Publications

Arbitrage with financial constraints and market power

Journal of Economic Theory, Volume 217, April 2024, 105825

I study how (VaR-based) financial constraints affect liquidity and welfare under different structures of the arbitrage industry. When capital is dispersed across competitive arbitrageurs, financial constraints may impair their ability to provide liquidity, lowering other investors' welfare. However, when capital is concentrated among arbitrageurs with market power, introducing constraints can make everyone better off and increase liquidity. Further, alternative constraints (fixed margins, position limits) have the same effects as VaR constraints when arbitrageurs are competitive, but not when they have market power. These results lead to new policy implications for margin and capital requirements and yield new empirical predictions.

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Sequential entry in illiquid markets

 Authors: Vincent Fardeau

Journal of Financial Markets, Volume 64, June 2023, 100818

I study the sequential entry of intermediaries into an illiquid market. As intermediaries trade with rational counterparts, market depth affects and is affected by the possibility of entry. This feedback loop between entry and depth gives incumbent intermediaries more incentives to deter entrants, creating endogenous barriers to entry. Further, whether entry occurs or not in equilibrium has distinct effects on market quality: while entry improves depth, reduces spreads, and speeds up price convergence, the threat of entry disciplines only spreads. In a contestable market, more competition leads to higher spreads and intermediaries’ counterparties benefit more from deterrence than actual entry.

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 Stochastic overlapping generations with non-convex budget sets

Journal of Mathematical Economics, Volume 107, August 2023, 102866

Non-convexities and discrete choices have become important modeling tools in modern macroeconomics. Unfortunately, the existence of competitive equilibria in the presence of such non-convexities is not always ensured, and most results on the existence of equilibrium that can be found in the literature do not directly apply to models used in applications.
In this paper, we explain the three main difficulties one encounters when proving the existence and give simple sufficient conditions for the existence of competitive equilibria in stochastic OLG models with non-convex budget sets. We also give sufficient conditions for the existence of approximate equilibria that are recursive in the natural state.

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Independent versus collective expertise

Authors: Emiliano Catonini, Andrey Kurbatov, Sergey Stepanov

Games and Economic Behavior, Volume 143, January 2024, Pages 340-356

We consider the problem of a decision-maker who seeks for advice from several experts. The experts have reputation concerns which generate incentives to herd on the prior belief about the state of the world. We address the following question: Should the experts be allowed to exchange their information before providing advice (“collective expertise”) or not (“independent expertise”)? We show that collective expertise is more informative than independent expertise under low prior uncertainty about the state and less informative otherwise. We also argue that collective expertise gains advantage as the number of experts grows.

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 Reputation and information aggregation

Journal of Economic Behavior & Organization, Volume 208, April 2023, Pages 156-173

We analyze how reputation concerns of a partially informed decision maker affect her ability to extract information from reputation-concerned advisors. Too-high decision maker’s reputation concerns destroy her incentives to seek advice. However, when such concerns are low, she is tempted to solicit advice regardless of her private information, which can undermine advisors’ truth-telling incentives. The optimal strength of the decision maker’s reputation concerns maximizes advice-seeking while preserving advisors’ truth-telling. Prior uncertainty about the state of nature calls for a more reputation-concerned decision maker. Higher expected competence of advisors may worsen information aggregation, unless the decision maker’s reputation concerns are properly adjusted.

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Optimal and efficient mechanisms with asymmetrically budget constrained buyers

Authors: Alexei Boulatov, Sergei Severinov

Games and Economic Behavior, Volume 127, May 2021, Pages 155-178

The paper characterizes the optimal (revenue-maximizing) mechanism for allocating a good to buyers who face asymmetric budget constraints. The optimal mechanism belongs to one of two classes. When the budget differences between the buyers are small, the mechanism discriminates only between high-valuation types for whom the budget constraint is binding. All low valuations buyers are treated symmetrically despite budget differences. When budget differences are sufficiently large, the mechanism discriminates in favor of buyers with small budgets when the valuations are low, and in favor of buyers with larger budgets when the valuations are high. We also provide a characterization of the constrained-efficient (surplus maximizing) mechanism and demonstrate that it shares the above properties of the optimal mechanism.

