Research projects 2013

Finance, banking, and the macroeconomy 

Efficiency of financial markets 

Corporate governance

Finance, banking, and the macroeconomy

Deposit insurance on the Russian banking market (Vladimir Sokolov (with Lucy Chernykh)

We examine the design of insured and uninsured deposit contract in an emerging market with severe competition for limited retail deposit funds. Using detailed data from almost 80,000 deposit contract observations in a large sample of Russian banks, we find that banks use a broad variety of implicitly and explicitly priced contract terms to aggressively compete for limited household funds in the fast-growing emerging banking market. Consistent with the market discipline hypothesis, we also find that uninsured deposit contracts are highly sensitive to the bank risk profiles.  From a regulatory perspective, our findings suggest that the policy measures of deposit rates monitoring or imposing deposit rate ceilings for preventing deposit accumulation by risky bank could be ineffective. Our results show that banks can complement deposit contracts with embedded options attractive for depositors thus enabling banks to compete for insured deposits even in the presence of deposit rate monitoring.

On the Efficiency of Nominal GDP Targeting in a Large Open Economy (Udara Peiris (with Matthew Hoelle, Department of Economics, Purdue University)

Since 2007, there have been increasing calls to abandon a regime of Stabilizing Inflation (SI) in favor of Nominal GDP (NGDP) targeting. One argument in favor of NGDP targeting is that it allows inflation to redistribute resources among bond holders efficiently. Here we examine this claim in a large open monetary economy and show that, in contrast to SI, NGDP targeting is in fact (Pareto) efficient in a world with stochastic real uncertainty, and in the absence of complete insurance markets (only nominally risk free bonds are available). However this result is ultimately fragile and breaks down once we attempt to deviate from the simplistic setting necessary for the result to hold.

Efficiency of financial markets

Hidden and Displayed Liquidity in Securities Markets with Informed Liquidity Providers (Alex Boulatov (with Thomas George)

We examine the impact of hiding versus displaying liquidity on the quality of a securities market. Displaying liquidity expropriates informational rents from informed agents who trade as liquidity providers. This causes the informed to exit liquidity provision in favor of demanding liquidity where they trade less aggressively on their information. Display also enables those who remain as liquidity providers to better predict order flow and to price discriminate more effectively against liquidity demanders. Competition among liquidity providers, and competition overall, is less intense when liquidity is displayed than when it is hidden. This results in higher trading costs to uninformed liquidity demanders, wider bid-ask spreads and less informationally efficient midquotes. Our analysis suggests that a market innovation such as allowing liquidity to be hidden, which may seem to favor the informed over the uninformed, can enhance market quality by intensifying competition among the informed. 

Idiosyncratic risk and indirect transaction costs (Sergey Gelman (with Dmitry Borisenko)

A popular measure of liquidity – the indirect measure of full transaction costs introduced in Lesmond et al. (1999) – is known to be significantly upward biased. We show that the bias stems from the mistreatment of large countercyclical idiosyncratic shocks in individual stock returns. We suggest a modification, which applies a Generalized Extreme Value distribution to capture such shocks, and, with help of Monte-Carlo simulations, find that our approach fully eliminates bias under a normal distribution assumption and significantly diminishes bias under fatter tails. Using a sample of S&P 500 constituent stocks we show that our modified estimate is much more precise than the Lesmond et al. measure (1999). 

Changing the Conversation: Coercion of the Financial Press in Developing Markets (Patrick Kelly)

In this paper we will examine whether media coverage of politically connected firms is biased and whether financial markets are influenced by this biased coverage, or whether the bias has no effect on prices in financial markets. Our hypotheses are that press coverage is positively biased when firms have members of the board of directors, or large owners (greater than 5% stake) which are affiliated with the government. We also expect to find differences based on differences in the level of corruption and level of  protection of minority shareholder interests and perhaps measures of the relative freedom of the press. Analyses will be conducted both across markets and within markets.

Data collection has been in process for the last 9 months, but more is needed to successfully complete this study. Research assistance is needed to help with the hand matching of politicians to owners of firms and their boards of directors as well as verifying the accuracy of these links.

This research is co-author with John Griffin of the University of Texas at Austin and Nicholas Hirschey of the London Business School.

Hedge Fund Risk Premia: Transparency, Liquidity, Complexity, and Concentration (Olga Kuzmina (with Sergiy Gorovyy)

We use a proprietary dataset obtained from a fund of funds to study the risk premia associated with hedge fund transparency, liquidity, complexity, and concentration over the period from April 2006 to March 2009. We are able to directly measure these qualitative characteristics by using the internal grades that the fund of funds attached to all the funds it invested in, and that represent the unique information that cannot be obtained from quantitative data alone. Consistent with factor models of risk premium, we find that during the normal times low-transparency, low-liquidity, low-complexity, and high-concentration funds delivered a return premium, with economic magnitudes of 5% to 10% per year, while during bad states of the economy, these funds experienced significantly lower returns. We also offer a novel explanation for why highly concentrated funds command a risk premium by revealing that it is mostly prevalent among the non-transparent funds where investors are unaware about the exact risks they are facing and hence cannot diversify them away.

Corporate governance

Pros and Cons of Long-Term Incentives (Stanimir Morfov)

This paper formally analyzes the provision of long-term versus short-term incentives in a principal-agent model with effort persistence and contract terminations. We consider both short-term and long-term contracts where the principal can or cannot commit to keeping the agent in the long run. We analyze how persistence in firm's technology and agent's outside options affects the length of the contract and its incentive structure. Our analysis suggests that in the presence of frictions, long-term incentives may be suboptimal to short-term incentives. Therefore, advocating compensation packages oriented towards long-term performance should be taken with caution. 

Corporate Governance and Performance in Normal and Crisis Times: Evidence from Russian Non-Listed Firms (Carsten Sprenger (with Olga Lazareva and Sergey Stepanov)

In this project we investigate the effect of corporate governance on performance and survival of non-listed Russian firms for the period 2006-2011. In emerging market economies with less developed financial markets non-listed firms typically represent a large part of the economy. As there are no readily available corporate governance indicators for such firms, we develop an original corporate governance index based on survey questions on shareholder rights, work and composition of the board of directors, and corporate disclosure. Preliminary results show that good corporate governance and high ownership concentration decrease the likelihood of a firm to go bankrupt for the time period of up to six years after the survey. The estimates show that both mechanisms are substitutes (the interaction term has a positive effect on the likelihood of bankruptcy). Also, good corporate governance tends to improve operating performance for firms with high ownership concentration. We will study particular mechanisms through which corporate governance affects performance, such as corporate investment and cash holdings. 

Mergers & Acquisitions and Firm Risk (Marie-Ann Betschinger, Alex Settles (with Olivier Bertrand)

An abundant academic literature has examined the impact of M&A deals on an acquirer’s performance. Various authors have looked into the factors that make an acquisition a success or a failure. It has been clearly established that on average M&As destroy value for an acquirer’s shareholders. However, a central concept in financial theory is the tradeoff between risk and return. Increased performance means little for an investor or manager if it goes along with a major increase in risk. In fact, some acquisitions might be done not to improve profits, but to reduce the risk associated with the company, and inversely. Similarly, the factors that enhance (or deteriorate) the performance of acquisitions could have a differential effect on risk. However, the existing work on risk in relation with M&A is relatively small, leaving ample room for further research. In this project we are going to explore how the risk associated with the target and/or the acquirer can influence the M&A process. We will also investigate the relationship between M&A and different aspects of firm risk and which firm-, industry- and country-level moderators can play a role in the M&A-firm risk relationship and in the relationship between M&A, performance and risk.