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AFA Ph.D. Student Poster Session

Poster Session

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

Manchester Grand Hyatt San Diego, 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 propose enhanced necessary criteria to select Factor-Mimicking Portolios (FMPs) that genuinely present a true risk factor. Ideally, FMPs should (a) be correlated with underlying factors, (b) be related to the systematic risk in asset returns, (c) explain the cross-sectional of mean returns, and (d) be robust to the included assets. Existing methods do not satisfy these criteria and are exposed to several econometric difficulties such as errors-in-variables bias. We study the improvements based on the Instrumental Variables method (IV) and Stein’s shrinkage method. The IV approach leads to nearly unbiased risk premium estimation in simulations, while other methods have large biases. We find that FMPs constructed with IV satisfy the above criteria for equities when mimicking consumption growth, inflation, and the unemployment rate and for corporate bonds when mimicking 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

Merger 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 the market for corporate control is an important information source to resolve the uncertainties in 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 tree model of ambiguity is then proposed that explains salient points of ambiguity on asset pricing in empirical tests in this paper and in cite{Izhakian18}. The paper finds that the financial news media have a bigger influence on asset prices than social media except in recent periods of recessions. The paper provides a market-wide and natural event evidence of agents' maxmin utility optimisation behavior in cite{Gilboa89}.

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.

Asset Pricing on Blockchain: Slow Moving Capital, Crypto-Momentum, and Bubbles

Dexin Hou
,
Tsinghua University
Jie Li
,
Shanghai Jiao Tong University
Li Liao
,
Tsinghua University
Hong Zhang
,
Tsinghua University

Abstract

Limited capacity in processing transactions presents one of the most fundamental technical challenges to blockchain-based financial applications (e.g., Bitcoin). We argue that this property also has profound impacts on asset prices by limiting the speed and scale at which capital can flow, which may distort prices in two important and distinctive ways: 1) to limit the speed of information dissemination in normal days, which generates momentum; and 2) to give rise to sharp price shifts and subsequent reversals in high-tension periods, which leads to bubbles and crashes. Accordingly, we expect that blockchain-based financial assets—e.g., cryptocurrencies—may be vulnerable to both momentum and bubbles and that the two types of price distortions can be largely exclusive. Based on a sample of 1392 cryptocurrencies, we find that momentum strategy works for normal-stage cryptocurrencies but not for bubble-stage ones. Moreover, contrary to equity-momentum, crypto-momentum is not associated with higher crash risk. If anything, crash risk is associated with, and can be predicted by, the bubble stage of cryptocurrencies. Our results shed new lights on blockchain-based Fintech products and services.

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 activation of a macroprudential measure, namely the countercyclical capital buffer (CCyB), by the Swiss National Bank (SNB) in 2013. Since the Swiss sectoral implementation of the CCyB applies to residential mortgage lending only, we investigate the potential intended and unintended consequences of the SNB intervention on the real estate market in Switzerland. As an identification strategy, we exploit the heterogeneity in treatment intensity across cantons, using data on the composition of mortgage suppliers in each canton. We find that some of the cantons with the most overheated residential property markets (e.g. Zurich and Geneva) are hardly affected, since a significant share of mortgages is financed by more universal or wealth management oriented banks rather than by mortgage-specialized institutions. We also find that canton’s higher exposure to the CCyB treatment leads to a mitigated growth of single-family house prices. 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 for positive yields.

Bank Intermediation in Corporate Bond Issuance

Kerry Siani
,
Columbia University

Abstract

This paper studies the frictions in the primary market for corporate bonds. Using a novel proprietary dataset about corporate bond issuance in the U.S. from 2010-2018, I find reduced form evidence that corporate issuers are heterogeneously exposed to global demand shocks based on their bank relationships. Specifically, I look at the ECB's corporate bond buying program in June 2016. I find that firms that were more exposed to the Eurozone through their bank relationships faced higher demand for their bonds, achieved a lower cost of capital, and issued more bonds. This evidence suggests that there are bank-related frictions in primary markets that cause an uneven dispersion of demand shocks. I argue that these frictions are not due to balance sheet effects, but rather to search costs that banks incur when they act as matching agents between firms and investors in the primary corporate bond market. These costs vary based on the relative mass of investors and issuers. When there is more investor interest in US corporate bonds, banks have lower search costs, and encourage issuers to borrow more.

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 instrumenting local aging with casualties during World War II.

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.

Commissions and Investment Adviser Misconduct

Tarun Patel
,
University of Washington

Abstract

I study the investment advisory industry to analyze the relation between commissions and financial misconduct. I exploit quasi-exogenous changes in individual investment advisers' compensation arrangements caused by mergers between large registered investment advisory firms. The experimental design allows for a rich set of controls, ruling out firm- and market-level effects. The opportunity to earn sales commissions significantly increases the number of advisers who engage in misconduct. I find that advisers are more likely to engage in misrepresentation, consistent with the hypothesis that commissions bias advice. Damages paid out in claims involving commission-motivated advisers are $25,013 greater than other claims. Overall, I find that the rent-seeking motive for commissions dominates the information-gathering motive.

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

I exploit adoptions of state anti-plug molding laws – that prohibited “unscrupulous” reverse engineering by competitors – and their subsequent invalidation by the U.S. Supreme Court to examine how competition affects firms’ non-patented innovation and value. I find firms decrease patenting activity when the laws are effective but reinitiate it after they’re invalidated. I also document that affected firms show increases in investment spending, profitability, and value following the laws’ adoptions, with value gains larger for firms more at risk of imitation or more innovative. After the laws are overturned, investment spending, profitability, and value gains dissipate, with innovative firms especially harmed.

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 affect the acquisition of private information and investment decisions using data on Chinese mutual fund managers' visits to firm headquarters and interim stock trades. I measure information costs with travel times between fund families and firms and exploit exogenous variation induced by the staggered introductions of high-speed rail lines to identify the causal effects. I find that reductions in information costs lead to sizable increases in fund managers' information acquisition activities and investment profits at the fund family-firm pair level. These findings provide evidence for investors’ optimal information choices in financial markets.

Credit Information Uncertainty and Corporate Bond Prices

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

Abstract

This paper explores the relations between credit information uncertainty and corporate bond prices. Theory suggests that ambiguous quality of credit information makes bond prices respond more to bad news than to good news, and noisy and obscure information about default likelihood increases premiums for holding corporate bonds. Empirical results strongly support the hypotheses using our measures of credit information uncertainty based on both time-series and cross-sectional fluctuations in credit rating distributions. The findings are robust to the inclusion of a battery of controls such as issue-specific characteristics, risk and alternative uncertainty factors as well as macroeconomic variables.

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 a monetary policy shock, two aggregate macroeconomic shocks, and three credit supply shocks. Related SVAR models investigating the role of credit shocks primarily focus on total private credit and do not separate it by sector. I find evidence that credit supply shocks not only vary by the sectors in which they arise in, but also by their consequences for business cycle dynamics. Credit supply shocks arising 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 contrast with the existing literature, household and bank credit shocks may have long-run consequences for inflation explaining up to 15% of its fluctuations. Within a historical context, the model identifies a considerable number of credit supply disturbances and trends that are well-documented in the data. Examples include the introduction of certificates of deposits (CDs) in 1961, the Carter Administration's 1980 consumer credit controls, and the rapid expansion in mortgage lending during the early 2000s housing bubble. With respect to the 2008 financial crisis, the model uncovers a much 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 was most 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
,
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.

