Fourth International Moscow Finance Conference
List of speakers and paper abstracts
Suleyman Basak
London Business School (co-author: Adem Atmaz, Krannert School of Management, Purdue University)
Belief Dispersion in the Stock Market
We develop a dynamic model of belief dispersion which simultaneously explains the empirical regularities in a stock price, its mean return, volatility, and trading volume. Our model with a continuum of (possibly Bayesian) investors differing in beliefs is tractable and delivers exact closed-form solutions. Our model has the following implications. We find that the stock price is convex in cash-flow news, and it increases in belief dispersion while its mean return decreases when the view on the stock is optimistic, and vice versa when pessimistic. We also show that the presence of belief dispersion generates excess stock volatility, non-trivial trading volume, and a positive relation between these two quantities. Moreover, we find that the investors' Bayesian learning induces less excess volatility when belief dispersion is higher. Furthermore, we demonstrate that the more familiar, otherwise identical, finitely-many-investor models of heterogeneous beliefs do not necessarily generate our main results.
We develop a dynamic model of belief dispersion which simultaneously explains the empirical regularities in a stock price, its mean return, volatility, and trading volume. Our model with a continuum of (possibly Bayesian) investors differing in beliefs is tractable and delivers exact closed-form solutions. Our model has the following implications. We find that the stock price is convex in cash-flow news, and it increases in belief dispersion while its mean return decreases when the view on the stock is optimistic, and vice versa when pessimistic. We also show that the presence of belief dispersion generates excess stock volatility, non-trivial trading volume, and a positive relation between these two quantities. Moreover, we find that the investors' Bayesian learning induces less excess volatility when belief dispersion is higher. Furthermore, we demonstrate that the more familiar, otherwise identical, finitely-many-investor models of heterogeneous beliefs do not necessarily generate our main results.
Svetlana Bryzgalova
Stanford Graduate School of Business, Stanford University (co-author: Christian Julliard, London School of Economics)
The Consumption Risk of Bonds and Stocks
Aggregate consumption growth reacts slowly, but significantly, to bond and stock return innovations. As a consequence, slow consumption adjustment (SCA) risk, measured by the reaction of consumption growth cumulated over many quarters following a return, can explain most of the cross-sectional variation of expected bond and stock returns. Moreover, SCA shocks explain about a quarter of the time series variation of consumption growth, a large part of the time series variation of stock returns, and a significant (but small) fraction of the time series variation of bond returns, and have substantial predictive power for future consumption growth.
Aggregate consumption growth reacts slowly, but significantly, to bond and stock return innovations. As a consequence, slow consumption adjustment (SCA) risk, measured by the reaction of consumption growth cumulated over many quarters following a return, can explain most of the cross-sectional variation of expected bond and stock returns. Moreover, SCA shocks explain about a quarter of the time series variation of consumption growth, a large part of the time series variation of stock returns, and a significant (but small) fraction of the time series variation of bond returns, and have substantial predictive power for future consumption growth.
Andrew Ellul
Kelley School of Business, Indiana University, CSEF, ECGI and CEPR (co-author: Marco Pagano, University of Naples Federico II, CSEF, EIEF, ECGI and CEPR)
Strategic Leverage and Employees’ Rights in Bankruptcy
The seniority of employees’ claims in the liquidation of insolvent firms, and their rights in the renegotiation of their debt varies greatly across countries. Using a simple model of strategic leverage, we show that the balance between these rights of employees and those of other creditors affects the strategic value of debt: in equilibrium, stronger employees’ seniority rights in bankruptcy liquidation increases firm leverage, unless bankruptcy costs are very high or the workers’ claim are senior to all other debt. Moreover, employees’ seniority invariably increases the positive response of leverage to increases in the value of its assets and in its cash flow. Conversely, stronger employees’ rights in the renegotiation of corporate debt are predicted to decrease firm leverage. These predictions differ starkly from those obtaining if firms’ leverage is determined by a collateral constraint. To test them, we construct novel measures of employees’ protection in bankruptcy via questionnaires to law firms and other sources, and investigate whether these measures affect the response of firm leverage in a sample of 12,445 companies in 28 countries between 1988 and 2013. We find that increases in the value of these firms’ real estate is associated with a greater increase in leverage for companies located in countries where employees have stronger seniority in company liquidation and weaker rights in debt renegotiation, as predicted by the strategic leverage model. For a subsample of 928 mining and oil companies, we find a similar differential response of leverage to profitability shocks resulting from changes in the prices of the commodities produced by these companies.
