Research articles for the 2019-04-20
Aggregate Demand and Sovereign Debt Crises
SSRN
Sovereign debt crises are associated with pronounced recessions. In the conventional view, poor economic conditions increase default incentives and hence bond spreads. I provide evidence suggesting that the reaction of consumption demand creates feedback from sovereign spreads to output even while the government is in good standing with creditors. Because they ignore the savings behavior of private agents, existing models cannot capture this empirical feature of crises. I study the implications of this feedback mechanism in a model where the government of a small open economy borrows from foreign lenders but some of the debt is held by domestic savers who are heterogeneous in their wealth. This heterogeneity means that potential sovereign defaults carry redistributive effects in addition to aggregate income losses. Both of these effects introduce risk in private agents' expectations after bad news for repayment. Default risk then exacerbates the precautionary motive of households and depresses aggregate demand when spreads increase.
SSRN
Sovereign debt crises are associated with pronounced recessions. In the conventional view, poor economic conditions increase default incentives and hence bond spreads. I provide evidence suggesting that the reaction of consumption demand creates feedback from sovereign spreads to output even while the government is in good standing with creditors. Because they ignore the savings behavior of private agents, existing models cannot capture this empirical feature of crises. I study the implications of this feedback mechanism in a model where the government of a small open economy borrows from foreign lenders but some of the debt is held by domestic savers who are heterogeneous in their wealth. This heterogeneity means that potential sovereign defaults carry redistributive effects in addition to aggregate income losses. Both of these effects introduce risk in private agents' expectations after bad news for repayment. Default risk then exacerbates the precautionary motive of households and depresses aggregate demand when spreads increase.
Chief Risk Officers and Firm Value: Empirical Evidence From the Insurance Industry
SSRN
We study the relationship between enterprise risk management and firm value. We analyze how the influence and reporting of the chief risk officer (CRO) and the incentives to compensate him or her contribute to firm value. We use U.S. publicly traded insurers data between 2009 and 2017 and find that the participation of a CRO is insufficient for value creation in insurers. Our results present a negative relationship between a CRO and firm value. However, we find empirical evidence of a positive relationship between firm value and the incentives related to the compensation of the CRO, specifically including the CRO in the compensation committee of the board and providing the CRO with an equity-based compensation plan.
SSRN
We study the relationship between enterprise risk management and firm value. We analyze how the influence and reporting of the chief risk officer (CRO) and the incentives to compensate him or her contribute to firm value. We use U.S. publicly traded insurers data between 2009 and 2017 and find that the participation of a CRO is insufficient for value creation in insurers. Our results present a negative relationship between a CRO and firm value. However, we find empirical evidence of a positive relationship between firm value and the incentives related to the compensation of the CRO, specifically including the CRO in the compensation committee of the board and providing the CRO with an equity-based compensation plan.
Collateral Booms and Information Depletion
SSRN
We develop a new theory of information production during credit booms. In our model, entrepreneurs need credit to undertake investment projects, some of which enable them to divert resources towards private consumption. Lenders can protect themselves from such diversion in two ways: collateralization and costly screening, which generates durable information about projects. In equilibrium, the collateralization-screening mix depends on the value of aggregate collateral. High collateral values raise investment and economic activity, but they also raise collateralization at the expense of screening. This has important dynamic implications. During credit booms driven by high collateral values (e.g. real estate booms), the economy accumulates physical capital but depletes information about investment projects. As a result, collateral-driven booms end in deep crises and slow recoveries: when booms end, investment is constrained both by the lack of collateral and by the lack of information on existing investment projects, which takes time to rebuild. We provide new empirical evidence using US firm-level data in support of the model's main mechanism.