Cultural Distance in Family and Corporate Risk-taking

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

Abstract

Do the inherited cultural values distance between husband and wife affect each other’s decision-making? A growing literature documents how cultural heritage of chief executive officers (CEOs) shapes firm performance and how other family members affect CEOs corporate decisions, especially firm risk. However, this literature faces challenge when it neglects the cultural transmission between couples. Cultural distance in personalities, lifestyles, and beliefs affect couples personal concept imperceptible through cultural transmission. In this study, we examine whether cultural distance and cultural transmission between CEOs and CEO spouses influences corporate risk-taking. Our study contributes to the research on how culture heritage and cultural transmission affect financial outcomes. We argue CEO cultural heritage, CEOs’ spouse cultural heritage, and their cultural heritage distance jointly affect CEO risk-taking and corporate outcomes. Cultural sociology researchers believe culture changes with environment, inventions, and contacting with other cultures (Griswold, 2012). In social psychology studies, husband-wife interaction potentially change couples personality, perception, lifestyle and affect their decisions making (Kenkel, 1961). Cultural transmission through cross-cultural marriages have strong effect on personal traits and preferences, especially when families of origin differ greatly in their values and rituals (Falicov, 1995; McFadden, 2001; Remennick, 2009). Therefore, we conjecture that CEO’s spouse cultural heritage could potentially affect CEO’s personalities and preferences. Higher cultural distance in uncertain avoidance between CEO and CEO spouse is negatively correlated with corporate risk-taking. To identify the cultural heritage of CEOs and CEO spouses, we hand-collect a novel data set to track ancestry information of CEOs in S&P 500 firms from 2000 to 2015 and their corresponding spouses. We obtain CEO names from ExecuComp and CEO spouse names from a set of various data sources. We use Ancestry.com to trace a person’s ancestry immigrant information following Nguyen, Hagendorff and Eshraghi (2017). We then use a person’s name to infer his or her cultural heritage distribution based on immigrant records if we cannot find exact information of this person’s ancestors, following Pan, Siegel and Wang (2017). With the distribution of culture origin, we employ Hofstede’s (2001) six country level cultural dimensions to capture culture values. Specifically, we focus on uncertain avoidance index (UAI) which reflects attitudes toward risk and uncertainty for unfamiliar situations in a society. We obtain UAI proxy for both CEOs and CEO spouses in the form of weighted-average UAI using the distribution of countries of origins. The cultural distance is measured by UAI of spouse minus UAI of CEO then scaled by UAI of CEO. Our hypothesis is that the UAI distance between CEO spouses and CEOs should be negatively associated with firm risk. We conjecture that high uncertainty avoidance of CEO spouses will influence CEOs’ personal uncertainty avoidance, and then lead to less corporate risk-taking. We primarily measure firm risk with the quarterly standard deviation of firm operation return from industry average, i.e. σ(ROA). To distinguish the effect of culture, our models control CEO personal characteristics, firm characteristics, corporate governance, industry fixed effect and time fixed effect. Our baseline results show that UAI distance has negative and statistically significant coefficient firm operation risk. In economic terms, one standard deviation increase in UAI distance is associated with 0.11% decrease in σ(ROA), which is corresponding to approximately 5% of one standard deviation of the σ(ROA). Our second measure is R&D investments, which is a typical measure of risky corporate policies because of its uncertain benefits. We construct R&D investments with R&D expenditure over total assets for each quarter. We find

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 economies of scale 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 a firm’s market to book ratio, life cycle stage, and competition intensity within its industry does not alter the relationship. Relating this result to missing regulatory intervention is however not feasible for now. In deals between two public firms, data intensity of either acquirer or target cannot explain differences in combined M&A announcement returns and deal value to sales multiples.

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 new evidence on distinct roles of risk and uncertainty in financial markets through 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 dramatic drop in uncertainty after the release of Federal Open Market Committee (FOMC) statements. Following the non-FOMC macro news, equity trading activity increases moderately as does risk, while uncertainty remains stable. Comparing the trading activity prior to news release with those in non-event days, we find a significant reduction in both stock and option trades for FOMC news. For non-FOMC macro news, we report a surge instead in the option trades. Our results suggest that (1) FOMC news help resolve uncertainty, (2) resolution of uncertainty encourages more trading activity than a rise in risk, and (3) investors actively exploit their insights when there is little change in uncertainty.

Do Banks Help 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. We find that the presence of bank dual holder is associated with a significant increase in corporate tax avoidance. Using the mergers between debt-holding banks and equity-holding banks of the same firms as an exogenous shock to dual holding status, we establish the causality between dual holders and tax avoidance in differences-in-difference tests.

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 analyzes the effect of creditor rights and the conflict of interest between creditors on the design of corporate debt contracts. I study how bank-loan holders respond to improving control rights of securitization creditors following the enactment of the anti-recharacterization statute. I find that bank loans granted to firms using asset-backed securitization have higher interest rates after the legal change. Strengthening bargaining power of securitization lenders in bankruptcy would eliminate their incentives to maximize recoveries in chapter 11 and thus increase the risk of the other creditors such as bank-loan holders. Consistent with this intuition, I also find that loans to securitization users are charged with higher fees, have smaller size and include a greater number of covenants subsequently. I further show that the effect is more pronounced for smaller firms, firms with lower z-score and firms with higher ratio of receivables to assets. The results of my paper thus shows the unintended consequences arising from strengthening control rights of some corporate 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 FinTech has raised questions about whether it is driven by technology innovations or purely due to speculations. Although several theoretical studies argue that the value of cryptocurrency is fundamentally anchored by the underlying utility value, there is little empirical evidence on this matter because measuring their fundamental is challenging. This paper overcomes this challenge by constructing a novel measure from Initial Coin Offerings (ICOs) whitepapers. Using machine learning techniques, we construct a text-based Technology Index (Tech Index) from a comprehensive sample of ICOs whitepapers from January 2017 to December 2018. We find that ICOs with a higher Tech Index are more likely to succeed and less likely to be delisted. Although the Tech Index does not affect short-run returns of ICOs, it has positive impact on ICOs’ long-run performance. Overall, the results suggest that fundamental is 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 provides empirical evidence on strategic use of financial disclosure to enhance bargaining position with labor unions. Since informational advantage of management hinders a union's bargaining activity, a firm has an incentive to increase information asymmetry between the firm and the employees. Using confidential treatment orders and collective bargaining contract expiration dates, I find that firms strategically choose to redact information about material agreements before wage negotiations. I further find that strategic redaction is amplified when unions cannot accurately predict firms' prospects, when firms have low growth opportunity, when liquidity is less constrained, and when the estimated costs of a work stoppage are low. The evidence illustrates that a firm's strategic information sharing with a union entails trade-offs between detrimental capital market outcomes and favorable bargaining condition.

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 and find a significant positive relation between economic policy uncertainty and analyst forecast errors. A doubling of economic policy uncertainty is associated with a 4.29 percentage points increase in earnings (EPS) forecast errors, and the volatility and dispersion in analyst forecast errors are positively related to the economic policy uncertainty. Earnings forecast errors are higher for firms with higher sensitivity to the economic policy uncertainty, and the uncertainty factor retains its significance when compared to other risk factors. Additionally, firms with higher idiosyncratic risks show a higher sensitivity to the economic policy uncertainty.

