Research articles for the 2021-03-06
Derivatives Clearing, Central Counterparties and Novation: The Economic Implications
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Derivatives market central counterparties play an important role in exchange traded and some OTC derivatives markets. They exist side by side with bilaterally-cleared derivatives. These two clearing structures share common conceptual elementsâ€"netting, credit risk mitigationâ€"though they differ in important details with attendant implications for market structure and systemic risks. That both clearing structures co-exist strongly suggests that neither structure is dominant. The continuing evolution of derivatives clearing involves a tension between public and private interests and the legal environments, both internationally and in particular jurisdictions, which govern derivatives contracts and regulatory agencies. This paper develops a framework for analysing the economic and legal considerations, the public policy choices facing regulators as clearing structures compete and evolve, and the private interests that are at stake.
SSRN
Derivatives market central counterparties play an important role in exchange traded and some OTC derivatives markets. They exist side by side with bilaterally-cleared derivatives. These two clearing structures share common conceptual elementsâ€"netting, credit risk mitigationâ€"though they differ in important details with attendant implications for market structure and systemic risks. That both clearing structures co-exist strongly suggests that neither structure is dominant. The continuing evolution of derivatives clearing involves a tension between public and private interests and the legal environments, both internationally and in particular jurisdictions, which govern derivatives contracts and regulatory agencies. This paper develops a framework for analysing the economic and legal considerations, the public policy choices facing regulators as clearing structures compete and evolve, and the private interests that are at stake.
Does Bankruptcy Protection Affect Asset Prices? Evidence from changes in Homestead Exemptions
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Does the ability to protect an asset from unsecured creditors affect its price? This paper identifies the impact of bankruptcy protection on house prices using 139 changes in homestead exemptions. Large increases in the homestead exemption raised house prices 3% before 2005. Smaller exemption increases, to adjust for inflation, did not affect house prices. The effect disappeared after BAPCPA, a 2005 federal law designed to prevent bankruptcy abuse. The effect was bigger in inelastic locations.
SSRN
Does the ability to protect an asset from unsecured creditors affect its price? This paper identifies the impact of bankruptcy protection on house prices using 139 changes in homestead exemptions. Large increases in the homestead exemption raised house prices 3% before 2005. Smaller exemption increases, to adjust for inflation, did not affect house prices. The effect disappeared after BAPCPA, a 2005 federal law designed to prevent bankruptcy abuse. The effect was bigger in inelastic locations.
Doing Well by Doing Good? Evidence From Luxury Brands’ Social Responsibility Disclosure and Their Financial Performance
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Noting the sparse literature on the corporate social responsibility (CSR) commitments of luxury brands, we focus on the constituents of the S&P Global Luxury Index and their non-luxury peers to examine the impact of CSR disclosure on firms’ financial performance. We find that both luxury and non-luxury firms’ accounting performance improves when their CSR disclosure is moderate but worsens if such CSR disclosure is in the extreme. On the other hand, the effect of CSR disclosure on firms’ market performance is either insignificant or negative. These patterns are more pronounced for non-luxury firms than for luxury firms. By highlighting the different impacts of CSR disclosure (reporting or not reporting) and the disclosure level (how much to report) on luxury brands’ performance, this study enriches the understanding on how luxury firms’ fundamental attributes impact their corporate decisions for CSR commitments and disclosure. The results shed new light on the interplay of CSR disclosure, responsible investing, and luxury brand management.
SSRN
Noting the sparse literature on the corporate social responsibility (CSR) commitments of luxury brands, we focus on the constituents of the S&P Global Luxury Index and their non-luxury peers to examine the impact of CSR disclosure on firms’ financial performance. We find that both luxury and non-luxury firms’ accounting performance improves when their CSR disclosure is moderate but worsens if such CSR disclosure is in the extreme. On the other hand, the effect of CSR disclosure on firms’ market performance is either insignificant or negative. These patterns are more pronounced for non-luxury firms than for luxury firms. By highlighting the different impacts of CSR disclosure (reporting or not reporting) and the disclosure level (how much to report) on luxury brands’ performance, this study enriches the understanding on how luxury firms’ fundamental attributes impact their corporate decisions for CSR commitments and disclosure. The results shed new light on the interplay of CSR disclosure, responsible investing, and luxury brand management.