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Optimal portfolio under ambiguous ambiguity

Author: Dmitry Makarov

Finance Research Letters, Volume 43, November 2021, 101961

A prominent approach to modelling ambiguity about stock return distribution is to assume that investors have multiple priors about the distribution and these priors are distributed according to a certain second-order distribution. Realistically, investors may also have multiple priors about the second-order distribution, thus allowing for ambiguous ambiguity. Despite a long history of debates about this idea (Reichenbach, 1949; Savage, 1954), there seems to be no formal analysis of investment behavior in the presence of this feature. We develop a tractable portfolio choice framework incorporating ambiguous ambiguity, characterize analytically the optimal portfolio, and examine its properties.

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Biased performance evaluation in a model of career concerns: incentives versus ex-post optimality

Author: Sergey Stepanov

Journal of Economic Behavior & Organization, Volume 179, November 2020, Pages 589-607

I study a career concerns model in which the principal receives information about the agent’s performance from an intermediary (evaluator). I show that, in general, a biased evaluator is ex-ante optimal for the principal. The ex-ante optimal bias solves the tradeoff between ex-post optimality of the principal’s decisions about the agent and incentive provision. It is “anti-agent” (“pro-agent”) when the agent has an a priori high value (low value) for the principal. It increases with the strength of the agent’s career concerns and decreases with the degree of uncertainty about his ability. Delegating decisions to the evaluator dominates communication with her when ex-ante optimality calls for a sufficiently large bias.

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Security design with status concerns

Journal of Economic Dynamics and Control, Volume 118, September 2020, 103976

This paper provides a status-based explanation for convertible securities. An entrepreneur with status concerns inducing risk-taking decides how to finance the firm and how to dynamically manage it. Solving analytically for the optimal security, we find that it is substantially similar to a convertible security. Our model can explain why convertible securities are mainly issued by start-ups and small firms, as we show that their salient characteristics, higher volatility and dynamic flexibility, accentuate incentives to issue convertible securities. We also provide analytical results relevant to quantifying how status concerns affect credit risk, an established factor behind security choice.

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Ambiguity attitudes and self-confirming equilibrium in sequential games

Games and Economic Behavior Volume 115, May 2019, Pages 1-29

We consider a game in extensive form recurrently played by agents who are randomly drawn from large populations and matched. We assume that preferences over actions at any information set admit a smooth-ambiguity representation in the sense of Klibanoff et al. (2005), which may induce dynamic inconsistencies. We take this into account in our analysis of self-confirming equilibrium (SCE) given players' feedback about the path of play. Battigalli et al. (2015) show that the set of SCE's of a simultaneous-move game with feedback expands as ambiguity aversion increases. We show by example that SCE in a sequential game is not equivalent to SCE applied to the strategic form of such game, and that the previous monotonicity result does not extend to general sequential games. Still, we provide sufficient conditions under which the monotonicity result holds for SCE.

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The RAND Journal of Economics 2019. Vol. 50. No. 2. P. 453-480

I model the choice between a negotiated block trade and a public tender offer as means of acquiring control in a firm with a large minority blockholder. Potential acquirers differ in their (privately known) value‐creation ability. In equilibrium, block trades are made by lower ability acquirers compared to tender offers. The equal opportunity rule (EOR) and the “freezeout” rule are complements in promoting efficiency of control transfers. Stronger investor protection may hamper value‐increasing takeovers when the EOR is present. The model also delivers predictions about announcement returns and the incidence of block trades and tender offers under different legal regimes.

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Journal of Financial Stability Volume 36, June 2018, Pages 265-278

Most discussions of the Greek debt overhang have focussed on the implications for Greece. We show that when additional funds released to the debtor (Greece), via debt restructuring, are used efficiently in pursuit of a practicable business plan, then both debtor and creditor can benefit. We examine a dynamic two country model calibrated to Greek and German economies and support two-steady states, one with endogenous default and one without, depending on creditors’ expectations. In the default steady state, debt forgiveness lowers the volatility of both German and Greek consumption whereas demanding higher recovery rates has the opposite effect. In a second order approximation of the model, conditional welfare analysis shows that a policy of immediate leniency followed by harsher terms as the economy grows is beneficial to both creditors and debtors.

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Journal of Economic Behavior & Organization No. 133., January 2017, P. 87-107

We propose a model in which an entrepreneur, seeking outside financing, sells a large equity share to an outside blockholder in order to signal his low propensity to extract private benefits. A conventional theoretical rationale for the presence of an outside blockholder is mitigation of the agency problem via some type of monitoring or intervention. Our model provides a novel insight: outside blockholders may be attracted by firms with low, rather than high, agency problems. Our result yields a new implication for the interpretation of an often documented positive relationship between outside ownership concentration in a firm and its market valuation: such relationship may be driven by "sorting" rather than by a direct effect of blockholder monitoring. In fact, we show that the positive correlation may arise even if the blockholder derives private benefits and has no positive impact on the value of small shares. Finally, we argue that our analysis may help explain why the market reacts more favorably to private placements of equity as opposed to public issues.

