Knowledge that Transforms

We examine the microstructure of liquidity provision in the COVID-19 corporate bond liquidity crisis. During the two weeks leading up to Federal Reserve System interventions, volume shifted to liquid securities, transaction costs soared, trade-size pricing inverted, and dealers, particularly non-primary dealers, shifted from buying to selling, causing dealers’ inventories to plummet. Liquidity provisions in electronic customer-to-customer trading increased, though at prohibitively high costs. By improving dealer funding conditions and providing a liquidity backstop, the Primary Dealer Credit Facility and the Secondary Market Corporate Credit Facility (SMCCF) stabilized trading conditions. Most of the impact of SMCCF on bond liquidity seems to have materialized following its announcement. We argue that the Federal Reserve's actions reflect a new role as market maker of last resort.

This paper documents the emergence of a large bank loan market in the absence of contracting institutions: the trusted assistant loan market in 19th century China. These loans were legally unenforceable, one-shot loans to poor scholars that funded the costs of assuming lucrative administrative appointments offering ample opportunities for corruption. The trusted assistant loan’s distinguishing feature was a legally unenforceable stipulation that the borrower incorporate an agent of the creditor into his administrative cadre. We model the enforcement of these loans through expertise leverage and test the model’s predictions using data from officials’ diaries and a bank loan book.

The field of academic finance has grown and evolved in the 47 years since the Journal of Financial Economics (JFE) began publishing papers. This paper examines detailed data on the 3,003 papers written by 3,358 different authors published in the JFE over the period 1974–2020. Advances in computing power and electronic communication have driven trends toward more empirical work, more coauthorship, and more complex papers. The set of authors, referees, and editors has also evolved as the field spans a much larger geographic footprint and as women have come to play a larger role in all aspects of academic finance. Growth in the demand for finance faculty has driven up faculty compensation and the demand for scarce journal space.

Recent complex financial products sold to households contradict the basic premise of canonical innovation theories: Financial innovation benefits its adopters. In my 2006–2015 sample of over 28,000 yield enhancement products (YEP), the securities offer attractive yields but negative returns. The products lose money both ex ante and ex post due to their embedded fees. On average, YEPs charge 6–7% in annual fees and subsequently lose 6–7% relative to risk-adjusted benchmarks. Simple and cheap combinations of listed options often statewise dominate YEPs. Competition, disclosure, or learning do not eliminate this inferior financial innovation over my sample period.

We propose a theory in which each stock's environmental, social, and governance (ESG) score plays two roles: (1) providing information about firm fundamentals and (2) affecting investor preferences. The solution to the investor's portfolio problem is characterized by an ESG-efficient frontier, showing the highest attainable Sharpe ratio for each ESG level. The corresponding portfolios satisfy four-fund separation. Equilibrium asset prices are determined by an ESG-adjusted capital asset pricing model, showing when ESG raises or lowers the required return. Combining several large data sets, we compute the empirical ESG-efficient frontier and show the costs and benefits of responsible investing. Finally, we test our theory's predictions using proxies for E (carbon emissions), S, G, and overall ESG.

Do more talented traders prefer to bet on and against rare events or common events? Bets on rare events include out of the money options. Bets against rare events include the carry trade and investment grade bonds. In a model where traders specialize, equilibrium pricing reflects trading ability: A market with more skilled traders has a larger bid ask spread. We show that lower skill traders bet on and against rare events, while higher skill traders bet on and against frequent events, leading to higher bid-ask spreads in common event assets, and reducing financial markets’ ability to predict rare events.

We examine the effects of investor disagreement on price discovery using a recurring public information event in the highly liquid crude oil futures market, a market free of short sale constraints. We show that prices reflect positive news within one-half second of trading but continue to drift for five minutes when news is negative. Evidence suggests the drift arises from a systematic surge in buying pressure that impedes the price discovery process when news is negative. Our results are consistent with price drift arising from differences in trading horizons, where traders taking long positions condition trades on information beyond the news.

We document a 24% decline in loan issuances in the UK syndicated loan market after the Brexit vote relative to a set of comparable loan markets. The decline in lending is driven by a pervasive reduction in demand by UK firms. Changes in GDP forecast around the Brexit vote explain about 61% of the decline in lending. We do not find evidence, however, that the United Kingdom loses its attractiveness as a financial center for cross-border lending. Our results point to the resilience of global financial centers in the face of large unexpected shocks.

This paper studies the disciplinary spillover effects of proxy contests on companies that share directors with target firms, that is, interlocked firms. In difference-in-differences tests, I find that interlocked firms reduce excess cash holdings, increase shareholder payouts, cut CEO compensation, and engage in less earnings management in the year after proxy contests. The effects are more pronounced when both the interlocked and target firms have a unitary board and when the interlocking director is up for election, is younger, or has shorter tenure. Overall, the evidence highlights the importance of directors’ career concerns in policy spillovers across firms with board interlocks.

We study how disclosure requirements for large short positions affect investor behavior and security prices. Short positions accumulate just below the applicable disclosure threshold as certain investors never disclose any of their positions. Further tests suggest that this secrecy is part of investors’ general policy of avoiding disclosure to protect their unique, profitable investment strategies against reverse engineering by competitors. No evidence supports the notion that short sellers avoid disclosure because of potential adverse effects on securities' lending fees, risk of recall, or short squeezes. Finally, the evasive behavior by short sellers in response to transparency regulations hampers price discovery.