Knowledge that Transforms

We study the relation between severe investor disagreement and stock returns based on the observed short-interest and long positions of hedge funds. We show strong disagreements are prevalent among active, sophisticated investors. From 1997 to 2014, 30% of highly shorted stocks have high hedge fund ownership, but these stocks do not earn abnormal returns. Evidence shows that large simultaneous holdings of short sellers and hedge fund managers likely arise from their information-acquisition activities. Although active long or short positions on average predict subsequent stock returns, neither long investors nor short sellers consistently prevail when the two sides disagree.

During the last decade Colombian international financial conglomerates (IFCs) expanded abroad, significantly increasing their geographical complexity. This paper analyzes the effect of changes in geographical complexity on the level of bank risk. We used the z-score as a measure of bank risk and as a measure of geographical complexity, the number of countries where a Colombian IFC has bank subsidiaries. Our results suggest that complexity is associated with higher levels of banks' risk, due to the Colombian expansion overseas to countries with large GDP co-movements and lower regulatory qualities. In addition, we found some evidence that complex banks increase their demand for external funds when the internal cost of capital increases. Moreover, local monetary policy affects the relationship between banking complexity and bank risk.

This paper investigates how bank-specific characteristics have affected credit growth in five Latin American countries (Brazil, Chile, Colombia, Mexico and Peru). We use detailed credit registry data and apply a common empirical strategy to analyse the pre- and post-crisis periods. We find that large and well-capitalised banks with low risk indicators, stable sources of funding and a commercial business model generally supply more credit. Such banks are also more sheltered from monetary and global shocks, with the role of specific characteristics varying by the type of shock.

Farre-Mensa, Michaely and Schmalz (2018) document that many firms issue new equity to finance their payouts to shareholders, despite the substantial cost of equity issuance. We find that equity-financed payouts are related to institutional investors’ horizon. Specifically, firms with a larger ownership by short-horizon institutions are more likely to have equity-financed discretionary payouts, and firms with equity-financed discretionary payouts tend to cut down their investments in the following years. Our results suggest that investor short-termism has significant effects on firms’ payout, financing and investment policies.

We study a bank levy that funds government guarantees in a general equilibrium setting where banks intermediate between risk-averse households and state-contingent investments. We offer an analytical characterization of the optimal bank levy as a function of household risk-aversion and guarantees. We show that household risk-taking is increasing in guarantees, while it is decreasing as the bank levy and household risk-aversion increase. This allows us to establish a non-trivial relationship between the optimal bank levy and household risk-aversion: Higher risk-aversion optimally induces a higher levy when guarantees exceed a threshold; otherwise, a higher levy shall be observed in economies with less risk-averse households.

Existing literature suggests that publication space within and across disciplines is unevenly spaced and that “home bias” and “barriers to entry” negatively impact publication potential, possibly limiting journal accessibility and author inclusivity. We investigate these issues within the field of finance, while considering journal quality, adding another dimension to the literature. Among the quality finance journals included in our study, we find little evidence against inclusiveness with respect to the average number of authors per paper or the percentage of unique authors; however, our analysis indicates that geographical diversity differs among the journals. Consistent with the higher proportion of top finance programs in the U.S., Tier 1 journals exhibit a higher authorship concentration in North America, relating journal quality and geographical diversity. Yet, Tier 2 journals demonstrate a broader regional representation than Tier 3 journals, indicating that geographical inclusivity is not driven exclusively by journal quality. Finally, our results consistently suggest that JBF is the most geographically inclusive journal among the 17 quality finance journals in our study.

We use logit and Markov switching models to assess, in (pseudo-)real-time, the ability of 27 indicators to predict systemic financial crises in the European Union. Before the global financial crisis (GFC), some models provided early warning signals, but it is unclear whether a specific model would have been favored over other candidate models providing contradictory evidence. Only after the GFC do debt service ratios, credit-to-GDP gaps as well as house price-to-income and house price-to-rent ratios appear as robust early warning indicators. Our results highlight that the predictive ability of indicators may change due to new risk factors or policy actions.

We examine whether the relationship between managerial risk-taking incentives and bank risk is sensitive to the underlying macroeconomic conditions. We find that risk-taking incentives provided to bank executives are associated with higher bank riskiness during economic downturns. We attribute this finding to the increase in moral hazard during macroeconomic downturns when the perceived probability of future bailouts and government guarantees rises. This association is particularly strong for larger banks, banks that maintain lower capital ratios and banks that are managed by more powerful Chief Executive Officers (CEOs). Our findings highlight the importance of the interaction between managerial incentives and the macroeconomic environment. Boards and regulators may find it useful to consider the countercyclical nature of the relationship between risk-taking incentives and bank riskiness when designing managerial compensation.

Based on a generalization of the Campbell and Shiller (1988) approach to a framework with regime-switching parameters and variances, we analyze the conditional variance decomposition of the market return over the business cycle. Discount-rate news is more important than cash-flow news in determining the conditional variance of the market return in recessions, while the opposite holds true in expansions. In an asset pricing model with regime-switching fundamentals, the fact that discount-rate news is more sensitive to changes in investors’ beliefs about the state of the economy, which are more volatile in recessions, provides a potential explanation.

Multivariate GARCH models do not perform well in large dimensions due to the so-called curse of dimensionality. The recent DCC-NL model of Engle et al. (2019) is able to overcome this curse via nonlinear shrinkage estimation of the unconditional correlation matrix. In this paper, we show how performance can be increased further by using open/high/low/close (OHLC) price data instead of simply using daily returns. A key innovation, for the improved modeling of not only dynamic variances but also of dynamic correlations, is the concept of a regularized return, obtained from a volatility proxy in conjunction with a smoothed sign of the observed return.