Research articles for the 2019-11-07

529 College Savings Plan under the TCJA: Evaluating Age-Based Portfolios
Riskin, Ross
The enactment of the Tax Cuts and Jobs Act of 2017 (TCJA) introduces some of the most sweeping tax law changes in more than 30 years and enhances the flexibility investors have when using 529 college savings plans for more than just qualified higher education expenses. Investors can now use funds from these accounts to pay for qualified K-12 tuition expenses without being taxed or penalized on the earnings associated with the distributions at the federal level. While this new provision may make 529 college savings plans more attractive, investors may now need to re-evaluate their investment holdings in these plans especially if they are using age-based portfolios and are planning for pre-undergraduate education expenses, post-graduate education expenses, or are considering using a combination of in-state and out-of-state 529 college savings plans to achieve their education planning goals.

A Regulated Market Under Sanctions: On Tail Dependence Between Oil, Gold, and Tehran Stock Exchange Index
Shirvani, Abootaleb,Volchenkov, Dimitri
We demonstrate that the tail dependence should always be taken into account as a proxy for systematic risk of loss for investments. We provide the clear statistical evidence of that the structure of investment portfolios on a regulated market should be adjusted to the price of gold. Our finding suggests that the active bartering of oil for goods would prevent collapsing the national market facing the international sanctions.

Are We Spending Too Little in Retirement?
Statman, Meir
The drumbeat of “retirement crisis” is much too loud. Madamba and Utkus (2017) reported that 55 percent of retirees believe there is a national retirement crisis, but only 4 percent describe their own retirement situation as a crisis. They also reported that 90 percent of recent retirees are able to spend freely, within reason, or cover needs with some discretionary spending; only 10 percent said that they are on a strict budget.

Distance Effects in CMBS Loan Pricing: Banks versus Non-Banks
Eichholtz, Piet,Mimiroglu, Nagihan,Ongena, Steven,Yönder, Erkan
The composition of lenders has changed dramatically since the crisis, and non-bank lenders have become important players in the commercial mortgage{backed securities (CMBS) markets. Comparing banks to non-bank lenders, we investigate whether the geographical distance between lenders, borrowers and their properties is reflected in the pricing of US mortgages that were included in US CMBS pools during the 2000 to 2017 period. We find that a doubling in bank borrower distance is associated with a 2.5 basis point increase in the spread, and that this effect is more pronounced if the loan is collateralized by a riskier property. Geographical distance does not seem to have any effect on the loan spread for mortgages granted by 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.

Dynamics of Venture Capital Syndication: Perspective of Information
Chen, Rong,Qiu, Zhiyi
Syndication develops an increasing social network of venture capitals (VC). On one hand, information channel to the center of network. On the other hand, firms in the center are faced with redundant information. Using the evidence from China, we investigate the dynamics of syndication network with the perspective of information. The position of a firm in the network exerts a curvilinear effect on its strategy of syndication in the future. Specifically, less-centered firms focus more on the quantity of information and are prone to gather information by syndication (especially with familiar partners). Contrarily, the top centered firms focus more on information diversity and are prone to operate solo or to syndicate with new partners. Furthermore, cross-clique syndication improves VC firm’s performance. In addition, the ownership and experience of VC firms affects the curvilinear relationship.

Earnings Management around Seasoned Equity Offerings: Evidence from Non-Investment Accruals.
Rapushi, Loreta
Managers appear to inflate the firm's non-investment accruals, and then adjust financing and investment decisions to capitalize on this inflation. Using a large sample of corporate seasoned equity offerings for the period 1972 - 2017, we find that firms which adjust non-investment accruals to inflate pre-issue earnings, have lower stock returns in the years that follow. Our evidence is consistent with investors being overly optimistic at the time of the issue, while in the long run revaluing the firm down because high reported earnings are not justified by fundamentals. Quantile analysis indicate that the aggressive firms have a 10% stock return under-performance in the post-issue year compared to the conservative firms and have a 15% higher probability of issuing equity in the following quarters. We find that managers are more aggressive with the pre-issue inflation of their non-investment accruals when the firm is highly dependent on equity finance.

House Prices, Home Equity, and Personal Debt Composition
Li, Jieying,Zhang, Xin
Using a monthly panel dataset of individuals' debt composition including mortgage and nonmortgage consumer credit, we show that house price changes can explain a significant fraction of personal debt composition dynamics. We exploit the variation in local house price growth as shocks to homeowners' housing wealth to study the consequential adjustment of personal debt composition. To account for local demand shocks and disentangle the housing collateral channel from the wealth effect, we use renters and non-equity-withdrawal homeowners in the same region as control groups. We present direct evidence that homeowners reoptimize their debt structure by using withdrawn home equity to pay down comparatively expensive short-term non-mortgage debt during a housing boom, unsecured consumer loans in particular. We also find that homeowners withdraw home equity to finance their entrepreneurial activities. Our study sheds new light on the dynamics of personal debt composition in response to changes in house prices.

