Research articles for the 2021-03-05

Banks and Firms: Evidence from a legal reform altering contract design
Degryse, Hans,De Jonghe, Olivier,Karagiannis, Nikolaos
Banks are unique in designing loan contracts. Contract design determines liquidation and continuation decisions of firms. Smaller firms are often the weaker party when interacting with their banks. We study a legal reform that aims to improve small firms’ bargaining position by altering the contractual environment. The new law gives small firms the right to prepay loans against a contractually specified penalty and requires banks to offer firms’ best-suited loan type. Using this quasi-natural experiment, we show that, while the legal reform increases overall credit availability, banks dampen the effect of the act by tilting their credit supply to loans that are unaffected by the legal change, i.e., credit lines. Using bank-firm-credit-type data, we show that banks reduce the supply of term loans by 0.7% while credit lines increase by 4%. This effect is more pronounced for borrowers with longer relationships. Our results show that reforms generate unintended consequences since banks strategically try to undo part of the regulation.

Do Bank Insiders Impede Equity Issuances?
Goetz, Martin,Laeven, Luc,Levine, Ross
We evaluate the role of insider ownership in shaping banks’ equity issuances in response to the global financial crisis. We construct a unique dataset on the ownership structure of U.S. banks and their equity issuances and discover that greater insider ownership leads to less equity issuances. Several tests are consistent with the view that bank insiders are reluctant to reduce their private benefits of control by diluting their ownership through equity issuances. Given the connection between bank equity and lending, the results stress that ownership structure can shape the resilience of banksâ€"and hence the entire economyâ€"to aggregate shocks.

Do Personal Taxes Affect Investment Decisions and Stock Returns?
Kontoghiorghes, Alexander P.
I study the causal effects of personal investment taxes on stock demand, stock returns, and the dividend policy of companies. I exploit a change in legislation in 2013 which allowed stocks listed on the Alternative Investment Market, a sub-market of the London Stock Exchange, to be held in a capital gains and dividend tax-exempt investment account for the first time. Using a difference-in-differences approach, I find that after the tax cut, stock demand increased, stock returns decreased, and dividends increased. I rationalize my results by introducing a life-cycle model which incorporates two risky assets with varying taxes. My results demonstrate the importance of personal taxes for both investors and companies.

Dynamic Connectedness between COVID-19 News Sentiment, Capital and Commodity Markets
Apergis, Nicholas,Chatziantoniou, Ioannis,Gabauer, David
Using a TVP-VAR connectedness approach, we investigate dynamic connectedness of either market returns or conditional volatility, between COVID-19 news sentiment (captured by the Google Trends Index), capital (S&P500) and commodity (WTI) markets. Connectedness is much stronger for volatility, reaches a peak in mid-March 2020 and then eventually declines. COVID-19 related news are a persistent net transmitter of volatility shocks to both markets; however, they do not seem to have a prominent role as net transmitters of return spillovers.

Dynamics in the VIX Complex
Posselt, Anders Merrild
This paper provides a characterization of the dynamic interactions in the VIX complex, composed of the VIX itself, the term structure of VIX futures, and VIX ETPs. I investigate a model that summarizes the VIX futures term structure using latent factors (level, slope, and curvature) and expand it with the VIX and VIX futures demand stemming from VIX ETPs. I find evidence of VIX ETPs impacting the VIX futures term structure, but no evidence of any impacts on the VIX.

Endogenous Acquisition of Multi-Dimensional Information in a Strategic Trading Model
Ou-Yang, Hui,Wu, Weili
We analyze a strategic trading model with endogenous acquisition of multi-dimensional costly private information. We find that integer constraints on the number of informed traders, coupled with the interactions among different types of informed traders, lead to multiplicity and nonexistence of equilibria in the information market. Multiplicity stems either from information substitutability or from information complementarity, and nonexistence stems from the combined effect of information substitutability and information complementarity. Integer constraints also lead to asymmetric equilibria even when the model setup is symmetric. Under integer constraints, the fixed point theorem is no longer applicable and new methodologies are developed to prove the existence of equilibria as well as to find specific solutions for equilibria.

