Cost of Capital
Liquidity, Economic Activity, and Mortality
William Evans & Timothy Moore
Review of Economics and Statistics, forthcoming
Abstract:
We document a within-month mortality cycle where deaths decline before the 1st day of the month and spike after the 1st. This cycle is present across a wide variety of causes and demographic groups. A similar cycle exists for a range of economic activities, suggesting the mortality cycle may be due to short-term variation in levels of economic activity. We provide evidence that the within-month activity cycle is generated by liquidity. Our results suggest a causal pathway whereby liquidity problems reduce activity, which in turn reduces mortality. These relationships may help explain the pro-cyclical nature of mortality.
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Was Privateering Plunder Efficient?
Peter Leeson & Alex Nowrasteh
Journal of Economic Behavior & Organization, forthcoming
Abstract:
This paper argues that when contracts between enemies are enforceable and transaction costs are low, plunderers and their victims benefit from trade that facilitates the former's ability to plunder the latter. Coasean "plunder contracts" transform part of plunder's social costs into private benefits for plunderers and their victims. A significant portion of the wealth that plunder would otherwise destroy is preserved instead. The result is more efficient plunder. To investigate our hypothesis we consider maritime marauding in the 18th and 19th centuries. Privateers developed a system of ransom and parole founded on Coasean plunder contracts with victim merchantmen.
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Monica Banyi, Dennis Caplan & Roger Graham
Critical Perspectives on Accounting, forthcoming
Abstract:
Proponents of private equity investment in corporate ventures assert that private equity creates shareholder wealth by alleviating agency costs, improving venture governance, and allocating resources more efficiently. Critics claim private equity expropriates wealth from public company shareholders to private investors and managers. We use managerialism as a framework to examine these competing claims in the context of the power amplifier business at Lucent Technologies. Lucent spun off this business in 2001 into a company called Celiant Corporation, and then sold Celiant in a series of transactions in 2001 and 2002. We estimate that Lucent contributed assets to Celiant worth $330 million, but that the spin-off and sale of Celiant generated only $91 million for Lucent's shareholders. The apparent loss of over $200 million of shareholder wealth is consistent with a scenario in which Lucent managers and private equity investors used their superior information for personal gain.
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Strategic Forecasting on the FOMC
Peter Tillmann
European Journal of Political Economy, forthcoming
Abstract:
The Federal Open Market Committee (FOMC) of the Federal Reserve consists of voting- and non-voting members. Apart from deciding about interest rate policy, members individually formulate regular inflation forecasts. This paper uncovers systematic differences in individual inflation forecasts submitted by voting and non-voting members. Based on a data set with individual forecasts recently made available it is shown that non-voters systematically overpredict inflation relative to the consensus forecast if they favor tighter policy and underpredict inflation if they favor looser policy. These findings are consistent with non-voting member following strategic motives in forecasting, i.e. non-voting members use their forecast to influence policy.
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High Frequency Trading and Its Impact on Market Quality
Jonathan Brogaard
Northwestern University Working Paper, November 2010
Abstract:
In this paper I examine the impact of high frequency trading (HFT) on the U.S. equities market. I analyze a unique dataset to study the strategies utilized by high frequency traders (HFTs), their profitability, and their relationship with characteristics of the overall market, including liquidity, price discovery, and volatility. The 26 HFT firms in the dataset participate in 68.5% of the dollar-volume traded. I find the following key results: (1) HFTs tend to follow a price reversal strategy driven by order imbalances, (2) HFTs earn gross trading profits of approximately $2.8 billion annually, (3) HFTs do not seem to systematically engage in a non-HFTr anticipatory trading strategy, (4) HFTs' strategies are more correlated with each other than are non-HFTs', (5) HFTs' trading levels change only moderately as volatility increases, (6) HFTs add substantially to the price discovery process, (7) HFTs provide the best bid and offer quotes for a significant portion of the trading day and do so strategically so as to avoid informed traders, but provide only one-fourth as much book depth as non-HFTs, and (8) HFTs may dampen intraday volatility. These findings suggest that HFTs' activities are not detrimental to non-HFTs and that HFT tends to improve market quality.
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Do the SEC's Enforcement Preferences Affect Corporate Misconduct?
Simi Kedia & Shiva Rajgopal
Journal of Accounting and Economics, forthcoming
Abstract:
Recent frauds have questioned the efficacy of the SEC's enforcement program. We hypothesize that differences in firms' information sets about SEC enforcement and constraints facing the SEC affect firms' proclivity to adopt aggressive accounting practices. We find that firms located closer to the SEC and in areas with greater past SEC enforcement activity, both proxies for firms' information about SEC enforcement, are less likely to restate their financial statements. Consistent with the resource-constrained SEC view, the SEC is more likely to investigate firms located closer to its offices. Our results suggest that regulation is most effective when it is local.
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Have community banks reduced home foreclosure rates?