Financial Efficiency and the Lucas Puzzle
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I present a model that provides a theoretical solution to the Lucas Puzzle using Financial Efficiency, which is a time-varying component of TFP. The model predicts that a financially underdeveloped economy is to benefit from financial integration through FDI capital inflow only if it experiences faster technological growth, or faster Financial Development than the developed economy. Fitting the model to the data of India, I find that a sharp increase in India’s Financial Efficiency since 1990 provides a test for the theoretical prediction above and its congruence with the empirical part of the model. Increases in India’s capital per worker and Foreign Direct Investment capital inflow during the same period serve as external validation of the model.
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I present a model that provides a theoretical solution to the Lucas Puzzle using Financial Efficiency, which is a time-varying component of TFP. The model predicts that a financially underdeveloped economy is to benefit from financial integration through FDI capital inflow only if it experiences faster technological growth, or faster Financial Development than the developed economy. Fitting the model to the data of India, I find that a sharp increase in India’s Financial Efficiency since 1990 provides a test for the theoretical prediction above and its congruence with the empirical part of the model. Increases in India’s capital per worker and Foreign Direct Investment capital inflow during the same period serve as external validation of the model.
Managerial Incentives to Innovate During Crises: The Schumpeterian View
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Existing literature offers opposing views on the effects of financial crises on firm innovation. We provide evidence supporting the Schumpeter’s view of the creative destruction of crises. We identify one specific channel, the internal compensation mechanism that firms use to motivate managers to innovate during crises, as an important driver that improves firm innovative output. We show that during financial crises, increasing managerial option pay leads to firms producing more, higher quality patents as compared to normal times. Moreover, we find that less financially constrained firms are relatively better able to innovate by compensating managers with options. We identify exogenous variation in option compensation using multiyear option plans. Our results indicate that crises provide unique growth opportunities for innovative firms.
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Existing literature offers opposing views on the effects of financial crises on firm innovation. We provide evidence supporting the Schumpeter’s view of the creative destruction of crises. We identify one specific channel, the internal compensation mechanism that firms use to motivate managers to innovate during crises, as an important driver that improves firm innovative output. We show that during financial crises, increasing managerial option pay leads to firms producing more, higher quality patents as compared to normal times. Moreover, we find that less financially constrained firms are relatively better able to innovate by compensating managers with options. We identify exogenous variation in option compensation using multiyear option plans. Our results indicate that crises provide unique growth opportunities for innovative firms.
Stock Performance Under Alternative Shariah Screening Methods: Evidence from Australia
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This paper examines the effect of Shariah screening on performance. We use the constituents of the ASX200 to identify Shariahâ€compliant investments (SCI) using eight different Shariah screening methods (SSMs) and investigate the effect of quantitative screening ratios and purification ratios on performance. We find significant differences in the constituents of the SCI universe and performance across SSMs. Our results demonstrate consistent evidence that the debt and purification ratios are negatively associated with SCI performance. However, we find mixed results for the impact of liquidity ratios on performance.
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This paper examines the effect of Shariah screening on performance. We use the constituents of the ASX200 to identify Shariahâ€compliant investments (SCI) using eight different Shariah screening methods (SSMs) and investigate the effect of quantitative screening ratios and purification ratios on performance. We find significant differences in the constituents of the SCI universe and performance across SSMs. Our results demonstrate consistent evidence that the debt and purification ratios are negatively associated with SCI performance. However, we find mixed results for the impact of liquidity ratios on performance.
The Complementarity Between Man and Machine in Forecasting
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This paper explores the complementarity between man and machine in forecasting. We use data on analysts' earnings forecasts. We first show that a machine-learning forecast combining analyst expectations with data dominates both pure data-based and pure analyst forecasts. We then decompose the relative accuracy of these forecasts into three components: two adjustments for analyst bias and noise (which permit improvement over analysts' forecast) and an analyst information advantage (which permits improvement over the data-based forecast). We find that information advantage is large, particularly at shorter horizons, and analyst bias and noise are larger, especially at longer horizons. The simultaneous presence of all three components explains the superiority of the combined forecast. Finally, we document two determinants of man-machine complementarity. First, it is especially strong when there is more firm-level and aggregate uncertainty, consistent with bounded rationality: analysts' information is more valuable, but comes at a cost of more bias and noise. Secondly, complementarity is stronger for firms followed by fewer analysts, for which the consensus forecast contains significant noise.