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.

Dynamic Contracting with a Forthcoming Technology of Automation

Vincent Tena
,
Toulouse School of Management

Abstract

This paper investigates the microfundation of the high-skill jobs' automation in a continuous-time agency framework. In this model, a project is either driven by the agent's unobservable effort or by a forthcoming technology of automation that arises randomly and that can substitute to the agent. We derive an optimal contract that secures the principal-agent relationship at early-stage and then eases the automation through punishment when the technology becomes available. As a consequence, only the automation of successful agents is postponed as the instantaneous termination of the contract would be too costly. Our model predicts that the less successful agents are the first to be substituted by the technology and also that the agent's lump-sum bonuses decrease after the technological advent.

Dynamic Financing and Pricing of the Platform Market

Juan Chen
,
London School of Economics

Abstract

This paper develops a fully micro-founded dynamic platform market framework featuring the cross-group network effects and the price setting capability of the platform. Under this framework, the paper solves for interaction between the platform's optimal financing and pricing strategies when there exist financial frictions. The main results are: 1) the platform charges non-decreasing spreads; 2) a more valuable platform makes more subsidies at initial stages; 3) using up available funds to make subsidies at early stages is constrained-optimal; and 4) staging is a natural choice to mitigate financial frictions and the number of financing rounds increases with the profits the financiers require.

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 an entire generation of Chinese of their opportunities to receive higher education. We estimate the human capital cost of this tragedy and find that Chinese firms led by CEOs without college degrees spend less in R&D, generate fewer patents and receive fewer citations. The result is robust when we use an exogenous CEO turnover sample. Furthermore, we take the CEO’s Cultural Revolution experience as an instrument for access to college education, and find that higher education indeed increases the CEO’s human capital. This cannot be explained by changes in beliefs. Finally, by adopting a regression-discontinuity design, we estimate the causal effects of college education on human capital.

Electronic Trading and Traders

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

Abstract

How did trading automation impact the finance industry? I leverage the high degree of financial regulation in the US to construct a linked employer-employee panel of traders, financial analysts, and brokerage firms and analyze the consequences of electronic trading on employment, skills, and performance. These data combine publicly available individual records from FINRA, NFA, SEC and other sources to provide a unique characterization of over 600,000 broker-dealers since 1970. Exploiting regulatory changes that fostered speed-driven competition and local variation in IT use, I show how electronic markets affected the skill level and licensing of workers in less tech-intensive occupations within finance, and the entry and financial outcomes of trading firms.

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 factor portfolios and other macro economic variables.

ESG Preference and Market Efficiency: Evidence from Mispricing and Institutional Trading

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 informational efficiency of stock prices. The return predictability of mispricing signals is much stronger among firms held by more socially responsible institutions (SR_Is). The results are driven by the divergence of trading implications from ESG performance and mispricing signals. SR_Is are less likely to buy underpriced stocks with bad ESG performance or sell overpriced stocks with good ESG performance. We rule out alternatives, such as known limits to arbitrage. The inefficiency only emerges in recent years with the rise of ESG investing, and is not fully offset by ESG-neutral arbitrageurs due to funding liquidity constraints.

Excess Proceeds in the Equity Financing Process

Chong Meng
,
University of Alberta

Abstract

Random market fluctuations and information generated during the book-building process lead to a difference between the filing and actual issuance amounts in initial public offerings (IPOs). In this paper, I refer to this difference as excess proceeds. I document that excess proceeds exhibit substantial cross-sectional variation and have implications for long-term corporate decisions and stock performance. I decompose excess proceeds into market and idiosyncratic excess proceeds and show that issuers are more likely to treat market excess proceeds as a cash windfall while to spend idiosyncratic excess proceeds by expanding existing operations. Relative to IPOs with low excess proceeds, high-excess-proceeds IPOs’ stocks underperform more and are more likely to delist within three years after IPOs. Further analysis shows that high-excess-proceeds IPOs are less likely to return to the market for future financing, potentially worsening the free cash flow problem discussed in Jensen (1986). Collectively, these findings highlight the impact of the issuance process on issuers’ long-term performance.

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 Rights and the Gender Gap in Entrepreneurship

Jonathan Zandberg
,
Boston College

Abstract

The gender gap in entrepreneurship is a well-documented puzzle. It refers to the persistent gap between the number of male and female entrepreneurs. We analyze four different data sets that cover six different decades and find strong evidence that better access to reproductive health care increases a woman’s propensity to become an entrepreneur. First, we document that access to reproductive health care correlates positively with female entrepreneurial activity. This correlation is driven by women who own large firms, and by women in the middle tercile of wealth. In addition, we find that access to reproductive health care is negatively correlated with the age of female entrepreneurs, suggesting that women with better control over their reproduction can become entrepreneurs at a younger age. For empirical identification, we exploit the 1973 Roe v. Wade Supreme Court ruling and the staggered enactment of state-level Targeted Regulation of Abortion Providers (TRAP) Laws and show that better access to reproductive health services causes higher levels of female entrepreneurship. None of the empirical results hold when tested on men, women above 40, or when examining other placebo professions. Our results suggest that changes in policies securing better reproductive rights can help close this gender gap and empower women who seek 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.

Financial Constraints and Pricing Flexibility

Ishita Sen
,
Harvard University
Varun Sharma
,
London Business School

Abstract

Using corporate bond holdings of U.S. life insurers, we show that life insurers used internal models to over-report the value of a large fraction of corporate bond assets 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 and for insurers that are constrained by regulatory capital. We document significant heterogeneity in misreporting across U.S. states and show that it correlates with the strictness of the state regulator during the crisis. Consequently, we show that there is greater misreporting in positions that are held by fewer insurers, as concentrated holdings helps to minimize regulatory scrutiny. Our findings have implications for the ex-ante portfolio choice of insurers, which impacts 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 has a strictly concave (convex) claim on the firm’s net worth. For intermediate risk preferences investors’ claim is S-shaped, resembling preferred stock. We derive investors’ utility weights absent wealth distribution 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 more reputable borrowers enjoy lower borrowing costs and better loan contract terms: Relative to otherwise similar firms’ loans, Most Admired firms’ bank loans cost 26.7% less, have 11.8% fewer financial covenants, and are 5.4% less likely to be secured with collateral. My identification strategy is based on propensity score matching, a regression discontinuity design, and clean reputation measures removing the impact of prior financial performance. Operating performance increases more than expected after being recognized as a Most Admired company, consistent with this reputation proxy containing important information on borrower 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 of 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

Abstract

We construct a direct measure of U.S. investor foreign sentiment using flow shifts towards international mutual funds. Our foreign sentiment measure is distinct from local sentiment measures in the U.S. and international markets. The reversal pattern associated with U.S. foreign sentiment in international markets is driven by overreaction to local negative public news. This effect is stronger for countries that are culturally different from the U.S. In contrast, non-U.S. local investor sentiment is not responsive to the same public news. Overall, our findings shed light on a new behavioral explanation to how foreign sentiment can be generated, consistent with the concept of “foreign sentiment” in Dumas, Lewis and Osambela (2017, RFS).

