven and CEPR
Yalin Gunduz
,
Deutsche Bundesbank
Kuchulain O'Flynn
,
University of Zurich and Swiss Finance Institute
Steven Ongena
,
University of Zurich

Abstract

Firms with credit-default swaps (CDS) traded on their debt may face ``empty creditors'' as hedged creditors have less incentive to participate in firm restructuring. We test for the existence of empty creditors by employing an exogenous change to the bankruptcy code in Germany, that effectively removes their potential impact on CDS firms. Using a unique dataset on bank-firm CDS net notional and credit exposures we find that the probability of default for firms with CDS traded on them drops when the effect of empty creditors is removed. This effect increases in the average CDS hedge position of a firm's creditors and in the concentration of the firm's debt. Further, we find that firms with longer credit relationships, with higher average collateral ratios of their debt, and financially safer firms are less affected by empty creditors. Banks that are not capital constrained, and that are liquidity constrained recognise the empty creditor effect to a larger extent. Furthermore, banks' business models affect the degree to which they recognise the empty creditor effect. Where banks that monitor their creditors less and that earn a smaller portion of their income from interest activities, recognise the empty creditor effect to a larger extent.

Identifying Indicators of Systemic Risk

Benny Hartwig
,
Goethe University Frankfurt, Deutsche Bundesbank
Christoph Meinerding
,
Deutsche Bundesbank
Yves Schueler
,
Deutsche Bundesbank

Abstract

We operationalize the definition of systemic risk provided by the IMF, BIS, and FSB and derive testable hypotheses to identify indicators of systemic risk. We map these hypotheses into a two-stage hierarchical test which combines insights from the early-warning literature on financial crises with recent advances on growth-at-risk. Applying it to a set of candidate variables, we find that the Basel III credit-to-GDP gap does not serve the goal of coherently indicating systemic risk across the panel of G7 countries. A composite financial cycle measure does indicate systemic risk up to three years ahead, but its single components like credit growth or house price growth do not pass our test. Our results suggest that, by smoothing the financial cycle, pre-emptive countercyclical macroprudential policy may address vulnerability episodes in boom phases, which then mitigates systemic risk in the future.

Impact of Internal Governance on a CEO's Investment Cycle

Ivan Brick
,
Rutgers University
Darius Palia
,
Rutgers University
Yankuo Qiao
,
Rutgers University

Abstract

This paper examines the impact of internal governance on a CEO’s investment cycle. Extant literature defines internal governance as the mechanism by which senior executives help discipline the CEO to maximize shareholder value. Pan, Wang and Weisbach (2016) find evidence of a CEO’s investment cycle, in which investment increases over a CEO’s tenure, whereas disinvestment decreases. They suggest that the older CEOs exhibit agency problems due to private benefits that accrue over her tenure. We find that good internal governance helps reduce older CEOs underinvesting before their exit, whereas bad governance does not. For younger CEOs we do not find any relationship between internal governance and investment. We find that good internal governance has no impact on asset disposal rates for the incoming CEOs. However, when firms have good internal governance, we find that asset disposal is profitable when the previous CEO who acquired these assets is older. These findings suggest that the outgoing CEOs of firms with good internal governance made appropriate acquisitions during her tenure, but the asset mix does not match well with the skill set of the incoming CEO. The above results are not driven by the endogeneity of CEO turnover and to performance-related forced turnover.

Information Leakage Prior to SEC Form Filings --- Evidence from TAQ Millisecond Data

Steven Wei Ho
,
Columbia University
Mingrui Zhang
,
Columbia University

Abstract

We investigate the stock price movements prior to the publication of publicly-listed firms’ SEC form filings. By analyzing the time-stamps of all SEC form filings as well as the stock prices in the 30-minute interval pre- and post-publication, utilizing the TAQ millisecond data, we find strong evidence of information leakage in the 30-minute intervals around Edgar acceptance timestamp of corporate SEC filings, in that if the stocks are ranked into 5 portfolios based on the price run-up prior to filing release, for all form types, the events with the highest run-up would also have the highest price increase post filing release. Regressing pre-publication return on buyer-initiated (classified according to Lee and Ready) minus seller-initiated trade volume fraction yields a positive and highly statistically-significant coefficient. Also, depending on the type of the SEC filing, for filings that could contain both positive and negative information, for example, form 8K 10K and 10Q (as opposed to 13D or 13G which generally can only be good new for stock price), the events with the most run-down prior to the release would also have the most price decrease post filing release. The results are not driven by momentum, and they remain even after the SEC’s server fix in March, 2015, as Bolandnazar et al. (2018) have documented information leakage in the several-minutes range due to a technical issue related to SEC’s dissemination through FTP and PDS services, which is also a different time-horizon than the 30-minute range we are focusing on. To the best of our knowledge, this is the first paper that documents this phenomenon.

Information Leakages, Distribution of Profits from Informed Trading, and Last Mover Advantage

Andrey Pankratov
,
USI Lugano and Swiss Finance Institute

Abstract

I model a market in which an insider is subject to a careful scrutiny by another
agent (follower) who immediately observes the insider’s trading decisions and mimics
the insider while trading on his own behalf. The follower can be interpreted as a broker
or a high-frequency trader.
I show that if the follower is sufficiently good at detecting the insider (noise is
small), then the follower absorbs a dominant fraction of the expected profits coming
from informed trading. My model is able to explain why dollar returns on the trades
of insiders can be quite moderate.
Additionally, I provide an extension and explain a sudden upsurge of HFT activity
during a five-year period 2004-2009.

Inorganic Growth in Innovative Firms: Evidence from Patent Acquisitions

Sungjoung Kwon
,
Drexel University

Abstract

Startup firms are better suited to exploration (radical breakthrough) than exploitation (incremental improvements). Nonetheless, I find that approximately 10% of VC-backed companies acquire external patents while still private. They are neither low-quality firms nor firms with low patent output, lending little support to the hypothesis that patent acquisition is a response to low productivity. Rather, patent litigation risk appears to play an important role. Startup firms are significantly more likely to buy external patents when they are sued for patent infringement or exposed to a high threat of litigation. Using a difference-in-differences design around the Supreme Court decision Alice Corp. vs. CLS Bank, I show that firms whose patent litigation risks are reduced the most become significantly less likely to buy patents. Consistent with these findings and with the litigation risk preventing firms from reaching their full potential, firms buying patents are significantly more likely to be acquired rather than to go public.

Inter-county Economic Growth and Municipal Access to Finance: Does Your Neighbor’s Credit Rating Matter?

Zihan Ye
,
Pennsylvania State University

Abstract

Exploiting the exogenous rating changes of U.S. municipal bonds caused by Moody’s scale recalibration in 2010, this paper adopts a difference-in-differences approach to identify the inter-county economic effect of municipal credit ratings. I find a positive differential effect on county-level employment and wage income of 3%, following a rating upgrade in the neighboring county. This indirect inter-county effect of neighbor’s upgrade is independent, consistent, and comparable in economic magnitude with the direct effect of an upgrade on same-county outcomes. Four channels, working in parallel, explain the positive effect: government expenditure, commuting flow, economic spillover, and migration. Findings in this paper identify a new economic effect of municipal credit ratings that extends beyond the issuers’ geographic boundaries and into the neighboring counties.

Investor Attention and Market Return Predictability

Zhi Da
,
University of Notre Dame
Jian Hua
,
Baruch College
Chih-Ching Hung
,
Baruch College
Lin Peng
,
City University of New York-Baruch College

Abstract

We find that aggregated retail attention to individual stocks (ARA) strongly and negatively predicts future market returns. The predictability is robust and persists across a wide range of horizons from one day to four weeks ahead. A one standard deviation increase in ARA is followed by a negative market return of 26 basis points over the next five trading days, and the predictability is stronger during periods of high investor sentiment. In contrast, aggregated institutional attention or direct retail attention to the market factor do not exhibit this predictability. Our results suggest that the interaction of high retail attention to individual stocks and high investor sentiment drives marketwide overvaluation.

Investor Sentiment, Behavioral Heterogeneity and Stock Market Dynamics

Changtai Li
,
Nanyang Technological University
Sook Rei Tan
,
Nanyang Technological University
Sy Ha Ho
,
Nanyang Technological University
Wai Mun Chia
,
Nanyang Technological University

Abstract

Recent empirical works have confirmed the importance of sentiment in asset pricing. In this paper, we propose that sentiment may not affect everyone in a homogeneous way. We construct a sentiment indicator taking into consideration behavioral heterogeneity of interacting investors. We find that sentiment contributes to several financial anomalies such as fat tails and volatility clustering of returns. More importantly, investor sentiment could also be a significant source of financial market volatility. Our model with sentiment is also able to replicate different types of crises, in which the severity of crisis intensifies with investors’ sentiment sensitivity.

