Knowledge that Transforms

[We show that Treasury security prices in the secondary market decrease significantly in the few days before Treasury auctions and recover shortly thereafter, even though the time and amount of each auction are announced in advance. These results are linked to dealers' limited risk-bearing capacity and end-investors' imperfect capital mobility, highlighting the important role of frictions even in very liquid financial markets. Our results imply a hidden issuance cost to the U.S. Department of the Treasury, estimated to be 9 to 18 bps of the auction size, or over half a billion dollars for the issuance size in 2007.]

[We show that the credit quality of corporate debt issuers deteriorates during credit booms and that this deterioration forecasts low excess returns to corporate bondholders. The key insight is that changes in the pricing of credit risk disproportionately affect the financing costs faced by low-quality firms, so debt issuance of low-quality firms is particularly useful for forecasting bond returns. We show that a significant decline in issuer quality is a more reliable signal of credit market overheating than rapid aggregate credit growth. We use these findings to investigate the forces driving time variation in expected corporate bond returns.]

[We propose a decomposition for time series in components classified by levels of persistence. Employing this decomposition, we provide empirical evidence that consumption growth contains predictable components highly correlated with well-known proxies of consumption variability. These components generate a term-structure of sizable risk premia. At low frequencies we identify a component correlated with long-run productivity growth and commanding a yearly premium of approximately 2%. At high frequencies we identify a component with yearly half-life, which contributes to the equity premium for another 2%. Accounting for persistence heterogeneity, we obtain an estimate of the IES strictly above one and robust across subsamples.]

[We show that bond risk premia rise with uncertainty about expected inflation and fall with uncertainty about expected growth; the magnitude of return predictability using these uncertainty measures is similar to that by multiple yields. Motivated by this evidence, we develop and estimate a long-run risks model with timevarying volatilities of expected growth and inflation. The model simultaneously accounts for bond return predictability and violations of uncovered interest parity in currency markets. We find that preference for early resolution of uncertainty, time-varying volatilities, and non-neutral effects of inflation on growth are important to account for these aspects of asset markets.]

[We compare various bank capital regulation regimes using a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period and the business cycle determines loans' probabilities of default. Banks hold endogenous capital buffers as a precaution against shocks that impair their future lending capacity. We find that Basel II is more procyclical than Basel I but makes banks safer, and it is generally superior in welfare terms. For high social costs of bank failure, the optimal capital requirements are higher but less cyclically varying, like those currently targeted by Basel III.]

We explore a continuous-time agency model with double moral hazard. Using a venture capitalist (VC)–entrepreneur relationship where the VC both supplies costly effort and chooses the optimal timing of the initial public offering (IPO), we show that optimal IPO timing is earlier under double moral hazard than under single moral hazard. Our results also indicate that the manager's compensation tends to be paid earlier under double moral hazard. We derive several comparative static results, notably that IPO timing is earlier when the need for monitoring by the VC is smaller and when the volatility of cash flows is larger.

[In a financial contracting model, we study the optimal debt structure to resolve financial distress. We show that a debt structure where two distinct debt classes coexist—one class fully concentrated and with control rights upon default, the other dispersed and without control rights—removes the controlling creditor's liquidation bias when investor protection is strong. These results rationalize the use and the performance of floating charge financing, which refers to debt financing where the controlling creditor takes the entire business as collateral, in countries with strong investor protection. Our theory predicts that the efficiency of contractual resolutions of financial distress should increase with investor protection.]

[Using proprietary energy futures position data, we provide evidence that mean hedger profits are negative whereas speculator (especially hedge fund) profits are positive, that traders (whether speculators or hedgers) who hold net positions opposite in sign to likely hedgers in aggregate have higher profits than traders whose net positions align with likely hedgers, and that profits on long positions vary inversely with inventories and directly with price volatility. These findings are consistent with the risk premium, hedging pressure, and modern theory of storage hypotheses, respectively. Further, our findings suggest that commodity futures momentum may be due largely to hedging pressure.]

[Empirical evidence on the relations between board independence and board decisions and firm performance is generally confounded by serious endogeneity issues. We circumvent these endogeneity problems by demonstrating the strong impact of the local director labor market on board composition. Specifically, we show that proximity to larger pools of local director talent leads to more independent boards for all but the largest quartile of S&P 1500. Using local director pools as an instrument for board independence, we document that board independence has a positive effect on firm value, operating performance, fraction of CEO incentive-based pay, and CEO turnover.]

[We examine whether "rating shopping" or "rating catering" is a more accurate characterization of rating agency interactions regarding collateralized debt obligations (CDOs). Although investors paid a premium for dual ratings, AAA CDO tranches rated by both Moody's and S&P defaulted more frequently than tranches rated by only one of them, which is inconsistent with pure rating shopping. Rating agencies made upward adjustments beyond their model when their competitor had more lenient assumptions. Finally, consistent with rating catering, S&P's and Moody's adjustments and disagreements at security issuance were reflected in subsequent rating downgrades, suggesting that adjustments were harmful.]