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

Based on 2,000 ICOs from 105 countries between 2015 and 2018, we discuss the international development of ICOs and examine the impact of institutional strength on the number of ICOs per country, their probability of success and return volatility. We provide evidence that institutional strength has a positive and significant effect on the number of ICOs, their probability of success and their volatility. Furthermore, we show 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. We also observe that this relationship is particularly relevant for countries with no or light regulations concerning ICOs, which indicates that institutions, to some extent, substitute for the regulatory void. Our study, therefore, provides evidence that strong institutions support the development of ICOs, infer trustworthiness to investors and, thereby, reduce the return volatility associated with ICOs.

Friends with Threats: Credit Risk Under Common Ownership

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

Abstract

This paper empirically shows that the cost of bank debt is lower when firms’ shareholders hold more shares in their industry peers. This effect is stronger for firms with poorer credit conditions, higher opacity, more entrenched CEOs, a stronger tendency to overinvest, and when lenders have less industry expertise. Such common owners appear to monitor management more effectively while also reducing information asymmetry. However, payout patterns after covenant violations suggest that creditors face higher shareholder wealth transferring potential as an expense of more effective monitoring over management. Despite this concern, overall results on loan spread and additional analyses on CDS premium indicate lower credit risk under better governance of common ownership.

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 directors 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 announcement. The winning bids are 14% lower after interacting with other corporate directors, and the lower land prices allow the developers to sell new units 8% cheaper. However, the lower land prices by informed bidders generate negative spillovers on neighboring properties. Our results imply that the informal interactions enable developers to realize higher profits, while the government loses the land sale revenues

High-Frequency Trading, Endogenous Capital Commitment and Market Quality

Yenan Wang
,
Duke University

Abstract

I study the 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 is beneficial, lower capital commitment deteriorates market quality. Specifically, the market's ability to satisfy large demand is impaired. I consider both price and quantity effects of high-frequency trading to obtain a more integrated characterization on how high-frequency trading changes market quality. I further use this framework to analyze how market quality is affected by different regulatory measures and argue that the spread is not necessarily a good measure of market liquidity.

House Price Risks and Mortgage Choice

Lu Liu
,
Imperial College London

Abstract

Following the 2008-09 financial crisis, there has been a renewed debate on housing finance reform (e.g. Campbell, 2012, Mian and Sufi, 2015, Greenwald et al., 2018). One key question is to what extent mortgage products can be designed to allow for more efficient sharing of risks (Shiller and Weiss 1999, Piskorski and Seru 2018). The US mortgage market stands out in an international comparison given its reliance on 25 to 30-year fixed rate mortgages (Badarinza et al. 2016) that are insured by the government-sponsored entities (GSEs). This allows borrowers to lock in a rate until they voluntarily choose to prepay, for instance because interest rates have fallen, or because the household wants to sell the house. Most other developed economies do not offer such long fixation periods and borrowers are forced to refinance throughout the life of the mortgage, until the loan is repaid. For instance, in the UK, the predominant product is a 2 to 5-year fixed rate mortgage that reverts to a high-premium variable rate at the end of the fix period, with the majority of borrowers indeed regularly refinancing within 6 months of the end of the fixation window, to avoid the penalizing revert rate (Cloyne et al, 2019). This paper studies the insurance value of interest rate fixation in the context of house price risk. In the UK, mortgages are priced in 5 to 10% LTV steps across the whole of the country, with limited pricing of regional heterogeneity in house price risks, ex ante. In the US, pooling of interest rates across regions with different house price risks due to the LTV x FICO-based pricing schedule of the GSEs leads to implicit risk-sharing across regions (Hurst et al, 2016). However in the UK, because borrowers have to return to the market to refinance, the interest rate they pay gets ``marked-to-market’’ based on their current LTV, and hence gets repriced ex post. If a borrower in a particular region experiences a house price decline, in particular during the initial years of the loan when the loan balance is still high, the LTV and concominant interest rate will increase. This risk of repricing is an alternative source of risk in addition to interest rate risk, i.e., variation in aggregate interest rates over time, and may be relevant for monetary policy and financial stability. Repricing at the refinance event may have an exacerbating effect on the debt burden of the most constrained households who borrow at high LTV and are hence particularly vulnerable to deteriorations in their house prices. Mortgages with a longer fixation duration can be understood as providing insurance against this deterioration in house prices, as borrowers can stay in their contract for longer, without getting repriced. There is a competing motive for choosing a lower fixation duration, however, which is that lenders typically charge a ``duration premium’’, and may hence be less affordable for households who are highly credit constrained (Campbell and Cocco, 2003, 2015). This paper aims to study the link between mortgage choice and house price risks, by assessing 1) to what extent households are exposed to house price risks through remortgaging, 2) how households insure against these risks by fixing their mortgage rates, and 3) which households would benefit most from insurance. The analysis employs detailed administrative data on mortgage borrowing and house prices in the UK. The paper further aims to provide a quantitative evaluation of household decisions using a model of optimal mortgage choice. Its goal is hence to add to existing research on mortgage choice that focuses on contract features in the US market context, and study differences in the risk management problem that households face across countries (Campbell and Cocco 2003) with a focus on house price risks, in order to better understand the risks and insurance mechanisms of a given mortgage market design, and help inform policy aimed at reforming housing finance more generally. Referen

How do Financial Contracts Evolve for New Ventures?

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

Abstract

This paper is the first to focus on the evolution of the financial contracts used to raise equity capital for new ventures. With contract terms extracted from over 2,000 copies of Certificate of Incorporation of 300 U.S. based VC-backed companies, we analyse how the cash-flow and control rights given to investors vary over time depending on the performance of the new venture. We also manage to provide empirical evidence, for the first time, on renegotiation in private equity contracts. We have developed a new measure – headroom – which is the ratio of the post-money value of the business at each funding round to the cumulative liquidation preference that exists for the preferred stock investors. We quantify how headroom, which can be thought of as a proxy for company’s financial flexibility, evolves over time for a large sample of new ventures and explore whether this is a key determinant of the way venture capital contract terms evolve. Our key findings so far are as follows: firstly, the marginal seniority of terms needed to attract new investors is positive in earlier rounds but declines over time, in other words, terms offered to attract new investors do not necessarily become more investor friendly. Secondly, stocks issued in earlier rounds are more likely to get renegotiated, and conditional on renegotiation happening, cashflow rights such as liquidation order and liquidation participation are most likely to get worse while control rights such as votes per share get better in a majority of rounds. Thirdly, the stocks issued in later rounds do not necessarily have better terms than those issued in earlier rounds, at least not in all rights. Our preliminary regression results reveal that headroom is positively related to ownership of common stock, but negatively related to ownership of latest series since higher headroom may be associated with more bargaining power for the founders. Moreover, ownership of both types of stocks is negatively related to round number. In the case of common stock, the dilution of ownership due to one more round is even more pronounced for Silicon Valley companies. Finally, there seems to be inertia in ownership of both stocks.

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
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, effectively removing their impact on CDS firms. Using a unique data set 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 book leverage of a firm, its efficiency, in the concentration of its debt, and in the average CDS hedge position of its creditors. Further, we find that larger firms, more profitable firms with more tangible assets, and firms with higher average collateral ratios of their debt are less affected by empty creditors. Finally, while financially vulnerable firms are severely affected by empty creditors, safe firms are not affected.

