Knowledge that Transforms

Technical traders attempt to exploit trends in market prices and the order flow. Despite this little is known about how these traders behave in a micro-structure context. We consider a model of an order book based financial market. The market contains two groups: informed traders and technical traders. A numerical technique is used to identify a Markov perfect equilibrium of the trading game and so determine the optimal strategies. We find that technical trading rules are profitable and allow traders to increase their returns. The effect of technical traders on the market, however, is ambiguous. They decrease volatility and pricing errors but also increase trading costs despite primarily acting as liquidity suppliers.

Agency theory suggests that outside shareholders prefer higher dividend payouts in order to reduce the free cash flows of firms that are under the insiders’ control. Our study investigates the effects of mutual funds, typically the most important and influential type of outside shareholder, on firms’ dividend payouts in China during the period from 2003 to 2011. We find that mutual funds influence firms to pay higher cash dividends. The results are consistent with the predictions from exit theory. The effects are more pronounced in firms controlled by state and regional governments and in firms with relatively higher free cash flows. We also find evidence that the mutual funds’ effects are stronger when their investment horizon is longer and the ownership interest is larger. Other institutional investors, such as banks, insurance companies, and securities companies have a lower exit threat and do not have an influence on firms’ cash dividend payments or financial performances.

This paper presents the first theoretical model of the profit maximizing price-setting policy for the issuers of exchange-traded retail certificates. Unlike previous theoretical microstructure models, the market considered is unique in that the market makers do not face significant inventory costs or risk from informed traders. The model derives the time structure of the optimal markups over a certificate’s fair theoretical value and its relationship with optimal spreads, unhedgeable risk faced by the issuer and investors’ buying and selling decisions. It shows that (i) the optimal markups decrease inter-temporally, (ii) issuers adjust the markups according to investors’ demand, (iii) unhedgeable risk results in higher markups and influences their time structure, (iv) the markups and the spread are negatively related. Using data from the German market for leverage certificates, we find strong empirical support for the model-derived hypotheses, except for (iv). We find spreads exhibit little variation and this suggests that markups and spreads are not substitute profit sources for issuers in this market.

The Japanese banking system provides a distinctive platform for the examination of the long-lasting effect of problem loans on efficiency. We measure technical efficiency by modifying a translog enhanced hyperbolic distance function with two undesirable outputs, identified as problem loans and problem other earning assets. Our unique database allows us to distinguish between bankrupt and restructured loans to investigate the underlying causality between these loans and efficiency. From the flexible panel vector autoregression specification, primary results reveal that bankrupt loans have a positive impact on efficiency related to the “moral hazard, skimping” hypothesis, with the causality originating from bankrupt loans. In contrast, findings for the relationship between restructured loans and efficiency support the “bad luck” hypothesis.

This paper finds that stocks of repurchasers with high sensitivity to investor sentiment are more likely to be mispriced. Thus, such repurchases are followed by superior post-buyback stock performance. This abnormal return associated with sensitivity to sentiment cannot be explained by other undervaluation factors: book-to-market or prior return effects. My results are robust with factor model analysis and controls for contamination effects. I conclude that this sentiment-driven undervaluation may result from the difficulty to value and/or limits to arbitrage rather than investor overreaction.

The stability of estimates is critical when applying advanced measurement approaches (AMA) such as loss distribution approach (LDA) for operational risk capital modeling. Recent studies have identified issues associated with capital estimates by applying the maximum likelihood estimation (MLE) method for truncated distributions: significant upward mean-bias, considerable uncertainty about the estimates, and non-robustness to both small and large losses. Although alternative estimation approaches have been proposed, there has not been any comprehensive study of how alternative approaches perform compared to the MLE method. This paper is the first comprehensive study on the performance of various potentially promising alternative approaches (including minimum distance approach, quantile distance approach, scaling-based bias correction, upward scaling of lower quantiles, and right-truncated distributions) as compared to MLE with regards to accuracy, precision and robustness. More importantly, based on the properties of each estimator, we propose a right-truncation with probability weighted least squares method, by combining the right-truncated distribution and minimizing a probability weighted distance (i.e., the quadratic upper-tail Anderson–Darling distance), and we find it significantly reduces the bias and volatility of capital estimates and improves the robustness of capital estimates to small losses near the threshold or moving the threshold, demonstrated by both simulation results and real data application.

Public capital injections into the banking system are a comprehensive policy program aimed at reducing the financial risks faced by capital-injected banks, thereby stimulating their lending and profitability. This paper evaluates empirically Japan’s two large-scale capital injections in 1998 and 1999. We begin by extracting the treatment effects of the public injections from bank-level panel data. Using a difference-in-difference estimator in two-way fixed-effects regression models, we find that the public injections significantly reduced the financial risks faced by the capital-injected banks but did not stimulate their lending or profitability. Next, we investigate what factors impeded bank lending after the public injections using a matched sample of Japanese banks and their borrowers. By employing three-way fixed-effects regression models corresponding to the matched sample, we provide evidence that the deterioration of borrowers’ creditworthiness inhibited not only the injected banks but also the noninjected banks from lending more.

Building on intuition from the dynamic asset pricing literature, we uncover unobserved risk aversion and fundamental uncertainty from the observed time series of the variance premium and the credit spread while controlling for the conditional variance of stock returns, expectations about the macroeconomic outlook, and interest rates. We apply this methodology to monthly data from both Germany and the US. We find that the variance premium contains a substantial amount of information about risk aversion whereas the credit spread has a lot to say about uncertainty. We link our risk aversion and uncertainty estimates to practitioner and “academic” risk aversion indices, sentiment indices, financial stress indices, business cycle indicators and liquidity measures.

The relationship between bank revenue composition and bank risk in Australia is modeled using data drawn from Australian bank confidential regulatory returns. It is found that those banks with lower levels of non-interest income and higher revenue concentration are less risky, consistent with previous international evidence. Evidence is also found supportive of increased risk due to too-big-to-fail effects, with this risk increase being offset by a decline in large bank risk after the crisis of 2007–2008. Non-interest income is generally found to be risk increasing, but some types of non-interest income are risk reducing when bank specialization effects are considered. It is also found that the 2008 financial crisis changed some aspects of the relationship between bank risk and revenue composition.

The growth in commodity-related investments has sparked interest in the performance of momentum strategies in these markets. This paper introduces a behavioral proxy of the 52-week high and low momentum that explains a significant proportion of the variation of conventional momentum returns after controlling for commodity specific risk factors. Our findings show that the 52-week high strategy generates significant profits after accounting for transaction costs. We report that the 52-week high strategy is a better predictor of returns than conventional momentum. Our findings suggest that term structure and hedging pressure risk factors provide only a partial explanation of the results.