SSRN
We develop a new theory of information production during credit booms. In our model, entrepreneurs need credit to undertake investment projects, some of which enable them to divert resources towards private consumption. Lenders can protect themselves from such diversion in two ways: collateralization and costly screening, which generates durable information about projects. In equilibrium, the collateralization-screening mix depends on the value of aggregate collateral. High collateral values raise investment and economic activity, but they also raise collateralization at the expense of screening. This has important dynamic implications. During credit booms driven by high collateral values (e.g. real estate booms), the economy accumulates physical capital but depletes information about investment projects. As a result, collateral-driven booms end in deep crises and slow recoveries: when booms end, investment is constrained both by the lack of collateral and by the lack of information on existing investment projects, which takes time to rebuild. We provide new empirical evidence using US firm-level data in support of the model's main mechanism.
Multi-Dimensional Policy Framework for Analyzing and Responding to Global Economic Crises
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This paper builds a Holistic Evaluative Model (or HEM) to analyze crises responses, focusing on multiple narratives (explanations) from fields as varied as economics, political science, finance and public policy. A broader framework equips policymakers with more options to shape responses to crises which routinely occurred during the last 75 years of heightened globalization. A HEM reflects the actual process of policy evaluation by combining data across different fields with a valid approach clear enough to discuss increasing opportunities to ameliorate crisis impacts. Even if they are identified, policymakers may not directly influence the causes of crises, which for 2007-2009 included (a) limited market corrections; (b) regulation deficiencies (c) systemic risks; (d) irrational behaviors; (e) informational complexities and (f) cultural failings (that exacerbated these inefficiencies), but they can focus on developing and implementing adequate policy responses. As such, HEMs increase options over a siloed approach by incorporating multiple theoretical tools, dynamic ripple-effects and diverse stakeholders â€" simultaneously evaluating monetary-fiscal policy, actor rationality, systematic risk and the cultural context.
SSRN
This paper builds a Holistic Evaluative Model (or HEM) to analyze crises responses, focusing on multiple narratives (explanations) from fields as varied as economics, political science, finance and public policy. A broader framework equips policymakers with more options to shape responses to crises which routinely occurred during the last 75 years of heightened globalization. A HEM reflects the actual process of policy evaluation by combining data across different fields with a valid approach clear enough to discuss increasing opportunities to ameliorate crisis impacts. Even if they are identified, policymakers may not directly influence the causes of crises, which for 2007-2009 included (a) limited market corrections; (b) regulation deficiencies (c) systemic risks; (d) irrational behaviors; (e) informational complexities and (f) cultural failings (that exacerbated these inefficiencies), but they can focus on developing and implementing adequate policy responses. As such, HEMs increase options over a siloed approach by incorporating multiple theoretical tools, dynamic ripple-effects and diverse stakeholders â€" simultaneously evaluating monetary-fiscal policy, actor rationality, systematic risk and the cultural context.
Spillover Effects of State Regulated Corporate Disclosures on the Mortgage Market
SSRN
I investigate the spillover effects of disclosure requirements imposed by state governments on oil and gas companies operating in the state. Recently, several state governments have begun requiring companies to publicly disclose information about chemicals used in their fracking operations. The chemicals can result in land and water contamination, thereby creating uncertainty about property values near fracking operations. I hypothesize and find that the disclosure mandate reduces uncertainty about property values and subsequently increases mortgage lending activity, i.e., probability of obtaining a mortgage and loan-to-value by 2.6 and 2.2 percentage points, respectively. My analyses exploit the staggered adoption of disclosure regulations across states as well as variation in the location of properties relative to fracking wells. I conduct cross-sectional tests based on property characteristics (e.g., drinking water source, lender type) and the content of the information disclosed to further substantiate my inference that disclosures related to fracking chemicals facilitate mortgage lending activity. Finally, I find that fracking chemical disclosures decrease the variance in property prices, suggesting that a reduction in uncertainty about collateral value is the mechanism through which these disclosures affect mortgage lending. My results highlight the value of information disclosed by one sector of the economy for economic activity in different sector of the economy.