Is Anti-herding Always a Smart Choice? Evidence from Mutual Funds

Jun Ma
,
University of Auckland

Abstract

Mutual fund managers with a higher tendency to act against other institutions’ previous trading direction have better performance. This paper defines a new contrarian behavior using the contemporary trading direction of the crowd and focuses on the asymmetric performance of contrarian-buy and contrarian-sell behavior. We find that mutual fund managers are skilled in contrarian-buy practice but fail to add value through contrarian-sell behavior. Specifically, we find contrarian-buy funds outperform their momentum-buy peers by over 3.2% per year, whereas contrarian-sell funds underperform their momentum-sell peers by over 4.2% per year. This relationship is stronger for small and growth-style funds. Further evidence shows that mutual funds with better past performance, a higher level of fund-specific risk, lower fund inflow, smaller size, higher management fee, and older age tend to have more (less) contrarian buy (sell) behavior.

Is Cross-hedging an Optimal Hedging Strategy for Commodity Currencies?

Stefan Lee
,
EAESP-FGV
William Eid Jr.
,
FGV/EAESP

Abstract

Recent studies have revealed that commodity currencies provide currency risk premiums, attracting carry traders. However, currency risk premiums may disincentive financial and nonfinancial institutions from investing in countries with commodity currencies due to the negative expected returns of hedging with currency futures contracts. We investigate four different hedging strategies for managing exchange rate risk: full, partial, no and cross-hedging. The cross-hedging strategy consists of using commodity futures contracts to hedge exchange rate risk. Our main findings based on nine commodity countries is that for many risk aversions cross-hedging is the optimal hedging strategy for exchange rate risk.

Is Innovation Always Beneficial? Externalities of Innovation on Product Market Relationship

Chang Suk Bae
,
University of Pittsburgh

Abstract

This paper investigates negative externalities of innovation along supply chain by analyzing the effect of customer innovation on supplier trade credit. I find that supplier extends more trade credit after customer makes innovation, and the effect is robust after controlling for various firm characteristics and industry-specific market conditions, and, to potential endogeneity issues. The effect is mainly driven by the holdup channel as opposed to the demand channel and the financing channel. Next, I document that the technological relatedness between customer’s innovation and supplier’s innovation downsizes the positive sensitivity of supplier’s trade credit provision to customer’s innovation. Lastly, I find that supplier adopts more conservative financial policy and produces more innovation by learning from customer’s innovation.

Is Mandatory Board Gender Quota Beneficial? Insights from Insiders’ Trade

Ge Yang
,
National University of Singapore

Abstract

Studies examining the effect of corporate and exogenous regulatory events on firm value typically examine stock returns around each specific event. This market reaction does not necessarily reflect the information of corporate insiders, who are likely to have superior access to information regarding the firm’s operation and specific conditions. This paper examines the differential reactions of the stock market and corporate insiders to the mandatory gender quota imposed on the boards of California-based firms. The stock market reacts negatively to the introduction of this quota: firms below the quota experience negative abnormal returns. However, insiders of these firms do not seem to concur with the negative market reaction. The insiders increase their net purchase of the firms' shares, suggesting that they view this gender-based quota to be less costly than the market’s perception. The increases in net insider purchase are more salient for large firms, firms with large board size, and firms located in areas with fewer female directors, which are coincidental with more negative stock market reactions. On aggregate, insiders increase their net purchase when they observe negative stock returns, consistent with them disagreeing with outside investors. This study therefore highlights the importance of examining insider reactions to exogenous corporate events.

Is Positive Sentiment in Corporate Annual Reports Informative? Evidence from Deep Learning

Anup Agrawal
,
University of Alabama
Mehran Azimi
,
University of Alabama

Abstract

We use a novel text classification approach from deep learning to more accurately measure sentiment in a large sample of 10-Ks. In contrast to most prior literature, we find that positive, and negative, sentiment predicts abnormal return and abnormal trading volume around 10-K filing date and future firm fundamentals and policies. Our results suggest that the qualitative information contained in corporate annual reports is richer than previously found. Both positive and negative sentiments are informative when measured accurately, but they do not have symmetric implications, suggesting that a net sentiment measure advocated by prior studies would be less informative.

CEO Employee Approval and Principal Agent Problems: Evidence from Employees' Choice Awards

Spencer Barnes
,
Florida State University

Abstract

This study examines the impact of chief executive officer (CEO) employee opinion on CEO myopia exploiting plausible exogenous variation from Glassdoor's "Top CEOs Employees' Choice" award list in both event study and regression discontinuity specifications. Award news results in a negative 1% cumulative abnormal return totaling on average a loss of 900 million dollars. However, exceptional CEO employee opinion generates value over time. Economic mechanisms include short-run expenses and long-term efficiency. Since superior CEO employee approval sacrifices current performance for future financial gains it decreases CEO shortsightedness serving as an agent monitoring device in a principal agent problem.

Jumps and the Correlation Risk Premium: Evidence from Equity Options

Nicole Branger
,
University of Muenster
René Flacke
,
University of Muenster
Frederik Middelhoff
,
University of Muenster

Abstract

This paper breaks the correlation risk premium down into two components: a premium related to the correlation of continuous stock price movements and a premium for bearing the risk of co-jumps. We propose a novel way to identify both premiums based on a dispersion trading strategy that goes long an index option portfolio and short a basket of option portfolios on the constituents. The option portfolios are constructed to only load on either diffusive volatility or jump risk. We document that both risk premiums are economically and statistically significant for the S&P 100 index. In particular, selling insurance against states of high jump correlation generates a sizable annualized Sharpe ratio of 0.85.

Legal Origins and Institutional Investors' Support for CSR

Rob Bauer
,
Maastricht University
Jeroen Derwall
,
Maastricht University
Colin Tissen
,
Maastricht University

Abstract

Using data on approximately 2,500 environmental and social shareholder proposals, we show that institutional investors from civil law countries use their voting power to positively influence the CSR of common law firms. A one percentage point increase in civil law institutional ownership increases the percentage of votes in favor of U.S. environmental and social proposals by 0.70 percentage points. Exploring their motive for doing so, we provide evidence that institutional investors from civil law countries are more likely to support CSR for financial rather than social motives. In comparison to institutional investors from common law countries, we argue that institutional investors from civil law countries have a more enlightened view of value maximization: they believe that the creation of stakeholder value ultimately benefits shareholder value.

Leveraged Loans, Systemic Risk and Network Interconnectedness

Monica Billio
,
Università Ca' Foscari Venezia
Alfonso Dufour
,
University of Reading
Ana Sina
,
University of Reading
Simone Varotto
,
University of Reading

Abstract

We study the U.S. syndicated market and make the following contributions. First, by analyzing the leveraged loans we show that they have already exceeded the pre-financial crisis level, which may pose financial stability concerns. Second, we gauge the leveraged interconnectedness of the lead arrangers and study its relationship with their systemic risk. To achieve this result we disentangle the leveraged loans from all the other loans. Finally, we graphically illustrate how the lead arrangers’ interconnectedness has increased over the last two decades. We propose novel measures of risk and investigate possible implications for the future.

Linear Cross-Sectional Model Comparisons

Reed Douglas
,
University of Southern California

Abstract

This paper evaluates a specification for conditional beta models following Fama and French (2019). In this paper, I reject the Fama and French model that assumes characteristics are conditional betas in favor of a linear conditional beta model following Shanken (1990). Model-implied zero-beta rates are particularly sensitive to the specification, and the linear conditional beta model provides a significantly lower rate. Out-of-sample tests show that the linear-beta model has a significantly lower bias and Clark and West (2007) adjusted-MSPE, but it may come at the cost of a larger variance than the Fama and French model.

Local House Price Comovements

Marcel Fischer
,
Copenhagen Business School
Roland Füss
,
University of St.Gallen
Simon Stehle
,
University of Konstanz

Abstract

We study the micro-level evolution of residential house prices using data on repeat sales on Manhattan Island from 2004 to 2015. We document that excess price comovement is a highly local and persistent phenomenon. The strength of such excess comovements vanishes with both spatial and temporal distance. Local underperformance is more persistent than local overperformance - particularly when house prices on aggregate level increase.

Local Spillover of M&As

Han Ma
,
Georgia State University

Abstract

I examine the local spillover effect of mergers & acquisitions. By conducting analysis with both MSA and household level data, I find that merger completion in manufacturing sector is associated with lower employment growth rate in non-tradable sector by lowering local consumer demand. I use the interaction of aggregate industry abnormal return and the local presence of the same industry as a source of exogenous variation in the probability of a merger. The effects are stronger for MSAs with higher dependence on manufacturing sector and non-diversifying merger deals. Further tests with household level data confirms the finding. While acquirers’ wealth gain is positively correlated with the local non-tradable sector employment decline, targets are not compensated for the loss of local prosperity. Finally, a lower level of minimum wage at the state level can help to mitigate the negative pressure on non-tradable sector employment growth. Overall, the paper finds that firms may improve operating efficiency at the cost of local community by decreasing local consumer demand.

