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The aim of this paper is to examine what has been the role of information provision to the market throughout the crisis. We consider two main sources of information to the market, financial statements and information provided by credit rating agencies. We examine how these sources of information work and the effectiveness of their disclosure process during the crisis. Contrary to the commonly held view, fair value accounting did not have a major impact on the crisis development and severity. However, the structure and lack of accountability of credit rating agencies had a profound impact on their incentives, which may have jeopardized the accuracy of the whole rating process. We claim that the crisis experience has changed the way we think about information as well as market discipline and discuss policy implications and proposals for regulation. JEL Classification: G01, G24, G28, M41, M48
Prepared by Christian Laux, Vienna University of Economics and Business & Center for Financial Studies (CFS) for the “Workshop on Liquidity Premium in Solvency II: Conceptual and Measurement Issues,” DNB Amsterdam, March 18, 2011. The insurance industry and the Committee of European Insurance and Occupational Pension Supervisors (CEIOPS) propose to add a liquidity premium to the risk-free rate when discounting liabilities in times of financial turmoil. The objective is to counterbalance adverse effects on regulatory capital due to a decrease in asset values caused by illiquidity in a crisis. As I argue in this note, although the motive might be sensible, the proposal to add a liquidity premium when discounting liabilities is not the right approach to tackle the problem.
In this paper we challenge the view that corporate bonds are always arm’s length debt. We analyze the effect of bond ratings on the stock price return to acquirers in M&A transactions, which tend to have significant effects on creditor wealth. We find acquirers abnormal returns to be higher if they are unrated, controlling for a wide variety of other effects identified in the literature. Tracing the difference in returns to distinct managerial decisions, we find that, everything else constant, rated firms increase their leverage in takeover transactions by less than their unrated counterparts. Consistent with a significant role for rating agencies, we find monitoring effects to be strongest when acquirer bonds are rated at the borderline between investment grade and junk. Finally, we are able to empirically exclude a large number of alternative explanations for the empirical regularities that we uncover. JEL Classification: G21, G24, G32, G34 Keywords: Acquisitions, Credit Ratings, Mergers and Acquisitions, Arm’s Length Debt, Abnormal Returns
This paper outlines a new method for using qualitative information to analyze the monetary policy strategy of central banks. Quantitative assessment indicators that are extracted from a central bank's public statements via the balance statistic approach are employed to estimate a Taylor-type rule. This procedure allows to directly capture a policymaker's assessments of macroeconomic variables that are relevant for its decision making process. As an application of the proposed method the monetary policy of the Bundesbank is re-investigated with a new dataset. One distinctive feature of the Bundesbank's strategy consisted of targeting growth in monetary aggregates. The analysis using the proposed method provides evidence that the Bundesbank indeed took into consideration monetary aggregates but also real economic activity and inflation developments in its monetary policy strategy since 1975. JEL Classification: E52, E58, N14 Keywords: Monetary Policy Rule, Statement Indicators, Bundesbank, Monetary Targeting
There is ample empirical evidence documenting widespread financial illiteracy and limited pension knowledge. At the same time, the distribution of wealth is widely dispersed and many workers arrive on the verge of retirement with few or no personal assets. In this paper, we investigate the relationship between financial literacy and household net worth, relying on comprehensive measures of financial knowledge designed for a special module of the DNB (De Nederlandsche Bank) Household Survey. Our findings provide evidence of a strong positive association between financial literacy and net worth, even after controlling for many determinants of wealth. Moreover, we discuss two channels through which financial literacy might facilitate wealth accumulation. First, financial knowledge increases the likelihood of investing in the stock market, allowing individuals to benefit from the equity premium. Second, financial literacy is positively related to retirement planning, and the development of a savings plan has been shown to boost wealth. Overall, financial literacy, both directly and indirectly, is found to have a strong link to household wealth. JEL Classification: D91, D12, J26 Keywords: Financial Education, Savings and Wealth Accumulation, Retirement Preparation, Knowledge of Finance and Economics, Overconfidence, Stock Market Participation
This paper studies the impact of the concentration of control, the type of controlling shareholder and the dividend tax preference of the controlling shareholder on dividend policy for a panel of 220 German firms over 1984-2005. While the concentration of control does not have an effect on the dividend payout, there is strong evidence that the type of controlling shareholder matters as family controlled firms have high dividend payouts whereas bank controlled firms have low dividend payouts. However, there is no evidence that the dividend preference of the large shareholder has an impact on the dividend decision. JEL Classification: G32, G35 Keywords: Dividend Policy, Payout Policy, Lintner Dividend Model, Tax Clientele Effects, Corporate Governance
We revisit the role of time in measuring the price impact of trades using a new empirical method that combines spread decomposition and dynamic duration modeling. Previous studies which have addressed the issue in a vector-autoregressive framework conclude that times when markets are most active are times when there is an increased presence of informed trading. Our empirical analysis based on recent European and U.S. data offers challenging new evidence. We find that as trade intensity increases, the informativeness of trades tends to decrease. This result is consistent with the predictions of Admati and Pfleiderer’s (1988) rational expectations model, and also with models of dynamic trading like those proposed by Parlour (1998) and Foucault (1999). Our results cast doubt on the common wisdom that fast markets bear particularly high adverse selection risks for uninformed market participants. JEL Classification: G10, C32 Keywords: Price Impact of Trades, Trading Intensity, Dynamic Duration Models, Spread Decomposition Models, Adverse Selection Risk
We present an intertemporal consumption model of consumer investment in financial literacy. Consumers benefit from such investment because their stock of financial literacy allows them to increase the returns on their wealth. Since literacy depreciates over time and has a cost in terms of current consumption, the model determines an optimal investment in literacy. The model shows that financial literacy and wealth are determined jointly, and are positively correlated over the life cycle. Empirically, the model leads to an instrumental variables approach, in which the initial stock of financial literacy (as measured by math performance in school) is used as an instrument for the current stock of literacy. Using microeconomic and aggregate data, we find a strong effect of financial literacy on wealth accumulation and national saving, and also show that ordinary least squares estimates underestate the impact of financial literacy on saving. JEL Classification: E2, D8, G1, J24 Keywords: Financial Literacy, Cognitive Abilities, Human Capital, Saving
This paper studies the market quality of an internalization system which is designed as part of an open limit order book (the Xetra system operated by Deutsche Börse AG). The internalization sys-tem (Xetra BEST) guarantees a price improvement over the inside spread in the Xetra order book. We develop a structural model of this unique dual market environment and show that, while adverse selection costs of internalized trades are significantly lower than those of regular order book trades, the realized spreads (the revenue earned by the suppliers of liquidity) is significantly larger. The cost savings of the internalizer are larger than the mandatory price improvement. This suggests that internalization can be profitable both for the customer and the internalizer. JEL Classification: G10