Fifth International Moscow Finance Conference

Private Money Creation and Equilibrium Liquidity

Can a perfectly competitive issuance of private money fulfill the liquidity needs of the economy? The answer is no. Multiple equilibria are possible: there exist good equilibria with complete satiation of liquidity and absence of default on private money, and bad equilibria characterized by a shortage of liquidity and default. Capital requirements improve welfare provided that leverage is neither too high nor too low. Liquidity regulation can be counterproductive. Government intervention during liquidity crises is beneficial unless fiscal capacity is limited.

Retail-banking Currency Trading

This paper develops a rational model to examine retail-banking currency trading. In this model, one risky asset is exchanged for a riskless asset between a bank and its customers. The bank posts an ask and a bid quote, and executes customers’ upcoming orders to buy or sell the risky asset at these quotes. For realism, customers are less informed than the bank about the true value of the risky asset, and hold heterogeneous beliefs about this value. In equilibrium, the width of the spread between the bid and ask quotes depends on the smallness of the support of the risky-asset distribution, which often goes together with how small the volatility of the risky asset is. For a sufficiently small support of the risky-asset distribution, the spread between the bid and ask quotes is always wide, whereas for larger distribution supports, the spread may partly shrink. This equilibrium result contrasts with the view that greater volatility of the risky asset triggers wider bid-ask spreads.

Who Wants to Be an Entrepreneur? Financial Development and Occupational Choice

Theory suggests that access to finance facilitates entrepreneurship. However, evidence from randomized surveys of over one million individuals in India show instead that financial access shifts workers away from micro-entrepreneurship into wage employment. Identifying access to finance using bank branch location determined by government policy, we find that individuals living in a district with greater access to finance are significantly less likely to be entrepreneurs in micro-enterprises and more likely to be formally employed. This shift is more pronounced for more educated workers, and those living urban areas. The results also show that individuals are paid higher wages on average in districts with more bank branches, which is driven by those engaged in formal employment. To establish the firm-level channel, we use randomized surveys of over 400,000 service sector firms, and find that firms located in districts with more bank branches have significantly higher bank loans. The results show that access to finance does benefit a certain group of entrepreneurs: large, formal sector firms are more productive, employ more workers, and pay higher wages on average in more financially developed districts. Our results suggest a mechanism by which financial development facilitates economic growth: by moving workers out of less productive, informal entrepreneurial activity into formal jobs in more productive firms.

Product Market Competition, Capital Constraints, and Firm Growth

We examine the impact of product market competition on quantity-of-capital constraints in 58 countries. Prior work shows that competition increases the costs of debt and equity, which reduce the economic profit from investment. Capital constraints, however, may prevent firms from exploiting all positive NPV projects. Using econometric techniques and unique survey data, we avoid endogeneity problems common to the study of both capital constraints and product market competition. We find that product market competition increases capital constraints and it is a more important determinant of capital constraints than banking competition. Finally, we show that quantity-of-capital constraints negatively impact firm growth.

Operational and Financial Hedging: Evidence from Trade

We use hand-collected data on a sample of German public firms during 2011-2014 to show that firms use currency derivatives more often when they export or import, and especially when exchange-rate fluctuations are larger, but to a lesser extent when having high export and import shares simultaneously. We interpret this finding as evidence of operational hedging arising as foreign-denominated revenues and costs match, substituting for financial hedging. Our identification strategy uses both cross-sectional heterogeneity in exchange-rate exposures and time-series variation in exchange-rate fluctuations. Our results highlight the importance of examining operating strategies as integral determinants of corporate financing policies.

Relationship Trading in OTC Markets

We examine the network of bilateral trading relations between insurers and dealers in the over-the-counter corporate bond market. Using comprehensive regulatory data we find that many insurers use only one dealer while the largest insurers have a network of up to eighty dealers. To understand the heterogeneity in network size we build a model of decentralized trade in which insurers trade off the benefits of repeat business against more intense dealer competition. Empirically, large insurers form more relations and receive better prices than small insurers. The model matches both the distribution of insurers’ network sizes and how prices depend on insurers’ size and the size of their dealer network.

Misvaluation of Investment Options

We study whether investment options are fairly priced by market participants. Forthis purpose, we build and estimate a real options model of optimal investment in the presence of demand uncertainty. We then classify stocks into undervalued and overvalued based on the difference between observed and model-implied firm values. A long-short strategy that buys stocks classified as the most undervalued by the model and shorts the most overvalued stocks generates annualized alphas from major asset pricing models that range between 10% and 17% for value-weighted portfolios. This relation between estimated misvaluation and future returns is only present within subsamples of firms with relatively high fractions of investment options to existing assets. We interpret these findings as evidence of investors having difficulties in valuing investment options, leading to mispricing in equity markets that is gradually corrected over time.

Gender Composition of Corporate Boards and Firm Performance: Evidence from Russia

This paper studies economic effects of the gender composition of corporate boards in Russia. It takes advantage of a new and unique longitudinal dataset of virtually all Russian companies whose shares were traded in the RTS/MICEX/MOEX in 1998-2014. Using multiple identification approaches, alternative measures of gender diversity and several performance measures, we find some evidence that the gender composition of corporate boards matters in Russian firms. In particular, the regression results suggest better performance of companies that have two to three women on the board. This effect appears to be more pronounced in bad economic times/for firms experiencing economic difficulties. The presence of women on the corporate board also seems to strengthen the sensitivity of CEO turnover to past firm performance.

A Trade-off Theory of Ownership and Capital Structure

This paper investigates the ownership connections between two firms, when a tax-bankruptcy trade-off determines their cost of debt. It shows that a hierarchical organization, with a levered parent that fully owns a subsidiary, is optimal when the parent tax rate is sufficiently high. Otherwise, any intercorporate ownership of the multi-unit organization delivers the same value to controlling shareholders. An enriched trade-off, including intercorporate dividend taxes, make horizontal or pyramidal groups value maximizing.

The Fisher Equation Reconsidered: Inside-Outside Money and the Transmission of Monetary Policy in a Simple Model of Banking

According to Alvarez et al. (2001) “Interest rates and inflation,” there exists systematic evidence that increases in average rates of money growth are associated with equal increases in average inflation rates and in interest rates; which conforms to the quantity theory or, alternatively, the Fisher equation. And this is a conundrum, as there is a consensus that inflation can be reduced by increasing short term interest rates. Here, we develop an argument to resolve the conundrum. The Central Bank sets the interbank rate that we identify with the short term rate; commercial banks trade in the interbank market to accommodate flows in balances. The interbank rate, thus, poses a wedge between the return to deposits and the cost of borrowing; which accounts for a negative relation between the short term rate and inflation or, alternatively, between the short term rate and economic activity with no contradiction either with the quantity theory or the Fisher equation.

High-Frequency Trading and Market Quality

We argue that the development of today's high-frequency trading environment derives from traders' desire to be first in exploiting information that is likely also to be possessed by other traders. A key aspect of this environment is that multiple strategic traders act on identical information. Back, Cao and Willard (2000) find that a dynamic equilibrium fails to exist in this setting under the Bayesian Nash Equilibrium (BNE) concept. In this paper, we instead use the concept of Bayesian Stackelberg Equilibrium (BSE) where informed traders are the leaders. We show that a BSE exists with perfectly correlated information and any number of informed traders, which resolves the Back, Cao and Williard puzzle and suggests the BSE concept is better suited to modeling trading in a high-frequency environment. Solving the dynamic version of the model poses significant technical challenges. We develop and apply a new solution method to meet these challenges.