Long-term Investors and the Yield Curve

Kristy Jansen
,
Tilburg University

Abstract

The preferred habitat theory states that long-term investors, such as pension funds and life insurance companies, have a preference for long-term bonds, thereby affecting interest rates at the long-end of the yield curve. This preference arises because long-term bonds provide a hedge for the long-term nature of their liabilities. Hedging incentives are driven by two important factors: economic hedging demand and regulatory hedging demand. I study both hedging incentives using detailed holdings data on long-term investors. In particular, I exploit a change in the regulatory yield curve at which liabilities are evaluated, where the long-end of the yield curve became less dependent on market interest rates. The regulatory change did not affect economic hedging demand but decreased regulatory hedging demand. The extent to which regulatory hedging demand is affected depends on liability durations of pension funds and insurers, where long liability durations are more exposed to the regulatory change than short liability durations. I report two key findings. First, pension funds and insurance companies with high exposure to the regulatory change decreased long-term bond holdings to a larger extent. Second, pension funds closer to their funding constraint decreased long-term bond holdings more than non-constrained ones. These findings are supported by a mean-variance optimization problem in an asset liability context with regulatory constraints.

Managerial Bullshitting and Shareholders’ Cognitive Processing Abilities: Evidence from M&As

Désirée-Jessica Pély
,
Ludwig-Maximilians-Universität München

Abstract

This study examines takeover motives stated by CEOs in press releases and general media. I find that the more motives are claimed by the manager for pursuing M&As, the poorer the transaction. Specifically, managers use special merger rhetoric to whitewash a deal which leads to inferior short- and long-term performance. For example, if a long-short portfolio strategy is applied on single vs. multi-motive bidders, excess returns of approx. 13% can be achieved after five years. Claiming many M&A synergies is linked to a bullshitting behavior and managerial overconfidence to which an average shareholder overreacts. However, institutional investors see the manager’s impression management through and correctly incorporate the single vs. multi-M&A information into prices already at deal announcement. If complexities with regard to claimed synergies are reduced, then the average shareholders' behavioral bias of overreaction is decreased. When computational linguistics are applied to objectively quantify M&A synergies, the results are even more significant.

Mandatory Pollution Abatement, Financial Constraint and Firm Investment

Tri Vi Dang
,
Columbia University
Youan Wang
,
University of Hong Kong
Zigan Wang
,
University of Hong Kong

Abstract

This paper provides a theoretical and empirical analysis of how pollution abatement regulation or the designation of nonattainment status affects corporate investment and performance. If consumers value environmental awareness, spending on mandatory pollution abatement and other investment are complements for financially unconstrained firms but substitutes for financially constrained firms. Financially unconstrained firms invest more, have lower current profits but higher future profits while constrained firms invest less, have stable current profits and lower long-term profits. This paper shows that consumer environmental awareness and firms’ financial resources are determinants of whether environmental regulation crowds out or stimulates R&D investment and capital expenditure.

Measuring Liquidity Provision by Customers in Corporate Bond Markets: Evidence from 54 Million Transactions

Jinming Xue
,
University of Maryland, College Park

Abstract

This paper measures the role of liquidity provision by buy-side customers in corporate bond markets via a structural vector auto-regression (SVAR). Unobservable shocks to the willingness of customers and bond dealers to provide liquidity affect the choice of bond dealers, in opposite directions, between market-making (principal) and matchmaking (riskless principal) transactions. Exploiting this distinction, the SVAR disentangles these two shocks and reveals two episodes of high level of liquidity provision by customers in corporate bond markets: (i) the 2008 “flight-to-safety” and (ii) the 2014-2015 “requests for quotations” technology developments. Further, yield spreads for bonds of different credit ratings respond differentially to shocks in liquidity provision by dealers and customers. My empirical identification strategy for the SVAR is motivated using a theoretical model of decentralized liquidity provision.

Moonshots: Speculative Trading, Bitcoin, and Stock Returns

Qingjie Du
,
Hong Kong Polytechnic University

Abstract

We investigate whether investors categorize stocks into an investment theme of disruptive innovation, i.e., “moonshots.” To identify moonshots, we estimate the absolute sensitivity of individual stock returns to Bitcoin returns using daily Bitcoin prices from 2013 to 2018. Stocks with high absolute Bitcoin sensitivity (ABS) experience temporary over-valuation and subsequent return reversal that exceeds −1% per month. The return patterns are not due to size, book-to-market, momentum, illiquidity, idiosyncratic volatility, expected idiosyncratic skewness, and maximum daily returns. Additional analysis suggests that retail investors drive the speculative trading in moonshot stocks.

Mortgage Credit and Housing Markets

Yushi Peng
,
University of Zurich; Swiss Finance Institute

Abstract

This paper investigates how mortgage credit conditions affect housing markets and the demand for homeownership. Using unique data on homeowners' listings and transactions from the largest Chinese real estate brokerage company, and exploiting policy-driven changes in mortgage credit conditions in China, I provide empirical evidence that higher mortgage interest rates and down payment requirements have a negative effect on housing demand and prices. Estimating a structural model of households' demand and supply of residential properties, I find that mortgage interest rates and down payment requirements negatively affect households' willingness to pay and the value of owning residential properties. With counterfactual experiments, I quantify how mortgage credit policies influence housing demand, supply, price, market liquidity, bargaining power and study the role of expectations in determining housing market outcomes.

Mutual Fund Market Timing: Daily Evidence

Jeffrey Busse
,
Emory University
Jing Ding
,
Tsinghua University
Lei Jiang
,
Tsinghua University
Ke Wu
,
Renmin University of China

Abstract

We examine mutual fund market timing based on beta asymmetry from the dynamic conditional correlation (DCC) model. We find significant timing based on daily return but not based on monthly return. The sensitivity of our findings to data frequency is consistent with funds altering their market exposure at a greater frequency than can be precisely captured with monthly returns. Timing skill is especially evident during down markets, when the gains associated with market timing are especially meaningful. Successful market timers earn significant abnormal returns and attract greater investor cash flows than non-timers. Holding diversified portfolios and short selling help facilitate successful market timing.

Fast and furious: the market quality implications of speed in cross-border trading

Khaladdin Rzayev
,
London School of Economics

Abstract

Using a measure of transmission latency between exchanges in Frankfurt and London
and exploiting speed-inducing technological upgrades, we investigate the impact of
international transmission latency on liquidity and volatility. We find that a decrease in
transmission latency increases liquidity and volatility. In line with existing theoretical models, we show that the amplification of liquidity and volatility is associated with variations in adverse selection risk and aggressive trading. We then investigate the net economic effect of high speed and find that the liquidity-enhancing benefit of increased trading speed in financial markets outweighs its volatility-inducing effect.

On the Effect of Social Environment of Racial Inequality: Trump Election and Minority CEO Pessimism

Ya Kang
,
National University of Singapore

Abstract

Donald Trump’s election on 9 November 2016 unexpectedly increased the salience of ethnic inequality. Its emotional and real impact on the ethnic minority groups has not yet been documented. By exploring the variations in management forecasts, this study finds that in response to the Trump’s election, minority CEOs exhibit more pessimism in earnings forecasts for the subsequent quarter (underestimation of the mean of earnings), compared with their non-minority counterparts. The effect is stronger for firms with less experienced and less confident minority CEOs. The textual analysis also reveals that minority CEOs have a more negative tone when describing different risk factors. They express more concerns about litigation and migration risk. As a sharp contrast, the stock market does not react significantly to the election event for firms with minority CEOs. Collectively, this study provides the first evidence that Trump Election induces behavioral bias in the form of pessimism in minority CEOs, while its real impact on firm fundamentals is limited.

One Man's Meat, Another's Poison: Spillover Effect of Bank-Firm Common Ownership

Xiaotian Liu
,
City University of Hong Kong

Abstract

This paper studies a new and increasingly important phenomenon: institutional investors simultaneously hold equity of banks and industrial firms (“bank-firm common ownership”). We show that the bank-firm common ownership raises the risk of proprietary information leakage, in turn causing a real effect on loan and product markets. When a firm’s rivals and its banks establish common shareholder relationship, the firm is more likely to reduce borrowing from its current banks that are connected to its rivals. However, we find little evidence that the loan spread is higher for firms whose banks are rival-connected. We establish the causality by using a difference-in-differences method based on a quasi-natural experiment of financial institution mergers.

Optimal Currency Exposure Under Risk and Ambiguity Aversion

Urban Ulrych
,
University of Zurich and Swiss Finance Institute
Nikola Vasiljević
,
University of Zurich

Abstract

This paper addresses the choice of optimal currency exposure for a risk and ambiguity averse international investor. Robust mean-variance preferences, explicitly capturing an investor’s dislike for model uncertainty, are used in order to derive the model-free optimal currency exposure in the presence of both risk and ambiguity aversion. We show that the sample efficient currency demand can be expressed as a vector of generalized ridge regression coefficients of fully hedged portfolio returns on the excess currency returns. Moreover, the underlying model uncertainty corresponds to the penalty term in the regression. The empirical analysis of the derived currency overlay strategy employs the foreign exchange, stock, and bond returns over the period from 1999 to 2018. We find that our proposed hedging strategy leads to significant improvements of the portfolio performance and examine the effect of model uncertainty on optimal currency allocations.

