Research articles for the 2019-07-26
An American Perspective on Financial Market Development in Emerging Asia (Presentation Slides)
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Presentation in Panel on What Model for Financial Market Development in Emerging Asia: Anglo-Saxon, China, India, or even the EU?
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Presentation in Panel on What Model for Financial Market Development in Emerging Asia: Anglo-Saxon, China, India, or even the EU?
Bank Efficiency in Vietnam (Presentation Slides)
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Discussion of "Bank efficiency in Vietnam: Do scale expansion strategies and non-performing loans matter?" By Chau Le, Roman Matousek, Panayiotis Tzeremes, Trong Ngo.
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Discussion of "Bank efficiency in Vietnam: Do scale expansion strategies and non-performing loans matter?" By Chau Le, Roman Matousek, Panayiotis Tzeremes, Trong Ngo.
Corporate Refinancing, Covenants, and the Agency Cost of Debt
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How valuable are restrictive debt covenants in reducing the agency costs of debt? I exploit the revealed preference decision to refinance fixed-coupon bonds, which weighs observable interest rate savings against the unobservable costs of a change in restrictive covenants. Variation in this trade-off reveals that firms require higher interest rate savings to refinance when it would add restrictive covenants. I structurally estimate a model of debt refinancing and find that a high-yield bond's restrictive covenant package increases the value of speculative-grade firms by 2.4 percent. This suggests that covenants are essential for allowing the tax benefits of debt to offset costs of financial distress.
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How valuable are restrictive debt covenants in reducing the agency costs of debt? I exploit the revealed preference decision to refinance fixed-coupon bonds, which weighs observable interest rate savings against the unobservable costs of a change in restrictive covenants. Variation in this trade-off reveals that firms require higher interest rate savings to refinance when it would add restrictive covenants. I structurally estimate a model of debt refinancing and find that a high-yield bond's restrictive covenant package increases the value of speculative-grade firms by 2.4 percent. This suggests that covenants are essential for allowing the tax benefits of debt to offset costs of financial distress.
Discussion of 'Has the Split-Share Reform Influenced Corporate Behaviour? Chinese Firms’ Fixed Capital Investment 2002-2016' (Presentation Slides)
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Comments on "Has the Split-Share Reform Influenced Corporate Behaviour? Chinese Firms’ Fixed Capital Investment 2002-2016".
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Comments on "Has the Split-Share Reform Influenced Corporate Behaviour? Chinese Firms’ Fixed Capital Investment 2002-2016".
Disentangling the Role of the Exchange Rate in Oil-Related Scenarios for the European Stock Market
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Until now, stock market responses to a distress scenario for oil prices have been analysed considering prices in domestic currency. This assumption implies merging the commodity risk with the exchange rate risk when oil and stocks are traded in different currencies. This article proposes incorporating explicitly the exchange rate, using the convolution concept, to assess how could change the stock market response depending on the source of risk that moves oil prices. I apply this framework to study the change in the 10th lowest percentile of the European stock market under an oil-related stress scenario, without overlooking the role of the exchange rate. The empirical exercise shows that the same stress oil-related scenario in euros could generate an opposite impact in the European stock market depending on the source of risk. The source of risk is not incorporated when performing a bivariate analysis, which suggests ambiguous estimates of the stock response. This framework can improve our understanding of how the exchange rate interacts in global markets. Also, it contributes to reduce the inaccuracy in the impact assessment of foreign shocks where the exchange rate plays a relevant role.
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Until now, stock market responses to a distress scenario for oil prices have been analysed considering prices in domestic currency. This assumption implies merging the commodity risk with the exchange rate risk when oil and stocks are traded in different currencies. This article proposes incorporating explicitly the exchange rate, using the convolution concept, to assess how could change the stock market response depending on the source of risk that moves oil prices. I apply this framework to study the change in the 10th lowest percentile of the European stock market under an oil-related stress scenario, without overlooking the role of the exchange rate. The empirical exercise shows that the same stress oil-related scenario in euros could generate an opposite impact in the European stock market depending on the source of risk. The source of risk is not incorporated when performing a bivariate analysis, which suggests ambiguous estimates of the stock response. This framework can improve our understanding of how the exchange rate interacts in global markets. Also, it contributes to reduce the inaccuracy in the impact assessment of foreign shocks where the exchange rate plays a relevant role.
