View All Issues

Volume 73: Issue 1 (February 2018)


ISSUE INFORMATION FM

Pages: 1-3  |  Published: 2/2018  |  DOI: 10.1111/jofi.12552  |  Cited by: 0


Personal Lending Relationships

Pages: 5-49  |  Published: 12/2017  |  DOI: 10.1111/jofi.12589  |  Cited by: 13

STEPHEN ADAM KAROLYI

I identify the effects of personal relationships on loan contracting using executive deaths and retirements at other firms as a source of exogenous variation in executive turnover. After plausibly exogenous turnover, borrowers choose lenders with which their new executives have personal relationships 4.1 times as frequently, and loans from these lenders have 20 basis points lower spreads and 12.5% larger amounts. Personal relationships benefit firms across loan terms, especially during macroeconomic downturns. Increased financial flexibility from personal relationships insulated firms from financial shocks during the recent financial crisis: they exhibited less constrained investment and were less likely to layoff employees.


Measuring Liquidity Mismatch in the Banking Sector

Pages: 51-93  |  Published: 11/2017  |  DOI: 10.1111/jofi.12591  |  Cited by: 15

JENNIE BAI, ARVIND KRISHNAMURTHY, CHARLES-HENRI WEYMULLER

This paper constructs a liquidity mismatch index (LMI) to gauge the mismatch between the market liquidity of assets and the funding liquidity of liabilities, for 2,882 bank holding companies over 2002 to 2014. The aggregate LMI decreases from +$4 trillion precrisis to −$6 trillion in 2008. We conduct an LMI stress test revealing the fragility of the banking system in early 2007. Moreover, LMI predicts a bank's stock market crash probability and borrowing decisions from the government during the financial crisis. The LMI is therefore informative about both individual bank liquidity and the liquidity risk of the entire banking system.


Optimal Debt and Profitability in the Trade-Off Theory

Pages: 95-143  |  Published: 12/2017  |  DOI: 10.1111/jofi.12590  |  Cited by: 3

ANDREW B. ABEL

I develop a dynamic model of leverage with tax deductible interest and an endogenous cost of default. The interest rate includes a premium to compensate lenders for expected losses in default. A borrowing constraint is generated by lenders' unwillingness to lend an amount that would trigger immediate default. When the borrowing constraint is not binding, the trade‐off theory of debt holds: optimal debt equates the marginal interest tax shield and the marginal expected cost of default. Contrary to conventional interpretation, but consistent with empirical findings, increases in current or future profitability reduce the optimal leverage ratio when the trade‐off theory holds.


The Leverage Ratchet Effect

Pages: 145-198  |  Published: 12/2017  |  DOI: 10.1111/jofi.12588  |  Cited by: 21

ANAT R. ADMATI, PETER M. DEMARZO, MARTIN F. HELLWIG, PAUL PFLEIDERER

Firms’ inability to commit to future funding choices has profound consequences for capital structure dynamics. With debt in place, shareholders pervasively resist leverage reductions no matter how much such reductions may enhance firm value. Shareholders would instead choose to increase leverage even if the new debt is junior and would reduce firm value. These asymmetric forces in leverage adjustments, which we call the leverage ratchet effect, cause equilibrium leverage outcomes to be history‐dependent. If forced to reduce leverage, shareholders are biased toward selling assets relative to potentially more efficient alternatives such as pure recapitalizations.


Diagnostic Expectations and Credit Cycles

Pages: 199-227  |  Published: 1/2018  |  DOI: 10.1111/jofi.12586  |  Cited by: 16

PEDRO BORDALO, NICOLA GENNAIOLI, ANDREI SHLEIFER

We present a model of credit cycles arising from diagnostic expectations—a belief formation mechanism based on Kahneman and Tversky's representativeness heuristic. Diagnostic expectations overweight future outcomes that become more likely in light of incoming data. The expectations formation rule is forward looking and depends on the underlying stochastic process, and thus is immune to the Lucas critique. Diagnostic expectations reconcile extrapolation and neglect of risk in a unified framework. In our model, credit spreads are excessively volatile, overreact to news, and are subject to predictable reversals. These dynamics can account for several features of credit cycles and macroeconomic volatility.