The seniority of employees’ claims in the liquidation of insolvent firms, and their rights in the renegotiation of their debt varies greatly across countries. Using a simple model of strategic leverage, we show that the balance between these rights of employees and those of other creditors affects the strategic value of debt: in equilibrium, stronger employees’ seniority rights in bankruptcy liquidation increases firm leverage, unless bankruptcy costs are very high or the workers’ claim are senior to all other debt. Moreover, employees’ seniority invariably increases the positive response of leverage to increases in the value of its assets and in its cash flow. Conversely, stronger employees’ rights in the renegotiation of corporate debt are predicted to decrease firm leverage. These predictions differ starkly from those obtaining if firms’ leverage is determined by a collateral constraint. To test them, we construct novel measures of employees’ protection in bankruptcy via questionnaires to law firms and other sources, and investigate whether these measures affect the response of firm leverage in a sample of 12,445 companies in 28 countries between 1988 and 2013. We find that increases in the value of these firms’ real estate is associated with a greater increase in leverage for companies located in countries where employees have stronger seniority in company liquidation and weaker rights in debt renegotiation, as predicted by the strategic leverage model. For a subsample of 928 mining and oil companies, we find a similar differential response of leverage to profitability shocks resulting from changes in the prices of the commodities produced by these companies.
Christian Julliard
London School of Economics (co-authors: Lorenzo Bretscher, London School of Economics and Carlo Rosa, Federal Reserve Bank of New York)
Human Capital and International Portfolio Diversification: A Reappraisal
We study the implications of human capital hedging for international portfolio choice. First, we document that, at the household level, the degree of home country bias in equity holdings is increasing in the labor income to financial wealth ratio. We show that a heterogeneous agent model in which households face short selling constraints and labor income risk, calibrated to match both micro and macro labor income and asset returns data, can both rationalize this finding and generate a large aggregate home country bias in portfolio holdings. Second, we find that the empirical evidence supporting the belief that the human capital hedging motive should skew domestic portfolios toward foreign assets, is driven by an econometric misspecification rejected by the data. Third, we show that, given the high degree of international GDP correlations in the data, very small domestic redistributive shocks are sufficient to skew portfolios toward domestic assets.
We study the implications of human capital hedging for international portfolio choice. First, we document that, at the household level, the degree of home country bias in equity holdings is increasing in the labor income to financial wealth ratio. We show that a heterogeneous agent model in which households face short selling constraints and labor income risk, calibrated to match both micro and macro labor income and asset returns data, can both rationalize this finding and generate a large aggregate home country bias in portfolio holdings. Second, we find that the empirical evidence supporting the belief that the human capital hedging motive should skew domestic portfolios toward foreign assets, is driven by an econometric misspecification rejected by the data. Third, we show that, given the high degree of international GDP correlations in the data, very small domestic redistributive shocks are sufficient to skew portfolios toward domestic assets.
Dmitry Livdan
Haas School of Business, University of California Berkeley (co-author: Alexander Nezlobin, Haas School of Business, University of California, Berkeley)
Accounting Rules, Equity Valuation, and Growth Options
In a model with irreversible capacity investments, we show that financial statements prepared under replacement cost accounting provide investors with sufficient information for equity valuation purposes. Under alternative accounting rules, including historical cost and value in use accounting, investors will generally not be able to value precisely a firm's growth options and, therefore, its equity. For these accounting rules, we describe the range of valuations that is consistent with the firm's financial statements. We further show that replacement cost accounting preserves all value-relevant information if the firm's investments are reversible. However, the directional relation between the firm's equity value and the replacement cost of its assets is different from that in the setting with irreversible investments.