Kathy Fogel, Raja Kali & Tim Yeager
Journal of Banking & Finance, forthcoming
Abstract:
Compared with mortgage brokers and universal banks, community banks have stronger incentives to originate high-quality residential home loans. Using the RealtyTrac database on residential foreclosures between 2005 and 2008, we show that county-level foreclosure rates are lower in counties with greater community bank presence. This finding is robust to a host of county-level economic and demographic control variables and after controlling for possible endogeneity of community bank presence.
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The Causal Relationship Between Employment and Business Networks in U.S. Cities
Zachary Neal
Journal of Urban Affairs, forthcoming
Abstract:
Scholars from a range of disciplines have long recognized that a city's economic fortunes are closely tied to its position in networks of interurban exchanges. However, it remains unclear whether cities occupy a central position in the network because they are sites of significant economic activity (i.e., a flow generation hypothesis), or whether they experience greater economic growth because they occupy a central position in the network (i.e., a structural advantage hypothesis). This article tests these complementary hypotheses by examining the total nonfarm employment in, and air travel patterns of business passengers among, 128 U.S. metropolitan areas from 1993 to 2008 using a series of lagged regression models. Results lend support to the structural advantage hypothesis, but not for the flow generation hypothesis: centrality drives employment, but not vice versa. The article concludes with a discussion of the implications of these results for infrastructure-focused approaches to economic development.
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Kissan Joseph, Babajide Wintoki & Zelin Zhang
International Journal of Forecasting, forthcoming
Abstract:
We examine the ability of online ticker searches (e.g. XOM for Exxon Mobil) to forecast abnormal stock returns and trading volumes. Specifically, we argue that online ticker searches serve as a valid proxy for investor sentiment - a set of beliefs about cash flows and investment risks that are not necessarily justified by the facts at hand - which is generally associated with less sophisticated, retail investors. Based on prior research on investor sentiment, we expect online search intensity to forecast stock returns and trading volume, and also expect that highly volatile stocks, which are more difficult to arbitrage, will be more sensitive to search intensity than less volatile stocks. In a sample of S&P 500 firms over the period 2005-2008, we find that, over a weekly horizon, online search intensity reliably predicts abnormal stock returns and trading volumes, and that the sensitivity of returns to search intensity is positively related to the difficulty of a stock being arbitraged. More broadly, our study highlights the potential of employing online search data for other forecasting applications.
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Economic impact of a private sector micro-financing scheme in South Dakota
David Benson et al.
Small Business Economics, February 2011, Pages 157-168
Abstract:
While poverty rates on Native American Indian reservations are triple the US average. Small business incubation programs, available elsewhere in the US, scarcely exist on the Native American Indian Reservations (NAIRs). Our unique study tests the effects of the Lakota Fund (LF), a private sector small business development initiative on the Pine Ridge Reservation in South Dakota, on the economic development of the NAIRs. Our objective is to determine whether the SBA-like programs (loans, training, and consulting) can improve economic conditions. The 1980-2006 annual county-level (Shannon Co. is ‘treatment,'and Todd Co. is ‘control') data are a natural experiment. Results indicate that the LF inception and duration significantly raised real per capita income (RPCI) - suggesting not only the success of the LF, but support for the broader notion that privately funded small business initiatives can be used to support economic development of isolated impoverished groups within the US economy.
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Credit Default Swaps and the Empty Creditor Problem
Patrick Bolton & Martin Oehmke
Review of Financial Studies, forthcoming
Abstract:
The empty creditor problem arises when a debtholder has obtained insurance against default but otherwise retains control rights in and outside bankruptcy. We analyze this problem from an ex ante and ex post perspective in a formal model of debt with limited commitment, by comparing contracting outcomes with and without insurance through credit default swaps (CDS). We show that CDS, and the empty creditors they give rise to, have important ex ante commitment benefits: By strengthening creditors' bargaining power, they raise the debtor's pledgeable income and help reduce the incidence of strategic default. However, we also show that lenders will over-insure in equilibrium, giving rise to an inefficiently high incidence of costly bankruptcy. We discuss a number of remedies that have been proposed to overcome the inefficiency resulting from excess insurance.
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Risk and Return Characteristics of Islamic Equity Funds
Raphie Hayat & Roman Kraeussl
Emerging Markets Review, forthcoming
Abstract:
Islamic equity funds (IEFs) differ fundamentally from conventional equity funds since Muslims are prohibited to invest in certain companies/sectors and pay or receive interest. This paper analyzes the risk and return characteristics of a sample of 145 IEFs over the period 2000 to 2009. Our results show that IEFs are underperformers compared to Islamic as well as to conventional equity benchmarks. This underperformance seems to have increased during the recent financial crisis. We also find that IEF managers are bad market timers. They try to time the market, but in doing so, reduce the return rather than increasing it. An important implication of our results is that Muslim investors might improve their performance by investing in index tracking funds or ETFs rather than to invest in individual IEFs.
