Knowledge that Transforms

I exploit a Dutch reform in the regulatory discount curve that makes the liabilities of pension funds and insurance companies (P&Is) more sensitive to changes in 20-year interest rates but less so to longer maturity rates. Following the reform, P&Is reduced their longest maturity bond holdings but increased those with 20-year maturities, steepening the long end of the yield curve. Using the reform as a shock to identify price elasticities of demand at the sector level based on holdings across maturity buckets and time, I show that banks are more price elastic than other investors and absorb demand shocks.

We study how risk management through hedging affects firms and competition among firms in the life insurance industry, an industry with over 7 trillion in assets and over 1,000 private and public firms. We examine firms after a staggered state-level reform that reduces the costs of hedging by granting derivatives superpriority in case of insolvency. We show that firms that are likely to face costly external finance increase hedging and reduce risk and the probability of receivership. Firms that are likely to face costly external finance also lower prices, increase policy sales, and increase their market share post-reform.

We study the role of brokers in selection markets. We find broker-clients in the Canadian mortgage market are observationally different from branch-clients. They finance larger loans with more leverage and longer amortization. We build and estimate a model of mortgage demand to disentangle three possible explanations for these riskier product choices: (1) selection on observables, (2) unobserved borrower preferences for riskier loans, and (3) a causal effect of brokers. Although we find that brokers influence product choices, the main reason borrowers choose high-leverage products is unobserved preferences. Borrowers prefer larger loans and brokers facilitate qualification for them.

I study the real effects of centralized derivative markets using the staggered introduction of futures contracts for different steel products in the United States. Employing a difference-in-differences strategy, I find that the arrival of centralized futures markets improves price transparency and risk management in the underlying product market: price dispersion decreases and steel producers increase their hedging activity. Moreover, market share is reallocated toward low-cost producers, while product prices, producers’ profits, and valuations decrease. Overall, the results indicate that centralized futures markets foster competition in the product market.

This paper examines whether capital structure is irrelevant for enterprise value and investment when investors care about environmental, social, and governance issues, which we refer to as “ESG-Modigliani-Miller” (ESG-MM). Theoretically, we show that ESG-MM holds with linear pricing and additive ESG. ESG-MM means that issuing low-yielding green bonds does not lower the overall cost of capital because it makes the issuer’s other securities browner. Hence, a firm’s incentive to make a green investment does not depend on its financing choice. We provide suggestive evidence of failure of ESG-MM, implying that firms and governments can exploit inconsistent ESG attribution or segmented markets.

How should an investor value financial data? The answer is complicated because it depends on the characteristics of all investors. We develop a sufficient statistics approach that uses equilibrium asset return moments to summarize all relevant information about others’ characteristics. Our approach values public or private data, data about one or many assets, and data relevant for dividends or sentiment. While different data types, of course, have different valuations, heterogeneous investors also value the same data very differently. This finding suggests a low price elasticity for data demand. Heterogeneous investors’ data valuations are also affected very differentially by market illiquidity.

In an investment experiment, we show variations in information affect beliefs and decision-making within the information-beliefs-decisions chain. Subjects observe the time series of a risky asset and a signal that, in random rounds, helps predict returns. Subjects form extrapolative forecasts following a signal they perceive as useless, and their investment decisions underreact to their beliefs. If the same subjects perceive the signal as predictive, they rationally use it in their forecasts, they no longer extrapolate, and they rely significantly more on their forecasts when making risk allocations. Analyzing investments without observing forecasts and information sets leads to erroneous interpretations.

We offer new evidence on the relationship between competition and innovation that overcomes two measurement difficulties compromising the extant literature: aggregation at either firm level (or higher) of innovative activity, and the mediating influence of distance-to-technological-frontier. FDA awards of Breakthrough Therapy Designations (BTDs) on specific drugs, instrument stochastic unleveling of therapeutic (ie, product) markets. Rivals’ innovative responses generally show an inverted-U pattern in ex ante competitiveness of the shocked market. However, the shape of the relation changes with distance to technological frontier in that market, proxied by whether the rival project uses one of the technologies embedded in the BTD-awarded drug.

We develop an economic model to compare equilibrium security of Proof-of-Work (PoW) versus Proof-of-Stake (PoS) blockchains. We derive general conditions to determine when PoW blockchains are more secure than otherwise equivalent PoS blockchains and vice versa. Applying real-world parameter values to these conditions, we demonstrate that PoS blockchains are more secure than otherwise equivalent PoW blockchains. Furthermore, we demonstrate that PoS’s security advantage over PoW is particularly salient for high-scale blockchains.

In the United States, a significant number of criminal defendants are held in pretrial detention and face substantial financial burdens. Matching individual-level criminal case records to household-level financial data, we exploit the quasi-random assignment of court commissioners to study how pretrial detention affects household solvency. We find that pretrial detention results in higher rates of household insolvency, driven by higher rates of chapter 7 bankruptcies and judgment liens, and higher foreclosure rates during periods of decreasing house prices. We document that the effects spill over to family members and show that home equity can cushion households from insolvency.