Firms experiencing increases in import competition significantly reduce their leverage ratios by issuing equity and selling assets to repay debt. Using import tariffs and foreign exchange rates as instrumental variables for import penetration, I show that these results are not manifestations of endogenous relations between import competition and leverage. The results are consistent with traditional trade-off models of capital structure that predict a positive relation between book leverage and expected future profitability. Further evidence suggests that import competition affects leverage through changes in the trade-off between the tax benefits of debt and the costs of financial distress.

Duffee (2005) shows that the amount of consumption risk (i.e., the conditional covariance between market returns and consumption growth) is procyclical. In light of this “Duffee Puzzle,” I empirically demonstrate that the conditional covariance between dividend growth (i.e., the immediate cash flow part of market returns) and consumption growth is (1) procyclical and (2) a consistent source of procyclicality in the puzzle. Moreover, I solve an external habit formation model that incorporates realistic joint dynamics of dividend growth and consumption growth. The procyclical dividend-consumption comovement entails two new procyclical terms in the amount of consumption risk via cash flow and valuation channels, respectively. These two procyclical terms play an important role in generating a realistic magnitude of consumption risk. In contrast to extant habit formation models, the conditional equity premium no longer increases monotonically when a negative consumption shock arrives because it might lower the amount of risk while increasing the price of risk.

Privately issued money often bears default risk, which creates transaction frictions when used as a medium of exchange. The late 19th century US provides a unique context to evaluate the real effects of supplying a new type of money that is safe from default. We measure the local change in “monetary” transaction frictions with a market access approach derived from general equilibrium trade theory. Consistent with theories hypothesizing that lowering transaction frictions benefits the traded and inputs-intensive sectors, we find an increase in traded goods production, in the share of manufacturing output and employment, and in innovation.

We infer the latent social networks of investors using data on their stock holdings. We map linkages to portfolio weights using a portfolio-choice model. The precision of an investor’s private signal about firm value is assumed to increase with his connections in the city where the firm is headquartered. Using money-manager data, we find that managerial linkages to a city are overly dispersed relative to the Erdös–Rényi model of i.i.d. connections. Managers at the tail of this distribution with non-i.i.d. linkages have more university alumni in that city. Their stock holdings there outperform their holdings in other cities.

Johnson et al. (2002. American Economic Review 92 (5), 1335–1356) examine the relative importance of property rights and external finance in several Eastern European countries. They find property rights to be overwhelmingly important, while external finance explains little of firm reinvestment. McMillan and Woodruff (2002. Journal of Economic Perspectives 16 (3), 153–170) further conjecture that as transition moves along, market-supporting (financial) institutions should become more important. This paper reexamines those issues in the context of China in 2002, when the transition had moved far. We also find that secure property rights are a significant predictor of firm reinvestment. However, in line with McMillan and Woodruff, we find that access to external finance in the form of bank loans is also associated with more reinvestment. Following Acemoglu and Johnson (2003. Unbundling institutions. Unpublished working paper 9934, National Bureau of Economic Research, Cambridge, MA), we separate our proxies for the security of property rights into two groups: those measuring the risk of expropriation by the government and those measuring the ease and reliability of contract enforcement. Whereas those authors’ cross-country results suggest that risk of expropriation is the more severe impediment to economic development, ours indicate that both expropriation risk and contract enforcement play a role in Chinese firms’ reinvestment decisions. We also find that another aspect of property rights, the extent of private ownership, is associated with greater reinvestment. At China's current stage of development, expropriation risk, contract enforcement, access to finance, and ownership structure all appear to matter for reinvestment decisions. Some evidence also exists that access to finance and government expropriation affect small firms more than large ones.

Households hold undiversified stock portfolios of firms headquartered near their city of residence. Leading explanations assign a causal role for proximity. The literature neglects that distance is endogenous. Households may locate based on unobservables such as optimism about a city’s economic prospects, which can be correlated with latent local-stock demand. We use location-choice models to account for this selection. We propose as instruments that older households prefer to locate in recreational areas for non-pecuniary reasons. Our analysis based on a widely used household data set yields significantly smaller estimates for proximity in determining portfolio choice compared to those in the literature.

We examine how financial market development affects technological innovation. Using a large data set that includes 32 developed and emerging countries and a fixed effects identification strategy, we identify economic mechanisms through which the development of equity markets and credit markets affects technological innovation. We show that industries that are more dependent on external finance and that are more high-tech intensive exhibit a disproportionally higher innovation level in countries with better developed equity markets. However, the development of credit markets appears to discourage innovation in industries with these characteristics. Our paper provides new insights into the real effects of financial market development on the economy.

We demonstrate that a financial intermediary-based asset pricing model offers a compelling explanation for a new set of conditional moments of equity term structure and convenience yields. The model’s key mechanism is that the time-varying tightness of intermediaries’ leverage constraints drives significant mean reversion in the price of risk. This model guides us in devising a novel empirical methodology to estimate the tightness of these constraints (i.e., the Relative Tightness Index) from cross-sectional returns of various asset classes. Our findings affirm that this measure significantly drives the dynamics of equity yield slope and convenience yields, both empirically and quantitatively.

We examine subjective risk premia implied by return expectations of individual investors and professionals for portfolios of stocks, bonds, currencies, and commodity futures. While in-sample predictive regressions with realized excess returns suggest that objective risk premia vary countercyclically with business-cycle and asset-valuation measures, subjective risk premia extracted from survey data are largely acyclical. Out-of-sample forecasts of excess returns exhibit a similar lack of cyclicality, which suggests that investors’ learning of forecasting relationships in real time may help explain the cyclicality gap. There is a subjective risk-return tradeoff, with subjective risk premia increasing in subjective perceptions of risk quantity.