Extracting Information from Corporate Bond Yields: A Machine Learning Approach
Guo, Xu,Lin, Hai,Wu, Chunchi,Zhou, Guofu
We document strong evidence of cross-sectional predictability of corporate bond returns based on 48 yield predictors that capture the information in the yields of past one to 48 months. Besides standard regression forecasts, we generate forecasts from machine learning, which improves the forecast performance especially for junk bonds, and find that short- and long-term yield predictors are most informative for future bond returns. Return predictability is economically and statistically significant, and is robust to various controls. The uncovered predictability presents the most pronounced anomaly in the corporate bond literature that challenges rational pricing models.

Financial Crises, Macroprudential Policy and the Reliability of Credit-to-GDP Gaps
Alessandri, Piergiorgio,Bologna, Pierluigi,Galardo, Maddalena
The Basel III regulation explicitly prescribes the use of Hodrick-Prescott filters to estimate credit cycles and calibrate countercyclical capital buffers. However, the filter has been found to suffer from large ex-post revisions, raising concerns on its fitness for policy use. To investigate this problem we study credit cycles in a panel of 26 countries between 1971 and 2018. We reach two conclusions. The bad news is that the limitations of the one-side HP filter are serious and pervasive. The good news is that they can be easily mitigated. The filtering errors are persistent and hence predictable. This can be exploited to construct real-time estimates of the cycle that are less subject to ex-post revisions, forecast financial crises more reliably, and stimulate the build-up of bank capital before a crisis.

Homeownership and Portfolio Choice Over the Generations
Paz-Pardo, Gonzalo
Earnings are riskier and more unequal for households born in the 1960s and 1980s than for those born in the 1940s. Despite the improvements in financial conditions, younger generations are less likely to be living in their own homes than older generations at the same age. By using a life-cycle model with housing and portfolio choice that includes flexible earnings risk and aggregate asset price risk, I show that changes in earnings dynamics account for a large part of the reduction in homeownership across generations. Lower-income households find it harder to buy housing, and as a result accumulate less wealth.

Inventory Management, Dealers’ Connections, and Prices in OTC Markets
Colliard, Jean-Edouard,Foucault, Thierry,Hoffmann, Peter
We propose a new model of trading in OTC markets. Dealers accumulate inventories by trading with end-investors and trade among each other to reduce their inventory holding costs. Core dealers use a more efficient trading technology than peripheral dealers, who are heterogeneously connected to core dealers and trade with each other bilaterally. Connectedness affects prices and allocations if and only if the peripheral dealers’ aggregate inventory position differs from zero. Price dispersion increases in the size of this position. The model generates new predictions about the effects of dealers' connectedness and dealers' aggregate inventories on prices.

Investing Ethical: Harder Than You Think
Burghof, Hans-Peter,Gehrung, Marcel
After the financial crisis, the public perception of capital markets changed from means of an efficient capital allocation to being an irresponsible institution that endangers the stability of the economy. Seemingly, only the state can prevent such negative outcomes through increasing regulation of financial markets. With the threats from climate change, politicians and regulators used their newfound legitimacy for state interventions to widen the perspective of the required ethical behavior on financial markets towards green and ethical investments. In this paper, we discuss the role that private financial markets can play in this context. Individual ethical investments work in line with investors’ intentions if they reduce the price of capital for such investment and thus set positive incentives for an increase in the amount of ethical investments. Consequently, we scrutinize the existing literature on whether ethical investments outperform similar conventional investments. The results of the numerous studies are diverse, but they mainly find no or only very modest premia. Seemingly, capital markets show a sufficient degree of perfection to prevent or limit such distortions. A direct positive effect of ethical investments can only be expected through direct investments or through the employment of specialized intermediaries.

Is There a Replication Crisis in Finance?
Jensen, Theis Ingerslev,Kelly, Bryan T.,Pedersen, Lasse Heje
Several papers argue that financial economics faces a replication crisis because the majority of studies cannot be replicated or are the result of multiple testing of too many factors. We develop and estimate a Bayesian model of factor replication, which leads to different conclusions. The majority of asset pricing factors: (1) can be replicated, (2) can be clustered into 13 themes, the majority of which are significant parts of the tangency portfolio, (3) work out of sample in a new large data set covering 93 countries, and (4) have evidence that is strengthened (not weakened) by the large number of observed factors.

