Knowledge that Transforms

Existing research suggests that retail trading is associated with volatility in financial markets. To extend the literature, we study the dynamic effects of retail trading on volatility during the COVID-19 pandemic. Using marketable retail trades identified from the Boehmer et al. (2021) algorithm and novel empirical methods discussed in Jordá (2005), we document a negative, persistent impact of retail trading on the stability of stock prices that is particularly stronger during the pandemic than during the pre-pandemic period. These results highlight how periods of crises - like the pandemic - affect the destabilizing influence of retail trading. To provide additional evidence, we replicate our empirical exercise during the 2008-09 financial crisis. Consistent with the COVID-19 period, we again find that retail trading leads to more volatility during the financial crisis vis-á-vis the pre-crisis period. These results again support the idea that periods of crises strengthen the link between retail trading and volatility.

This paper studies finite-horizon consumption-portfolio decisions with recursive utility. We show that the parameter seemingly representing the individual’s bequest preference in traditional recursive utility formulations is quantitatively and qualitatively misleading. The parameter value is uninformative about the optimal bequest which, in some cases, is even inversely related to the magnitude of the apparent bequest weight. We argue that the ratio between optimal bequest and the optimal consumption rate just before the terminal date is a much better representation of the strength of the bequest motive. Numerical examples illustrate the pitfalls using the traditional specification and clarifies how the bequest preference affects optimal decisions and the life-cycle patterns of consumption and wealth assuming constant investment opportunities or stochastic interest rates. We show that the typical utility representation for a unit elasticity of intertemporal substitution actually assumes a strong bequest preference.

Using proprietary balance sheet data for Korean banks and a simultaneous equation model , we use a unique measure of the cost of new funding to document that increased funding costs lead to larger solvency risk (as measured by regulatory capital), which, in turn, leads to larger funding costs. When including the great financial crisis in the sample, our estimates imply that a 100 basis points (bp) increase in the cost of new funding (regulatory capital) is associated with a 265 (23) bp increase in regulatory capital (cost of new funding). We show these results are robust to alternative measures of solvency risk and that the traditionally used measure of average funding costs (interest expense over interest-bearing liabilities) does not properly capture this two-way negative feedback loop. The strength of this link is weaker during periods of monetary policy tightening, and is not affected by the specific funding business model chosen by banks. Our findings can inform macroprudential stress-tests calibration.

Lending to corporates in foreign currencies can expose banks to substantial currency risk. Using global syndicated loan data, we find that a one-standard-deviation increase in exchange rate volatility increases loan spreads somewhere in the range between 5.5 and 16.1 basis points for loans made in a currency different from the lenders’. This implies excess interest of approximately 1 to 3 USD million for loans of average size and duration. We also show that this finding is mostly attributed to credit constraints and deviations from perfect competition in international lending markets, and that borrowers can lower the extra cost by forming strong lending relationships with their banks.

We examine the minutes of Indian banks' board meetings and offer insights into the issues tabled and discussed in bank boards. We find that risk issues account for only 10% of the issues tabled with regulation and compliance accounting for the most (41%), followed by business strategy (31%). Majority of the issues are not deliberated in detail. We interpret the evidence as suggestive of under-investment in risk and over-investment in regulation and compliance by bank boards.

How are trading activity and performance impacted by material events during individual investors’ lifetimes? Using a unique dataset, we identify transfers of common stock initiated by the major event of divorce and analyze trading patterns and performance of divorced traders. In aggregate, divorcing individuals underperform, and part of this underperformance is due to liquidation needs arising from divorce. Cross-sectionally, however, actively-trading divorced investors demonstrate superior performance in the window surrounding divorce settlement, while underperforming just prior to divorce. This result survives a difference-in-differences analysis based on a propensity-score matched sample of non-divorced investors. Our analysis thus suggests that the life-cycle distraction of divorce temporarily reduces the performance of active retail traders, which improves once the stressor is removed.

A growing literature is devoted to understand how companies react to major external shocks. Contributing to this research, we study how the presence of families in corporate ownership and leadership affected the reaction of firms to the Covid-19 pandemic. Using data from Italy, we find that family firms exhibited higher market performance and operating profitability than other firms during the pandemic period. This result is stronger for companies without relevant minority investors and with multiple family shareholders. Delving into the mechanisms, we show that the outperformance of family firms is driven by a more efficient use of labor and a lower drop in revenues. Collectively, our results expand existing research by showing how family ties shape the response to adverse events.

Some mutual funds act as contrarian traders, earning returns in the stock market by providing liquidity, while others demand liquidity and suffer costs of immediacy. The funds’ liquidity demand has increased over time. On average, the mutual funds’ costs of immediacy exceed their returns from providing liquidity by 1.9% pa. High market beta funds, large cap funds, and funds exposed to momentum suffer over 2.5% pa. in costs of immediacy. Other results are that mutual funds’ average alpha becomes insignificant when the costs of immediacy are accounted for and in the cross-section, the funds’ costs of immediacy predict their alphas.

We exploit cross-country variation in banks’ confidential reporting requirements under COREP, the common European supervisory risk reporting framework, as an indicator for banking supervisors’ preference for private information. Our results suggest that a stronger preference for confidential reporting is associated with significantly lower trading volume, return volatility, and absolute returns around banks’ earnings announcements. These findings are independent of the level of countries’ stock market development and supervisors’ resources and legal power, and are consistent with the idea that investors perceive banks’ public reporting to be less informative when supervisors have a strong private informational advantage. Our study adds to the literature on the influence of bank supervisors’ institutional characteristics on market discipline, and highlights the role of private supervisory knowledge in shaping investors’ monitoring incentives.

We study how banks’ special interests affect the resolution of failed banks. Using a sample of FDIC auctions between 2007 and 2016, we find that bidding banks that lobby regulators have a higher probability of winning an auction. However, the FDIC incurs larger costs in such auctions, amounting to 24.8 percent of the total resolution losses. We also show that lobbying winners match less well with acquired banks and display worse post-acquisition performance than their non-lobbying counterparts, suggesting that lobbying interferes with an efficient allocation of failed banks. Our results provide new insights into the bank resolution process and the role of special interests.