Has the CDS market lowered the cost of corporate debt?

Many have claimed that credit default swaps (CDSs) have lowered the cost of debt financing to firms by creating new hedging opportunities and information for investors. This paper evaluates the impact that the onset of CDS trading has on the spreads that underlying firms pay to raise funding in the corporate bond and syndicated loan markets. Employing a range of methodologies, we fail to find evidence that the onset of CDS trading lowers the cost of debt financing for the average borrower. Further, we uncover economically significant adverse effects on risky and informationally opaque firms.     

What does PIN identify? Evidence from the T-bill market

The probability of informed trading (PIN) measure has been increasingly used in empirical research in finance. However, there is a growing debate as to whether PIN measures information-based or liquidity-based trading. We contribute to the discussion by estimating PIN using transaction data for one-month T-bills. Our PIN estimates exceed those reported for equities, despite it being unlikely that the probability of informed trading is higher in T-bills than equities. We conclude that PIN identifies trading clusters and that the source of the clustering depends on the economics of the market. The economics of the T-bill market suggest discretionary liquidity traders are the likely source of the clustering.     

Does product market competition affect corporate governance? Evidence from corporate takeovers

We examine the extent to which shareholders strategically allow a weak governance structure in response to increasing competition pressures in the product market. We treat acquisitions by rival firms as shocks that increase threats in a competitive product market. We find that firms adopt greater entrenchment provisions when there are greater competition threats. Moreover, firms with high institutional ownership – especially by dedicated investors – and​ board independence within the compensation committee are particularly aggressive, which is consistent with our theory that aggressive behavior represents a strategic decision by shareholders. Finally, we find positive relationship between the adoption of entrenchment provisions and firm’s future performance, but only for the adoption under relatively severe competitive pressures.     

Did CDS trading improve the market for corporate bonds?

Financial innovation through the creation of new markets and securities impacts related markets as well, changing their efficiency, quality (pricing error), and liquidity. The credit default swap (CDS) market was undoubtedly one of the salient new markets of the past decade. In this paper we examine whether the advent of CDS trading was beneficial to the underlying secondary market for corporate bonds. We employ econometric specifications that account for information across CDS, bond, equity, and volatility markets. We also develop a novel methodology to utilize all observations in our data set even when continuous daily trading is not evidenced, because bonds trade much less frequently than equities. Using an extensive sample of CDS and bond trades over 2002–2008, we find that the advent of CDS was largely detrimental. Bond markets became less efficient, evidenced no reduction in pricing errors, and experienced no improvement in liquidity. These findings are robust to various slices of the data set and specifications of our tests.     

The Jarrow/Turnbull default risk model—Evidence from the German market

Abstract

This article estimates default intensities within the continuous-time Jarrow and Turnbull model for German bank and corporate bond prices. It is shown that a joint implicit estimation of the default intensity and the recovery rate is numerically unstable. In addition to cross-sectional estimations, separate estimations (for each bond individually) are performed. Results strongly support separate estimation over the building of any cross-sections. In contrast to preceeding literature, the optimum volume of data required to provide reasonable estimates of the default intensity is also investigated. It is shown that calibration based on daily data as a rule does not minimize the ex ante mean squared pricing errors. Finally, it is shown that the constant default intensity assumption is not sound with the underlying data and the determinants of the default intensity are investigated. Regressions show that the lagged default intensity estimate, the level of the default-free term structure and liquidity proxies affect the estimated default intensity via joint parameters.     

Idiosyncratic volatility vs. liquidity? Evidence from the US corporate bond market

Our objective in this paper is to determine empirically the extent to which fixed-income investors are concerned about the relative effects of equity volatility and bond liquidity in the cross-section of corporate bond spreads. Our tests reveal that while both volatility and liquidity effects are significant, volatility, representing ex-ante credit shock, has the first-order impact, and liquidity represented by bond characteristics and price impact measure has the secondary impact on bond spreads. Conditional analysis further reveals that distressed bonds and distress regimes are both associated with significantly higher impact of volatility and liquidity shocks. However, the relative impact of these effects varies conditional on the underlying bond attributes and overall market conditions.     

What drives individual investors in the bear market?

This study uses a unique dataset from a large anonymous brokerage firm to examine the net investment of individual investors during a bear market. The study's empirical evidence reveals that individual investors provide liquidity by acting as net buyers. Particularly, male and younger investors tend to have a higher buying intensity than the others during the market downturn. Besides, better performances when the market crashed encourage investors to be overconfident, thus exhibiting self-attribution bias since we do not find similar results in the bull-market subsample. Results from the stock-level analysis imply that investors tend to buy stocks with worse short-term past performance, higher liquidity, and larger market capitalization. Our findings on the individual investor trading behaviour cannot be explained by either a superior stock-picking ability or a higher tendency to gamble during the market downswing.     

What drives volatility persistence in the foreign exchange market?