Issuance and Valuation of Corporate Bonds with Quantitative Easing
Pegoraro, Stefano,Montagna, Mattia
After the announcement of the European Central Bank’s corporate quantitative easing program, non-financial corporations timed the bond market by shifting their issuance toward bonds eligible for the program. However, issuers of eligible bonds did not increase total issuance compared to other issuers; nor did they experience different economic outcomes. Instead, the announcement produced substantial spillover effects on risk premia. Credit risk premia declined, both in the corporate bond market and in the default swap market, whereas the valuation of eligible bonds did not change relative to comparable ineligible bonds. Firms took advantage of reduced risk premia by issuing riskier bond types. Using a novel and comprehensive dataset of corporate bonds in the euro area, we document how firms substituted across bond characteristics, and we find evidence of their intention to time the market. Our model indicates corporate market timing is instrumental in allowing quantitative easing to produce spillover effects.

It's RILA Time: An Introduction to Registered Index-Linked Annuities
Moenig, Thorsten
Registered index-linked annuities (RILAs) are increasingly popular equity-based retirement savings products offered by U.S. life insurance companies. They combine features of fixed-index annuities and traditional variable annuities (TVAs), offering investors equity exposure with downside protection in a tax-deferred setting. This article introduces RILAs to the academic literature by describing the products' key features, developing a general pricing model, and deriving the providers' hedging strategy by decomposing their liabilities into short-term European options. Numerical illustrations show that RILAs offer investors similar risk profiles (in the long run) as TVAs with maturity guarantees, and that many products currently sold appear to be priced quite favorably for investors. For providers, RILAs may be a preferable alternative or complement to TVAs as they greatly simplify the management of the embedded equity risk and can naturally reduce the TVA capital requirements. These features position RILAs as a viable long-term solution for this product space.

LSIs’ Exposures to Climate Change Related Risks: An Approach to Assess Physical Risks
Pagliari, Maria Sole
This paper proposes an approach to estimate the impact of adverse climatic events on the profitability of small European banks (LSIs). By considering river flooding phenomena, we construct a unique database matching the information on location, frequency and severity of floods with the location and balance sheet data of institutions mainly operating in the areas where they are headquartered (territorial LSIs). We compare the performance of territorial LSIs across regions at low and high flooding risk and test for the “core lending channel” hypothesis, whereby lending to the real economy is a catalyst of physical risks. Results show that an adverse event dropping loans to households and non-financial corporations by one percentage point (pp) of total assets entails a decrease in the Return on Assets (ROA) of territorial LSIs in riskier areas by 0.01pps (~3.1%). Moreover, if all territorial LSIs were located in riskier areas, one bank out of two would report an average ROA between 0.0001 and 0.52 percentage points lower than what observed.

Lapse-and-Reentry in Variable Annuities
Moenig, Thorsten,Zhu, Nan
Section 1035 of the current US tax code allows policyholders to exchange their variableannuity policy for a similar product while maintaining tax-deferred status. When the variableannuity contains a long-term guarantee, this “lapse-and-reentry” strategy allows the policyholderto potentially increase the value of the embedded guarantee. We show that for a return-of-premium death benefit guarantee this is frequently optimal, which has severe repercussionsfor pricing. We analyze various policy features that may help mitigate the incentive to lapse,and compare them regarding the insurer’s average expense payments and their post-tax utilityto the policyholder.We find that a ratchet-type guarantee and a state-dependent fee structure best mitigatethe lapse-and-reentry problem, outperforming the typical surrender schedule. Further, whenaccounting for proper tax treatment, the policyholder prefers a variable annuity with either ofthese three policy features over a comparable stock investment.

Limited Liability, Strategic Default and Bargaining Power
Balatti, Mirco,López-Quiles, Carolina
In this paper we examine the effects of limited liability on mortgage dynamics. While the literature has focused on default rates, renegotiation, or loan rates individually, we study them together as equilibrium outcomes of the strategic interaction between lenders and borrowers. We present a simple model of default and renegotiation where the degree of limited liability plays a key role in agents' strategies. We then use Fannie Mae loan performance data to test the predictions of the model. We focus on Metropolitan Statistical Areas that are crossed by a State border in order to exploit the discontinuity in regulation around the borders of States. As predicted by the model, we find that limited liability results in higher default rates and renegotiation rates. Regarding loan pricing, while the model predicts higher interest rates for limited liability loans, we find no such evidence in the Fannie Mae data. We further investigate this by using loan application data, which contains the interest rates on loans sold to private vs public investors. We find that private investors do price in the difference in ex-ante predictable default risk for limited liability loans.

