Paris December 2020

The aim of this work is to understand and measure to what extent equity options price credit risk. With the exception of Toft and Prucyk (1997), which is a dated work based on the simplistic assumption of a reference company issuing perpetual debt, all the work in the literature which try to establish a link between the credit default swaps and equity options rely on reduced-form models (Carr and Linetsky 2006, Carr and Wu 2010, Carr et al. 2010). Thus, the connection between the firm’s fundamentals and the pricing of these derivative contracts are ignored. With a novel structural model, which stems from Geske (1977, 1979), equity is priced as a compound call option written on the firm’s asset. The proposed structural model is first able to reconcile some puzzling findings documented by Carr and Wu (2017) on increasing leverage due to increasing business risk. Moreover, as the price equity options is shown to depends on the probability of the option expiring in-the-money, conditional on the firm’s survival, this decomposition allows to construct a new measure of impact of credit risk on options. It is then shown that put options, contrary to calls, are sensitive to changes in the default risk in the underlying company. In addition, this measure is able to forecast future changes of the negative skew of long-term maturity options written on the equity of the same company. Finally, I show that the implied volatilities estimated á la Black-Scholes tend to average out the effect of credit risk over the moneyness space, leading to potential biases when applied for risk management purposes.

Life insurers massively sell savings policies that guarantee minimum withdrawal payouts. When market interest rates increase, these guarantees become in-the-money. Hence, an increase in interest rates leads to more withdrawals of life insurance policies. We document this effect by exploiting partly hand-collected insurer-level data covering more than two decades. A one-standard deviation increase in interest rates relates to an increase in withdrawal rates by roughly 0.35 standard deviations. As a result, the duration of life insurance policies decreases with higher interest rates. A reduction in duration implies that life insurers may be forced to sell assets when interest rates rise. We build a granular model of life insurers' cash flows to estimate the resulting price impact and fire sale costs. Under plausible assumptions, the model predicts that forced sales reduce asset prices by up to 1% and reduce insurers' equity capital by up to 15bps. Forced sales are primarily driven by insurers' long-dated assets investments, which slow down an increase in policy returns when interest rates rise.

A simple return extrapolation model suggests that streaks in returns, which we define as n-day consecutive over-/under-performance relative to the market, predict future returns. We test this prediction using daily data from international equity markets and find strong empirical support. US-based value-weighted trading strategies have annualized Sharpe ratios around 2 (depending on the specification). We replicate the results in international markets and are able to increase the Sharpe ratio to above 3 by diversifying across regions. We argue that liquidity is unlikely to explain the results as streak portfolio returns based on mid-quote-prices are strongest among stocks with the lowest bid-ask spreads.

We use Norwegian household-level data and full structures of family relationships to understand how succession decisions are made when the family has multiple potential heirs. We argue that the decision on ownership distribution in family firms is related to the potential of future family conflicts, and that such within-family dynamics have implications for firm investment and growth. We identify the causal effect by looking at whether the founder has experienced a divorce or a separation in the distant past. We instrument the founder's divorce with the frequency of divorces in the extended family relationships outside of the nuclear family, which makes the founder's divorce more socially acceptable. Since some family conflicts are inevitable and family heirs might not be able to trade their shares, founders should consider adjusting their inheritance to minimize the possibility of heir feuds and adverse effects on firm growth.

We examine whether entrepreneurs’ freedom of movement can be a potential concern for creditors when extending trade credit. Utilizing a Difference-in-Differences approach that relies on the staggered changes of controlling shareholders’ overseas residency status in Chinese firms, we show that their mobility negatively influences firms’ ability to obtain trade credit. The fleeing entrepreneurs concern of trade creditors is especially detrimental to firms that are perceived as less trustworthy ex ante. Our results, through the lens of trade credit, shed light on the hidden costs of entrepreneurs’ freedom in corporate financing activities by echoing the idea that “freedom is never free”.