SSRN
I investigate the spillover effects of disclosure requirements imposed by state governments on oil and gas companies operating in the state. Recently, several state governments have begun requiring companies to publicly disclose information about chemicals used in their fracking operations. The chemicals can result in land and water contamination, thereby creating uncertainty about property values near fracking operations. I hypothesize and find that the disclosure mandate reduces uncertainty about property values and subsequently increases mortgage lending activity, i.e., probability of obtaining a mortgage and loan-to-value by 2.6 and 2.2 percentage points, respectively. My analyses exploit the staggered adoption of disclosure regulations across states as well as variation in the location of properties relative to fracking wells. I conduct cross-sectional tests based on property characteristics (e.g., drinking water source, lender type) and the content of the information disclosed to further substantiate my inference that disclosures related to fracking chemicals facilitate mortgage lending activity. Finally, I find that fracking chemical disclosures decrease the variance in property prices, suggesting that a reduction in uncertainty about collateral value is the mechanism through which these disclosures affect mortgage lending. My results highlight the value of information disclosed by one sector of the economy for economic activity in different sector of the economy.
The CSPP at Work - Yield Heterogeneity and the Portfolio Rebalancing Channel
SSRN
We assess the impact of the corporate sector purchase programme (CSPP), the corporate arm of the ECB’s quantitative easing, over its first year of activity (June 2016 â€" June 2017). Focusing on the primary bond market, we find evidence of a significant impact of the CSPP on yield spreads, both directly on purchased and targeted bonds and indirectly on all other bonds. The magnitude and the timing of the changes in yield spreads, coupled with the evolution of bond placements, are fully consistent with the proper unfolding the portfolio rebalancing channel.
SSRN
We assess the impact of the corporate sector purchase programme (CSPP), the corporate arm of the ECB’s quantitative easing, over its first year of activity (June 2016 â€" June 2017). Focusing on the primary bond market, we find evidence of a significant impact of the CSPP on yield spreads, both directly on purchased and targeted bonds and indirectly on all other bonds. The magnitude and the timing of the changes in yield spreads, coupled with the evolution of bond placements, are fully consistent with the proper unfolding the portfolio rebalancing channel.
Variance Risk Premium Components and International Stock Return Predictability
SSRN
In this paper, we document and explain the distinct behaviors of U.S. downside and upside variance risk premiums (DVP and UVP, respectively) and their international stock return predictability patterns. DVP, the compensation for bearing downside variance risk, is positive, highly correlated with the total variance premium, and countercyclical, whereas UVP is, on average, borderline positive and procyclical with large negative spikes around episodes of market turmoil. We then provide robust evidence that decomposing VP into its downside and upside components significantly improves domestic and international stock return predictability. DVP is a robust predictor at four to six months and exhibits a hump-shaped pattern, whereas UVP performs the best at very short horizons. These stylized facts highlight the importance of acknowledging asymmetry in equity risk premiums. Hence, in the second part of the paper, we rationalize the economic sources of DVP and UVP in an international dynamic asset pricing model featuring asymmetric and time-varying risk aversion and economic uncertainty in a partially integrated world economy. We show that DVP is mostly driven by the upside movements of risk aversion, whereas UVP loads significantly and negatively on downside economic uncertainty. Moreover, we find that DVP (UVP) transmits to international markets mostly through financial integration (real economic integration).
SSRN
In this paper, we document and explain the distinct behaviors of U.S. downside and upside variance risk premiums (DVP and UVP, respectively) and their international stock return predictability patterns. DVP, the compensation for bearing downside variance risk, is positive, highly correlated with the total variance premium, and countercyclical, whereas UVP is, on average, borderline positive and procyclical with large negative spikes around episodes of market turmoil. We then provide robust evidence that decomposing VP into its downside and upside components significantly improves domestic and international stock return predictability. DVP is a robust predictor at four to six months and exhibits a hump-shaped pattern, whereas UVP performs the best at very short horizons. These stylized facts highlight the importance of acknowledging asymmetry in equity risk premiums. Hence, in the second part of the paper, we rationalize the economic sources of DVP and UVP in an international dynamic asset pricing model featuring asymmetric and time-varying risk aversion and economic uncertainty in a partially integrated world economy. We show that DVP is mostly driven by the upside movements of risk aversion, whereas UVP loads significantly and negatively on downside economic uncertainty. Moreover, we find that DVP (UVP) transmits to international markets mostly through financial integration (real economic integration).
