Liquidity clienteles : transaction costs and investment decisions of individual investors

Theoretical papers link the liquidity premium to the optimal trading decisions of investors facing transaction costs. In particular, investors'holding periods determine how transaction costs are amortized and priced in asset returns. Using a unique data set containing two million trades, this paper investigates the relationship between holding periods and transaction costs for 66,000 households from a large discount brokerage. The author finds that transaction costs are an important determinant of investors'holding periods, after controlling for household and stock characteristics. The relationship between holding periods and transaction costs is stronger among more sophisticated investors. Households with longer holding periods earn significantly higher returns after amortized transaction costs, and households that have holding periods that are positively related to transaction costs earn both higher gross and net returns. The author shows that there is correlation in the demand for liquid assets across households and, consistent with the notion of flight to liquidity, this demand increases during times of low market liquidity. Households with higher incomes and with higher wealth investedin the stock market supply liquidity when market liquidity is low.Debt Markets,Mutual Funds,Emerging Markets,Economic Theory&Research,Markets and Market Access

Has the global banking system become more fragile over time ?

This paper examines time-series and cross-country variations in default risk co-dependence in the global banking system. The authors construct a default risk measure for all publicly traded banks using the Merton contingent claim model, and examine the evolution of the correlation structure of default risk for more than 1,800 banks in more than 60 countries. They find that there has been a significant increase in default risk co-dependence over the three-year period leading to the financial crisis. They also find that countries that are more integrated, and that have liberalized financial systems and weak banking supervision, have higher co-dependence in their banking sector. The results support an increase in scope for international supervisory co-operation, as well as capital charges for"too-connected-to-fail"institutions that can impose significant externalities.Banks&Banking Reform,Debt Markets,Financial Intermediation,Emerging Markets,Access to Finance

The Chrysler effect : the impact of the Chrysler bailout on borrowing costs

Did the U.S. government's intervention in the Chrysler reorganization overturn bankruptcy law? Critics argue that the government-sponsored reorganization impermissibly elevated claims of the auto union over those of Chrysler's other creditors. If the critics are correct, businesses might suffer an increase in their cost of debt because creditors will perceive a new risk, that organized labor might leap-frog them in bankruptcy. This paper examines the financial market wherethis effect would be most detectible, the market for bonds of highly unionized companies. The authors find no evidence of a negative reaction to the Chrysler bailout by bondholders of unionized firms. They thus reject the notion that investors perceived a distortion of bankruptcy priorities. To the contrary, bondholders of unionized firms reacted positively to the Chrysler bailout. This evidence suggests that bondholders interpreted the Chrysler bailout as a signal that the government will stand behind unionized firms. The results are consistent with the notion that too-big-to-fail government policies generate moral hazard in the credit markets.Debt Markets,Bankruptcy and Resolution of Financial Distress,Emerging Markets,Deposit Insurance,Access to Finance

Essays in Asset Pricing.

This work consists of three essays that investigate the effect of investor behavior on asset prices. In the first essay, titled “Transaction Costs and Investment Decisions of Individual Investors,” I study the liquidity decisions of 66,000 households from a large discount brokerage. My paper provides an empirical link between investors’ optimal trading decisions and the liquidity premium observed in the market. In particular, I show that transaction costs are an important determinant of investors’ holding periods which determine how transaction costs are amortized and priced in asset returns. I also show that there is correlation in the demand for liquid assets across households, and consistent with the notion of flight to liquidity, this demand increases during times of low market liquidity. The second essay, “Is there a Distress Risk Anomaly? Bond Spreads as a Proxy for Default Risk,” investigates the pricing of default risk in stock returns. The results show that credit spreads predict corporate defaults better than previously used measures, such as, bond ratings, accounting variables and structural model parameters. Contrary to previous findings, using corporate credit spreads to proxy for default risk, this study finds no significant pricing of default risk in the cross-section of equity returns. The final essay, “Affect in a Behavioral Asset Pricing Model”, investigates the role of psychological heuristic Affect in asset pricing. The paper outlines a behavioral asset pricing model where expected returns are high when objective risk is high and also when subjective risk is high. High subjective risk comes with negative affect. Investors prefer stocks with positive affect and their preference boosts the prices of such stocks and depresses their returns. Empirical support for the model is provided by studying the preferences of investors as reflected in surveys conducted by Fortune magazine during 1983- 2006. The returns of admired stocks, those highly rated by the Fortune respondents, were lower than the returns of despised stocks, those rated low. This is consistent with the hypothesis that stocks with negative affect have high subjective risk and their extra returns compensate for that risk.Ph.D.Business AdministrationUniversity of Michigan, Horace H. Rackham School of Graduate Studieshttp://deepblue.lib.umich.edu/bitstream/2027.42/75892/1/danginer_1.pd

Risk absorption by the state: when is it good public policy ?

