Research articles for the 2020-02-14
A Simple Method for Extracting the Probability of Default from American Put Option Prices
SSRN
In this paper, we present a novel method to extract the risk-neutral probability of default of a from from American put option prices. Building on the idea of a default corridor proposed in Carr and Wu (2011), we derive a parsimonious closed-form formula for American put option price from which the probability of default can be inferred. The proposed method is easy to implement and helps overcome the main limitation of the method used in Carr and Wu (2011), which relies on the price of one deep-out-of-the-money put option. Our empirical results based on seven large U.S. firms between 2002 and 2010 show that the option-implied probability of default can provide a more accurate estimate of default probability in some cases, compared to the estimates implied from credit default swap spreads.
SSRN
In this paper, we present a novel method to extract the risk-neutral probability of default of a from from American put option prices. Building on the idea of a default corridor proposed in Carr and Wu (2011), we derive a parsimonious closed-form formula for American put option price from which the probability of default can be inferred. The proposed method is easy to implement and helps overcome the main limitation of the method used in Carr and Wu (2011), which relies on the price of one deep-out-of-the-money put option. Our empirical results based on seven large U.S. firms between 2002 and 2010 show that the option-implied probability of default can provide a more accurate estimate of default probability in some cases, compared to the estimates implied from credit default swap spreads.
Acquisition for Sleep
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Within the policy debate, there is a fear that large incumbent firms buy small firms’ inventions to ensure that they are not used in the market. We show that such â€Å"acquisitions for sleep� can occur if and only if the quality of a process invention is small; otherwise, the entry profit will be higher than the entry-deterring value. We then show that the incentive for acquiring for the purpose of putting a patent to sleep decreases when the intellectual property law is stricter because the profit for the entrant then increases more than the entry-deterring value does.
SSRN
Within the policy debate, there is a fear that large incumbent firms buy small firms’ inventions to ensure that they are not used in the market. We show that such â€Å"acquisitions for sleep� can occur if and only if the quality of a process invention is small; otherwise, the entry profit will be higher than the entry-deterring value. We then show that the incentive for acquiring for the purpose of putting a patent to sleep decreases when the intellectual property law is stricter because the profit for the entrant then increases more than the entry-deterring value does.
Alpha by Affiliation
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Using novel data establishing hedge fund families, we show that changes in overlapping hedge fund family positions predict abnormal returns in U.S. stocks. A long-short portfolio of unanimous family entries and exits in overlapping positions earns an annualized alpha of 7.32%. Panel regressions and double-sorts provide evidence for a mispricing-based explanation as results are consistent with fund families facing binding short sale constraints to coordinated exits. The returns are larger for high information asymmetry stocks and suggest that hedge fund families coordinate on information, despite having no shared legal structure like mutual fund families.
SSRN
Using novel data establishing hedge fund families, we show that changes in overlapping hedge fund family positions predict abnormal returns in U.S. stocks. A long-short portfolio of unanimous family entries and exits in overlapping positions earns an annualized alpha of 7.32%. Panel regressions and double-sorts provide evidence for a mispricing-based explanation as results are consistent with fund families facing binding short sale constraints to coordinated exits. The returns are larger for high information asymmetry stocks and suggest that hedge fund families coordinate on information, despite having no shared legal structure like mutual fund families.
Attention Utility: Evidence from Individual Investors
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Attention utility is the hedonic pleasure or pain derived purely from paying attention to information. Using data on brokerage account logins by individual investors, we show that individuals devote disproportionate attention to already-known positive information about the performance of individual stocks within their portfolios. This aversion to paying attention to unfavorable information, through its effect on logins, has consequences for trading activity; it reduces trading after recent losses and increases trading after recent gains. Attention utility is distinct from models of belief-based utility and information aversion (in which information not sought is not fully known), and implies that the pleasure and pain of attending to known information may be important for individual behavior.
