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|Date: Friday, 23/Aug/2019|
|7:30 - 8:30||Women in Finance networking breakfast|
The session aims to encourage women working in finance to get to know each other and share their career experiences. The breakfast will be organized with round tables where senior and junior researchers can discuss and address current issues. We strongly encourage all women in finance to attend.
|Azure Restaurant (on Nova SBE campus)|
|8:30 - 10:00||APE-11: The cross-section of expected returns|
Session Chair: Dacheng Xiu, University of Chicago
1Northwestern University, United States of America; 2Georgia Institute of Technology, United States of America; 3University of Notre Dame, United States of America
We propose new methodology to estimate arbitrage portfolios by utilizing information contained in firm characteristics for both abnormal returns and factor loadings. The methodology gives maximal weight to risk-based interpretations of characteristics' predictive power before any attribution to abnormal returns. We apply the methodology in simulated factor economies and on a large panel of U.S. stock returns from 1965–2014. The methodology works well in simulation and when applied to U.S. stocks. Empirically, we find the arbitrage portfolio has (statistically and economically) significant alphas relative to several popular asset pricing models and annualized Sharpe ratios ranging from 0.67 to 1.12. Data-mining-driven alphas imply that performance of the strategy should decline after the discovery of pricing anomalies. However, we find that the abnormal returns on the arbitrage portfolio do not decrease significantly over time.
Estimating The Anomaly Baserate
1UIUC, United States of America; 2University of Notre Dame; 3University of Chicago
The academic literature contains literally hundreds of variables that seem to predict the cross-section of expected returns. This so-called ‘anomaly zoo’ has caused many to question whether researchers are using the right tests for statistical significance. But, here’s the thing: even if a researcher is using the right tests, he will still be drawing the wrong conclusions from his analysis if he is starting out with the wrong priors—i.e., if he is starting out with incorrect beliefs about the ex ante probability of discovering a tradable anomaly prior to seeing any test results. So, what are the right priors to start out with? What is the correct anomaly baserate? We propose a new statistical approach to answer this question. The key insight is that, under certain conditions, there’s a one-to-one mapping between the ex ante probability of discovering a tradable anomaly and the best-fit tuning parameter in a penalized regression. When we apply our new statistical approach to the cross-section of monthly returns, we find that the anomaly baserate has fluctuated substantially since the start of our sample in May 1973. The ex ante probability of discovering a tradable anomaly was much higher in 2003 than in 1990. As a proof of concept, we construct a trading strategy that invests in previously discovered predictors and show that adjusting this strategy to account for the prevailing anomaly baserate boosts its performance.
Thousands of Alpha Tests
1Yale University; 2Rutgers University, United States of America; 3University of Chicago
Data snooping is a major concern in empirical asset pricing. By exploiting the ``blessings of dimensionality'' we develop a new framework to rigorously perform multiple hypothesis testing in linear asset pricing models, while limiting the occurrence of false positive results typically associated with data-snooping. We first develop alpha test statistics that are asymptotically valid, weakly dependent in the cross-section, and robust to the possibility of omitted factors. We then combine them in a multiple-testing procedure that ensures that the rate of false discoveries is ex-ante bounded below a pre-specified 5% level. We also show that this method can detect all positive alphas with reasonable strengths. Our procedure is designed for high-dimensional settings and works even when the number of tests is large relative to the sample size, as in many finance applications. We illustrate the empirical relevance of our methodology in the context of hedge fund performance (alpha) evaluation. We find that our procedure is able to select -- among more than 3,000 available funds -- a subset of funds that displays superior in-sample and out-of-sample performance compared to the funds selected by standard methods.
|8:30 - 10:00||APT-5: Crash Risk|
Session Chair: Anders Trolle, HEC Paris
Credit and Option Risk Premia
1Carnegie Mellon University, United States of America; 2Arizona State University; 3University of Washington
We estimate a structural model of credit risk to quantify the impact of time-varying bankruptcy costs and risk on credit spreads. To identify these channels, the estimation relies on information in firm-level CDS rates and option prices. While CDS rates are sensitive to both time-varying bankruptcy costs and risk, equity option prices are only sensitive to risk because equity holders lose everything in bankruptcy. Our model features a representative agent with recursive preferences and Markov-switching states for the drift and volatility of consumption and earnings growth. The dynamics for consumption and earnings feature persistent and rare economic disasters, which are crucial for the valuation of CDS and option contracts. Firms issue debt trading off tax benefits and bankruptcy costs, refinance when their interest coverage ratio is too high, and optimally default when their interest coverage ratio is too low. A structural decomposition reveals that time-variation in bankruptcy costs account for 3% and time-variation in risk for 75% of the level of credit spreads.
The Dynamics of the Implied Volatility Surface
1HEC Montréal, Canada; 2University of Texas at Dallas
The term structure of the implied volatility is upward-sloping in good and normal times but downward-sloping in bad times. In addition, the implied volatility features a negative skew in bad times, i.e., the implied volatility of out-of-the-money put options is larger than that of at-the-money options, while the implied volatility resembles more to a smile as economic conditions improve. These findings are robust features of the U.S. and international option markets. An asset-pricing model with rare disasters followed by recoveries can explain the aforementioned empirical regularities. By contrast, ignoring post-disaster recoveries generates predictions that are inconsistent with the data.
Downside Risks and the Price of Variance Uncertainty
1University of Münster, Germany; 2University of Zurich, Switzerland
This paper studies the role of generalized disappointment aversion (GDA) in reconciling several asset-pricing puzzles in models of long-run risks. To fully capture the nonlinearities introduced by these preferences, we solve the model globally with projection. This allows us to scrutinize the channels through which GDA unfolds. A key feature of our calibrated model is the significant wedge GDA drives between the physical and the risk-neutral measure. The model captures not only the size of the variance risk premium (VRP), but also the hump-shaped predictability pattern and the prominent role of downside risks for the VRP and its predictive power.
|8:30 - 10:00||MM-5: Market design and Liquidity|
Session Chair: Elvira Sojli, University of New South Wales
Market Structure and Corporate Payout Policy: Evidence from a Natural Experiment
1Guangxi University, China, People's Republic of; 2University of Illinois Urbana-Champaign; 3NBER
In 2016, the Securities and Exchange Commission increased tick size (the minimum price variation) for 1,200 randomly selected firms, and imposed restrictions on dark-pool trading on 400 of them. We find that firms reduce share repurchases by 67% and total payout by 51% once they face binding tick-size constraints in both stock exchanges and dark pools. Surprisingly, firms with large increases in depth, especially on the bid side, reduce their payouts the most because regulations on share repurchases discourage the use of market orders, which turns a market with great depth into an illiquid market for repurchasing firms.
Dark Trading and the Fundamental Information in Stock Prices
1David Eccles School of Business, University of Utah; 2Cox School of Business, Southern Methodist University
We study the causal effect of dark trading on the incorporation of firm-specific fundamental information into stock prices. Theory suggests dark pools may facilitate or discourage price informativeness. Using a comprehensive sample of dark trading activity, we find that a higher level of dark trading is associated with greater firm-specific fundamentals in stock prices. To overcome endogeneity concerns we exploit the SEC’s Tick-Size Pilot Program that resulted in a large exogenous shock to dark pool trading. The results remain. The results cannot be explained by liquidity, price efficiency, or high frequency traders. In support of the information acquisition interpretation, we directly observe a shift in the information acquisition through SEC EDGAR searches for the treatment firms, among other evidence around the exogenous shock to dark trading. Overall, the evidence is consistent with dark trading improving the incorporation of firm-specific fundamentals into stock prices.
Cross-Venue Liquidity Provision: High Frequency Trading and Ghost Liquidity
1KU Leuven, IWH, CEPR; 2UCLouvain, Louvain School of Management; 3Université Paris-Dauphine, PSL, DRM, CNRS; 4Cass Business School, City University of London
We measure the extent to which consolidated liquidity in modern fragmented equity markets overstates true liquidity due to a phenomenon that we call Ghost Liquidity (GL). GL exists when traders place duplicate limit orders on competing venues, intending for only one of the orders to execute, and when one does execute, duplicates are cancelled. We employ data from 2013, covering 91 stocks trading on their primary exchanges and three alternative platforms and where order submitters are identified consistently across venues, to measure the incidence of GL and to investigate its determinants. On average, for every 100 shares passively traded by a multi-market liquidity supplier on a given venue, around 19 shares are immediately cancelled by the same liquidity supplier on a different venue. This percentage is significantly greater for HFTs than for non-HFTs and for those trading as principal. GL is larger on alternative platforms than on primary exchanges. Overall, GL implies that simply measured consolidated liquidity exceeds true consolidated liquidity but its average weight in total consolidated depth, i.e., slightly more than 4%, does not challenge the liquidity benefits of fragmentation.
|8:30 - 10:00||CFGE-5: New theory and evidence on IPOs|
Session Chair: Per Strömberg, Stockholm School of Economics
Initial Public Offerings and the Local Economy
University of Kansas, United States of America
We provide evidence that a firm’s transition from private to public ownership stunts local economic growth, especially in less populated and poorer areas. After accounting for endogeneity in the ownership decision, areas hosting companies that go public experience muted growth in employment, establishments, population, and wages, relative to areas where firms remain private. Establishment-level analyses and tests of IPO filer acquisition activity reveal that transitioning to public ownership causes firms to geographically diversify their establishments and employee base. These findings are consistent with public ownership reducing a firm’s reliance on local agglomeration economies, to the detriment of the local community.
