Research articles for the 2019-11-15
A Price Index for Residential Real Estate from 1866-1953 in Baltimore
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This paper introduces the first repeat sales index of US residential real estate prices in the late 19th and early 20th centuries. The index reveals greater price declines during the 1890s and 1930s than scholars have previously described, and higher leverage as well. During the Great Depression in particular, while previous data suggest most borrowers should have been able to retain positive equity, I estimate that about 28 percent of residential mortgage borrowers had negative equity by 1932, and more than one in four such borrowers experienced foreclosure.
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This paper introduces the first repeat sales index of US residential real estate prices in the late 19th and early 20th centuries. The index reveals greater price declines during the 1890s and 1930s than scholars have previously described, and higher leverage as well. During the Great Depression in particular, while previous data suggest most borrowers should have been able to retain positive equity, I estimate that about 28 percent of residential mortgage borrowers had negative equity by 1932, and more than one in four such borrowers experienced foreclosure.
A Regulated Market Under Sanctions. On Tail Dependence Between Oil, Gold, and Tehran Stock Exchange Index
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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.
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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.
Access to Credit by Firms and Sovereign Credit Rating Stability
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This paper studies the impact of the number of sovereign credit rating and outlook changes on the access to credit by firms. The data sample consists of 127,000 firms from 139 countries surveyed by World Bank over the period, 2006 to 2016. An ordered logit model is used as a primary tool for empirical analysis. It finds a significant negative relation between the instability of sovereign rating and outlooks; and the access to credit by firms. A collection of sub-sample analyses across rating agencies and country groups validate the results.
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This paper studies the impact of the number of sovereign credit rating and outlook changes on the access to credit by firms. The data sample consists of 127,000 firms from 139 countries surveyed by World Bank over the period, 2006 to 2016. An ordered logit model is used as a primary tool for empirical analysis. It finds a significant negative relation between the instability of sovereign rating and outlooks; and the access to credit by firms. A collection of sub-sample analyses across rating agencies and country groups validate the results.
Agency Costs and Firm Productivity
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We explore how the separation between ownership and control affects firm productivity. Using Finnish administrative data on the universe of limited liability firms, we document a substantial increase in firm productivity when the CEO obtains majority ownership or when the majority owner becomes the CEO. We exploit plausibly exogenous variations to ownership and control, induced for example by shocks to the CEO spouse's health. Extending the analysis beyond typical samples of large public firms, we show that our effects are stronger in medium-sized private firms. We also investigate possible mechanisms and provide suggestive evidence that increased ownership boosts CEO's effort at work.
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We explore how the separation between ownership and control affects firm productivity. Using Finnish administrative data on the universe of limited liability firms, we document a substantial increase in firm productivity when the CEO obtains majority ownership or when the majority owner becomes the CEO. We exploit plausibly exogenous variations to ownership and control, induced for example by shocks to the CEO spouse's health. Extending the analysis beyond typical samples of large public firms, we show that our effects are stronger in medium-sized private firms. We also investigate possible mechanisms and provide suggestive evidence that increased ownership boosts CEO's effort at work.
Benchmark Interest Rates When the Government is Risky
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Since the Global Financial Crisis, rates on interest rate swaps have fallen below maturity matched U.S. Treasury rates across different maturities. Swap rates represent future un- collateralized borrowing between banks. Treasuries should be expensive and produce yields that are lower than those of maturity matched swap rates, as they are deemed to have supe- rior liquidity and to be safe, so this is a surprising development. We show, by no-arbitrage, that the U.S. sovereign default risk explains the negative swap spreads over Treasuries. This view is supported by a quantitative equilibrium model that jointly accounts for macroeco- nomic fundamentals and the term structures of interest and U.S. credit default swap rates. We account for interbank credit risk, liquidity effects, and cost of collateralization in the model. Thus, the sovereign risk explanation complements others based on frictions such as balance sheet constraints, convenience yield, and hedging demand.
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Since the Global Financial Crisis, rates on interest rate swaps have fallen below maturity matched U.S. Treasury rates across different maturities. Swap rates represent future un- collateralized borrowing between banks. Treasuries should be expensive and produce yields that are lower than those of maturity matched swap rates, as they are deemed to have supe- rior liquidity and to be safe, so this is a surprising development. We show, by no-arbitrage, that the U.S. sovereign default risk explains the negative swap spreads over Treasuries. This view is supported by a quantitative equilibrium model that jointly accounts for macroeco- nomic fundamentals and the term structures of interest and U.S. credit default swap rates. We account for interbank credit risk, liquidity effects, and cost of collateralization in the model. Thus, the sovereign risk explanation complements others based on frictions such as balance sheet constraints, convenience yield, and hedging demand.
