We examine the extent to which institutional investors herd in the U.S. corporate bond market and the price impact of their herding behavior. We find that the level of institutional herding in corporate bonds is substantially higher than what is documented for equities, and that sell herding is much stronger and more persistent than buy herding. The price impact of herding is also highly asymmetric. While buy herding facilitates price discovery, sell herding causes transitory yet large price distortions. Such price destabilizing effect of sell herding is particularly pronounced for speculative-grade, small, and illiquid bonds, and during the financial crisis.

We examine synergies in mergers and acquisitions (M&As) generated by firms’ comparative advantages in access to bank finance. We find robust evidence that greater access to bank finance increases firms’ attractiveness as acquisition targets. Targets’ comparative advantage in bank finance improves bank credit supply and reduces financing costs for the merged firms. These effects are more pronounced for acquirers with greater frictions in accessing bank loans and acquirers with greater growth opportunities. Overall, this paper reveals that targets, not just acquirers, contribute to financial synergies in M&As.

We derive a model with qualitative implications for options pricing under counterparty credit risk and provide empirical evidence using the data from the Hong Kong derivatives market during 2005–2014. We find that the log-price difference between a derivative warrant with counterparty credit risk and an otherwise identical option without counterparty credit risk is significantly and negatively associated with the credit default swap spread on the warrant issuer. We also find that the prices of out-of-the-money put warrants are more sensitive to credit risk than those of other warrants. Our results show counterparty credit risk matters for derivative pricing.

Corporate bond mutual funds increased their selling of credit protection in the credit default swaps (CDS) market during the 2007–2008 financial crisis. This trading activity was primarily in multi-name CDS, greater among larger and established funds, and directed toward counterparty dealers in financial distress. Funds that sold credit protection during the crisis experienced greater credit market risk and superior post-crisis performance, consistent with higher expected returns from liquidity provision. Funds using Lehman Brothers as a counterparty experienced abnormal outflows and returns of –2% immediately following Lehman's bankruptcy, suggesting that funds’ opportunistic trading in CDS exposed investors to counterparty risk.

Embedding disasters into a general equilibrium model with heterogeneous firms induces strong nonlinearity in the pricing kernel, helping explain the empirical failure of the (consumption) CAPM. Our single-factor model reproduces the failure of the CAPM in explaining the value premium in finite samples without disasters and its relative success in samples with disasters. Due to beta measurement errors, the estimated beta-return relation is flat, consistent with the beta “anomaly,” even though the true beta-return relation is strongly positive. Finally, the consumption CAPM fails in simulations, even though a nonlinear model with the true pricing kernel holds exactly by construction.