The Wharton School, University of Pennsylvania, United States of America
This paper studies the strategy of entrepreneurs to finance their experimentation given the presence of adverse selection in capital markets. It quantifies the effect of information frictions on firm value by structurally estimating a dynamic model that features volatile market valuation, strategic experimentation, and dynamic adverse selection. Entrepreneurs make decisions to access public financing by weighing market-timing incentives against the costly delay to signal by conducting additional experimentation. Leveraging the unique setting of biotech startups with drug development, I employ data variations in leading drug stages at IPOs, durations of staying private, and IPO valuations to estimate the model. I find that adverse selection is prevalent between early-stage startups and investors. My baseline estimates suggest that information frictions cause about 24% loss of ex- ante firm value, which is due to the direct effect of market belief distortions and the indirect effect of firms remaining private longer and hence burdened with higher financing costs by approximately 15%. I also document substantial variations in magnitude of the effect across VC-backed startups and firms with more effective “patent fences.” These results show that information frictions have a large impact on the financing behavior of startups and firm values.
Technological Disruptiveness and the Evolution of IPOs and Sell-Outs
1University of Lugano and Swiss Finance Institute; 2University of Southern Californa; 3Virginia Tech
We show that the recent decline in IPOs on U.S. markets is related to changes in the technological disruptiveness of startups, which we measure using textual analysis of patents from 1930 to 2010. We focus on VC-backed startups and show that those with ex-ante disruptive technologies are more likely to exit via IPO and less likely to exit via sell-out. This is consistent with IPOs being favored by firms with the potential to carve out independent market positions with strong defenses against rivals. We document an economy-wide trend of declining technological disruptiveness since World War II that accelerated since the late 1990s. This trend predicts fewer IPOs and more sell-outs, and we find that roughly 20% of the recent dearth of IPOs, and 49% of the surge in sell-outs, can be attributed to changes in firms' technological characteristics.
|8:30 - 10:00||CFGE-14: Labor and Finance|
Session Chair: Ashwini Agrawal, LSE
Fewer and Less Skilled? Human Capital, Competition, and Entrepreneurial Success in Manufacturing
1George Washington University, United States of America; 2University of Maryland, United States of America
We use micro data on skill levels of establishments to examine the human capital of US manufacturing entrants and incumbent plants over the period 2005-2013. We find a large drop in the cognitive skill levels of the entrant work force over this period. This has serious long-term implications since initial cognitive skills at the establishment level predict future skills and growth rates. While there is a differential decline in entrant skills in industries exposed to Chinese imports, we also find that incumbents upgrade skill levels in exposed industries. High skilled incumbents grow faster than low skilled establishments in exposed industries. The evidence for entrants is weaker, suggesting that they are entering in niches appropriate to their skill sets. The economic effect of import competition on the differential in skills between entrants and incumbents is economically significant explaining between 17%-60% of the skill differential in 2011. Overall, we find that entrepreneurial firms and incumbents are acquiring different skill sets, leaving entrants more exposed to the risk of automation or offshoring.
Local Taxes and the Demand for Skilled Labor: Evidence From Job Postings
1Cornell University; 2Indiana University, United States of America; 3University of Notre Dame
We show how state personal income taxes influence firms' decisions to hire skilled workers. Using a novel, comprehensive dataset containing US firms' online job postings, we document a measurable, negative effect of personal taxes on the level of education and skill required by firms. This effect is mitigated by firms' financial strength and in states that account for a large fraction of firms' sales, but it is aggravated where firms do not rely on local input. Our findings point to a ``brain-drain" of states with high personal income taxes. This is one of the first pieces of evidence showing that state taxes affect the demand for human capital and the skills of workers in the local labor market.
Do Minimum Wage Increases Cause Financial Stress to Small Businesses? Evidence from 15 Million Establishments
Georgia Tech, United States of America
Do increases in federal minimum wage impact financial health of small businesses? Using inter-temporal variation in whether a state's minimum wage is bound by the federal minimum wage and credit-score data for approximately 15.2 million establishments for the period 1989-2013, we find that increases in federal minimum wage worsen the financial health of small businesses in the affected states. Small, young, labor-intensive, minimum-wage sensitive establishment located in bounded states and businesses located in competitive and low-income areas experience higher financial stress. Increases in minimum wage also lead to lower bank loans, a higher risk of loan default and higher exit rate for affected small businesses. We use various matching methods and fixed effects to control of unobservable differences in treatment and control groups. The evidence suggests that some small businesses are unable or unwilling to pass-through costs to customers immediately and consequently experience financial stress. Our results document the costs to the one-size-fits-all nationwide minimum wage and highlight how the increases in minimum wages can have an adverse effect on the financial health of small businesses.
|8:30 - 10:00||HH-1: Household Consumption-Debt Behavior|
Session Chair: Adair Morse, UC Berkeley
Expectations Uncertainty and Household Economic Behavior
1Federal Reserve Board, United States of America; 2Ohio State University; 3University of North Carolina
We show that there exists significant heterogeneity across US households in how uncertain they are in their expectations regarding personal and macroeconomic outcomes, and that uncertainty in expectations predicts households' choices. Individuals with lower income or education, more precarious finances, and living in counties with higher unemployment are more uncertain in their expectations regarding own-income growth, inflation, and national home price changes. People with more uncertain expectations, even accounting for their socioeconomic characteristics, exhibit more precaution in their consumption, credit, and investment behaviors.
Crowdsourcing Financial Information to Change Spending Behavior
1Boston College, United States of America; 2University of Maryland; 3University of Chicago
We document five effects of providing individuals with crowdsourced spending information about their peers (individuals with similar demographics) through a FinTech app. First, users that overspend with respect to peers reduce their spending significantly whereas users that underspend keep constant or increase their spending. Second, users' distance from their peers' spending affects the reaction monotonically in both directions. Third, users' reaction is severely asymmetric -- spending cuts are three times as large as increases. Fourth, lower income users react more than others. Fifth, discretionary spending drives the reaction in both directions and especially cash withdrawals, which are commonly used for incidental expenses and anonymous transactions. We argue none of Bayesian updating, peer pressure, or the fact that bad news loom more than (equally-sized) good news alone can explain all these facts.
Shocked by Bank Funding Shocks: Evidence from Consumer Credit Cards
1Georgia Institute of Technology, United States of America; 2Emory University, United States of America
We examine the transmission of an unexpected sharp decline in banks' short-term wholesale funding availability in 2008 to their consumers using a comprehensive matched bank -- borrower data set. For the same consumer borrowing from two different credit card issuers, a 10% reduction in the bank's wholesale funding leads to a reduction of 0.74% in credit card limits for its borrowers. Consumers could not completely hedge away the liquidity shock transmitted by their banks, leading to a 0.36% reduction in aggregate credit card consumption for a 1% reduction in aggregate credit card limits. The effects are more severe (0.68--1.54%) for credit-constrained consumers with lower credit scores and higher credit card utilization ratios in the short-run and the long-run. We confirm our primary results on the full universe of approximately 500 million credit cards. Our results suggest that the structure of a bank's balance sheet impacts their consumers, with banks transmitting their funding shocks to consumers through credit cards, thus affecting aggregate credit card consumption.
|8:30 - 10:00||FIIE-1: Fund performance|
Session Chair: Charlotte Christiansen, CREATES, Aarhus University
Imperial College Business School, United Kingdom
We use publicly disclosed short positions for EU stock markets from 2012 to 2018 to show that the alpha of the average short position in our data set is not statistically significant after adjusting for momentum, but short positions for which hedge funds have high conviction outperform other short positions that account for a smaller proportion of the funds' disclosed positions. The six-factor alpha of a long-short strategy based on conviction is 6 per cent per year after adjusting for transaction costs. Our results inform the public policy debate about the pros and cons of the public disclosure of short positions akin to Frank, Poterba, Shackelford, and Shoven (2004) for the public disclosure of long positions.
What Do Mutual Fund Managers' Private Portfolios Tell Us About Their Skills?