Bundlers' Dilemmas in Financial Markets with Sampling Investors
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We study banks' incentive to pool assets of heterogeneous quality when investors evaluate pools by extrapolating from limited sampling. Pooling assets of heterogeneous quality induces dispersion in investors' valuations without affecting their average. Prices are determined by market clearing assuming that investors cannot borrow nor short-sell. A monopolistic bank has the incentive to create heterogeneous bundles only when investors have enough money. When the number of banks is sufficiently large, oligopolistic banks choose extremely heterogeneous bundles, even when investors have little money and even if this turns out to be collectively detrimental to the banks. If in addition banks can originate low quality assets, even at a cost, this collective inefficiency is exacerbated and pure welfare losses arise. Robustness to the presence of rational investors and to the possibility of short-selling is discussed.
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We study banks' incentive to pool assets of heterogeneous quality when investors evaluate pools by extrapolating from limited sampling. Pooling assets of heterogeneous quality induces dispersion in investors' valuations without affecting their average. Prices are determined by market clearing assuming that investors cannot borrow nor short-sell. A monopolistic bank has the incentive to create heterogeneous bundles only when investors have enough money. When the number of banks is sufficiently large, oligopolistic banks choose extremely heterogeneous bundles, even when investors have little money and even if this turns out to be collectively detrimental to the banks. If in addition banks can originate low quality assets, even at a cost, this collective inefficiency is exacerbated and pure welfare losses arise. Robustness to the presence of rational investors and to the possibility of short-selling is discussed.
Call Auction Mechanism and Closing Price Manipulation: Evidence from the Hong Kong Stock Exchange
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The Hong Kong Stock Exchange adopted a closing call auction in 2008 but suspended its operation ten months later due to suspicion of widespread price manipulation. The Exchange relaunched the auction in 2016 with manipulation-deterrence enhancements. We exploit this unique setting by applying a triple-differences methodology to examine the causal effect of a call auction on closing price manipulation. Our results indicate that a call auction mechanism is prone to closing price manipulation. Under this mechanism overnight price reversal is more pronounced on days with excessive trading just before the close and days when the derivative contract expires.
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The Hong Kong Stock Exchange adopted a closing call auction in 2008 but suspended its operation ten months later due to suspicion of widespread price manipulation. The Exchange relaunched the auction in 2016 with manipulation-deterrence enhancements. We exploit this unique setting by applying a triple-differences methodology to examine the causal effect of a call auction on closing price manipulation. Our results indicate that a call auction mechanism is prone to closing price manipulation. Under this mechanism overnight price reversal is more pronounced on days with excessive trading just before the close and days when the derivative contract expires.
Corporate Political Connections and Favorable Environmental Regulation
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We examine whether the Environmental Protection Agency (EPA) uniformly enforces the Clean Air Act for politically connected and unconnected firms using a close election setting. We find no difference in regulated pollutant emissions or EPA investigations between the two groups, though connected firms experience less regulatory enforcement and lower penalties. These results are more pronounced for firms connected to politicians capable of influencing regulatory bureaucrats and for connected firms that are more important to their supported politicians. Taken together, our results show that campaign contributions can indirectly benefit firms by way of reduced environmental regulatory enforcement and penalties.
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We examine whether the Environmental Protection Agency (EPA) uniformly enforces the Clean Air Act for politically connected and unconnected firms using a close election setting. We find no difference in regulated pollutant emissions or EPA investigations between the two groups, though connected firms experience less regulatory enforcement and lower penalties. These results are more pronounced for firms connected to politicians capable of influencing regulatory bureaucrats and for connected firms that are more important to their supported politicians. Taken together, our results show that campaign contributions can indirectly benefit firms by way of reduced environmental regulatory enforcement and penalties.
Correlations, Value Factor Returns, and Growth Options
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Ex ante (expected) average equity market correlation is linked to the differential correlation dynamics of growth and value firms, as well as the value premium. It predicts the value premium, returns of growth and value firms, and the level of growth options within an economy for horizons up to one year. A production-based asset-pricing model supports the existence of a homogeneous correlation among stocks with similar growth characteristics, depending on the prevailing idiosyncratic firm variance, increasing in the value of growth options and, hence, is connected to the value premium. Due to its link to growth options and the value premium, implied correlation serves as a leading procyclical state variable. Value Index-based implied correlations improve the predictability of value-related factors.
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Ex ante (expected) average equity market correlation is linked to the differential correlation dynamics of growth and value firms, as well as the value premium. It predicts the value premium, returns of growth and value firms, and the level of growth options within an economy for horizons up to one year. A production-based asset-pricing model supports the existence of a homogeneous correlation among stocks with similar growth characteristics, depending on the prevailing idiosyncratic firm variance, increasing in the value of growth options and, hence, is connected to the value premium. Due to its link to growth options and the value premium, implied correlation serves as a leading procyclical state variable. Value Index-based implied correlations improve the predictability of value-related factors.
