Published: 6/7/2023 | DOI: 10.1111/jofi.13250
DAVIDSON HEATH, MATTHEW C. RINGGENBERG, MEHRDAD SAMADI, INGRID M. WERNER
After a natural experiment is first used, other researchers often reuse the setting, examining different outcome variables. We use simulations based on real data to illustrate the multiple hypothesis testing problem that arises when researchers reuse natural experiments. We then provide guidance for future inference based on popular empirical settings including difference‐in‐differences, instrumental variables, and regression discontinuity designs. When we apply our guidance to two extensively studied natural experiments, business combination laws and the Regulation SHO pilot, we find that many results that were statistically significant using single hypothesis testing do not survive corrections for multiple hypothesis testing.
Liquidity, Volume, and Order Imbalance Volatility
Published: 6/5/2023 | DOI: 10.1111/jofi.13248
VINCENT BOGOUSSLAVSKY, PIERRE COLLIN‐DUFRESNE
We examine the dynamics of liquidity using a comprehensive sample of U.S. stocks in the post‐decimalization period. Motivated by a continuous‐time inventory model, we compute a high‐frequency measure of order imbalance volatility to proxy for the inventory risk faced by liquidity providers. We show that high‐frequency order imbalance volatility is an important driver of liquidity and explains the often positive time‐series relation between spread and volume for large stocks, which seems to run counter to most theoretical models. Furthermore, order imbalance volatility is priced in the cross‐section of stock returns.
Barter Credit: Warehouses as a Contracting Technology
Published: 6/5/2023 | DOI: 10.1111/jofi.13252
JANIS SKRASTINS
A large Brazilian agribusiness lender introduces a new contracting technology: grain warehouses. Using runner‐up warehouse locations as a control group, I find that construction of these warehouses permits a new debt contract, namely, barter credit repayable in grain. This contract increases borrowers' debt capacity and reduces borrowing costs. The effects are stronger when grain price risk is higher, for municipalities with weaker courts, and for financially constrained borrowers. These findings are consistent with barter credit reducing financial market imperfections by mitigating borrowers' output price risk.
A Sentiment Measure Constructed from Issuances of Retail Structured Equity Products
Published: 5/27/2023 | DOI: 10.1111/jofi.13253
BRIAN J. HENDERSON, NEIL D. PEARSON, LI WANG
We use retail structured equity product (SEP) issuances to construct a new sentiment measure for large capitalization stocks. The SEP sentiment measure predicts negative abnormal returns on the SEP reference stocks based on a variety of factor models, and also predicts returns in Fama‐MacBeth regressions that include a wide range of covariates. Consistent with our interpretation that SEP issuances reflect investor sentiment, aggregate SEP issuances are highly correlated with the Baker‐Wurgler sentiment index. Tobit regressions reveal that proxies for attention and sentiment predict SEP issuance volumes, providing additional evidence consistent with the hypothesis that SEP issuances reflect sentiment.
Employee Costs of Corporate Bankruptcy
Published: 5/27/2023 | DOI: 10.1111/jofi.13251
JOHN R GRAHAM, HYUNSEOB KIM, SI LI, JIAPING QIU
An employee's annual earnings fall by 13% the year her firm files for bankruptcy, and the present value of lost earnings from bankruptcy to six years following bankruptcy is 87% of pre‐bankruptcy annual earnings. More worker earnings are lost in thin labor markets and among small firms. Ex‐ante compensating wage differentials for this “bankruptcy risk” are up to 2% of firm value for a firm whose credit rating falls from AA to BBB, comparable in magnitude to debt tax benefits. Thus, wage premia for expected costs of bankruptcy are sufficiently large to be an important consideration in capital structure decisions.
Is There a Replication Crisis in Finance?
Published: 5/26/2023 | DOI: 10.1111/jofi.13249
THEIS INGERSLEV JENSEN, BRYAN KELLY, LASSE HEJE PEDERSEN
Several papers argue that financial economics faces a replication crisis because the majority of studies cannot be replicated or are the result of multiple testing of too many factors. We develop and estimate a Bayesian model of factor replication that leads to different conclusions. The majority of asset pricing factors (i) can be replicated; (ii) can be clustered into 13 themes, the majority of which are significant parts of the tangency portfolio; (iii) work out‐of‐sample in a new large data set covering 93 countries; and (iv) have evidence that is strengthened (not weakened) by the large number of observed factors.
