The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy

We evaluate the effect of the Federal Reserve’s purchase of long-term Treasuries and other long-term bonds ("QE1" in 2008-2009 and "QE2" in 2010-2011) on interest rates. Using an event-study methodology we reach two main conclusions. First, it is inappropriate to focus only on Treasury rates as a policy target because QE works through several channels that affect particular assets differently. We find evidence for a signaling channel, a unique demand for long-term safe assets, and an inflation channel for both QE1 and QE2, and an MBS pre-payment channel and a corporate bond default risk channel for QE1. Second, effects on particular assets depend critically on which assets are purchased. The event-study suggests that (a) mortgage-backed securities purchases in QE1 were crucial for lowering mortgage-backed security yields as well as corporate credit risk and thus corporate yields for QE1, and (b) Treasuries-only purchases in QE2 had a disproportionate effect on Treasuries and Agencies relative to mortgage-backed securities and corporates, with yields on the latter falling primarily through the market’s anticipation of lower future federal funds rates.

The Demand for Treasury Debt

We show that the US Debt/GDP ratio is negatively correlated with the spread between corporate bond yields and Treasury bond yields. The result holds even when controlling for the default risk on corporate bonds. We argue that the corporate bond spread reflects a convenience yield that investors attribute to Treasury debt. Changes in the supply of Treasury debt trace out the demand for convenience by investors. We show that the aggregate demand curve for the convenience provided by Treasury debt is downward sloping and provide estimates of the elasticity of demand. We analyze disaggregated data from the Flow of Funds Accounts of the Federal Reserve and show that individual groups of Treasury holders also have downward sloping demand curves. Even groups with the most elastic demand curves have demand curves that are far from flat. The results have bearing for important questions in finance and macroeconomics. We discuss implications for the behavior of corporate bond spreads, interest rate swap spreads, the riskless interest rate, and the value of aggregate liquidity. We also discuss the implications of our results for the financing of the US deficit, Ricardian equivalence, and the effects of foreign central bank demand on Treasury yields.

Limited Asset Market Participation and the Elasticity of Intertemporal Substitution

The paper presents empirical evidence based on the US Consumer Expenditure Survey that accounting for limited asset market participation is important for estimating the elasticity of intertemporal substitution (EIS). Differences in estimates of the EIS between assetholders and non-assetholders are large and statistically significant. This is the case whether estimating the EIS based on the Euler equation for stock index returns or the Euler equation for T-bills, in each case distinguishing between assetholders and non-assetholders as best possible. Estimates of the EIS are around 0.3-0.4 for stockholders and around 0.8-1 for bondholders, and are larger for households with larger asset holdings within these two groups.

The Increase in Income Cyclicality of High-Income Households and Its Relation to the Rise in Top Income Shares

income, cyclicality, households

Mandated Disclosure, Stock Returns, and the 1964 Securities Acts Amendments

The 1964 Securities Acts Amendments extended the mandatory disclosure requirements that had applied to listed firms since 1934 to large firms traded Over-the-Counter (OTC). We find several pieces of evidence indicating that investors valued these disclosure requirements, two of which are particularly striking. First, a firm-level event study reveals that OTC firms most impacted by the 1964 Amendments had abnormal excess returns of about 3.5 percent in the weeks immediately surrounding the announcement that they had begun to comply with the new requirements. Second, we estimate that the most affected OTC firms had abnormal excess returns ranging between 11.5 and 22.1 percent in the period between when the legislation was initially proposed and when it went it went into force, relative to unaffected listed firms and after adjustment for the standard four-factor model. While we cannot determine how much of shareholders' gains were a transfer from insiders of these same companies, our results suggest that mandatory disclosure causes managers to more narrowly focus on the maximization of shareholder value.

A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002

We evaluate the net benefits of the Sarbanes-Oxley Act (SOX) for shareholders by studying the lobbying behavior of investors and corporate insiders to affect the final implemented rules under the Act. Investors lobbied overwhelmingly in favor of strict implementation of SOX, while corporate insiders and business groups lobbied against strict implementation. We identify the firms most affected by the law as those whose insiders lobbied against strict implementation, and compare their returns to the returns of less affected firms. Cumulative returns during the four and a half months leading up to passage of SOX were approximately 10 percent higher for corporations whose insiders lobbied against one or more of the SOX disclosure-related provisions than for similar non-lobbying firms. Analysis of returns in the post-passage implementation period indicates that investors' positive expectations with regards to the effects of the law were warranted for the enhanced disclosure provisions of SOX.

Informational Hold-up and Performance Persistence in Venture Capital

We propose and test a theory of learning and informational hold-up in the venture capital market. The model predicts that higher returns on the current fund increase the probability that a VC will raise a follow-on fund, the size of the follow-on fund, and the performance fee investors are charged in the follow-on fund. If learning is asymmetric, such that incumbent investors learn more about fund manager skill than potential new investors, the model also predicts persistence in returns, poor performance among first-time funds, persistence in investors from fund to fund, and over-subscription in follow-on funds raised by successful fund managers. Our empirical evidence is consistent with these predictions. The model provides a unified framework for understanding a series of empirical facts about the venture capital industry

Informational Hold-up and Performance Persistence in Venture Capital

Why don't successful venture capitalists eliminate excess demand for their follow-on funds by aggressively raising their performance fees? We propose a theory of learning that leads to informational hold-up in the VC market. Investors in a fund learn whether the VC has skill or was lucky, whereas potential outside investors only observe returns. This gives the VC's current investors hold-up power when the VC raises his next fund: Without their backing, he cannot persuade anyone else to fund him, since outside investors would interpret the lack of backing as a sign that his skill is low. This hold-up power diminishes the VC's ability to increase fees in line with performance. The model provides a rationale for the persistence in after-fee returns documented by Kaplan and Schoar (2005) and predicts low expected returns among first-time funds, persistence in investors from fund to fund, and over-subscription in follow-on funds raised by successful VCs. Empirical evidence from a large sample of U.S. VC funds raised between 1980 and 2006 is consistent with these predictions