I add an oil good endowment to the Long-Run Risk model of Bansal and Yaron (2004) to study the asset pricing implications of a constrained oil supply. Lack of responsiveness of the oil endowment changes both the physical and risk-neutral dynamics of oil prices, and explains significant differences in the observed behavior of oil futures prices and returns from 2004 to 2008 relative to the prior 15 years. The model predicts that an unresponsive oil supply increases the risk of exogenous oil shocks, but mitigates risk from other shocks to growth, thereby lowering overall economic risk and the equity premium.
{"title":"Oil Prices and Long-Run Risk","authors":"Robert Ready","doi":"10.2139/ssrn.1720502","DOIUrl":"https://doi.org/10.2139/ssrn.1720502","url":null,"abstract":"I add an oil good endowment to the Long-Run Risk model of Bansal and Yaron (2004) to study the asset pricing implications of a constrained oil supply. Lack of responsiveness of the oil endowment changes both the physical and risk-neutral dynamics of oil prices, and explains significant differences in the observed behavior of oil futures prices and returns from 2004 to 2008 relative to the prior 15 years. The model predicts that an unresponsive oil supply increases the risk of exogenous oil shocks, but mitigates risk from other shocks to growth, thereby lowering overall economic risk and the equity premium.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"261 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-05-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115891908","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
While internal capital markets may afford firms a real option to avoid costly outside financing [Matsusaka and Nanda (2002)], we show that they also provide an option to avoid the monitoring that accompanies the raising of capital. Consistent with this view, we find conglomerates which cross-subsidize divisions or engage in value-destroying investment avoid oversight from the external capital markets by refraining from issuing capital or paying dividends. We further show that firms that issue capital while operating inefficient internal capital markets suffer significant negative abnormal SEO announcement returns in excess of other diversified firms conducting SEOs. Evidence likewise indicates that these firms suffer from a free cash flow problem. High coincident levels of free cash flow and investment are responsible for these inefficient capital allocations, the acceptance of value-destroying investments, and overall lower long-run firm value. However, we show that the issuance of capital is associated with additional oversight and those firms issuing capital garner significantly more attention from the analyst community. The additional analyst oversight significantly mitigates the free cash flow problem and is ultimately linked to higher firm value.
{"title":"The Perils of Free Cash Flow, Avoidance of Outside Monitoring, and the Exploitation of the Internal Capital Market","authors":"Brandon N. Cline, J. L. Garner, Adam S. Yore","doi":"10.2139/ssrn.1027224","DOIUrl":"https://doi.org/10.2139/ssrn.1027224","url":null,"abstract":"While internal capital markets may afford firms a real option to avoid costly outside financing [Matsusaka and Nanda (2002)], we show that they also provide an option to avoid the monitoring that accompanies the raising of capital. Consistent with this view, we find conglomerates which cross-subsidize divisions or engage in value-destroying investment avoid oversight from the external capital markets by refraining from issuing capital or paying dividends. We further show that firms that issue capital while operating inefficient internal capital markets suffer significant negative abnormal SEO announcement returns in excess of other diversified firms conducting SEOs. Evidence likewise indicates that these firms suffer from a free cash flow problem. High coincident levels of free cash flow and investment are responsible for these inefficient capital allocations, the acceptance of value-destroying investments, and overall lower long-run firm value. However, we show that the issuance of capital is associated with additional oversight and those firms issuing capital garner significantly more attention from the analyst community. The additional analyst oversight significantly mitigates the free cash flow problem and is ultimately linked to higher firm value.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"105 19 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-05-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127454015","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Utility-maximizing consumption and investment strategies in closed form are unknown for realistic settings involving portfolio constraints, incomplete markets, and potentially a high number of state variables. Standard numerical methods are hard to implement in such cases. We propose a numerical procedure that combines the abstract idea of artificial, unconstrained complete markets, well-known closed-form solutions in affine or quadratic return models, straightforward Monte Carlo simulation, and a standard iterative optimization routine. Our method provides an upper bound on the wealth-equivalent loss compared to the unknown optimal strategy, and it facilitates our understanding of the economic forces at play by building on closed-form expressions for the strategies considered. We illustrate and test our method on the life-cycle problem of an individual who receives unspanned labor income and cannot borrow or short sell. The upper loss bound is small, and our method performs well in comparison with two existing methods. This paper was accepted by Wei Xiong, finance.
