Knowledge that Transforms

This study examines the effects of trade liberalization on municipal financing costs. Using the granting of permanent normal trade relations (PNTR) to China as an exogenous shock, we find that U.S. counties that are more exposed to trade liberalization issue bonds with significantly higher tax-adjusted yield spreads. Moreover, these counties pay higher gross spreads and are less likely to issue bonds after PNTR. We also show that secondary market yield spreads increase significantly in response to the U.S. granting of PNTR to China. In addition, we provide evidence that a reduction in debt serving capacity serves as a channel underlying the trade shock effects. Our findings highlight the costs of trade liberalization for public finance.

We investigate the impact of implicit government guarantees (IGGs) on the trading behavior of retail stock investors for non-default firms, using China’s first corporate bond default in March 2014 as a negative shock to public expectations of IGGs. Our difference-in-differences analysis shows that, following the Chaori default shock, retail investors withdraw from high-default-risk firms that have not yet defaulted. This outcome is not attributed to industry, geographical or supply-chain contagions, declining stock prices, worsened financial metrics, or merely a seasonal effect. The effect is more pronounced for firms with preexisting larger retail ownership breadth or higher stock trading turnovers, for non-state-owned enterprises, and for firms with less sustainable earnings. When the initial default shows signs of a bailout, retail investors’ withdrawal partially reverses. Overall, the diminishment of IGGs seems to have reduced the moral hazard of retail stock investors and encouraged them to focus more on firms’ fundamentals, potentially enhancing the capital allocation efficiency in China’s stock market in the long run.

This paper empirically examines how listed non-financial firms use the “call option” feature of one of the most important financial assets, available-for-sale securities, as earnings manipulation tools owing to bad-news-hoarding motives. In 2007, China set its first accounting standards for financial instruments, which classify financial assets based on the highly subjective “managerial holding intention” criterion. We find that holding available-for-sale securities is positively associated with the likelihood of stock price crashes in Chinese listed firms. The main effect is more pronounced under lax external regulation and lower information transparency. It is further accentuated when CEOs have lower educational backgrounds, weaker competence in managing core business activities, or face greater performance pressures. Our findings indicate that, in typical emerging markets, fair value accounting may have unintended consequences, inducing non-financial firms to employ financial assets as tools to hoard bad news.

Does the informational interdependence among countries affect market quality? Guided by the theoretical literature, this paper examines disruptions to international information flow as a source of financial market frictions. Using nonoverlapping holidays as a novel identification method, I find that disruptions to foreign information inflow deteriorate domestic market liquidity and fairness. I show that market quality worsens through both the informational sensitivity and the abnormal trading channels. Additional analyses indicate that stocks with lower liquidity and higher volatility are prone to more manipulative trading during information disruptions. Furthermore, a stock exchange upgrade weakens the abnormal trading channel. These findings suggest that international information flow is important to financial market quality.

This study investigates the underexplored role of onsite viewing activities in the housing search process. By incorporating buyer heterogeneity into the housing search model of Courant (1978), we show that buyers with higher private valuations tend to view more properties onsite and ultimately pay higher prices. Utilising a proprietary dataset from the largest real estate agency in Beijing, our analysis reveals that increased onsite viewings significantly enhance both the likelihood of a transaction and the final purchase price. We establish causality by employing an instrumental variable approach that leverages exogenous variations in heavy pollution and rainfall, which hinder buyers’ ability to conduct onsite house viewings. More intensive onsite viewings raise transaction price as they reveal a buyer’s higher private valuation to the seller. Besides, onsite viewings also function through reducing information asymmetry and improving match quality.

The increased impact of extreme weather events and droughts has prompted the rapid growth of the water market. This paper develops a real options valuation model for a hydropower plant that incorporates uncertainty in water and electricity prices, water inflows, and drought severity. Using a stochastic optimal control framework, the model is calibrated with monthly data from a reservoir in California. Water inflow and prices are modeled as functions of the California Drought Severity Index. Results highlight strong seasonality and uncertainty in price dynamics and show that revenues from water rights trading are highly sensitive to climate conditions. The model provides a comprehensive understanding into managing and valuing hydropower reservoirs under volatile environmental and market conditions.

Since the 2008 financial crisis, regulators and supervisors have been granted increased independence from political bodies. But there is no clear evidence of the benefits of more independence for the stability of the banking sector. In this paper we introduce a new indicator of regulatory and supervisory independence for 98 countries from 1999 to 2019. We combine this index with bank-level data to investigate the relationship between independence and financial stability. We find that greater regulatory and supervisory independence is associated with improved financial stability. We show that these results are robust to alternative measures of financial stability and to a number of tests. Overall, our findings indicate that increasing the independence of regulators and supervisors is beneficial for financial stability.

Using an international sample of 38 countries, we find that firms located in countries experiencing greater socioeconomic damage from extreme climate events have higher implied costs of equity capital. This finding is attributed to heightened operational uncertainty, greater information asymmetry, and intensified agency conflicts that arise in the wake of extreme climate events. The relation is stronger for firms that derive substantial revenue from domestic markets, operate in climate-vulnerable industries, or are closely held by domestic institutional investors. The effect also varies across countries and is concentrated in markets characterized by low transparency or limited integration into the global financial market. While extreme climate events negatively influence firm performance and valuation, they raise corporate awareness of climate risk.

Despite regulatory reforms, Money Market Funds (MMFs) experienced severe stress in March 2020, following large redemptions and dislocations in short-term markets. We provide a model showing the trade-offs between liquidity and capital preservation services offered by MMFs. We show that in a crisis, MMFs cannot provide liquidity and capital preservation to investors at the same time. As a result, investors have an incentive to run pre-emptively. We calibrate our model on data from USD MMFs and find that most funds would have been unable to meet redemptions above 30% mid-March 2020. Unless short-term funding markets are made resilient in times of stress, MMFs will face similar challenges during future liquidity crises.

Using 13F quarterly holdings data of institutional investors, we introduce a novel measure for differences of opinions among investors by analyzing divergence in institutional investors’ trades. We find that increases in institutional trade dispersion predict a significant decline in future abnormal returns. Moreover, we find that this relationship persists after controlling for other proxies of divergence of investor opinions, such as the dispersion in analysts’ earnings forecasts, the change in the number of institutions holding the stock, and the dispersion in institutional investors’ holdings relative to their benchmarks. Consistent with Miller (1977), underperformance of high-dispersion stocks is found to be the strongest among stocks that experienced recent significant price increases, the stocks with the highest mispricing scores, and the stocks that face increases in short-interest positions after the onset of dispersion.