Household Consumer Debt, Endogenous Money and Growth: A Supermultiplier-Based Analysis
Pariboni, Riccardo
The paper provides a simple theoretical framework to assess the macroeconomic implications of debt-fuelled consumption. In particular, the analysis is conducted through an extended super-multiplier model with endogenous credit money, which highlights the role of the autonomous components of demand, and in particular autonomous consumption, as the main drivers of economic growth. The author sketches a comparison with alternative heterodox formulations. He argues that, unlike the neo-Kaleckian models, in the model proposed here output growth adjusts to the path of debt-financed consumption. Having treated investment as fully induced, it follows that also the rate of capital accumulation adjusts to the rate of growth, which is itself determined by the evolution of autonomous demand. Finally, it is shown that the stability of the ratio of debt to debtors’ income is affected, among other things, by the growth differential between workers’ autonomous consumption (and debt) and the other autonomous components of demand, i.e. public expenditure and capitalists’ autonomous consumption.

Household Debt, Consumption, and Monetary Policy in Australia
Loukoianova, Elena,Ching Wong, Yu,Hussiada, Ioana
This paper discusses the evolution of the household debt in Australia and finds that while higher-income and higher-wealth households tend to have higher debt, lower-income households may become more vulnerable to rising debt service over time. Then, the paper analyzes the impact of a monetary policy shock on households' current consumption and durable expenditures depending on the level of household debt. The results corroborate other work that households' response to monetary policy shocks depends on their debt and income levels. In particular, households with higher debt tend to reduce their current consumption and durable expenditures more than other households in response to a contractionary monetary policy shocks. However, households with low debt may not respond to monetary policy shocks, as they hold more interest-earning assets.

Industry Returns in Global Value Chains: The Role of Upstreamness and Downstreamness
Branger, Nicole,Flacke, René Marian,Windmueller, Steffen
This paper studies how upstreamness and downstreamness affect industry returns in global value chains. Up- and downstreamness measure the average distance from final consumption and primary inputs, respectively, and are computed from world input-output tables. We show that downstreamness is a key driver of expected returns around the globe, whereas upstreamness is not. Industries that are farthest away from primary inputs earn approximately 5% higher returns per year than industries that are closest. The effect is found within countries and business sectors and suggests that investors perceive supplier-dependence in global value chains as an important source of risk.

Inflexibility and Leverage
Gu, Lifeng,Hackbarth, Dirk,Li, Tong
We examine whether a firm's inflexibility (i.e., inability to adjust its scale in response to profitability shocks) influences its financial policy. Based on a firm's historical range of operating costs-to-sales ratio, scaled by the volatility of its sales growth, we find robust evidence that inflexible firms adopt a lower level of financial leverage compared with flexible firms. This effect is much more pronounced among value firms where the inflexibility to scale down during economic downturns is relatively more important. Following a positive credit supply shock induced by staggered state-level bank branching deregulation or the introduction of credit default swap (CDS), inflexible firms increase leverage more than flexible firms. These results suggest that operating flexibility plays an important role in shaping corporate financial policies.

Less is Not More: Information Presentation Complexity and 401(K) Planning Choices
Cardella, Eric,Kalenkoski, Charlene M.,Parent, Michael
This paper presents the results of an experiment that is designed to examine how information presentation and complexity impact retirement-savings behavior. The experiment is performed twice, using both a Qualtrics panel of new employees and a sample of business school students. In this experiment, participants first were provided with either a long or short description of a hypothetical employer-sponsored 401(k) plan. Then they were asked whether they would enroll in the hypothetical plan and, if so, what percentage of their salary they would contribute.If they chose to contribute, they were asked how they would like to allocate their contribution between stocks and bonds. Participants were offered the option to stick with pre-assigned default options such as a 4% contribution and a 50-50 stocks and bonds split. The hypothesis is that providing concise information with helpful recommendations would improve choices over providing lengthy and detailed information. However, controlling for demographic and other factors, this hypothesis was not supported by the data, for either the new employees or the business school students. Thus, the data suggest that simplifying the presentation of retirement-plan information to employees is unlikely to result in vastly improved retirement-planning choices.

