Knowledge that Transforms

We show that part of the outperformance of low-volatility stocks can be explained by a premium for interest rate exposure. Low-volatility stock portfolios have negative exposure to interest rates, whereas the more volatile stocks have positive exposure. Incorporating an interest rate premium explains part of the anomaly. We also find that the interest rate risk premium in equity markets exhibits time variation similar to bond markets, but that the level of the interest rate premium, as estimated from the cross-section of stocks, is much higher than the premium observed in the bond market.

This paper studies bargaining power allocation and stable matching between venture capitalists and entrepreneurs with double-sided moral hazard in venture capital markets. We find that the optimal bargaining power allocation is determined by the output elasticities of effort by the two parties; the higher the output elasticity for one's effort, the greater her bargaining power. We show that efficient and stable matching follows the principle of positive assortative matching, suggesting that strong entrepreneurs/VCs match with strong partners, and weak ones match with weak counterparts. Using a large sample from the Chinese venture capital market, we empirically confirm that entrepreneurs and VCs with similar standing in their peer groups are more likely to match.

Conventional wisdom suggests that greater competition in banking, by eroding bank charter values, exacerbates banks’ incentives to take excessive risks. This paper presents a model in which, contrary to this view, competition can cause banks to act more prudently: As competition intensifies and profit margins decline, banks face more-binding threats of failure, to which they may respond by taking lower risks. Nonetheless, competition is unambiguously destabilizing in this model: The direct effect of lower margins on bank failure rates always outweighs the prudence effect. A key implication is that the effects of competition on bank risk taking and on failure risk can move in opposite directions.

Using market-wide data from the Brazilian stock lending market at the deal level, we find strong evidence of short-selling skill for institutions and individuals. Skilled short-sellers present out-of-sample performance persistence. Exploring the granularity of our dataset, we find that skilled short-sellers do not display the disposition effect, are more likely to pick value, liquid, high-volatility, and losing stocks, and to initiate a short position before earnings announcements and around sell recommendations.

This paper explores avenues to improve VaR backtesting against violations of unconditional coverage, with emphasis on detecting underestimates of risk. I show that existing tests for unconditional coverage have an undesirable asymmetry in power, making them less (more) effective at detecting underestimates (overestimates) of risk. A set of Lagrange multiplier (LM) tests is proposed, leading to improved power against the more dangerous underestimates. Also, the use of one-sided coverage tests is revisited, with a one-sided version of the new LM test performing best. Results are supported by simulations, showing the effectiveness of the new tests in finite samples. The same issues of asymmetric power are shown to carry over to the case of conditional coverage, though it appears that finite sample issues affecting the independence component of the tests can adversely impact performance. A simple weighted test statistic is shown to help alleviate this problem, providing an avenue to exploit the advantages of the LM approach in a conditional coverage setting.

Using hand-collected data, we find residual state ownership is negatively related to stock return volatility, following China's secondary privatization initiated by the non-tradable share reform. Conservative corporate policies are channels through which residual state ownership reduces stock return volatility. Further, the volatility-mitigating effect is more prevalent in firms in which the government has greater influence on corporate decisions. However, the volatility-mitigating effect is temporary, lasting up to three years after state shares become fully tradable. The evidence suggests the government can send credible signals by retaining state ownership, which reduces investor uncertainty. However, investors must weigh the positive signaling effect of residual state ownership in reducing uncertainty, surrounding sudden policy changes, against the inefficiencies of state control.

We examine how time-varying macroeconomic conditions affect firms’ financing decisions. A principal components decomposition of several macroeconomic variables characterizes three phases of the business cycle relative to recessions: early recovery, robust recovery, and economic crest; a fourth represents “windows of opportunity” in capital markets that are unrelated to recessions. This characterization yields results that traditional approaches miss. Specifically, debt issuance exhibits a non-monotonic pattern during the upward phase of the business cycle: it declines in robust recovery relative to recessions but peaks at the economic crest. Financially constrained firms issue more equity during windows of high stock market valuation, whereas unconstrained firms time debt issuance in response to debt market spreads.

The paper uses firm-level data from the World Bank's Enterprise Surveys to explore the impact of the strength of family ties on the individual firms’ financing constraints in 138 developing countries. Financing constraints reflect survey-based perceptions of firms regarding access to finance. The strength of family ties expresses the degree of connection among kin and family and affect the firms’ choice between formal and informal finance. However, family finance is associated with benefits and shadow costs and reflects social preferences. The results show that stronger family ties are associated with higher financing constraints of firms in developing countries, but also appear to exert beneficial effects on financing constraints in smaller countries with smaller firms and in countries with high population density. The results remain broadly robust against various types of sensitivity testing and a country's macroeconomic conditions and its institutional and social environment affect them.

This paper analyzes the strong comovement between real stock and nominal bond yields at generational frequencies. Using a stochastic overlapping generations model with cash-in-advance constraints, we show that the simulated life-cycle patterns in savings behavior make both real stock and nominal bond yields comove with the changing population age structure. These persistent comovements account for the equilibrium relation between stock and bond markets. A stochastic Fisher decomposition of nominal bond yields reveals that, while having a moderate effect on both the inflation risk premium and expected inflation, demographic changes affect nominal yields mainly through real bond yields. Using both U.S. data and a cross-country panel, we find empirical support for these theoretical predictions. Finally, we show that the strength of the demographic effect on real yields explains cross-country differences in the comovement between stock and bond markets, while alternative demographic channels fail to explain such cross-country heterogeneity.

This paper studies depositor behavior in a bank run experiment with partial deposit insurance. In the experiment, depositors face two forms of uncertainty regarding their deposit coverage in the event of a bank run: (i) “intrinsic” uncertainty related to the size of the deposit insurance fund, and (ii) “strategic” uncertainty, as the actual coverage depends on the number of depositors who run on the bank. We consider three scenarios that differ in the way the deposit insurance scheme reimburses depositors. The results show that intrinsic uncertainty on its own has a negligible effect on the number of bank runs. However, when combined, the two forms of uncertainty exert a significant impact on the propensity to withdraw and result in a large number of bank runs. Moreover, runs are more frequent when leaving funds in the bank is an increasingly costly strategy.