Identifying Indicators of Systemic Risk

Benny Hartwig
,
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.

Impact of Internal Governance on a CEO's Investment Cycle

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

Abstract

Agency theory tells us that unless CEO owns 100% of the firm, the motive of CEO will deviate from maximizing shareholder’s wealth. Furthermore, we would expect that conflict of interest between CEO and shareholders escalates as the CEO grows older and closes to retirement because the CEO horizon is much shorter than the shareholder. To mitigate the agency problem and the horizon issue, the literature suggests and examines various forms of corporate governance provisions such as compensation package design, board governance and external regulations. In this paper, we focus on the impact of internal governance, the monitoring of the CEO from within the top management, upon the investment policy of the firm around the CEO turnover period. Previous literature has found that there is a substantial change in the firm’s investment policy around the turnover event. The mechanism of internal governance is conceptualized in Acharya, Myers and Rajan (2011), and we modify the empirical proxy in Aggarwal, Fu and Pan (2017) whereby using the text mining technique, REGEX in R and Python. We demonstrate that the cyclical change in investment policy for old and myopic CEO is less likely to occur during the transition period if the firm prior to the CEO turnover event had effective internal governance. Moreover, the empirical evidence implies that the asset disposal at the beginning of a CEO’s tenure is more likely due to skill set mismatch. We further find that good governance helps incoming CEOs get rid of less profitable investments previously made by older and myopic predecessors at less loss or perhaps even a gain. We acknowledge that CEO turnover is endogenously determined. Among other robustness checks, we conduct a natural experiment whereby using hand-collected CEO sudden death events from news release on Factiva. We find that older CEOs with good governance underinvest less, a result that is consistent with the main results above.

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 corporations' 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 that if the stocks are ranked into 5 portfolios bins based on the price run-up prior to filing release, those with the highest run-up would also have the highest price increase post filing release, and vice-versa. The results are not driven by momentum, and they remain even after the SEC’s server fix in February 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 phenomenon has not been previously documented in the literature using high frequency intra-day data.

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 a trader with superior information about an asset is subject to a careful scrutiny by another agent who immediately observes the trading decisions of the informed agent with some noise and engages in (klepto)parasitic behavior by mimicking the informed trader and trading on her own behalf (this can be interpreted as a broker or a high-frequency trader). I show that if the precision with which the parasitic trader observes the informed trader’s decisions is high enough, then the parasitic trader absorbs a dominant fraction of the expected abnormal profits coming from informed trading. My theory is able to explain why percentage abnormal returns on the trades of corporate insiders are high while dollar returns on these trades can be quite moderate. Additionally, I explain through my model 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

Do young innovative firms grow organically? Across 27,870 private firms with initial venture capital (VC) financing between 1980–2013, approximately 10% buy external patents. These firms are neither low-quality firms nor firms with low patent output, lending little support to the hypothesis that patent acquisition is a response to weak internal innovation. Rather, firms’ patent acquisition behaviors appear to be closely related to the intellectual property (IP) environment. Firms sued for patent infringement, and firms whose public competitors own broad patents, thus exposed to high threat of litigation, are significantly more likely to buy patents. 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 are significantly less likely to buy patents after the ruling. In the short run, patent acquisitions are perceived by informed investors as a signal that is not as good as patent applications. I interpret this as patent acquisitions sending a signal that firms have higher patent litigation risks than previously realized. In the long run, firms buying patents are more likely to be acquired rather than go public, suggesting that acquiring patents does not fully offset the litigation risk these firms face. Neither product market competition nor investors’ contractual horizon explains startup firms’ patent acquisition decisions. In sum, the findings highlight how IP rights affect young firms’ growth paths.

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 corroborate importance of sentiment in asset pricing. We further propose that sentiment may not affect everyone in a homogeneous way. In this paper, we construct a sentiment indicator taking into consideration behavioral heterogeneity of interacting investors. From our model simulation, we find sentiment contributes to several financial anomalies such as fat tails and volatility clustering of returns. More importantly, investor sentiment could be a significant source of financial market volatility. Our model with sentiment is also able to replicate different types of crises. Our finding shows that 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 Costly? Insights from Insiders’ Trades

Ge Yang
,
National University of Singapore

Abstract

California became the first U.S. state to mandate specific numbers of women directors on corporate boards on September 30, 2018. The stock market reacts negatively to the introduction of this quota, with more severe reaction for large firms, firms with large board size, firms located in areas with fewer existing female directors, and firms without female executives. However, insiders of these firms do not react negatively. In general, insiders increase their net purchase of shares of affected firms, suggesting that they view this law to be less costly than the market’s perception. They particularly disagree with market views on the heterogeneous effect of this quota on large firms, firms with large board size, and firms located in areas with fewer female directors. On aggregate, insiders increase their net purchase when they observe negative stock return.

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.

Is There Value in Employee Opinion? The Effect of CEO Employee Approval on Financial Outcomes

Spencer Barnes
,
Florida State University

Abstract

Implementing a regression discontinuity design as an identification strategy to help mitigate endogeneity concerns, this study examines how employee opinion of chief executive officers' (CEO) affects firm outcomes. The paper produces several key results and is the first to empirically test the seminal theory of Jensen and Meckling (1976) using a unique dataset that matches a company's financials, CEO, and CEO employee approval for 2013 to 2018. First, the news of a company making Glassdoor's "Top CEOs Employees' Choice" award list results in a negative one percent cumulative abnormal stock return corresponding to an average market value loss of 900 million dollars. Second, an ex-ante tradable portfolio strategy that holds companies on the top CEO list generates annual excess stock returns around four percent. Third, using panel regressions and a fuzzy regression discontinuity design at the CEO list threshold, top ranking CEOs cause increases in Tobin's Q. Fourth, award list inclusion for a CEO implies increases in personal salary and decreases in turnover. The economic mechanisms that these findings operate through are changes in operational expenses and firm efficiency as theory suggests. The findings in this study are the first to establish a causal link between CEO employee approval and firm outcomes, which confirms the hypothesis that exceptional CEO employee relations are not valued by the market as an intangible, are costly in current market values, develop firm value over time, and supply CEOs personal benefits.

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 Betas in the Cross-Section of Asset Returns

Reed Douglas
,
University of Southern California

Abstract

This paper evaluates a specification for conditional beta models following Fama and French (2019). It rejects the Fama and French model using betas conditional on characteristics in favor of a linear conditional beta model following Shanken (1990). The tests used allow the data to select either the Fama and French (2019) model or the more flexible linear specification. Model-implied zero-beta rates are particularly sensitive to the choice of specification, and the linear conditional beta model provides a more stable, and more realistic, rate.

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

What determines the yield curve? Recent papers show suggestive evidence for the preferred habitat theory, where long-term investors such as pension funds and life insurers have a strong preference for long-term bonds, affecting the yields for these maturities. The cause of this natural preference for long-term bonds may be twofold: economic versus regulatory hedging motives. I study both hedging motives using detailed holdings data on long-term investors. In particular, I exploit a change in the regulatory discount curve where interest rates at which liabilities are evaluated increased at the long end of the yield curve, and hence had a positive effect on funding positions. The effect of the regulatory change differs across pension funds and insurers depending on their liability structure. Pension funds and insurers with long liability durations are more exposed to the regulatory change than others. Exploiting this cross-sectional heterogeneity in liability durations, I find that pension funds and insurers more exposed to the regulatory change decreased long-term holdings to a larger extent. To substantiate my findings, I solve a mean-variance optimization problem in an asset liability context with regulatory constraints. My findings have important policy implications as they show the relevance of incorporating regulatory frameworks of long-term investors to analyze effects of monetary policy.