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Review of Finance May 2017

We exploit variation in consumer price inflation across 71 Russian regions to examine the relationship between the perceived stability of the domestic currency and financial dollarization. Our results show that regions with higher inflation experience an increase in the dollarization of household deposits and a decrease in the dollarization of loans. The impact of inflation on credit dollarization is weaker in regions with less integrated banking markets. This suggests that the currency-portfolio choices of households and firms are constrained by the asset-liability management of banks.

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Annals of Finance 2016 11 (3-4), pp. 297-318

We analyze a static Kyle (Continuous auctions and insider trading. Princeton University, Princeton, 1983) model in which a risk-neutral informed trader can use arbitrary (linear or non-linear) deterministic strategies, and a finite number of market makers can use arbitrary pricing rules. We establish a strong sense in which the linear Kyle equilibrium is  robust : the first variation in any agent’s expected payoff with respect to a small variation in his conjecture about the strategies of others vanishes at equilibrium. Thus, small errors in a market maker’s beliefs about the informed speculator’s trading strategy do not reduce his expected payoffs. Therefore, the original equilibrium strategies remain optimal and still constitute an equilibrium (neglecting the higher-order terms). We also establish that if a non-linear equilibrium exists, then it is not robust.

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Author: Sokolov V., Yulia Davydova

Journal of Empirical Finance, Volume 29, December 2014, Pages 247-265.

We investigate the rationale and impact of the corporate debt subsidization program implemented by the Russian government during the recent financial crisis. Employing the difference-in-difference approach, we show that the program did not have a significant impact on capital investments of subsidy recipients, contrary to its intentions. We also find that a matched group of non-recipients on average exhibited a higher degree of cash hoarding behavior than subsidy-recipients in the post-program period, which suggests that the program eased external financial constraints of recipient-firms. Consistent with the theory on precautionary cash savings by firms, we further find that firms non-recipients based in cities with low banking development accumulated more cash holdings than recipients based in cities with a high banking development. Overall, our findings indicate that greater cash holdings are positively associated with the level of financial constraints of firms.

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Author: Stepanov S., Enikolopov R., Petrova M.

Journal of Banking & Finance, Volume 46, September 2014, Pages 72-84.

Recent empirical research suggests that country-level and firm-level governance institutions are substitutes with respect to their effect on firm value. In this paper we demonstrate that during a crisis these institutions may actually become complements. Specifically, we find that the decline in companies’ valuation during the financial crisis of 2007–2009 was more sensitive to firm-level transparency in countries with stronger investor protection. We propose a theoretical model that reconciles our findings with the results in the literature. In our model, during “normal times” strong firm-level governance is crucial to attract outside financing in countries with weak investor protection, but is less important in countries with good investor protection. During a crisis, however, investment opportunities decline even in countries with strong investor protection, and, as a result, relative  importance of firm-level governance increases in such places.

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Author: Boulatov A.

Review of Financial Studies 2013, 26 (8), pp. 2096-2137

We examine the impact on the quality of a securities market of hiding versus displaying orders that provide liquidity. Display expropriates informational rents from informed agents who trade as liquidity providers. The informed then exit liquidity provision in favor of demanding liquidity where they trade less aggressively. Trading costs to uninformed liquidity demanders are higher, bid-ask spreads are wider, and midquotes are less informationally efficient when orders that provide liquidity are displayed. Our analysis suggests that market innovations, which might seem to favor the informed over the uninformed, can enhance market quality by intensifying competition among the informed.

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Author: Peiris U

Economic Theory, pp. 1-28, 2013 year 

In the presence of uninsurable idiosyncratic risk, the optimal credit contract allows for the possibility of default. In addition, the optimal contract incorporates a precautionary savings motive over and above what agents would otherwise save. When default is sufficiently high, credit markets may collapse. A regulatory requirement on the level of savings can increase risk sharing and improve welfare by increasing the gains to trade in credit exchange. Under the appropriate verifiability condition on the level of savings, an appropriate market structure, agents voluntarily increase their level of storage such that trade and welfare improve. 