Do Targeted Business Tax Subsidies Achieve Expected Benefits?
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We examine the association between thousands of state and local firm-specific tax subsidies and business activity in the surrounding county, measured as the number of employees, aggregate wages, per capita employment, per capita wages, and number of business establishments. Using three different matched control groups, we find a positive association between subsidies and the employment measures. However, we show that local information â€" measured based on subsidy-specific disclosures, public awareness, and local press coverage â€" plays an important role in the effectiveness of subsidies. We also demonstrate that (i) receipt of multiple or subsequent subsidies in the same counties is critical for these employment outcomes and (ii) results are concentrated in the largest subsidy packages by dollar value. In addition, we observe mixed evidence for the relation between subsidies and business establishments and find little to no local effects for over 1,000 subsidies that cost approximately $99.8 million in aggregate. By providing a large-scale empirical analysis of the relation between firm-specific tax subsidies and aggregate economic activity at the county level, we extend a literature that generally focuses on the real effects of statutory tax policies that impact all firms in a jurisdiction. We also contribute to the accounting literature by examining the role of the local information environment in subsidy effectiveness.
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We examine the association between thousands of state and local firm-specific tax subsidies and business activity in the surrounding county, measured as the number of employees, aggregate wages, per capita employment, per capita wages, and number of business establishments. Using three different matched control groups, we find a positive association between subsidies and the employment measures. However, we show that local information â€" measured based on subsidy-specific disclosures, public awareness, and local press coverage â€" plays an important role in the effectiveness of subsidies. We also demonstrate that (i) receipt of multiple or subsequent subsidies in the same counties is critical for these employment outcomes and (ii) results are concentrated in the largest subsidy packages by dollar value. In addition, we observe mixed evidence for the relation between subsidies and business establishments and find little to no local effects for over 1,000 subsidies that cost approximately $99.8 million in aggregate. By providing a large-scale empirical analysis of the relation between firm-specific tax subsidies and aggregate economic activity at the county level, we extend a literature that generally focuses on the real effects of statutory tax policies that impact all firms in a jurisdiction. We also contribute to the accounting literature by examining the role of the local information environment in subsidy effectiveness.
Does Expected Idiosyncratic Volatility Explain the Cross-Section of Expected Returns?
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Expected idiosyncratic volatility and its relation to the expected return of Fu (2009) can be closely replicated, but only when we include all information up to t when estimating the idiosyncratic volatility of t. Since look-ahead bias may exist, we re- estimate the expected idiosyncratic volatility using information only up to t âˆ' 1. We find no significant relation between idiosyncratic volatility and return, and our results are robust to the sample extended to before and after that of Fu (2009). Our findings are consistent with the fact that idiosyncratic risk is not priced.
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Expected idiosyncratic volatility and its relation to the expected return of Fu (2009) can be closely replicated, but only when we include all information up to t when estimating the idiosyncratic volatility of t. Since look-ahead bias may exist, we re- estimate the expected idiosyncratic volatility using information only up to t âˆ' 1. We find no significant relation between idiosyncratic volatility and return, and our results are robust to the sample extended to before and after that of Fu (2009). Our findings are consistent with the fact that idiosyncratic risk is not priced.
Does Money Talk? Market Discipline Through Selloffs and Boycotts
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Using a novel dataset of negative news coverage of the environmental and social (E&S) practices of firms around the world, we show that customers and investors can provide market discipline and impose their ethical standards on firm policies. Investors sell firms with heightened E&S risk, especially if they are from E&S conscious countries or hold portfolios with high sustainability ratings. Similarly, heightened E&S risk is associated with a drop in firms' sales in E&S conscious countries. This behavior of E&S conscious investors and customers leads to declines in stock prices, which push firms to improve their E&S policies in the years following negative realizations of E&S risk. Overall, our results indicate that customers and shareholders are able to impose their social preferences on firms, suggesting that market discipline works.
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Using a novel dataset of negative news coverage of the environmental and social (E&S) practices of firms around the world, we show that customers and investors can provide market discipline and impose their ethical standards on firm policies. Investors sell firms with heightened E&S risk, especially if they are from E&S conscious countries or hold portfolios with high sustainability ratings. Similarly, heightened E&S risk is associated with a drop in firms' sales in E&S conscious countries. This behavior of E&S conscious investors and customers leads to declines in stock prices, which push firms to improve their E&S policies in the years following negative realizations of E&S risk. Overall, our results indicate that customers and shareholders are able to impose their social preferences on firms, suggesting that market discipline works.