In a model with irreversible capacity investments, we show that financial statements prepared under replacement cost accounting provide investors with sufficient information for equity valuation purposes. Under alternative accounting rules, including historical cost and value in use accounting, investors will generally not be able to value precisely a firm's growth options and, therefore, its equity. For these accounting rules, we describe the range of valuations that is consistent with the firm's financial statements. We further show that replacement cost accounting preserves all value-relevant information if the firm's investments are reversible. However, the directional relation between the firm's equity value and the replacement cost of its assets is different from that in the setting with irreversible investments.
Dmitry Makarov
ICEF, Higher School of Economics (co-authors: Suleyman Basak, London Business School, Alex Shapiro, New York University and Marti Subrahmanyam, New York University)
Security Design with Status Concerns
This paper studies security design in a dynamic economy in the presence of status concerns. Our setting involves an entrepreneur with status concerns who has an idea for a project requiring an initial investment, which she raises by issuing a security to a financier. We characterize analytically the optimal security and find that its payoff profile is considerably similar to that of a convertible security. In contrast to existing explanations for convertible securities, ours does not rely on agency problems or asymmetric information. The more volatile the project is, the more similar the optimal security is to a convertible security. This is consistent with the observation that convertible securities are primarily used to finance relatively volatile projects. Our analysis uncovers the entrepreneur’s and financier’s risk attitudes as factors that can explain why convertible securities have different conversion ratios. While the paper focuses on convertible securities for expositional purposes, our analysis is potentially relevant for understanding a broader class of hybrid securities as well as executive compensation contracts.
This paper studies security design in a dynamic economy in the presence of status concerns. Our setting involves an entrepreneur with status concerns who has an idea for a project requiring an initial investment, which she raises by issuing a security to a financier. We characterize analytically the optimal security and find that its payoff profile is considerably similar to that of a convertible security. In contrast to existing explanations for convertible securities, ours does not rely on agency problems or asymmetric information. The more volatile the project is, the more similar the optimal security is to a convertible security. This is consistent with the observation that convertible securities are primarily used to finance relatively volatile projects. Our analysis uncovers the entrepreneur’s and financier’s risk attitudes as factors that can explain why convertible securities have different conversion ratios. While the paper focuses on convertible securities for expositional purposes, our analysis is potentially relevant for understanding a broader class of hybrid securities as well as executive compensation contracts.
Albert J. Menkveld
VU University Amsterdam and Tinbergen Institute (co-author: Vincent Van Kervel, Pontifical Catholic University of Chile and Tilburg Law and Economics Center (TILEC), Tilburg University)
High-Frequency Trading around Large Institutional Orders
Liquidity suppliers lean against the wind. We analyze whether high-frequency traders (HFTs) lean against large institutional orders that execute through a series of child orders. The alternative is that HFTs go "with the wind" and trade in the same direction. We find that HFTs lean against the order in the first hour, but turn around and trade with the order in the case of multi-hour executions. This pattern could explain why institutional trading cost is 39% lower when HFTs lean against the order (by one standard deviation), but are 64% higher when they go with it.
Liquidity suppliers lean against the wind. We analyze whether high-frequency traders (HFTs) lean against large institutional orders that execute through a series of child orders. The alternative is that HFTs go "with the wind" and trade in the same direction. We find that HFTs lean against the order in the first hour, but turn around and trade with the order in the case of multi-hour executions. This pattern could explain why institutional trading cost is 39% lower when HFTs lean against the order (by one standard deviation), but are 64% higher when they go with it.
Thomas Noe
Saïd Business School and Balliol College, University of Oxford (co-author: Dawei Fang, Department of Economics, University of Gothenburg)
Skewing the odds: Taking risks for rank-based rewards
How do prize structures affect contestant risk-taking strategies in contests? We address this question using a model where, subject only to a capacity constraint on mean performance, an arbitrary number of contestants compete for rank-based prizes through choosing random performance levels. Based on the closed-form solution of the unique equilibrium, we examine the relation between the prize structure and the shape of the equilibrium performance distribution, including (a)symmetry, modality, and tail behavior, and study the factors that affect performance dispersion and skewness. Increasing real gain inequality, adding contestants, and merging contests all make performance more dispersed but not necessarily more right-skewed. In contrast, convexifying prize schedule increases both performance dispersion and right-skewness, implying that the common heuristics for rank-based prize allocations used in economics, such as the power law and Gibrat’s law, always imply highly dispersed and right-skewed contestant performance.