Federal Reserve Board of Governors, United States of America
I collect a registry-based dataset on the personal portfolios of Swedish mutual fund
managers. The managers who invest personal money in the very same funds they professionally manage outperform the managers who do not. The main results are consistent with a Berk and Green (2004) equilibrium in which fund managers, in contrast to regular investors, are certain about their ability to generate abnormal returns---or lack thereof---and invest their personal wealth accordingly.
Text Sophistication and Sophisticated Investors
1University of Oulu, Finland; 2University at Buffalo, United States; 3Singapore Management University
We show that two novel measures of text sophistication, applied to hedge fund strategy descriptions, encapsulate incremental information about funds. Consistent with the linguistics literature, hedge funds with lexically diverse strategy descriptions outperform, eschew tail risk, and encounter fewer legal problems. In line with the literature, hedge funds with syntactically complex strategy descriptions grapple with more legal issues and report more rule violations. Fund investors recognize the dichotomy and direct flows accordingly, but not enough to erode away the alphas of lexically diverse funds. Our findings suggest that text sophistication measures provide texture on the cognitive ability and trustworthiness of sophisticated investors.
|8:30 - 10:00||FIIE-9: Exchange-Traded Funds and Fund Flows|
Session Chair: Francesco Franzoni, USI Università della Svizzera italiana, Swiss Finance Institute
Asset Prices and Corporate Responses to Bank of Japan ETF Purchases
1National University of Singapore, Singapore; 2Alberta School of Business, University of Alberta; 3National Bureau of Economic Research; 4Asian Bureau of Finance and Economic Research; 5European Corporate Governance Institute
Since 2010, the Bank of Japan (BOJ) has purchased stocks to boost domestic firms’ valuations to increase GDP growth. The stock return elasticity with respect to BOJ purchases relative to the previous month’s market cap is around 2 and increases across longer horizons. Over one quarter, BOJ share purchases worth 1% of assets correspond to an increase of 1% in share valuation and a .27% increase in assets. Consistent with elevated valuations letting firms “cash out,” BOJ share purchases predict equity issuances and fewer stock buybacks. However, less than 9% of increased assets reflect net tangible capital investments, whereas cash and short-term investments account for over 50%. This unconventional monetary stimulus thus boosts share prices but is largely not transmitted into real investment growth.
Swing Pricing and Fragility in Open-end Mutual Funds
1International Monetary Fund; 2Said Business School, University of Oxford; 3Imperial College London
In recent years, markets have observed an innovation that changed the way open-end funds are priced. Alternative pricing rules (known as swing or dual pricing) adjust funds’ net asset values to pass on funds’ trading costs to transacting shareholders. Using data on open-end corporate bond mutual funds, we show that alternative pricing rules eliminate the first-mover advantage arising from the traditional pricing rule and significantly reduce redemptions that are observed during stress periods. Using unique data available at the end-investor level, we confirm that alternative rules alter investors’ behavior. Fund companies perceive their pricing schemes as a substitute to other means of liquidity risk management.
Phantom of the Opera: ETFs and Shareholder Voting
1University of Virginia, United States of America; 2University of Cambridge; 3Villanova University
Short-selling and liquidity provision in Exchange-Traded Funds create ETF shares with cash flows rights but no associated voting rights. These “phantom shares” trade at ETF market prices, but, because they are not backed by the underlying basket of securities held by the ETF sponsor’s custodian they are not voted by the sponsor, removing any associated voting rights. We introduce a novel measure of phantom shares, and show that in proxy voting of the underlying stocks of the ETF, it is associated with an increase in broker non-votes and a corresponding decrease in both votes for and against. We also find that increases in our measure of phantom shares reflecting a decrease in the total outstanding shares to be voted, is associated with an increase in the vote premium during shareholder meetings with close votes, proxy contests, special meeting items, or if ISS recommended voting against the item.
|8:30 - 10:00||FIIT-1: Banks' responses to macroprudential policies|
Session Chair: Leonardo Gambacorta, Bank for International Settlements
The Aggregate Demand for Bank Capital
1University of Chicago; 2University of Pennsylvania; 3Stockholm School of Economics
We propose a novel conceptual approach to characterizing the credit market equilibrium in economies with multi-dimensional borrower heterogeneity. Our method is centered around a micro-founded representation of borrowers’ aggregate demand correspondence for bank capital. The framework yields closed-form expressions for the composition and pricing of credit, including a sufficient statistic for the provision of bank loans. Our analysis sheds light on the roots of compositional shifts in credit toward risky borrowers prior to the most recent crises in the U.S. and Europe, as well as the macroprudential effects of bank regulations, policy interventions, and financial innovations providing alternatives to banks.
The Anatomy of the Transmission of Macroprudential Policies
1Erasmus University Rotterdam, Netherlands, The; 2Reserve Bank of India; 3Trinity College Dublin; 4University of Michigan; 5Central Bank of Ireland
We analyze the effect of regulatory limits on household leverage on residential mortgage credit, house prices, and banks' portfolio choice. Combining supervisory loan level and house price data, we examine the introduction of loan-to-income and loan-to-value limits on residential mortgages in Ireland. Mortgage credit is reallocated from low- to high-income borrowers and from high- to low-house price appreciation areas, cooling down, in turn, ``hot'' housing markets. Consistent with a bank portfolio choice channel, more-affected banks drive this reallocation and increase their risk-taking in their securities holdings and corporate credit, two asset classes not targeted by the policy.
Macroprudential FX Regulations:Shifting the Snowbanks of FX Vulnerability?
1Bank of England, United Kingdom; 2MIT, NBER, CEPR; 3Bank of Canada
Can macroprudential foreign exchange (FX) regulations on banks reduce the financial and macroeconomic vulnerabilities created by borrowing in foreign currency? To evaluate the effectiveness and unintended consequences of macroprudential FX regulations, we develop a parsimonious model of bank and market lending in domestic and foreign currency and derive four predictions. We confirm these predictions using a rich dataset of macroprudential FX regulations. These empirical tests show that FX regulations: (1) are effective in terms of reducing borrowing in foreign currency by banks; (2) have the unintended consequence of simultaneously causing firms to increase FX debt issuance; (3) reduce the sensitivity of banks to exchange rate movements, but (4) are less effective at reducing the sensitivity of corporates and the broader financial market to exchange rate movements. As a result, FX regulations on banks appear to be successful in mitigating the vulnerability of banks to exchange rate movements and the global financial cycle, but partially shift the snowbank of FX vulnerability to other sectors.
|10:00 - 10:30||Coffee break offered by WRDS|
|10:30 - 12:00||APE-5: Economic Risk Factors|
Session Chair: Francisco Gomes, London Business School
Hedging Risk Factors
1UCLA; 2University of Rochester
Standard risk factors can be hedged with minimal reduction in average return. This is true for ``macro'' factors such as industrial production, unemployment, and credit spreads, as well as for ``reduced form'' asset pricing factors such as value, momentum, or profitability. Low beta versions of the factors perform close to as well as high beta versions, hence a long short portfolio can hedge factor exposure with little reduction in expected return. For the reduced form factors this mismatch between factor exposure and expected return generates large alphas. For the macroeconomic factors, hedging the factors also hedges business cycle risk by significantly lowering exposure to consumption, GDP, and NBER recessions. We study implications both for optimal portfolio formation and for understanding the economic mechanisms for generating equity risk premiums.
News Shocks and Asset Prices
1London Business School, United Kingdom; 2Federal Reserve Board; 3London School of Economics
We examine the role of expectation, or news, shocks for the measurement of macroeconomic risk and the natural rate of interest. To this end, we estimate a New-Keynesian dynamic stochastic general equilibrium model that allows us to infer agents’ expectations about future fundamentals at different horizons. Accounting for news shocks results in better-specified macroeconomic risk factors that have significant explanatory power for the cross-section of stock and long-term bond returns. Further, anticipated changes in future productivity growth induce sizeable fluctuations in the natural rate of interest, which we show to have important implications for the conduct of monetary policy.
Decomposing Firm Value
1INSEAD, France; 2PIMCO; 3University of Minnesota
What are the economic determinants of the firm’s market value? We answer this question through the lens of a generalized neoclassical model of investment with physical capital, quasi-fixed labor, and two types of intangible capital, knowledge capital and brand capital. We estimate the structural model using firm-level data on U.S. publicly traded firms and use the parameter values to infer the contribution of each input for explaining firm’s market value in the last four decades. The model performs well in explaining both cross-sectional and time-series variation in firms’ market values across all firms, with a time series R2 of 80% and a cross sectional R2 of 99%. We find that the relative importance of each input for firm value varies across industries. On average, physical capital accounts for 22.7% to 56.7% of firm’s market value, installed labor force accounts for 18.2% to 40.1%, knowledge capital accounts for 0.9% to 33%, and brand capital accounts for 3.5% to 24%. These values also vary over time: the importance of physical capital for firm value has decreased in the last decades, while the importance of knowledge capital has increased, especially in high tech industries. Overall, our value decomposition provides direct empirical evidence supporting models with multiple capital inputs as main sources of firm value.
|10:30 - 12:00||APT-4: Information and Entry|
Session Chair: Bradyn Breon-Drish, UC San Diego
Delayed Information Acquisition and Entry into New Trading Opportunities
UC San Diego, United States of America
We model dynamic information acquisition and entry by a strategic trader. Instead of requiring the trader to commit before the market opens, we allow her to choose when to enter in response to public news. We characterize the unique equilibrium, in which entry is driven by public uncertainty and generically exhibits delay. The model provides novel implications for how the likelihood and timing of entry, and precision choice, depend on news volatility and the trading horizon. Our results shed light on why institutional investors delay entry into new opportunities, and how these dynamics vary across asset characteristics and market environments.