SSRN
Attention utility is the hedonic pleasure or pain derived purely from paying attention to information. Using data on brokerage account logins by individual investors, we show that individuals devote disproportionate attention to already-known positive information about the performance of individual stocks within their portfolios. This aversion to paying attention to unfavorable information, through its effect on logins, has consequences for trading activity; it reduces trading after recent losses and increases trading after recent gains. Attention utility is distinct from models of belief-based utility and information aversion (in which information not sought is not fully known), and implies that the pleasure and pain of attending to known information may be important for individual behavior.
Diversifying Trends
SSRN
This paper provides a new method to disentangle the systematic component from the idiosyncratic part of the risk associated with trend following strategies. A simple statistical approach, combined with standard dimension reduction techniques, enables us to extract the common trending part in any asset price. We apply this methodology on a large set of futures, covering all the major asset classes, and extract a common risk factor, called CoTrend. We show that common trends are higher for some cross-asset class pairs than from intra-asset class ones, such as JPY/USD and Gold. This result helps to create sectors in a portfolio diversification context, especially for trend following strategies. In addition, the CoTrend factor helps to understand arbitrage-based hedge fund strategies, which by essence are decorrelated with the standard risk factors.
SSRN
This paper provides a new method to disentangle the systematic component from the idiosyncratic part of the risk associated with trend following strategies. A simple statistical approach, combined with standard dimension reduction techniques, enables us to extract the common trending part in any asset price. We apply this methodology on a large set of futures, covering all the major asset classes, and extract a common risk factor, called CoTrend. We show that common trends are higher for some cross-asset class pairs than from intra-asset class ones, such as JPY/USD and Gold. This result helps to create sectors in a portfolio diversification context, especially for trend following strategies. In addition, the CoTrend factor helps to understand arbitrage-based hedge fund strategies, which by essence are decorrelated with the standard risk factors.
Futures Market Liquidity and the Trading Cost of Trend Following Strategies
SSRN
We use a unique dataset reporting the trading of an institutional asset manager implementing trend following strategies to estimate the associated transaction costs. With information both at the trade and the fund levels, we disentangle the impact of the execution quality from the management decisions on these costs. We show that the disappointing performances observed for trend following these recent years are explained by a drop in the volatility of the futures markets these strategies generally trade.
SSRN
We use a unique dataset reporting the trading of an institutional asset manager implementing trend following strategies to estimate the associated transaction costs. With information both at the trade and the fund levels, we disentangle the impact of the execution quality from the management decisions on these costs. We show that the disappointing performances observed for trend following these recent years are explained by a drop in the volatility of the futures markets these strategies generally trade.
Global Financial Crisis and Determinants of Capital Structure: Evidence from Ghanaian Non-Financial Listed Firms
SSRN
This study uses Generalized Method of Moments (GMM) to analyze the effects of macroeconomic and firm-specific factors on the capital structure of non-financial listed firms in Ghana, for both the normal period (2006-2016) and the global financial crisis period (2008-2009). Real GDP growth, firm size, profitability, tangibility, and growth opportunities have a significant effect on varying leverage ratios of sample firms in the normal period. Inflation and real GDP growth do not significantly influence the financing choice of sample firms during the global financial crisis period. However, profitability, firm size, tangibility, liquidity, and growth opportunities have significant effects on capital structure decisions of sample firms, which could differ in periods of the global financial crisis. Our findings illuminate the possible role of the trade-off, pecking order and agency cost theories in the capital structure of sample firms despite the crisis period. The study also offers policy implications on the need for the development of capital markets as well as the ability of managers to influence corporate capital structure to remain competitive regardless of a global financial crisis event.