How do prize structures affect contestant risk-taking strategies in contests? We address this question using a model where, subject only to a capacity constraint on mean performance, an arbitrary number of contestants compete for rank-based prizes through choosing random performance levels. Based on the closed-form solution of the unique equilibrium, we examine the relation between the prize structure and the shape of the equilibrium performance distribution, including (a)symmetry, modality, and tail behavior, and study the factors that affect performance dispersion and skewness. Increasing real gain inequality, adding contestants, and merging contests all make performance more dispersed but not necessarily more right-skewed. In contrast, convexifying prize schedule increases both performance dispersion and right-skewness, implying that the common heuristics for rank-based prize allocations used in economics, such as the power law and Gibrat’s law, always imply highly dispersed and right-skewed contestant performance.
Tarun Ramadorai
Saïd Business School and Oxford-Man Institute of Quantitative Finance, University of Oxford (co-authors: Santosh Anagol, Wharton School of Business, Business Economics and Public Policy Department, University of Pennsylvania, and Oxford-Man Institute of Quantitative Finance and Vimal Balasubramaniam, Saïd Business School, Oxford-Man Institute of Quantitative Finance, University of Oxford)
The Effects of Experience on Investor Behavior: Evidence from India's IPO Lotteries
We exploit the randomized allocation of stocks in 54 Indian IPO lotteries to 1.5 million investors between 2007 and 2012 to provide new estimates of the causal effect of investment experiences on future investment behavior. We find that investors experiencing exogenous gains in IPO stocks (the treatment) are more likely to apply for future IPOs, increase trading in their portfolios, exhibit a stronger disposition effect, and tilt their portfolios towards the sector of the treatment IPO. Treatment effects vary with the characteristics of the treatment (size, variability, and salience of the gain), and are stronger for smaller and younger accounts. Treatment effects persist for larger and older accounts, suggesting that experiencing gains exerts a powerful force even on sophisticated players.
We exploit the randomized allocation of stocks in 54 Indian IPO lotteries to 1.5 million investors between 2007 and 2012 to provide new estimates of the causal effect of investment experiences on future investment behavior. We find that investors experiencing exogenous gains in IPO stocks (the treatment) are more likely to apply for future IPOs, increase trading in their portfolios, exhibit a stronger disposition effect, and tilt their portfolios towards the sector of the treatment IPO. Treatment effects vary with the characteristics of the treatment (size, variability, and salience of the gain), and are stronger for smaller and younger accounts. Treatment effects persist for larger and older accounts, suggesting that experiencing gains exerts a powerful force even on sophisticated players.
Vladimir Sokolov
ICEF, Higher School of Economics (co-author: Laura Solanko, BOFIT, Bank of Finland)
Firm Performance, Political Influence and External Shocks
Using representative survey data on manufacturing firms and the official registry data, we study how firms’ political influence at the regional level affects firms’ financial performance. We find that firms with political influence exhibit higher profitability but also retain larger cash holdings. We also find that politically influential firms are not more likely to take bank credit than non-influential ones, but if they do so, they enjoy longer maturities. Furthermore, after conditioning on the level of the regional institutional development we find that the significant impact of the firms’ regional political influence is present only in regions with poor institutions and is almost absent in the regions with high level of democracy/market freedom. Most importantly, we are able to show that firms that were influential in 2004 during the survey had a higher probability to be liquidated after the 2008 economic crisis. These findings suggest that having regional political influence may turn out to be detrimental when faced with a sudden, exogenous shock.
Using representative survey data on manufacturing firms and the official registry data, we study how firms’ political influence at the regional level affects firms’ financial performance. We find that firms with political influence exhibit higher profitability but also retain larger cash holdings. We also find that politically influential firms are not more likely to take bank credit than non-influential ones, but if they do so, they enjoy longer maturities. Furthermore, after conditioning on the level of the regional institutional development we find that the significant impact of the firms’ regional political influence is present only in regions with poor institutions and is almost absent in the regions with high level of democracy/market freedom. Most importantly, we are able to show that firms that were influential in 2004 during the survey had a higher probability to be liquidated after the 2008 economic crisis. These findings suggest that having regional political influence may turn out to be detrimental when faced with a sudden, exogenous shock.