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

Désirée-Jessica Pély
,
Ludwig-Maximilians-Universität München

Abstract

Due to practitioners' negative connotations with regard to M&As, the clear communication of takeover motives becomes crucial for management. Not only must managers meet differing goals of stakeholders, but they must also justify high premiums paid for acquisitions. 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 a 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 synergies is linked to a bullshitting behavior and managerial overconfidence to which an average shareholder overreacts. In contrast, institutional investors see the manager’s bullshitting content through and correctly incorporate the single- vs. multi-M&A information into prices already at deal announcement. If complexities with regard claimed M&A synergies are reduced through more precise and observable information, which allows for a more easy M&A synergy evaluation, shareholders' behavioral bias of overreaction is reduced. When computational linguistics are applied to objectively quantify M&A synergies, the results are even more significant.

Mandatory Pollution Abatement, Environmental Awareness, 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 whether mandatory pollution abatement crowds out R&D investment and how it affects firm performance. If consumers value environmental awareness, spending on pollution abatement and R&D investment are complements for financially unconstrained firms but substitutes for financially constrained firms. Therefore, unconstrained firms invest more in R&D and have lower current profits but higher future profits. For constrained firms this regulation reduces R&D investment as well as current and future profits. The market value of regulated firms declines but the adverse impact is stronger for financially constrained firms.

Measuring Customer Liquidity Provision in the Corporate Bond Market

Jinming Xue
,
University of Maryland, College Park

Abstract

This paper provides an approach to measure the amount of customer liquidity provision in the corporate bond market. This measure is inferred from relative movements of trading volume and average bid-ask spreads when dealers make the market or organize matchmakings. An increase in customer liquidity provision and a raise of dealers' market making willingness have opposite impacts on the realized riskless principal trading volume, whereas neither of them would lower the bid-ask spreads. I exploit such heterogeneity to extract a separation of unobservable fluctuations in customer liquidity provision and changes of dealers' market making willingness from observed trading activities. I show that the amount of customer liquidity provision negatively relates to the bid-ask spreads in the high-yield bond market even when dealers provide liquidity. Moreover, interdealer relations become more valuable during periods of increased customer 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 Zürich

Abstract

This paper investigates how mortgage market conditions affect housing markets and the demand for home ownership. Using unique data on home owners' 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 quantify how mortgage interest rates and down payment requirements affect the value of holding residential properties, and how they influence housing demand, housing market liquidity, and the relative bargaining power of property sellers and buyers in housing markets.

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.

Need for Speed? International Transmission Latency, Liquidity and Volatility

Khaladdin Rzayev
,
University of Edinburgh

Abstract

Using a measure of the 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 latency and find that the liquidity deterioration effect of high latency dominates its volatility reducing effect. This implies that the liquidity enhancing benefit of increased trading speed in financial markets outweighs its volatility-inducing effect.

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

Ya Kang
,
National University of Singapore

Abstract

Donald Trump’s unexpected election on Nov 9, 2016 is a negative shock to the social institution of racial equality. Its emotional and real impact on the ethnic minority groups has not yet been documented. By exploring the setting of management forecast, this study examines whether and how Trump Election affects management sentiment of the ethnic minority CEOs, as well as their subsequent firm policies. This study finds that in response to Trump Election, minority CEOs are less willing to issue management forecasts, compared with their non-minority counterparts. Conditional on issuance of forecasts, minority CEOs exhibit more pessimism in the short run (underestimation of the mean of earnings). Further textual analysis of risk factor suggests that minority CEOs are more concerned about litigation risk and migration risk, and their tones are more negative (overestimation of risk). However, stock market does not react significantly to firms with minority CEOs around the election event. Subsequent firm leverage, profitability or investment do not differ significantly between firms with minority CEOs and those without. Collectively, this study provides the first evidence that Trump Election induces short-term behavioral bias (pessimism) in minority CEOs, while its real impact on firm policy 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 switch banks, and less likely to borrow from its current banks that are connected to rivals. This adverse effect of “rival-bank common ownership” is more pronounced in a diversified industry and when a firm and its rivals share more similar product lines. We also find that the rival-bank common ownership causes a negative impact on firm’s market share in product markets. 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
Nikola Vasiljević
,
University of Zurich

Abstract

The choice of optimal currency exposure for a risk and ambiguity averse international investor is derived and studied. Robust mean-variance preferences, explicitly capturing 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. Additionally, we show that the sample efficient currency demand is found as a vector of generalized ridge regression coefficients of fully hedged portfolio returns on excess currency returns, where the model uncertainty corresponds to the penalty term in the regression. The empirical analysis of the currency hedging strategy is conducted using the foreign exchange, stock, and bond returns over the period 1999 to 2018. We find that the proposed hedging strategy leads to significant improvements of the portfolio performance and examine the effect of model uncertainty on equilibrium 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 in General Equilibrium

Francesca Bastianello
,
Harvard University
Paul Fontanier
,
Harvard University

Abstract

We study the aggregate implications of information diffusion in a financial market where agents fail to understand the general equilibrium consequences of their actions, a form of limited thinking that we call "Partial Equilibrium Thinking" (PET). In particular, we model a financial market where agents think they are the only ones inferring information from prices, when actually everyone is behaving in the same way. Since PET agents use a misspecified model of the world, they extract and trade on the wrong information. Although agents adopt a thought process that is in between the rational expectations and the competitive equilibrium benchmarks, the resulting equilibrium does not lie in the convex set of these two standard equilibrium concepts, and results in over-reaction to news. Next, we exploit the tractability of our model to allow for heterogeneous agents with very general forms of model misspecification that can accommodate various biases and cognitive limitations. This leads to endogenous heterogeneous beliefs which are all consistent with the equilibrium price agents observe. Finally, we argue that the feedback effect between prices and agents' beliefs which arises in this model lends itself to a range of different macro and finance applications, such as credit cycles, investment booms, and business cycles.

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 to make informed trades than non-politically connected insiders. This effect, however, is limited to insider sales, consistent with insider sales facing higher legal risk. Politically connected insiders are also more likely to execute trades that would normally be more likely to trigger an SEC insider trading investigation: trading closer to the earnings announcements, trading during periods that overlap with traditional blackout periods, and missing SEC timely reporting requirements.

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

Insurers' cash flows are largely independent of capital market conditions. Thus as the largest stakeholder in the corporate bond market, insurance firms may provide liquidity in stressful states, i.e., "rainy days". We theoretically model and empirically support this distinct role played by insurers. Specifically, we show that insurer corporate bond purchases improve bond liquidity while their bond sales do not. Separating the sample into crisis and non-crisis periods, as well as bond groups based upon rating and liquidity, we find that liquidity provision by insurers is stronger under stressful conditions. Our empirical analyses reveal that cash flow position and investment horizons strongly influence insurers' purchase of low-rating bonds, and that insurers increased their purchase of low-rating bonds both during the financial crisis and after the adoption of the Dodd-Frank Act.