Time-Varying Market Participation, Consumption Risk-Sharing, and Asset Dynamics
University of Toronto, Canada
We propose a general equilibrium model where heterogeneous risk-averse agents endogenously choose to enter or exit the market. We characterize the equilibrium in semi-closed form and present a novel conditional CCAPM. The model implies a procyclical variation in stock market participation. This time-variation gives rise to a countercyclical share of dividend in stockholders aggregate consumption, which drives the countercyclical amount of stockholders' consumption risk, as opposed to aggregate consumption risk dynamics. The price of consumption risk in our model is not only affected by consumption redistribution of stockholders, but also by the time-variation in stock market participation. We find, under the assumption of time-invariant risk aversion, that the latter effect dominates the former, leading to the procyclical price of consumption risk. We provide empirical evidence for both the amount and price of consumption risk dynamics, supporting our theory. Overall, this article shows that it is the countercyclical stockholders' amount of risk due to time-varying risk-sharing that explains time-varying risk premium and excess volatility.
Why Does Public News Augment Information Asymmetries?
Tilburg University, Netherlands, The
The arrival of a public signal worsens the adverse selection problem if informed investors are risk-averse. Precisely, the public signal reduces uncertainty which boosts informed investors' participation leading to more toxic order flow. I confirm the model's empirical predictions by estimating the effect of the publication of the weekly change in oil inventories on liquidity via a difference-in-differences strategy. I show that the mean bid-ask spread doubles immediately after the release and volume increases by 32 percent regardless of the report's content. Further, in line with the model, implied volatility drops and insider's trading increase after the report's publication.
|10:30 - 12:00||APE-9: Leverage Constraints and Liquidity in Equity Markets|
Session Chair: Naveen Gondhi, INSEAD
Leveraged Funds and the Shadow Cost of Leverage Constraints
University of Georgia, United States of America
Using the most comprehensive dataset of leveraged funds, we measure the market-wide shadow cost of leverage constraints and examine its pricing implications. The shadow cost averages 0.51% per annum from 2006 to 2016. It spikes upon quarter-ends when financial intermediaries make mandatory reporting, positively predicts future betting-against-beta (BAB) returns, and negatively correlates with contemporaneous BAB returns. Stocks that underperform when the shadow cost increases earn 0.75% more per month. Our shadow cost measure helps identify supply and demand shifts in the leverage market. Overall, using our shadow cost measure rather than the widely used TED spread uncovers strong support for the predictions of leverage-constraint based theories.
Boston College, United States of America
We revisit the role of liquidity risk. We successfully replicate Pastor and Stambaugh’s (2003) gamma liquidity risk index and, within their time period, concur with their risk premium estimate. An out-of-their-time-period analysis finds post-time-period returns that are higher and pre-time-period returns that are lower than in-time-period returns. Modest variations to the index that are intended to improve power—such as value weighting, including zero volume days, including all stock price levels, and a modification intended to reduce estimation error—all cast doubt on whether the gamma premium is compensation for liquidity risk. We create five alternative liquidity risk indices from various popular liquidity proxies. Using time-series that start in either 1932 or 1968, none of the ten specifications produce statistically significant risk premia.
1USI Lugano and SFI; 2Imperial College London
We build on a growing literature that studies the impact of market frictions on the dynamics of stock markets, such as momentum, price spirals, excess volatility, and investigate the potential feedback effects of delta-hedging in derivative markets on the underlying market. We document a link between large aggregate dealers' gamma imbalances in illiquid markets and intraday momentum/reversal and market fragility. This link is distinct from information frictions (adverse selection and private information) and funding liquidity frictions (margin requirement shocks). We test our joint hypothesis using a large panel of index and equity options that we use to compute a proxy of aggregate gamma imbalance. We find supporting evidence that intra-day momentum (reversal) is explained by the interaction of negative (positive) aggregate gamma imbalance and market illiquidity. The effect is stronger for the least liquid underlying securities. The result helps to explain both intra-day volatility and autocorrelation of returns.
|10:30 - 12:00||CFGE-6: Ownership and governance|
Session Chair: Heitor Almeida, UIUC
Why are firms with more managerial ownership worth less?
1EPFL, Switzerland; 2Ohio State University; 3Babson College
Using more than 50,000 firm-years from 1988 to 2015, we show that the empirical relation between a firm’s Tobin’s q and managerial ownership is systematically negative. When we restrict our sample to larger firms as in the prior literature, our findings are consistent with the literature, showing that there is an increasing and concave relation between q and managerial ownership. We show that these seemingly contradictory results are explained by cumulative past performance and liquidity. Better performing firms have more liquid equity, which enables insiders to more easily sell shares after the IPO, and they also have a higher Tobin’s q.
Corporate Capture of Blockchain Governance
1London School of Economics; 2Hong Kong University; 3Queen Mary University of London
We develop a theory of blockchain governance. In our model, the proof-of-work system, which is the most common set of rules for validating transactions in blockchains, creates an industrial ecosystem with specialized suppliers of goods and services. We analyze the two-way interactions between blockchain governance and the market structure of the industries in the blockchain ecosystem. Our main result is that the proof-of-work system leads to a situation where the governance of the blockchain is captured by a large firm.
Does corporate governance impact equity volatility? Theory and worldwide evidence
1Queen's University, Canada; 2HEC Montreal
This paper studies the impact of corporate governance on equity volatility. We develop a cor- porate finance model with endogenous financing policies and manager-shareholder agency conflicts. Stronger corporate governance boosts asset valuation and the optimal debt level, but the valuation effect reduces equity volatility more than the additional debt increases it. Thus, equity volatility drops with corporate governance improvements, especially for firms that are financially riskier and more constrained. We confirm our theoretical predictions with a difference-in-difference specifica- tion exploiting the staggered passage of corporate governance reforms on a sample of 33,831 firms from 48 countries over the 1990-2016 period.
|10:30 - 12:00||CFGE-16: Spillover effects|
Session Chair: Morten Bennedsen, University of Copenhagen
Business Group Spillovers: Evidence from the Golden Quadrilateral in India
1HKUST, Hong Kong S.A.R. (China); 2Columbia University and NBER
We compare the investment behavior of standalone firms in different geographical areas after a positive shock to the local investment opportunities generated by a large-scale highway development project. We show that the investment behavior of standalone firms is affected by the density of business groups in the local area, with higher density associated with lower standalone investment. We find evidence in support of a financing mechanism driving this effect: Following the shock, banks disproportionally allocate new loans to business group affiliates, denying standalone firms of external finance. Moreover, we show that standalone firms deprived of finance have higher profitability and TFP than business group affiliates. Overall, our study documents the costs of conglomeration wherein business groups inhibit the growth of standalone firms.
Corporate rivalry and return comovement
1NHH Norwegian School of Economics; 2Tuck School of Business at Dartmouth, USA; 3California Institute of Technology, USA
We study changes in extra-factor, extra-industry return comovement among rival firms as they react to increased competition. Theory of industrial organization suggests that rivals will generally react in one of two ways: increase product differentiation from (become less similar to) close rivals, or reduce differentiation (become more similar) to take advantage of cost-saving scale economies. As changes in idiosyncratic return comovement reflect the resulting changes in underlying cash-flows correlations, our evidence is informative about these two mutually exclusive reaction functions. Notwithstanding substantial cross-industry heterogeneity, rivals typically become more-not less-similar.
