Bank Funding Risk, Reference Rates, and Credit Supply
Pages: 5-56 | Published: 12/2024 | DOI: 10.1111/jofi.13411 | Cited by: 0
HARRY COOPERMAN, DARRELL DUFFIE, STEPHAN LUCK, ZACHRY WANG, YILIN (DAVID) YANG
Corporate credit lines are drawn more heavily when funding markets are stressed. This elevates expected bank funding costs. We show that credit supply is dampened by the associated debt‐overhang cost to bank shareholders. Until 2022, this impact was reduced by linking the interest paid on lines to a credit‐sensitive reference rate like the London interbank offered rate (LIBOR). We show that transition to risk‐free reference rates may exacerbate this friction. The adverse impact on credit supply is offset if drawdowns are expected to be deposited at the same bank, which happened at some of the largest banks during the global financial crisis and COVID recession.
Intermediary Leverage Shocks and Funding Conditions
Pages: 57-99 | Published: 12/2024 | DOI: 10.1111/jofi.13407 | Cited by: 0
JEAN‐SÉBASTIEN FONTAINE, RENÉ GARCIA, SERMIN GUNGOR
The aggregate leverage of broker‐dealers responds to demand and supply disturbances that have opposite effects on financial markets. Specifically, leverage supply shocks that relax broker‐dealers' funding constraints increase leverage, liquidity, and returns and carry a positive price of risk, while leverage demand shocks also increase leverage but reduce liquidity and returns and carry a negative price of risk. Disentangling demand‐ and supply‐like shocks resolves existing puzzles around the price of leverage risk and yields consistent evidence across many markets of a central role for intermediation frictions and dealers' aggregate leverage in asset pricing.
The Global Credit Spread Puzzle
Pages: 101-162 | Published: 12/2024 | DOI: 10.1111/jofi.13409 | Cited by: 0
JING‐ZHI HUANG, YOSHIO NOZAWA, ZHAN SHI
We examine the ability of structural models to predict credit spreads using global default data and security‐level credit spread data in eight developed economies. We find that two representative, pure default‐risk models tend to underpredict the average credit spreads on investment‐grade (IG) bonds, especially their spreads over government bonds, thereby providing evidence for a “global credit spread puzzle.” However, a model incorporating endogenous liquidity in the secondary debt market helps mitigate the puzzle. Furthermore, the model captures certain determinants of corporate bond market frictions across the eight economies and substantially improves the cross‐sectional fit of individual IG credit spreads.
Private Equity and Financial Stability: Evidence from Failed‐Bank Resolution in the Crisis
Pages: 163-210 | Published: 11/2024 | DOI: 10.1111/jofi.13399 | Cited by: 0
EMILY JOHNSTON‐ROSS, SONG MA, MANJU PURI
This paper investigates the role of private equity (PE) in failed‐bank resolutions after the 2008 financial crisis, using proprietary Federal Deposit Insurance Corporation failed‐bank acquisition data. PE investors made substantial investments in underperforming and riskier failed banks, particularly in geographies where local banks were also distressed, filling the gap created by a weak, undercapitalized banking sector. Using a quasi‐random empirical design based on detailed bidding information, we show that PE‐acquired banks performed better ex post, with positive real effects for the local economy. Overall, PE investors played a positive role in stabilizing the financial system through their involvement in failed‐bank resolution.
Equilibrium Data Mining and Data Abundance
Pages: 211-258 | Published: 10/2024 | DOI: 10.1111/jofi.13397 | Cited by: 0
JÉRÔME DUGAST, THIERRY FOUCAULT
We study theoretically how the proliferation of new data (“data abundance”) affects the allocation of capital between quantitative and nonquantitative asset managers (“data miners” and “experts”), their performance, and price informativeness. Data miners search for predictors of asset payoffs and select those with a sufficiently high precision. Data abundance raises the precision of the best predictors, but it can induce data miners to search less intensively for high‐precision signals. In this case, their performance becomes more dispersed and they receive less capital. Nevertheless, data abundance always raises price informativeness and can therefore reduce asset managers' average performance.
Pages: 259-319 | Published: 12/2024 | DOI: 10.1111/jofi.13415 | Cited by: 1
STEFANO GIGLIO, DACHENG XIU, DAKE ZHANG
We show that two important issues in empirical asset pricing—the presence of weak factors and the selection of test assets—are deeply connected. Since weak factors are those to which test assets have limited exposure, an appropriate selection of test assets can improve the strength of factors. Building on this insight, we introduce supervised principal component analysis (SPCA), a methodology that iterates supervised selection, principal‐component estimation, and factor projection. It enables risk premia estimation and factor model diagnosis even when weak factors are present and not all factors are observed. We establish SPCA's asymptotic properties and showcase its empirical applications.