Option Return Predictability, a Machine-Learning Approach

Steven Wei Ho
,
Columbia University
Yutong Hu
,
London Business School

Abstract

We apply the Least Absolute Shrinkage and Selection Operator (LASSO) to make option return forecasts using 101 signals as candidate predictors. We inves- tigate the entire option universe from January 1996 to December 2016. We hold the options till maturity and buy the options from inception with corresponding positions in the underlying stocks to establish a delta-hedge. Our LASSO results yield delta-hedged trading strategies with annualized Sharpe Ratios above 1 for at-the-money calls and puts with 30 days-to-maturity. The LASSO selected pre- dictors also work well out-of-sample. The LASSO selected predictors are different if we restrict our attention to options of different moneyness or maturities (30-, 60-, or 90-day). Overall, the results emphasize the importance of Capital gains overhang in predicting options returns, as it is one of the most frequently selected characteristics, in addition to lagged one month return of the underlying stock and 12 month momentum of the stock, institutional ownership, Standardized Unexplained Volume, cash-to-asset ratio and book-to-market ratio.

Partial Equilibrium Thinking

Francesca Bastianello
,
Harvard University
Paul Fontanier
,
Harvard University

Abstract

We model a financial market where agents fail to understand the general equilibrium consequences of their actions, a form of limited thinking that we refer to as "Partial Equilibrium Thinking" (PET). In our model, PET agents reason in "partial equilibrium" in that they think they are the only ones inferring information from price changes, when actually everyone is behaving in the same way. This leads uninformed agents to mistakenly attribute any price change they observe to new information alone, when in reality part of the price change is due to uninformed agents' buying/selling pressure. We show how the endogenous feedback effect between prices and beliefs which arises naturally in our model may lead to two different types of equilibria: if the information content in prices is high enough, be it because there are enough informed agents or because the information they receive is very precise, then the equilibrium is stable, so that prices and beliefs converge to a state-dependent equilibrium which exhibits over-reaction relative to the Rational Expectations Equilibrium. If instead the information content is too low, so that the feedback effect between prices and beliefs is too strong, the equilibrium is unstable, and prices and beliefs become extreme and decoupled from fundamentals. Moreover, we show how it is possible for the transition dynamics to endogenously switch from an unstable to a stable path. We leverage this insight to build a theory of bubbles driven by PET behavior, and we provide conditions for when a bubble endogenously arises, and when it may burst. Finally, we argue that the endogenous feedback between prices and agents' beliefs generated in our model can be applied more generally to setups where agents learn from a general equilibrium variable, thus lending itself to a variety of other macro and finance applications, such as credit cycles and investment booms.

Performance-vesting Compensation and Firm Investment/Financing Decisions

Xiao Zhong
,
University of Utah

Abstract

Since the regulation change in 2005 (ASC 718) which makes granting options as compensation more expensive, performance-vesting (p-v) provisions have been increasingly adopted by firms to replace stock options in executive compensation packages. Previous research about managerial incentives mainly focus on stock options, without considering the effect of p-v provisions after the regulation change. Among the limited research that study p-v provisions, focus has been on association rather than establishing causation. Using a generated (3-stage) IV approach (Adams, Almeida, and Ferreira 2009), I show that performance-vesting (p-v) provisions in executive compensation lead to mixed changes in managerial risk-taking decisions. P-v provisions based on accounting metrics result in generally riskier investment/financing choices with the exception of declining R&D expenditure; stock price-based p-v provisions induce riskier investment choices but less risky financing policies. Relevant stakeholders should be aware of the varying effects on firm investment/financing decisions brought about by the adoption of p-v provisions in executive compensation.

Political Connections and Insider Trading

Thuong Harvison
,
University of Arizona

Abstract

Politically connected insiders, especially senior officers who hold a director position, are more likely sell shares prior to negative abnormal returns. Politically connected insiders are also more likely to engage in other risky behavior: trading prior and closer to the earnings announcements, trading during periods that overlap with traditional blackout periods, and missing SEC timely reporting requirements. These finding are consistent with insiders perceiving their political connections as protection against SEC enforcement. Connections with Senators matter more since they have more control over the SEC. Connections with a particular political party have a greater effect on insider trading when the party controls both the House and the Senate.

Predatory Trading in Mutual Funds

Tianyue Zhao
,
University of Pittsburgh

Abstract

I hypothesize that mutual fund managers sell shares to induce price pressure in stocks owned by competitor funds in order to hurt competitors’ performance, thereby improving their own funds’ relative performance. I find that this predatory trading occurs primarily among top-ranked funds where the flow-performance relation is highly convex and in the fourth quarter when the incentives are the strongest. Predatory trading is not widespread, however, because managers anticipate and respond to the threat of predation. Specifically, smaller funds own fewer shares in illiquid stocks that are also held by larger competing funds ranked nearby. My paper is the first to provide evidence of strategic predatory trading by mutual funds and the resulting impact on the equilibrium allocation of assets within the mutual fund industry.

Pre-FOMC Information Asymmetry

Farshid Abdi
,
University of Massachusetts Amherst
Botao Wu
,
New York University

Abstract

We uncover information asymmetry before federal open market committee (FOMC) announcements, and explain the pre-FOMC announcement drift in the stock market as a compensation for the information asymmetry risk. Using corporate bond transaction level data, we document extensive evidences of informed trading starting several days before the FOMC announcements. We show that U.S. corporate bond returns and yield changes in the blackout period preceding FOMC announcements can predict monetary policy surprises, with a 20% adjusted R-squared. Moreover, starting several days before the announcements, costumers buy (sell) corporate bonds more often and corporate bond prices surge (decline) before expansionary (contractionary) monetary policy surprises. Furthermore, consistent with the informativeness of corporate bond transactions, we show that lagged corporate bond customer-dealer trade imbalances can predict pre-FOMC stock market movements and explain pre-FOMC drift. Corporate bond yield changes Granger-cause stock market pre-FOMC movements, and this bond-to-stock granger causality does not exist for non-pre-FOMC periods. Finally, we show that stocks of companies with higher probability of default are more sensitive to the lagged corporate bond market movements.

Psychological Barrier and Cross-firm Return Predictability

Shiyang Huang
,
University of Hong Kong
Tse-Chun Lin
,
University of Hong Kong
Hong Xiang
,
University of Hong Kong

Abstract

We provide a psychological explanation for the delayed price response to news about economically linked firms. We show that the return predictability of economically linked firms depends on the nearness to the 52-week high. The interaction between news about economically linked firms and the nearness to 52-week high can partially explain the underreaction to news about customers, geographic neighbors, industry peers, or foreign industries. We further examine how anchoring on the 52-week high affects belief updating regarding analyst recommendation. We find that analysts react to news about economically linked firms but that anchoring on the 52-week high reduces such reactions.

Rainy Day Liquidity

Jingzhi Huang
,
Pennsylvania State University
Xin Li
,
University of Cincinnati
Mehmet Saglam
,
University of Cincinnati
Tong Yu
,
University of Cincinnati

Abstract

Being the largest stakeholder in the corporate bond market with a cash flow largely independent of capital market conditions, insurance firms can provide liquidity in stressful conditions. This paper models and presents evidence on this distinct role played by insurers. We find that insurers' corporate bond purchases improve bond liquidity while their bond sales do not. Liquidity improvement is stronger in "rainy days", e.g., during the financial crisis, among low-rated and poor-liquidity bonds. Further, insurers' funding and holding horizon positively affect the liquidity of the bonds they purchase, highlighting the link between funding ability and rainy day liquidity provision.

Real Effects of Shareholder Proposals in the Context of Climate Change

Greg Tindall
,
Florida Atlantic University

Abstract

Extant literature has struggled to identify real effects of shareholder proposals, finding them to depend on their context. Progressively, climate change has gathered interest at annual meetings where shareholders present proposals related to the subject. The literature explains circumstances in which diversification can serve as a defense. I find that firms in receipt of shareholder proposals related to climate change diversify more, mostly into related industries. I find mixed evidence on wealth enhancements of diversification spurred by these proposals. I address endogeneity concerns in a variety of ways. The robustness of my results suggest that shareholder proposals have a strong impact on diversification, at least in the context of climate change.

Regulation and Initial Capital Structure: Evidence from the JOBS Act

Khaled Alsabah
,
University of Colorado
Katie Moon
,
University of Colorado Boulder

Abstract

We examine capital structure implications of newly public firms' availing themselves of regulatory exemptions. Title I of the Jumpstart Our Business Startups (JOBS) Act provides newly public firms broad-scale regulatory relief but limits the benefits to a certain subset of firms named ``Emerging Growth Companies (EGCs)." One of the EGC criteria is based on a $700 million public float threshold. We find evidence that firms appear to manipulate their public float at IPO issuance by bunching around the threshold to be eligible for the EGC status. Firms staying below the threshold are more likely to substitute public equity with debt. We further find the leverage effect persists over time, although public-float bunching attenuates.