Carsten Sprenger
ICEF, Higher School of Economics, Moscow (co-author: Olga Lazareva, Faculty of Economics, Higher School of Economics)
Corporate Governance and Investment: Evidence from Russian Non-Listed Firms
This paper investigates the effect of corporate governance 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. As there are no readily available corporate governance indicators for such firms, we develop an original index based on survey questions on shareholder protection (including activity and composition of the board of directors), as well as on transparency and disclosure. The main result is that better shareholder protection diminishes the cash flow sensitivity of investment in firms with low ownership concentration. We also find that ownership concentration lowers cash flow sensitivity and that shareholder protection and ownership concentration act as substitute mechanisms in this process. State ownership is associated with lower investment and reduced cash flow sensitivity. We address the problem of endogeneity of corporate governance by using an instrumental variable approach that relies on legal provisions on corporate governance based on the number of shareholder of a firm. The results confirm the main result.
This paper investigates the effect of corporate governance 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. As there are no readily available corporate governance indicators for such firms, we develop an original index based on survey questions on shareholder protection (including activity and composition of the board of directors), as well as on transparency and disclosure. The main result is that better shareholder protection diminishes the cash flow sensitivity of investment in firms with low ownership concentration. We also find that ownership concentration lowers cash flow sensitivity and that shareholder protection and ownership concentration act as substitute mechanisms in this process. State ownership is associated with lower investment and reduced cash flow sensitivity. We address the problem of endogeneity of corporate governance by using an instrumental variable approach that relies on legal provisions on corporate governance based on the number of shareholder of a firm. The results confirm the main result.
Bart Taub
Adam Smith Business School, University of Glasgow
Rousseauian contracts: Credit-like characteristics of private-information contracts in continuous time
In a dynamic setting with many agents who have stochastically fluctuating endowments, mutual consumption insurance should be possible. If productivity shocks are unobservable, any mutual insurance contract must depend on the reports of the agents. I establish that the resulting incentive-compatible contract is essentially the same as a credit equilibrium by reconciling the inverse Euler condition that is a central feature of dynamic contract models with the conventional Euler condition that appears in dynamic portfolio models. This equivalence enables me to motivate credit constraints using contract theory considerations.
In a dynamic setting with many agents who have stochastically fluctuating endowments, mutual consumption insurance should be possible. If productivity shocks are unobservable, any mutual insurance contract must depend on the reports of the agents. I establish that the resulting incentive-compatible contract is essentially the same as a credit equilibrium by reconciling the inverse Euler condition that is a central feature of dynamic contract models with the conventional Euler condition that appears in dynamic portfolio models. This equivalence enables me to motivate credit constraints using contract theory considerations.
Mihail Zervos
London School of Economics (co-authors: Ronald W. Anderson, London School of Economics, M. Cecilia Bustamante, University of Maryland, and Stephane Guibaud, London School of Economics)
Agency, Firm Growth and Managerial Turnover
We consider managerial incentive provision under moral hazard in a firm that is subject to stochastic growth opportunities. In the model that we study, managers are dismissed after poor performance as well as when an opportunity to improve the firm's profitability that requires a change of management arises. The optimal contract may induce managerial entrenchment, whereby, ex post-attractive growth opportunities are foregone after good performance because of contractual commitments. Realized growth depends on the frequency and size of growth opportunities as well as on the severity of moral hazard. The prospect of growth-induced turnover limits the firm's ability to rely on deferred compensation as a disciplinary device.
We consider managerial incentive provision under moral hazard in a firm that is subject to stochastic growth opportunities. In the model that we study, managers are dismissed after poor performance as well as when an opportunity to improve the firm's profitability that requires a change of management arises. The optimal contract may induce managerial entrenchment, whereby, ex post-attractive growth opportunities are foregone after good performance because of contractual commitments. Realized growth depends on the frequency and size of growth opportunities as well as on the severity of moral hazard. The prospect of growth-induced turnover limits the firm's ability to rely on deferred compensation as a disciplinary device.
Have you spotted a typo?
Highlight it, click Ctrl+Enter and send us a message. Thank you for your help!
To be used only for spelling or punctuation mistakes.