Embedded Supervision: How to Build Regulation into Blockchain Finance
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The spread of distributed ledger technology (DLT) in finance could help to improve the efficiency and quality of supervision. This paper makes the case for embedded supervision, ie a regulatory framework that provides for compliance in tokenised markets to be automatically monitored by reading the market's ledger, thus reducing the need for firms to actively collect, verify and deliver data. After sketching out a design for such schemes, the paper explores the conditions under which distributed ledger data might be used to monitor compliance. To this end, a decentralised market is modelled that replaces today's intermediary-based verification of legal data with blockchain-enabled data credibility based on economic consensus. The key results set out the conditions under which the market's economic consensus would be strong enough to guarantee that transactions are economically final, so that supervisors can trust the distributed ledger's data. The paper concludes with a discussion of the legislative and operational requirements that would promote low-cost supervision and a level playing field for small and large firms.
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The spread of distributed ledger technology (DLT) in finance could help to improve the efficiency and quality of supervision. This paper makes the case for embedded supervision, ie a regulatory framework that provides for compliance in tokenised markets to be automatically monitored by reading the market's ledger, thus reducing the need for firms to actively collect, verify and deliver data. After sketching out a design for such schemes, the paper explores the conditions under which distributed ledger data might be used to monitor compliance. To this end, a decentralised market is modelled that replaces today's intermediary-based verification of legal data with blockchain-enabled data credibility based on economic consensus. The key results set out the conditions under which the market's economic consensus would be strong enough to guarantee that transactions are economically final, so that supervisors can trust the distributed ledger's data. The paper concludes with a discussion of the legislative and operational requirements that would promote low-cost supervision and a level playing field for small and large firms.
Executive Incentives, Import Restrictions, and Competition: Empirical Analysis of Antidumping and Countervailing Duty Orders
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To better understand the political economy of trade policy, I examine executive compensation around the time of changes to import restrictions through antidumping and countervailing duty orders. Trade policy restrictions limit international competition, so I explore the resulting compensation of firm managers. When imports are restricted, firms linked to restrictive orders give their CEOs compensation in cash and equity incentives that is 17 percent higher than when the restrictions are not in place. Furthermore, CEOs’ compensation is $1 million higher than expected, suggesting the additional compensation is not explained by superior firm performance or other characteristics. Overall, the findings suggest that executives benefit amid import restrictions, thereby contributing to research on executive incentives, trade, and public choice.
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To better understand the political economy of trade policy, I examine executive compensation around the time of changes to import restrictions through antidumping and countervailing duty orders. Trade policy restrictions limit international competition, so I explore the resulting compensation of firm managers. When imports are restricted, firms linked to restrictive orders give their CEOs compensation in cash and equity incentives that is 17 percent higher than when the restrictions are not in place. Furthermore, CEOs’ compensation is $1 million higher than expected, suggesting the additional compensation is not explained by superior firm performance or other characteristics. Overall, the findings suggest that executives benefit amid import restrictions, thereby contributing to research on executive incentives, trade, and public choice.
Financial Literacy and Attitudes to Cryptocurrencies
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We examine the relationship between financial literacy and attitudes to cryptocurrencies, using microdata from 15 countries. Our financial-literacy proxy exerts a large negative effect on the probability of currently owning cryptocurrencies. The financially literate are also more likely to be aware, but not to intend to own cryptocurrencies. We show that the relationships are explained by a different perception of the financial risk involved in cryptocurrencies, vis-à -vis alternative instruments, by the more financially literate. Our findings shed light on the demand for cryptocurrencies and suggest that, apart from parties interested in illegal transactions, and ‘cryptofunds’, it also largely comprises of unsophisticated investors.
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We examine the relationship between financial literacy and attitudes to cryptocurrencies, using microdata from 15 countries. Our financial-literacy proxy exerts a large negative effect on the probability of currently owning cryptocurrencies. The financially literate are also more likely to be aware, but not to intend to own cryptocurrencies. We show that the relationships are explained by a different perception of the financial risk involved in cryptocurrencies, vis-à -vis alternative instruments, by the more financially literate. Our findings shed light on the demand for cryptocurrencies and suggest that, apart from parties interested in illegal transactions, and ‘cryptofunds’, it also largely comprises of unsophisticated investors.
Financial Reporting and Market Efficiency With Extrapolative Investors
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We model a financial market in which companies engage in strategic financial reporting knowing that investors only pay attention to a randomly drawn sample from firms' reports and extrapolate from this sample. We investigate the extent to which stock prices differ from the fundamental values, assuming that companies must report all their activities but are otherwise free to disaggregate their reports as they wish. We show that no matter how large the samples considered by investors are, a monopolist can induce a price of its stock bounded away from the fundamental. Besides, increasing the number of companies competing to attract investors may exacerbate the mispricing of stocks.
