What factors influence European corporate bond spread?

This paper examines the main determinants of corporate euro-bond spread. We analyse a large sample of corporate euro-country bonds over the period May 2005 -January 2012, considering three sub-periods: May 2005- July 2007 (pre-crisis period), August 2007-April 2010 (worldwide financial crisis) and May 2010-January 2012 (European sovereign debt crisis). We show that both liquidity risk and risk related to the country of the issuing firms affect corporate bond spread. We also find that the market yield of corporate bonds issued in the main European countries is, other things being equal, strongly influenced by the risk of the corresponding sovereign bonds and Credit Default Swap (CDS). Finally, we compare the yields of bonds issued by banks with those of bonds issued by firms from other sectors and find that the spread, other things being equal, is significantly higher for banks. These findings may have operating implications for market activity, regulators and policy makers

Funding Constraints and Market Illiquidity in the European Treasury Bond Market

Theoretical studies show that shocks to funding constraints should affect and be affected by market illiquidity. However, little is known about the empirical magnitude of such responses because of the intrinsic endogeneity of illiquidity shocks. This paper adopts an identification technique based on the heteroskedasticity of illiquidity proxies to infer the reaction of one measure to shocks affecting the other. Using data for the European Treasury bond market, we find evidence that funding illiquidity shocks affect bond market illiquidity and of a weaker simultaneous feedback reverse. We also investigate the determinants of the magnitude of these effects in the cross-section of bonds and find that the responses of individual bonds' market illiquidity to funding illiquidity shocks increase with bond duration, with the credit risk of the issuer, and with haircuts

Funding Constraints and Market Illiquidity in the European Treasury Bond Market

Theoretical studies show that shocks to funding constraints should affect and be affected by market illiquidity. However, little is known about the empirical magnitude of such responses because of the intrinsic endogeneity of illiquidity shocks. This paper adopts an identification technique based on the heteroskedasticity of illiquidity proxies to infer the reaction of one measure to shocks affecting the other. Using data for the European Treasury bond market, we find evidence that funding illiquidity shocks affect bond market illiquidity and of a weaker simultaneous feedback reverse. We also investigate the determinants of the magnitude of these effects in the cross-section of bonds and find that the responses of individual bonds' market illiquidity to funding illiquidity shocks increase with bond duration, with the credit risk of the issuer, and with haircuts

Option prices and costly short-selling

Much empirical evidence shows that stock short-selling costs and bans have significant effects on option prices. We reconcile these findings by providing a dynamic analysis of option prices with costly short-selling and option marketmakers. We obtain simple, closed-form, unique option bid and ask prices that represent option marketmakers’ expected hedging costs, and are weighted-averages of well-known benchmark prices (Black-Scholes, Heston). Our analysis delivers rich implications that support the empirical evidence on the effects of short-selling costs and bans on option prices, as well as uncovering several novel predictions. We also apply our methodology to corporate bonds, which have option-like payoffs

New market reforms and stock exchange liquidity: the case of Kuwait

In developing markets, new regulations are imposed to protect investors, to assure fairness and to enhance trust through controlling all types of market abuse. In addition, these regulations are imposed to enhance the overall market performance and efficiency. Market liquidity is one of the main pillars used to measure market overall performance. In this paper, the authors attempt to analyze market liquidity before and after the passage of the Capital Market Authority Law of 2010 (CMA), aimed at enhancing investors’ confidence and reinforcing better disclosure quality and accountability for Kuwait public companies. By introducing six liquidity measures that captures market depth, turnover, and volatility, the authors documented highly significant deterioration in all the measures following the CMA Law with more profound effect on smaller firms. The researchers concluded that overstated regulations in developing markets, in spite of its goal of improving market overall performance, structure, enhancing investors’ protection, and market integrity, can have an adverse effect on market efficiency

Essays on Misallocation and Firm Regulations

This dissertation is a collection of three essays on misallocation and firm regulations. The first chapter investigates how size-dependent firm regulation policies can mitigate misallocation. The second chapter uses the same framework as the first to explore the intuition of a theoretically more subtle concept of misallocation. The third chapter analyzes a more specific firm regulation that targets at financial dealers. In chapter 1, I study the welfare implications of size-dependent firm regulation policies (SDPs) in the presence of entrepreneurial risks. Although SDP has been considered a source of misallocation, I show that, once entrepreneurial risks are taken into account, SDP might improve efficiency. Quantitatively, I show that, based on French data, removing the SDP leads to output and welfare loss by 1.5% and 1.3%, respectively, in opposition to the output gain reported by the previous literature that abstracts from risks. Qualitatively, I solve an optimal non-linear SDP problem and show that the observed SDP shares certain features with the optimal SDP. The analysis uncovers a novel trade-off between the inefficiencies of the intensive and extensive margins. In extension, it is shown that (1) whether SDPs improve efficiency depends on the level of financial development and (2) capital accumulation and consumption-smoothing motive further justify SDPs. In chapter 2, which is a joint work with Misaki Matsumura, we use the same competitive entrepreneurship model to investigate the economic intuition of constrained inefficiency caused by uninsurable risks. Although the constrained efficiency of various models has been studied in the literature, the economic intuition of why the constrained planner's intervention yields an improvement is usually not available. The competitive entrepreneurship model is particularly suitable for seeing the logic of constrained inefficiency since the structure of the market equilibrium is characterized by the indifference condition instead of the marginal condition. To illustrate this point, we contrast the competitive entrepreneurship model with simple versions of the Aiyagari model and the Krebs model. In chapter 3, which is also a joint work with Misaki Matsumura, we build a general equilibrium model to analyze the impact of the Volcker rule, a dealer regulation imposed after the financial crisis, on price quality (informativeness and volatility) and its implications on the welfare of market participants. We argue that although price informativeness, volatility and the dealer's profitability all deteriorate, against conventional wisdom, other market participants are better off due to the dealer's risk-shifting motive. A static model is used to clarify the main intuition, and the robustness of the welfare results as well as the fragility of the conventional wisdom about price quality are discussed by incorporating dynamics and endogenizing information acquisition

On the relation between liquidity and the futures-cash basis: evidence from a natural experiment

As a response to the 2015 Chinese stock market crash, regulators prohibited arbitrage activities in the index futures and cash markets. We use this natural experiment to test the hypothesis that liquidity and pricing efficiency causally affect each other. We find that resulting shift in the arbitrage boundary led to the breakdown of the two-way causality relation between liquidity and the absolute futures-cash basis. We thus confirm that the relation between liquidity and the absolute futures-cash basis is not driven by the omitted variable bias, but is indeed due to arbitrage