Knowledge that Transforms

Abstract We show that the transmission of a monetary policy tightening varies in the cross-section of banks when central bank reserves are abundant. Specifically, the net worth of reserve-rich banks may display a boost when the interest rate paid on reserves increases strongly. Focusing on the European Central Bank’s 2022 rate hiking cycle, we show that reserve-rich banks’ credit supply is less sensitive to the monetary policy tightening compared to other banks. The effect varies in the cross-section of both banks and firms. The results are binding at the firm level, indicating the presence of real effects.

Abstract Cyber risk exposes banks to operational disruptions that can trigger runs. A bank chooses its cybersecurity by trading off protection against attacks with remaining resilient if an attack succeeds. Cybersecurity functions as a risk-management decision: it reduces the bank’s exposure to adverse outcomes but entails lower balance-sheet returns. Equilibrium cybersecurity depends on whether failure is driven by insolvency or illiquidity. When failure is insolvency-driven, bank and creditor actions reinforce one another: greater cybersecurity leads to a higher debt burden, which strengthens incentives for protection. When failure is illiquidity-driven, additional cybersecurity lowers the debt burden, eliminating the bank’s private risk–return trade-off. Socially optimal cybersecurity differs from the private choice, and corrective instruments must target either the protection or resilience margins. We extend the model to a system-wide environment in which cybersecurity is a public good, highlighting free-riding and the need for targeted regulation.

Abstract We document widespread use of personal financial advice among retail investors. Individuals seek competent and trusted sources for financial advice among their family and friends. Investors who provide advice to family and friends are positively selected and emphasize the reputational costs of giving risky financial advice. While previous studies have shown that advice shared on social media promotes active trading, we show that personal financial advice encourages investing in funds over single stocks. Our evidence complements the existing literature on financial advice in online social networks by highlighting differences in incentives and outcomes of advice to close personal connections.

Abstract We model the feedback loop between the sales of trading advantages (e.g., data or co-location services) and traders’ endogenous participation in financial markets. Whereas a trader’s benefit from purchasing trading advantages increases with aggregate market participation, the benefit from participating decreases with other traders’ purchases of trading advantages that impose negative externalities on counterparties. In equilibrium, sellers of trading advantages (e.g., data providers or securities exchanges) may maximize their profits by prompting inefficiently low market participation and liquidity. We study the consequences of altering the market structure and show that the resulting policy prescriptions contrast sharply with standard models.

Abstract Many initial public offerings (IPOs) are priced at exactly the high-end of the pricing range. Investing in IPOs priced at the high-end leads to first-day returns that are substantially higher than investing in IPOs that are priced just below or above the high-end. We argue that these results are in line with issuing firms settling for positively perceived salient pricing points in negotiations with underwriters.

Abstract We combine high-frequency stock returns with risk-neutralization to extract the daily common component of tail risks perceived by investors in the cross-section of firms. Our tail risk measure significantly predicts the equity premium and variance risk premium at short horizons. Furthermore, a long–short portfolio built by sorting stocks on their recent exposure to tail risk generates abnormal returns with respect to standard factor models. Incorporating investors’ preferences via risk-neutralization is fundamental to our findings: the predictive power of the physical tail risk is weaker and generally subsumed by its risk-neutral counterpart.

Abstract Data-driven lending relies on the calibration of models using training periods. We find that this type of lending is not resilient in the presence of economic conditions that are materially different from those experienced during the training period. Using data from a small business fintech lending platform, we document that the small business credit supply collapsed during the COVID-19 crisis of March 2020 even though the demand for loans doubled relative to pre-pandemic levels. As the month progressed, most lenders significantly reduced or halted their lending activities, likely due to the heightened risk of model miscalibration under the new economic conditions.

Abstract This article studies how corporate tax hikes transmit across countries through multinationals’ internal networks of subsidiaries. We build a parsimonious multicountry model to highlight two opposing spillover effects: while tax competition between countries generates positive investment spillover, intra-firm production linkages predict negative spillover. Using subsidiary-level data and exogenous corporate tax hikes, we find that local business units cut investment by 0.5 percent for a 1 percent increase in foreign corporate tax. This result highlights the importance of production linkages in propagating foreign tax shocks, as the supply-chain-induced negative spillover dominates the positive spillover effect suggested by the conventional wisdom of tax competition.

Abstract This article extends the rare disaster framework by introducing a model with a time-varying disaster recovery feature. The model yields closed-form pricing formulas for stocks and dividend strips. Calibrated using international disaster data, it quantitatively captures both the unconditional and conditional term structures of equity risk premia. It replicates key empirical patterns, including a downward-sloping unconditional term structure of one-period returns and a countercyclical conditional slope, and generates novel predictions for capital asset pricing model beta, alpha, and price.

Abstract This article explores a new channel through which exchange-traded funds (ETFs) can affect underlying asset prices. In over-the-counter markets, daily disclosure of ETF portfolio holdings increases price transparency and therefore retail investors’ bargaining power. I show that ETF-held municipal bonds have significantly lower dealer markups than observationally similar non-ETF-held bonds. This effect cannot be explained by bond selection or ETFs’ own trading activity. Rather, ETFs’ disclosure of end-of-day bond pricing is associated with lower retail markups by 5–9 basis points.