Institutional horizontal shareholdings and generic entry in the pharmaceutical industry
1Chinese University of Hong Kong, Hong Kong S.A.R. (China); 2Tuck School of Business at Dartmouth College
Brand-name pharmaceutical companies often file lawsuits against generic drug manufacturers that challenge the monopoly status of patent-protected drugs. Institutional horizontal shareholdings, measured by the weight of generic shareholders' ownership in the brand-name company relative to their ownership in the generic manufacturer, are significantly positively associated with the likelihood that the two parties will enter into a settlement agreement in which the brand pays the generic to stay out of the market. Horizontal shareholdings are also positively associated with the brand's daily abnormal returns around the settlement agreement. Generic manufacturers who settle with the brand-name company and receive a 180 day period of marketing exclusivity are more likely to delay the sale of generic substitutes if they have higher horizontal shareholdings with the brand-name firms. These delays preclude other generic firms from entering the market.
|10:30 - 12:00||HH-2: Discrimination|
Session Chair: Daniel Paravisini, London School of Economics
Predictably Unequal? The Effects of Machine Learning on Credit Markets
1Imperial College London; 2Yale School of Management; 3Swiss National Bank
Innovations in statistical technology, including in predicting creditworthiness, have sparked concerns about differential impacts across categories such as race. Theoretically, distributional consequences from better statistical technology can come from greater flexibility to uncover structural relationships, or from triangulation of otherwise excluded characteristics. Using data on US mortgages,
we predict default using traditional and machine learning models. We find that Black and Hispanic borrowers are disproportionately less likely to gain from the introduction of machine learning. In a simple equilibrium credit market model, machine learning increases disparity in rates between and within groups; these changes are primarily attributable to greater flexibility.
Discrimination in the Auto Loan Market
1Rice University, United States of America; 2Southern Methodist University, United States or America
We provide evidence of discrimination in the auto loan market. Combining credit bureau records with borrower characteristics, we find that Black and Hispanic applicants’ loan approval rates are 1.5 percentage points lower than White applicants’, even controlling for creditworthiness. In aggregate, this discrimination leads to over 80,000 minorities failing to secure loans each year. Results are stronger in more racially biased states and where banking competition is lower. Minorities who receive loans pay interest rates 70 basis points higher than comparable White borrowers. Ceteris paribus, minority borrowers have lower ex post default rates, consistent with preference-based racial discrimination. An anti-discrimination enforcement policy initiated in 2013, but halted in 2018, was effective in reducing unexplained racial disparities in interest rates by nearly 60%.
Performance Isn't Everything: Personal Characteristics and Career Outcomes of Mutual Fund Managers
1Brandeis University, United States of America; 2University Of California Davis; 3Board of Governors of the Federal Reserve System
We investigate the determinants of mutual fund manager career outcomes. We find that, although career outcomes are largely determined by past performance, measured by returns and fund flows, personal attributes also factor in. All else equal, female managers are less likely to be promoted and have shorter tenures than male fund managers. This finding applies to a greater extent to women who co-manage funds with other managers, which suggests that working in teams negatively affects women's careers when compared to men's. Moreover, we show that, all else equal, younger managers, U.S.-educated managers, and managers who attended elite schools experience better career outcomes than otherwise similar managers.
|10:30 - 12:00||ECB-1: Interaction of monetary and macroprudential policies, impact of regulations and spillover across the financial sector|
Session Chair: Angela Maria Maddaloni, European Central Bank
Bank Market Power and Monetary Policy Transmission: Evidence from a Structural Estimation
1University of Illinois, Urbana-Champaign; 2University of Michigan; 3Columbia University
We quantify the impact of bank market power on the pass-through of monetary policy to borrowers. To this end, we estimate a dynamic banking model in which monetary tightening increases banks' funding costs. Given their market power, banks optimally choose how much of a rate increase to pass on to borrowers. In the model, banks are subject to capital and reserve regulations, which also influence the degree of pass-through. Compared with the conventional regulation-based channels, we find that in the two most recent decades, bank market power explains a significant portion of monetary transmission. The quantitative effect is comparable in magnitude to the bank capital channel. In addition, the market power channel interacts with the bank capital channel, and this interaction can reverse the effect of monetary policy when the Federal Funds rate is low.
Inspecting the Mechanism of Quantitative Easing in the Euro Area
1Universite du Luxembourg, Luxembourg; 2Chicago Booth Business School; 3Princeton University; 4Banque de France
Using new security-level portfolio holdings data in the euro area by country and investor type, we study how investors rebalance in response to the European Central Bank’s (ECB) purchase programme that started in March 2015. To quantify changes in risk concentration, we estimate the evolution of the distribution of duration, sovereign, and corporate credit risk exposures across investors and geographies. We find that 70% of ECB purchases are sold by the foreign sector and that risk mismatch, if anything, reduces. We use an instrumental variables estimator to show that the average impact on yields was -13bp. We connect the portfolio rebalancing and price effects by estimating a sector-level asset demand system for government debt.
Banking Supervision, Monetary Policy and Risk-Taking: Big Data Evidence from 15 Credit Registers
1ECB; 2ICREA-Universitat Pompeu Fabra; 3CREI; 4Barcelona GSE; 5Imperial College London; 6CEPR
We analyse the role of banking supervision for banks’ risk-taking behaviour, and its interactions with monetary policy. We exploit a new, proprietary dataset based on 15 European credit registers, in conjunction with the centralization of bank supervision for some banks at the supranational level, over a period of unprecedented monetary policy action. We find that: (1) banks with higher ex-ante non-performing loans (NPL) supply more credit toward riskier firms, with identical effects for banks headquartered in stressed and non-stressed countries. Results are identical to considering a measure of NPL that excludes the borrower’s industry, and also to the inclusion of a large set of controls, such as borrower-lending matching and time-varying unobserved borrower and lender fundamentals that explain 70 p.p. of the R-squared, thereby suggesting strong exogeneity of our results to credit demand and other bank characteristics; (2) For banks operating in stressed countries only, centralized supervision compresses lending to riskier firms, although by a smaller extent for banks with higher NPL. Effects are similar if we include only banks around the threshold of eligibility for centralized supervision, and effects are only significant after the centralization of supervision; (3) Monetary policy easing increases bank risk-taking, but– only in stressed countries– this is partly offset by centralized supervision, with weaker effects for banks with higher NPLs. Overall, results show that leveraging on multiple credit registers –as done in this paper for the first time– is crucial for analysing heterogeneous effects and for the external validity.
|10:30 - 12:00||FIIE-10: Asset Management|
Session Chair: Richard Evans, University of Virginia
Out of Sight No More? The Effect of Fee Disclosures on 401(k) Investment Allocations
1University of Texas at Austin; 2University of Illinois at Urbana-Champaign; 3Indiana University; 4Board of Governors of the Federal Reserve System
Using a hand-collected dataset on investment menus for a large sample of 401(k) plans, we examine the effects of a 2012 regulatory reform of investment option disclosures on participants' allocations across funds. Despite skepticism surrounding the effectiveness of the regulation, we show that participants become significantly more attentive to expense ratios after the reform. The results are stronger for plans with larger account balances and those that are non-unionized. Additionally, they are not driven by secular changes in investor attention or sponsor-initiated changes to the investment menu before the reform. Finally, we find that flows also become more sensitive to short-term performance measures.
Finding Fortune: How Do Institutional Investors Pick Asset Managers?
1Indiana University, Bloomington, United States of America; 2University of North Carolina, Chapel Hill; 3Tulane University
We propose a framework of private information acquisition and decision timing for asset allocators who hire outside investment managers. We test the framework using unique data detailing due diligence interactions between an allocator and 1,093 hedge funds over 8 years. We find that the production of private information complements public information at the intensive margin and substitutes it at the extensive margin. The allocator strategically chooses the precision at which to acquire private signals, reducing due diligence time by 58% and improving decision quality. In a matched sample, selected funds outperform by 9.0% over 20 months. This outperformance relates to learning about funds’ return-to-scale constraints and innate skill earlier than other asset allocators.
How much labor do you need to manage capital?
1Boston College, United States of America; 2Bocconi University
We use employment data for U.S. registered investment advisors (RIAs) to investigate which clienteles, asset classes, and investment strategies require more labor, and to study the marginal value of labor in investment management. After controlling for observables, having more employees is not associated with better returns. However, a larger payroll is associated with more assets under management in the future, justifying the additional labor costs from the firm’s point of view. Our results are consistent with a simple model in which investment firms optimize marketing-related versus investment-related employment under labor market frictions.
|10:30 - 12:00||FIIT-2: Designing bank regulation and supervision|
Session Chair: Joao Santos, Federal Reserve Bank of New York
Illiquidity, Closure Policies and the Role of LOLR
1European Central Bank, Germany; 2Columbia University
We develop a dynamic model of a bank which chooses its optimal liquidity buffers, equity issuance policies, and asset portfolio size when facing frictions in equity issuance, asset liquidations, and closure policies. The bank has a fixed level of debt that it can roll over in the interbank market and has access to central bank liquidity facilities. The central bank policies generally lead to a greater investment in new loans, lower asset liquidations and a lower expected cost of closure. On the other hand, the central bank's provision of liquidity causes the bank to hold lower cash buffers than the bank would have held in the absence of a central bank. It also reduces the incentives of the bank to issue equity or cut dividends. We show that the collateral framework inherently produces these tradeoffs. Using novel data sets we estimate that the average borrowing capacity of banks at the ECB is about 50% of the assets held by the banks. The data also shows that the banks with higher borrowing capacity tend to originate more new loans. These stylized facts are broadly consistent with the model's implications. The credit spreads in the interbank market widens in periods of illiquidity. We run some policy experiments within the modeling framework, wherein we explore the effects of changes in ex-ante margins, penalty rates, and bank closure boundaries on the lending channel, equity issuance and liquidity buffers.