Does Other Comprehensive Income Volatility Influence Credit Risk and the Cost of Debt?
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We examine the usefulness of other comprehensive income (OCI) to debt investors in nonfinancial companies. Motivated by Merton’s (1974) real options framework, we construct a measure of incremental OCI volatility, designed to capture the effect of OCI on overall firm asset volatility, which is a primary driver of credit risk in Merton’s (1974) model. We find that the volatility of incremental OCI influences the likelihood of default, credit ratings, and the cost of debt. Overall, our evidence suggests that creditors use information from OCI in their assessment of firm credit risk and in pricing debt contracts.
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We examine the usefulness of other comprehensive income (OCI) to debt investors in nonfinancial companies. Motivated by Merton’s (1974) real options framework, we construct a measure of incremental OCI volatility, designed to capture the effect of OCI on overall firm asset volatility, which is a primary driver of credit risk in Merton’s (1974) model. We find that the volatility of incremental OCI influences the likelihood of default, credit ratings, and the cost of debt. Overall, our evidence suggests that creditors use information from OCI in their assessment of firm credit risk and in pricing debt contracts.
Efficiency in the Mortgage Market for High-Priced Homes: Evidence from a Regression-Discontinuity Design
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I exploit exogenous variation in the probability that a mortgage is exposed to Fannie Mae and Freddie Mac generated by property appraisals to examine how well buyers of high-priced homes balance loan size and loan cost. I find that they generally strike a proper balance despite wide variation in interest rates with respect to loan type (i.e. fixed versus adjustable rate) and over time (specifically, from 1992 to 2017). The evidence suggests that the mortgage market for high-priced homes is efficient and offers future research an opportunity to learn about this market through the behavior of the borrowers in it.
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I exploit exogenous variation in the probability that a mortgage is exposed to Fannie Mae and Freddie Mac generated by property appraisals to examine how well buyers of high-priced homes balance loan size and loan cost. I find that they generally strike a proper balance despite wide variation in interest rates with respect to loan type (i.e. fixed versus adjustable rate) and over time (specifically, from 1992 to 2017). The evidence suggests that the mortgage market for high-priced homes is efficient and offers future research an opportunity to learn about this market through the behavior of the borrowers in it.
Evaluating Boards: A Policy Agenda in Need of Perspective
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For at least 30 years, and with growing intensity through recurring corporate governance crises, public policy in many countries has been striving to encourage boards of directors to undertake regular evaluations. The policy push has stimulated much practical advice, many tools for evaluation, strong encouragement from professional bodies, and considerable skepticism from those being evaluated. While some scholars have sought to conceptualize the practice, we lack a fuller understanding that can help us see how the promised benefits and feared drawbacks arise. This Director Notes report reviews the policy context and practitioner accounts and builds frameworks for practice and policy analysis. The authors find that board evaluation is a multidimensional concept in which the interactions across the dimensions open paths to improvement of boards processes while also to unintended consequences. The authors then suggest avenues for future research and a shift in policy and practice toward greater experimentation.
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For at least 30 years, and with growing intensity through recurring corporate governance crises, public policy in many countries has been striving to encourage boards of directors to undertake regular evaluations. The policy push has stimulated much practical advice, many tools for evaluation, strong encouragement from professional bodies, and considerable skepticism from those being evaluated. While some scholars have sought to conceptualize the practice, we lack a fuller understanding that can help us see how the promised benefits and feared drawbacks arise. This Director Notes report reviews the policy context and practitioner accounts and builds frameworks for practice and policy analysis. The authors find that board evaluation is a multidimensional concept in which the interactions across the dimensions open paths to improvement of boards processes while also to unintended consequences. The authors then suggest avenues for future research and a shift in policy and practice toward greater experimentation.
Firm Listing Status and the Investment Home Bias
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Prior research has found that public firm investment rates are more sensitive than private firm investment rates to new investment opportunities. We confirm these findings and offer a new explanation for this result. Public and private firm investment sensitivities differ because the types of investments favored by firms varies with their listing status. Private firms have a much stronger investment home-bias than similar public firms which makes their investment decisions more sensitive to measures of local, non-industry investment opportunities, but due to resource constraints less sensitive to firm- and industry-measures of investment opportunities. Controlling for both types of investment opportunities explains roughly four-fifths of the differential sensitivity of public and private firms to new investment opportunities.
