Research projects 2016

1. Optimal execution with multiple agents

We analyze optimal execution strategies when multiple traders are simultaneously involved in optimal execution. In this case, we obtain new trading strategies that follow from a direct extension of the mean variance approach of Grinold and Kahn (1995), and Almgren and Chriss (1999). However, as we show below, the proposed strategies can be quite different from the standard ones obtained in Grinold and Kahn (1995), and Almgren and Chriss (1999). 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. In particular, 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. Our further research focuses on relaxing model assumptions (such as full information) and introducing other players to the trading game (market-makers, noisy traders).

2. Security Design with Status Concerns

The goal of this project is to shed light on arguably the most intriguing aspect of venture capital financing – the widespread use of convertible securities. These securities are interesting since they combine the traits of both stocks and bonds. We aim to show that a convertible debt contract emerges as the outcome of the interaction between an entrepreneur and a financier when the entrepreneur is driven by status concerns. We will then address the issue of why the use of convertible securities is concentrated in venture capital financing, while in contrast established firms do not rely much on this form of financing. A defining characteristic of start-up projects is that their future profits are much more uncertain as compared to established firms, and so we will examine how the optimal financial contract depends on the project volatility. Our insight is that the higher project volatility the closer the optimal contract to convertible debt. While not prevalent among established firms, some of them do use convertible debts. As documented in Noddings, Christoph, and Noddings (2001), among firms relying on convertible debt 58% are small-cap firms, 27% are medium cap, and 15% are large caps. Given the empirical regularity that small firms are more volatile than bigger firms, the aforementioned result on the volatility would provide a rationale for why it is mainly small firms that use convertible debt.

3. Debt, Recovery Rates and the Greek Dilemma

We present a dynamic 2 country model calibrated to the Greek economy, which obtains loans from Germany, a large external lender. Greek households issue secured debt (by capital) and unsecured debt upon which the possibility of default exists. If default occurs, Greek households renegotiate, at a cost, the amount in arrears. We find that forgiving debt in arrears lowers the volatility of German consumption and dampens fluctuations in TFP shocks while increasing the recovery rate has the opposite effect. Our model provides an endogenous debt-to-assets ratio and an endogenous structure of liabilities (secured-to- unsecured debt ratio).

4. Corporate governance and investment: Evidence from non-listed Russian firms

This paper investigates the effect of the quality of corporate governance at the firm level on cash flow sensitivity of investment in non-listed Russian firms. In emerging market economies with less developed financial markets, non-listed firms typically represent a large part of the economy. We develop two original indices based on two rounds of a large-scale enterprise survey conducted in 2005 and 2006 concerning two major aspects of corporate governance, shareholder protection (including board composition and procedures), and transparency (including information disclosure and audit). We estimate standard panel investment regressions with a proxy for investment opportunities and cash flows, augmented by our corporate governance indices, variables capturing ownership structure (concentration and insider ownership), and their interactions with cash flows. We find that better shareholder protection diminishes the cash flow sensitivity of investment, particularly in firms with high ownership concentration and low managerial ownership. We address the problem of endogeneity of corporate governance by using fixed-effects regressions and an instrumental variable approach that relies on legal provisions for corporate governance that depend on a firm’s number of shareholders.