Does the market discipline banks? New evidence from regulatory capital mix

While bank capital requirements permit a bank to freely substitute between equity and subordinated debt, lenders and investors view debt and equity as imperfect substitutes. It follows that, after controlling for the level of regulatory capital, the mix of debt in capital isolates the role that the market plays in disciplining banks. I document that the mix of debt in capital affects bank behavior, but only when investors can impose real constraints. In particular, the mix of debt reduces the probability of failure and future distress for BHC-affiliated institutions (where the investor has control rights through an equity position) and for stand-alone banks before the Basel Accord (when debt issues included restrictive covenants). However, substituting equity for subordinated debt at the bank holding company level or in stand-alone banks since the Basel Accord (where the investor has few protections) only increases the probability of distress and failure.     

Is market fragmentation harming market quality?

We examine how fragmentation is affecting market quality in US equity markets. We use newly available trade reporting facilities (TRFs) data to measure fragmentation, and we use a variety of empirical approaches to compare execution quality and efficiency of stocks with more and less fragmented trading. We find that fragmentation affects all stocks; more fragmented stocks have lower transactions costs and faster execution speeds; and fragmentation is associated with higher short-term volatility but greater market efficiency, in that prices are closer to being a random walk. Our results that fragmentation does not appear to harm market quality are consistent with US markets being a single virtual market with multiple points of entry.     

Policy uncertainty and bank’s funding costs: The effects of the financial crisis,Covid-19 pandemic,and market discipline

This paper examines the impacts of economic policy uncertainty (EPU) on bank funding costs using the 2001–2021 data of US banks. We document consistent evidence of a negative relationship between EPU and bank funding costs, implying lower bank funding costs during a time of high EPU, consistent with the hypothesis that economic agents tend to reallocate their assets into safer investments, such as bank deposits during high uncertainty. Large banks are likely to benefit most during high EPU when experiencing lower costs of funds compared with other banks, suggesting the “too-big-to-fail” perception of depositors. Cross-sectional analysis indicates that depositors require safer banks to pay lower rates, indicating the existence of market discipline. The cost-decreasing effects of policy uncertainty are less pronounced during the global financial crisis than the Covid-19 crisis.     

NASDAQ to mtroduce ETF market

The Nasdaq Stock Market Inc. （NASDAQ） announced on July 4 it will introduce the NASDAQ Exchange Traded Fund （ETF） Market, a market segment designed specifically for ETFs and Index Linked Notes （ILNs）.     

Tangent Lévy market models

In this paper, we introduce a new class of models for the time evolution of the prices of call options of all strikes and maturities. We capture the information contained in the option prices in the density of some time-inhomogeneous Lévy measure (an alternative to the implied volatility surface), and we set this static code-book in motion by means of stochastic dynamics of It?’s type in a function space, creating what we call a tangent Lévy model. We then provide the consistency conditions, namely, we show that the call prices produced by a given dynamic code-book (dynamic Lévy density) coincide with the conditional expectations of the respective payoffs if and only if certain restrictions on the dynamics of the code-book are satisfied (including a drift condition à la HJM). We then provide an existence result, which allows us to construct a large class of tangent Lévy models, and describe a specific example for the sake of illustration.     

Is the market underreacting or overreacting to open market share repurchases? A UK perspective

Using UK open market repurchases, we reject the market underreaction hypothesis and the market overreaction hypothesis proposed by Ikenberry et al. (1995) and Peyer and Vermaelen (2009), respectively. The evidence suggests that the UK market reacts slowly to actual repurchases made by value firms. UK repurchases on average do not suffer from share undervaluation prior to the announcement. Value firms perform just as well as glamour firms during the authorisation period but outperform glamour firms significantly 2 years following the announcement. It turns out that value firms repurchase over 6% more shares than glamour firms during the authorisation period.     

A note on the time–series relationship between market industry concentration and market volatility

Using cross-sectional regression analysis, previous studies provide conflicting results regarding the relationship between market industry concentration and market volatility. This paper investigates this relationship in the time–series. Using data from twenty one developed markets and the world market, we find that this relationship is significant and positive in about 61% of the markets: the more concentrated the market, the more volatile the market. We also find that, in 70% of the markets, there exists a causal relationship between market industry concentration and market volatility and the direction of causality runs from the former to the latter. Our results suggest that market industrial structure is a significant factor in explaining market volatility.     