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

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 Costs: 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 retail investment clients can select between a flat-fee and an inducement-based pricing model that both come with the same professional financial advisory services at no extra costs? In a field experiment with a German online bank we document that only 1.8% of all clients switch to the flat-fee scheme. Those improve portfolio efficiency and risk-adjusted portfolio returns by taking and following financial advice more. Our evidence suggests that flat fees enhance the perceived quality of advice and we rule out alternative explanations such as simple cost advantages, sunk-cost fallacy, novelty effects or advisor 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.

Social Psychology Determinants of VC Investment: A Study Using Video Data and Machine Learning

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

Abstract

Abstract This paper studies how social psychological determinants affect investors’ investment decisions. We exploit a setting where US startup incubators make early-stage investment decisions in entrepreneurial companies. We capture social psychological characteristics of entrepreneurs using a novel set of thousands of archival pitch videos recorded at the time of starting up. With state-of-the-art machine learning algorithms and unstructured data processing techniques, we characterize each entrepreneur (team) using her facial expressions, content of speech, and voice qualities, along social psychological traits well-grounded in psychology theories. Under a two-pass empirical framework, we document two major findings. (1) At the investment stage, the “happiness” and “passion” component in facial and vocal emotion is positively associated with the probability of being invested by the accelerators; while textual proxies for “ability” and “competence” negatively predict this probability. (2) Interestingly, conditional on receiving accelerator funding, startups' future outcomes are negatively related to “happiness” and “passion” emotion but positively to “ability” and “competent” revealed in speech content. Our results suggest that venture capital investors systematically overweigh some social psychological characteristics of entrepreneurs (emotions from facial expressions and voice) but underweigh more informative aspects (content of the speech), which leads to costly behavioral bias in investment decisions.

Speculator Spreading Pressure and the Commodity Futures Risk Premium

Yujing Gong
,
University of Warwick

Abstract

This paper investigates the impact of speculators' trading activities on the commodity futures risk premium. In particular, we focus on speculators' spread positions, and study the asset pricing implications of spreading pressure on the cross-section of commodity futures returns. We document that spreading pressure negatively predicts futures excess returns even after controlling for well-known determinants of futures returns such as basis-momentum. Furthermore, 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 2-factor or 3-factor models in the literature. We interpret these results as spreading pressure reflecting speculators' expectation on the change in the slope and curvature of futures term structures and our spreading pressure factor linking to innovations in real economic uncertainty.

Speed of Financial Contagion and Optimal Timing for Intervention

Diana Mikhail
,
Carnegie Mellon University

Abstract

Motivation Systemic crises are typically accompanied by policy interventions that aim to limit financial contagion. While the sequencing, range and scope of these policy interventions are well-studied in the literature, the timing of such interventions is largely ignored. Intervention that is not timely may ‘miss’ the crisis, incur substantial economic costs, and ultimately prove ineffective in limiting financial contagion. The 2008-2009 financial crisis is a prime example of an untimely intervention that threatened a collapse of the global financial system and world economy. This paper develops a conceptual and theoretical framework to determine what constitutes timely intervention during a systemic crisis. Timely intervention can minimize disruption to the financial system through reducing the economic costs incurred by financial institutions and accelerating their recovery from the crisis. More importantly, it can substantially reduce the fraction of institutions that face financial distress or default during a systemic crisis. The crisis highlights that financial system stability is integral to the stability of the global economy. Timely intervention that addresses vulnerabilities in the financial system will have the critical macroeconomic consequences of limiting the extent of financial contagion which will ultimately reduce the severity and duration of systemic crises. Research Outline Policy intervention during a systemic crisis is time-sensitive. Nonetheless, empirical evidence suggests that the timing of such policy interventions vary by 3-41 months from the crisis start date. Possible theories for the range of intervention times may stem from the government’s uncertainty about the systemic nature of the crisis and the underlying source of financial contagion. Other factors that may have bearing on the observed timing of intervention include political economy considerations, the specific characteristics of the economy in distress and whether the crisis is coupled with other crises such as a sovereign debt or a currency crisis. The current literature fails to provide a frame of reference on what constitutes timely intervention during a systemic crisis. Intervention that is too early may incur unnecessary economic costs and confirm market fears triggering a confidence crisis. Moreover, early intervention may not be appropriately designed due to the uncertainty surrounding the true nature of the crisis. Intervention that is too late may exacerbate the severity and duration of systemic crises and prove ineffective in crisis resolution. Thus, there is an optimal window for timely intervention that ensures its effectiveness. The objective of this research is to provide guidance concerning the optimal timing for intervention in the face of a systemic crisis. In order to identify an optimal window for intervention, it is necessary to measure the speed of financial contagion. Fast contagion may necessitate earlier intervention while slow contagion may allow the government more time to learn about the nature of the crisis and design appropriate policy prior to intervention. The speed of financial contagion is highly dependent on the topology of the financial network. In particular, it depends on the location of the node facing the shock within the network topology and its degree of interconnectedness with the financial system. I develop a theoretical model to identify an optimal window for intervention during a systemic crisis as a function of the network topology and the speed of financial contagion. In my model, speed accounts for the interaction between the level of capital buffers and the maturity of outstanding liabilities for nodes along the path of the cascade. Lower capital buffers and shorter liability maturities between counterparties both accelerate financial contagion. A node with little or no cash flow will not default in a given period unless it has outstanding obligations due in that period. Therefore,

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.

Terrorism Intensity and Acquisitions

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

Abstract

We provide causal evidence that firms located near terrorism-stricken areas are less likely to receive a takeover bid within two years post-terrorist attack and attract lower acquisition premium. The latter finding is reflected in lower target firm abnormal returns and synergy gains. Additionally, in such areas, acquirers increase cross-border and cross-MSA acquisitions indicating that terrorism-afflicted target firms become less attractive. We attribute our results, among others, to human capital being influenced by safety uncertainty and fear. They both affect target firm’s labor productivity, which decreases in terrorism-affected areas. They also induce acquirer CEOs’ reluctance for acquisitions of terrorism-afflicted target firms.

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 Fed Call: FOMC Announcements and Stock Market Uncertainty

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

Abstract

We empirically study the behavior of stock market uncertainty around U.S. monetary policy decisions using high-frequency option quotes. We find that FOMC announcements trigger sudden and large movements in uncertainty, with highly significant drops for multiple horizons and different price levels. While short-term uncertainty approximately resolves its pre-meeting elevation, intermediate- and long-term uncertainty substantially fall below their 30-day averages. Uncertainty in the tails builds up remarkably before the announcements and is only resolved for left tail uncertainty (bad economic states). For right tail uncertainty (good economic states), the elevation persists with an average of +8% relative to the 30-day average. This is especially true when considering announcements in which the committee cut the short-rate, surprising monetary policy decisions were taken, a press conference was held, or the primary information conveyed concerned the economic outlook. We coin this effect of FOMC announcements the 'Fed Call'.

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 65 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.