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Prior research has found that public firm investment rates are more sensitive than private firm investment rates to new investment opportunities. We confirm these findings and offer a new explanation for this result. Public and private firm investment sensitivities differ because the types of investments favored by firms varies with their listing status. Private firms have a much stronger investment home-bias than similar public firms which makes their investment decisions more sensitive to measures of local, non-industry investment opportunities, but due to resource constraints less sensitive to firm- and industry-measures of investment opportunities. Controlling for both types of investment opportunities explains roughly four-fifths of the differential sensitivity of public and private firms to new investment opportunities.
Getting Tired of Your Friends: The Dynamics of Venture Capital Relationships
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Does doing more deals together always strengthen investor relationships? Based on the relationships of the top 50 US venture capital firms, this paper focuses on the strengths of relationships and their dynamic evolution. Empirical estimates indicate that having a deeper relationship leads to fewer, not more future coinvestments. Moreover, deeper relationships lead to lower exit performance, even after controlling for endogeneity. Interestingly, deeper relationships first lead to lower performance, and subsequently lead to a slowdown in the relationship intensity. Relationship effects are more negative for VC firms with less central network positions, and for deals made in “hot†investment markets.
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Does doing more deals together always strengthen investor relationships? Based on the relationships of the top 50 US venture capital firms, this paper focuses on the strengths of relationships and their dynamic evolution. Empirical estimates indicate that having a deeper relationship leads to fewer, not more future coinvestments. Moreover, deeper relationships lead to lower exit performance, even after controlling for endogeneity. Interestingly, deeper relationships first lead to lower performance, and subsequently lead to a slowdown in the relationship intensity. Relationship effects are more negative for VC firms with less central network positions, and for deals made in “hot†investment markets.
Hamilton's Law and Finance â€" Borrowing from the Brits (And the Dutch)
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We live in an era when Modern Monetary Theory has gained purchase. Deficits do not seem to matter to nations or their finance ministers. States believe the can print their way to utopia without a reckoning; this is a scheme freighted with disaster. This article centers on the achievements of America’s greatest finance minister whose grasp of political economy was without equal. Hamilton charted the course for American economic power. His work is timely and worthy of study.Late-18th century America sought commercial growth and new manufacturers yet feared monopolistic economic power. Hamilton’s economic program, centered on a national bank and program for manufacturing, provided the framework for the finance-led transformation of America. In a short time, Hamilton’s elegant solutions (based upon the English financial model) transformed America from a defaulting debtor to a magnet that attracted immense amounts of capital in the 19th century. The burden of the Revolutionary War debt needed to be resolved. Hamilton’s program: the assumption of the states and Confederation debt, its monetization, the establishment of the Bank of the United States, and Report on Manufactures laid the foundation for a vibrant economy. The article demonstrates how Hamilton’s prudent program strengthened the new federal government while providing the blueprint for the commercial society that emerged in the 19th century.
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We live in an era when Modern Monetary Theory has gained purchase. Deficits do not seem to matter to nations or their finance ministers. States believe the can print their way to utopia without a reckoning; this is a scheme freighted with disaster. This article centers on the achievements of America’s greatest finance minister whose grasp of political economy was without equal. Hamilton charted the course for American economic power. His work is timely and worthy of study.Late-18th century America sought commercial growth and new manufacturers yet feared monopolistic economic power. Hamilton’s economic program, centered on a national bank and program for manufacturing, provided the framework for the finance-led transformation of America. In a short time, Hamilton’s elegant solutions (based upon the English financial model) transformed America from a defaulting debtor to a magnet that attracted immense amounts of capital in the 19th century. The burden of the Revolutionary War debt needed to be resolved. Hamilton’s program: the assumption of the states and Confederation debt, its monetization, the establishment of the Bank of the United States, and Report on Manufactures laid the foundation for a vibrant economy. The article demonstrates how Hamilton’s prudent program strengthened the new federal government while providing the blueprint for the commercial society that emerged in the 19th century.
