Knowledge that Transforms

This paper studies the effects of hedge disclosure requirements on corporate risk management and product market competition. The analysis is based on a model of market entry and shows that to prevent entry incumbent firms engage in risk management when these activities remain unobserved by outsiders. In the resulting equilibrium, financial markets are well informed and entry is efficient. However, potential attempts for more transparency by additional disclosure requirements introduce a commitment device that provides incumbents with incentives to distort risk management activities thereby influencing entrant beliefs. In equilibrium, firms engage in significant risk-taking. This behavior limits entry and adversely affects the nature of competition in industries.

We provide a tractable model of counterparty risk in a risk transfer market, and analyze the consequences of this risk being private information. We show that unknown type information can be revealed in the presence of a large trader identification policy; however, the market allocation is shown to be constrained inefficient. The inefficiency is highlighted by considering the imposition of a transaction tax, which can improve welfare by encouraging more information revelation and increasing risk transfer. The results suggest that increased transparency and/or central counterparty arrangements in over-the-counter derivative markets may promote transparency of counterparty risk.

We find that certain bank characteristics—aggressive credit growth, less reliance on deposit funding, and size—prior to the 2007−2009 crisis are consistently related to the systemic dimensions of bank risk during the crisis. Exposures to real estate play a major role explaining this relationship: Banks with larger real estate betas exhibited higher levels of systemic risk during the crisis. The impact of real estate betas on systemic risk increases for larger banks, following aggressive credit growth policies in the presence of housing bubbles. We show that the relationship between bank characteristics and risk could also be detected using measures of systemic risk calculated prior to the financial crisis.

Using a comprehensive survey, we show that investors with a larger capital allocation to private equity are more specialized−measured by the degree to which the investor focuses on private equity rather than other classes of investments−and have a wider scope of due diligence and investment activities. Other investor characteristics (experience, type, location, compensation structure, number of funds under management) play no role. In particular, endowments are not special according to the survey measures. These results are consistent with the changing LP–GP relationship in private equity as capital is increasingly concentrated in the hands of large investors.

We present evidence that the Federal Reserve stress tests produce information about both the stress-tested bank holding companies and the overall state of the banking industry. Our evidence goes beyond a standard event study, which cannot differentiate between small abnormal returns and large, but opposite-signed, abnormal stock returns. We find that stress test disclosures are associated with significantly higher absolute abnormal returns, as well as higher abnormal trading volume. More levered and riskier holding companies seem to be more affected by the stress test information. We find no evidence that stress test disclosures have reduced the production of private information. After disclosure begins, stress tested firms attract equity analysts without changing analysts’ forecast dispersions or their mean forecast error.

Using a unique dataset we provide new evidence on the significant penalty on client fund performance due to conflicts of interest related to the cross trading (TCT) activities of mutual fund advisers: funds managed by advisers in the top TCT quintile significantly underperform funds managed by advisers in the bottom TCT quintile by 1% per year. Adviser incentives to engage in cross trading are directly related to their opportunities for generating revenues from affiliated trading operations. Additional tests suggest that the significantly higher trading commissions paid by client funds of high-TCT advisers are a major source of their under-performance.

I study credit rationing in small firm-bank relationships by using a unique data set of matched loan applications and contracts. I establish the degree of credit rationing by relating a firm's requested loan amount to the bank's granted amount. In line with theoretical predictions, credit rationing is higher for opaque than transparent firms at the beginning of their bank relationships and decreases over time for both. After testing for several alternative explanations, the results suggest that information and incentive problems explain the observed credit rationing and its dynamics.

Homestead exemptions to personal bankruptcy allow households to retain their home equity up to a limit determined at the state level. Households that may experience bankruptcy thus have an incentive to bias their portfolios toward home equity. Using US household data for the period 1996–2006, we find that household demand for real estate is relatively high if the marginal investment in home equity is covered by the exemption. The home equity bias is more pronounced for younger and less healthy households that face more financial uncertainty and therefore have a higher ex ante probability of bankruptcy. These results suggest that homestead exemptions have an important bearing on the portfolio allocations of US households and the extent to which they insure against bad shocks.

We show that new public debt issues cause an auction cycle for Italian secondary-market debt, but not for German debt. The cycle is mainly observed for the crisis period since mid-2007 and is larger when the crisis, as measured by yield volatility and CDS spreads of primary dealers, is more intense. Volatility seems to be the main driving factor. The cycle is also present in secondary-market series with maturities close to the auctioned series. Our findings are consistent with the theory of primary dealers’ limited risk-bearing capacity. There is also weak evidence of spill-overs from foreign auctions to domestic markets.

This paper investigates the impact of ample liquidity provision by the European Central Bank on the functioning of the overnight unsecured interbank market from 2008 to 2014. We use novel data on interbank transactions derived from TARGET2, the main euro area payment system. To identify exogenous shocks to central bank liquidity, we exploit the timing of ECB liquidity operations and use a simple structural vector auto-regression framework. We argue that the ECB acted as a de facto lender-of-last-resort to the euro area banking system and identify two main effects of central bank liquidity provision on interbank markets. First, central bank liquidity replaces the demand for liquidity in the interbank market, especially during the financial crisis (2008–2010). Second, it increases the supply of liquidity in the interbank market in stressed countries (Greece, Italy and Spain) during the sovereign debt crisis (2011–2013).