Knowledge that Transforms

This paper shows that productivity shocks to the 100 largest U.S. firms (by revenue) contain systematic information. Specifically, shocks to the top-100 firms predict future shocks to geographically close firms. Intra-sector trade links are an important economic channel for spillover effects. However, these spillovers are not restricted to firms’ trade links only. Knowledge externalities and state income tax payments of the top-100 firms are other economic channels through which shocks propagate. Market participants do not fully incorporate the information contained in shocks to the top-100 firms. Consequently, a portfolio analysis that exploits the slow diffusion of information generates an annual risk-adjusted return of 5.4%. Overall, the results show how productivity shocks to the few largest firms in the U.S. spillover to other firms and potentially aggregate to affect the national economy.

Using a large, representative sample of high-frequency credit card transactions in the United States, this paper examines the causal effect of sunshine-induced mood on contemporaneous household credit card spending. We document a 0.3 percent increase in credit card spending in response to a one-unit increase in the same-day local abnormal sunshine. The spending response is stronger for consumers with higher credit card debt, lower FICO score, and shorter tenure with the bank. The effect manifests in long-term, durable goods spending, and is not driven by other weather conditions, complementarity between sunshine and consumption, or intentional choice of consumption time. We document similar responses of spending on seasonal and non-seasonal goods and during times with high and low sunshine levels. Finally, the sunshine effect occurs among consumers with various characteristics.

Employing unique representative survey data from New Zealand collected in 2016 and 2019, we study public knowledge about and attitude towards a specific monetary policy institution, the Policy Targets Agreement (PTA). We assess how much the population knows about the PTA and also ask whether our respondents support a clause in the PTA that allows the government to over-ride the RBNZ if the government deems it necessary. Responses to that question are interpreted as attitudes towards central bank independence (CBI). Using logit regression, we study which characteristics make people favour more CBI. Subjective and objective knowledge about the RBNZ and monetary policy increases support for CBI, whereas voting for a national-orientated party and trusting the government reduces it. We then investigate how the 2018 amendment of the Reserve Bank of New Zealand Act of 1989, effective April 2019, affected answers. The population does not have a clear view on whether CBI should be expanded; instead, people's attitudes seems to be dominated by a status-quo view. Overall, our results raise doubts that the PTA had a strong impact on anchoring inflation expectations among households.

We propose that relationship bankers are able to benefit their clients even after they indicate distress. Relationship bankers continually learn about their clients to reduce the asymmetric information problem, reduce adverse selection risk and manage loan risk. We examine the consequences of corporate disclosure, namely profit warnings, as a negative information-releasing event during the normal course of business and evaluate the evolving nature of relationship banking before and after such an event. We show that lenders generally increase the cost of loans, loan security and reduce loan maturity after profit warnings. The average loan spread increases by 17–37 basis points holding all else constant. However, borrowing from relationship lenders lowers the loan spread by 17 basis points compared to borrowing from non-relationship lenders, implying that relationship lenders are able to benefit borrowers. Moreover, borrowers often choose to remain with their relationship bankers due to more favorable loan terms and the high costs of switching lenders. Ultimately, these borrowers end up reducing their default risk and improving their profitability after the profit warning. Our results remain robust even when we control for firms that did not issue profit warnings. We conclude that relationship bankers efficiently use client information to provide effective financial intermediation, even after distress.

In the 2000 s, U.S. commercial real estate (CRE) prices experienced a boom and bust as dramatic as the more widely analyzed swings in house prices and contributed significantly to bank failures. We model short-run and long-run movements in capitalization rates (rent-to-price-ratio) and risk premia for office building and apartments. In the mid-2000s’ boom, CRE prices were mainly driven by declines in required risk premia that stemmed from a weakening of capital requirements. In the bust, CRE price declines were initially driven by a jump in general risk premia and later by a tightening of effective capital requirements on commercial mortgage-backed securities (CMBS) from the Dodd-Frank Act. The subsequent recovery in CRE prices was induced and sustained by unusually low real Treasury yields. We conclude that macro-prudential regulation of leverage may help limit asset price booms by preventing sharp declines in risk premia.

Middle-aged people have a higher demand for bank loans compared to other age groups and banks that are active in regions with more middle-aged residents are exposed to higher loan demand. This generates a geographically varying demand for loans. Using this variation, we show that banks increase their loan supply and expand their balance sheet with an increase in their loan demand. They finance this expansion mainly with debt. This leads to a decrease in their Tier 1 ratios and an increase in their leverage, i.e., leverage is procyclical. By differentiating between worse-and better-capitalized banks, we highlight the importance of bank capital in banks’ lending and financing decisions.

We find significant positive abnormal returns surrounding a surprising and quick enactment of a law that restricts executive pay to a binding upper limit in a few industries. We find that the effect is concentrated only for firms in which the restriction is binding. We also find that the increase in value is greater for firms with weaker corporate governance and smaller for firms that grant a greater portion of equity-based compensation to their executives. These results provide indications that, on average, compensation contracts can be set in a way that does not maximize firm value.

Using a broad sample of earnings announcements, we find a monotonic increase in the spread between call and put implied volatilities as it gets closer to the earnings announcement date. The steady build-up of volatility spread in the days leading up to the announcement date, coupled with the predictive power of cumulative abnormal implied volatility spread on subsequent announcement returns, suggests that informed traders are the driving force behind the option market activities prior to earnings announcements. Such informed trading, as proxied by the abnormal implied volatility spread, increases rather than decreases the stock market response to earnings announcements after controlling for an array of firm and announcement characteristics. This effect is most pronounced when the pre-earnings option trading volume is heightened. Overall, our findings lend strong support to the notion that informed options trading immediately before earnings announcements helps alleviate the stock market under-reaction to earnings announcements and make it closer to a complete response.

According to an influential argument, corporate hedging supports corporate investment when internal cash flows are volatile and external financing is costly (Froot, Scharfstein and Stein, 1993). Despite its vast influence, the predictions of this theory have not yet been directly tested using actual derivative cash flows. This study uses hand-collected data on cash flows from derivative positions in the oil and gas industry between 2000 and 2015. Strikingly, on average, an extra dollar in derivative cash flows translates into one more dollar in capital expenditure. During industry recessions, the median ratio of derivative cash flows to capital expenditure rises to 20% for hedging firms, suggesting that derivatives play a crucial role in sustaining investment when the cost of external financing rises abruptly.

Annual stress tests have become a regular part of the supervisors’ toolkit following the global financial crisis. We investigate their market implications in the United States by looking at price and trade reactions as well as information asymmetry and uncertainty indicators around the tests, and bank behavior after the tests. The evidence we present supports the notion that there is important new information in stress tests. This is particularly the case during crisis. Moreover, public disclosure appears not to adversely affect informational asymmetries and uncertainties. Importantly, public disclosure of stress test results (and methodology) does not seem to have reduced private incentives to generate information or to have led to distorted incentives.