Measuring the Cost of Equity of Euro Area Banks
Altavilla, Carlo,Bochmann, Paul,Ryck, Jeroen De,Dumitru, Ana-Maria,Grodzicki, Maciej,Kick, Heinrich,Fernandes, Cecilia Melo,Mosthaf, Jonas,O’Donnell, Charles,Palligkinis, Spyros
The cost of equity for banks equates to the compensation that market participants demand for investing in and holding banks’ equity, and has important implications for the transmission of monetary policy and for financial stability. Notwithstanding its importance, the cost of equity is unobservable and therefore needs to be estimated. This occasional paper provides estimates of the cost of equity for listed and unlisted euro area banks using a three-step methodology. In the first step, ten different models are estimated. In the second step, the models’ results are combined applying an equal-weighting procedure. In the third step, the combined costs of equity for individual banks are aggregated at the euro area level and according to banks’ business models. The results suggest that, since the Great Financial Crisis of 2007-08, the premia that investors demand to compensate them for the risk they bear when financing banks’ equity has been persistently higher than the return on equity (ROE) generated by banks. We show that our estimates of cost of equity have plausible relationships to banks’ fundamentals. The cost of equity tends to be higher for banks that are riskier (higher non-performing loan ratios), less efficient (higher cost-to-income ratio), and with more unstable funding sources (higher relative reliance on interbank deposits). Finally, we use bank fundamentals to estimate the cost of equity for unlisted banks. In general, unlisted banks are found to have a somewhat lower cost of equity compared to listed banks, with business model characteristics accounting for part of the estimated difference.

Modeling Extreme Events: Time-Varying Extreme Tail Shape
Schwaab, Bernd,Lucas, Andre,Zhang, Xin
We propose a dynamic semi-parametric framework to study time variation in tail parameters. The framework builds on the Generalized Pareto Distribution (GPD) for modeling peaks over thresholds as in Extreme Value Theory, but casts the model in a conditional framework to allow for time-variation in the tail shape parameters. The score-driven updates used improve the expected Kullback-Leibler divergence between the model and the true data generating process on every step even if the GPD only fits approximately and the model is mis-specified, as will be the case in any finite sample. This is confirmed in simulations. Using the model, we find that Eurosystem sovereign bond purchases during the euro area sovereign debt crisis had a beneficial impact on extreme upper tail quantiles, leaning against the risk of extremely adverse market outcomes while active.

Models, Markets, and the Forecasting of Elections
Sethi, Rajiv,Seager, Julie,Cai, Emily,Benjamin, Daniel M.,Morstatter, Fred
We examine probabilistic forecasts for battleground states in the 2020 US presidential election, using daily data from two sources over seven months: a model published by the Economist, and prices from the PredictIt exchange. We find systematic differences in accuracy over time, with markets performing better several months before the election, and the model performing better as the election approached. A simple average of the two forecasts performs better than either one of them overall, even though no average can outperform both component forecasts for any given state-date pair. This effect arises because the model and the market make different kinds of errors in different states: the model was confidently wrong in some cases, while the market was excessively uncertain in others. We conclude that there is value in using hybrid forecasting methods, and propose a market design that incorporates model forecasts via a trading bot to generate synthetic predictions. We also propose and conduct a profitability test that can be used as a novel criterion for the evaluation of forecasting performance.

On the Interaction between Monetary and Macroprudential Policies
Martin, Alberto,Mendicino, Caterina,Van der Ghote, Alejandro
The Global Financial Crisis fostered the design and adoption of macroprudential policies throughout the world. This raises important questions for monetary policy. What, if any, is the relationship between monetary and macroprudential policies? In particular, how does the effectiveness of macroprudential policies (or lack thereof) influence the conduct of monetary policy? This discussion paper builds on the insights of recent theoretical and empirical research to address these questions.

One Size Fits Some: Analysing Profitability, Capital and Liquidity Constraints of Custodian Banks Through the Lens of the Srep Methodology
Coste, Charles-Enguerrand,Tcheng, Céline,Vansieleghem, Ingmar
Custodians play a key but discrete role in the global financial market infrastructure. In Europe, they are licensed as “credit institutions ”, a legal requirement for European deposit-taking institutions, and therefore they face the same prudential requirements as “traditional” banks. However, their business model and risk profile are different from those of traditional banks since the core of their activity does not encompass balance sheet transformation and the associated risks.