Decentralized Exchange: The Uniswap Automated Market Maker
Pages: 321-374 | Published: 12/2024 | DOI: 10.1111/jofi.13405 | Cited by: 0
ALFRED LEHAR, CHRISTINE PARLOUR
Uniswap is a system of smart contracts on the Ethereum blockchain and is the largest decentralized exchange with a liquidity balance worth up to 4 billion USD and daily trading volume of up to 7 billion USD. It is a new model of liquidity provision, so‐called automated market making. For this new market form, we characterize equilibrium in the liquidity pools. We collect all 95.8 million Uniswap interactions and compare this automated market maker (AMM) to a centralized limit order book. We document absence of long‐lived arbitrage opportunities, and show conditions under which the AMM dominates a limit order market.
Pages: 375-414 | Published: 10/2024 | DOI: 10.1111/jofi.13401 | Cited by: 0
JONATHAN BROGAARD, MATTHEW C. RINGGENBERG, DOMINIK ROESCH
Although algorithmic trading now dominates financial markets, some exchanges continue to use human floor traders. On March 23, 2020 the NYSE suspended floor trading because of COVID‐19. Using a difference‐in‐differences analysis around the closure of the floor, we find that floor traders are important contributors to market quality. The suspension of floor trading leads to higher spreads and larger pricing errors for treated stocks relative to control stocks. To explore the mechanism, we exploit two partial floor reopenings that have different characteristics. Our finding suggests that in‐person human interaction facilitates the transfer of valuable information that algorithms lack.
Scope, Scale, and Concentration: The 21st‐Century Firm
Pages: 415-466 | Published: 11/2024 | DOI: 10.1111/jofi.13400 | Cited by: 0
GERARD HOBERG, GORDON M. PHILLIPS
We provide evidence using firm 10‐Ks that over the past 30 years, U.S. firms have expanded their scope of operations. Increases in scope were achieved largely without increasing traditional operating segments. Scope expansion significantly increases valuation and is realized primarily through acquisitions and investment in R&D, but not through capital expenditures. Traditional concentration ratios do not capture this expansion of scope. Our findings point to a new type of firm that increases scope through related expansion, which is highly valued by the market.
Sending Out an SMS: Automatic Enrollment Experiments for Overdraft Alerts
Pages: 467-514 | Published: 12/2024 | DOI: 10.1111/jofi.13404 | Cited by: 0
MICHAEL D. GRUBB, DARRAGH KELLY, JEROEN NIEBOER, MATTHEW OSBORNE, JONATHAN SHAW
At‐scale field experiments at major U.K. banks show that automatic enrollment into “just‐in‐time” text alerts reduces unarranged overdraft and unpaid item charges 17% to 19% and arranged overdraft charges 4% to 8%, implying annual market‐wide savings of £170 million to £240 million. Incremental benefits from “early‐warning” alerts are statistically insignificant, although economically significant effects are not ruled out. Prior to the experiments, over half of overdrafts could have been avoided by using lower‐cost liquidity available in savings and credit card accounts. Alerts help consumers achieve less than half of these potential savings.
Personal Communication in an Automated World: Evidence from Loan Repayments
Pages: 515-559 | Published: 11/2024 | DOI: 10.1111/jofi.13388 | Cited by: 0
CHRISTINE LAUDENBACH, STEPHAN SIEGEL
We examine the effect of personal, two‐way communication on the payment behavior of delinquent borrowers. Borrowers who speak with a randomly assigned bank agent are significantly more likely to successfully resolve the delinquency relative to borrowers who do not speak with a bank agent. Call characteristics related to the human touch of the call, such as the likeability of the agent's voice, significantly affect payment behavior. Borrowers who speak with a bank agent are also significantly less likely to become delinquent again. Our findings highlight the value of a human element in interactions between financial institutions and their customers.
Dynamic Competition in Negotiated Price Markets
Pages: 561-614 | Published: 12/2024 | DOI: 10.1111/jofi.13408 | Cited by: 0
JASON ALLEN, SHAOTENG LI
Using contract‐level data for the Canadian mortgage market, this paper provides evidence of an “invest‐and‐harvest” pricing pattern. We build a dynamic model of price negotiation with search and switching frictions to capture key market features. We estimate the model and use it to investigate the effects of market frictions and the resulting dynamic competition on borrowers' and banks' payoffs. We show that dynamic pricing and the presence of search and switching costs have important implications for public policies.
Carbon Returns across the Globe
Pages: 615-645 | Published: 10/2024 | DOI: 10.1111/jofi.13402 | Cited by: 0
SHAOJUN ZHANG
The pricing of carbon transition risk is central to the debate on climate‐aware investments. Emissions are tightly linked to sales and are available to investors only with significant lags. The positive carbon return, or brown‐minus‐green return differential, documented in previous studies arises from forward‐looking firm performance information contained in emissions rather than a risk premium in ex ante expected returns. After accounting for the data release lag, carbon returns turn negative in the United States and insignificant globally. Developed markets experience lower carbon returns due to intense climate concern shocks, while countries with stringent climate policies exhibit higher carbon returns.
Pages: 648-649 | Published: 1/2025 | DOI: 10.1111/jofi.13419 | Cited by: 0