Safe Asset Migration

Chase Ross
,
Yale University

Abstract

Post-crisis reforms changed the location of safe asset production. I propose a pair of tests to identify who issues safe assets and which safe asset issuers opportunistically time issuance when the price of safe assets is high. Federal agency issuance both (1) responds to day-to-day fluctuations in demand for safe assets—measured via the convenience yield—and (2) is an important determinant in the subsequent price of safe assets. Agencies issue more the day after an unexpected increase in the convenience yield, and an unexpectedly large agency issue decreases the convenience yield the next day. The Federal Home Loan Bank system is a newly crucial safe asset producer. The FHLBs' ability to produce safe assets depends on their implicit government backing, a potential source of concern for future policymakers.

Same Bank, Same Client but Different Pricing: How do Flat-fees for Mutual Funds affect Retail Investor Portfolios?

Benjamin Loos
,
University of Mannheim
Steffen Meyer
,
University of Southern Denmark & Danish Finance Institute
Charline Uhr
,
Goethe University Frankfurt
Andreas Hackethal
,
Goethe University Frankfurt

Abstract

What happens when a bank introduces a flat-fee pricing scheme for trading mutual funds to its brokerage clients while leaving everything else unchanged? Only 1.26% of clients adopt the fee scheme. Adopters have been using financial advice and are less prone to inertia. Difference-in-differences analyses of previously advised clients reveal that flat-fee clients seek and follow more advice and improve their portfolio efficiency. A second field experiment, with a large branch bank replicates the main results. We suggest that flat-fees increase trust in advisor quality and reject alternative explanations, like cost-advantages, sunk-cost fallacy, novelty effects or advisor (time) fixed effects.

Security Design and Credit Rating Risk in the CLO Market

Dennis Vink
,
Nyenrode Business Universiteit
Mike Nawas
,
Nyenrode Business Universiteit
Vivian van Breemen
,
De Nederlandsche Bank

Abstract

In this paper, we empirically explore the effect of the complexity of a security’s design on hypotheses relating to credit rating shopping and rating catering in the collateralized loan obligation (CLO) market in the period before and after the global financial crisis in 2007. We find that complexity of a CLO’s design is an important factor in explaining the likelihood that market participants display behaviors consistent with either rating shopping or rating catering. In the period prior to 2007, we observe for more complex CLOs a higher incidence of dual-rated tranches, which are more likely to have been catered by credit rating agencies to match each other. Conversely, in the period after 2007, for CLOs, it is more likely that issuers shopped for ratings, in particular opting for a single credit rating by Moody’s, not by S&P. Furthermore, contrary to what market participants might expect, investors do not value dual ratings more than single ratings in the determination of the offering yield at issuance. Looking at the explanatory power of credit ratings for a dual rated CLO, the degree to which investors increase their reliance on credit ratings depends to a large extent on the disclosure of an S&P rating, not Moody’s. This suggests that investors recognize credit rating risk by agency in pricing CLOs. In sum, the policy implication is that, to effectively regulate CLOs, the regulatory environment ought to differentiate between complex and non-complex CLOs.

Slowly Unfolding Disasters

Mohammad Ghaderi
,
University of Houston
Mete Kilic
,
University of Southern California
Sang Byung Seo
,
University of Houston

Abstract

We develop a model that endogenously generates slowly unfolding disasters not only in the macroeconomy, but also in financial markets. Due to imperfect information, disaster periods in the model are not fully identified by investors ex ante at the onset, but ex post using the peak-to-trough approach as in the data. Bayesian learning leads to a gradual reaction of equity prices to persistent consumption declines during disasters, consistent with the empirical evidence. We show that this mechanism is crucial in explaining the VIX, the variance risk premium, and risk premia on put-protected portfolios, addressing the shortcomings of traditional disaster risk models.

Human Interactions and Financial Investment: A Video-Based Approach

An (Allen) Hu
,
Yale University
Song Ma
,
Yale University

Abstract

Economic decisions are often made after human interactions. This paper proposes a flexible and extendable empirical framework to study micro-level human interactions and their connections to financial investment decisions. We project human interactions to three dimensions—visual, vocal, and verbal, and construct easily interpretable metrics along these dimensions using machine learning algorithms with videos as data input. The framework and methodology are applied to pitch videos in which entrepreneurs pitching investors for funding. We find that startup founder(s)’s behaviors differ significantly in their pitches. Venture investors are more likely to invest in startup teams that show more warmth and positivity (happy, passionate), but startup teams showing such features underperform conditional on investment. These features in human interactions carry more weight when evaluating female entrepreneurs, but women are often neglected when presenting together with their male teammates. We do not find strong evidence supporting that human interactions allow venture investors to extract additional valuable information about entrepreneurs on net.

Speculator Spreading Pressure and the Commodity Futures Risk Premium

Yujing Gong
,
University of Warwick
Arie E. Gozluklu
,
University of Warwick
Gi H. Kim
,
University of Warwick

Abstract

This paper investigates the impact of speculative trading on the commodity futures risk premium. We focus on speculators’ spread positions, and study the asset pricing implications of spreading pressure on the cross-section of commodity futures returns. Spreading pressure negatively predicts futures excess returns even after controlling for well-known determinants of futures returns such as basis-momentum. The spreading pressure factor-mimicking portfolio carries a significant risk premium of 21.55% per annum after commodity market financialization. Our single-factor model provides a better cross-sectional fit than the existing factor models. We show that spreading pressure reflects speculators’ expectation on the change in the slope and curvature of futures term structure, and our spreading pressure is explained by innovations in real economic uncertainty.

Speed of Financial Contagion and Optimal Timing for Intervention

Diana Mikhail
,
Carnegie Mellon University

Abstract

What constitutes timely intervention during a systemic crisis? Intervention that is 'too early' may not be appropriately designed due to the uncertainty surrounding the systemic nature of the crisis and may trigger panic. Intervention that is 'too late' may exacerbate the severity and duration of the crisis and ultimately prove ineffective in limiting financial contagion. In this paper, I develop a model to study optimal timing for intervention in a Core-Periphery interbank network of the financial system. Optimal timing for intervention during a cascade depends on two trade-offs: resilience of nodes against maturity of liabilities ('speed of financial contagion') and welfare of defaulting nodes against the cost of a systemic bailout. I find that faster contagion necessitates more immediate intervention and there is a threshold of speed beyond which immediate intervention becomes optimal. A 'too-interconnected-to-fail' effect arises endogenously in my model where a systemic bailout is warranted earlier when core nodes default even when it is more expensive. This finding is robust even when core nodes contribute less welfare to the financial system.

Systemic Cyber Risk

Rustam Jamilov
,
London Business School

Abstract

Cyber risk is a new and rapidly emerging form of operational threat that scales with digital automation and may cause significant disruptions to the financial market infrastructure. In this paper, I present a case that firm-level cyber attacks can have substantial aggregate implications. First, using multiple datasets on reported cyber incidents I build a time-varying value-weighted index of systemic cyber risk (SCR). Following positive shocks to SCR, firm-level stock returns (volatility) fall (rise) by roughly 2% (3%). Using spatial autoregressions identified with high-dimensional stock market networks, I find that up to 70% of the overall effect is due to second-order network effects. In the aggregate, positive shocks to SCR lead to significant reductions in market returns, spikes in corporate bond spreads, as well as increases in common proxies of aggregate uncertainty such as the VIX and the economic policy uncertainty index. Second, in order to study the social cost of cyber crime (SCCC), I build a dynamic general equilibrium model with heterogeneity, idiosyncratic risk, and costly endogenous default. In the model, heterogeneous bankers are subject to idiosyncratic stochastic volatility shocks - cyber attacks. The model is calibrated using the newly assembled dataset and can match the annual worldwide SCCC which ranges from $300 billion to over $1 trillion.

Does Safety Uncertainty Affect Acquisitions?

Tung Nguyen
,
University of Surrey
Dimitris Petmezas
,
University of Surrey
Nikolaos Karampatsas
,
University of Surrey

Abstract

Using terrorist attacks as an exogenous shock to safety uncertainty, we provide causal evidence that firms located near terrorism-stricken areas receive lower takeover premium. The latter finding is reflected in lower target firm abnormal returns and synergy gains. Additionally, given that firms in terrorism-afflicted areas become less attractive, they are less likely takeover targets for two years after the terrorist attack, and acquirers from such areas are more likely to buy target firms from more distant locations. We attribute our results to human capital which is affected by terrorism induced safety uncertainty, consistent with Abadie and Gardeazabal’s (2008) theoretical model.

The Bond Investor’s Trading Horizon and the Cost of Debt

Li-Ting Chiu
,
SUNY-BUFFALO

Abstract

This paper examines how trading behaviors among institutional bond investors affect the cost of debt. Firms with a larger percentage of long-term investors have lower debt cost. By contrast, high short-term ownership results in the uncertainty of capital supply and high debt cost. These findings are not driven by investors’ or bonds’ characteristics after using the investors’ funding structure as an instrument. The results suggest that short-term investors’ capital uncertainty results in fragility problems in the corporate bond market. Conversely, long-term investors play an important role in enhancing corporate governance, thereby lowering the cost of debt.