Policy Uncertainty, Lender of Last Resort and the Real Economy
Jasova, Martina,Mendicino, Caterina,Supera, Dominik
We show that a reduction in lender of last resort (LOLR) policy uncertainty positively affects bank lending and propagates to investment and employment. We exploit a unique policy that reduced uncertainty regarding the availability of future LOLR funding for banks as a quasi-natural experiment. Using micro-level data on banks, firms and loans in Portugal, we generate cross-sectional variation in banks’ exposure to uncertainty and find that the size of the haircut subsidy - the gap between private market and central bank security valuations - plays a key role in the propagation of the shock to lending and the real economy.

Revisiting the Risk-Neutral Approach to Optimal Policyholder Behavior: A Study of Withdrawal Guarantees in Variable Annuities
Moenig, Thorsten,Bauer, Daniel
Policyholder exercise behavior presents an important risk factor for pricing Variable Annuities. However, approaches presented in the literatureâ€"building on value-maximizing strategies akin to pricing American optionsâ€"do not square with observed price and exercise patterns for popular withdrawal guarantees. We show that including taxes into the valuation closes this gap between theory and practice. In particular, we develop a subjective risk-neutral valuation methodology that takes into consideration differences in the tax structure between investment opportunities. We demonstrate that accounting for tax advantages significantly affects the value of the guarantees and produces results that are in line with empirical patterns.

Risk Aversion and Bank Loan Pricing
Camba-Méndez, Gonzalo,Mongelli, Francesco Paolo
How much of the heterogeneity in bank loan pricing is explained by disparities in banks’ attitude towards risk? The answer to this question is not simple because there are only very weak proxies for gauging the degree of a bank’s risk aversion. We handle this constraint by means of a novel econometric approach that allows us to disentangle the amount of risk faced by banks and the price they charge for holding that risk. Some of our results are aligned with previous studies and confirm that disparities in market power, banks’ funding costs, and banks’ funding risks are reflected in bank lending rates. However, our new modelling framework reveals that the heterogeneity in bank lending rates is also a reflection of the non-negligible disparities in banks’ risk aversion.

Shifts in the Portfolio Holdings of Euro Area Investors in the Midst of COVID-19: Looking-Through Investment Funds
Carvalho, Daniel,Schmitz, Martin
We study the impact of the COVID-19 shock on the portfolio exposures of euro area investors. The analysis “looks-through” holdings of investment fund shares to first gauge euro area investors' full exposures to global debt securities and listed shares by sector at end-2019 and to subsequently analyse the portfolio shifts in the first and second quarters of 2020. We show important heterogeneous patterns across asset classes and sectors, but also across euro area less and more vulnerable countries. In particular, we find a broad-based rebalancing towards domestic sovereign debt at the expense of extra-euro area sovereigns, consistent with heightened home bias. These patterns were strongly driven by indirect holdings â€" via investment funds â€" especially for insurance companies and pension funds, but levelled off in the second quarter. On the contrary, for listed shares we find that euro area investors rebalanced away from domestic towards extra-euro area securities in both the first and the second quarter, which may be associated with better relative foreign stock market performance. Many of these shifts were only due to indirect holdings, corroborating the importance of investment funds in assessing investors' exposures via securities, in particular in times of large shocks. We also confirm the important intermediation role played by investment funds in an analysis focusing on the large-scale portfolio rebalancing observed between 2015 and 2017 during the ECB's Asset Purchase Programme.

Should Shareholders Have a Say on Acquisitions?
Becht, Marco,Polo, Andrea,Rossi, Stefano
Shareholders of U.S. corporations have lost billions of dollars in acquisitions they never approved. In the United Kingdom the listing rules give shareholders a binding say when targets are large relative to acquirers. A transatlantic comparison suggests that if U.S. shareholders had a say on acquisitions, they would incur fewer losses. There is a significant difference in the difference in performance between deals subject to a vote in the United Kingdom but not in the United States and deals with no mandatory vote in either country. The United States has given shareholders a mandatory say on pay; shareholders might also wish to have a binding say on corporate acquisitions.

