This paper presents evidence that firms choose conservative financial policies to mitigate firms’ exposure to short selling threat. I exploit changes in the regulation of short selling constraints as an exogenous shock to the short selling threat borne by firms. I find that higher short selling threat leads to decreased corporate leverage, particularly for firms facing greater expected short selling threats, for firms with higher financial distress risks, and for firms whose managers are more risk averse. The findings suggest that short selling threats have a significant impact on corporate financing decisions through changes in the costs of financial distress.

The liquidity shocks of ’08–’09 revealed that measures of liquidity risk being used in most financial institutions turned out to be woefully inadequate. The construction of long-short portfolios based on liquidity proxies introduces errors such as extraneous risk factors and hedging error. We develop a new measure for liquidity risk using exchange-traded funds (ETFs) that attempts to minimize this error. We form a theoretically-supported measure that is long ETFs and short the underlying components of that ETF, i.e., long and short a similar set of underlying securities with the same weights. Pricing discrepancies between the long and short positions are driven by liquidity differences between the ETF and its underlying components. Constructing liquidity risk factors in a number of markets, we undertake several tests to validate our new liquidity metric. The results show that our illiquidity measure is strongly related to other measures of illiquidity, explains bond index returns, and reveals a systematic illiquidity component across fixed-income markets.

In an attempt to explain the weak evidence of priced exchange rate risk, we hypothesize that in addition to currency derivative usages, earnings management serves as another factor contributing to a reduction in exchange rate exposure. Our evidence reveals that earnings management activities, particularly those undertaken for the purpose of income smoothing, significantly reduce firm-specific exchange rate exposure, and that such role is particularly important if appropriate currency derivative instruments are limited. These results complement prior attempts to explain the puzzle of unpriced exchange rate risk. The investigation also highlights the importance of recognizing different managerial purposes behind discretionary accruals.

We examine whether religion affects the terms of bank loans. We hypothesize that lenders value the traits of religious adherents, such as risk aversion, ethical behavior and honesty, and thus offer favorable loan terms to religious borrowers. Consistent with this hypothesis, we find that corporate borrowers located in counties with a high level of religiosity are charged lower interest rates, have larger loan amounts and fewer loan covenants. These results suggest that the corporate culture of borrowers influences the availability and cost of bank loans.

We document that acquirer announcement returns and post-M&A performance rise with a target's proportion of intangible assets. This shareholder wealth creation is associated with profitable acquirers purchasing complementary intangible assets and promising growth options from less profitable targets. Purchase prices are lower when targets face financial constraints limiting their ability to pursue promising investment opportunities. Analyzing acquisitions across different classes of intangible assets and matching successful with failed bids for targets with intangible assets support our main findings and suggest that these results are robust to endogeneity concerns. We conclude that target intangible assets provide important sources of M&A value creation.

If prices of individual stocks are unbiased but noisy approximations to fundamental values, there will be a gap in returns between the standard cap-weighted market portfolio and the one based on fundamentals. The discrepancy occurs because, relative to fundamentals, cap-weights are too large (small) for stocks with positive (negative) deviations from fundamental values. It follows that the usual cap-weighted portfolio will underperform relative to the fundamental-based portfolio as long as prices revert to fundamental values. This has led Arnott et al. to propose new market indices based on a firm’s fundamental size as measured by its revenues, number of employees, and so on. In this paper we follow the same principle but propose to estimate fundamental weights using a smoothed average of standard cap-weights. Since the putative excess returns of a fundamentals-weighted portfolio requires reversion to fundamental values, and because fundamental values are likely to change slowly, we can estimate current fundamentals by smoothing the time series of a stock’s noisy prices. The determination of fundamental size in terms of accounting data is thereby replaced by a simple estimate based on price history. We derive expressions for expected returns of the market capitalization-based and fundamentals-based portfolios under various assumptions about (i) the random deviations from fundamental values and (ii) the change in fundamentals over time. We present empirical comparisons between portfolios and find the returns of the fundamentals-based portfolios exceed the standard indices by an amount comparable to the prior estimates that used accounting data to determine size.

This paper tests for herding towards the market consensus for US and UK leading stocks, and to the best of our knowledge addresses a gap in the literature regarding the importance of major fundamental macroeconomic announcements. The results indicate that US investors tend to herd during days when important macro data are released, and that there have been herding spill-over effects from the US to the UK during earlier financial crises. Further results reveal more differences in herding behavior between the two markets: in the US we find that investors herd due to both fundamentals and non-fundamentals during different crises, when in the UK there is herding only due to fundamentals and only during the Dotcom bubble burst. These results suggest that the drivers of herding behavior are period and country specific.

This study investigates the underexplored role of onsite viewing activities in the housing search process. By incorporating buyer heterogeneity into the housing search model of Courant (1978), we show that buyers with higher private valuations tend to view more properties onsite and ultimately pay higher prices. Utilising a proprietary dataset from the largest real estate agency in Beijing, our analysis reveals that increased onsite viewings significantly enhance both the likelihood of a transaction and the final purchase price. We establish causality by employing an instrumental variable approach that leverages exogenous variations in heavy pollution and rainfall, which hinder buyers’ ability to conduct onsite house viewings. More intensive onsite viewings raise transaction price as they reveal a buyer’s higher private valuation to the seller. Besides, onsite viewings also function through reducing information asymmetry and improving match quality.

Using a large sample of firms from 43 markets, we find significant time-series variation in firms’ leverage ratios around the world. Industry median leverage ratios and aggregate leverage ratios also change substantially over time. Relative to actual leverage ratios, target leverage ratios estimated from the time-varying target models are much more stable. Variance decomposition shows that leverage instability is largely driven by deviations from the target. A number of firm and market characteristics are related to capital structure instability. We also find evidence consistent with firms using financing activities to adjust their leverage ratios towards the target in global markets.

We explore the impact of capital adequacy requirements on financial institutions’ risk-taking behavior from a novel perspective. Specifically, we show that an important feature of the risk-based capital (RBC) system—a built-in diversification benefit in aggregating risk categories—induces moral hazard. We find that insurers that face lower marginal RBC costs of fixed-income (FI) investment tend to purchase riskier FI securities. This relationship holds even when lower marginal RBC costs result from increased risk in other risk categories, which is an unintended consequence of the RBC's square root rule. Using Hurricanes Katrina and Sandy as exogenous shocks to the RBC cost, we find that insurers that suffered more in the two disasters undertook more risk in their FI investments and witnessed an increase in their overall risk. We further show that insurers with a high RBC cost sell similar risky bonds during the financial crisis, presenting a source of systemic risk. These results provide an important regulatory implication for minimum capital calculation in capital regulation regimes.