Knowledge that Transforms

We propose that the arrival of new information is a source of systematic risk for the holder of a financial security. Using several measures of information flows, we demonstrate that a stock’s sensitivity to market-wide information flow is associated with a robust cross-sectional return premium that is distinct from other return premia. We find that the amount of information impounded in prices through trading has increased in recent years consistent with declining trading costs and the rise of algorithmic trading. We show that the information flows risk premium is increasing through time.

We utilize the Eurosystem securities lending facilities as a laboratory to investigate the impact of collateral scarcity on market functioning. The reduction of securities lending fees, implemented in November 2020, provides a quasi-natural experiment for our analyses. This policy change results in a surge in the utilization of securities lending facilities, particularly for bonds with limited supply elasticity in the repo market. We find no evidence of substitution effects; instead, the overall activity in the repo market expands through the collateral multiplier. The improved pricing conditions alleviate collateral scarcity and enhance market quality in both the repo and cash markets.

We examine the causal effects of a policy allowing early withdrawal of pension funds on individuals’ investment behavior. Upon turning 55, eligible individuals may withdraw a portion of their pension savings. Using detailed brokerage data, we find that this liquidity access triggers increased trading of 9% to 33%, especially in riskier, leveraged assets, without improving investment performance. The resulting increase in trading costs and portfolio volatility, particularly among males and lower-income investors, ultimately diminishes retirement wealth.

We exploit unexpected corporate data breaches to study the loss and repair of corporate reputation. Reputation loss decreases equity and brand values, increases customer churn, and prompts more negative media coverage. Firms repair their reputation by increasing their charitable donations and have CSR scores that are more than 0.5 standard deviations higher. They increase political contributions, employee wages, and IT investment. These actions are targeted to stakeholders that are particularly important or in situations that are particularly salient to their stakeholders. We observe similar dynamics of reputation loss and repair following the release of negative news about firms’ social behaviors.

We provide novel evidence on the role of firms’ banking relationships with government banks (GOBs) during a climate-related shock when relief funds are unavailable. Using variation in the locations of rainfall shocks and firms’ banking relationships, we find that firms maintaining exclusive banking relationships with GOBs (GOB firms) secure more debt relative to other firms during rainfall shocks. We do not find such effects for firms that maintain exclusive relationships with private banks, foreign banks, or maintain multiple banking relationships. We also find that GOB relationships are particularly beneficial for firms that are more vulnerable to rainfall shocks, have long-term relationships with GOBs, and are, at the same time, healthier compared to other firms. With regard to real effects, GOB firms invest more and remain profitable than other firms during rainfall shocks. Overall, our results highlight the benefits of GOB relationships for firms during climate shocks.

We study the impact of ring-fencing on bank riskiness using short-term money markets. Ring-fencing is when the government restricts some banking activities to a subsidiary of the group whilst restricting intra-group transfers. Exploiting confidential data on sterling-denominated repo transactions, we document that banking groups subject to ring-fencing are perceived to be safer—repo investors lend to ring-fenced groups at lower rates—and that the safety perception is amplified during times of market stress. We show that ring-fenced groups also intermediate more cautiously. Our article suggests that structural reforms can create a “safe-haven” bank in the financial system.

We study how the Volcker rule affects bond pricing in the pritmary market. Following implementation, Volcker-affected bonds have greater credit spreads at issuance than non-affected bonds. Bond liquidity in the year after issuance is also negatively affected by the Volcker rule. These effects are concentrated in the Rule 144A bond market. The Volcker rule’s impacts on credit spreads and liquidity are stronger for bonds with lower expected liquidity. The results suggest that expected liquidity deterioration due to the Volcker rule increases the liquidity premium demanded by primary market investors.

We study the influence of multi-sector conglomerate firms on sectoral comovement. Using an innovative network model of firms and industries, we derive a novel measure of the co-concentration of industries in which two industries are more co-concentrated if they share greater exposure to the same conglomerate firms. Using time-series, cross-sectional, and longitudinal tests on establishment-level data from nearly all US firms over 1991 to 2019, we find that industries with higher co-concentration exhibit stronger comovement in employment, sales, and asset growth. Controlling for alternative explanations, a one-standard deviation increase in co-concentration corresponds to a 0.32-standard deviation increase in the comovement of employment growth. In variance-covariance decompositions, we find that firm-specific shocks explain nearly half of aggregate volatility and industry comovement and that conglomerates play a significant role in sectoral comovement. Our framework helps explain how idiosyncratic, firm-level shocks contribute to aggregate fluctuations and influence business cycles.

We investigate the role of strategic security design in the market for retail investment products. Focusing on a dominant yet understudied design feature, we provide evidence consistent with issuers’ strategic increase of product complexity to mitigate price competition. Complexity facilitates product differentiation, thereby impairing investors’ ability to compare products. Because more complex products entail greater markups, imply higher tail risk, and are first-order stochastically dominated by simpler products, the empirically observed rise in market complexity increases uncompensated risk-taking, particularly among less sophisticated investors. Overall, our findings indicate that complexity is shaped by issuers’ deliberate design choice to preserve product rents.

This study estimates analyst-level stickiness in forecast updating and investigates its underlying determinants. Consistent with recent experimental findings on belief updating under cognitive noise, analysts often compress their forecasts toward an intermediate default, such as prior forecasts, when uncertain about forecast precision, leading to forecast stickiness. This tendency is more evident among analysts with characteristics associated with higher cognitive noise, including lower forecast accuracy, limited experience, and complex portfolio coverage, and during periods of heightened macroeconomic uncertainty. A model incorporating sticky updating behavior shows that the consensus revision by sticky analysts exhibits stronger return predictability than the traditional consensus revision by all analysts, with this predictability increasing with the proportion of sticky analysts covering a stock. Empirical evidence supports these predictions. Additionally, the return predictability of sticky revisions is especially pronounced when forecast difficulty is elevated. Analyst-level stickiness provides more information about the cross-section of stock returns than firm-level stickiness.