Keywords: Credit; Default; Endogenous contracts; Precautionary savings; Uninsurable risk
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Author: Sokolov V.

Review of International Economics 2012, 20 (4), pp. 707-722

This paper examines how the 2005 shift in Russian exchange rate policy from US dollar (USD) single-currency to USD–EUR (euro) bi-currency targeting has impacted domestic interest rates. The finding show that this policy shift has disconnected Russian interest rates from US dollar-denominated interest rates, while instead linking them to a synthetic interest rate composed of USD and EUR rates at the same proportion as that of these two currencies in the currency basket against which the ruble's exchange rate is set. The Russian experience shows that while the adoption of bi-currency targeting may help ensure that domestic interest rates are less dependent on the monetary cycle of a single country, these rates are instead likely to reflect financial developments in all countries whose currencies are included in the currency basket. This insight is likely to be relevant for other countries that pursue basket-targeting policies.

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Author: Sprenger C.

Journal  of the  New Economic Association (in Russian) 2012, pp.154-157

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Author: Sokolov V.

Journal  of the  New Economic Association (in Russian) 2012, pp.51-78

Using data on foreign borrowing, I identify Russian banks that were affected by the sudden stop of external financing caused by the Lehman Brothers’ collapse. Applying the difference-in-difference method, I compare these «affected» banks to «unaffected» ones and find that the Russian Central Bank’s (CBR) anti-crisis financial assistance primarily went to the former group. Tracing the impact of the CBR’s liquidity infusions on banks’ portfolio allocation decisions, I find that banks used CBR funds not only to pay out foreign debt, but also to accumulate cash deposits in non-resident banks. I also find that affected banks increased their holdings of market securities significantly more than unaffected ones, which suggests that the CBR’s bailout policies impacted their risk-taking strategies. While there was no significant difference in corporate lending growth between the two groups after the sudden stop, lending to borrowers with weaker banking relationships (individuals and entrepreneurs) decreased more among affected banks.

Keywords: foreign borrowing; bailout, banks, crisis. 

JEL classification: G21, E58

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Autohor: Boulatov A., Hendershott T., Livdan D.

Review of economic studies 2012, Vol. 80, Issue 1, pp. 35-72

We solve a multi-period model of strategic trading with long-lived information in multiple assets with correlated innovations in fundamental values. Market makers in each asset can only condition their price functions on trading in that asset (but not on trading in the other asset). Using daily non-public data from the New York Stock Exchange we test the model's predictions on the conditional and unconditional lead-lag relations of institutional order flows and returns within portfolios. We find support for the model prediction of positive autocorrelations in portfolio returns as well as the predictions for how informed order flow positively predicts future returns and future informed order flow. As the model predicts we find these relations strengthen for portfolios formed from assets with higher correlation of fundamental values.

Keywords: informed trading, portfolio autocorrelations, adverse selection

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Authors: Boulatov A., Dieckmann S.

Journal of risk and insurance, Vol. 80, Issue 1, March 2013, pp. 37-64 

We study the risk sharing implications that arise from introducing a disaster relief fund to the cat insurance market. Such a form of intervention can increase efficiency in the private market, and our design of disaster relief suggests a prominent role of catastrophe reinsurance. The model predicts buyers to increase their demand in the private market, and the seller to lower prices to such an extent that her revenues decrease upon introduction of disaster relief. We test two predictions in the context of the Terrorism Risk Insurance Act (TRIA). It is already known the introduction of TRIA led to negative abnormal returns in the insurance industry. In addition, we show this negative effect is stronger for larger and for low risk-averse firms -- two results that are consistent with our model. The seller's risk aversion plays an important role in quantifying such feedback effects, and we point towards possible distortions in which a firm may even be overhedged upon introduction of disaster relief.

Keywords:  Catastrophe Risk, Government Intervention, TRIA, Reinsurance

JEL Classifications:  D42, G22, H30
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Author: Betschinger M.-A., Bertrand O.

Journal of comparative economics 2012, 40 (3), pp. 413-437

This paper investigates the long-term impact of domestic and international acquisitions, initiated by Russian firms, on their operating performance. In general, acquisitions can be associated with synergy gains, internalization advantages, and higher market power. Acquisitions, however, may also give rise to agency problems as well as new integration and organizational costs, leading to an ambiguous overall impact on the performance of acquirers. Based on a sample of more than 600 acquirers we show that both domestic and international acquisitions tend to reduce the performance of acquirers compared to non-acquiring firms. Examining how different deal, firm and industry level characteristics moderate the value destroying effects of acquisitions, our results suggest that Russian acquirers suffer from the inability to leverage value due to low M&A experience and capability, especially when making international acquisitions.

