Counterparty risk could hamper trade and worsen a financial crisis. A central clearing party (CCP) insures traders against counterparty default and thus benefits trade. Default of the CCP however becomes a new systemic risk. CCP risk management does not account for risks associated with crowded positions. This paper proposes a CCP exposure measure based on tail risk in trader portfolios. It identifies and measures crowded risk and assigns it to traders according to the polluter pays principle. CCP data show that crowded positions increase CCP exposure most (about one-third) on turbulent days, when exposure is high already

We use a unique data set from the Trade Reporting and Compliance Engine (TRACE) to study liquidity effects in the U.S. structured product market. Our main contribution is the analysis of the relation between accuracy in measuring liquidity and the level of detail of the trading data employed. We find evidence that, in general, liquidity measures that use dealer-specific information can be efficiently proxied by means of measures that use less detailed information. However, when the level of trading activity in individual securities or overall market activity is low, measures based on more detailed trading data permit a more precise assessment of liquidity. These results provide us with a better understanding of the information contained in disseminated OTC trading data, in general.

– Since corporate debt tends to be riskier in recessions, transfers from equity holders to debt holders that accompany corporate decisions also tend to concentrate in recessions. Such systematic risk exposures of debt overhang have important implications for corporate investment and financing decisions, and for the ex ante costs of debt overhang. Using a calibrated dynamic capital structure model, we show that the costs of debt overhang become higher in the presence of macroeconomic risk. We also provide several new predictions on how the cyclicality of a firm’s assets in place and growth options affect its investment and capital structure decisions.

A survey of 255 papers that rely on the instrumental variable (IV) approach for identifying causal effects published in the “Big Three” finance journals reveals that IV estimates are larger than their corresponding uninstrumented estimates in about 80% of the studies, regardless of whether the potential endogeneity is expected to create a positive or negative bias based on economic reasoning. The magnitude of the IV estimates is, on average, nine times of that of the uninstrumented estimates even when economic insights do not suggest a downward bias of the latter. This study provides several explanations to the “implausibly large” IV estimates in finance research, and proposes best practices for identification-conscientious researchers. Received January 20, 2017; editorial decision April 7, 2017 by Editor Gregor Matvos

Using a comprehensive survey, we show that investors with a larger capital allocation to private equity are more specialized−measured by the degree to which the investor focuses on private equity rather than other classes of investments−and have a wider scope of due diligence and investment activities. Other investor characteristics (experience, type, location, compensation structure, number of funds under management) play no role. In particular, endowments are not special according to the survey measures. These results are consistent with the changing LP–GP relationship in private equity as capital is increasingly concentrated in the hands of large investors.

We present the first empirical study of loan searching strategies and loan granting decisions in a context where banks observe whether applicants have unsuccessfully applied for credit to other lenders in the past. Our identification strategy benefits from the use of granular data on loan applications and exploits the fact that evaluating lenders observe only the rejections received by a borrower up to six months before the current application. We document that past rejections diminish the probability of approval and increase the probability that a loan search is interrupted.

This paper analyzes in an international sample of banks from 104 countries if the sensitivity of the cost of deposits to bank risk varies across banks depending on their systemic and absolute size. We analyze a period before the 2007 financial crisis and control for endogeneity of bank size, intervention policies in past banking crises, and soundness of countries’ public finances. Our results are consistent with the predominance of the too-big-to-fail hypothesis, although this effect is stronger in countries that did not impose losses on depositors in past banking crises and in countries with sounder public finances

This paper studies the effects of hedge disclosure requirements on corporate risk management and product market competition. The analysis is based on a model of market entry and shows that to prevent entry incumbent firms engage in risk management when these activities remain unobserved by outsiders. In the resulting equilibrium, financial markets are well informed and entry is efficient. However, potential attempts for more transparency by additional disclosure requirements introduce a commitment device that provides incumbents with incentives to distort risk management activities thereby influencing entrant beliefs. In equilibrium, firms engage in significant risk-taking. This behavior limits entry and adversely affects the nature of competition in industries

Extant literature shows that IPO first-day returns are correlated with market returns preceding the issue. We propose a rational explanation for this puzzling predictability by adding a public signal to Benveniste and Spindt (1989)’s information-based framework. A novel result of our model is that the compensation required by investors to truthfully reveal their information decreases with the public signal. This “incentive effect” receives strong empirical support in a sample of 6300 IPOs in 1983–2012. Controlling for the incentive effect, the positive relation between initial returns and pre-issue market returns disappears for top-tier underwriters, where the order book is held to be most informative, effectively resolving the predictability puzzle.

We examine how access to bank credit affects trade credit in the supplier–customer relationships of U.S. public firms. For identification, we use exogenous liquidity shocks to supplier firms in the form of staggered changes to interstate bank branching laws. Using a variety of tests, we show that supplier firms with greater access to banking liquidity offer more trade credit to their customers. We also show that when bank branching restrictions are relaxed in the supplier’s state, the supplier–customer relationship is more likely to survive.