To investigate whether centralized exchanges of cryptocurrencies engage in wash trading, we devise a set of statistical tests using first significant digits, size clustering, and tail distribution on transactions involving Bitcoin, Ethereum, etc., at 3 regulated and 26 unregulated major crypto exchanges. All regulated exchanges feature trades consistent with statistical benchmarks and behavioral patterns from traditional financial markets; most unregulated exchanges, especially those less prominent, exhibit anomalous patterns unexplained by investors’ activities. We estimate that unregulated exchanges on average engage in wash trading for over 70% of their total reported volume. We also document that wash trades improve exchange ranking, and exchanges vying for dominance engage more in wash trading, consistent with their economic incentives. Finally, we discuss the regulatory implications of such manipulation in the emerging crypto sector and in financial markets in general.

This paper examines the role of the “Big Three” (i.e., BlackRock, Vanguard, and State Street Global Advisors) on the reduction of corporate carbon emissions around the world. Using novel data on engagements of the Big Three with individual firms we find evidence that the Big Three focus their engagement effort on large firms with high CO2 emissions in which these investors hold a significant stake. Consistent with this engagement influence being effective, we observe a strong and robust negative association between Big Three ownership and subsequent carbon emissions among MSCI index constituents, a pattern that becomes strong in the later years of the sample period. Additional tests exploiting several sources of plausibly exogenous variation in Big Three ownership and in the cost of CO2 emissions suggest that these correlations probably reflect a causal link.

We analyze how information processing power and data abundance affect speculators' search for predictors. Speculators optimally search for a predictor whose signal-to-noise ratio exceeds an endogenous threshold. Greater computing power raises this threshold, and therefore price informativeness, because it reduces the cost of search. In contrast, data abundance can lower this threshold because (i) it intensifies competition among speculators, which reduces the benefit of finding a good predictor and (ii) it increases the total expected cost of finding a predictor. In the former (latter) case, price informativeness increases (decreases) with data abundance. We present additional testable implications of these effects.

Investors pay a substantial premium to hedge against fluctuations in volatility—the variance risk premium (VRP). The asset-pricing literature has presented numerous models with jumps in economic fundamentals to reproduce the properties and the time variation of the VRP. This paper shows that these quantitative results are almost exclusively driven by an inaccurate measure of conditional volatility. Solved accurately, conditional volatility exhibits—counterfactually—a strong procyclical pattern and the models do not deliver a sizeable VRP in response to jumps in state variables. The notion that the VRP is purely a compensation for fluctuations in macroeconomic uncertainty does not hold.

The maturity of a firm’s liabilities affects the information financiers produce about the firm’s assets. In my model, long-term financing creates an excessive tendency for financiers to acquire information and screen out lower quality borrowers. In contrast, short-term financing deters information production at origination but induces it when firms are forced to liquidate, depressing the market value of assets due to adverse selection. Through the feedback effect between firms’ maturity structures and asset prices, increases in uncertainty can impair the aggregate volume of short-term financing and investment. The analysis can jointly rationalize i) the widespread use of short-term debt by financial firms, ii) periodic disruptions in short-term funding markets and iii) regulations that curb short-term funding markets in normal times and support them in periods of market stress.

We find a significant negative relationship between stock returns during the week and the reported incidence of domestic violence during the weekend. Our findings suggest that wealth shocks caused by the stock market can affect stress levels within families, escalate arguments, and trigger violence. The effect of stock returns on reported domestic violence is primarily attributable to negative returns, and the incidence of domestic violence increases with the magnitude of loss. The effect also increases with local stock market participation. Using Google search volumes as an alternative proxy for the incidence of domestic violence yields similar results.

