Knowledge that Transforms

Abstract Previous research documents differences in trading desk skills across management companies that result in significant variation in execution costs. In this paper, we utilize links between management companies and their institutional clients to explore variation in execution costs within management companies. For a subset of management companies, we find that systematic differences in execution costs exist across clients; these differences are comparable to the variation documented across management companies and persist over time. Clients who receive lower execution costs reward management companies with an increase in dollar trading volume. We find no evidence that the results are driven by broker commissions or differences in trading practices. Given the economic significance of our findings and implications for institutional investors, this aspect of execution should be recognized regardless of the ultimate source of the differences.

Abstract This paper develops a novel method for classifying oil price changes as supply or demand driven using information in asset prices. Motivated by a simple model, demand shocks are identified as returns to an index of oil producing firms which are orthogonal to unexpected changes in the VIX index, with supply shocks capturing the remaining variation in oil prices. Demand shocks are strongly positively correlated with market returns and economic output, whereas supply shocks have a strong negative correlation. The negative correlation of supply shocks and returns is strongest in industries that produce consumer goods, while the positive correlation of demand shocks is stronger for industries which use relatively large amounts of oil as an input.

Abstract We examine how dividend policy is used to mitigate potential conflicts of interest between majority and minority shareholders in private Norwegian firms. The average payout is 50% higher if the majority shareholder’s equity stake is 55% (high conflict potential) rather than 95% (low conflict potential). Such minority-friendly payout is also associated with higher subsequent minority shareholder investment. These results suggest that controlling shareholders voluntarily use dividends to reduce agency conflicts and build trust, rather than opportunistically preferring private benefits to dividends. We show that our results are unlikely to arise from liquidity or signaling motives.

Abstract We measure credit risk premia—prices for bearing corporate default risk in excess of expected default losses—using Markit CDS and Moody’s Analytics EDF data. We find dramatic variation over time in credit risk premia, with peaks in 2002, during the global financial crisis of 2008–09, and in the second half of 2011. Even after normalizing these premia by expected default losses, median credit risk premia fluctuate over time by more than a factor of 10. Credit risk premia comove with macroeconomic indicators, even after controlling for variation in expected default losses, with higher premia per unit of expected loss during times of market-wide distress. Countercyclical variation of premia-to-expected-loss ratios is more pronounced for investment-grade issuers than for high-yield issuers.

Abstract This article characterizes the interbank deposit network as a flow network that is able to channel liquidity flows among banks. These flows are beneficial, allowing banks to cope with liquidity risk. First, we analyze the efficiency of three network structures: star-shaped, complete, and incomplete in transferring liquidity among banks. The star-shaped interbank network achieves the complete coverage of liquidity risk with the smallest amount of interbank deposits held by each bank. This result implies that the star-shaped network is most resilient to systemic risk. Second, we analyze the banks’ decentralized interbank deposit decisions for a given network structure. We show that all network structures can generate an inefficiently low amount of interbank deposits. However, the star-shaped network induces banks to hold an amount of interbank deposits that is the closest to the efficient level. These results provide a rationale for consistent empirical evidence on sparse and centralized interbank networks.

Abstract We exploit variation in consumer price inflation across seventy-one Russian regions to examine the relationship between the perceived stability of the domestic currency and financial dollarization. Our results show that regions with higher inflation experience an increase in the dollarization of household deposits and a decrease in the dollarization of loans. The impact of inflation on credit dollarization is weaker in regions with less integrated banking markets. This suggests that the currency-portfolio choices of households and firms are constrained by the asset-liability management of banks.

Abstract Option listing increases informed and uninformed trading by 12.4% and 23.9%, respectively, in the USA between 2001 and 2010, hence reducing relative information risk. We establish the causal effects using control stocks with similar propensities of listing and a quasi-natural experiment using option listing standards. The benefits are more prominent for stocks with active options trading and opaque stocks. The reduction of information risk is larger for good news than bad news, and the stock price response to earnings surprise weakens after listing. The results suggest that options improve the overall market information environment beyond substitutional effects to stock trading.

Abstract We hypothesize that labor participation in governance helps improve risk sharing between employees and employers. It provides an ex post mechanism to enforce implicit insurance contracts protecting employees against adverse shocks. Results based on German establishment-level data show that skilled employees of firms with 50% labor representation on boards are protected against layoffs during adverse industry shocks. They pay an insurance premium of 3.3% in the form of lower wages. Unskilled blue-collar workers are unprotected against shocks. Our evidence suggests that workers capture all the gains from improved risk sharing, whereas shareholders are no better or worse off than without codetermination.

Abstract We empirically reinvestigate the issue of the excess co-movement of commodity prices initially raised in Pindyck and Rotemberg (1990). Excess co-movement appears when commodity prices remain correlated even after adjusting for the impact of fundamentals. We use recent developments in large approximate factor models to consider a richer information set and adequately model these fundamentals. We consider a set of eight unrelated commodities along with 184 real and nominal macroeconomic variables, from developed and emerging economies, from which nine factors are extracted over the 1993–2013 period. Our estimates provide evidence of time-varying excess co-movement which is particularly high after 2007. We further show that speculative intensity is a driver of the estimated excess co-movement, as speculative trading is both correlated across the commodity futures markets and correlated with the futures prices. Our results can be taken as direct evidence of the significant impact of financialization on commodity-price cross-moments.

Abstract We characterize dependence in corporate credit and equity returns for 215 firms using a new class of large-scale dynamic copula models. Copula dependence and especially tail dependence are highly variable and persistent, increase significantly in the financial crisis, and have remained high since. The most drastic increases in credit dependence occur in July/August of 2007 and in August of 2011 and the decrease in diversification potential caused by the increases in dependence and tail dependence is large. Credit default swap correlation dynamics are important determinants of credit spreads.