Research projects 2015
1. Transfers of Corporate Control in Firms with Non-Controlling Blockholders
We model the choice between a negotiated block trade and a public tender offer as means of acquiring control in a firm with a dominant minority blockholder. Potential acquirers differ in their (privately known) ability to create value in the target firm. In equilibrium, high types go for a tender offer, intermediate types purchase just the blockholder’s stake, and low types abstain. The model yields a number of implications. Compared to tender offers, block trades are associated with lower efficiency in equilibrium, which explains lower target announcement returns following block trades. Some equilibrium block trades are value-reducing. The equal opportunity rule (EOR) helps eliminating them, but it needs to go together with a rule allowing to “freeze out” non-tendering shareholders in order to ensure that no value-increasing takeover fails. The two rules are complements: introducing one without the other may hurt efficiency. Better investor protection raises the incidence of full-scale acquisitions relative to block trades. Yet, when the EOR is present, an increase in investor protection may be detrimental for efficiency as it may prevent some value-increasing takeovers.
2. Optimal execution with multiple agents
We analyze optimal execution strategies when multiple traders are simultaneously involved in optimal execution. Our goal is to obtain new equilibrium (in Nash sense) strategies and study their behaviour and features; particularly, under what circumstances strategies are aggressive (predatory) or passive (defensive). The project relies on solution of particular differential game. It thus utilizes methods of optimal control and game theory elements.
We obtain new equilibrium strategies for the case of N risk-averse traders who perfectly know each other positions. Though aggregate equilibrium order flow has some properties analogous to standard Almgren and Chriss (1999, 2000) strategies, as we show below individual equilibrium strategies can be quite different from the standard ones obtained in Grinold and Kahn (1995), and Almgren and Chriss. This is because each trader (assumed to be rational) is trying to minimize her trading cost or "implementation shortfall" and therefore takes into account the price impacts caused by herself and all other traders. We also obtain a close form characterization for the dynamic Nash equilibrium in terms of the system of second-order ODEs, which can be solved explicitly. The resulting equilibrium strategies describe different types of predatory and defensive behavior, though aggregate order flow profile have some properties of standard Almgren and Chriss strategies, e.g. is monotonous and convex. We show that the traders with smaller holdings are involved in predatory strategies, while traders with larger holdings tend to defend themselves against potential predators by following the delayed trading strategies. We also show that depending on liquidity and volatility parameters, predatory traders may be frontrunners or contrarian traders.
3. Default and the propagation of shocks in the real economy
The goal of the research is to establish the consequences of forgiving some of the debt of Greece. This is in terms of the path of consumption and investment for Greece and the path of income for the lender (Germany). We study a Dynamic Stochastic General Equilibrium Model in the spirit of the Real Business Cycle theory. We assume that the capital stock is externally financed by debt in addition to internal financing. Debt can be either secured, in which case failure to honour the debt would invoke bankruptcy proceedings which are ruled out, or unsecured, in which the lender has a limited claim on the existing wealth of the borrower and cannot invoke bankruptcy proceedings. Importantly, the possibility of default in equilibrium exists on unsecured debt. In our model we assume that non state contingent loans are the only source of new funds for borrowers. Debtors may choose to renege on some of their debt obligations, but then suffer a renegotiation cost. In order to be able to borrow again, they must pay this cost and, in this way, the decision to default is strategic.
The possibility of default is micro-founded on the moral hazard problem between debtors and creditors. If debtors default, they incur a welfare cost of renegotiating the defaulted-upon amount proportional to the quantity of debt defaulted upon. This cost effectively creates a borrowing constraint and stems from Shubik and Wilson. (1977) and Dubey et al. (2005) and applied in Tsomocos (2003), Goodhart et al. (2005) and Goodhart et al. (2006) and in the RBC literature, our model shares similar features to De Walque et al. (2010). We argue that credit-conditions can be adequately captured by an appropriate state variable in order to describe the relationship between loan delinquencies and capital stock. We deviate from much of the collateral literature by allowing default to occur in equilibrium and in this way we share features of the work of BGG. We consider the effect of allowing lenders to seize a proportion of income defaulted upon. In this way, borrowers effectively incur two costs of defaulting: the non-pecuniary punishment and a pecuniary punishment from having wealth confiscated.
In this project we argue that immediate debt restructuring which reduces the present value of debt would benefit both Greece as well as its creditor countries, specifically Germany, over the medium and long term. We establish within a two country RBC model that the default channel, that exacerbates the volatility of consumption, may actually be reduced with more lenient debt restructuring terms. Put another way, we argue that the dilemma is not whether there is a moral duty of creditor nations to transfer resources to Greece, but whether creditors are willing to trade off short-term losses for medium and long-run gains.
4. Market Discipline in the Banking sector
This project examines how the price market discipline mechanism restrains moral hazard behavior of banks. We also examine the strength of the price discipline mechanism across regions characterized by different levels of financial development. We use unique and comprehensive data on the deposit products offered by 555 Russian banks to determine how deposit rates fluctuate in relation to the risks banks face. Using an index of regional financial development constructed by the Central Bank of Russia we show that the more financial developed is the region the smaller is the premium on uninsured deposits relative to insured deposits. This finding demonstrates that the price market discipline imposes stricter constraints on banks from less financially developed regions.
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