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We model a financial market in which companies engage in strategic financial reporting knowing that investors only pay attention to a randomly drawn sample from firms' reports and extrapolate from this sample. We investigate the extent to which stock prices differ from the fundamental values, assuming that companies must report all their activities but are otherwise free to disaggregate their reports as they wish. We show that no matter how large the samples considered by investors are, a monopolist can induce a price of its stock bounded away from the fundamental. Besides, increasing the number of companies competing to attract investors may exacerbate the mispricing of stocks.
Information Environment and the Cost of Borrowing in the International Bond Market
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We examine whether and how a firm's information environment â€" as characterized by earnings quality, analyst forecast dispersion, and the probability of informed trading â€" affects its total cost of borrowing in the international bond market. Both yield spread required by investors and the issuance costs such as underwriting fee, management fee and selling concession fee are examined. Using a sample of Eurobonds issued by firms across 38 countries, we find that bonds issued by firms with poor information environments are associated with higher yield spreads, lower credit ratings, greater probability of split bond ratings, and higher issuance cost. The firms characterized by poorer information environment are considered riskier issuers by underwriters, thus bonds issued by these firms are more likely to be offered in syndication by more managers and are charged with higher fees. We demonstrate that information environment plays a crucial role in determining the total cost of borrowing for firms raising capital in the international bond market.
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We examine whether and how a firm's information environment â€" as characterized by earnings quality, analyst forecast dispersion, and the probability of informed trading â€" affects its total cost of borrowing in the international bond market. Both yield spread required by investors and the issuance costs such as underwriting fee, management fee and selling concession fee are examined. Using a sample of Eurobonds issued by firms across 38 countries, we find that bonds issued by firms with poor information environments are associated with higher yield spreads, lower credit ratings, greater probability of split bond ratings, and higher issuance cost. The firms characterized by poorer information environment are considered riskier issuers by underwriters, thus bonds issued by these firms are more likely to be offered in syndication by more managers and are charged with higher fees. We demonstrate that information environment plays a crucial role in determining the total cost of borrowing for firms raising capital in the international bond market.
Internationalization of Futures Markets: Lessons from China
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Foreign access to China’s commodity futures markets was obstructed until 2018. This paper is the first to examine the impact of internationalization on the quality of Chinese iron ore and purified terephthalic acid (PTA) futures markets. We compare market quality in terms of trading activities, costs and price volatilities before and after internalization. Using a difference-in-difference framework, we find that internationalization improves market quality for PTA futures, while the opposite effect is observed for iron ore futures. Such divergence is not caused by the activity of hedgers and speculators. Instead, decreases in market quality for iron ore are largely explained by the erosion of locational arbitrage opportunities. Overall, the effects of internationalization appear to differ on commodities, thus its success must be assessed cautiously on a case-by-case basis.
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Foreign access to China’s commodity futures markets was obstructed until 2018. This paper is the first to examine the impact of internationalization on the quality of Chinese iron ore and purified terephthalic acid (PTA) futures markets. We compare market quality in terms of trading activities, costs and price volatilities before and after internalization. Using a difference-in-difference framework, we find that internationalization improves market quality for PTA futures, while the opposite effect is observed for iron ore futures. Such divergence is not caused by the activity of hedgers and speculators. Instead, decreases in market quality for iron ore are largely explained by the erosion of locational arbitrage opportunities. Overall, the effects of internationalization appear to differ on commodities, thus its success must be assessed cautiously on a case-by-case basis.
Learning from Trees: A Mixed Approach to Building Early Warning Systems for Systemic Banking Crises
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Banking crises can be extremely costly. The early detection of vulnerabilities can help prevent or mitigate those costs. We develop an early warning model of systemic banking crises that combines regression tree technology with a statistical algorithm (CRAGGING) to improve its accuracy and overcome the drawbacks of previously used models. Our model has a large set of desirable features. It provides endogenously-determined critical thresholds for a set of useful indicators, presented in the intuitive form of a decision tree structure. Our framework takes into account the conditional relations between various indicators when setting early warning thresholds. This facilitates the production of accurate early warning signals as compared to the signals from a logit model and from a standard regression tree. Our model also suggests that high credit aggregates, both in terms of volume and as compared to a long-term trend, as well as low market risk perception, are amongst the most important indicators for predicting the build-up of vulnerabilities in the banking sector.
