Knowledge that Transforms

After the financialization of commodity futures markets in 2004–2005 oil volatility has become a strong predictor of returns and volatility of the overall stock market. Furthermore, stocks’ exposure to oil volatility risk now drives the cross-section of expected returns. The difference in average return between the quintile of stocks with low exposure versus high exposure to oil volatility is significant at 0.66% per month, and oil volatility risk carries a significant risk premium of −0.60% per month. We also find that increases in oil price uncertainty predict tightening funding constraints of financial intermediaries suggesting a link between oil volatility risk and the stock market.

Most quantitative easing programmes primarily involve central banks acquiring government liabilities in return for central bank reserves. In all cases this process is undertaken by purchasing these liabilities from private sector intermediaries rather than directly from the government. This paper estimates the cost of this round-trip transaction – government issuance of liabilities and central bank purchases of those liabilities in the secondary market – for the UK. I estimate that this cost amounts to about 0.5% of the total value of QE (over £1.8 billion in my sample). I also find some evidence that this figure is inflated by the unusual design of UK QE operations.

Scope economies resulting from the joint offering of loans and savings accounts (as opposed to loans only) are customarily invoked to promote the transformation of credit-only microfinance institutions (MFIs) into integrated loans-and-savings entities. To ensure robust inference, we estimate scope economies for the microfinance industry using a novel approach which, among its other advantages, accommodates inherent heterogeneity across loans-only and loans-and-savings MFIs as well as controls for endogenous self-selection of institutions into the either type. For analysis, we use a large 2004–2014 Mixmarket dataset. Unlike earlier studies, we do not find prevalent scope economies in the microfinance industry. We find that the median degree of scope economies is statistically indistinguishable from zero and that scope economies are significantly positive for less than a half of loans-and-savings MFIs. For a non-trivial 14% of institutions, the empirical evidence suggests the existence of significantly negative diseconomies of scope indicating that the separate production of loans and savings accounts actually has the potential to reduce an MFI’s costs. We also find that the failure to account for endogenous selectivity dramatically overestimates the degree of scope economies resulting in the failure to detect scope diseconomies among MFIs. Thus, our findings call for caution when invoking scope economies as a blanket justification for universal expansion of the scope of financial operations by MFIs. Instead, promoting integrated loans-and-savings MFIs may be justifiable as a means to meeting the needs of the poor rather than as a way for the industry to save costs.

We study the impact of gender on asset allocation recommendations. Graduate business students and professional wealth managers are randomly assigned a male or female client. Participants recommend an allocation and choose an allocation for themselves. Male students choose a riskier allocation than female students, consistent with existing evidence of a gender difference in risk tolerance, and recommend a riskier allocation. In contrast, male and female wealth managers choose and recommend the same allocation, indicating that male and female finance professionals feature similar risk preferences. In both samples, a subject's allocation choice is the strongest predictor of the recommendation provided.

Using a sample of U.S. firms during the 1989–2015 period, we study whether the efficiency with which managers generate revenue is sensitive to monitoring by institutional shareholders. We find that institutional ownership is positively related to managerial efficiency. Our identification relies on a discontinuity in ownership around the Russell 1000/2000 Index threshold and suggests that the positive effect of institutional ownership on managerial efficiency is causal. Furthermore, we document that monitoring by institutions helps improve managerial efficiency, and that an exogenous increase in institutional ownership leads to higher pay-for-performance sensitivity. Finally, we find consistent results after excluding from our sample forced CEO turnovers, suggesting that institutional shareholders force incumbent managers to exert greater effort rather than influence the replacement of less efficient CEOs. Taken together, our findings highlight the important role played by institutional shareholders in getting the most out of corporate executives.

Forecasting the risk of extreme losses is an important issue in the management of financial risk. There has been a great deal of research examining how option implied volatilities (IV) can be used to forecast asset return volatility. However, the role of IV in the context of predicting extreme risk has received relatively little attention. The potential benefit of IV in forecasting extreme risk is considered within a range of models beginning with the traditional GARCH based approach, along with a number of novel point process models. Univariate models where IV is included as an exogenous variable are considered along with a novel bivariate approach where extreme movements in IV are treated as another point process. It is found that in the context of forecasting Value-at-Risk, the bivariate models produce the most accurate forecasts across a wide range of scenarios.

We examine whether monetary policy uncertainty influences the reaction of the equity, Treasury security, foreign exchange and crude oil markets, as well as medium-term interest rates, to U.S. macroeconomic announcements. Using intraday futures data, we show that in the presence of higher policy uncertainty the response to macroeconomic news weakens in the stock and crude oil markets and strengthens in the Treasury, interest rate and foreign exchange markets. In times of elevated monetary policy uncertainty, macroeconomic announcements impact the financial and crude oil markets to a large extent through expectations of future monetary policy.

Answering a major demand in modern credit risk management, we propose a nonparametric survival approach for the modeling of the recovery rate and the recovery time of a defaulted counterparty, by introducing what we call the Recovery Reinforced Urn Process, a special type of combinatorial stochastic process. The new model allows for the elicitation and exploitation of prior knowledge and experts’ judgements, and for the constant update of this information over time, as soon as new data become available. We show how to use it to perform Bayesian nonparametric prediction about the recovered amounts and the (total) recovery time of a series of defaulted exposures. An application to real data is provided using the Single Family Loan-Level Dataset by Freddie Mac.

We investigate a new facet of hedging ability among hedge fund managers. Using a sentiment exposure model, we find evidence that fund managers adjust the market exposure of their portfolios to changes in market sentiment. Out-of-sample evidence indicates that hedge funds having the highest negative sentiment exposure outperform funds having the highest positive sentiment exposure by 1.7%–2.4% per year. The results remain persistent for both the sub-period analysis and the analysis excluding crisis periods. We also find that a hedge fund's willingness to take on sentiment exposure decreases with fund age and fund size and increases with incentive fees. Our findings remain robust even after controlling for hedge fund data biases, as well as using alternative sentiment measures.

Individual deposits in the United States grew from 5% to 23% of GDP between 1863 and 1913. A comprehensive database shows bank entry underlying this trend while historical events, including the National Banking Acts, resumption in 1879, and the election of 1896, influenced deposits at the bank-level. The nation's embrace of deposits was thus driven by stability of the monetary system and confidence in the safety and utility of established and well-capitalized banks. Bank-level and county-level regressions confirm these patterns for national banks over the entire postbellum period and for a sample of Midwest state and national banks from 1888.