Stockholder Politics
Tallarita, Roberto
Shareholders of large public companies make frequent use of federal proxy voting rules to submit proposals on political, environmental, ethical, and social issues, from climate change and employee diversity to animal welfare and corporate political spending. But why do investors in a business corporation concern themselves with public-interest issues? And how should corporate and securities law address this phenomenon?In this Article, I make three main contributions toward answering these questions. First, I provide a comprehensive empirical account of shareholder activism on public-interest issues (“stockholder politics”), based on the analysis of more than 2,400 proposals filed at S&P 500 companies over the last decade, including over 17,000 pages of documents from the decision record of the Securities Exchange Commission.Second, in light of the empirical findings, I question the conventional views on stockholder politics proposed by supporters and critics, and develop a richer analytical framework for understanding the phenomenon. In this framework, shareholder choices are based not only on financial motives but also on prosocial and expressive motives. However, shareholders do not have enough incentives to monitor management choices on public-interest issues. A small number of institutional actors (which I call “stockholder politics specialists”), with a peculiar structure of costs and incentives, mitigate this agency problem by performing a two-sided role. They “sell” information and voting opportunities internally to shareholders and they “sell” corporate voice externally to outside actors, including employees, consumers, and citizens concerned about corporate externalities. Third, I examine the normative implications of the proposed framework and present the case for strengthening shareholder voice on matters of public welfare and for removing many of the existing regulatory restrictions on stockholder politics.

Stress-Testing Net Trading Income: The Case of European Banks
Giglio, Carla,Shaw, Frances,Syrichas, Nicolas,Cappelletti, Giuseppe
Net trading income is an important but volatile source of income for many euro area banks, highly sensitive to changes in financial market conditions. Using a representative sample of European banks, we study the distribution of net trading income (normalized by total assets) conditional to changes in key macro-financial risk factors. To map the linkages of net trading income with financial risk factors and capture non-linear effects, we implement a dynamic fixed effects quantile model using the method of moments approach. We use the model to empirically estimate and forecast the conditional net trading income distribution from which we quantify tail risk measures and expected losses across banks. We find a heterogeneous and asymmetric impact of the risk factors on the distribution of net trading income. Credit and interest rate spreads affect lower quantiles of the net trading income distribution while stock returns are an important determinant of the upper quantiles. We also find that the onset of the Covid-19 pandemic resulted in a significant increase in the 5th and 10th percentile expected capital shortfall. Moreover, adverse scenario forecasts show a wide dispersion of losses and a long-left tail is evident especially in the most severe scenarios. Our findings highlight strong inter-linkages between financial risk factors and trading income and suggest that this tractable methodology is ideal for use as an additional tool in stress test exercises.

The China-U.S. Equity Valuation Gap
Bekaert, Geert,Ke, Shuojia,Zhang, Xiaoyan
Before 2009, the price earnings ratio (PE) of China is significantly higher than that of the U.S., despite the fact that PEs from most emerging markets are lower than those from developed countries. After 2009, the valuation gap reverses. Using data from 1995 to 2018, we analyze the sources of valuation differentials between comparable Chinese and U.S. firms. The sectoral composition of the indices, growth expectations, financial openness, financial development, and the investor base, all contribute to the cross-sector and time-series variation of the valuation differentials, but financial openness and changing growth expectations are the most important contributors.

The Economics of a Secondary Market for Variable Annuities
Moenig, Thorsten,Zhu, Nan
This article demonstrates that a secondary market for U.S. variable annuity policies may be immediately welfare-enhancing to all parties involved: the insurer, the original policyholder, and a third-party investor. Our model reflects relevant market frictions---here, the product's tax benefits---that produce differing valuation perspectives for the three parties. This allows for policy transfers that benefit all parties simultaneously, including the insurance company, irrespective of the level of control that it exerts over this secondary market. We illustrate our insights first with a theoretical two-period model, followed by an empirically motivated numerical analysis. Our numerical results suggest a best-estimate total welfare gain of 2.6\% of the initial investment amount under the optimal secondary-market structure.