Optimal Retirement Planning Under Partial Information
Bäuerle, Nicole,Chen, An
The present paper analyses an optimal consumption and investment problem of a retiree with a constant relative risk aversion (CRRA) who faces parameter uncertainty about the financial market.We solve the optimization problem under partial information by making the market observationally complete and consequently applying the martingale method to obtain closed-form solutions to the optimal consumption and investment strategies. Further, we provide some comparative statics and numerical analyses to deeply understand the consumption and investment behavior under partial information. Bearing partial information has little impact on the optimal consumption level, but it makes retirees with a RRA smaller than one invest more riskily, while it makes retirees with a RRA larger than one invest more conservatively.

Pre-IPO Hype by Affiliated Analysts: Motives and Consequences
Qian, Yiming,Shao, Xinjian,Liao, Jingchi
Researchers and practitioners debate on the merit of recent US regulatory changes about pre-IPO analyst coverage and involvement in the IPO process. We contribute to this debate by examining underwriter-affiliated analyst coverage prior to IPOs using data from China. We document that affiliated analysts make highly overoptimistic forecasts about IPO clients. More optimistic forecasts are associated with poorer long-term stock performance. IPO investors are insensitive to analyst hype because the offer price is set sufficiently lower than short-term postmarket prices. Further investigation suggests that underwriters gain monetary benefits from hyping and they hype to inflate prices.

Risk Factors of CLO's and Corporate Bonds
Wahrenburg, Mark,Barth, Andreas,Izadi, Mohammad,Rahhal, Anas
Structured products like collateralized loan obligations (CLOs) tend to offer significantly higher yield spreads than corporate bonds with the same rating. At the same time, empirical evidence does not indicate that this higher yield is reduced by higher default losses of CLOs. The evidence thus suggests that CLOs offer higher expected returns compared to corporate bonds with similar credit risk. This study aims to analyze whether this return difference is captured by asset pricing factors. We show that market risk is the predominant risk factor for both corporate bonds and CLOs. CLO investors, however, additionally demand a premium for their risk exposure towards systemic risk. This premium is inversely related to the rating class of the CLO.

Robert C. Merton and the Science of Finance
Bodie, Zvi
Starting with his 1970 doctoral dissertation and continuing to today, Robert C. Merton has revolutionized the theory and practice of finance. In 1997 Merton shared a Nobel Prize in Economics “for a new method to determine the value of derivatives.” His contributions to the science of finance, however, go far beyond that. In this essay I describe Merton’s main contributions. They include the following: 1. The introduction of continuous-time stochastic models (the Ito calculus) to the theory of household consumption and investment decisions. Merton’s technique of dynamic hedging in continuous time provided a bridge between the theoretical complete-markets equilibrium model of Kenneth Arrow and the real world of personal financial planning and management. 2. The derivation of the multi-factor Intertemporal Capital Asset Pricing Model (ICAPM). The ICAPM generalizes the single-factor CAPM and explains why that model might fail to properly account for observed market excess returns. It also provides a theory to identify potential forward-looking risk premia for use in factor-based investment strategies. It is therefore both a positive and normative theory. 3. The invention of Contingent Claims Analysis (CCA) as a generalization of option pricing theory. CCA applies the technique of dynamic replication to the valuation and risk-management of a wide range of corporate and government liabilities. Merton’s CCA model for the valuation and analysis of risky debt is known among scholars and practitioners alike as the Merton Model. 4. The development of financial engineering which employs CCA to design and produce new financial products. Merton was the first to apply CCA to analyze government guaranty programs such as deposit insurance, and to suggest improvements in the way those programs are managed. He and his students have applied his insights at both the micro and macro policy levels. 5. And finally, the development of a theory of financial intermediation that explains and predicts how financial systems differ across countries and change over time. Merton has applied that theory -- called functional and structural finance, to guide the design and regulation of financial systems at the level of the firm, the industry, and the nation. He has also used it to propose reforms in pensions, sovereign wealth funds, and macro-stabilization policy.

Stuck in Subprime? Examining the Barriers to Refinancing Mortgage Debt
Lambie-Hanson, Lauren,Reid, Carolina
Despite falling interest rates and major federal policy intervention, many borrowers who could financially gain from refinancing have not done so. We investigate the rates at which, relative to prime borrowers, subprime borrowers seek and take out refinance loans, conditional on not experiencing mortgage default. We find that starting in 2009, subprime borrowers are about half as likely as prime borrowers to refinance, although they still shop for mortgage credit, indicating their interest in refinancing. The disparity in refinancing is driven in part by the tightened credit environment post-financial crisis, along with the fact that many subprime borrowers are ineligible for the Home Affordable Refinance Program (HARP), which is the major policy initiative designed to assist borrowers in refinancing their mortgages. We argue that these barriers to refinancing for subprime borrowers have long-term implications for social stratification and wealth building. These concerns are exacerbated by an additional finding of our work that refinance rates have been significantly lower for black and Hispanic borrowers, even after controlling for borrower credit status.