Stress Testing and Bank Lending
1University of Oxford; 2Frankfurt School of Finance and Management
Bank stress tests are a major form of regulatory oversight implemented in the wake of the financial crisis. Banks respond to the strictness of the tests by changing their lending behavior. As regulators care about bank lending, this affects the design of the tests and creates a feedback loop. We analyze a reputational model of this feedback effect where the regulator trades off the costs of reduced credit to the real economy versus the benefits of preventing default. Stress tests may be (1) lenient, in order to encourage lending in the future, (2) tough, in order to reduce the risk of costly bank defaults, or (3) perfectly informative, and there may be multiple equilibria. We find that in some situations, surplus would be higher without stress testing and regulators may strategically delay stress tests.
Sovereign risk and bank fragility
We develop an equilibrium model of bank risk-taking in the presence of strategic sovereign default risk. Domestic banks can either invest in real projects or purchase government bonds. While an increase in purchases of government bonds crowds out profitable investment, it nevertheless improves the government's incentives to repay and reduces the bond price. However, since banks are price-takers in bond markets, this gives rise to a pecuniary externality. We analyze the welfare consequences of the externality and relate our findings to the debate on the efficacy of recent policy proposals for regulating banks' sovereign debt exposures.
|12:00 - 13:30||Lunch break|
|13:30 - 15:00||APE-6: Cross-section of stock returns: higher-order moments and mis-specification|
Session Chair: Grigory Vilkov, Frankfurt School of Finance and Management
Correcting Misspecified Stochastic Discount Factors
1EDHEC Business School, United Kingdom; 2Imperial College London; 3Stockholm School of Economics
We show how, given a misspecified stochastic discount factor (SDF), one can construct an admissible SDF, namely an SDF that prices assets correctly. We first extend the traditional Arbitrage Pricing Theory (APT) to capture misspecification from both pervasive (systematic) pricing errors and idiosyncratic pricing errors. The constructed admissible SDF, which uses the extended APT as its foundation, satisfies the Hansen and Jagannathan (1991) bound exactly.* If the number of assets N is large, the admissible SDF recovers the contribution of the missing pervasive factors completely without requiring one to identify the missing factors. Indeed, projecting the correction term of the SDF on the space spanned by the candidate missing factors, achieves an R-squared that converges to one as N increases. Our approach applies also to nonlinear SDFs that typically characterize equilibrium asset-pricing models, where our correction fully accounts for the nonlinear components. Simulations demonstrate that the theory we develop is remarkably effective in correcting various sources of misspecification.
1Bocconi University; 2University of Chicago, Booth School of Business
We estimate and analyze the ex ante higher order moments of stock market returns. We document that even and odd higher-order moments are strongly negatively correlated, creating periods where the return distribution is riskier because it is more left-skewed and fat tailed. Such higher-moment risk is negatively correlated with variance and past returns, meaning that it peaks during calm periods. The variation in higher-moment risk is large and causes the probability of a two-sigma loss on the market portfolio to vary from 3.3% to 11% percent over the sample, peaking in calm periods such as just before the onset of the financial crisis. In addition, we argue that an increase in higher-moment risk works as an "uncertainty shock" that deters firms from investing. Consistent with this argument, more higher-moment risk predicts lower future industrial production.
Crash Risk in Individual Stocks
University of Houston, United States of America
In this paper I study and implement skewness swaps in individual stocks, which are trading strategies closely related to the more familiar variance swaps. Just as variance swap returns measure the variance risk premium, skewness swap returns measure the skewness risk premium. I document that (i) the returns of the skewness swaps in individual stocks are positive and significant (ii) after the 2008/2009 financial crisis the returns of the skewness swaps on individual stocks increase substantially while the return of the skewness swap on the market index does not change. The result is robust for different measures of skewness and it is not driven by the difference in option data availability and liquidity between the index and individual stocks. This result provides evidence of a new idiosyncratic skewness risk priced in individual stock. I finally discuss different possible explanations for this pattern.
|13:30 - 15:00||MM-1: The Speed and Transparency of Trading|
Session Chair: Batchimeg Sambalaibat, Indiana University
Endogenous Specialization and Dealer Networks
Indiana University, United States of America
OTC markets exhibit a core-periphery interdealer network: 10-30 central dealers trade frequently and with many dealers, while hundreds of peripheral dealers trade sparsely and with few dealers. Existing work rationalize this phenomenon with exogenous dealer heterogeneity. We build a directed search model of network formation and propose that a core-periphery network arises from specialization. Dealers endogenously specialize in different clients with different liquidity needs. The clientele difference across dealers, in turn, generates dealer heterogeneity and the core-periphery network: The dealers specializing in clients who trade frequently form the core, while the dealers specializing in buy-and-hold investors form the periphery.
High-Frequency Trading During Flash Crashes: Walk of Fame or Hall of Shame?
1Research Center SAFE - Goethe University; 2CREATES, Aarhus University; 3Alliance Manchester Business School; 4Department of Economics, University of Verona
High Frequency Traders are not beneficial to the liquidity and efficiency of the stock market during flash crashes. Actually, and especially when crashes affect several stocks simultaneously, they consume the liquidity they should provide and originate a transient price impact which is not related to fundamentals. This is true even in a market where market makers are compensated for liquidity provision. The policy implication of our findings is that such a compensation scheme is not sufficient to prevent flash crashes from happening. These facts are uncovered by the analysis of a “big” dataset composed of all orders and transactions on stocks with categorized information about execution.
Quasi-dark trading: The effects of banning dark pools in a world of many alternatives
1University of Mannheim; 2University of Technology Sydney; 3University of Frankfurt; 4University of Vienna; 5Stockholm School of Economics, Riga; 6Research Center SAFE
We show that “quasi-dark” trading venues, i.e., markets with varying degree of opacity, are important parts of modern equity market structure alongside lit markets and dark pools. Using the European MiFID II regulation as a quasi-natural experiment, we find that dark pool bans lead to (i) volume spill-overs into quasi-dark trading mechanisms; (ii) little volume returning to transparent public markets; and consequently, (iii) a negligible impact on market liquidity and short-term price efficiency. These results show that quasi-dark markets serve as close substitutes for dark pools and consequently mitigate the effectiveness of dark pool regulation. Our findings highlight the need for a broader approach to transparency regulation in modern markets that takes into consideration the many alternative forms of quasi-dark trading.
|13:30 - 15:00||APE-4: Liquidity in Corporate Bond Market|
Session Chair: Peter Feldhütter, Copenhagen Business School
Corporate Bond Liquidity: Evidence from Government Guarantees
Federal Reserve Board, United States of America
We use a unique set of corporate bonds guaranteed by the full faith and credit of the U.S. to examine the default- and nondefault-related components in corporate bond spreads. Based on a matched sample of guaranteed and non-guaranteed corporate bonds, we find that 16% of the yield spread between investment grade corporate bonds and Treasury securities is not accounted for by government credit guarantees. Our estimate of the non-default component differs from the bond-CDS basis, suggesting that not only corporate bond spreads but also CDS spreads depend on non-default factors. Its magnitude is determined by the provision of dealer intermediation as well as bond-specific characteristics such as time to maturity and issue size.
Pledgeability and Asset Prices: Evidence from the Chinese Corporate Bond Markets
1MIT Sloan School of Management and NBER; 2PBC School of Finance, Tsinghua University; 3Booth School of Business, University of Chicago, and NBER; 4University of International Business and Economics, China, People's Republic of; 5CITIC Securities
We provide causal evidence for the value of asset pledgeability. Our empirical strategy is based on a unique feature of the Chinese corporate bond markets, where bonds with identical fundamentals are simultaneously traded on two segmented markets that feature different rules for repo transactions. We utilize a policy shock on December 8, 2014, which rendered a class of AA+ and AA bonds ineligible for repo on one of the two markets. By comparing how bond prices changed across markets and rating classes around this event, we estimate that an increase in haircut from 0 to 100% would result in an increase in bond yields in the range of 40 to 83 bps. These estimates help us infer the magnitude of the shadow cost of capital in China.