Does control‐ownership divergence impair market liquidity in an emerging market? Evidence from China

This paper examines how institutional characteristics of emerging economies influence the effect of control‐ownership divergence on market liquidity. We find that the divergence is negatively associated with liquidity and that this negative relationship is more pronounced in firms with more severe agency problems and information asymmetry. We argue that in an emerging market, the negative effect of the divergence on liquidity is worsened by state ownership and poorer shareholder protection, both of which result in more severe agency conflicts; we also find, however, that this effect is alleviated by the NTS reform, which aligns the interest of different shareholders.     

Are corporate bond market returns predictable?

This paper examines the predictability of corporate bond returns using the transaction-based index data for the period from October 1, 2002 to December 31, 2010. We find evidence of significant serial and cross-serial dependence in daily investment-grade and high-yield bond returns. The serial dependence exhibits a complex nonlinear structure. Both investment-grade and high-yield bond returns can be predicted by past stock market returns in-sample and out-of-sample, and the predictive relation is much stronger between stocks and high-yield bonds. By contrast, there is little evidence that stock returns can be predicted by past bond returns. These findings are robust to various model specifications and test methods, and provide important implications for modeling the term structure of defaultable bonds.     

Do jumps mislead the FX market?

This paper investigates the link between jumps in the exchange rate process and rumours of central bank interventions. Using the case of Japan, we analyse specifically whether jumps trigger false reports of intervention (i.e. an intervention is reported when it did not occur). Intraday jumps are extracted using a non-parametric technique recently proposed by Lee and Mykland in 2008 and by Andersen et al. in 2007, and later modified by Boudt et al. in 2011. Rumours are identified by using a unique database of Reuters and Dow Jones newswires. Our results suggest that a significant number of jumps on the YEN/USD have been falsely interpreted by the market as being the result of a central bank intervention. The paper has policy implications in terms of central bank interventions. We show that in times where the central bank is known to intervene, some investors may attach a lot of weight to central bank interventions as a source of exchange rate movement, leading to a false ‘intervention explanation’ for observed jumps.     

Do managers listen to the market?

There are competing theories as to whether managers learn from stock prices. Dye and Sridhar (2002), for example, argue that capital markets can be better informed than the firm itself, while Roll [Roll, R., 1986, “The hubris hypothesis of corporate takeovers,” Journal of Business 59, 97–216.] argues managers may ignore market signals due to hubris. In this paper, we examine whether managers listen to the market in making major corporate investments, and whether agency costs and corporate governance mechanisms help explain managers' propensity to listen. We find that, on average, managers listen to the market: they are more likely to cancel investments when the market reacts unfavorably to the related announcement. Further, we find mixed evidence consistent with the notion that managers' propensity to listen is related to agency costs. We find that firms tend to listen to the market more when more of their shares are held by large blockholders, and when their CEOs have higher pay-performance sensitivities.     

Stock market short-termism—an international perspective

This study uses a VAR approach with a time-varying risk premium to see if stock market investors are short-term oriented, placing too much weight on current and near cash flows. Using aggregate stock market data for Australia, Germany, Japan, USA and UK markets (1977–1999), we find the degree of persistent under-valuation of future cash flows is far higher in the UK relative to the other countries in our sample, and is market-wide. Also, over the period, US investors appear to have consistently underestimated long horizon cash flows in current stock market valuations relative to a rational valuation model.     

Can hedge funds time market liquidity?

We explore a new dimension of fund managers' timing ability by examining whether they can time market liquidity through adjusting their portfolios' market exposure as aggregate liquidity conditions change. Using a large sample of hedge funds, we find strong evidence of liquidity timing. A bootstrap analysis suggests that top-ranked liquidity timers cannot be attributed to pure luck. In out-of-sample tests, top liquidity timers outperform bottom timers by 4.0–5.5% annually on a risk-adjusted basis. We also find that it is important to distinguish liquidity timing from liquidity reaction, which primarily relies on public information. Our results are robust to alternative explanations, hedge fund data biases, and the use of alternative timing models, risk factors, and liquidity measures. The findings highlight the importance of understanding and incorporating market liquidity conditions in investment decision making.     