SSRN
This study uses Generalized Method of Moments (GMM) to analyze the effects of macroeconomic and firm-specific factors on the capital structure of non-financial listed firms in Ghana, for both the normal period (2006-2016) and the global financial crisis period (2008-2009). Real GDP growth, firm size, profitability, tangibility, and growth opportunities have a significant effect on varying leverage ratios of sample firms in the normal period. Inflation and real GDP growth do not significantly influence the financing choice of sample firms during the global financial crisis period. However, profitability, firm size, tangibility, liquidity, and growth opportunities have significant effects on capital structure decisions of sample firms, which could differ in periods of the global financial crisis. Our findings illuminate the possible role of the trade-off, pecking order and agency cost theories in the capital structure of sample firms despite the crisis period. The study also offers policy implications on the need for the development of capital markets as well as the ability of managers to influence corporate capital structure to remain competitive regardless of a global financial crisis event.
Policy Interventions and Liquidity in Segmented Chinese Credit Bond Markets
SSRN
This paper documents the effects of policy interventions on liquidity in the Chinese interbank and exchange corporate bond markets. First, liquidity responded strongly to the central bank’s liberalization policies on foreign investors in the interbank market and on domestic investors in the exchange market. Second, liquidity effects are priced in credit bond yields, and are more pronounced during crisis and liberalized periods. Third, bond yield spreads are more sensitive to liquidity effects for bonds approaching maturity, issued by credit-constrained firms, and rated by private credit rating agencies.
SSRN
This paper documents the effects of policy interventions on liquidity in the Chinese interbank and exchange corporate bond markets. First, liquidity responded strongly to the central bank’s liberalization policies on foreign investors in the interbank market and on domestic investors in the exchange market. Second, liquidity effects are priced in credit bond yields, and are more pronounced during crisis and liberalized periods. Third, bond yield spreads are more sensitive to liquidity effects for bonds approaching maturity, issued by credit-constrained firms, and rated by private credit rating agencies.
Rational Savings Account Models for Backward-Looking Interest Rate Benchmarks
SSRN
Interest rate benchmarks are currently undergoing a major transition. The LIBOR benchmark is planned to be discontinued by the end of 2021 and `replaced' by what ISDA calls an adjusted risk-free rate (RFR). ISDA has recently announced that the LIBOR `replacement' will most likely be constructed from a compounded running average of RFR overnight rates over a period matching the LIBOR tenor. This new backward-looking benchmark is markedly different when compared with LIBOR. It is measurable only at the end of the term in contrast to the forward-looking LIBOR, which is measurable at the start of the term. On the other hand though, RFRs provide a simplification because the cash flows and the discount factors may be derived from the same discounting curve, thus avoiding--on a superficial level--any multi-curve complications. We develop a new class of savings account models and derive a novel interest rate system specifically designed to facilitate a high degree of tractability for the pricing of RFR-based fixed-income instruments. The rational form of the savings account models under the risk-neutral measure enables the pricing in closed form of caplets, swaptions and futures written on the backward-looking interest rate benchmark. An interesting twist is that the proposed rational savings account models are different from so-called short rate models in that they cannot necessarily be expressed as an exponentiated integral of a short rate of interest.
SSRN
Interest rate benchmarks are currently undergoing a major transition. The LIBOR benchmark is planned to be discontinued by the end of 2021 and `replaced' by what ISDA calls an adjusted risk-free rate (RFR). ISDA has recently announced that the LIBOR `replacement' will most likely be constructed from a compounded running average of RFR overnight rates over a period matching the LIBOR tenor. This new backward-looking benchmark is markedly different when compared with LIBOR. It is measurable only at the end of the term in contrast to the forward-looking LIBOR, which is measurable at the start of the term. On the other hand though, RFRs provide a simplification because the cash flows and the discount factors may be derived from the same discounting curve, thus avoiding--on a superficial level--any multi-curve complications. We develop a new class of savings account models and derive a novel interest rate system specifically designed to facilitate a high degree of tractability for the pricing of RFR-based fixed-income instruments. The rational form of the savings account models under the risk-neutral measure enables the pricing in closed form of caplets, swaptions and futures written on the backward-looking interest rate benchmark. An interesting twist is that the proposed rational savings account models are different from so-called short rate models in that they cannot necessarily be expressed as an exponentiated integral of a short rate of interest.