Market Accessibility, Corporate Bond ETFs, Liquidity
1Indiana University, United States of America; 2Southern Methodist University, United States of America
We find that market accessibility ex ante plays an important role in how the underlying assets’ liquidity changes when a basket security is introduced. First, using a multi-market version of the Kyle model, We show that the less (more) accessible the underlying market is, the more its liquidity improves (deteriorates) when basket trading becomes available. Second, We empirically test these predictions using corporate bonds before and after the introduction of ETFs. Consistent with the model, liquidity improvement is larger for highly arbitraged, low-volume, high-yield, and long-term bonds and for 144A bonds to which retail investor access is not permitted.
|13:30 - 15:00||CFGE-7: Corporate Governance|
Session Chair: Vyacheslav Fos, Boston College
Media and Shareholder Activism
Indiana University, Bloomington, United States of America
Using more than twenty-five million firm-level articles published in the media, I examine the role of media in shareholder activism events during the years 2002-2014. I find that conditioning on numerous observable firm-specific characteristics and unobservables, broader and negative ex-ante media coverage is positively associated with the probability of a firm being a shareholder activist’s target. The positive correlation between media coverage and the propensity for targeting by activists is robust to the use of instrumental variable (IV) approach indicating that the documented relation is plausibly causal. The association between negative media tone and activism is stronger during the times of greater divergence of opinion about the firm amongst analysts. However, during times of overall low sentiments, the shareholder activists become less sensitive to media tone. I further document that media coverage also plays a crucial role in determining the outcomes of activism events. Target firms with ex-ante positive media coverage not only have significantly lower announcement returns but also have a higher likelihood of management winning. Overall, the results provide empirical evidence for the linkage between shareholder activism and limited investor attention and investor opinion, as suggested by theories.
Punish One, Teach A Hundred: The Sobering Effect of Punishment on the Unpunished
1University of Chicago, United States of America; 2Boston College, United States of America; 3Chinese University Hong Kong
Direct experience of a peer's punishment might make salient the probability and consequences of facing punishment and hence induce a change in the behavior of non-punished peers. We test this mechanism in a setting, China, in which we observe the reactions to the same peer's punishment by listed firms with different incentives to react -- state-owned enterprises (SOEs) and non-SOEs. After observing peers punished for wrongdoing in loan guarantees to related parties, SOEs -- which are less disciplined by traditional governance mechanisms than non-SOEs -- cut their loan guarantees. SOEs whose CEOs have stronger career concerns react more than other SOEs to the same punishment events, a result that systematic differences between SOEs and non-SOEs cannot drive. SOEs react more to more salient events even if information about all events is publicly available. After peers' punishments, SOEs also increase their board independence, reduce inefficient investment, increase total factor productivity, and experience positive cumulative abnormal returns around peers' punishments. We detect no shifting to more opaque forms of tunneling. Strategic punishments could be a cost-effective governance mechanism when other forms of governance are ineffective.
Peer Effects in Corporate Governance Practices: Evidence from Universal Demand Laws
1University of New South Wales (UNSW), Australia; 2Boston College; 3University of Hong Kong
Firms in the same networks tend to have similar corporate governance practices. However, it is difficult to disentangle peer effects, where governance practices propagate from one firm to another, from selection effects, where firms with similar governance preferences self-select into linked groups. Studying board-interlocked firms, we utilize a novel instrument based on the staggered adoption of universal demand laws across states to identify causal peer effects in firms’ decisions concerning CEO compensation, CEO duality, and anti-takeover provisions. Our results provide support for the existence of peer effect in the adoption of anti-takeover provisions. We find that the entrenchment index (E-Index) of a firm increases by 0.33 points for every point increase in the E-Index of firms in the same board interlock network. The impact of universal demand laws on the interlocking directors’ prior experience in passing these provisions is a likely mechanism explaining these effects.
|13:30 - 15:00||CFGE-15: Contracts and Incentives|
Session Chair: Isaac Hacamo, Nova School of Business and Economics
Payday before Mayday: CEO Compensation Contracting for Distressed Firms
1Boston College, United States of America; 2Texas A&M, United States of America
Using detailed information on features of CEO contracts for more than 1,400 US public firms in the period 1998-2016, we examine changes in the structure of CEO compensation contracts when firms become financially distressed. When performance declines, firms face significant changes in liquidity, the need to replace or to retain the incumbent CEO, and the need to align CEO interests with those of shareholders versus creditors, each of which impacts contracting and CEO incentives. We find that distressed firms have lower pay-performance sensitivity if performance is measured against stock or earnings based metrics, but not when measured by cash flow based metrics. Examining the ex-ante compensation contracts, we find that distressed firms increase their overall use of performance metrics, particularly those that are based on cash flows, and set performance targets farther above prior performance. These changes in contracting increase in frequency and magnitude in the years preceding default. Overall, the observed changes in contracts reflect the need to re-align incentives rather than rent extraction by CEOs of distressed firms.
Pay for Future Returns
1London School of Economics, United Kingdom; 2New York University Shanghai
We show that firms use inside information on future performance to determine executive compensation. Our research strategy - to focus on salary raises - is based on actual contract practice from 649 hand-collected CEO employment contracts. Provisions for compensation reviews are prevalent in 55% of contracts, and almost all provisions link reviews to fixed compensation. Firms with review provisions give 7.5% more salary raises and are 8.1% less likely to explain them with observable performance measures. These raises predict events and performance next year - 24% more product announcements with 0.3% higher announcement returns. A hypothetical long-short portfolio investing in salary-raising firms could earn annual abnormal returns of 6%. Our paper underscores the importance of \pay for future returns" in motivating long-term performance.
Relative Performance Evaluation and Strategic Competition
1Rotterdam School of Management, Erasmus University Rotterdam; 2Ross School of Business and the NBER, University of Michigan; 3Lancaster University Management
This paper examines how the use of relative performance evaluation (RPE) affects industry competition. Using data from the U.S. airline industry, we estimate a dynamic game of competition with heterogenous firms in an oligopolistic market with the presence of RPE contracts. As is standard, RPE makes CEO compensation less sensitive to market conditions. Therefore, the CEO’s propensity to operate in a given market is determined by a tradeoff arises between the reduction in compensation based on market conditions and the gain from being compared to competing agents. The estimation results show that the use of RPE decreases a firm’s tendency to be active under bad market conditions by 10.1%. Conversely, the tendency to be active rises in good market conditions by 12.4%. These effects are stronger for firms with lower fixed operating costs.
|13:30 - 15:00||HH-4: Labor Markets and Human Capital|
Session Chair: Paolo Sodini, Stockholm School of Economics
Do Robots Increase Wealth Dispersion?
1Sveriges riksbank, Sweden; 2Frankfurt School of Finance and Management, Germany
We demonstrate that increased automation has a significant impact on both static and dynamic aspects of wealth distribution. Households who are more exposed to robots at work accumulate less wealth and experience greater downward mobility in the wealth distribution. The negative wealth effects of robots are not merely a consequence of differences in earned incomes or in saving rates. We argue and provide evidence that the adverse effects of rapid robotization on individual workers’ human capital, and thereby, on their financial risk taking behavior and investment choices appear to be an additional operative channel.
Globalization, Competition and Entrepreneurial Activity: Evidence from US Households
1University of Houston, United States of America; 2Georgia State University
Motivated by the accelerated decline in US entrepreneurship in the past two decades, and using a unique panel dataset of US households, we theoretically and empirically analyze the economy-wide effects of increased product market competition through low-cost import penetration on household entrepreneurial activity. Our study is unique in documenting the asymmetric inter-sectorial shifts in entrepreneurial activity between (trade) exposed and non-exposed sectors. Greater import competition reduces especially business entry in exposed sectors by individuals with low occupational skills (for example, those in routine task-intensity service occupations or exhibiting high occupational mobility), but it increases entry by highly educated individuals in high-skill non-exposed sectors. The results are robust to several alternative hypotheses based on long-run trends in US entrepreneurship and labor market specialization, local collateral and credit shocks, long-run bank distress effects, and dynamic feedback effects.
Clustering Fosters Investment: Local Agglomeration and Household Portfolio Choice
1Cornell University, United States of America; 2University of Miami, United States of America; 3University of South Carolina, United States of America
We investigate the impact of local agglomeration economies on household portfolio choice. Using data from U.S. household surveys, we document that individuals who work in locally agglomerated industries are more likely to invest in risky assets. This pattern is best explained by industry clusters enhancing human capital and in turn, raising workers' allocations to risky assets. Our findings highlight the role of geography in shaping household financial decisions.
|13:30 - 15:00||FIIE-2: Reallocation of risk accross countries|
Session Chair: Hans Degryse, University of Leuven
The Credit Channel of Fiscal Policy Transmission
1Carnegie Mellon University; 2Pennsylvania State University
We propose and test a new channel through which fiscal policy changes affect the supply of intermediated credit and the real economy. Banks that have greater exposure to firms expected to repatriate a significant amount of foreign income as a result of a 2004-2005 U.S. tax holiday subsequently increase lending to other, purely domestic firms during the period of the tax holiday, leading to higher investment at these firms. Our results complement the existing literature on the credit channel of monetary policy transmission and highlight an important indirect spillover effect of fiscal policy changes on credit-constrained firms.