{"title":"Solving Constrained Consumption-Investment Problems by Simulation of Artificial Market Strategies","authors":"B. Bick, H. Kraft, Claus Munk","doi":"10.2139/ssrn.1357339","DOIUrl":"https://doi.org/10.2139/ssrn.1357339","url":null,"abstract":"Utility-maximizing consumption and investment strategies in closed form are unknown for realistic settings involving portfolio constraints, incomplete markets, and potentially a high number of state variables. Standard numerical methods are hard to implement in such cases. We propose a numerical procedure that combines the abstract idea of artificial, unconstrained complete markets, well-known closed-form solutions in affine or quadratic return models, straightforward Monte Carlo simulation, and a standard iterative optimization routine. Our method provides an upper bound on the wealth-equivalent loss compared to the unknown optimal strategy, and it facilitates our understanding of the economic forces at play by building on closed-form expressions for the strategies considered. We illustrate and test our method on the life-cycle problem of an individual who receives unspanned labor income and cannot borrow or short sell. The upper loss bound is small, and our method performs well in comparison with two existing methods. \u0000 \u0000This paper was accepted by Wei Xiong, finance.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"57 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-04-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115231111","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We compute six different sets of systemic risk measures for a sample of the 20 biggest European and 13 biggest US banks from January 2004 to November 2009. The six measures are based on i) Principal components of the bank’s Credit Default Swaps (CDSs), ii) Interbank interest rate spreads, iii) Structural credit risk models, iv) Collateralized Debt Obligations (CDOs) indexes and their tranches, v) Multivariate densities computed from CDS spreads and vi) Co-Risk measures. We then rank the measures using three different criteria: i) Causality tests, ii) Price discovery tests and iii) their correlation with an index of systemic events. For the European and US markets, the best indicators are the first Principal Component of the single-name CDSs and the LIBOR-OIS or LIBOR-TBILL spreads, respectively, whereas the least reliable indicators are the Co-Risk measures and the systemic spreads extracted from the CDO indexes and their tranches.
{"title":"Systemic Risk Measures: The Simpler the Better?","authors":"María Rodríguez-Moreno, J. Peña","doi":"10.2139/ssrn.1681087","DOIUrl":"https://doi.org/10.2139/ssrn.1681087","url":null,"abstract":"We compute six different sets of systemic risk measures for a sample of the 20 biggest European and 13 biggest US banks from January 2004 to November 2009. The six measures are based on i) Principal components of the bank’s Credit Default Swaps (CDSs), ii) Interbank interest rate spreads, iii) Structural credit risk models, iv) Collateralized Debt Obligations (CDOs) indexes and their tranches, v) Multivariate densities computed from CDS spreads and vi) Co-Risk measures. We then rank the measures using three different criteria: i) Causality tests, ii) Price discovery tests and iii) their correlation with an index of systemic events. For the European and US markets, the best indicators are the first Principal Component of the single-name CDSs and the LIBOR-OIS or LIBOR-TBILL spreads, respectively, whereas the least reliable indicators are the Co-Risk measures and the systemic spreads extracted from the CDO indexes and their tranches.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"54 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-03-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121356120","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper examines the impact of social norms on firm value and the capital structure of firms engaged in the production of tobacco, alcohol, and gambling services ('sin stocks') in the G20 nations. We first demonstrate that sin stocks are undervalued in countries where social norms are strongly against such firms. The negative impact on these firms’ equity valuation (roughly 8% on average) leads them to rely more heavily on debt financing. Specifically, we show that sin stocks compared to similar non-sin stocks have higher levels of debt (roughly 4 times), a greater probability of taking on debt, and a lower debt cost of capital (after controlling for debt load). Finally, we show that specific market behavior towards sin stocks is influenced by other country specific social norms like the degree of individualism and risk aversion. Our results are robust to alternative measures of firm valuation and debt load.
{"title":"Shades of Grey: Capital Structure Decisions of Non-Sin vs. Sin Firms in the G20 Nations","authors":"Michael B. McDonald, Larry Fauver","doi":"10.2139/ssrn.2017725","DOIUrl":"https://doi.org/10.2139/ssrn.2017725","url":null,"abstract":"This paper examines the impact of social norms on firm value and the capital structure of firms engaged in the production of tobacco, alcohol, and gambling services ('sin stocks') in the G20 nations. We first demonstrate that sin stocks are undervalued in countries where social norms are strongly against such firms. The negative impact on these firms’ equity valuation (roughly 8% on average) leads them to rely more heavily on debt financing. Specifically, we show that sin stocks compared to similar non-sin stocks have higher levels of debt (roughly 4 times), a greater probability of taking on debt, and a lower debt cost of capital (after controlling for debt load). Finally, we show that specific market behavior towards sin stocks is influenced by other country specific social norms like the degree of individualism and risk aversion. Our results are robust to alternative measures of firm valuation and debt load.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"29 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-03-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"117294749","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We study daily money market mutual fund flows at the individual share class level during the crisis of September 2008. The empirical approach that we apply to this fine granularity of data brings new insights into the investor and portfolio holding characteristics that are conducive to run-risk in cash-like asset pools, as well as providing evidence on the time-series dynamics of runs and the equilibria that develop. We propose two identification approaches to test predictions of recent theoretical models with strategic complementarities and incomplete information. First, we study dynamic interactions between investors with differing levels of sophistication within the same money fund, thus holding constant the quality of the underlying portfolio. Second, we employ a novel quantile regression methodology to identify relationships between observable characteristics and tail outcomes. Our results provide considerable support for the theoretical predictions, providing some of the strongest empirical evidence to date on run-like behavior within intermediated asset pools during the financial crisis.
