Knowledge that Transforms

Between March and August 2020, S&P and Moody’s downgraded approximately 25% of collateral feeding into CLOs and only 2% of tranche values, with rating actions concentrating in junior tranches. Both S&P and Moody’s modeling indicate that the impacts should have been considerably larger, especially for higher-rated tranches. Neither changes in correlation nor the accumulation of pre-COVID-19 protective cushions can explain the downgrade asymmetry on upper tranches. Instead, CLO managers repositioned their collateral pools to dampen the negative credit shock and rating agencies incorporated qualitative adjustments in their CLO ratings. Important potential policy and market implications from these findings are discussed.

Through a survey and analyses of observational data, we provide systematic evidence that institutional investors value and demand climate risk disclosures. The survey reveals the investors have a strong demand for climate risk disclosures, and many actively engage their portfolio firms for improvements. Empirical analyses of holdings data corroborate this evidence by showing a significantly positive association between climate-conscious institutional ownership and better firm-level climate risk disclosure. We establish further evidence of institutional investors’ influence on firms’ climate risk disclosures by examining a shock to the climate risk disclosure demand of French institutional investors (French Article 173).

We compare the investment of standalone firms across regions after a positive shock to the investment opportunities generated by a large-scale highway development project. We show that the standalones’ investment sensitivity is lower in regions with a higher density of business groups in the local area. We investigate mechanisms driving our results and find support for a financing mechanism whereby banks allocate capital preferentially to group-affiliated firms in responding to the increase in credit demand. Overall, our study documents that business groups have spillover effects on standalone firms.

We document that the aggregate hiring rate of publicly traded firms in the U.S. economy negatively predicts stock market returns and long-term cash flows, and positively predicts short-term cash flows. In addition, through a variance decomposition, we show that the time-series variation in the aggregate hiring rate is mainly driven by changes in discount rates and short-term expected cash flows, with no contribution from variation in long-term expected cash flows. We estimate a neoclassical dynamic model with labor market frictions and show that labor adjustment costs and time-varying risk are essential for the model to replicate the empirical patterns.

We investigate the link between exchange-traded funds and real investment. Cross-sectionally, higher ETF ownership is associated with an increased sensitivity of real investment to Tobin’s q and a heightened ability of stock returns to forecast future earnings. Inclusion of stocks in industry ETFs enhances investment-q sensitivity and implies greater incorporation of earnings information into prices prior to public releases. Greater nonmarket ETF ownership leads to increased (reduced) reliance of real investment on own (peers’) stock prices. Overall, the evidence is consistent with ETFs positively affecting real investment efficiency via greater flows of information.

We study the optimality of macroprudential policies in an environment where banks provide liquidity to firms. Informational frictions between banks can cause interbank market freezes, prompting firms to accumulate their own liquid assets. Liquidity hoarding by firms in turn reduces the demand for bank loans and bank profitability, makes interbank market freezes even more likely, and may ultimately trigger a self-fulfilling bad equilibrium. Such “liquidity panics” provide an additional rationale for liquidity requirements on banks, which alleviate frictions in the banking sector and, paradoxically, can increase aggregate investment. Instead, policies encouraging bank lending can have the opposite effect.

We study the stock market effects of the arrival of the three rounds of “stimulus checks” to U.S. taxpayers and the single round of direct payments to Hong Kong citizens. The first two rounds of U.S. checks appear to have increased retail buying and share prices of retail-dominated portfolios. The Hong Kong payments increased overall turnover and share prices on the Hong Kong Stock Exchange. We cannot rule out that these price effects were permanent. The findings raise novel questions about the role of fiscal stimulus in the stock market.

We present evidence that several popular low-frequency measures of effective spread suffer from a volatility-induced bias and that volatility is the primary driver of the variation of these liquidity proxies. Using data for U.S. equities and major foreign exchange rates, we show that the bias arises when the effective spread is small relative to volatility. We document that the bias has become more acute over time and show that volatility-biased measures fail to replicate some well-known results in empirical finance. We conclude by providing guidance on the choice of low-frequency measures in empirical applications.

We study how the growth of exchange-traded funds (ETFs) affects the sensitivity of international capital flows to the global financial cycle. Using comprehensive fund-level data on investor flows, we show that their sensitivity to global financial conditions for equity (bond) ETFs is 2.5 (2.25) times higher than for equity (bond) mutual funds. This higher sensitivity can be directly linked to ETFs underlying shorter-trading-horizon clientele that trades more often in response to shocks. Using country-level data, we find that where ETFs hold a larger share of financial assets, equity inflows and prices become more sensitive to global risk.

Does financing respond to changes in productive opportunities, even for the world’s poor? We answer this question by examining the response of private bank financing to an infrastructure program that brought road access to unconnected Indian villages. This program prioritized roads for villages above specific population thresholds, allowing us to exploit the resultant discontinuities for identification. Using detailed data from a large bank, we find that 75% more villagers get loans, and the average amount lent to them is 30%–35% higher, in villages just above these thresholds. District-level analyses further suggest that roads and loans are complements in the growth process.