We examine the stock market reaction to announcements of formal supervisory actions. We find that the variation in the quality and timeliness of disclosure by U.S. banks explains much of the variation in the market's reactions. We also find that these announcements can cause spillover effects. However, rather than representing contagion, these spillover effects are consistent with enhanced transparency. Only banks in the same region as the announcing bank, with similar exposures, are affected. Thus, enhanced disclosure can improve the allocation of resources in the banking system. Journal of Economic Literature Classification Numbers: G21, G28.

What are the causes and consequences of commonality in liquidity? We examine this issue using a model of liquidity trading in which liquidity shocks are decomposed into common (systematic) and idiosyncratic components. We show that common liquidity shocks do not give rise to commonality in trading volume. Indeed, trading volume is independent of systematic liquidity risk, and this risk is always priced irrespective of market liquidity. In contrast, idiosyncratic liquidity shocks create liquidity demand and volume, and investors can diversify their risk by trading. Hence, pricing of the risk of idiosyncratic liquidity shocks depends on market liquidity, with idiosyncratic liquidity risk being fully priced only in perfectly illiquid markets. While trading volume increases with the variance of idiosyncratic liquidity shocks, price volatility increases with the variance of both idiosyncratic and systematic liquidity shocks. Surprisingly, our results are largely independent of the number of different securities traded in the market. When asset returns are uncorrelated, there is no transmission of liquidity across assets even when investors experience common liquidity shocks, suggesting that such liquidity shocks may not be the source of commonality in liquidity across assets detected in the literature. However, under limited conditions, more liquid securities can act as substitutes for less liquid securities. Overall, our findings suggest that common factors in liquidity may be the outcome of covariation in investor heterogeneity (e.g., as measured by co-movements in the volatility of idiosyncratic liquidity shocks) rather than of common liquidity shocks. Moreover, we find that different liquidity proxies measure different things, which has implications for future empirical analysis.

We show that the pattern of short-term negative serial covariances for stock returns over different return measurement intervals is consistent with the implications of inventory-based microstructure models. We develop different testable implications of these models and document supporting evidence. Our findings indicate that to a large extent the short-horizon return revearsals can be explained by dealer-inventory-related market microstructure effects. Journal of Economic Literature Classification Numbers: G14, G20.

The commitment value of financial contracts is limited by the ability of contracting parties to renegotiate them away, if it becomes mutually beneficial to do so. When debt contracts are used by oligopolistic firms to commit to aggressive output strategies as in Brander-Lewis, we show that renegotiation may undermine commitment under symmetric information, but not generally under asymmetric information. Lasting contracts that survive renegotiation are proposed. It is shown that there exist lasting debt contracts which preserve the commitment value and in which not all debt is renegotiated away.

Dealers enter nonbinding expressions of interest during the Nasdaq preopening to promote price discovery and ease stock inventory management when the market opens. But does this practice of “indicating ahead” constitute best execution for an individual customer? Arguments in favor of the practice rely on the notion that best execution is a general condition as opposed to a concept applicable on a trade-by-trade basis. Some customers must sacrifice in individual instances to improve the functioning of the overall market. But the practice of indicating ahead violates the dealer agent's duty of loyalty to her individual customer. Moreover, the dealer's financial self-interest is best served by indicating ahead. Journal of Economic Literature Classification Numbers: G10, G18, K22.

The standard Principal–Agent (PA) model assumes that the principal can control the agent's consumption profile. In an intertemporal setting, however, Rogerson (1985, Econometrica53, 69–76) shows that given the optimal PA contract, the agent has an unmet precautionary demand for savings. Thus the standard PA model is invalid if the agent has access to credit markets. In this paper we generalize the standard PA model to allow for saving and borrowing by the agent. We show that the impact of such access critically depends upon the treatment of default. If default is not permitted, efficiency is strictly reduced by the introduction of credit markets, and the equilibrium level of borrowing or saving is indeterminate in the model. If default is allowed, however, the optimal contract depends upon the level of bankruptcy protection in the economy, which is described by a minimum level of wage income. We show that there is an optimal intermediate range of bankruptcy protection. Within this range, allowing default increases efficiency in the economy relative to the case of no default. Also, the model predicts specific levels of consumer debt, interest rates, and default rates as functions of the level of bankruptcy protection level. Journal of Economic Literature Classification Numbers: D80, G21, G28, J30.

This paper analyzes the role of financial intermediaries as marketmakers in the market for interest rate swaps. We argue that intermediaries which hold large nontraded portfolios of swaps are efficient alternatives to direct hedging by counterparties in publicly traded cash and futures instruments. The efficiency afforded by the swap marketmaker derives from reduction in transactions costs, diversification of basis risk, and reduced agency costs of debt. The analysis provides an explanation for the existence and success of the swaps market as a means for spreading risk and for its dominance by large financial institutions.

This paper presents a model of large institutional and small individual investors choosing stocks. Dividend policy of firms is determined by the preferences of the resulting stockholders. Large investors choose to invest in large corporations because it lowers their transaction costs. Since these institutions prefer dividends, the large corporations choose to pay dividends, while the small corporations, owned by individuals, do not. The results show that firm size and liquidity explain the decision ofwhetherto pay dividends well, whereas existing informational explanations (such as monitoring and signaling) explain thelevelof dividends well.Journal of Economic LiteratureClassification Numbers: G32, G35, G11.

Can fintech close the gender gap in access to financial services? Using novel survey data for 28 countries, this paper finds a large and ubiquitous ‘fintech gender gap’: while 29% of men use fintech products, only 21% of women do. This difference exceeds the gender gap in bank account ownership at traditional financial institutions. While country characteristics and individual-level controls explain about a third of the fintech gender gap, the residual gap declines by 60% when accounting for gender differences in the willingness to use new financial technology, the suitability of fintech products, and the willingness to use fintech entrants if they offer cheaper products. The paper concludes by discussing drivers of differences in attitudes and implications for policy to foster financial inclusion with new technology.