Knowledge that Transforms

Nearly half of the variation in European CDS returns is captured by a novel factor that mimics economic catastrophe risk. During the financial crisis of 2007–8, this factor became more important relative to other sources of risk, leading to a shift in the correlation structure of CDS returns. Using equivalent CDS and equity portfolios, we show that while crucial for explaining temporal and cross-sectional variation in CDS returns, the factor plays a lesser role for equity. This is likely due to the limited sensitivity of the equity value at default to whether the event is of systemic or idiosyncratic nature.

The paper shows that mispriced deposit insurance and capital regulation were of second-order importance in determining the capital structure of large U.S. and European banks during 1991 to 2004. Instead, standard cross-sectional determinants of non-financial firms’ leverage carry over to banks, except for banks whose capital ratio is close to the regulatory minimum. Consistent with a reduced role of deposit insurance, we document a shift in banks’ liability structure away from deposits towards non-deposit liabilities. We find that unobserved time-invariant bank fixed-effects are ultimately the most important determinant of banks’ capital structures and that banks’ leverage converges to bank specific, time-invariant targets.

We test the limits of arbitrage argument for the survival of irrationality-induced financial anomalies by sorting securities on their individual residual variability as a proxy for idiosyncratic risk – a commonly asserted limit to arbitrage – and comparing the strength of anomalous returns in low versus high residual variability portfolios. We find no support for the limits of arbitrage argument to explain undervaluation anomalies (small value stocks, value stocks generally, recent winners, and positive earnings surprises) but strong support for the limits of arbitrage argument to explain overvaluation anomalies (small growth stocks, growth stocks generally, recent losers, and negative earnings surprises). Other tests also fail to support the limits of arbitrage argument for the survival of overvaluation anomalies and suggest that at least some of the factor premiums for size, book-to-market, and momentum are unrelated to irrationality protected by limits to arbitrage.

This paper develops a convergence model of the term structure of interest rates in context of entering the European Monetary Union (EMU). Compared to other models developed so far in this field, our model specification ensures convergence of the domestic short-term interest rates to the euro area ones. We achieve this convergence by stating that the spread between domestic and euro short-term interest rate follows the Brownian bridge process. We also develop an econometric counterpart of the theoretical model. To tackle the problem of nonstationarity and nonlinearity of the model, we apply the extended Kalman filter for coefficient estimation.

The Federal Reserve adjusts the federal funds target rate discretely, causing discontinuity in short-term interest rates. Unlike Poisson jumps, these adjustments are well anticipated by the market. We propose a term structure model that incorporates an anticipated jump component with known arrival times but random jump size. We find that doing so improves the model performance in capturing the term structure behavior. The mean jump sizes extracted from the term structure match the realized target rate changes well. Specification analysis indicates that the jump sizes show strong serial dependence and dependence on the interest-rate factors.

We would like to inform all the readers and friends of the Review of Finance that there has been a change of guard among coeditors. Starting with this issue, Franklin Allen, Peter Bossaerts, Colin Mayer and Will Goetzmann are stepping down and are being replaced by Michael Brandt (Duke), Thierry Foucault (HEC Paris), Holger Mueller (NYU Stern) and Steven Ongena (Tilburg). We wish to express our gratitude to the departing coeditors for the splendid job that they have done for so many years: Franklin, Colin and Will since the start of the Review of Finance in 2004, and Peter since 2005. They have all played a crucial role in the journal's success with their hard work, good taste and ability to attract exciting and innovative papers. At the same time, we extend a very warm welcome to the new coeditors, who will contribute fresh energies as well as excellent competencies to the journal. We are also happy to inform you that Bernard Dumas will remain on board as coeditor, and that the departing coeditors have accepted to retain an active role in the journal: Franklin, Colin and Will as advisory editors, and Peter as associate editor.

Winners of the Best Paper Competition in Corporate Governance Get access Review of Finance, Volume 13, Issue 4, October 2009, Page v, https://doi.org/10.1093/rof/rfp027 Published: 01 October 2009

This paper argues, both theoretically and empirically, that sometimes no securities law may be better than a good securities law that is not enforced. The first part of the paper formalizes the sufficient conditions under which this happens for any law. The second part of the paper shows that a specific securities law – the law prohibiting insider trading – may satisfy these conditions. The third part of the paper takes this prediction to the data. We find that the cost of equity actually rises when some countries enact an insider trading law, but do not enforce it.

We show that acquirer returns are significantly higher in stock-swap acquisitions of difficult-to-value targets, as measured by R&D intensity and idiosyncratic return volatility. This finding contributes to an explanation of the determinants of, and value gains from, using stock as a method of payment. The effects of target-valuation uncertainty on both the method of payment and the market reaction to acquisitions are more likely to be apparent in samples of private acquisitions, as these effects can be masked in samples of acquisitions of publicly held targets. Nevertheless, our results hold for publicly traded targets in multivariate analysis.

We investigate how bank organization shapes banking competition. We show that a bank's geographical lending reach and loan pricing strategy is determined by its own and its rivals’ organizational structure. We estimate the impact of organization on the geographical reach and loan pricing of a large bank. We find that the reach of the bank is smaller when rival banks are large and hierarchically organized, have superior communication technology, have a narrower span of organization, and are closer to a decision unit with lending authority. Rival banks’ size and the number of layers to a decision unit soften spatial pricing.