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Banking crises can be extremely costly. The early detection of vulnerabilities can help prevent or mitigate those costs. We develop an early warning model of systemic banking crises that combines regression tree technology with a statistical algorithm (CRAGGING) to improve its accuracy and overcome the drawbacks of previously used models. Our model has a large set of desirable features. It provides endogenously-determined critical thresholds for a set of useful indicators, presented in the intuitive form of a decision tree structure. Our framework takes into account the conditional relations between various indicators when setting early warning thresholds. This facilitates the production of accurate early warning signals as compared to the signals from a logit model and from a standard regression tree. Our model also suggests that high credit aggregates, both in terms of volume and as compared to a long-term trend, as well as low market risk perception, are amongst the most important indicators for predicting the build-up of vulnerabilities in the banking sector.
Liquidity and Tail-Risk Interdependencies in the Euro Area Sovereign Bond Market
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The likelihood of severe contractions in an asset's liquidity can feed back to the ex-ante risks faced by the individual providers of such liquidity. These self-reinforcing effects can spread to other assets through informational externalities and hedging relations. We explore whether such interdependencies play a role in amplifying tensions in European sovereign bond markets and are a source of cross-market spillovers. Using high-frequency data from the inter-dealer market, we find significant own- and cross-market effects that amplify liquidity contractions in the Italian and Spanish bond markets during times of heightened risk. The German Bund's safe-haven status exacerbates these amplification effects. We provide evidence of a post-crisis dampening of cross-market effects following crisis-era changes to euro area policies and institutional architecture. We identify a structural break in Italy's cross-market conditional correlation during rising political tensions in 2018, which significantly reduced liquidity. Overall, our findings demonstrate potential for the provision of liquidity across sovereign markets to be vulnerable to sudden fractures, with possible implications for euro area economic and financial stability.
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The likelihood of severe contractions in an asset's liquidity can feed back to the ex-ante risks faced by the individual providers of such liquidity. These self-reinforcing effects can spread to other assets through informational externalities and hedging relations. We explore whether such interdependencies play a role in amplifying tensions in European sovereign bond markets and are a source of cross-market spillovers. Using high-frequency data from the inter-dealer market, we find significant own- and cross-market effects that amplify liquidity contractions in the Italian and Spanish bond markets during times of heightened risk. The German Bund's safe-haven status exacerbates these amplification effects. We provide evidence of a post-crisis dampening of cross-market effects following crisis-era changes to euro area policies and institutional architecture. We identify a structural break in Italy's cross-market conditional correlation during rising political tensions in 2018, which significantly reduced liquidity. Overall, our findings demonstrate potential for the provision of liquidity across sovereign markets to be vulnerable to sudden fractures, with possible implications for euro area economic and financial stability.
Minimum Relative Entropy Inference for Normal and Categorical Distributions
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We represent affine sub-manifolds of exponential family distributions as minimum relative entropy submanifolds. With such representation we derive analytical formulas for the inference from partial evidence on expectations and covariances of multivariate normal distributions; and we improve the numerical implementation via Monte Carlo simulations for the inference from partial evidence of generalized expectation type.
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We represent affine sub-manifolds of exponential family distributions as minimum relative entropy submanifolds. With such representation we derive analytical formulas for the inference from partial evidence on expectations and covariances of multivariate normal distributions; and we improve the numerical implementation via Monte Carlo simulations for the inference from partial evidence of generalized expectation type.
Private Policies and Public Power: When Banks Act as Regulators within a Regime of Privilege
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An emerging trend in financial services is banks’ increasingly common refusal to do business with industries for political reasons rather than for traditional business justifications. Banks’ refusals are often explained by a desire to make a difference or send a message. While this desire may not raise a concern in most cases, banks are not like most other businesses. Banks enjoy an extensive regime of privilege provided by federal and state governments that includes barriers to market entry and exit, more favorable regulatory treatment than nonbank competitors in some areas, and direct and privileged access to services provided by the government. This paper asks whether this public power, granted to banks for the purposes of facilitating lawful commerce, is being misused when banks try to regulate downstream markets through withholding services and what, if anything, should be done to address these actions by banks.
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An emerging trend in financial services is banks’ increasingly common refusal to do business with industries for political reasons rather than for traditional business justifications. Banks’ refusals are often explained by a desire to make a difference or send a message. While this desire may not raise a concern in most cases, banks are not like most other businesses. Banks enjoy an extensive regime of privilege provided by federal and state governments that includes barriers to market entry and exit, more favorable regulatory treatment than nonbank competitors in some areas, and direct and privileged access to services provided by the government. This paper asks whether this public power, granted to banks for the purposes of facilitating lawful commerce, is being misused when banks try to regulate downstream markets through withholding services and what, if anything, should be done to address these actions by banks.
Private Subsidiaries’ Information Disclosure: Does It Matter in the Cross-Section of Stock Returns?
