Knowledge that Transforms

This paper develops a general equilibrium model to study the link between the amount of capital invested in housing assets and the term structure of interest rates. In the model, the production of housing assets is irreversible and housing assets can be used as collateral for borrowing funds. Agents’ decisions about consumption and investments in housing and non-housing assets generate a time-varying market price of risk that drives the dynamics of the term structure. The calibration to U.S. data using the simulated method of moments technique captures the dynamics of consumption, and the short- and long-term interest rates.

We analyze spectral risk measures (SRMs) including its most popular representative, Expected Shortfall (ES), with respect to Gollier and Pratt (1996)’s concept of risk vulnerability. We find that SRMs and risk vulnerability are mutually exclusive, owing to the property of subadditivity: while subadditivity is commonly regarded as the axiomatic cornerstone of SRMs, risk vulnerability, by contrast, prevails if and only if superadditivity holds. The lack of risk vulnerability yields questionable predictions in portfolio problems: SRM-decision makers who split their wealth between a risk free and a risky asset do constantly opt for an increase in the risky investment when their deterministic background wealth is complemented by some additional background risk. The more general setting where background wealth is already random and then becomes more risky is not as clear-cut: Any SRM-decision maker may both increase or decrease the risky investment, depending on the concrete instance of the portfolio problem. However, when random background wealth and the risky asset are jointly normally distributed, SRM-decision makers will again unambiguously increase their risky investment. We further conduct a data analysis and discuss possible implications of the findings for regulatory risk management.

This paper examines the risk premium of value stocks within a global investment strategy framework. We test whether absolute or relative mispricing is better suited to capturing the global value premium by using fair value-based net asset values (NAVs) as our proxies for fundamental value. We find that investing in the most underpriced stocks relative to the average ratio of price to fundamental value in a country is the key to achieving superior risk-adjusted returns. The annualized excess return of the global value portfolio sorted according to relative mispricing is 10.0%, and remains significant after controlling for common risk factors.

We offer a new perspective on why initial public offerings (IPOs) occur in waves and propose that the customer-supplier relationships among industries help propagate IPO waves. Our empirical tests provide evidence that demand shocks increase the number of IPOs in an industry. The shocks then spread upstream through customer relationships leading to an increase in the number of IPOs in more central and connected industries. These findings contribute to the IPO literature by demonstrating the channel through which IPO waves propagate.

Aggregate productivity falls in recessions and rises in expansions. Several empirical studies suggest that the systematic behavior of lending standards, with laxer (tighter) standards applied during expansions (recessions), is responsible for reverting trends in aggregate productivity. We build a dynamic model that rationalizes these findings. Adverse selection in credit markets emerges as a potential source of macroeconomic instability. The key idea modeled is that in order to effectively signal their type to financiers, productive entrepreneurs must suffer a cost. The effective cost of signaling rises with higher cash flow brought about by stronger economic fundamentals, because higher cash flow makes it easier for the unproductive type to mimic the productive type. Competition among the financiers then results in suboptimally lax lending standards. Low productivity entrepreneurs obtain financing, the producer composition effect inducing a recession. This, in turn, creates conditions – weak economic fundamentals and low cash flow – conducive to the emergence of tighter lending terms, the strong composition effect leading to an economic recovery.

This study resolves a puzzle in the banking literature: why do an increasing number of countries adopt a deposit insurance scheme (DIS) while prior studies have shown that it increases the likelihood of banking crises? Using a dataset of 64 countries over the period 1970–2009, our study shows that the adoption of a DIS is associated with a 2.0–4.7 percentage points higher likelihood of banking crises (the “direct effect”), while it is associated with a 10.1–11.1 percentage points lower likelihood of non-banking financial crises (the “spillover effect”). Since the “spillover effect” is larger than the “direct effect”, a DIS actually increases overall financial stability. Additionally, we analyze the mechanisms through which a DIS affects financial crises. First, we highlight the existence of the implicit guarantee and examine its interaction with an explicit DIS. Second, we investigate the substitution effect between banking crises and non-banking crises.

We examine the response of ICE Brent Crude futures to the spot Dated Brent benchmark published by Platts. Trading activity in the futures market intensifies during the benchmark assessment. We also find trading in the direction of the published benchmark during the price assessment window. Aligned positions and a substantially increased arrival rate of informed traders suggest that sophisticated traders, taking advantage of a rise in uninformed trading activity, induce the price run-up in Brent futures, ahead of the Dated Brent assessment end. The general increase in the arrival rate of both informed and uninformed traders during the assessment window underlines the benchmark's relevance and its potential for attracting liquidity. Our results are robust to alternative specifications and underscore the significance of physical commodity benchmarks as critical elements of the financial market infrastructure.

China has been adopting a “mercantilist” policy by lavishing massive government subsidies on Chinese firms. Using hand-collected subsidy data on Chinese listed companies, we find that firms receiving more subsidies tend to have a lower cost of debt. However, such firms fail to have superior financial performance. Instead, firms with more subsidies tend to be overstaffed, which demonstrates higher social performance. These results are mainly driven by non-tax-based subsidies rather than tax-based subsidies. Overall, our results suggest that the Chinese government uses non-tax-based subsidies to achieve its social policy objectives at the expense of firms’ profitability.

We use strategic alliances as a setting to examine whether the readability of a firm's partner's 10-K matters. We find that the increase in the cumulative abnormal return (CAR) around the announcement of an alliance is relatively lower when the firm's partner in a strategic alliance has a less readable 10-K report. Additional tests show that the impact of the readability of a partner's 10-K is much stronger when investors suspect insufficient due diligence before the alliance's formation, when the partner is from a different industry, and when the alliance occurs before the Sarbanes–Oxley Act. Overall, our results show that the readability of a partner's annual report matters—it pays to partner with a firm that writes these reports well.

We demonstrate that investor satisfaction and investment behavior are influenced substantially by the price path by which the final investor return is achieved. In a series of experiments, we analyze various different price paths. Investors are most satisfied if their assets first fall in value and then recover, and they are least satisfied with the opposite pattern, independent of whether the final return is positive or negative. Price paths systematically influence risk preferences, return beliefs, and ultimately trading decisions. Our results enable a much more holistic perspective on a wide range of topics in finance, such as the disposition effect, risk-taking behavior after previous gains and losses, and behavioral asset pricing.