The global financial crisis brought public guarantees to the forefront of the policy debate. Based on a review of the theoretical foundations of public guarantees, this paper concludes that the commonly used justifications for public guarantees based solely on agency frictions (such as adverse selection or lack of collateral) and/or un-internalized externalities are flawed. When risk is idiosyncratic, it is highly unlikely that a case for guarantees can be made without risk aversion. When risk aversion is explicitly added to the picture, public guarantees may be justified by the state's natural advantage in dealing with collective action failures (providing public goods). The state can spread risk more finely across space and time because it can coordinate and pool atomistic agents that would otherwise not organize themselves to solve monitoring or commitment problems. Public guarantees may be transitory, until financial systems mature, or permanent, when risk is fat-tailed. In the case of aggregate (non-diversifiable) risk, permanent public guarantees may also be justified, but in this case the state adds value not by spreading risk but by coordinating agents. In addition to greater transparency in justifying public guarantees, the analysis calls for exploiting the natural complementarities between the state and the markets in bearing risk.Debt Markets,Banks&Banking Reform,Access to Finance,Insurance&Risk Mitigation,Labor Policies

Is there a Distress Risk Anomaly? Pricing of Systematic Default Risk in the Cross Section of Equity Returns

The standard measures of distress risk ignore the fact that firm defaults are correlated and that some defaults are more likely to occur in bad times. We use risk premium computed from corporate credit spreads to measure a firm’s exposure to systematic variation in default risk. Unlike previously used measures that proxy for a firm’s physical probability of default, credit spreads proxy for a risk-adjusted default probability and thereby explicitly account for the non-diversifiable component of distress risk. In contrast to prior findings in the literature, we find that stocks that have higher credit risk premia, that is stocks with higher systematic default risk exposures, have higher expected equity returns which are largely explained by the market factor. We confirm the robustness of these results by using an alternative systematic default risk factor for firms that do not have bonds outstanding. Consistent with the theoretical result in George and Hwang (2010), we also show that firms react to increases in their systematic default risk exposures by reducing their leverage, leading to lower physical probabilities of distress. Our results show no evidence of firms with high systematic default risk exposure delivering anomalously low returns

Is there a Distress Risk Anomaly? Pricing of Systematic Default Risk in the Cross Section of Equity Returns

The standard measures of distress risk ignore the fact that firm defaults are correlated and that some defaults are more likely to occur in bad times. We use risk premium computed from corporate credit spreads to measure a firm’s exposure to systematic variation in default risk. Unlike previously used measures that proxy for a firm’s physical probability of default, credit spreads proxy for a risk-adjusted default probability and thereby explicitly account for the non-diversifiable component of distress risk. In contrast to prior findings in the literature, we find that stocks that have higher credit risk premia, that is stocks with higher systematic default risk exposures, have higher expected equity returns which are largely explained by the market factor. We confirm the robustness of these results by using an alternative systematic default risk factor for firms that do not have bonds outstanding. Consistent with the theoretical result in George and Hwang (2010), we also show that firms react to increases in their systematic default risk exposures by reducing their leverage, leading to lower physical probabilities of distress. Our results show no evidence of firms with high systematic default risk exposure delivering anomalously low returns

Is there a Distress Risk Anomaly? Pricing of Systematic Default Risk in the Cross Section of Equity Returns

The standard measures of distress risk ignore the fact that firm defaults are correlated and that some defaults are more likely to occur in bad times. We use risk premium computed from corporate credit spreads to measure a firm’s exposure to systematic variation in default risk. Unlike previously used measures that proxy for a firm’s physical probability of default, credit spreads proxy for a risk-adjusted default probability and thereby explicitly account for the non-diversifiable component of distress risk. In contrast to prior findings in the literature, we find that stocks that have higher credit risk premia, that is stocks with higher systematic default risk exposures, have higher expected equity returns which are largely explained by the market factor. We confirm the robustness of these results by using an alternative systematic default risk factor for firms that do not have bonds outstanding. Consistent with the theoretical result in George and Hwang (2010), we also show that firms react to increases in their systematic default risk exposures by reducing their leverage, leading to lower physical probabilities of distress. Our results show no evidence of firms with high systematic default risk exposure delivering anomalously low returns

Corporate governance and bank capitalization strategies

This paper examines the relationship between banks’ capitalization strategies and their corporate governance and executive compensation schemes for an international sample of banks over the 2003–2011 period. Shareholder-friendly corporate governance, in the form of a separation of the CEO and chairman of the board roles, intermediate board size, and an absence of anti-takeover provisions, is associated with lower bank capitalization, consistent with shareholder incentives to shift risk towards the financial safety net. Higher values of executive option and stock wealth invested in the bank are associated with higher capitalization as a potential reflection of executive risk aversion, but the risk-taking incentives embedded in executive compensation packages are associated with lower capitalization