Knowledge that Transforms

Using detailed ownership data for a sample of European commercial banks, we analyze the link between ownership structure and risk in both privately owned and publicly held banks. We consider five categories of shareholders that are specific to our dataset. We find that ownership structure is significant in explaining risk differences but mainly for privately owned banks. A higher equity stake of either individuals/families or banking institutions is associated with a decrease in asset risk and default risk. In addition, institutional investors and non-financial companies impose the riskiest strategies when they hold higher stakes. For publicly held banks, changes in ownership structure do not affect risk taking. Market forces seem to align the risk-taking behavior of publicly held banks, such that ownership structure is no longer a determinant in explaining risk differences. However, higher stakes of banking institutions in publicly held banks are associated with lower credit and default risk.

Investment banks that develop new corporate securities systematically lead the new underwriting market despite being imitated early by equally competitive rivals. We study how innovators and imitators set underwriting fees in order to identify empirically the source of this advantage. Using data of innovative securities since 1985, we do find that innovators set systematically higher fees than imitators. This premium decreases as more issues occur, and faster for later generation products. Imitation is also quicker for later generations. This evidence supports the hypothesis that the innovator has superior skills in structuring any given issue of the new security.

We analyze the implications of European bank consolidation on the default risk of acquiring banks. For a sample of 134 bidding banks, we employ the Merton distance to default model to show that, on average, bank mergers are risk neutral. However, for relatively safe banks, mergers generate a significant increase in default risk. This result is particularly pronounced for cross-border and activity-diversifying deals as well as for deals completed under weak bank regulatory regimes. Also, large deals, which pose organizational and procedural hurdles, experience a merger-related increase in default risk. Our results cast doubt on the ability of bank merger activity to exert a risk-reducing and stabilizing effect on the European banking industry.

Does global currency volume increase on Federal Open Market Committee (FOMC) days? To test hypotheses of abnormal currency volume on FOMC days, a new data set from the Continuous Linked Settlement (CLS) Bank is used. The CLS measure captures more than half of the global trading volume in foreign exchange (FX) markets. The evidence shows that FX trading volume increases about 5% in the spot and the spot-next market following FOMC deliberations. The novelty of this result is that the aggregated CLS data controls for responses in various derivatives markets: a feature that existing studies based on intradaily data for specific trading platforms do not consider.

In practice, open-market stock repurchase programs outnumber self tender offers by approximately 10–1. This evidence is puzzling given that tender offers are more efficient in disbursing free cash and in signaling undervaluation – the two main motivations suggested in the literature for repurchasing shares. We provide a theoretical model to explore this puzzle. In the model, tender offers disburse free cash quickly but induce information asymmetry and hence require a price premium. Open-market programs disburse free cash slowly, and hence do not require a price premium, but because they are slow, result in partial free cash waste. The model predicts that the likelihood that a tender offer will be chosen over an open-market program increases with the agency costs of free cash and decreases with uncertainty (risk), information asymmetry, ownership concentration, and liquidity. These predictions are generally consistent with the empirical evidence.

Two widely discussed pricing benchmarks in the literature on payment card markets are the “tourist test” interchange fee (Rochet and Tirole, forthcoming), which internalizes usage externalities in payment card markets, and “perfect surcharging” by merchants (Rochet and Tirole, 2002). This paper shows that these benchmarks are allocatively equivalent. Implications for the regulatory treatment of interchange fees and no-surcharge rules are discussed.

We study the asset allocation of a linear loss-averse (LA) investor and compare it to the more traditional mean-variance (MV) and conditional value-at-risk (CVaR) investors. First we derive conditions under which the LA problem is equivalent to the MV and CVaR problems and solve analytically the two-asset problem of the LA investor for a risk-free and a risky asset. Then we run simulation experiments to study properties of the optimal LA and MV portfolios under more realistic assumptions. We find that under asymmetric dependence LA portfolios outperform MV portfolios, provided investors are sufficiently loss-averse and dependence is large. Finally, using 13 EU and US assets, we implement the trading strategy of a linear LA investor who reallocates his/her portfolio on a monthly basis. We find that LA portfolios clearly outperform MV and CVaR portfolios and that incorporating a dynamic update of the LA parameters significantly improves the performance of LA portfolios.

We estimate the slope of the demand curve for newly auctioned FHLB discount notes and investigate the impacts of arbitrage risk and heterogeneity of investor beliefs on demand elasticity. Our unique dataset of roughly 2900 observations of two price-quantity pairs—the first from a pre-auction dealer survey, the second from actual auction results—provides the quantity shift necessary to identify demand. In contrast to previous findings of downward-sloping demand curves for equities, we show that demand for newly issued FHLB notes is nearly perfectly elastic during normal market conditions. We find, however, that frictions like arbitrage risk and, to a lesser extent, heterogeneity of investor beliefs negatively affect elasticity and explain the nearly 50% drop in elasticity observed during the recent financial crisis.

This paper estimates fiscal policy reaction function in order to investigate the links between financial market movements and fiscal policy outcomes. An increase in asset prices affects in a positive and significant manner primary balances, with the response reflecting both an increase in government revenues and a fall in government spending. The most important impact on fiscal balances is due to changes in residential property prices. Changes in equity and commercial property prices are also important determinants of fiscal balances. Our findings suggest that the steepening of the slope of the yield curve contributes to expenditure based fiscal discipline.

Although the family firm is the dominant type among listed corporations worldwide, few papers investigate the behavioral differences between family and non-family firms. We analyze the differences in merger decisions and the consequences between them by using a unique Japanese dataset from a period of high economic growth. Empirical results suggest that family firms are less likely to merge than non-family firms are. Moreover, we find a positive relationship between pre-merger family ownership and the probability of mergers. Thus, ownership structure is an important determinant of mergers. Finally, we find that non-family firms benefit more from mergers than family firms do.