SSRN
This paper explores the complementarity between man and machine in forecasting. We use data on analysts' earnings forecasts. We first show that a machine-learning forecast combining analyst expectations with data dominates both pure data-based and pure analyst forecasts. We then decompose the relative accuracy of these forecasts into three components: two adjustments for analyst bias and noise (which permit improvement over analysts' forecast) and an analyst information advantage (which permits improvement over the data-based forecast). We find that information advantage is large, particularly at shorter horizons, and analyst bias and noise are larger, especially at longer horizons. The simultaneous presence of all three components explains the superiority of the combined forecast. Finally, we document two determinants of man-machine complementarity. First, it is especially strong when there is more firm-level and aggregate uncertainty, consistent with bounded rationality: analysts' information is more valuable, but comes at a cost of more bias and noise. Secondly, complementarity is stronger for firms followed by fewer analysts, for which the consensus forecast contains significant noise.
The Corporate Supply of (Quasi) Safe Assets
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Investors value safety services in financial assets, such as the ability to serve as a store of value, to serve as collateral, or to meet mandatory capital and liquidity requirements. I present a model in which investors value safety services not only in traditional safe assets such as US Treasuries, but also in corporate debt. Shareholders thus maximize the value of the firm by complementing standard business operations with safe asset creation. Based on this theoretical framework, I use the CDS-bond basis to derive a measurement of the safety premium of corporate bonds. I document substantial cross sectional variation in the safety premium of corporate bonds, which allows me to test the model's predictions. I show that a high safety premium leads to a marked increase in debt issuance by relatively safer firms. These debt proceeds have a small impact on real investment and are largely used instead for equity payouts. This mechanism can explain why, in the aftermath of the financial crisis, non-financial investment grade companies significantly increased their debt issuance and equity payout while investment remained weak.
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Investors value safety services in financial assets, such as the ability to serve as a store of value, to serve as collateral, or to meet mandatory capital and liquidity requirements. I present a model in which investors value safety services not only in traditional safe assets such as US Treasuries, but also in corporate debt. Shareholders thus maximize the value of the firm by complementing standard business operations with safe asset creation. Based on this theoretical framework, I use the CDS-bond basis to derive a measurement of the safety premium of corporate bonds. I document substantial cross sectional variation in the safety premium of corporate bonds, which allows me to test the model's predictions. I show that a high safety premium leads to a marked increase in debt issuance by relatively safer firms. These debt proceeds have a small impact on real investment and are largely used instead for equity payouts. This mechanism can explain why, in the aftermath of the financial crisis, non-financial investment grade companies significantly increased their debt issuance and equity payout while investment remained weak.
The Market View
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When investors disagree and trade on their views about asset returns, market prices reflect the wealth/consumption share weighted average belief about risk premia, where more accurate, risk tolerant, or patient investors carry a larger weight. We explore the properties of this market view, and show that many puzzling properties of survey measures can be reconciled within disagreement models. For instance, a model with disagreement about output growth matches the negative correlation between statistical and survey-based measures of the risk premium, the higher variance and lower persistence of statistical measures of the risk premium and the appearance of return extrapolation.
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When investors disagree and trade on their views about asset returns, market prices reflect the wealth/consumption share weighted average belief about risk premia, where more accurate, risk tolerant, or patient investors carry a larger weight. We explore the properties of this market view, and show that many puzzling properties of survey measures can be reconciled within disagreement models. For instance, a model with disagreement about output growth matches the negative correlation between statistical and survey-based measures of the risk premium, the higher variance and lower persistence of statistical measures of the risk premium and the appearance of return extrapolation.
Which Factors Macroeconomics or Financial More Influence Initial Return Anomaly in the Capital Market? Empirical Proving of WIPO Theory
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Various factors that influence investors’ decision in an IPO are reflected in the initial return anomaly. This paper analyse which factors are more influencing, financial, non-financial and macroeconomic, including stock-market performance on initial return. The research was conducted on 100 issuers in the IDX for the period 2018-2019 using the SEM method. The research shows that financial factors as systematic components have not a significant effect, but random components in the form of non-financial, macroeconomic, and stock market performance affect initial return. This result empirically proves WIPO theory and has important implications for market players, including the governments as the regulator.
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Various factors that influence investors’ decision in an IPO are reflected in the initial return anomaly. This paper analyse which factors are more influencing, financial, non-financial and macroeconomic, including stock-market performance on initial return. The research was conducted on 100 issuers in the IDX for the period 2018-2019 using the SEM method. The research shows that financial factors as systematic components have not a significant effect, but random components in the form of non-financial, macroeconomic, and stock market performance affect initial return. This result empirically proves WIPO theory and has important implications for market players, including the governments as the regulator.