The (re)allocation of bank risk
1European Central Bank, Germany; 2Columbia GSB
Little is known about the location of bank risk, i.e., which investors in which countries hold bank-issued securities like bonds and stocks. In this paper, we analyze the (re-)distribution of bank risk across asset classes (short- and long-term debt, equity), across investor types and across geographic locations. We also differentiate bank holdings according to riskiness based on credit ratings and yield spreads. We use the Securities Holdings Statistics database for the euro area which contains information on securities holdings at the ISIN level. Our main findings are as follows. First, bank risk is held disproportionately by other banks. Second, households are disproportionally exposed to riskier bank securities. Third, about 30% of bank securities are held outside the euro area, with these percentages larger (smaller) for short term debt and equities (long term debt). Large issuers of bank risk also hold most of the bank risk, with the exception of the Netherlands, which, despite being a top 5 issuer, holds almost no bank securities. Fourth, bank risk re-allocation is overall statistically significant but economically more important for bonds than for equities. Finally, we use a comprehensive stress test administered by the European Central Bank in 2014 to define differential shocks to bank’s riskiness. We find that if the riskiness of a bank increases, other banks increase their holdings of riskier bonds.
”Brexit” and the Contraction of Syndicated Lending
1Frankfurt School of Finance & Management, Germany; 2New York University
We analyze the effect of policy uncertainty on global syndicated loan markets using the “Brexit vote” – the vote of the UK citizens to leave the European Union – as a laboratory. Issuances in the UK syndicated loan market drop by 23% after the Brexit vote relative to a set of comparable syndicated loan markets. We propose a new matching strategy – “Siamese Twins Matching” – to identify appropriate counterfactuals for the UK market. We further analyze a novel channel, market attractiveness: firm-bank combinations that used to issue loans in both the UK market and other markets do not decrease their issuances in the UK market more than in other markets after the Brexit referendum – suggesting that the UK market did not significantly lose attractiveness relative to other international markets. We also document a strong decrease in the issuance of British pounds denominated loans after the Brexit for the same firm-bank combinations who switch into alternative currencies such as the US Dollar and the Euro. Our results help to understand the dynamics of competition between financial centers and the role of policy uncertainty shocks in this competition.
|13:30 - 15:00||FIIE-11: International Capital Markets|
Session Chair: Pedro Matos, University of Virginia
Session Chair: Richard Evans, University of Virginia
Do Foreign Institutional Investors Improve Market Efficiency?
1Imperial College London; 2Tsinghua University
We study the impact of foreign institutional investors on global capital allocation and welfare using firm-level international data. Using MSCI index inclusion as an exogenous shock to foreign ownership, we show that greater foreign ownership leads to more informative stock prices and this effect arises more from increased price efficiency than from improved firm governance. We further show that the impact of capital flows on price efficiency is due to real efficiency gains, as opposed to better information disclosure. Finally, we show that foreign ownership increases market liquidity, reduces firms' cost of equity, and leads to subsequent growth in their real investments, thus improving overall welfare.
Unbundling and Analyst Competition: Evidence from MiFID II
Columbia Business School
Sell-side research is typically bundled with transaction, giving rise to potential conflicts of interests between sell-side analysts and their clients. What will happen if research is unbundled from transaction? We investigate this question under the context of MiFID II. We provide evidence that unbundling causes a decrease in firm's sell-side coverage. Such a drop does not come from small or mid-cap firms, but concentrates on large firms. Contrary to the conventional wisdom, decrease in coverage quantity is not accompanied with decrease in coverage quality. Our analyzes suggest a competition channel driving the results. Redundant sell-side analysts drop out (extensive margin) and analysts who stay have stronger incentives to produce high-quality research (intensive margin). Our findings offer new insights on how analyst incentives affect research quality, provide empirical facts for designing the optimal way to pay for information, and have wide implications for regulatory authorities contemplating a similar regulatory change.
Credit default swaps around the world: Investment and financing effects
1Seoul National University, Korea, Republic of (South Korea); 2Warwick Business School; 3UNC Kenan-Flagler Business School; 4NYU Stern School of Business
We analyze the impact of the introduction of credit default swaps (CDS) on real decision making within the firm, taking into consideration differences in firms’ local economic and legal environments. We extend the model of Bolton and Oehmke (2011) to take into account uncertainty whether the actions taken by the reference entity will trigger credit events for the CDS obligations. We test the predictions of the model in a sample of more than 56,000 firms across 50 countries over the period 2001–2015 and find substantial evidence that the introduction of CDS affects real decisions within the firm, including those regarding leverage, investment, and the riskiness of the firm’s investments. Importantly, we find that the legal and market environments in which the reference entity operates have an influence on the impact of CDS. The effect of CDS is larger in environments where uncertainty regarding CDS obligations is reduced and where CDS mitigate weak property rights. Our results shed light on the incomplete nature of CDS contracts in international capital markets, related to significant legal uncertainty surrounding the interpretation of underlying credit events.
|13:30 - 15:00||FIIT-3: Dealers and market power|
Session Chair: Katrin Tinn, Imperial College Business School
Taking Orders and Taking Notes: Dealer Information Sharing in Treasury Auctions
1Columbia Business School, United States of America; 2Federal Reserve Bank of New York
The use of order flow information by financial firms has come to the forefront of the regulatory debate. A central question is: Should a dealer who acquires information by taking client orders be allowed to use or share that information? We explore how information sharing affects dealers, clients and issuer revenues in U.S. Treasury auctions. Because one cannot observe alternative information regimes, we build a model, calibrate it to auction results data, and use it to quantify counter-factuals. We estimate that yearly auction revenues would be \$2.4 billion higher with full-information sharing with clients and between dealers. When information sharing enables collusion, the collusion costs revenue; but if dealers share information with clients, prohibiting information sharing may cost more. For investors, the welfare effects of information sharing depend on how information is shared. The model shows that investors can benefit when dealers share information with each other, not when they share more with clients.
Prime Broker Exposures, Collateral, and Resilience in Hedge Fund Credit Networks
1Cornell University; 2Federal Reserve Board of Governors; 3Office of Financial Research, US Department of the Treasury; 4Oxford-Man Institute of Quantitative Finance, University of Oxford
The collapse of Lehman Brothers illustrated the importance of managing prime broker counterparty risks for hedge funds. The central role of prime brokers and hedge funds in financial intermediation also makes understanding their credit dynamics a financial stability concern. While the hedge fund-prime broker credit network is highly concentrated, the average hedge fund in our sample borrows from three prime brokers and has a total credit exposure of $2.15 billion. We show that hedge fund borrowing tends to be overcollateralized and most of the collateral is allowed to be rehypothecated. Using a within fund-quarter empirical strategy, we identify the effects of an idiosyncratic liquidity shock to a major creditor. Such a shock results in significantly reduced borrowing due to the prime broker reducing credit supply instead of a precautionary reduction in credit demand from connected hedge funds. Borrowing by funds with more rehypothecable collateral is less affected because such collateral improves the constrained creditor's liquidity situation. Even large hedge funds simultaneously borrowing from multiple creditors see a significant reduction in their aggregate borrowing following the shock. Larger, more connected and better-performing hedge funds and those that do less OTC trading are better able to compensate for this loss.
Risk-Sharing and Investment in Concentrated Markets
University of Texas at Austin, United States of America
We study investment and risk sharing in complete markets when agents internalize their impact on asset prices. Quantity shading of state-contingent claims by buyers and sellers generates excess exposure to idiosyncratic risk and low asset pledgeability. This depresses investment, the risk-free rate, and aggregate productivity. Rents from market power distort and misalign agents' marginal valuations of state-contingent returns, rendering risk-sharing constrained inefficient and as if markets were competitive but incomplete. When there is limited commitment, sellers face borrowing constraints that limit their ability to strategically restrict supply, thereby reallocating market power to buyers. When markets are decentralized, agents distort investment to capture arbitrage profits by acting as pass-through intermediaries.
|13:30 - 15:00||Panel 2: The EC Sustainable Finance Action Plan: the potential of regulation to tackle climate change|
Organized in collaboration with the European Commission – Joint Research Centre
|15:00 - 15:30||Coffee break|
|15:30 - 17:10||KS.GA: Keynote Speech - Prize Ceremony - EFA General Assembly|
Keynote Address by Professor Andrei Shleifer (Harvard University)
EFA Paper Prizes, Review of Finance Prizes and the EFA Doctoral Tutorial Prizes
|18:30||Bus Conference Dinner: Check exact route time and book your ride on time!|
|19:00 - 23:00||CD: Conference Dinner|
Participants are invited to join the highlight of the social program. The Conference Dinner will be held at the restaurant SUD Lisboa, which offers a wonderful view of the Tagus River and it is located close to the famous Belém area.