Can Security Design Foster Household Risk‐Taking?
Published: 5/17/2023 | DOI: 10.1111/jofi.13232
LAURENT E. CALVET, CLAIRE CELERIER, PAOLO SODINI, BORIS VALLEE
This paper shows that securities with nonlinear payoff designs can foster household risk‐taking. We demonstrate this effect by exploiting the introduction of capital guarantee products in Sweden between 2002 and 2007. Their fast and broad adoption is associated with an increase in expected financial portfolio returns. The effect is especially strong for households with low‐risk appetite ex ante. These empirical facts are consistent with a life‐cycle model in which households have pessimistic beliefs or preferences combining loss aversion and narrow framing. Our results illustrate how security design can mitigate behavioral biases to increase mean household portfolio returns.
Optimal Sequential Selling Mechanism and Deal Protections in Mergers and Acquisitions
Published: 5/13/2023 | DOI: 10.1111/jofi.13235
YI CHEN, ZHE WANG
We study the dynamic profit‐maximizing selling mechanism in a merger and acquisitions (M&A) environment with costly bidder entry and without entry fees. Depending on the parameters, the optimal mechanism is implemented by a standard auction or by a two‐stage procedure with exclusive offers to one bidder followed by an auction potentially favoring that bidder. The optimal mechanism may involve common deal protections like termination fees, asset lockups, or stock option lockups. Our proposed procedures resemble sales of targets filing Chapter 11 bankruptcy or M&A involving public targets, and they shed light on how to use deal protections in practice.
Modeling Corporate Bond Returns
Published: 5/8/2023 | DOI: 10.1111/jofi.13233
BRYAN KELLY, DIOGO PALHARES, SETH PRUITT
We propose a conditional factor model for corporate bond returns with five factors and time‐varying factor loadings. We have three main empirical findings. First, our factor model excels in describing the risks and returns of corporate bonds, improving over previously proposed models in the literature by a large margin. Second, our model recommends a systematic bond investment portfolio whose high out‐of‐sample Sharpe ratio suggests that the credit risk premium is notably larger than previously estimated. Third, we find closer integration between debt and equity markets than found in prior literature.
Rents and Intangible Capital: A Q+ Framework
Published: 5/5/2023 | DOI: 10.1111/jofi.13231
NICOLAS CROUZET, JANICE EBERLY
In recent years, U.S. investment has been lackluster, despite rising valuations. Key explanations include growing rents and growing intangibles. We propose and estimate a framework to quantify their roles. The gap between valuations—reflected in average Q—and investment—reflected in marginal q—can be decomposed into three terms: the value of installed intangibles; rents generated by physical capital; and an interaction term, measuring rents generated by intangibles. The intangible related terms contribute significantly to the gap, particularly in fast‐growing sectors. Our findings suggest care in a pure‐rents interpretation, given the rising role of intangibles.
Is COVID Revealing a Virus in CMBS 2.0?
Published: 4/18/2023 | DOI: 10.1111/jofi.13228
JOHN M. GRIFFIN, ALEX PRIEST
Commercial loan valuations crucially depend on accurate loan income, but underwritten income on commercial mortgage‐backed securities (CMBS) loans is commonly overstated relative to actual property income. Consistent with these differences being originator‐specific, income overstatement in CMBS 2.0 deals varies widely and persistently across originators, is priced by originators, is related across property types within an originator, is predictable ex ante, and is accompanied by inflation of past financials. Risk retention and associated regulation had no discernible effect on income overstatement. Originator income overstatement is highly predictive of pre‐ and COVID‐period loan distress. Overall, recent market stresses reveal large systemic differences in underwriting standards across originators.
Published: 4/12/2023 | DOI: 10.1111/jofi.13227
JOHN THANASSOULIS
Misconduct is widespread. Practices such as misselling, pump and dump, and money laundering cause harm while raising profits. This paper presents a mechanism that can determine what sorts of misconduct can be sustained in competitive equilibrium in concentrated markets, oligopoly settings, and markets with many small competing firms. The model studied allows general demand and distinguishes types of ethical dilemma using current psychological understanding. The paper shows, for example, that markets with many small competing firms are not vulnerable to misconduct if firms respond to entry with niche strategies or if the ethical dilemma draws an emotional response.