This study uses the universe of US public firms to examine the impact of credit default swap (CDS) trading on a firm’s cost of capital during the period 2001-2018. Our results show that the initiation of CDSs significantly reduces a firm’s weighted average cost of capital (WACC). We also find that highly levered firms reduce their debt, while firms with low leverage increase their usage of debt. CDS referenced firms adjust their debt placement by using more arm’s length debt, while they simultaneously reduce the usage of revolving credits and term loans from banks. The change in capital financing choices may be ascribed to the increased rollover risk induced by CDS trading and reflects the fact that CDS trading increases debt renegotiation costs and simultaneously reduces capital supply side frictions.

We study whether the stability of mutual funds and the propensity of a run among investors depend on the ownership structure. Flows of funds run by banks or by firms that belong to the same financial group as a bank are less volatile and less sensitive to bad past performance. This enables bank-affiliated funds to better weather distress and to hold lower precautionary cash buffers in comparison with their unaffiliated peers. Banks provide liquidity support to distressed affiliated funds increasing their stakes in funds that are experiencing large outflows. We find that liquidity support and other benefits of bank affiliation are stronger if the parent bank is more liquid and better capitalised. Analyzing the aftermath of two exogenous shocks to financial markets -- the Brexit referendum and political uncertainty in Italy -- we show that distress in the banking system spills over to the mutual fund sector via ownership links.

Regulators, exchanges, and politicians are considering reining in maker-taker pricing, which is used as a competitive tool by trading venues to acquire order ow. Examining the 2013 reduction in trading fees operated by BATS on its European venues, we document significant effects on market quality and market share both on BATS and in competing venues. Interestingly, we identify cross-sectional differences which suggest that traders in large (small) capitalization stocks are more sensitive to changes in make (take) fees. Our results are consistent with the predictions derived from a model of two competing order books that employ trading fees.

Corporate divestitures often accompany acquisitions, representing on average 33% of the acquisition value. Relying on a worldwide sample, we provide support for the efficient restructuring view of acquisition-related divestitures. About 60% of these divestitures occur following the acquisition completion, especially in large deals. We also document that acquirers divest more when they are diversified and acquisitive. On average, divestitures are associated with an increase of 1.85% in the value creation around focal acquisitions. Examining returns for divestitures, we find that those around acquisitions are not transactions with weak bargaining positions. Overall, asset sales are a tool to ease an acquisition and bolster the associated synergies.

Venture capital firms often continue to stay as shareholders and on the board of directors of their investee companies even after they have gone public. This paper examines the impact of venture capital ownership beyond the IPO listing on important consequential, corporate decisions in a firm’s lifetime, including time to dividend initiation. Using a sample of 1,409 US firms listed between 2000 and 2017, we find that venture capital firms delay the time to initiate dividends by approximately two years. The presence of venture capital firms further delays the use of external growth strategies (through acquisitions) and postpones the introduction to the corporate bond market while relying more quickly on seasoned equity offerings. Several robustness checks are performed, including controlling for possible reverse causality. These results are consistent with the view that venture capital firms extend the growth phase of the firms’ life-cycle prior to becoming a mature firm. We further show that the presence of VC funds in the firm at time of these decisions leads to positive stock price reactions, suggesting they offer a certification effect for continued growth opportunities.

I assess the overall supply of public sector capital in the U.S. through the lens of asset prices. Using a two-sector general equilibrium model, I demonstrate how the supply of public sector capital may become a source of priced risk, for which the price of risk changes sign as public sector capital becomes over- or under-supplied. Taking two complementary empirical approaches, I find consistent results suggesting that assets with higher sensitivity to variations in public investment have higher average returns. Together my findings imply that public sector capital is \textit{undersupplied}, and greater public investment is favorable for investors.

Analyzing unique data on loan applications by individuals who are majority owners of small firms, we detail how a bank’s credit decisions affect the future income of accepted versus rejected applicants. We use the bank’s cutoff rule, which is based on the applicants’ credit scores, as a source of exogenous variation in the decision to grant loans. We show that application acceptance increases recipients’ income five years later by more than 10% compared to denied applicants. This effect is mostly driven by the use of borrowed funds to undertake investments and is more pronounced in low-income areas and during a crisis period, namely when individuals are more credit constrained.

