Abstract We contribute to identifying proxies for the information set of investors in financial markets. We show that the marketwide price-dividend ratio highly correlates with inflation and labor market variables that also forecast consumption, dividend, and GDP growth, but not with aggregate consumption or GDP growth. Our model with learning from inflation and wage earnings rationalizes the moments of consumption and dividend growth, market return, the price-dividend ratio, real and nominal term structures, the low predictive power of the price-dividend ratio for consumption and dividends, and the dynamics of the price-dividend ratio, unlike a nested model with learning from consumption alone. (JEL E3, G12, G14)

Abstract Using merger announcements and applying methods from computational linguistics we find strong evidence that stock prices underreact to information in financial media. A one standard deviation increase in the media-implied probability of merger completion increases the subsequent 12-day return of a long-short merger strategy by 1.2 percentage points. Filtering out the 28% of announced deals with the lowest media-implied completion probability increases the annualized alpha from merger arbitrage by 9.3 percentage points. Our results are particularly pronounced when high-yield spreads are large and on days when only few merger deals are announced.

Abstract Owning valuable brands enhances the financial well-being of firms not only through increased revenues and profitability but also by mitigating agency problems, earnings management, and financial reporting irregularities. Firms with high brand equity are less likely to have income-inflating discretionary accruals, announce earnings restatements, or experience SEC investigations. Brand equity reduces the likelihood of manipulation through incentive and opportunity channels, which we capture in CEO characteristics and compensation, and corporate governance measures. Brand equity reduces the likelihood of financial reporting irregularities more for durable goods firms and firms with shorter-tenured CEOs, as the latter are most vulnerable to performance pressures. (JEL G31, G34, M31, M37, M41, M42) Received September 28, 2019; editorial decision May 27, 2020 by Editor Isil Erel.

We develop a model of liquidity shortages that incorporates a general equilibrium feature of liquidity: when banks hold more liquidity, other agents in the economy hold less of it and will supply less in times of crisis. We show that the private holdings of liquidity at banks are inefficient, with the direction of the bias being determined by the characteristics of the suppliers of liquidity to banks. Minimum liquidity requirements for banks may reduce welfare; in such cases interest rate policies that stimulate the ex-post supply of liquidity can restore efficiency. Overall, our results show that optimal liquidity policies critically depend on a financial institution’s (marginal) source of liquidity and will hence differ across institutions of different types.

We examine the long-lasting effects of the 2007 real estate price collapse on small business credit supply. Banks affected by the decline in real estate prices systematically contracted their credit to small firms. At the same time, regional and local banks, many of which were unaffected by the initial shock, increased small business lending to nearby borrowers and opportunistically expanded their branch networks, making gains in market share that persisted for the following decade. Although the net effect of the contraction in credit was negative, we show that opportunistic expansion tied to permanent market changes is an important offsetting force that dampened the negative effect on small firms during the GFC and its aftermath.

We develop a model of corporate cash holdings that incorporates CEO beliefs. An optimistic CEO views external financing as excessively costly but expects this cost to moderate over time. The optimistic CEO thus delays external financing while funding current investments with existing cash and maintaining a lower cash balance than rational CEOs. We find that, relative to rational CEOs, optimistic CEOs hold 24% less cash, hold lower cash to fund the firms' growth opportunities, and save less cash out of incremental cash flow.

Abstract This article develops a search and matching model of mergers and acquisitions (M&A) and uses it to evaluate the implications of merger activity for aggregate economic outcomes. The theory is consistent with a rich set of facts on U.S. M&A, including sorting among merging firms, a substantial merger premium and serial acquisition. It provides a sharp link between these facts and the nature of merger gains. At the micro-level, both complementarities between merging firms and productivity improvements of target firms are important in generating gains. At the macro-level, the model suggests a significant beneficial impact of M&A on aggregate outcomes—the contribution to steady state output is 14% and 4% for consumption—which occurs through the reallocation of resources across firms and equilibrium effects on firm selection and new entrepreneurship. Nevertheless, the economy is not efficient, suggesting a scope for policy improvements—a simple flat tax on M&A can raise steady state consumption as much as 2% relative to the laissez-faire equilibrium. In short, the boundaries of the firm can matter for macroeconomic outcomes.

Abstract We use the text of financial stability reports (FSRs) published by central banks to analyze the relation between the sentiment they convey and the financial cycle. We construct a dictionary tailored specifically to a financial stability context, which classifies words as positive or negative based on the sentiment they convey in FSRs. With this dictionary, we construct financial stability sentiment (FSS) indexes for thirty countries between 2005 and 2017. We find that central banks’ financial stability communications are mostly driven by developments in the banking sector. Moreover, the sentiment captured by the FSS index explains movements in financial cycle indicators related to credit, asset prices, systemic risk, and monetary policy rates. Finally, our results show that the sentiment in central banks’ communications is a useful predictor of banking crises—a one percentage point increase in FSS is followed by a twenty-nine percentage point increase in the probability of a crisis.

This paper extends the literature related to the role of trust on economic activity, focusing on the influence of trust on lender-borrower relationships and analysing its effect on the interest rate spread for a sample of 20,699 loans from 47 countries over the period 2003–2018. We consider not just the role of trust, but also how its effect is moderated by the country's legal enforcement and degree of economic development. The results show that trust has no effect on loan spreads. However, trust is found to reduce loan spreads when a country's formal institutions are weak, in line with the existence of a substitutive effect between formal and informal institutions in reducing interest rates. As regards the degree of economic development, our results show that both trust and legal enforcement have a greater influence on the interest rate spread of bank loans in countries with a lower level of economic development.