The Effect of Financial Development on Unemployment in Nigeria: Do Measures of Financial Development Matter?
Raifu, Isiaka Akande
The goal of every government is to provide decent employment for its citizenries. This goal has, however, become unattainable in many countries, particularly in developing countries, including Nigeria. As a result, several empirical studies have been conducted with the goal to find macroeconomic variables that are positively (negatively) correlated with the employment (unemployment) so that government can direct its policy arsenals towards that direction. However, few empirical investigations have been conducted on how financial development relates to unemployment in the short-run and the long-run, taking into consideration different measures of financial development. This is the aim of this study. Using various financial development indicators and employing ARDL as a method of estimation, it was found that only financial system deposit to GDP has a potential to reduce the unemployment rate in the short-run and the long-run. Other financial indicators such as credit to private sector, financial liquidity, financial efficiency and financial stability only reduce the unemployment rate in the short-run. We also found that financial development and unemployment rate (including inflation rate and real GDP) are cointegrated. The results we attributed to the level of financial sector development in Nigeria compared with the level of financial sector development in Emerging and Developed Countries. Based on this, it is important for the authority to further strengthen and deepen the financial sector through proper supervisions and regulations, as well as formulation and implementation of appropriate policies so that the sector can perform its intermediary role effectively and efficiently in the economy.

The Spouse Effect on Participation and Investment Decisions for Retirement Funds
Sung, Jamie,Hanna, Sherman D.
Worker decisions on retirement account participation and their investment choices for retirement accounts play an important role in post-retirement income. The interaction between the decisions of husbands and wives was investigated by using a bivariate probit model with a spouse effect. There were a positive spouse effects on the two decisions in households where both spouses were working. When marital status and working status were controlled, no significant gender difference in the decisions was found. Risk tolerance and the expected time horizon until retirement are important factors in the investment decision as expected.

The Value-Momentum Correlation: An Investment Explanation
Pazaj, Elisa
This paper shows that both value and momentum premia arise in a q-theoretic framework that considers optimal corporate policies under uncertain financing conditions. Book-to-market and past performance predict future returns because they serve as indicators of firm financing position. The book-to-market ratio increases with financing constraints, with high book-to-market firms investing less and demanding higher risk premia compared to unconstrained, low book-to-market firms. The value premium increases in bad times because value firms become even more constrained, while ample cash reserves allow growth firms to fare much better. Momentum effects appear among the most financially constrained firms. For these firms, financing constraints imply large price swings following cash-flow shocks and valuable equity market timing options imply positive autocorrelation in returns. Absent equity market timing during bad times, momentum disappears. The model is able to explain many empirical features of value and momentum premia, such as: (i) the procyclicality of the momentum premium, (ii) the countercyclicality of the value premium (iii) the negative correlation between the two, and (iv) severe losses to momentums strategies during market rebounds. Several new testable hypotheses arise regarding the fundamentals of value and momentum stocks. The empirical evidence is largely supportive.

Women and Diversity: Why the Conversation Must Continue in Financial Services
Bisco, Jill M,Gradisher, Suzanne,Mulholland, Barry S.
The financial advising professions are concerned that not only will there be insufficient talent in the workforce to replace those professionals that will soon retire and to meet the expected growth in advisors over the next decade, but the profession is also lacking in diversity. This paper focuses on The University of Akron’s Women and Diversity Symposium, which is the result of the alignment of industry initiatives to increase the number of women and people of diverse backgrounds in the financial services industry. The secondary goal is to increase the number of undergraduate students choosing financial planning as a degree. Through an analysis of surveys completed by attendees at the symposium, this research has shown that the symposium improved the impression of the financial services industry among those that attended.

Worker Representation on U.S. Corporate Boards
Palladino, Lenore
This article argues that workers should have representation on corporate boards of directors and explores the policy choices available in the U.S. context achieve the goal of worker representation. Effectively implementing such a reform requires consideration of key issues, including: how many directors should represent employees; how they should be chosen and who counts as a worker when the choice is made; how they should meaningfully represent workers, and what information the board owes the workforce; how these choices are different in a unionized or non-union context; and the relationship between a worker’s role as director and employee, in terms of pay, time, and protection from repercussions at work.