{"title":"Runs on Money Market Mutual Funds","authors":"Russ Wermers","doi":"10.2139/ssrn.1784445","DOIUrl":"https://doi.org/10.2139/ssrn.1784445","url":null,"abstract":"We study daily money market mutual fund flows at the individual share class level during the crisis of September 2008. The empirical approach that we apply to this fine granularity of data brings new insights into the investor and portfolio holding characteristics that are conducive to run-risk in cash-like asset pools, as well as providing evidence on the time-series dynamics of runs and the equilibria that develop. We propose two identification approaches to test predictions of recent theoretical models with strategic complementarities and incomplete information. First, we study dynamic interactions between investors with differing levels of sophistication within the same money fund, thus holding constant the quality of the underlying portfolio. Second, we employ a novel quantile regression methodology to identify relationships between observable characteristics and tail outcomes. Our results provide considerable support for the theoretical predictions, providing some of the strongest empirical evidence to date on run-like behavior within intermediated asset pools during the financial crisis.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-03-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127873277","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Many asset markets are composed of three types of participants: professional investors who possess superior skills or knowledge, uninformed private investors, and liquidity investors. In this paper, we analyze the properties of asset price and trading volume when professional investors are able to forecast future trading flows or the trading positions of liquidity traders. Private investors, on the other hand, can only observe the price and make their investment choices accordingly. In a rational expectations model based on Grossman and Stiglitz (1980), the interactions among these three types of investors lead to a set of clear comparative statics that match the results in the empirical asset pricing literature. There are also additional results that can be tested using asset market data.
{"title":"Informed Speculation About Trading Flows: Price Variability and Trading Volume","authors":"Qiang Li, Hua Sun","doi":"10.2139/ssrn.2022951","DOIUrl":"https://doi.org/10.2139/ssrn.2022951","url":null,"abstract":"Many asset markets are composed of three types of participants: professional investors who possess superior skills or knowledge, uninformed private investors, and liquidity investors. In this paper, we analyze the properties of asset price and trading volume when professional investors are able to forecast future trading flows or the trading positions of liquidity traders. Private investors, on the other hand, can only observe the price and make their investment choices accordingly. In a rational expectations model based on Grossman and Stiglitz (1980), the interactions among these three types of investors lead to a set of clear comparative statics that match the results in the empirical asset pricing literature. There are also additional results that can be tested using asset market data.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"51 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-03-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127444428","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
I present a general equilibrium model in which the financial sector employs too many productive inputs. Intermediation is similar, in some ways, to the creation of counterfeit money: a producer can increase the amount of money in his hands at some real cost, but this is socially wasteful as it only translates into higher nominal prices. In this model, producers can increase their funding by borrowing from depositors, who would otherwise be holding idle monetary reserves. This costly activity increases the money in circulation and raises the equilibrium price level, without any real return. In the simplest case, financial intermediation is a purely wasteful use of resources. However, in the presence of heterogeneous producers, the superior borrowing ability of productive agents may improve the allocation of inputs. In a dynamic general equilibrium model with heterogeneous productivities and increasing intermediation costs, I show that tight regulation of the financial system is optimal.