Knowing When to Splurge: Precautionary Saving and Chinese-Canadians
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Why do household saving rates differ so much across countries? This micro-level question has global implications: countries that systematically “oversave†export capital by running current account surpluses. In the recipient countries, interest rates are thus too low and financial stability is put at risk. Existing theories argue that saving is precautionary, but tests are limited to cross-country comparisons and are not always supportive. We report the findings of an original survey experiment. Using a simulated financial saving task implemented online, we compare the saving preferences of a large and diverse sample of Chinese-Canadians with other Canadians. This comparison is instructive given that Chinese-Canadians migrated from, or descend from those who migrated from, a high-saving environment to a low-savings, high-debt environment. We also compare behavior in the presence and absence of a simulated “welfare stateâ€, which we represent in the form of mandatory insurance. Our respondents exhibit behavior in the saving task that corresponds to standard economic assumptions about lifecycle savings and risk aversion. We find strong evidence that precautionary saving is reduced when a mandatory insurance is present, but no support that Chinese cultural influences â€" represented in linguistic or ethnic terms â€" have any effect on saving behavior.
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Why do household saving rates differ so much across countries? This micro-level question has global implications: countries that systematically “oversave†export capital by running current account surpluses. In the recipient countries, interest rates are thus too low and financial stability is put at risk. Existing theories argue that saving is precautionary, but tests are limited to cross-country comparisons and are not always supportive. We report the findings of an original survey experiment. Using a simulated financial saving task implemented online, we compare the saving preferences of a large and diverse sample of Chinese-Canadians with other Canadians. This comparison is instructive given that Chinese-Canadians migrated from, or descend from those who migrated from, a high-saving environment to a low-savings, high-debt environment. We also compare behavior in the presence and absence of a simulated “welfare stateâ€, which we represent in the form of mandatory insurance. Our respondents exhibit behavior in the saving task that corresponds to standard economic assumptions about lifecycle savings and risk aversion. We find strong evidence that precautionary saving is reduced when a mandatory insurance is present, but no support that Chinese cultural influences â€" represented in linguistic or ethnic terms â€" have any effect on saving behavior.
Liquid Speed: On-Demand Fast Trading at Distributed Exchanges
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Exchanges acquire excess processing capacity to accommodate trading activity surges associated with zero-sum high-frequency trader (HFT) "duels." The idle capacity's opportunity cost is an externality of low-latency trading. We build a model of decentralized exchanges (DEX) with flexible capacity. On DEX, HFTs acquire speed in real-time from peer-to-peer networks. The price of speed surges during activity bursts, as HFTs simultaneously race to market. Relative to centralized exchanges, HFTs acquire more speed on DEX, but for shorter timespans. Low-latency "sprints" speed up price discovery without harming liquidity. Overall, speed rents decrease and fewer resources are locked-in to support zero-sum HFT trades.
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Exchanges acquire excess processing capacity to accommodate trading activity surges associated with zero-sum high-frequency trader (HFT) "duels." The idle capacity's opportunity cost is an externality of low-latency trading. We build a model of decentralized exchanges (DEX) with flexible capacity. On DEX, HFTs acquire speed in real-time from peer-to-peer networks. The price of speed surges during activity bursts, as HFTs simultaneously race to market. Relative to centralized exchanges, HFTs acquire more speed on DEX, but for shorter timespans. Low-latency "sprints" speed up price discovery without harming liquidity. Overall, speed rents decrease and fewer resources are locked-in to support zero-sum HFT trades.
Monetary Policy, Macroprudential Policy, and Financial Stability
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This paper reexamines from a theoretical perspective the role of monetary and macroprudential policies in addressing the build-up of risks in the financial system. We construct a stylized general equilibrium model in which the key friction comes from a moral hazard problem in firms financing that banks’ equity capital serves to ameliorate. Tight monetary policy is introduced by open market sales of government debt, and tight macroprudential policy by an increase in capital requirements. We show that both policies are useful, but macroprudential policy is more effective in fostering financial stability and leads to higher social welfare.
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This paper reexamines from a theoretical perspective the role of monetary and macroprudential policies in addressing the build-up of risks in the financial system. We construct a stylized general equilibrium model in which the key friction comes from a moral hazard problem in firms financing that banks’ equity capital serves to ameliorate. Tight monetary policy is introduced by open market sales of government debt, and tight macroprudential policy by an increase in capital requirements. We show that both policies are useful, but macroprudential policy is more effective in fostering financial stability and leads to higher social welfare.