The Paradox of Financial Fire Sales: The Role of Arbitrage Capital in Determining Liquidity

Pages: 229-274  |  Published: 11/2017  |  DOI: 10.1111/jofi.12584  |  Cited by: 2

JAMES DOW, JUNGSUK HAN

How can fire sales for financial assets happen when the economy contains well‐capitalized but nonspecialist investors? Our explanation combines rational expectations equilibrium and “lemons” models. When specialist (informed) market participants are liquidity‐constrained, prices become less informative. This creates an adverse selection problem, decreasing the supply of high‐quality assets, and lowering valuations by nonspecialist (uninformed) investors, who become unwilling to supply capital to support the price. In normal times, arbitrage capital can “multiply” itself by making uninformed capital function as informed capital, but in a crisis, this stabilizing mechanism fails.


Government Credit, a Double-Edged Sword: Evidence from the China Development Bank

Pages: 275-316  |  Published: 11/2017  |  DOI: 10.1111/jofi.12585  |  Cited by: 6

HONG RU

Using proprietary data from the China Development Bank (CDB), this paper examines the effects of government credit on firm activities. Tracing the effects of government credit across different levels of the supply chain, I find that CDB industrial loans to state‐owned enterprises (SOEs) crowd out private firms in the same industry but crowd in private firms in downstream industries. On average, a $1 increase in CDB SOE loans leads to a $0.20 decrease in private firms' assets. Moreover, CDB infrastructure loans crowd in private firms. I use exogenous timing of municipal politicians' turnover as an instrument for CDB credit flows.


A Model of Monetary Policy and Risk Premia

Pages: 317-373  |  Published: 7/2017  |  DOI: 10.1111/jofi.12539  |  Cited by: 7

ITAMAR DRECHSLER, ALEXI SAVOV, PHILIPP SCHNABL

We develop a dynamic asset pricing model in which monetary policy affects the risk premium component of the cost of capital. Risk‐tolerant agents (banks) borrow from risk‐averse agents (i.e., take deposits) to fund levered investments. Leverage exposes banks to funding risk, which they insure by holding liquidity buffers. By changing the nominal rate the central bank influences the liquidity premium, and hence the cost of taking leverage. Lower nominal rates make liquidity cheaper and raise leverage, resulting in lower risk premia and higher asset prices, volatility, investment, and growth. We analyze forward guidance, a “Greenspan put,” and the yield curve.


The Share of Systematic Variation in Bilateral Exchange Rates

Pages: 375-418  |  Published: 11/2017  |  DOI: 10.1111/jofi.12587  |  Cited by: 20

ADRIEN VERDELHAN

Sorting countries by their dollar currency betas produces a novel cross section of average currency excess returns. A slope factor (long in high beta currencies and short in low beta currencies) accounts for this cross section of currency risk premia. This slope factor is orthogonal to the high‐minus‐low carry trade factor built from portfolios of countries sorted by their interest rates. The two high‐minus‐low risk factors account for 18% to 80% of the monthly exchange rate movements. The two risk factors suggest that stochastic discount factors in complete markets' models should feature at least two global shocks to describe exchange rates.


Agency, Firm Growth, and Managerial Turnover

Pages: 419-464  |  Published: 11/2017  |  DOI: 10.1111/jofi.12583  |  Cited by: 5

RONALD W. ANDERSON, M. CECILIA BUSTAMANTE, STÉPHANE GUIBAUD, MIHAIL ZERVOS

We study managerial incentive provision under moral hazard when growth opportunities arrive stochastically and pursuing them requires a change in management. A trade‐off arises between the benefit of always having the “right” manager and the cost of incentive provision. The prospect of growth‐induced turnover limits the firm's ability to rely on deferred pay, resulting in more front‐loaded compensation. The optimal contract may insulate managers from the risk of growth‐induced dismissal after periods of good performance. The evidence for the United States broadly supports the model's predictions: Firms with better growth prospects experience higher CEO turnover and use more front‐loaded compensation.


MISCELLANEA

Pages: 465-465  |  Published: 2/2018  |  DOI: 10.1111/jofi.12549  |  Cited by: 0


ANNOUNCEMENTS

Pages: 467-467  |  Published: 2/2018  |  DOI: 10.1111/jofi.12550  |  Cited by: 0


American Finance Association

Pages: 468-468  |  Published: 2/2018  |  DOI: 10.1111/jofi.12608  |  Cited by: 0

David Hirshleifer


ISSUE INFORMATION BM

Pages: 469-472  |  Published: 2/2018  |  DOI: 10.1111/jofi.12553  |  Cited by: 0