Knowledge that Transforms

[We study the effects of the controlling shareholders' portfolio diversification on the initial public offering (IPO) process. Less diversified shareholders have more to gain from taking their firm public, and are more willing to accept a lower price for shares. We test these hypotheses using the data on all IPOs in Sweden between 1995 and 2001. Using detailed information on the portfolio composition of shareholders in private and public firms, we construct several proxies of their portfolio diversification and relate them to the probability of the IPO and the underpricing. We show that the less diversified individual shareholders, especially those with lower wealth, sell more of their shares at the IPO. Firms held by less diversified controlling shareholders are more likely to go public, and exhibit higher underpricing. These effects are economically and statistically significant, while the diversification of noncontrolling shareholders has no effect. Our findings suggest that diversification of controlling shareholders plays a prominent role in the IPO process.]

[Despite extensive disclosure requirements, mutual fund investors do not observe all actions of fund managers. We estimate the impact of unobserved actions on fund returns using the return gap--the difference between the reported fund return and the return on a portfolio that invests in the previously disclosed fund holdings. We document that unobserved actions of some funds persistently create value, while such actions of other funds destroy value. Our main result shows that the return gap predicts fund performance.]

[This article introduces a new nonparametric test to detect jump arrival times and realized jump sizes in asset prices up to the intra-day level. We demonstrate that the likelihood of misclassification of jumps becomes negligible when we use high-frequency returns. Using our test, we examine jump dynamics and their distributions in the U.S. equity markets. The results show that individual stock jumps are associated with prescheduled earnings announcements and other company-specific news events. Additionally, S&P 500 Index jumps are associated with general market news announcements. This suggests different pricing models for individual equity options versus index option.]

[We present a rational general equilibrium model that highlights the fact that relative wealth concerns can play a role in explaining financial bubbles. We consider a finite-horizon overlapping generations model in which agents care only about their consumption. Though the horizon is finite, competition over future investment opportunities makes agents' utilities dependent on the wealth of their cohort and induces relative wealth concerns. Agents herd into risky securities and drive down their expected return. Even though the bubble is likely to burst and lead to a substantial loss, agents' relative wealth concerns make them afraid to trade against the crowd.]

[Information advantage and entry deterrence incentives are investigated as they affect lending outcomes and competitive structure of the U.S. residential mortgage market. In the model, when assessing a loan applicant, the incumbent monopoly lender employs a proprietary screening technology to produce a privately observed estimate of loan credit quality. When faced with potential competitive entry, the incumbent signals poor credit quality by charging high prices to higher-quality borrowers. Market structure and loan pricing strategy are derived endogenously, where the incumbent deters entry first by segmenting consumers into prime and sub-prime loan markets and second by charging prime market borrowers a uniform rate that is higher than the risk-based monopoly rate. Empirical implications of the model are identified, and evidence is presented that is consistent with predictions.]

[A reduction in inflation can fuel run-ups in housing prices if people suffer from money illusion. For example, investors who decide whether to rent or buy a house by simply comparing monthly rent and mortgage payments do not take into account the fact that inflation lowers future real mortgage costs. We decompose the price-rent ratio into a rational component--meant to capture the "proxy effect" and risk premia--and an implied mispricing. We find that inflation and nominal interest rates explain a large share of the time series variation of the mispricing, and that the tilt effect is very unlikely to rationalize this finding.]

[We have developed Bayesian Markov chain Monte Carlo (MCMC) methods for inferences of continuous-time models with stochastic volatility and infinite-activity Lévy jumps using discretely sampled data. Simulation studies show that (i) our methods provide accurate joint identification of diffusion, stochastic volatility, and Lévy jumps, and (ii) the affine jump-diffusion (AJD) models fail to adequately approximate the behavior of infinite-activity jumps. In particular, the AJD models fail to capture the "infinitely many" small Lévy jumps, which are too big for Brownian motion to model and too small for compound Poisson process to capture. Empirical studies show that infinite-activity Lévy jumps are essential for modeling the S&P 500 index returns.]

[We test whether capital account liberalization led to higher economic growth using de jure measures of capital account and financial current account openness for 94 nations, from 1950 (or independence) onward. We argue that measurement error, differing time periods used, and collinearity among independent variables account for conflicting results in prior scholarship. We use pooled time-series, cross-sectional OLS and system GMM estimators to examine economic growth rates, 1955-2004. Capital account liberalization had a positive association with growth in both developed and emerging market nations. We confirm that equity market liberalization has an independent effect on economic growth.]

[We examine how well several institutional- and firm-level factors explain firms' perceptions of property rights protection. The institutional theories we investigate account for approximately 50% of the country-level variation, indicating that current research addresses first-order factors. Firm-level characteristics, such as legal organization and ownership structure, are comparable with institutional factors in explaining variations in property rights protection. A country's legal origin predicts property rights variation better than its religion, ethnic fractionalization, or natural endowments. However, these results are driven by the inclusion of former Socialist economies in the sample. When we exclude the former Socialist economies, legal origin explains considerably less than ethnic fractionalization does.]

[As the number of bank failures increases, the set of assets available for acquisition by surviving banks enlarges but the total liquidity available with surviving banks falls. This results in "cash-in-the-market" pricing for liquidation of banking assets. At a sufficiently large number of bank failures, and in turn, at a sufficiently low level of asset prices, there are too many banks to liquidate and inefficient users of assets who are liquidity-endowed may end up owning the liquidated assets. In order to avoid this allocation inefficiency, it may be ex-post optimal for the regulator to bail out some failed banks. We show, however, that there exists a policy that involves granting liquidity to surviving banks in the purchase of failed banks, which is equivalent to the bailout policy from an ex-post standpoint. Crucially, this liquidity provision policy gives banks incentives to differentiate, rather than to herd, makes aggregate banking crises less likely, and thereby dominates the bailout policy from an ex-ante standpoint.]