Robust (Bayesian) Persuasion
SSRN
We propose a robust solution concept for the model of persuasion under commitment that accounts for the Sender's ambiguity over (i) the exogenous sources of information the Receivers may learn from, and (ii) the way the Receivers play, given the available information. The Sender proceeds in two steps. First, she identifies all information structures that yield the largest payoff in the "worst-case scenario," i.e., when Nature provides information and coordinates the Receivers' play to minimize the Sender's payoff. Second, she picks an information structure that, in case Nature and the Receivers play favorably to her, maximizes her expected payoff over all information structures that are \worst-case optimal." Thus, a robust solution is an information structure that is best-case optimal among all worst-case optimal ones. We characterize properties of robust solutions, identify conditions under which robustness requires separation of certain states, and qualify in what sense robustness calls for more information disclosure than standard Bayesian persuasion. Finally, we discuss how some of the results in the Bayesian persuasion literature change once robustness is accounted for.
SSRN
We propose a robust solution concept for the model of persuasion under commitment that accounts for the Sender's ambiguity over (i) the exogenous sources of information the Receivers may learn from, and (ii) the way the Receivers play, given the available information. The Sender proceeds in two steps. First, she identifies all information structures that yield the largest payoff in the "worst-case scenario," i.e., when Nature provides information and coordinates the Receivers' play to minimize the Sender's payoff. Second, she picks an information structure that, in case Nature and the Receivers play favorably to her, maximizes her expected payoff over all information structures that are \worst-case optimal." Thus, a robust solution is an information structure that is best-case optimal among all worst-case optimal ones. We characterize properties of robust solutions, identify conditions under which robustness requires separation of certain states, and qualify in what sense robustness calls for more information disclosure than standard Bayesian persuasion. Finally, we discuss how some of the results in the Bayesian persuasion literature change once robustness is accounted for.
Tax Savvy Executives
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We investigate why firms include individuals with significant professional tax experience on their senior management team and the consequences associated with the presence of these tax-savvy senior executives. We find that past performance, network connections, geographic location, and tax rate level relative to industry peers are all significant determinants in having a tax-savvy executive on the senior management team. Using propensity score matching, we find that effective tax rates decrease substantially after a tax-savvy executive is added to senior management and revert following the departure of a tax-savvy executive from senior management. We connect the changes in effective tax rates to changes in the usage of foreign subsidiaries in low tax jurisdictions.
SSRN
We investigate why firms include individuals with significant professional tax experience on their senior management team and the consequences associated with the presence of these tax-savvy senior executives. We find that past performance, network connections, geographic location, and tax rate level relative to industry peers are all significant determinants in having a tax-savvy executive on the senior management team. Using propensity score matching, we find that effective tax rates decrease substantially after a tax-savvy executive is added to senior management and revert following the departure of a tax-savvy executive from senior management. We connect the changes in effective tax rates to changes in the usage of foreign subsidiaries in low tax jurisdictions.
The Dark Side of Corporate Social Responsibility: The Case of Director Information Acquisition
SSRN
Using the staggered enactment of state-level constituency statutes as an exogenous shock to corporate social responsibility, we find that directors’ information acquisition intensity, measured by the return for their trading of company shares, decreases by 4% after the enactment. Our results are consistent with the argument that allowing directors to consider stakeholders’ interests makes directors less accountable. We further show that the effect is more pronounced when directors either have less incentive to collect information or it is more costly to do so. Last, less informed directors seem to be less effective monitors but not less effective advisors.
SSRN
Using the staggered enactment of state-level constituency statutes as an exogenous shock to corporate social responsibility, we find that directors’ information acquisition intensity, measured by the return for their trading of company shares, decreases by 4% after the enactment. Our results are consistent with the argument that allowing directors to consider stakeholders’ interests makes directors less accountable. We further show that the effect is more pronounced when directors either have less incentive to collect information or it is more costly to do so. Last, less informed directors seem to be less effective monitors but not less effective advisors.