A cross-currency Lévy market model

The Lévy Libor or market model which was introduced in Eberlein and Özkan (The Lévy Libor model. Financ. Stochast., 2005, 9, 327–348) is extended to a multi-currency setting. As an application we derive closed form pricing formulas for cross-currency derivatives. Foreign caps and floors and cross-currency swaps are studied in detail. Numerically efficient pricing algorithms based on bilateral Laplace transforms are derived. A calibration example is given for a two-currency setting (EUR, USD).     

Do mutual fund managers time market liquidity?

This paper examines mutual fund managers' ability to time market-wide liquidity. Using the CRSP mutual fund database, we find strong evidence that over the 1974–2009 period, mutual fund managers demonstrate the ability to time market liquidity at both the portfolio level and the individual fund level. Liquidity timing predicts future fund performance and the difference in the risk-adjusted returns between top and bottom liquidity-timing funds is approximately 2% per year. Funds exhibiting liquidity-timing ability tend to have longer histories, higher expense ratios, and higher turnover rates.     

Can Warren Buffett forecast equity market corrections?

Warren Buffett suggested that the ratio of the market value of all publicly traded stocks to the Gross National Product could identify potential overvaluations and undervaluations in the US equity market when this ratio deviates above 120% or below 80%. We investigate whether this ratio is a statistically significant predictor of equity market corrections and rallies. We find that Buffett's decision rule does not deliver satisfactory forecasts. However, when we adopt a time-varying decision rule, the ratio becomes a statistically significant predictor of equity market corrections. The two time-varying decision rules are: (i) predict an equity market correction when the ratio exceeds a 95% one-tail confidence interval based on a normal distribution, and (ii) predict an equity market correction when the ratio exceeds a threshold computed using Cantelli's inequality. These new decision rules are robust to changes in the two key parameters: the confidence level and the forecasting horizon. This paper also shows that the MV/GNP ratio performs relatively well against the four most popular equity market correction models, but the ratio is not a particularly useful predictor of equity market rallies.     

Does competition for capital discipline governments? The role of fiscal equalization

This paper examines how a fiscal equalization system affects the disciplining effect of competition for capital among heterogeneous regions in a decentralized economy. I build a model in which regions that are heterogeneous in initial endowments try to attract capital by competing public input that enhances the productivity of capital; meanwhile, a fiscal equalization system is imposed by the central government to reduce regional disparities in fiscal capacity. The key prediction, borne out in data from the German equalization system, is that while competition for capital strengthens discipline in the well-endowed regions, it weakens discipline in the poorly endowed regions. However, a conventional equalization transfer scheme, common to many countries, can be effective in correcting the distortion driven by the heterogeneity of initial endowments across competing regions.     

China's land market auctions: evidence of corruption?

In China, urban land is allocated by leasehold sales by local officials. Attempting to end widespread corruption, the government now requires sales to be conducted publicly, by either English or “two‐stage” auctions. However, corruption persists through the choice of auction format and preauction side deals between favored bidders and local officials. Two‐stage auctions have a first stage where favored developers signal that auctions are “taken,” deterring entry of other bidders. Empirics show that both sales prices and competition are significantly less for two‐stage than English auctions. Selection on unobserved property characteristics is positive: officials divert hotter properties to two‐stage auctions.     

Relative equity market valuation conditions and acquirers’ gains

We examine whether the relative equity market valuation conditions (EMVCs) in the countries of merging firms help acquirers’ managers to time the announcements of both domestic and foreign targets. After controlling for several deal- and merging firm-specific features we find that the number of acquisitions and acquirers’ gains are higher during periods of high-EMVCs at home, irrespective of the domicile of the target. We also find that the higher gains of foreign target acquisitions realized during periods of high-EMVCs at home stem from acquiring targets based in the RoW (=World-G7), rather than the G6 (=G7-UK) group of countries. We argue that this is due to the low correlation of EMVCs between the UK (home) and the RoW group of countries. However, these gains disappear or even reverse during the post-announcement period. Moreover, acquisitions of targets domiciled in the RoW (G6) countries yield higher (lower) gains than acquisitions of domestic targets during periods of high-EMVCs at home. This suggests that the relative EMVCs between the merging firms’ countries allow acquirers’ managers to time the market and acquire targets at a discount, particularly in countries in which acquirers’ stocks are likely to be more overvalued than the targets’ stocks.