Flow and stock effects of large-scale treasury purchases: Evidence on the importance of local supply

The Federal Reserve’s 2009 program to purchase $300 billion of US Treasury securities represented an unprecedented intervention in the Treasury market and provides a natural experiment with the potential to shed light on the price elasticities of Treasuries and theories of supply effects in the term structure. Using security-level data on Treasury prices and quantities during the course of this program, we document a ‘local supply’ effect in the yield curve—yields within a particular maturity sector responded more to changes in the amounts outstanding in that sector than to similar changes in other sectors. We find that this phenomenon was responsible for a persistent downward shift in yields averaging about 30 basis points over the course of the program (the “stock effect”). In addition, except at very long maturities, purchase operations caused an average decline in yields in the sector purchased of 3.5 basis points on the days when those operations occurred (the “flow effect”). The sensitivity of our results to security characteristics generally supports a view of segmentation or imperfect substitution within the Treasury market during this time.     

Integration of Trans-Atlantic Capital Markets, 1790-1845

During the 1790s, European investors began to purchase substantial quantities of US government and corporate securities. A number of these securities were traded in markets on both sides of the Atlantic. Based on market price quotations we compiled for the same securities in London and New York markets, we ask if these early trans-Atlantic securities markets were integrated, and, if so, when they became integrated. We find little evidence of market integration before 1816, and substantial evidence of it thereafter. Financial globalization - the convergence of financial asset prices in markets on different continents - began earlier than most have suspected.     

Portfolio rebalancing and the transmission of large-scale asset purchase programs: Evidence from the Euro area

The European Central Bank's large-scale asset purchase program targeted safe assets, but also aimed to impact prices of risky assets. The mechanism for this is the “portfolio rebalancing channel”, where financial institutions’ portfolio decisions impact financial prices more broadly. We examine this mechanism using cross-sectional heterogeneity in how the financial portfolios of different sectors of the European economy were affected around the purchase program. We find evidence of rebalancing. In vulnerable countries, where macroeconomic unbalances and relatively high risk premia remained, we document rebalancing towards riskier securities. In less vulnerable countries, based on granular information for large European banks, we document rebalancing toward bank loans.     

The relationship between house prices and house purchase loans: The Spanish case

This paper looks at recent developments in house purchase loans and house prices in Spain and the linkages between them. It aims at identifying deviations of these variables from their equilibrium levels, and for this purpose, we estimate a vector error-correction model. The results show that both variables are interdependent in the long-run and that both variables were above their equilibrium level by the end of the sample period (2009:Q1). The paper also offers insight into how overvaluation (overindebtedness) in house prices can lead to a false sense of no overindebtedness (house prices overvaluation).     

The shortage of safe assets in the US investment portfolio: Some international evidence

This paper develops a Bayesian Global VAR (GVAR) model to track the international transmission dynamics of two stylized shocks, namely a supply and demand shock to US-based safe assets. Our main findings can be summarized as follows. First, we find that (positive) supply-sided shocks lead to pronounced increases in economic activity which spills over to foreign countries. The impact of supply-sided shocks can also be seen for other quantities of interest, most notably equity prices and exchange rates in Europe. Second, a demand-sided shock leads to an appreciation of the US dollar and generally lower yields on US securities, forcing investors to shift their portfolios towards foreign fixed income securities. This yields sizable positive effects on US output, equity prices and a general decrease in financial market volatility.     

A model of a systemic bank run

This paper provides a model of the view that the 2008 financial crisis is reminiscent of a bank run, focussing on six stylized key features. In particular, core financial institutions have invested their funds in asset-backed securities rather than committed to long-term projects: in distress, these can potentially be sold to a large pool of outside investors at steep discounts. I consider two different motives for outside investors and their interaction with banks trading asset-backed securities: uncertainty aversion versus adverse selection. I shall argue that the version with uncertainty averse investors is more consistent with the stylized facts than the adverse selection perspective: in the former, the crisis deepens, the larger the market share of distressed core banks, while a run becomes less likely instead as a result in the adverse selection version. Therefore, the outright purchase of troubled assets by the government at prices above current market prices may both alleviate the financial crises as well as provide tax payers with returns above those for safe securities.     

Credit market shocks and economic fluctuations: Evidence from corporate bond and stock markets

To identify disruptions in credit markets, research on the role of asset prices in economic fluctuations has focused on the information content of various corporate credit spreads. We re-examine this evidence using a broad array of credit spreads constructed directly from the secondary bond prices on outstanding senior unsecured debt issued by a large panel of nonfinancial firms. An advantage of our “ground-up” approach is that we are able to construct matched portfolios of equity returns, which allows us to examine the information content of bond spreads that is orthogonal to the information contained in stock prices of the same set of firms, as well as in macroeconomic variables measuring economic activity, inflation, interest rates, and other financial indicators. Our portfolio-based bond spreads contain substantial predictive power for economic activity and outperform—especially at longer horizons—standard default-risk indicators. Much of the predictive power of bond spreads for economic activity is embedded in securities issued by intermediate-risk rather than high-risk firms. According to impulse responses from a structural factor-augmented vector autoregression, unexpected increases in bond spreads cause large and persistent contractions in economic activity. Indeed, shocks emanating from the corporate bond market account for more than 30 percent of the forecast error variance in economic activity at the two- to four-year horizon. Overall, our results imply that credit market shocks have contributed significantly to US economic fluctuations during the 1990-2008 period.     