The Impact of an SEC-Induced Increase to Stock Liquidity on Voluntary Disclosure
Hagenberg, Thomas C.,Miller, Brian P.,Sharma, Anish,Yohn, Teri Lombardi
In addition to disclosure regulation, the Securities and Exchange Commission (SEC) periodically intervenes in the market making process to facilitate fair, orderly, and efficient capital markets. For example, responding to calls for increased market maker competition on the Nasdaq in the early 1990s, the SEC imposed several reforms in 1997 to decrease bid-ask spreads and dealer rents. While prior research documents that this reform was successful in improving market maker competition and stock liquidity, we examine whether this increase in liquidity sufficiently altered firm’s incentives to disclose, such that firms reduced voluntary disclosure. In a differences-in-differences design, we examine whether firms affected by the reforms subsequently reduced their voluntary disclosure and whether this reduction in disclosure increased information asymmetry among investors. Our results suggest that firms impacted by the regulatory intervention subsequently reduced management forecast frequency relative to a set of firms unaffected by the regulation. Further, the firms that reduced disclosure experienced an increase in information asymmetry among investors through an increased probability of informed trading.

The Implications of Liquidity Regulation for Monetary Policy Implementation and the Central Bank Balance Sheet Size: An Empirical Analysis of the Euro Area
Kedan, Danielle,Veghazy, Alexia Ventula
We analyse the impact of the Liquidity Coverage Ratio (LCR) on the demand for central bank reserves in the euro area with difference-in-differences estimation techniques. Using a novel dataset and an identification strategy that exploits the cross-country heterogeneity in the regulatory treatment of reserves for LCR purposes prior to the announcement of a harmonised euro area standard as a quasi-natural experiment, we find evidence that points to LCR-induced demand for reserves. Specifically, our results suggest that banks with low LCRs relative to peers increased their central bank reserve holdings as a result of the LCR regulation. Our findings have economically meaningful implications for the operational framework of monetary policy and imply that the Eurosystem’s balance sheet may need to remain larger than it was prior to the financial crisis and the associated introduction of new liquidity regulation.

The Investment Style Drift Puzzle and Risk-Taking in Venture Capital
Koenig, Lukas,Burghof, Hans-Peter
Limited partners allocate capital into venture capital funds with the expectation of a risk-return profile matching the fund's investment style in terms of startup investment stage, location and industry. This paper draws a connection between style drifts in these three dimensions and the connected risk-taking attitude of the general partner. By analyzing a sample of 31,521 investments with respect to the motivation for style drifts, this paper seeks to answer whether style drifts are deliberate risk-shifts or happen out of competitive pressure. The results suggest that venture capitalists increase risk, when they have strong past performance and public markets are bullish in order to make the most of the balance of compensation and employment incentives. This balancing most likely constitutes an agency conflict between limited partners and general partners. Further, results show that most risky style drifts have a negative impact on the probability of a successful exit even after controlling for performance persistence and endogeneity. Finally, the findings show that aggregate style drift has a negative effect on a fund's performance measured as its exit rate.

To Diversify or Not to Diversify? â€" Questioning the Diversification Discount in Germany
Eulerich, Marc,Fligge, Benjamin
The decision to realign a company through diversification is highly relevant not only for the board and corporate development functions but also for shareholders and other stakeholders. In research and practice, the diversification of risk and return is always considered against the background of effects on stock market valuation. In this context, the question of the extent to which diversified companies are better or worse valued by the capital market has to be answered time and again. Against this background, this study examines the effects of diversification on capital market valuations using German data. Although the fact that conglomerates trade at a discount seems to be common knowledge, the results for the German market are ambiguous and outdated. Using a 2SLS approach, our study confirms the existence of a conglomerate discount, which ranges from 6.3% to 14% depending on the measure of market value. However, we find that this discount is not caused by diversification but by the factors that affect the propensity to diversify.

Variable Annuities: Market Incompleteness and Policyholder Behavior
Moenig, Thorsten
Variable annuities (VAs) are popular personal savings and investment vehicles with long-term guarantees. They include various exercise-dependent features, and the pricing, valuation and hedging of the guarantees depend critically on the investors' decision making. I study whether the optimal exercise behavior of a VA investor is affected by market incompleteness, which arises since the VA generates payout profiles that intersect financial risk and idiosyncratic mortality risk and can thus not be (fully) replicated with traditional financial and insurance products.Implementing a generic VA policy with a withdrawal guarantee (GMWB) that reflects typical US product characteristics, I find that the optimal withdrawal behavior derived from a lifecycle utility model is closely approximated by the corresponding (after-tax) value maximization strategy. That is, from the perspective of the investor, the market around VA policies is sufficiently complete to justify the common approach of assessing optimal VA policyholder behavior with a risk-neutral valuation method.