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New estimates of the cost of capital for pharmaceutical firms
Carmelo Giaccotto, Joseph Golec & John Vernon
Journal of Corporate Finance, forthcoming
Abstract:
Academic researchers, as well as pharmaceutical firms themselves, often use the Capital Asset Pricing Model (CAPM) to estimate a firm's cost of capital. But the CAPM implicitly assumes that cash flows follow a random walk. This assumption is inconsistent with our finding that large U.S.-based pharmaceutical firms' cash flow growth rates display either momentum or mean-reversion. We show that growth rate momentum implies: (1) the systematic risk of a project increases monotonically with time to maturity of the cash flows; and (2) longer duration projects require a higher cost of capital. One of the practical implications of our results is that the traditional CAPM underestimates the cost of capital for some pharmaceutical firms by as much as 2.8%. These findings are quite relevant for the policy debate about the high rates of return earned by pharmaceutical companies, which some claim are pure rents and are not necessary to attract investors. Our theoretical and empirical analysis shows that high returns are often required to compensate for the higher systematic risk of long-duration pharmaceutical cash flows.
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Idiosyncratic risk and financial policy
Andrés Carvajal & Herakles Polemarchakis
Journal of Economic Theory, forthcoming
Abstract:
In economies subject to uninsurable idiosyncratic risks, competitive equilibrium allocations are constrained inefficient: reallocations of assets support Pareto superior allocations. This is the case even if the asset market for the allocation of aggregate risks is complete.
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Informed and Uninformed Investment in Housing: The Downside of Diversification
Elena Loutskina & Philip Strahan
Review of Financial Studies, forthcoming
Abstract:
Mortgage lenders that concentrate in a few markets invest more in information collection than diversified lenders. Concentrated lenders focus on the information-intensive jumbo market and on high-risk borrowers. They are better positioned to price risks and, thus, ration credit less. Adverse selection, however, leads to higher retention of mortgages relative to diversified lenders. Finally, concentrated lenders have higher profits than diversified lenders, their profits vary less systematically, and their stock prices fell less during the 2007-2008 credit crisis. The results imply that geographic diversification led to a decline in screening by lenders, which likely played a role in the 2007-2008 crisis.
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Oil prices and the impact of the financial crisis of 2007-2009
Ramaprasad Bhar & A.G. Malliaris
Energy Economics, forthcoming
Abstract:
Oil prices increased dramatically during 2004-6. Industry experts initially attributed these price increases to fundamental factors such as the rise in global demand, but also because of disruptions in the supply of oil. The price increases however were so substantial that additional factors are needed to explain such dramatic changes. We propose that the decline in the value of the U.S. dollar measured both by the appreciation of the Euro and of gold prices, played an important role as oil suppliers demanded compensation for the declining value of the dollar. Using a Markov switching regime methodology we find evidence that this hypothesis is true prior to the financial crisis, but its validity does not hold after the crisis when oil prices crashed and the dollar rallied.
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Consumer Bankruptcy and Default: The Role of Individual Social Capital
Sumit Agarwal, Souphala Chomsisengphet & Chunlin Liu
Journal of Economic Psychology, forthcoming
Abstract:
An individual's decision to maximize his investment in social capital is determined by his socioeconomic characteristics, such as homeownership and mobility (Glaeser, Laibson, and Sacerdote, 2002). In this paper, we empirically assess the role of individual social capital variables on personal bankruptcy and default outcomes in the consumer credit market. After controlling for a borrower's risk score, debt, income, wealth, and legal and economic environments, we find that default/bankruptcy risk rises and then falls over the lifecycle, while a borrower who owns a home or is married has a lower risk of default/bankruptcy. Moreover, a borrower who migrates 190 miles from his "state of birth" is 17 percent more likely to default and 15 percent more likely to file for bankruptcy, while a borrower who continues to live in his state of birth is 14 and 10 percent less likely to default and file for bankruptcy, respectively. A borrower who moves to a rural area is 9 and 7 percent less likely to default and declare bankruptcy, respectively. We also find that measures of social networks, norms, and cooperation and trust (i.e., aggregate social capital) are inversely related to consumer bankruptcy.
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An Experimental Analysis of the Demand for Payday Loans
Bart Wilson et al.
B.E. Journal of Economic Analysis & Policy, October 2010
Abstract:
The payday loan industry is one of the fastest growing segments of the consumer financial services market in the United States. We design an environment similar to the one that payday loan customers face and then conduct a laboratory experiment to examine what effect, if any, the existence of payday loans has on individuals' abilities to manage and to survive financial setbacks. Our primary objective is to examine whether access to payday loans improves or worsens the likelihood of financial survival in our experiment. We also test the degree to which people's use of payday loans affects their ability to survive financially. We find that payday loans help the subjects to absorb expenditure shocks and therefore survive financially. However, subjects whose demand for payday loans exceeds a certain threshold level are at a greater risk than a corresponding subject in the treatment in which payday loans do not exist.