Daily Changes in Fed Funds Futures Prices

This paper explores the properties of daily changes in the prices for near-term fed funds futures contracts. The paper finds these contracts to be excellent predictors of the fed funds rate, and shows that the claim of a nonzero term premium in the short-horizon contracts is more sensitive to outliers than previous research appears to have recognized. I find some statistically significant evidence of serial correlation in the daily changes, but this accounts for only a tiny part of the 1-day movements and there is essentially zero predictability for horizons longer than 1 day. Settlement futures prices for each day appear to incorporate the information embodied in that day's term structure of longer-horizon Treasury securities. Previous employment growth makes a statistically significant contribution to predicting futures price changes, though again this could only account for a tiny part of the daily variance. The paper concludes that futures prices provide a very useful measure of the daily changes in the market's expectation of near-term changes in Fed policy.     

Endogenous informed trading in the presence of trading costs: Theory and evidence

The basic premise of the model we propose is that market frictions (trading costs) force traders with market-wide information to strategically choose which securities to trade in. We study the effect of recognizing trading costs on the choices of informed traders and the resulting statistical properties of security prices. Specifically, we show that (1) stocks with intermediate β's have the least informative prices, even though they are traded by the greatest number of informed traders; (2) for high β securities, the contemporaneous correlation of prices is close to the correlation in fundamental values; (3) a security with a higher β, higher volume of liquidity trading and lower idiosyncratic variance is more likely to lead another security. With market capitalization as a proxy for the level of liquidity trading, these specific predictions of the model on the lead–lag relationship are also shown to be strongly supported by the data.     

Piecing together the extent of retail fractional trading

We examine the introduction of fractional trading and its impact on retail security ownership. Fractional trading aims to increase investor access to securities with high prices. Over the initial months of Robinhood’s fractional trading program, the number of unique owners increases approximately 53 percentage points more for stocks priced above $100 versus those priced below $50. Intraday, high-price stocks exhibit incremental ownership growth specifically during periods when fractional trading is permitted. Our results show that Robinhood investors make ample use of fractional trading to acquire previously inaccessible securities, indicating a substantial reduction in price-based investing frictions and carrying implications for retail portfolio management. In addition, we show that potential market impacts of fractional trading appear negligible based on share volume data from multiple brokers with fractional trading programs.     

Perpetual securities and stock prices: Korean evidence

Perpetual securities are classified as equity under the International Financial Reporting Standards, but various contract terms embedded in the securities create additional debt- and equity-like characteristics. This study examines whether stock market investors differentiate between diverse contract attributes. Using quarterly data on listed non-financial firms in the Korea Exchange that issued perpetual securities during 2012–2020, we document the following findings. First, perpetual securities are positively associated with stock prices. Second, the positive association is driven by perpetual securities convertible to stocks rather than non-convertible ones. Third, when further decomposing convertible perpetual securities based on whether the conversion price is fixed or floating, only fixed-priced convertibles show a positive association with stock prices. Overall, our findings suggest that equity investors consider the detailed contract attributes important for financial instruments.     

Ex Ante Skewness and Expected Stock Returns

We use option prices to estimate ex ante higher moments of the underlying individual securities’ risk‐neutral returns distribution. We find that individual securities’ risk‐neutral volatility, skewness, and kurtosis are strongly related to future returns. Specifically, we find a negative (positive) relation between ex ante volatility (kurtosis) and subsequent returns in the cross‐section, and more ex ante negatively (positively) skewed returns yield subsequent higher (lower) returns. We analyze the extent to which these returns relations represent compensation for risk and find evidence that, even after controlling for differences in co‐moments, individual securities’ skewness matters.     

Commercial banks in investment banking conflict of interest or certification role?

When commercial banks make loans to firms and also underwrite securities, does this hamper or enhance their role as certifiers of firm value? This paper examines empirically the pricing of bank-underwritten securities as compared to investment-house-underwritten securities over a unique period in the U.S. (pre-Glass-Steagall) when both banks and investment houses were allowed to underwrite securities. The evidence shows that investors were willing to pay higher prices for securities underwritten by banks rather than investment houses. The results support a certification role for banks, which is more valuable for junior and information sensitive securities.     