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Public firms may choose to have private subsidiaries to hide bad news and/or proprietary information. We hypothesize that the private subsidiaries’ information disclosure (PSID) level reflects the degree of information hiding activities of their parental firm, and may be able to forecast the future performance of parental firm. Empirically, we find that the higher the PSID level, the larger the future returns of their public parent firms. A long-short value-weighted portfolio of public parent firms sorted on their PSID yields a significant Fama and French (2018) six-factor alpha of more than 50 bps per month. This PSID based abnormal return cannot be explained by a variety of risk factors, firm characteristics, and risk-based arguments.
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Public firms may choose to have private subsidiaries to hide bad news and/or proprietary information. We hypothesize that the private subsidiaries’ information disclosure (PSID) level reflects the degree of information hiding activities of their parental firm, and may be able to forecast the future performance of parental firm. Empirically, we find that the higher the PSID level, the larger the future returns of their public parent firms. A long-short value-weighted portfolio of public parent firms sorted on their PSID yields a significant Fama and French (2018) six-factor alpha of more than 50 bps per month. This PSID based abnormal return cannot be explained by a variety of risk factors, firm characteristics, and risk-based arguments.
Robust Inference with Functional Deviations from Unity in Predictive Regression
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This study explores predictive regressions with functional deviations from unity. Specifically, we extend self-generated instrumentation, called IVX, to the case of functional local-to-unit root, functional mildly explosive root, and functional mildly stationary root. The asymptotic distributions of IVX estimators under time-varying parameters are novel compared with the time-invariant case. The numerical experiments justify the robustness of the IVX inferential procedures with functional deviations from unity in the finite sample. In the empirical analysis, we verify the existence and predictability of functional-coefficient regressors using S&P 500 data.
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This study explores predictive regressions with functional deviations from unity. Specifically, we extend self-generated instrumentation, called IVX, to the case of functional local-to-unit root, functional mildly explosive root, and functional mildly stationary root. The asymptotic distributions of IVX estimators under time-varying parameters are novel compared with the time-invariant case. The numerical experiments justify the robustness of the IVX inferential procedures with functional deviations from unity in the finite sample. In the empirical analysis, we verify the existence and predictability of functional-coefficient regressors using S&P 500 data.
Start-up Subsidies: Does the Policy Instrument Matter?
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New knowledge-intensive firms contribute to innovation, competition, and employment growth, but externalities like knowledge spillovers can prevent entrepreneurs from appropriating the full returns from their investments. In addition, uncertainty and information asymmetry pose challenges for financing. Public policy programs therefore aim to support start-ups. This study evaluates the effects of participation in such programs on the performance of start-ups in high-tech and knowledge-intensive sectors that were founded in Germany between 2005 and 2012. Distinguishing between grants and subsidized loans and after matching recipients and non-recipients based on a broad set of founder and company characteristics, we find that both grants and subsidized loans facilitate tangible investment, employment and revenue growth. Grants are, however, better suited to increasing R&D investments than loans are. Combined with grants, subsidized loans facilitate turning research results into marketable products by means of investments in tangible assets. Start-ups that participate in both types of programs outperform grant-only recipients in terms of innovation performance, employment and future revenues. Finally, program participation does not crowd out private venture capital.
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New knowledge-intensive firms contribute to innovation, competition, and employment growth, but externalities like knowledge spillovers can prevent entrepreneurs from appropriating the full returns from their investments. In addition, uncertainty and information asymmetry pose challenges for financing. Public policy programs therefore aim to support start-ups. This study evaluates the effects of participation in such programs on the performance of start-ups in high-tech and knowledge-intensive sectors that were founded in Germany between 2005 and 2012. Distinguishing between grants and subsidized loans and after matching recipients and non-recipients based on a broad set of founder and company characteristics, we find that both grants and subsidized loans facilitate tangible investment, employment and revenue growth. Grants are, however, better suited to increasing R&D investments than loans are. Combined with grants, subsidized loans facilitate turning research results into marketable products by means of investments in tangible assets. Start-ups that participate in both types of programs outperform grant-only recipients in terms of innovation performance, employment and future revenues. Finally, program participation does not crowd out private venture capital.
Systematic 13F Hedge Fund Alpha
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Institutions holding greater than $100 million in securities are required to disclose their holdings in US listed stocks to the Securities and Exchange Commission (SEC) no later than 45 days after the quarter-end, in a form known as 13F. We show that the "best ideas" of hedge funds produce economically meaningful and statistically significant risk-adjusted returns that outperform the S&P500, following tests identified in Cohen, Polk, and Silli (2010). We construct alternative measures that are more suitable for hedge funds, rather than mutual funds: conviction and consensus. We find that to systematically identify hedge fund alpha in the 13F filings, one must select the right group of managers that have longer-term views on stock picks. We construct a trading strategy that combines conviction and consensus of such managers that outperforms the S&P500 by 3.80% on average and delivers a Sharpe ratio of 0.75 over the period Q1 2004 to Q2 2019.