The Trinity of Market Participants: Taking Sides on Return Predictability

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

Abstract

We study how various investors trade with respect to 131 stock return anomalies. Retail investors and institutions accumulate shares in stocks that become anomaly-shorts and reduce holdings in stocks that become anomaly-longs. In contrast, firms that issue shares become anomaly-shorts and firms that repurchase shares become anomaly-longs. All three types of investors continue to trade in the same direction once anomaly information is public. Retail buys are associated with lower future stock returns, institutional trades do not predict returns, while firm trades predict returns in the intended direction. The results suggest that firms are the smart money.

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. By exploiting the staggered introduction of SoP regulations across ten major European economies, we show by difference-in-differences regressions that the value of voting rights has increased for firms with excessive CEO pay, while it has decreased for other companies. Thus, the option to signal dissent with current compensation is not per se valuable and can actually translate into net costs for shareholders. Advisory votes trigger stronger effects on voting values than binding votes. Finally, the effect of mandatory SoP on voting values is not persistent but rather concentrated on the year of introduction.

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.

Ticket to Heaven: Beliefs in the Afterlife, Portfolio Choice, and Asset Prices

Carina Cuculiza
,
University of Miami

Abstract

I examine how beliefs in the afterlife affect household asset allocation decisions and asset returns in the United States. Economic achievement is an indication that a Protestant will reach heaven but it is of lesser importance for a Catholic's salvation. Incentivized to accumulate wealth, Protestants 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 high-Protestant areas. Overall, these findings suggest that religious beliefs in the afterlife can have social and economic implications.

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

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

Abstract

We examine the effect of a debt collection practice driven by the misuse of borrowers’ private information with data from a large cash loan platform in China. Using collectors’ choice not to contact some borrowers for collection due to excessive workloads as a quasi-natural experiment, we find that collections utilizing private data lead to a lower recovery rate for overdue loans, which is contradictory to collection intention. The negative effect on loan performance is stronger for borrowers with lower credit risk. The fact that borrowers subject to collection are not affected in terms of online consumption shows that the collection practice does not cause borrowers to become severely liquidity constrained. Rather, the underlying mechanism could be that the misuse of private information has elicited negative reciprocity; that is, borrowers retaliate by choosing deliberate default.

Tweeting in the Dark: Corporate Tweeting and Information Diffusion

Isabella Wolfskeil
,
Bocconi University

Abstract

Do firm-initiated Twitter messages (tweets) contain relevant information? Do they reduce investors' information processing costs? 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 consistent with the finding that bad news travel slowly (Hong, Lim, Stein (2000)) and is stronger for firms with lower levels of institutional ownership and for firms with a larger social media network. The results suggests that firms are able to successfully manage the expectations of investors, especially if investors are unsophisticated. This result is consistent with theoretical 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)). I also find evidence that firm-initiated tweets increase the speed of information diffusion to investors. This result is consistent with theoretical 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 establish a new measure of the economic value of patents. We first develop a dynamic model with limited investor attention to analyze how differences in investor attention across different types of innovation announcements affect the stock market response to these announcements. We establish that, in addition to an announcement effect, innovation announcements will be followed by a stock return drift. Further, while the announcement effect of an innovation announcement will be increasing in investor attention, the post-announcement drift will be decreasing in investor attention. We then empirically test these hypotheses using two different datasets: first, a matched sample of patent grant announcements from the biopharmaceutical industry and subsequent FDA drug approval announcements; and second, a dataset of the universe of patent grant announcements from the USPTO. We use the media coverage received by the innovating firm around various innovation announcements as proxies for the investor attention paid to them. Our findings are summarized as follows. First, using our matched patent-drug sample from the biopharmaceutical industry, we find that the abnormal stock returns upon patent grant announcements are smaller than those upon FDA drug approval announcements; the subsequent stock return drifts, however, are larger for patent grant announcements compared to the corresponding FDA drug approval announcements. Second, regardless of whether we use the matched patent grant and drug approval sample from the biopharmaceutical industry or the general sample of all patent grants from the USPTO, we show that the announcement effect of patent grant announcements is increasing in the investor attention paid to such announcements while the subsequent stock return drift is decreasing in this investor attention. We show that a long-short portfolio using investor attention is profitable over the month after patent grant announcements in our general USPTO sample. Finally, we establish that the stock-return drift following patent grant announcements has predictive power for the economic value of patents for the patenting firm, over and above any information contained in their announcement effect.

What Shapes Credit Rating Effectiveness in China Evidence from the Upgrading in the Banking Sector

Shida Liu
,
Tsinghua University
Hao Wang
,
Tsinghua University

Abstract

We observe 180 upgrades but two downgrades among 657 Chinese banks during China’s economic growth slowdown in 2015-2017. The upgrades coincided with dramatic rating standard deterioration. Except for banks being upgraded to AAA and AA+ that gained significant regulatory advantages, the upgrades did not lead to proper reductions in credit prices. Regulations’ reliance on credit ratings unintentionally gave rise to regulation arbitrage opportunities that constitute a primary driver of rating inflation. Although investors were able to discover information, they tended to accept inflated ratings for regulation arbitrage. In the expectation of government bailout, agency-investor conflicts and agency reputation effects were silent in restricting 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 hold naked option positions, 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 and sophisticated strategies outperform their peers, and those using naked options underperform; (iii) volatility traders mainly gain from selling volatilities although subject to large downside risk. Our findings suggest that skilled options traders use volatility and complicated strategies, but informational advantage and country domicile are less important.

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

Yanran Liu
,
University of Pittsburgh

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)

Abstract

My study is the first large-scale empirical analysis of the pledging phenomenon among U.S. CEOs. Between 2007 and 2016, 7.6% of 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 dollar value of margin loans is an economically sizeable $65 million and the total dollar amount pledged aggregated across all U.S. CEOs each year is substantial and fluctuates between $7.8 billion and $19.3 billion. CEOs use the funds to either double down, hedge their ownership, or for purposes unrelated to changing their effective ownership. Returns surrounding the initiations of margin loans suggest that CEOs are able to time the market. My event study results suggest that the stock market participants perceive share pledging as value-enhancing, but view significant pledging as value-destroying.

Why 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 longer-term debts post hedge fund activism. The target firms' median proportion of debt maturing in more than 3 years increases by 19% in three years around activists’ interventions. Our results suggest that this debt maturity change may be influenced by both bankers’ reluctance to provide capital (supply constraints) and targets’ increasing reliance on longer-term public debts (demand-side factors). Hedge fund activism increases the propensity to raise longer-term public debts in target firms. This indicates that new longer-term debtholders believe in ‘shared benefits’ hypothesis by extending longer-term debts 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 shorter-term debtholders to the 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 Macro Risks

Anne Hansen
,
University of Copenhagen

Abstract

How important are macro risks for explaining variation in bond yields? We show that the macroeconomic impact on yield curve volatility varies substantially over time. For this purpose, we introduce a novel no-arbitrage macro-finance term structure model with multivariate GARCH volatility. Our model is tractable and captures empirical measures of volatility in U.S. Treasury bond yields between 1971 and 2019 closely. We find that the fraction of yield curve variation due to macro risks ranges between 0 and 56 pct with large month-to-month changes. Macro risks explain most variation in expansions and primarily affect bond yields through expectations to future short rates. Also, we show that the importance of macro risks ceased during the Great Moderation but regained explanatory power after the Great Recession. Finally, investors are willing to pay large premia for hedging uncertainty related to macro risks.
JEL Classifications
  • G0 - General