Financial & Economic Blog

We show that transactions accounts, by providing ongoing data on borrowers’ activities, help financial intermediaries monitor borrowers. This information is most readily available to commercial banks, which offer these accounts and lending together. We find that (1) monthly changes in accounts receivable are reflected in transactions accounts; (2) borrowings in excess of collateral predict credit downgrades and loan write-downs; and (3) the lender intensifies monitoring in response. This is evidence on a key issue in financial intermediation—there is an advantage to providing deposit-taking and lending jointly. But this advantage may have fallen as the cost of communication has declined. (JEL G10, G20, G21)

We examine whether spin-offs or divestitures cause improvements in conglomerate investment efficiency. At issue are endogeneity of these restructuring decisions and correct measurement of investment efficiency. Endogeneity is a problem because the factors that induce firms to spin off or divest divisions may also improve investment efficiency; measurement error is a problem because efficiency measures employ Tobin’s q as a noisy proxy for investment opportunities. We find important differences between firms that divest or spin off and a control sample. After accounting for these differences and for measurement error in q, we find no evidence of improvements in investment efficiency. (JEL G31, G34)

We provide evidence that commercial banks extend their reputation in underwriting syndicated loans and private placements (private debt) to their bond-underwriting activities. In the absence of bond market reputation, private-debt-market reputation enables commercial banks to win underwriting mandates from their loan clients. Furthermore, it allows them to credibly commit to investors against opportunistically using lending information and thereby deliver superior certification benefits in the form of higher issue prices relative to investment-bank underwriters. This pricing benefit is not offset by higher underwriting fees and thus results in lower total issuance costs for borrowers.(JEL G21, G28, L14, L15)

The article shows that two measures of the amount of private information in stock price—price nonsynchronicity and probability of informed trading (PIN)—have a strong positive effect on the sensitivity of corporate investment to stock price. Moreover, the effect is robust to the inclusion of controls for managerial information and for other information-related variables. The results suggest that firm managers learn from the private information in stock price about their own firms’ fundamentals and incorporate this information in the corporate investment decisions. We relate our findings to an alternative explanation for the investment-to-price sensitivity, namely that it is generated by capital constraints, and show that both the learning channel and the alternative channel contribute to this sensitivity. (JEL G14, G31)

We examine the predictive power of the dividend yields for forecasting excess returns, cash flows, and interest rates. Dividend yields predict excess returns only at short horizons together with the short rate and do not have any long-horizon predictive power. At short horizons, the short rate strongly negatively predicts returns. These results are robust in international data and are not due to lack of power. A present value model that matches the data shows that discount rate and short rate movements play a large role in explaining the variation in dividend yields. Finally, we find that earnings yields significantly predict future cash flows. (JEL C12, C51, C52, E49, F30, G12)

This article studies cross-sectional variations in trading activity for a comprehensive sample of NYSE/AMEX and Nasdaq stocks over a period of about 40 years. We test whether trading activity depends upon the degree of liquidity trading, the mass of informed traders, and the extent of uncertainty and dispersion of opinion about fundamental values. We hypothesize that liquidity (or noise) trading depends both on a stock’s visibility and on portfolio rebalancing needs triggered by past price performance. We use firm size, age, price, and the book-to-market ratio as proxies for a firm’s visibility. The mass of informed agents is proxied by the number of analysts whereas forecast dispersion and firm leverage proxy for differences of opinion. Earning volatility and absolute earning surprises proxy for uncertainty about fundamental values. Overall, the results provide support for theories of trading based on stock visibility, portfolio rebalancing needs, differences of opinion, and uncertainty about fundamental values.

We investigate the trading of institutions immediately before the release of analysts’ initial buy recommendations. We document abnormally high institutional trading volume and buying beginning five days before recommendations are publicly released. Abnormal buying is related to initiation characteristics that would require knowledge of the content of the report—such as the identity of the analyst and brokerage firm, and whether the recommendation is a strong buy. We confirm that institutions buying before the recommendation release earn abnormal profits. Our results are consistent with institutional traders receiving tips regarding the contents of forthcoming analysts’ reports. (JEL G14, G18, G24)

We conduct an analysis of the risk and return characteristics of a number of widely used fixed-income arbitrage strategies. We find that the strategies requiring more "intellectual capital" to implement tend to produce significant alphas after controlling for bond and equity market risk factors. These positive alphas remain significant even after taking into account typical hedge fund fees. In contrast with other hedge fund strategies, many of the fixed-income arbitrage strategies produce positively skewed returns. These results suggest that there may be more economic substance to fixed-income arbitrage than simply "picking up nickels in front of a steamroller."

This article uses a unique option data set to provide detailed descriptive statistics on the purchased and written open interest and open buy and sell volume of several classes of investors. We also show that volatility trading through straddles and strangles accounts for a small fraction of option trading volume and presents evidence that a large percentage of call writing is part of covered call positions. Finally, we find that during the stock market bubble of the late 1990s and early 2000 the least sophisticated investors in the data set substantially increased their purchases of calls on growth but not value stocks. (JEL: G0, G1, G12, G13, G14)

Implied risk aversion estimates reported in the literature are strongly U-shaped. This article explores different potential explanations for these "smile" patterns: (i) preference aggregation, both with and without stochastic volatility and jumps in returns, (ii) misestimation of investors’ beliefs caused by stochastic volatility, jumps, or a Peso problem, and (iii) heterogeneous beliefs. The results reveal that preference aggregation and misestimation of investors’ beliefs caused by stochastic volatility and jumps are unlikely to be the explanation for the smile. Although a Peso problem can account for the smile, the required probability of a market crash is unrealistically large. Heterogeneous beliefs cause sizable distortions in implied risk aversion, but the degree of heterogeneity required to explain the smile is implausibly large. (JEL: G12, G13)