It is relatively easy for us humans to detect that a question we asked has not been answered – we teach this skill to a computer. More specifically, we develop a measure that detects the rejection, avoidance or dodging of a question. Using a supervised machine learning framework on a large training set of 47,892 classified responses to questions, we identify 1027 trigrams that signal whether or not the respondent provides a non-answer. We show that this dictionary has economic relevance by applying it to a validation set of contemporaneous stock market reactions after earnings conference calls. Our findings suggest that obstructing the flow of information leads to significantly lower cumulative abnormal stock returns and higher implied volatility. Our metric is designed to be of general applicability for Q&A situations, and hence, is capable of identifying non-answers outside the contextual domain of financial earnings conference calls.

The prevalence of pay based on risky firm outcomes for non-executive workers presents a puzzling departure from conventional contract theory, which predicts insurance provision by the firm. I revisit this puzzle in a framework with workers who prefer early resolution of uncertainty. When workers at the same firm compete against each other for promotions, the optimal contract features pay based on firm outcomes as insurance against unfavorable promotion prospects. The model’s predictions are consistent with observed phenomena such as performance-based vesting, option-like payoffs, and overvaluation of equity pay by non-executive workers. It also generates novel predictions linking organizational structure to firm performance pay.

We investigate corporate reactions to problems related to Environmental, Social, and Governance (ESG) issues by observing the connection between negative media attention to these issues and CEO turnover. We use a sample of large US and European firms, which allows us to consider covariates not only at individual-, firm-, and industry levels, but also at the country level. We find that ESG-related negative news has a robust and significant impact on CEO replacement odds, and this impact is proportional to the severity of an event. Also, CEO turnover probability is inversely proportional to the stock market reaction to an ESG incident in both common-law and civil-law countries, however, the negative media attention on itself (“shaming”) can trigger CEO turnover only on latter group of countries.

If capital won't come to fund managers, then fund managers will go to capital. I document that fund managers move across mutual fund firms to manage amounts of capital that better match their skill, which improves the allocative efficiency of capital across fund managers. For causal identification, I exploit exogenous shocks to fund managers' ability to switch firms due to state-level changes to non-compete laws. In states that strengthen the enforceability of non-compete agreements, the propensity of fund managers to switch mutual fund firms is halved, capital misallocation across managers increases by about 10%, and the monthly total value added of managers declines by over $25 million. These results indicate that fund managers' mobility across firms plays an important role in the efficient reallocation of capital within the mutual fund industry.

The strength of the US dollar has attributes of a barometer of dollar credit conditions, whereby a stronger dollar is associated with tighter dollar credit conditions. Using finely disaggregated data on export shipments, we examine how dollar strength impacts exports through the lens of dollar financing availability. We find that exporters who are reliant on dollar-funded bank credit suffer a decline in exports due to increased funding costs. We argue that the US dollar is a global financial factor with real effects on the economy.

We investigate the peer effects from corporate real estate. Shocks to real estate prices shift firms’ debt capacity, which has a significant impact not only on firm investment but also on the investment of peer firms: a $1 of increase in the price of peer real estate assets induces a $0.072 increase in investment. The peer effect from corporate real estate is stronger when firms or their peers have more investment opportunities; financially constrained firms invest more out of their own price shocks, while the peer effect is stronger for unconstrained firms; and we find significant peer effects within - but not between - groups of small and large firms, respectively. Overall, we document a new channel through which real estate is an economically significant determinant of corporate finance.

We show that institutional investors are more likely to invest in firms from regions to which they have stronger social ties. Firms in regions with stronger social ties to places with substantial institutional capital have higher valuations and higher liquidity. These effects are largest for small firms with little analyst coverage. We find no evidence that investors generate differential returns from investments in locations to which they are socially connected. Our results suggest that the social structure of regions affects firms' access to capital and contributes to geographic differences in economic outcomes.