The Corporate Supply of (Quasi) Safe Assets

Lira Mota
,
Columbia University

Abstract

This paper presents evidence that firms actively respond to the demand for safety by changing their capital structure. I introduce the cross-basis as a measure of safety premium in corporate bonds. Let the bond-CDS basis be the difference between the credit spread and the CDS spread, i.e., the component of the credit spread which is not explained by credit risk. The cross-basis of a firm is defined as the difference between the cross-sectional average of the bond-CDS basis in the market and the bond-CDS basis of the firm. The cross-basis forecasts bond issuance and equity payout, and does not forecast real investment. The evidence is consistent with a model in which investors value safety in financial assets and firms can act as liquidity providers by issuing securities that provide safety services.

The Disposition Effect in Boom and Bust Markets

Sabine Bernard
,
University of Mannheim
Benjamin Loos
,
University of Technology Sydney
Martin Weber
,
University of Mannheim

Abstract

Most papers investigating the disposition effect implicitly assume it to be constant over time and use data that only cover boom periods. However, drivers of the disposition effect (preferences and beliefs) are rather countercyclical. We use individual investor trading data comprising several boom and bust periods (2001-2015). Our results show that the disposition effect also moves countercyclical, i.e. is higher in bust than in boom periods. Our findings are driven by individuals realizing more gains in bust periods. Investors are, in relative (absolute) terms, 25 (4.6) percent more likely to realize a gain in bust than in boom periods.

The Effect of Conflict on Lending: Empirical Evidence from Indian Border Areas

Mrinal Mishra
,
University of Zurich and Swiss Finance Institute
Steven Ongena
,
University of Zurich

Abstract

We study the effect of conflict on loan officers in areas bordering India and Pakistan in the state of Jammu & Kashmir in India. We observe that the loan terms borrowers obtain in equilibrium get progressively worse after repeated incidences of conflict. This may be attributed to changes in beliefs or changes in risk aversion on behalf of the branch administration. Our tests demonstrate that both factors, changing risk preferences and beliefs contribute to the final outcome. The latter primarily manifests itself through changes in expected future default probability due to learning about the environment. Our results are expected to inform policymakers how lending may evolve when faced with shocks emanating from political and economic turmoil.

The Effect of Policy Uncertainty on VC Investments Around the World

Romora Sitorus
,
University of Oklahoma

Abstract

This study documents a significant negative relationship between policy uncertainty and Venture Capital (VC) investment in entrepreneurial firms across non-U.S. countries. The adverse effect of policy uncertainty is exacerbated for younger and early-stage firms. By contrast, the effect is attenuated for firms which have headquarters in cities with high concentration of global Venture Capital investment or in countries with more developed stock markets, and for firms which are backed by corporate or government lead VCs. Using close national elections and ethnic fractionalization to alleviate endogeneity concerns, I find that the baseline results continue to hold. Furthermore, I also find that policy uncertainty reduces the amount of cross-border VC investment. Finally, this study provides evidence that uncertainty increases the number of financing rounds, decreases the fraction of investment amount during the first round, and reduces the likelihood of successful exit through acquisition.

The Costs of Scheduling FOMC Meetings

Heiner Beckmeyer
,
University of Muenster
Nicole Branger
,
University of Muenster
Thomas Grünthaler
,
University of Muenster

Abstract

Using a set of liquid high-frequency options on a broad market index, we study the behavior of economic uncertainty around U.S. monetary policy announcements. We find a remarkable pattern from a week before to a day after announcement days. Uncertainty increases on the first two days of the blackout period, and then gradually resolves as we near the meeting day, with a sizable jump at the announcement time. We show that this pattern can be explained by uncertainty about tail events. FOMC meetings command a premium for being exposed to the possibility of such events. Our results are amplified on days with press conferences indicating that markets seek for opportunities to categorize the importance of meetings, and we show that unexpected decisions trigger a large resolution of uncertainty. We accredit this reaction to news provided by the Fed being unexpectedly good in recent decades.

The Information Content of Commodity Futures Markets

Romulo Alves
,
Erasmus University Rotterdam
Marta Szymanowska
,
Erasmus University Rotterdam

Abstract

We find that commodity futures returns contain information relevant to stock market returns and macroeconomic fundamentals for a large number of countries. Commodity futures returns predict stock market returns in 59 out of 70 countries and macroeconomic fundamentals in 62 countries. This predictability is not concentrated in the Energy and Industrial Metals sectors, as it is economically and statistically significant across all sectors. Surprisingly, we find that the role of countries' dependence on commodity trade is limited in its ability to account for this predictability. This holds true even when considering new measures that take into account indirect exposures through financial and trade linkages between countries. We find much stronger evidence of predictability being related to the ability of commodities to forecast inflation rates. Overall, our evidence is consistent with commodity markets having a truly global information discovery role in relation to financial markets and the real economy.

The Real Effects of Distressed Bank Mergers

Valeriya Dinger
,
University of Osnabrueck
Christian Schmidt
,
University of Mannheim
Erik Theissen
,
University of Mannheim

Abstract

In this paper we revisit the question whether negative shocks to banks have adverse real economic effects. We analyze German savings banks and propose a new identification strategy. We consider distressed mergers and interpret them as exogenous shocks to the (initially non-distressed) acquiring bank. We find that in the years after a distressed merger (i) the performance of acquiring savings banks deteriorates; (ii) the shock is transmitted to firms in the acquirer's region who cut back their investments and (iii) the overall macroeconomic dynamics in the region of the acquirer deteriorates, leading to lower investment and employment growth. To justify a causal interpretation of our results we perform several additional tests that establish the exogeneity of the shock to the acquiring bank with respect to local economic dynamics.

The Role of Investor Attention in Seasoned Equity Offerings: Theory and Evidence

Thomas Chemmanur
,
Boston College
Karen Simonyan
,
Suffolk University
Yu Wang
,
Boston College
Xiang Zheng
,
Boston College

Abstract

Models of seasoned equity offerings (SEOs) such as Myers and Majluf (1984) assume that all investors in the economy pay immediate attention to SEO announcements and the pricing of SEOs. In this paper, we analyze, theoretically and empirically, the implications of only a fraction of investors in the equity market paying immediate attention to SEO announcements. We first show theoretically that, in the above setting, the announcement effect of an SEO will be positively related to the fraction of investors paying attention to the announcement and that there will be a post-announcement stock-return drift that is negatively related to investor attention. In the second part of the paper, we test the above predictions using the media coverage of firms announcing SEOs as a proxy for investor attention, and find evidence consistent with the above predictions. In the third part of the paper, we develop and test various hypotheses relating investor attention paid to an issuing firm to various SEO characteristics. We empirically show that SEO underpricing, the post-SEO equity market valuation of firms, and institutional investor participation in SEOs are all positively related to investor attention. The results of our identification tests show that the above results are causal.

The Term Structure of Credit Spreads and Institutional Equity Trading

Efe Cotelioglu
,
USI Lugano and Swiss Finance Institute

Abstract

This paper empirically investigates the role of long-term institutional investors in information diffusion from the credit market to equities. The results show that a 1-percent increase in CDS slope is associated with a 0.114 percentage point increase in the sales of the long-term institutions. However, changes in CDS slope do not significantly predict short-term institutional trading. My findings provide evidence that a low CDS slope predicts improved creditworthiness, which in turn, is transmitted to the equity market through the trading of long-term institutions.

Taking Sides on Return Predictability

David McLean
,
Georgetown University
Jeffrey Pontiff
,
Boston College
Christopher Reilly
,
Boston College

Abstract

We study how nine different market participants, which include retail investors, short sellers, firms, and 6 types of institutions, trade with respect to 131 stock return anomalies, and how each market participant’s trades relate to subsequent returns. Retail investors do the worst. They accumulate anomaly-shorts and sell anomaly-longs. Firms do the best; they buy anomaly-longs and sell anomaly-shorts. Short sellers build positions in anomaly-shorts before the portfolio-formation date, and then exit soon afterwards. Institutional investors build unfavorable positions before the portfolio-formation date, and then reduce these positions after the formation date. Retail and bank trades predict stock returns in the wrong direction, other institutional trades do not consistently predict returns, firm and short seller trades predict returns in the intended direction. Overall, our results suggest that firms and short sellers are the smart money, institutions are neutral, and retail investors do the worst.

The Value of Renewable Energy and Subsidies: An Investor's Perspective

Alexander Kronies
,
Copenhagen Business School

Abstract

I provide a novel theoretical approach to value wind energy investments. It allows to adjust for a number of risk parameters, including wind speeds, electricity price forecasts, discount rates, and uncertainty in subsidies. I use this approach to model wind energy investments under two different subsidy schemes in Denmark through a numerical Monte Carlo simulation. Moreover, I model wind energy investments under the assumption of a subsidy-free asset class. I compare the three systems and expose them to various sources of uncertainty through which I provide more clarity on which risk parameters matter most to wind energy investors and how the three systems compare to each other.