The dark side of financial innovation: A case study of the pricing of a retail financial product

The offering prices of 64 issues of a popular retail structured equity product were, on average, almost 8% greater than estimates of the products' fair market values obtained using option pricing methods. Under reasonable assumptions about the underlying stocks' expected returns, the mean expected return estimate on the structured products is slightly below zero. The products do not provide tax, liquidity, or other benefits, and it is difficult to rationalize their purchase by informed rational investors. Our findings are, however, consistent with the recent hypothesis that issuing firms might shroud some aspects of innovative securities or introduce complexity to exploit uninformed investors.     

ARE TREASURY INFLATION PROTECTED SECURITIES REALLY TAX DISADVANTAGED?

In 1997, the U.S. Treasury introduced Inflation Protected Securities, commonly known as TIPS. Several in the finance field have since described these securities as “tax disadvantaged” relative to conventional securities, leading to serious questions regarding their appropriateness outside of tax‐deferred accounts. In this article, we develop a framework that demonstrates that at least in a real sense the tax treatment of TIPS is trivially different from that of conventional Treasury securities. Moreover, empirically we find evidence that TIPS generally have after‐tax yields comparable to, if not exceeding, conventional fixed‐rate Treasury securities. We also show that TIPS have generally outperformed matched‐maturity conventional Treasury securities in terms of after‐tax rates of return.     

Raising rival's costs in the securities settlement industry

The competition between a central securities depository (CSD) and a custodian bank is analyzed in a Stackelberg model. Investor banks decide whether to use the services of the CSD or of the custodian bank, depending on the prices and their preferences for their inhomogeneous services. Since the custodian bank uses services provided by the CSD as input, the CSD can raise its rival's costs. The CSD's equilibrium market share is higher than socially optimal, unless the CSD is not allowed to charge negative prices. This result has important policy implications that are related to a discussion currently taking place in the securities settlement industry.     

Related securities and price discovery: Evidence from NYSE-listed Non-U.S. stocks

In this paper we analyze whether handling related securities improves a market maker's information environment and helps to incorporate new information in stock prices. Our empirical tests are focused on New York Stock Exchange specialists and the U.S. share in price discovery of 64 British and French companies cross-listed on the NYSE. We define related securities as stocks from the same country, the same region, or other foreign stocks. We find strong evidence that a higher prominence of related stocks in the specialist portfolio is associated with a higher U.S. share in price discovery of our sample firms. We interpret our findings as evidence that concentrating market makers in similar stocks reduces information asymmetries and improves the information environment as market makers can extract information relevant to a stock from order flow to related securities. To support our argument, we show that the adverse selection component of the bid–ask spread is negatively related to the prominence of other foreign stocks in the specialist portfolio.     

Banking in the theory of finance

Banks are financial intermediaries that issue deposits and use the proceeds to purchase securities. This paper argues that when banking is competitive, these portfolio management activities in principle fall under the Modigliani-Miller theorem on the irrelevance of pure financing decisions. It follows that there is no need to control the deposit creation or security purchasing activities of banks to obtain a stable general equilibrium with respect to prices and real activity. In practice, however, banks are forcibly involved in the process by which a pure nominal commodity or unit of account is made to play the role of numeraire in a monetary system. The paper examines the nature of such a nominal commodity and how, through reserve requirements, banks get involved in making it a real economic good.     

Barriers to international investing and market segmentation: Evidence from Indian GDR market

In this paper we evaluate market segmentation and its effect on the pricing of cross-listed securities using Indian Global Depositary Receipts (GDRs). When international capital markets are segmented, cross-listed securities may trade at different prices. We test this market segmentation hypothesis using a theoretical and empirical model developed along the lines of Hietala [Hietala, P.T., 1989, Asset pricing in partially segmented markets: Evidence from the Finnish market, Journal of Finance 44, 697–718]) and Foerster and Karolyi [Foerster, S.R., Karolyi, A.G., 1999, The effects of market segmentation and investor recognition on asset prices: Evidence from foreign stocks listing in the United States, Journal of Finance 54, 981–1013; Foerster, S.R., Karolyi, A.G., 1999, The long-run performance of global equity offerings, Working Paper, Ohio State University]. Our model looks at a specific type of market segmentation in India, where capital flow barriers are such that domestic investors are allowed to invest only in domestic securities, while the foreign investors can invest in dollar-denominated Indian GDRs as well as other foreign securities. Tests on these GDRs indicate that foreign investors, who hold these depositary receipts, estimate the expected returns at a lower level than the domestic investors do. This leads to the GDRs being priced at a premium over the exchange rate adjusted prices of the underlying Indian securities. GDR index returns are affected by both domestic and international factors, while the underlying Indian securities are affected only by domestic variables.     

The role of the media in disseminating insider-trading news

We use the process through which insider trading (SEC Form 4) filings are made public to investigate whether media coverage affects the way securities markets assimilate news. To do this, we use recent changes in disclosure rules governing insider trades as well as the initiation of coverage by Dow Jones to cleanly identify media effects. Using high-resolution intraday data, we find clear effects of media dissemination on the way prices and volume respond to insider trading news in the minutes after its release. These results help to resolve open questions regarding the role of the media in capital markets, including why apparently second hand news affects securities prices.