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Institute
We analyze global data about electricity generation and document that the risk exposure of a firm’s owners and its workers depends on competitors’ ability or willingness to change their output in response to productivity shocks. Competitor inflexibility appears to be a risk factor: the sales of firms with more inflexible competitors respond more strongly to aggregate sales shocks. As a consequence, competitor inflexibility also affects the stability of firms’ total wage- and dividend-payments. Firms with relatively flexible competitors appear to smoothen both wages and dividends, but an increase in competitor inflexibility is associated with less dividend-smoothing and more wage-smoothing. Our evidence supports the idea that labor productivity risk associated with competitor inflexibility should be borne by firms’ shareholders, rather than by their workers.
Low risk anomalies?
(2016)
This paper shows theoretically and empirically that beta- and volatility-based low risk anomalies are driven by return skewness. The empirical patterns concisely match the predictions of our model which generates skewness of stock returns via default risk. With increasing downside risk, the standard capital asset pricing model increasingly overestimates required equity returns relative to firms' true (skew-adjusted) market risk. Empirically, the profitability of betting against beta/volatility increases with firms' downside risk. Our results suggest that the returns to betting against beta/volatility do not necessarily pose asset pricing puzzles but rather that such strategies collect premia that compensate for skew risk.
Using merger announcements and applying methods from computational linguistics we find strong evidence that stock prices under-react to information in financial media. A one standard deviation increase in the media-implied probability of merger completion increases the subsequent 12-day return of a long-short merger strategy by 1.2 percentage points. Filtering out the 28% of announced deals with the lowest media-implied completion probability increases the annualized alpha from merger arbitrage by 9.3 percentage points. Our results are particularly pronounced when high-yield spreads are large and on days when only few merger deals are announced. We also document that financial media information is orthogonal to announcement day returns.
n traditional portfolio theory, risk management is limited to the choice of the relative weights of the riskless asset and a diversified basket of risky securities, respectively. Yet in industry, risk management represents a central aspect of asset management, with distinct responsibilities and organizational structures. We identify frictions that lead to increased importance of risk management and describe three major challenges to be met by the risk manager. First, we derive a framework to determine a portfolio position's marginal risk contribution and to decide on optimal portfolio weights of active managers. Second, we survey methods to control downside risk and unwanted risks since investors frequently have non-standard preferences which make them seek protection against excessive losses. Third, we point out that quantitative portfolio management usually requires the selection and parametrization of stylized models of financial markets. We therefore discuss risk management approaches to deal with parameter uncertainty, such as shrinkage procedures or re- sampling procedures, and techniques of dealing with model uncertainty via methods of Bayesian model averaging.
We examine the dynamics of assets under management (AUM) and management fees at the portfolio manager level in the closed-end fund industry. We find that managers capitalize on good past performance and favorable investor perception about future performance, as reflected in fund premiums, through AUM expansions and fee increases. However, the penalties for poor performance or unfavorable investor perception are either insignificant, or substantially mitigated by manager tenure. Long tenure is generally associated with poor performance and high discounts. Our findings suggest substantial managerial power in capturing CEF rents. We also document significant diseconomies of scale at the manager level.
This paper uses recent legislation in Austria to establish a link between sovereign reputation and yield spreads. In 2009, Hypo Alpe Adria International, a bank previously co-owned by the regional government of Carinthia, had been nationalized by Austria’s central government in order to avoid a default triggering multi-billion Euro local government guarantees. In 2015, special legislation retroactively introduced collective action clauses allowing a haircut on both the bonds and the guarantees while avoiding formal default. We document that legislative and administrative action designed to partly abrogate the guarantees resulted in a loss of reputation, leading to higher yield spreads for sovereign debt. Our analysis of covered bonds uncovers an increase in yield spreads on the secondary market and a deterioration of primary market conditions.
Sovereign bond risk premiums
(2013)
Credit risk has become an important factor driving government bond returns. We therefore introduce an asset pricing model which exploits information contained in both forward interest rates and forward CDS spreads. Our empirical analysis covers euro-zone countries with German government bonds as credit risk-free assets. We construct a market factor from the first three principal components of the German forward curve as well as a common and a country-specific credit factor from the principal components of the forward CDS curves. We find that predictability of risk premiums of sovereign euro-zone bonds improves substantially if the market factor is augmented by a common and an orthogonal country-specific credit factor. While the common credit factor is significant for most countries in the sample, the country-specific factor is significant mainly for peripheral euro-zone countries. Finally, we find that during the current crisis period, market and credit risk premiums of government bonds are negative over long subintervals, a finding that we attribute to the presence of financial repression in euro-zone countries.
Using the pandemic as a laboratory, we show that asset markets assign a time- varying price to firms' disaster risk exposure. In 2020 the cross-section of realized and expected stock returns reflected firms' different exposure to the pandemic, as measured by their vulnerability to social distancing. Realized and expected return differentials initially widened and then narrowed, but disaster exposure still commanded a risk premium in December 2020. When inferred from market outcomes, resilience correlates not only with social distancing, but also with cash and environmental ratings. However, vulnerability to social distancing is the only characteristic that identifies persistently scarred firms.
This paper shows that long debt maturities eliminate equity holders’ incentives to reduce leverage when the firm performs poorly. By contrast, short debt maturities commit equity holders to such leverage reductions. However, shorter debt maturities also lead to higher transactions costs when maturing bonds must be refinanced. We show that this tradeoff between higher expected transactions costs against the commitment to reduce leverage when the firm is doing poorly motivates an optimal maturity structure of corporate debt. Since firms with high costs of financial distress benefit most from committing to leverage reductions, they have a stronger motive to issue short-term debt.
This paper takes a novel approach to estimating bankruptcy costs by inference from market prices of equity and put options using a dynamic structural model of capital structure. This approach avoids the selection bias of looking at firms in or near default and therefore permits theories of ex ante capital structure determination to be tested. We identify significant cross sectional variation in bankruptcy costs across industries and relate these to specific firm characteristics. We find that asset volatility and growth options have significant positive impacts, while tangibility and size have negative impacts. Our bankruptcy cost variable estimate significantly negatively impacts leverage ratios. This negative impact is in addition to that of other firm characteristics such as asset intangibility and asset volatility. The results provide strong support for the tradeoff theory of capital structure.