{"title":"The Wasteful 'Money Creation' Aspect of Financial Intermediation","authors":"Maya Eden","doi":"10.2139/ssrn.2023514","DOIUrl":"https://doi.org/10.2139/ssrn.2023514","url":null,"abstract":"I present a general equilibrium model in which the financial sector employs too many productive inputs. Intermediation is similar, in some ways, to the creation of counterfeit money: a producer can increase the amount of money in his hands at some real cost, but this is socially wasteful as it only translates into higher nominal prices. In this model, producers can increase their funding by borrowing from depositors, who would otherwise be holding idle monetary reserves. This costly activity increases the money in circulation and raises the equilibrium price level, without any real return. In the simplest case, financial intermediation is a purely wasteful use of resources. However, in the presence of heterogeneous producers, the superior borrowing ability of productive agents may improve the allocation of inputs. In a dynamic general equilibrium model with heterogeneous productivities and increasing intermediation costs, I show that tight regulation of the financial system is optimal.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"641 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-03-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"131821563","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Credit unions have become an important component of the American financial system, with more than 10% of all savings deposits and non-revolving consumer loans; as well as some 12% of all depository institution employees. With nearly any measure of depository institution market share, credit unions have been growing.Credit unions fared better than banks in the past two big financial crises (1980s and 2008-2010). But there were some institutions whose common bond forced them to take on more risk during that time period. In some of those cases, their members were underserved by other financial institutions, making the small credit union a systemically important financial institution for them. Therefore, in 2010, a TARP program was offered to shore up community development financial institutions (CDFIs). The Community Development Capital Initiative (CDCI) was the only direct TARP loan program offered to credit unions. Although nearly 200 credit unions qualified, only 48 received funding (all in late September 2010). The recipient credit unions borrowed less than $70 million total.This paper assesses the effectiveness of the TARP program for the recipient credit unions. We find that CDFI credit unions were far more likely to fail since the initiation of the TARP than other credit unions. We also find that recipient credit unions did not use funds to enrich members, but used the funds as they were intended, to improve capital and liquidity. We wonder if a special program needed to be established to generate these $70 million in loan funds because of the weakness among credit unions’ preferred lender, the corporate credit unions.
{"title":"The Effect of Tarp Funding on Recipient Credit Unions","authors":"Keldon Bauer","doi":"10.2139/SSRN.2024335","DOIUrl":"https://doi.org/10.2139/SSRN.2024335","url":null,"abstract":"Credit unions have become an important component of the American financial system, with more than 10% of all savings deposits and non-revolving consumer loans; as well as some 12% of all depository institution employees. With nearly any measure of depository institution market share, credit unions have been growing.Credit unions fared better than banks in the past two big financial crises (1980s and 2008-2010). But there were some institutions whose common bond forced them to take on more risk during that time period. In some of those cases, their members were underserved by other financial institutions, making the small credit union a systemically important financial institution for them. Therefore, in 2010, a TARP program was offered to shore up community development financial institutions (CDFIs). The Community Development Capital Initiative (CDCI) was the only direct TARP loan program offered to credit unions. Although nearly 200 credit unions qualified, only 48 received funding (all in late September 2010). The recipient credit unions borrowed less than $70 million total.This paper assesses the effectiveness of the TARP program for the recipient credit unions. We find that CDFI credit unions were far more likely to fail since the initiation of the TARP than other credit unions. We also find that recipient credit unions did not use funds to enrich members, but used the funds as they were intended, to improve capital and liquidity. We wonder if a special program needed to be established to generate these $70 million in loan funds because of the weakness among credit unions’ preferred lender, the corporate credit unions.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"7 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-03-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125374276","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
For a comprehensive set of 21 equity premium predictors we find extreme variation in out-of-sample predictability results depending on the choice of the sample split date. To resolve this issue we propose reporting in graphical form the out-of-sample predictability criteria for every possible sample split, and two out-of-sample tests that are invariant to the sample split choice. We provide Monte Carlo evidence that our bootstrap-based inference is valid. The in-sample, and the sample split invariant out-of-sample mean and maximum tests that we propose, are in broad agreement. Finally we demonstrate how one can construct sample split invariant out-of-sample predictability tests that simultaneously control for data mining across many variables.
{"title":"Out-of-Sample Equity Premium Predictability and Sample Split Invariant Inference","authors":"Gueorgui I. Kolev, R. Karapandža","doi":"10.2139/ssrn.2024573","DOIUrl":"https://doi.org/10.2139/ssrn.2024573","url":null,"abstract":"For a comprehensive set of 21 equity premium predictors we find extreme variation in out-of-sample predictability results depending on the choice of the sample split date. To resolve this issue we propose reporting in graphical form the out-of-sample predictability criteria for every possible sample split, and two out-of-sample tests that are invariant to the sample split choice. We provide Monte Carlo evidence that our bootstrap-based inference is valid. The in-sample, and the sample split invariant out-of-sample mean and maximum tests that we propose, are in broad agreement. Finally we demonstrate how one can construct sample split invariant out-of-sample predictability tests that simultaneously control for data mining across many variables.","PeriodicalId":369344,"journal":{"name":"American Finance Association Meetings (AFA)","volume":"29 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-03-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116598617","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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