Knowledge that Transforms

We study how operating efficiencies in horizontal mergers affect market reactions of merging firms’ rivals, customers, and suppliers. We measure operating efficiency gains using projections disclosed by merging firms’ insiders. Higher efficiency gains are associated with lower announcement returns to merging firms’ rivals (due to increased equilibrium output of merging firms), higher returns to their customers (due to lower equilibrium price of merging firms’ output), and higher returns to their suppliers (due to the merged firm’s higher equilibrium demand for inputs). Our results suggest that the pass-through of efficiency gains along merging firms’ supply chains is as important as the effects of post-merger changes in market power.

The paper assesses how intelligence, education, and learning affect the disposition effect using our exhaustive NASDAQ OMX Tallinn dataset. We employ survival analysis to show that higher intelligence and stronger learning abilities as measured by education level and the type of education lessen the disposition effect. More highly educated and intelligent investors also learn faster by trading. We find that mathematical abilities are beneficial for overcoming the disposition effect and propose that learning ability is one of the most important components of intelligence in affecting the disposition effect.

I test whether the display format of market data affects the trading performance and behavior of retail investors. To do so, I exploit a large brokerage dataset covering a period during which the market information provided to the broker’s customers changed in format, but not in content. I find that a simultaneous display of cross-stock market data reduces the cognitive cost of monitoring the market and thus helps investors obtain better execution prices. In particular, investors better mitigate non-execution and adverse-selection risks when trading with limit orders. Hence, the display format of market data matters for the individual investor.

Do relationship banks help firms in distress? Combining a survey-based measure of relationship lending with unique credit registry data, I examine the effect of relationship lending on loan performance. I find that the same firm in the same time period is more likely to become delinquent on a relationship-based loan relative to a transaction-based loan. Higher delinquencies do not, however, result in more defaults or less loan recoveries for relationship banks when loans mature relative to transactional banks. Conditional on past delinquencies, relationship banks are more likely to offer follow-up financing and extract rents. Consistent with theory, relationship banks tolerate temporarily bad results, yet extract rents and secure future business in return. The paper provides new empirical evidence for rent extraction by relationship banks that have been lenient to distressed firms in the past.

The successful bail-in of creditors in African Bank, a small South African monoline lender, provides an opportunity to evaluate the intended and unintended consequences of new resolution tools. Using a dataset that matches quarterly, daily, and financial-instrument level data, I show that the bail-in led to money-market funds “breaking the buck”, triggering significant redemptions and some financial contagion. To limit potential systemic effects, the authorities used complementary interventions, including imposing discretionary liquidity restrictions on mutual funds and market-making facilities for affected financial instruments. This supported a sustainable restructuring of the bank and reduced financial spillovers. The lesson is that future interventions using these new resolution tools should take into account the potential unintended systemic implications, particularly in smaller jurisdictions where there is a high degree of interconnectedness between bank and nonbank financial institutions.

Using national elections as sources of exogenous variation in uncertainty, we show that political uncertainty affects the volume and outcome of cross-border acquisitions. When a country is about to hold a national election, this deters foreign firms’ inbound acquisitions, especially when the host country poses greater expropriation risk. An upcoming home country election encourages firms to conduct outbound cross-border acquisitions, especially to target countries with free-trade agreements, military allies, or countries with better governance. At transaction level, we show that announcement returns to cross-border deals incorporate political uncertainty considerations. Overall, these results shed light on the effects of political uncertainty through the cross-border acquisition channel.

We study a model where some investors (“hedgers”) are bad at information processing, while others (“speculators”) have superior information-processing ability and trade purely to exploit it. The disclosure of financial information induces a trade externality: if speculators refrain from trading, hedgers do the same, depressing the asset price. Market transparency reinforces this mechanism, by making speculators’ trades more visible to hedgers. Hence, issuers will oppose both the disclosure of fundamentals and trading transparency. Issuers may either under- or over-provide information compared to the socially efficient level if speculators have more bargaining power than hedgers, while they never under-provide it otherwise. When hedgers have low financial literacy, forbidding their access to the market may be socially efficient.

This paper documents the history of aggregate positions in US index options and investigates the driving factors behind use of this class of derivatives. We construct several measures of the magnitude of the market and characterize their level, trend, and covariates. Measured in terms of volatility exposure, the market is economically small, but it embeds a significant latent exposure to large price changes. Out-of-the-money puts are the dominant component of open positions. Variation in options use is well described by a stochastic trend driven by equity market activity and a significant negative response to increases in risk. Using a rich collection of uncertainty proxies, we distinguish distinct responses to exogenous macroeconomic risk, risk aversion, differences of opinion, and disaster risk. The results are consistent with the view that the primary function of index options is the transfer of unspanned crash risk.

Many households concurrently hold low-yield liquid assets while incurring costly credit card debt. In our sample, more than 80% of households with credit card debt also have low-yield liquid assets. Using data from the Health and Retirement Study (N = 30,517), we examine the role of noncognitive skills as well as the economic, financial, and demographic factors that affect the likelihood of co-holding. We find that the “Big Five” personality traits have a statistically significant and economically important effect: households with a more agreeable, introvert, and less conscientious head of household are more likely to co-hold. We also examine the role of intra-household dynamics.

In this paper, we forecast industry returns out-of-sample using the cross-section of book-to-market (BM) ratios and investigate whether investors can exploit this predictability in portfolio allocation. Cash-flow and return forecasting regressions show that cross-industry BM ratios contain significant predictive information beyond aggregate and industry-specific BM ratios. Forecast combination methods based on industry BM ratios generate significant out-of-sample predictability for many industries. Real-time portfolio-rotation strategies that buy industries with high predicted returns and short industries with low predicted returns based on combination forecasts earn significant alpha with respect to standard asset pricing models net of transaction costs.