This paper documents predictable time-variation in the real return beta of US Treasury Inflation Protected Securities (TIPS) and in the Sharpe ratios of both indexed and conventional bonds. The conditional mean and volatility of both bonds and their conditional correlation first are estimated from predetermined variables. These estimates then are used to compute conditional real return betas and Sharpe ratios. The time-variation in real return betas and the correlation between TIPS and nominal bonds coincides with major developments in the fixed-income market. One implication of this predictability is that portfolio managers can assess more efficiently the risk of investing in TIPS versus conventional bonds. Conditional Sharpe ratios indicate that over the sample period, TIPS had superior volatility-adjusted returns relative to nominal bonds. This finding is striking in view of the absence of a major inflation scare during the sample period from February 1997 through August 2001, but is loosely consistent with the possibility that TIPS elevated rather than reduced Treasury borrowing costs. On the other hand, mean–variance spanning tests indicate that TIPS did not enhance the mean–variance efficiency of diversified portfolios.

Tighter bank lending standards could increase firms' post-hedging currency exposure by reducing firms' ability to fund hedging (funding channel) and/or by constraining counterparties' capacity to facilitate hedging (capacity channel). We find that tighter lending standards materially increase firms' exposure. In addition, we find no support for a funding-channel effect as firms' internal liquidity does not mitigate the impact of lending standards on exposure, indicating that the impact is through the capacity channel. Finally, we find a negative association between lending standards and aggregate transactions in currency derivatives, bolstering support for a capacity-channel effect. Our results have implications for firms' hedging policy and the bank lending channel of monetary policy transmission.

We use unique features of the private credit market to examine if and how currency risk impacts firms' financing and whether currency risk is a priced systematic risk at the firm level. We find that currency exposure has a large impact on loan spreads. Decomposing loan spreads, we find that exposure increases the expected default loss premium and that internationalization, growth opportunities, and relationship intensify exposure's impact. Further, exposure exacerbates firms' financing risk by increasing the need for collateral, reducing loan maturity, inducing monitoring and covenant intensity, and influencing syndicate structure. However, exposure does not affect the expected return premium in loan spreads; hence, currency risk does not appear priced in the classical sense and, therefore, should not affect the “true” cost of debt. Our findings imply that while managers should be concerned about exposure's impact on their access to, and terms of, bank financing, they should not adjust hurdle rates on account of exposure when assessing investment projects.

We examine the hypothesis that fluctuations in the aggregate supply of bank loans influence the supply of new equity capital. Using residual lending standards as a clean measure of aggregate loan supply and a VAR framework to aid identification, we find that a one-standard-deviation shock to lending standards results in 15% fewer IPOs. Shocks elicit strong responses from IPO-firms that are highly dependent on external capital and increase the number of withdrawals, strengthening the interpretation that the above is driven by changes in the supply of equity. Our results suggest that credit conditions are important to a well-functioning IPO market.

We examine the impact of changes in Greek sovereign yield spreads on abnormal returns of financial sector stocks for a sample of Eurozone countries, during the Greek debt crisis. We find that increases in yield spreads are associated with negative abnormal returns on financial stocks in the Portugal, Spain and Netherlands. These abnormal returns are driven in part by ratings downgrades and other unfavorable news announcements about Greece. We isolate the effects of known transmission channels–impairment of financial firms’ asset base due to cross-holdings of Greek bonds, from increases in domestic interest rates and higher funding costs. Our analysis indicates that news events lead to spillovers in excess of what can be explained by these channels of transmission.

There is scant evidence on how risk-taking incentives impact specific firm risks. This has implications for board oversight of managerial risk taking, firms' development of comparative advantage in taking particular risks, and compensation design. We examine this question for exchange rate risk. Using multiple identification strategies, we find that vega increases exchange rate exposure for purely domestic and globally engaged firms. Vega's impact increases with international operations, declines post-SOX, and is robust to firm-level governance. Our results suggest that evidence that exposure reduces firm value can be viewed, in part, as a wealth transfer from shareholders and debt-holders to managers.

Whether, and how, the introduction of deposit insurance affects non-bank financial market development depends on whether banks and non-bank financial markets are substitutes or complements and theory has conflicting views. Using data on 134 countries over a 28-year period and several identification strategies we find that the introduction of deposit insurance retards the equity market, the non-bank depositaries sector, and the banking sector when law and order is weak. While strong law and order mitigates this effect, it does not lead to a positive outcome for all markets. For non-bank financial markets, the effect is greater in the long run so that while deposit insurance increases banking sector development in the long run, it retards non-bank financial markets regardless of the level of law and order. Finally, several design features exacerbate the negative outcomes. Our results have important policy implications for implementing or altering deposit insurance schemes.

We examine the impact of rivals’ competitive activities on firms’ quantity-of-capital constraints in 60 countries. Prior work shows that competition increases the costs of debt and equity, which reduce the economic profit from investment. Capital constraints, however, may prevent firms from exploiting all positive NPV projects. Using unique survey data and several econometric techniques, we address endogeneity problems that affect both capital constraints and rivals’ competitive activities. We find that rivals’ competitive activities are positively associated with firms’ capital constraints and are more strongly correlated with capital constraints than banking sector competition. We also show that quantity-of-capital constraints are negatively related to firm growth, incremental to the cost of capital.

This article was originally published in 2017 in The Accounting Review 92 (3): 155-184.

ABSTRACT We examine the response of informed market participants to the informational signal of auditor changes. Using propensity score matching and difference-in-differences research designs, we document that loan spreads increase by 22 percent on bank loans initiated within a year after auditor changes, increasing direct loan costs by approximately $6.6 million. We also find a significant increase in upfront and annual fees and the probability of pledging collateral, consistent with an increase in screening and monitoring by banks. The increase in spreads is significant for client-initiated auditor changes, with or without disagreements with the auditor, as well as for auditor resignations. Further, the significant increase in loan spreads is documented for upward, lateral, and downward auditor changes. Our results are robust to other proxies for financial reporting quality. Finally, we find no effect resulting from the forced auditor changes due to Arthur Andersen. Collectively, these results suggest that voluntary auditor changes increase information risk, which is priced in private credit markets. JEL Classifications: G20; G21; G32; K22.