The Relations between Exchange Rates and Stock Indexes for Brazil
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This research investigates the dynamic relations between exchange rates and stock indexes for Brazil by adopting the Granger causality test and the quantile regression model. The causality test results show that changes in stock indexes cause changes in exchange rates in the full sample period and all five subperiods. The results of different quantile regressions reveal an inverse U-shape pattern of the negative coefficients, which indicates that the negative correlation between changes in exchange rates and changes in stock indexes is even clearer when exchange rates become extremely low or high. The empirical results are consistent with the portfolio approach, which suggests that changes in stock indexes result in changes in exchange rates (the stock market leads the foreign exchange market) with the negative sign of correlation.
SSRN
This research investigates the dynamic relations between exchange rates and stock indexes for Brazil by adopting the Granger causality test and the quantile regression model. The causality test results show that changes in stock indexes cause changes in exchange rates in the full sample period and all five subperiods. The results of different quantile regressions reveal an inverse U-shape pattern of the negative coefficients, which indicates that the negative correlation between changes in exchange rates and changes in stock indexes is even clearer when exchange rates become extremely low or high. The empirical results are consistent with the portfolio approach, which suggests that changes in stock indexes result in changes in exchange rates (the stock market leads the foreign exchange market) with the negative sign of correlation.
The Role of Dividends in Equity Markets: Evidence from Sectoral-Level Analysis
SSRN
The purpose of this research is to identify how dividend payments affect the U.S. equity market at the sectoral level. A conventional stock valuation model predicts a positive response of equity price to higher dividend payment. Higher dividends convey confidence about the firm’s future to the general investors, which is supported by the signaling hypothesis. Using representative exchange traded funds for 11 sectors in the U.S. along with traditional OLS and panel regression analysis, this paper shows that the stock valuation model is generally confirmed. Eight sectors show positive impacts of dividends with statistical significance found in three sectors; Consumer Staples, Utilities, and Real Estate.
SSRN
The purpose of this research is to identify how dividend payments affect the U.S. equity market at the sectoral level. A conventional stock valuation model predicts a positive response of equity price to higher dividend payment. Higher dividends convey confidence about the firm’s future to the general investors, which is supported by the signaling hypothesis. Using representative exchange traded funds for 11 sectors in the U.S. along with traditional OLS and panel regression analysis, this paper shows that the stock valuation model is generally confirmed. Eight sectors show positive impacts of dividends with statistical significance found in three sectors; Consumer Staples, Utilities, and Real Estate.
What leads people to tolerate negative interest rates on their savings?
SSRN
Using an online experiment, we examine to what extent people are ready to bear negative interest rates (NIR hereafter) on their savings. We find some tolerance to NIR, i.e. people being willing to let money in the bank, rather than spend it, and thereby accepting to have less at some later time than now. This tolerance strongly depends on the amount of savings, time horizon, individual savings behavior, and anchoring. Specifically, the higher the amount, the lower the tolerance to NIR, which is consistent with a reverse magnitude effect. As time horizon increases, the tolerance to NIR decreases. Regular savers are more likely to tolerate NIR than non-regular savers, which is consistent with the status quo bias. We also find a higher tolerance to NIR on savings when participants are anchored towards NIR on savings first, i.e. when participants are presented first with NIR and then with positive interest rates (PIR hereafter).
SSRN
Using an online experiment, we examine to what extent people are ready to bear negative interest rates (NIR hereafter) on their savings. We find some tolerance to NIR, i.e. people being willing to let money in the bank, rather than spend it, and thereby accepting to have less at some later time than now. This tolerance strongly depends on the amount of savings, time horizon, individual savings behavior, and anchoring. Specifically, the higher the amount, the lower the tolerance to NIR, which is consistent with a reverse magnitude effect. As time horizon increases, the tolerance to NIR decreases. Regular savers are more likely to tolerate NIR than non-regular savers, which is consistent with the status quo bias. We also find a higher tolerance to NIR on savings when participants are anchored towards NIR on savings first, i.e. when participants are presented first with NIR and then with positive interest rates (PIR hereafter).