The Development of East Asian Bond Markets (Presentation Slides)
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Keynote address at Chapman Conference on Financial Market Development in Emerging Asia, May 4, 2018.
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Keynote address at Chapman Conference on Financial Market Development in Emerging Asia, May 4, 2018.
The Role of Cryptographic Tokens and ICOs in Fostering Platform Adoption
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Platform-specific digital tokens are becoming increasingly common with the proliferation of initial coin offerings (ICOs). In addition to a novel financing mechanism, such tokens can help address the coordination problem that is common in network adoption. We develop a model to investigate the use of tradable digital tokens to solve this coordination problem. Our analysis shows that platform-specific tokens, due to their tradability and consequent higher value if the platform succeeds, can provide another tool to overcome the coordination problem in a platform adoption setting and to support equilibria favorable to the platform. We find that if the platform is not facing capital constraints, the most profitable strategy is the traditional strategy to subsidize adoption. If the platform is capital constrained, however, then token issuance provides an alternative that is increasingly attractive as the platform's cost of capital increases. With tokens, the platform trades off future revenue for present revenue, which helps finance solving the coordination problem. In that sense, even pure utility tokens have certain characteristics of equity: (1) early adopters share the future gains if the platform succeeds, and (2) the tokens provide an alternative when traditional financing is too costly or not available to the platform.
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Platform-specific digital tokens are becoming increasingly common with the proliferation of initial coin offerings (ICOs). In addition to a novel financing mechanism, such tokens can help address the coordination problem that is common in network adoption. We develop a model to investigate the use of tradable digital tokens to solve this coordination problem. Our analysis shows that platform-specific tokens, due to their tradability and consequent higher value if the platform succeeds, can provide another tool to overcome the coordination problem in a platform adoption setting and to support equilibria favorable to the platform. We find that if the platform is not facing capital constraints, the most profitable strategy is the traditional strategy to subsidize adoption. If the platform is capital constrained, however, then token issuance provides an alternative that is increasingly attractive as the platform's cost of capital increases. With tokens, the platform trades off future revenue for present revenue, which helps finance solving the coordination problem. In that sense, even pure utility tokens have certain characteristics of equity: (1) early adopters share the future gains if the platform succeeds, and (2) the tokens provide an alternative when traditional financing is too costly or not available to the platform.
Value at Risk of Momentum Investment Strategy: Indonesia's Liquid Stocks Portfolio
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The capability of momentum investment strategy was explore through portfolio risk reduction by value at risk method at liquid stock collection in Indonesia stock exchange period 2008-2016. The result show for quarterly and semester period winner portfolio has superior capacity of portfolio risk reduce than loser.
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The capability of momentum investment strategy was explore through portfolio risk reduction by value at risk method at liquid stock collection in Indonesia stock exchange period 2008-2016. The result show for quarterly and semester period winner portfolio has superior capacity of portfolio risk reduce than loser.
Variance Risk Premium and Return Predictability: Evidence from the Chinese SSE 50 ETF Options
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The variance risk premium (VRP) reflects the degree of risk aversion of investors and the overestimation of the probability of extreme losses. We examine a variety of variance risk premiums, including both the upside and downside variance risk premiums, in the Chinese stock market. We find that there is strong presence of variance risk premiums in the Chinese stock market. Evidence on the corresponding delta-hedging portfolios confirms that investors are willing to pay the premium to hedge against the variance risk. We further investigate the predictability of variance risk premiums on Chinese stock markets. Our results show that the predictability limit is up to six months. More surprisingly, the predictive power mainly comes from the upside variance risk premium rather than the downside variance risk premium. The realized variances also have predictive power in the Chinese market while the risk-neutral variances do not.
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The variance risk premium (VRP) reflects the degree of risk aversion of investors and the overestimation of the probability of extreme losses. We examine a variety of variance risk premiums, including both the upside and downside variance risk premiums, in the Chinese stock market. We find that there is strong presence of variance risk premiums in the Chinese stock market. Evidence on the corresponding delta-hedging portfolios confirms that investors are willing to pay the premium to hedge against the variance risk. We further investigate the predictability of variance risk premiums on Chinese stock markets. Our results show that the predictability limit is up to six months. More surprisingly, the predictive power mainly comes from the upside variance risk premium rather than the downside variance risk premium. The realized variances also have predictive power in the Chinese market while the risk-neutral variances do not.