Keywords: M&A, Restructuring, FDI, Emerging Countries, Russia

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Author: Gelman S., Burhop C.

MPI Collective Goods Preprint 2011, No. 2011/19, 56p.

We analyze the determinants of illiquidity and its impact on asset pricing for purely call-auction traded stocks on Berlin Stock Exchange using 22 years of daily data (1892-1913). We use the Lesmond et al. (1999) measure of transaction costs to proxy illiquidity. We show that transaction costs were low and comparable to today’s costs. Liquidity was negatively correlated with active informed trading, particularly being low for small and distressed stocks and in crises times. Liquidity concerns were a major driver of asset pricing: we find significant illiquidity level and illiquidity risk premia as well as an explicit premium for informed trading.

JEL-Codes N23; G12; G14

Key words: Transaction Costs, Liquidity Premium, Informed Trading

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Author: Sprenger C.

Journal of Comparative Economics //Volume 39, Issue 2, June 2011, p.260-277

We use a large data set of Russian manufacturing firms to describe the ownership structure in the Russian industry at the end of the mass privatization program in 1994 and its subsequent evolution. The data shows a high, but gradually decreasing ownership stakes of firm insiders (managers and workers). We estimate the effect of a wide range of firm characteristics on the decision to privatize, the initial ownership structure after privatization, and on subsequent changes of ownership stakes. We test and find support for several predictions of the model by Aghion and Blanchard (1998). For example, collusion among workers makes them more reluctant to sell shares to outsiders. Firms in financial distress show a higher incidence of insiders selecting the option of privatization leading to high insider ownership. This can be explained by their desire to insure against unemployment in the case of restructuring by outsiders. No evidence is found of a sequencing in privatization according to the performance of firms before privatization. A methodological novelty of this paper is the application of a tobit model with sample selection to the choice of ownership stakes.

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Author: Sokolov V., Lee BJ., Mark N.

Journal: Pacific Economic Review 2011 № 16(4). pp.395—420

From a panel of 137 countries over the years 1971 to 2002, we find evidence that an exchange rate policy of "fear of foating.(de jure foat and de facto peg) is associated with superior macroeconomic performance in non-industrialized countries. We examine four different measures of performance- per capita GDP growth, ii) the CPI inflation rate, iii) GDP growth volatility, and iv) inflation volatility - and how they respond to a 'words versus deeds' measure of exchange-rate policy obtained by interacting a country's de jure exchange rate policy with its de facto policy as codified by Rogoff and Reinhart (2004). For non-industrialized countries, the highest GDP growth rates are associated with those who pursue fear of .fating whereas the lowest inflation rates are achieved by countries that pursue a matched fix (de jure and de facto fixing). Countries that exhibit fear of foating also experienced the lowest GDP and inflation volatility while those that pursued a matched de jure and de facto .oat experienced the greatest macroeconomic instability.

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Author: Gelman S., Saldakeeva O., Smirnova G.

Chapter: The Impact of the Global Financial Crisis on Emerging Financial Markets, 
Emerald 2011. 732 pp ISBN: 9780857247537; ISSN: 1569-3759

The Global Financial Crisis of 2007-2009 has highlighted the resilience of the financial markets and broader economies from the developing world. This outcome owes much to the bitter experience and economic strategies developed and implemented at both a national and international level following the Asian Financial Crisis of 1997-1998. The objective of this volume is to investigate and assess the impact and response to the crisis from an emerging markets perspective including asset pricing, contagion, financial intermediation, market structure and regulation. Our hope is that the assembled papers will offer clear insights into the complex financial arrangements that now link emerging and developed financial markets in the current economic environment. The volume spans four dimensions: first, a series of background studies offer explanations of the causes and impacts of the crisis on emerging markets more generally; then, implications are considered. The third and final sections provide insights from regional and country-specific perspectives.  

Author: Sprenger C., Urosevic B.

