Knowledge that Transforms

Transaction costs have a first-order effect on the performance of currency portfolios. Proportional costs based on quoted bid–ask spread are relatively small, but when a fund is large, costs due to the trading volume price impact are sizable and quickly erode returns, leaving many popular strategies unprofitable. A mean–variance-transaction-cost optimized approach (MVTC) that accounts for costs in the optimization efficiently tackles the problem with only relatively minor negative implications on before-cost profitability. MVTC is robust even when the price impact of trading is severe. Finally, we introduce an accurate extrapolation approach to expand the sample of the realized Amihud measure of Ranaldo and Santucci de Magistris (2022) from 12 to 26 currencies and from 2012 back in time to 1986.

We quantify the costs of major disclosure and governance regulations by exploiting a regulatory quirk: many rules trigger when a firm's public float exceeds a threshold. Consistent with firms avoiding costly regulation, we document significant bunching around three major regulatory thresholds. Estimations reveal that the three examined rules' compliance costs range from 1.2% to 1.8% of market capitalization for firms near thresholds. For a median U.S. public company, total costs amount to 4.3% of market capitalization, and at least 2.3% absent regulatory avoidance frictions. These cost estimates are robust across various extrapolation assumptions, ranging from 2.1% to 6.3% of market capitalization. Regulatory costs have a greater impact on private firms' IPO decisions than on public firms' going private decisions, but such costs only explain a small part of the decline in the number of public firms.

Comparing coverage of the same corporate financial news by the conservative Wall Street Journal and the liberal New York Times , we find strong evidence of political polarization in their reporting on both the intensive and extensive margins of coverage. We show that this politics-induced disagreement in corporate financial news leads to an increase in abnormal trading volume for the most politically extreme firms. Our results highlight a new source of investor disagreement, arising out of polarized reporting of corporate financial news, that generates trade among investors.

Capital ages and must eventually be replaced. We propose a theory of financing in which firms borrow to finance investment and deleverage as capital ages to have enough financial slack to finance replacement investments. To achieve these dynamics, firms issue debt with a maturity that matches the useful life of assets and a repayment schedule that reflects the need to free up debt capacity as capital ages. In the model, leverage and debt maturity are negatively related to capital age while debt maturity and the length of debt cycles are positively related to asset life. We provide empirical evidence that strongly supports these predictions.

RMBS sponsors contributed to the rise of new product features in securitized mortgages prior to the 2008 financial crisis. Using a regulatory shock to sponsor competition , we show securitization influences the design of mortgage contracts, empirically demonstrating a unique, feedback loop of product differentiation from the derived security (MBS) to the underlying asset (loans). Product differentiation in Prime MBS collateral rises faster than that of non-prime in the early boom period (2000–2004), a strategic choice by MBS sponsors in the face of increasing competition. At very high levels of competition, product differentiation targets non-prime (marginal) borrowers. We develop a theoretical framework for sponsor-induced product differentiation that explains these empirical findings.

In a SPAC transaction, a sponsor raises financing from investors using redeemable shares and rights. When investors are sophisticated, these features dilute the sponsor's stake and can lead to underinvestment in profitable targets. However, when investors are overconfident about their ability to respond to interim news, the optionality in such features is overpriced, and SPACs can lead to over-investment in unprofitable targets. Consistent with empirical evidence, the model predicts different returns for short-term and long-term investors and overall underperformance. While some policy interventions (e.g., eliminating redemption rights, limiting investor access, and restricting warrants) improve returns for unsophisticated investors, others (e.g., increased disclosure) can be counterproductive.

Households tend to hold substantial amounts of non-financial assets in the form of consumer goods inventories that are unobserved by traditional measures of wealth, about $725 on average for products covered by our sample. Such holdings can eclipse total financial assets among households in the lowest income quintile. Households can obtain significant financial returns from strategically shopping and managing these inventories. In addition, they choose to maintain liquid savings—household working capital—not just for precautionary motives but also to support this inventory management. We demonstrate that households earn high marginal returns from investing in household working capital, well above 20% at low levels of inventory, though these marginal returns decline rapidly as inventory increases. Nevertheless, average returns from inventory management are high—about 50% for the typical household—and affect household portfolio returns substantially for all but the top income and asset quintiles. We provide evidence from scanner and survey data that supports this conclusion. For many households, working capital is therefore an important asset class that has been largely ignored by the household finance literature, and inventory management provides them with an alternative to investing in risky financial markets at low levels of liquid wealth.

This study shows that firms regard stock price fragility - exposure to non-fundamental demand shocks stemming from the composition of equity ownership - as a salient corporate risk. We model ex ante corporate responses to higher potential for future stock market misvaluation and then empirically document that within firm variation in equity fragility has effects in line with the model: higher fragility raises cash holdings and lowers investment. Multiple natural experiments support a causal interpretation of the results. The results are shown to be more prominent in the face of high uncertainty and financial constraints. The evidence presents a new dimension of how managerial expectations affect corporate policies.

We show that forcing insolvent consumer debtors to repay a larger fraction of debt causes them to strategically manipulate the data they report to creditors. Exploiting a policy change that required insolvent debtors to increase debt repayments at an arbitrary income cutoff, we document that some debtors reduce reported income to just below this cutoff to avoid the higher repayment. Those debtors who manipulate income have a lower probability of default on their repayment plans, consistent with having access to hidden income. We estimate this strategic manipulation costs creditors 12% to 36% of their total payout per filing.

We estimate a structural model of borrowing and lending in the illegal money lending market using a unique panel survey of 1,090 borrowers taking out 11,032 loans from loan sharks. We use the model to evaluate the effects of interventions aimed at limiting this market. We find that an enforcement crackdown that occurred during our sample period increased lenders’ unit cost of harassment and interest rates, while lowering volume of loans, lender profits and borrower welfare. Policies removing borrowers in the middle of the repayment ability distribution, reducing gambling or reducing time discounting are also effective at lowering lender profitability.