Knowledge that Transforms

This article examines how the extent of short-term trading relates to the efficiency of stock prices. We employ a new duration measure based on quarterly institutional investors’ portfolio holdings, next to existing proxies such as trading volume, the percentage of transient institutions, and fund turnover. Momentum returns and subsequent returns reversal are generally much stronger for stocks held primarily by short-term investors, especially if these investors recently had superior recent performance which could make them overconfident. Our results point toward the behavioral theory in Daniel, Hirshleifer and Subrahmanyam (1998) and seem inconsistent with short-term institutions improving efficiency.

We present a new variance reduction method for Asian options under a general model framework. The three special cases we consider are Lévy processes, Heston stochastic volatility, and regime switching models. The proposed method combines a very effective control variate with conditional Monte Carlo. While the control variate can be used for any model allowing the numerical computation of the multivariate characteristic function of the log-return vector, conditional Monte Carlo is based on the unified representation of the three models. Computational results confirm that the new method performs better than available control variate methods.

Conventional wisdom holds that small banks have comparative advantages vis-à-vis large banks in serving small firms, while recent literature suggests this may not be the case. Using a panel of recent US start-ups, we investigate how small bank presence affects these firms in normal times (2004–06) and in the recent financial crisis (2007–09). We find that greater small bank presence yields significantly more lending to and slightly lower failure rates of these firms during normal times. However, these benefits disappear during the financial crisis, possibly because small banks are less diversified and benefit less from government guarantees than large banks.

We apply a new and innovative approach to communicating risks associated with financial products that should support investors in making better investment decisions. In our experiments, participants are able to gain “simulated experience” by random sampling of a previously described return distribution. We find that simulated experience considerably improves participants’ understanding of the underlying risk–return profile and prompts them to reconsider their investment decisions and to choose riskier financial products without regretting their higher risk-taking behavior afterwards. This method of experienced-based learning has high potential for being integrated into real-world applications and services.

Two important characteristics of current equity markets are the large number of competing trading venues with publicly displayed order books and the substantial fraction of dark trading, which takes place outside such visible order books. This article evaluates the impact on liquidity of dark trading and fragmentation in visible order books. Dark trading has a detrimental effect on liquidity. Visible fragmentation improves liquidity aggregated over all visible trading venues but lowers liquidity at the traditional market, meaning that the benefits of fragmentation are not enjoyed by investors who choose to send orders only to the traditional market.

We analyze how banks adjust their lending to small firms after distinct shocks from the cross-border transmission of the 2007–09 crisis by using unique loan application and contract data from AccessBank Azerbaijan. These data allow us to disentangle the effects of a funding shock from the effects of a real shock. Contrary to conventional assumptions, we find that the funding shock works through reduced prospecting—as opposed to tightened lending standards—and leads to fewer loan applications among new applicants in particular, which improves the borrower pool. The real economy shock instead works through loan approval and affects small and medium enterprise rather than micro borrowers.

We propose a regime-switching present-value model with latent variables to jointly investigate the predictability of stock returns and dividend growth. We find that both return predictability and dividend growth predictability are time-varying. Interestingly, the predictability of stock returns and dividend growth is a tug-of-war contest: when dividend growth is highly predictable in the high-volatility regime, stock returns are largely unpredictable; in contrast, when dividend growth is less predictable in the low-volatility regime, stock returns are significantly predictable. We also investigate macroeconomic determinants of regime switches and find that two regimes are intimately related to macroeconomic risk and economic activity.

We investigate the bank competition-stability nexus based on a unique regulatory dataset. First, we use outright bank defaults, and control for a wide array of different time-varying bank characteristics which are likely to influence the nexus. Second, we simultaneously include measures of competition and market power corresponding to the bank, county, and federal state level. Third, we investigate the role of bank competition in the transmission of monetary policy to bank risk. From a policy perspective, our findings indicate that competition-reducing regulation does not necessarily enhance either the stability of individual banks or their resilience to monetary policy shocks.

This article discusses the effects of small banks on economic growth. We first theoretically show that small banks operating at a regional level can spur local economic growth. As compared with big interregional banks, small regional banks are more effective in promoting local economic growth, especially in regions with lower initial endowments and severe credit rationing. We then test the model predictions using a sample of German banks and corresponding regional statistics. We find that small regional banks are more important funding providers in regions with low access to finance. The empirical results support the theoretical hypotheses.

Emerging equity markets have become increasingly interrelated over the past two decades. For a sample of thirty-two emerging markets from four different regions, we find significant positive time trends in cross-country correlations within regions, correlations across regions, and in comovements with the rest of the world. Furthermore, we examine the economic mechanisms that drive these trends. We find that official market liberalization, a continuous measure of equity market openness, equity market development, and to some extent, trade openness all play a role. However, we show important heterogeneity across regions, both in the speed at which comovements increase over time and in the underlying macroeconomic channels.