The Value Of Say On Pay

Axel Kind
,
Universität Konstanz
Marco Poltera
,
Universität Basel
Johannes Zaia
,
Universität Konstanz

Abstract

This paper measures the impact of “say on pay” (SoP) on the market value of corporate voting rights. We exploit the staggered introduction of SoP regulations across 14 economies on four continents and run a battery of difference-in-differences regressions. The results show that voting right values have increased in firms with excessive CEO pay, while they have remained largely unaffected (or even decreased) in other companies. Thus, the option to signal dissent with current compensation through say on pay is not per se valuable and might even translate into net costs for shareholders. The effects are persistent over time and are robust to many different regression specifications and alternative SoP shocks.

The Value Uncertainty Premium

Turan Bali
,
Georgetown University
Luca Del Viva
,
ESADE Business School
Menatalla El Hefnawy
,
ESADE Business School
Lenos Trigeorgis
,
University of Cyprus, King's College London and MIT

Abstract

This paper investigates whether the time-series volatility of book-to-market (BM), called value uncertainty (UNC), is priced in the cross-section of equity returns. A size-adjusted value-weighted factor with a long (short) position in high-UNC (low-UNC) stocks generates an annualized alpha of 6-8%. This value uncertainty premium is driven by outperformance of high-UNC firms, and is not explained by established risk factors or firm characteristics, such as price and earnings momentum, investment, profitability, or BM itself. UNC is correlated with macroeconomic fundamentals and predicts future market returns and market volatility. We provide a rational asset-pricing explanation of the uncovered UNC premium.

The Zero Lower Bound and Financial Stability: A Role for Central Banks

Tatjana Schulze
,
University of Oxford
Dimitrios Tsomocos
,
University of Oxford

Abstract

Macroprudential policy objectives have taken a new place in central bank pref- erences next to the prime objectives of monetary policy – stabilizing inflation and output. When deciding to raise interest rates from the zero lower bound (ZLB), central banks must take into account the effects of an increase in nominal interest rates on financial stability not only via bank profitability but also via aggregate default in the economy. We develop a general equilibrium model with a financial sector, an autonomous central bank, and collateral default to analyze (a) how mon- etary and macroprudential policy objectives affect optimal policies, and (b) how a lift-off from the ZLB affects liquidity and default (i) when the central bank cares only about monetary policy objectives, and (ii) when the central bank cares also about macroprudential policy objectives. A lift-off from the ZLB exacerbates default but mitigates default-induced deflation when the central bank has control over one instrument for each policy objective. A dual mandate without considering financial stability concerns increases the variance in targeted policy outcomes across states of nature. Pursuing macroprudential policy objectives on top of the dual mandate makes optimal monetary policy less pro-cyclical in our model.

Propensity to Accumulate Wealth, Portfolio Choice, and Asset Prices

Carina Cuculiza
,
University of Miami

Abstract

I examine how heterogeneous wealth accumulation motives affect household asset allocation decisions and asset returns in the United States. I find that households with a stronger propensity to accumulate wealth allocate more wealth to risky assets and are more likely to participate in the stock market. They also use financial markets to smooth their idiosyncratic income shocks, leading to lower income inequality, higher stock prices, and lower expected returns in areas where wealth accumulation motives are strong. Overall, these findings suggest that heterogeneity in the propensity to accumulate wealth can have social and economic implications.

Tit for Tat? The Consequence of Personal Information Misuse in Debt Collection

Li Liao
,
Tsinghua University
Zhengwei Wang
,
Tsinghua University
Congyi Zhou
,
Tsinghua University

Abstract

We examine consumers’ behavioral response to the misuse of personal information in the special case that personal contact data is employed to collect consumer loans without consumer authorization. Without controlling for endogeneity, this collection practice seems to reduce the default rate by 35%. However, using the fact that some borrowers are not collected due to excessive workloads for the collectors to develop our identification strategy, we find that the collection practice actually increase the default rate by 51%. Cross-section results suggest that the misuse of personal data has elicited negative reciprocity; that is, borrowers retaliate by deliberately choosing to default. Furthermore, based on online consumption data, we did not find evidence supporting that the increased default rate is related to declined repayment ability.

Tweeting in the Dark: Corporate Tweeting and Information Diffusion

Isabella Wolfskeil
,
Bocconi University

Abstract

Is there a link between corporate information dissemination on social media and valuations? Are social media reshaping the diffusion of corporate information? After constructing a novel and comprehensive dataset of over 7 million tweets posted by S\&P 1500 firms, I adopt text analysis methods and find that firms with negative earnings surprises have higher announcement returns if they tweet about earnings news. This result is concentrated among firms with higher retail investor ownership and larger social media networks. I also find evidence that firm-initiated tweets increase investors' fundamental information acquisition and the speed of information diffusion to investors. These findings are broadly supportive of the view that of the view that social media help facilitate price discovery after news releases. The results are consistent with models of investor sentiment, where investor sentiment is generally attributed to retail investors or noise traders (e.g., De Long et al. (1990), Lee et al. (1991), Shleifer and Vishny (1997)) and with models that use investor inattention to explain underreaction in returns (e.g., Barber et al. (2008), Cohen and Frazzini (2008), DellaVigna and Pollet (2009), Hirshleifer and Teoh (2003)).

Understanding the Onshore versus Offshore Forward Rate Basis: The Role of FX Position Limits and Margin Constraints

Hyeyoon Jung
,
New York University

Abstract

During the financial crisis of 2007-2009, the difference between the exchange rate for locally traded (onshore) forward contracts and contracts with the same maturity traded outside the jurisdiction of countries (offshore) grew significantly, but by different magnitude across currencies. This paper provides an explanation for the time-series and cross-sectional variation in the price gaps (``bases"), with margin requirements and foreign exchange net position limits imposed by local authorities. In time-series, bases depend on the shadow cost of margin constraint and that of position limit constraint, which are captured by the interest rate spread between collateralized and uncollateralized loans and the spread between onshore and offshore funding rates, respectively. In cross-section, bases depend on country-specific position limits and the shadow cost of position limit constraint. The main prediction is tested empirically, and the results suggest that the position limit has explanatory power for basis after controlling for the effect of margin requirement.

Visuals and Attention to Earnings News on Twitter

Shijia Wu
,
University of California at Irvine

Abstract

We propose a visual attention hypothesis that visuals in firm earnings announcements increase attention to the firm. We find that visuals in firm Twitter earnings announcements increase follower engagement with the message via retweets and likes. Consistent with attention spillover, same day other tweets with visuals increase retweets and likes. Additionally, retweets increase at the firm level and decrease at the message level with the number of firm earnings tweets on the announcement day. Firms are more likely to use visuals in their earnings messages when earnings exceed analyst consensus expectations and are less persistent, consistent with managerial opportunism. Finally, consistent with visuals increasing investor attention, the initial return response to earnings news is stronger, and the post-announcement response is lower when visuals are used. Furthermore, the higher ERC from visuals is more pronounced on high investor distraction days when many other firms are also announcing earnings.

Wealth Effects and Predictability of Firms' Government Sales Dependency

Bharat Parajuli
,
University of Utah

Abstract

In this paper, using a new channel of political connections, firm dependency on government sales, I study the value of political connections for firms. I find an economically and statistically significant relation between firm dependency on government entities in terms of revenues and the cross-section of future stock returns. Firms experience significantly higher profit margins post government dependency. In addition, past government sales significantly predict future government sales. The atypical features of government contracts and the information asymmetry between the contractor and contractee are likely to be behind the firms' higher profit margins. Further tests based on attention and uncertainty proxies suggest that investors' limited attention and greater valuation uncertainty contribute to abnormal returns. Furthermore, I find evidence suggesting that firms gain the wealth effects of political connections found by Cooper, Gulen, and Ovtchinnikov (2010) by winning material government contracts; however, the wealth effects of government dependency stay strong even after controlling for such connections.

What do Private Equity Firms do in the Credit Markets?

Mustafa Emin
,
University of Florida

Abstract

This paper provides evidence that Collateralized Loan Obligations (or “CLOs”), managed by Private Equity firms, exhibit different characteristics than other CLOs. These characteristics include uniqueness of borrowers in loan pool, industry concentration, default events, equity returns and CLO structure. While alternative hypothesis are not excluded, the results are consistent with the notion that the existence of an informed player in the market alleviates concerns with respect to information asymmetry problems. This is a potential explanation for the inconsistent results found in the CLO literature regarding the adverse selection problem.

What is the Value of an Innovation? Theory and Evidence on the Stock Market's Reaction to Innovation Announcements

Thomas Chemmanur
,
Boston College
Dongmei Li
,
University of South Carolina
Kevin Tseng
,
University of Kansas
Yu Wang
,
Boston College

Abstract

We analyze, theoretically and empirically, the effect of investor attention on the stock market reaction to innovation announcements and suggest how market-based measures of the economic value of patents can be enhanced. We develop a dynamic model with limited investor attention to show that, following the immediate market reaction to innovation announcements, there will also be a stock return drift: the magnitude of the announcement effect will be increasing while that of the post-announcement drift will be decreasing in investor attention. We test our model predictions using two different datasets: a matched sample of pharmaceutical industry patent grant and subsequent FDA drug approval announcements; and a general USPTO sample of patent grant announcements. We use the media coverage of innovation announcements as a proxy for the investor attention paid to them. Consistent with model predictions, we find the following. First, in our matched patent grant and drug approval analysis, the announcement effects of patent grant announcements are smaller than those of FDA drug approval announcements; the subsequent stock return drifts, however, are larger for patent grant announcements. Second, the announcement effect of patent grant announcements is increasing in investor attention while the subsequent stock return drift is decreasing in investor attention. Third, the stock-return drift following patent grant announcements has predictive power for the economic value of patents, over and above the information contained in the announcement effect. Finally, we show that a long-short trading strategy based on investor attention is profitable over the one-month period after patent grant announcements.