Chapter: Global Housing Markets: Crises, Policies, and Institutions. Hoboken, New Jersey, USA: John Wiley & Sons, 2011

This chapter provides a quantitative analysis of the housing and housing finance markets in Russia and its regions. Russia has experienced a sharp decline in mortgage lending at the end of 2008 and beginning of 2009 as a response to the liquidity problems in international financial markets. The decline in house prices has been, however, only moderate. The chapter focuses on the differences in prices and market conditions in Russia's regional housing and mortgage markets. It identifies the main drivers of housing prices using panel data for 80 Russian regions. Furthermore, the chapter discusses the default experience of mortgage loans during the crisis. The difference in default rates between ruble and dollar-denominated mortgage loans is discussed in connection with the large ruble depreciation in 2008 and 2009. 

Author: Betschinger M.-A.

Hamburg 2010, 336 Seiten,  ISBN 978-3-8300-5110-7

Foreign companies often forego high profile corporate investments in developing markets fearing regulatory opacity, investment barriers, or political instability. Host and investor home governments can develop appropriate strategies to mitigate such risks and attract FDI into these markets. One policy tool available to achieve this goal is bilateral or multi-lateral investment agreements. This study focuses on bilateral investment treaties and preferential trade and investment agreements and explores if and under which conditions these treaties promote different types of foreign direct investment. The empirical evidence involves Japanese multinational firms’ activities abroad. 

Author: Morfov S.

HSE Working Paper Series 9 «Research in economics and finance», no. 2010/03, 51p.

This paper computes the optimal executive compensation in an infinite-horizon moral hazard framework characterized by limited commitment and history-dependent  reservation utilities. The model is given a recursive form and some properties of the state space are established. I derive a sufficient condition for the optimal contract to provide the CEO with insurance against fluctuations in the value of his/her outside options under short-term history dependence. In the numerical computation of the endogenous state space, I use an innovative algorithm which does not rely on the convexity of the underlying set. Exerting effort appears to be the predominant strategy for the principal, but shirking may still be optimal when the manager is rich enough. The optimal wage scheme and the future utility of the CEO tend to grow in both his/her current utility and in the firm’s future profit. The manager’s utility tends to increase weakly in the long run and appears to have a non-degenerate long-term distribution depending on the initial utility promise but not on the initial history.

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Author: Morfov S.

HSE Working Paper Series 9 «Research in economics and finance», no. 2010/02, 41p.

This paper considers a moral hazard problem in an infinite-horizon, principal-agent framework. In the model, both the principal and the agent can commit only to short-term (single-period) contracts and their reservation utilities are allowed to depend on some finite truncation of the history of observables. After existence is proved, the original problem of obtaining the optimal incentive- compatible self-enforcing contract is given an equivalent recursive representation on a properly defined state space. I construct an auxiliary version of the problem where the participation of the principal is not guaranteed. The endogenous state space of agent’s expected discounted utilities which on a different dimension includes the set of truncated initial histories in order to account for their influence on the reservation utilities is proven to be the largest fixed point of a set operator. Then, the self-enforcing contract is shown to be recursively obtainable from the solution of the auxiliary problem by severely punishing any violation of the principal’s participation constraint.

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Author: Burhop C., Gelman S.

Bonn, Max Planck Institute for Research on Collective Goods, 2010, 23p.

We estimate effective spreads and round-trip transaction costs at the Berlin Stock Exchange for the period 1892-1913 using daily stock market returnsfor a sample of 27 stocks. Our results show that transaction costs at the main stock exchange in a bank-based financial system at the turn of the 20th century were quite low and about comparable to transaction costs in modern markets. Nonetheless, transaction costs varied substantially over time andacross securities, whereby the cross-sectional variation could be substantially explained by firm size and time variation by crises. Furthermore, we find surprising evidence that transaction costs decrease the expected excess returns. Thereby size and momentum premia are of expected signs while market beta has no significant influence on the cross-sectional return variation.

JEL classification: N23; G12; G14

Key words: Economic history, Germany, Transaction Costs, Effective spreads

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Author: Gelman S., Wilfling B.

Journal of Empirical Finance. 16 (2009), pp.745–758

The paper examines shifts in the market betas and the conditional volatility of stock prices of takeover targets. Using daily stock prices of five European and American targets, we find that adequately specified Markov-switching GARCH models are capable of detecting statistically regime-switches in all takeover deal-types (in cash bids, pure share-exchange bids, mixed bids). In particular, conditional volatility regime-switches are found to be most clear-cut for cash bids. Our economic findings have implications for a broad range of financial applications such as the valuation of target stock options.

JEL classification: C32; C52; G12; G14; G34

Keywords: Takeover bids; Stock price dynamics; Markov-switching models

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