SSRN
Institutions holding greater than $100 million in securities are required to disclose their holdings in US listed stocks to the Securities and Exchange Commission (SEC) no later than 45 days after the quarter-end, in a form known as 13F. We show that the "best ideas" of hedge funds produce economically meaningful and statistically significant risk-adjusted returns that outperform the S&P500, following tests identified in Cohen, Polk, and Silli (2010). We construct alternative measures that are more suitable for hedge funds, rather than mutual funds: conviction and consensus. We find that to systematically identify hedge fund alpha in the 13F filings, one must select the right group of managers that have longer-term views on stock picks. We construct a trading strategy that combines conviction and consensus of such managers that outperforms the S&P500 by 3.80% on average and delivers a Sharpe ratio of 0.75 over the period Q1 2004 to Q2 2019.
Taxation and the External Wealth of Nations: Evidence from Bilateral Portfolio Holdings
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This paper examines the impact of capital income taxation on the composition of foreign portfolio investment. Studying bilateral portfolio positions among a sample of 37 countries over the period 2001-2015, we find that capital gains and dividend taxation reduce the share of equities in foreign investments, while interest taxation increases this share. The results suggest that domestic capital income taxation affects the worldwide asset allocation of domestic investors. The estimated tax sensitivities imply a significant increase in country's external wealth following a tax policy change that stimulates investors to hold higher-yielding equity investments.
SSRN
This paper examines the impact of capital income taxation on the composition of foreign portfolio investment. Studying bilateral portfolio positions among a sample of 37 countries over the period 2001-2015, we find that capital gains and dividend taxation reduce the share of equities in foreign investments, while interest taxation increases this share. The results suggest that domestic capital income taxation affects the worldwide asset allocation of domestic investors. The estimated tax sensitivities imply a significant increase in country's external wealth following a tax policy change that stimulates investors to hold higher-yielding equity investments.
The Microstructure of Endogenous Liquidity Provision
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We propose a nonlinear rational expectations equilibrium model of high-frequency endogenous liquidity provision to explore fragile liquidity. With fast trading speed and private information, high-frequency traders can either compete with designated market makers (DMMs) by providing liquidity or attempt to profit from speculative trades that consume liquidity. The risk from this endogenous liquidity provision, coupled with limits to participation by DMMs, intensifies the adverse selection faced by DMMs. This can generate a gap between liquidity supply from DMMs and liquidity demand by informed traders. As a result, endogenous liquidity provision produces fragile liquidity, with the possibility of market breaks when high-frequency traders switch from liquidity provision to liquidity consumption on the basis of unexpected information signals.
SSRN
We propose a nonlinear rational expectations equilibrium model of high-frequency endogenous liquidity provision to explore fragile liquidity. With fast trading speed and private information, high-frequency traders can either compete with designated market makers (DMMs) by providing liquidity or attempt to profit from speculative trades that consume liquidity. The risk from this endogenous liquidity provision, coupled with limits to participation by DMMs, intensifies the adverse selection faced by DMMs. This can generate a gap between liquidity supply from DMMs and liquidity demand by informed traders. As a result, endogenous liquidity provision produces fragile liquidity, with the possibility of market breaks when high-frequency traders switch from liquidity provision to liquidity consumption on the basis of unexpected information signals.
Unconventional Monetary Policy and Auction Cycles of Eurozone Sovereign Debt
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We provide evidence that the ECB's unconventional monetary policy dampens yield cycles in secondary markets for Eurozone sovereign debt around new sovereign debt auctions. This dampening effect tends to be larger when market volatility is higher. Cycles caused by domestic auctions and the role of market volatility are largest for countries with low credit ratings. Auctions by these countries also generate highly-significant auction cycles in other countries. Auction cycles can have a non-negligible effect on debt-servicing costs, but these may be contained by concentrating debt issuance in tranquil periods and by coordinating auction calendars among countries, so as to maximize the dispersion of auction activity in time.
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We provide evidence that the ECB's unconventional monetary policy dampens yield cycles in secondary markets for Eurozone sovereign debt around new sovereign debt auctions. This dampening effect tends to be larger when market volatility is higher. Cycles caused by domestic auctions and the role of market volatility are largest for countries with low credit ratings. Auctions by these countries also generate highly-significant auction cycles in other countries. Auction cycles can have a non-negligible effect on debt-servicing costs, but these may be contained by concentrating debt issuance in tranquil periods and by coordinating auction calendars among countries, so as to maximize the dispersion of auction activity in time.