The Real Effects of Rating Inflation: Evidence from China

Shida Liu
,
Tsinghua University
Hao Wang
,
Tsinghua University

Abstract

Credit ratings in the Chinese corporate sector were inflated by one notch on average during the period of 2005-2017. Inflated ratings lead to partial reductions in bond issuance spreads by 23 bps on average. Firms with inflated ratings tend to increase leverage ratios; hold less cash; and invest more in capital assets. On average, rating inflation associates with faster sales growth, greater profitability and higher market-to-book ratios; but for firms with relatively weak fundamentals, rating inflation negatively correlates with operation efficiency. Rating-contingent regulations and the agency conflicts rooted in the issuer-paid rating business model jointly explain around 40% of rating inflation.

When does Liquidity matter?

Fabricius Somogyi
,
University of St. Gallen
Paul Söderlind
,
University of St. Gallen

Abstract

This paper studies the role of liquidity in the world's largest over-the-counter market (OTC), the foreign exchange (FX) market. We are the first to systematically disentangle FX liquidity from volatility showing that both relate to FX premia in distinct ways. Our results are derived from a comprehensive trade and quotes dataset covering a broad cross-section of currency pairs. We provide compelling evidence that FX liquidity is only priced conditional on volatility being high and derive a new pricing factor. Incorporating this new pricing factor into a conditional asset pricing framework distinguishing between good and bad states of the world significantly improves the fit. Our findings are consistent with the sensitivity of OTC markets to volatility swings and market participants' loss aversion.

When is a MAX not the MAX? How News Resolves Information Uncertainty

Ran Tao
,
University of Reading
Chris Brooks
,
University of Reading
Adrian Bell
,
University of Reading

Abstract

A well-known asset pricing anomaly, the ``MAX" effect, measured by the maximum daily return in the past month, depicts stocks' lottery-like features and investor gambling behaviour. Using the comprehensive stock-level Dow Jones (DJNS) news database between 1979 and 2016, we consider in a empirical setting how the presence of news reports affects these lottery-type stocks. We find an augmented negative relationship between MAX stocks without news and expect returns, whereby MAX with news coverage generates return momentum. The differing future return relationships between MAX stocks with and without news appears to be best explained by information uncertainty mitigation upon news arrival. Overall, our findings suggest that news plays a role in resolving information uncertainty in the stock market.

Which Post-Crisis Regulations are Constraining Banks' Market Making? Evidence from Strategic Accounting Classifications

Dennis Hamilton
,
University of Iowa

Abstract

Banks increased held-to-maturity (HTM) classifications by more than $600 billion between 2010 and 2016 despite binding sale restrictions that render HTM securities illiquid. They accepted this friction in order to protect regulatory capital ratios from Basel III’s expanded marking to market of fixed income security portfolios. I find the unprecedented rise in restrictive HTM classifications crowds out dealer inventories, resulting in constrained market making capacity and reduced liquidity provisions by banks. Ultimately, market liquidity worsens for securities most frequently classified as HTM. Contemporaneous regulations are ruled out through analyses of treated and control banks, dealers, asset classes and mortgage-backed securities.

Who Has Skills in Trading Options?

Jianfeng Hu
,
Singapore Management University
Antonia Kirilova
,
Singapore Management University
Seongkyu (Gilbert) Park
,
Hong Kong Polytechnic University
Doojin Ryu
,
Sungkyunkwan University

Abstract

This paper uses account-level transaction data in Korea’s index options and futures to examine
option trading skills by different types of investors. We first investigate how common option
trading strategies are used. We find that (i) retail investors, both domestic and foreign, are more
likely to use simple option strategies, while institutional investors are more likely to use
complicated strategies; (ii) volatility trading is used more often than the other classic options
strategies; (iii) a small number of accounts, both institutional and retail, generate large volumes
of trades using sophisticated and well hedged positions. Then we examine the association
between trading strategies and account performance. Our results show that (i) foreign investors
are similar to domestic investors; (ii) for both retail and institutional investors, those using
volatility strategies outperform their peers and mainly gain from selling volatilities, although
subject to large downside risk; (iii) retail investors who use simple one-directional strategies
underperform, but institutions are able to gain from such strategies, possibly due to
informational advantages. Our findings suggest that skilled options traders use volatility and
complicated strategies, but country domicile is less important.

Why Do Institutional Investors Oppose Shareholder Activism? Evidence from Voting in Proxy Contests

Yanran Liu
,
University of Pittsburgh/Indiana University

Abstract

This paper examines why institutional shareholders frequently oppose activists when activism increases the value of target firms. Because institutions underweight targets and activism could adversely affect the values of rival firms, institutional investors often lack incentives to support activists when gains on targets are diluted or offset by losses on rival firms. Using hand-collected data of mutual fund and pension fund voting in proxy contests, I find that institutions that benefit less from the activism events are less likely to support the activists. The evidence suggests that institutional investors’ portfolio returns explain their support for the activists.

Why Do U.S. CEOs Pledge Their Own Company's Stock?

Kornelia Fabisik
,
Ecole Polytechnique Fédérale de Lausanne (EPFL) and Swiss Finance Institute (SFI)

Abstract

Between 2007 and 2016, 7.6% of publicly listed U.S. firms disclosed that their CEOs had pledged company stock as collateral for a loan. On average, CEOs pledge 38% of their shares. The mean loan value is an economically sizeable $65 million. CEOs use the funds to either double down (6.0%), hedge their ownership (3.5%), or to obtain liquidity while maintaining ownership (90.5%). My event study results reveal that stock market participants view pledging as value-enhancing, but perceive significant pledging as value-destroying. Similarly, I find no evidence of its negative shareholder value consequences, except for CEOs who engage in significant pledging.

Why do US firms use more long-term debt post activist interventions?

Amanjot Singh
,
Deakin University
Saikat Sovan Deb
,
Deakin University
Harminder Singh
,
Deakin University

Abstract

We find that US firms increase the use of long-term debt post hedge fund activism. The target
firms' median proportion of debt maturing in more than 3 years increases by 19% in three years
around the activists’ interventions. Firms with a lower level of leverage, research and
development expenditure and cash holdings are the ones witnessing an increase in debt
maturity profile. Our results indicate that this debt maturity change may not be influenced
by bankers’ reluctance to provide capital (supply-side constraints) but due to targets’ increasing
reliance on long-term public debt (demand-side factors). Hedge fund activism increases
the propensity to raise long-term public debt in target firms. This indicates that new long-term
debtholders believe in ‘shared benefits’ hypothesis by extending longer-term debt to target
firms. The overall increase in debt maturity is more pronounced in target firms associated with
governance reforms. Collectively, our findings suggest possible governance substitution from
short-term debtholders to activist hedge funds.

Within-firm Labor Heterogeneity and Firm Performance: Evidence from Employee Political Ideology Conflicts

Xiao Ren
,
University of Georgia

Abstract

This paper explores the implication of within-firm labor heterogeneity for firm performance through the lens of employee political ideology. Using individual campaign donation information to capture political ideology, I find that political ideology conflicts, both those between CEOs and employees and those within employees, are negatively associated with firms’ future operating performance. This effect is stronger for firms whose employees are more geographically concentrated, more sophisticated, and more devoted to political participation. The reduced labor productivity and abnormal employee turnover are two plausible mechanisms through which employees’ political ideology conflicts hurt firm performance. To establish causality, I use an instrumental variable approach which relies on the exogenous variation in political ideology caused by local television station ownership changes.

Yield Curve Volatility and Macroeconomic Risk

Anne Lundgaard Hansen
,
University of Copenhagen

Abstract

I show that the relationship between the U.S. Treasury yield curve and macroeconomic risk fluctuates over time. I establish this result by introducing time-varying volatility and variance risk premia in a tractable term structure model. Based on my model, I characterize the joint behavior of the yield curve and macroeconomic risk captured by inflation and unemployment gap from 1971 to 2019. First, I find that the macroeconomic contribution to short-term yield volatility is high in the 1970s, low during the Great Moderation starting in the mid-1980s, and high again after the financial crisis. Second, investors are increasingly anchoring short-rate expectations to macroeconomic risk. Third, deflation fears increase term premia during the financial crisis. Finally, I show that macroeconomic shocks do not explain the yield curve inversion in 2019. My results suggest that the recent inversion is not a warning of an imminent recession and thus should not trigger monetary policy easing.
JEL Classifications
  • G0 - General