We propose a new empirical specification of volatility that links volatility to the information flow, measured as the order flow in the market, and to the price sensitivity to that information. The time-varying market sensitivity to information is estimated from high-frequency data, and movements in volatility can therefore be directly related to movements in order flow and market sensitivity. Empirically, the model explains a large share of the long-run variation in volatility. Importantly, the time variation in the market's sensitivity to information is at least as relevant in explaining the persistence of volatility as the rate of information arrival itself. This may be evidence of a link between changes over time in the aggregate behavior of market participants and the time-series properties of realized volatility.     

What drives the dating game of executive options exercise? Evidence from Taiwan

Examining Taiwanese firms from 2002 to 2008, this paper investigates the motivations behind backdating the exercising of executive stock options. The probability of suspect exercises (backdating) is positively related to the firm’s stock return, the value of the option, tax savings, institutional ownership and the extent of CEO equity ownership and negatively related to firm‐specific risk and the use of Big Four accounting firms. Tax incentives motivate executives to backdate the exercise date, implying that the greater the potential for larger tax savings, the greater the likelihood of backdating. Backdating usually occurs in firms that have heavy ownership by the CEO, have more claims to executive stock options and are not family‐run, confirming the presence of the agency cost problem.     

What drives stochastic risk aversion?

This paper examines determinants of stochastic relative risk aversion in conditional asset pricing models. Novel time-series specification tests are proposed as direct extensions of Guo, Wang, and Yang (2013, JMCB)'s model using nonlinear state-space models with heteroskedasticity. I then establish the following facts. First, the surplus consumption ratio implied by the external habit formation model is the most important determinant of relative risk aversion. Second, the CAY of Lettau and Ludvigson (2001a) without a look-ahead bias and the short term interest rate explain part of relative risk aversion. Third, the estimated risk aversion from 1957Q2 to 2010Q3 is countercyclical and positive. Finally, the selected models explain part of the momentum and the financial distress premiums.     

What drives the market value of firms in the defense industry?

This article assesses the relative importance of different types of news in driving significant stock price changes in the defense industry. We implement a systematic event study with the 58 largest publicly listed companies in the defense industry, over the time period 1995-2005. We first identify, for each firm, the statistically significant abnormal returns over the time period. Then, we look for information releases likely to cause such stock price movements. Most of the key drivers in the defense industry are the same as in other industries (key role of formal earnings announcements and analysts’ recommendations) but we also identify some specific features, in particular the influence of geopolitical events and the relevance and frequency of bids and contracts on stock prices. Finally, we examine the impact of the September 11 terrorist attacks on defense firms.     

Do dividend initiations signal a reduction in risk? Evidence from the option market

We investigate whether dividends convey information about the risk of a company by examining the reaction of implied volatility in the option market to the announcement of a dividend initiation. Implied volatility decreases after the announcement and the magnitude of the decline in volatility is positively related to both the magnitude of cumulative abnormal returns (CAR) in the equity markets and the size of the dividend. Additionally, firms with weaker (stronger) corporate governance experience larger (smaller) declines in implied volatility. Cross sectional analysis shows that a one-standard deviation decline in measures of risk increases the 2-day CAR by 74–137 basis points. Our results suggest that dividend initiations signal declining firm risk.     

Do liquidity and idiosyncratic risk matter? Evidence from the European mutual fund market

This paper examines the interaction of idiosyncratic risk, liquidity and return across time in determining fund performance, as well as across investment style portfolios of European mutual funds. This study utilizes a unique data set including returns for equity mutual funds registered in six European countries. Overall, using monthly data, we find that both liquidity and idiosyncratic risk are relevant in determining mutual fund returns. Our results are robust across different model specifications. We show that model specifications up to six factors are useful as these risk factors capture different aspects in the cross-section of mutual funds returns. The evidence regarding mutual funds subgroups is strongly in favor of the significance of liquidity, and idiosyncratic risk to a lesser extent, as risk factors. Even if liquidity and idiosyncratic risk are considered at the same time, one factor is not significantly decreasing the importance of the other factor.     

Are future capital gain opportunities important in the market for corporate control? Evidence from China

Stock prices of Chinese target companies react positively to the announcement of block trades. Such a reaction is greater when publicly tradable shares (PTS) are transferred than when bidders obtain nonpublicly tradable shares (NPTS). PTS transactions also perform significantly better in the long run than do NPTS transactions. These results suggest that stock liquidity matters for corporate control rights transactions to improve target firms' management. We also find that bidders appoint a new CEO or chief director in more than half of the cases of block trades. Better stock price performance for PTS transactions comes mainly from targets with high Tobin's Q. Capital gain opportunities are likely to motivate bidders to expand target firms' businesses for capital gains.     

Is corporate governance risk valued? Evidence from directors' and officers' insurance

We find that common equity firms pay lower D&O insurance premiums than income trusts, an alternative and riskier ownership form. This result has wide-ranging implications for investors insofar as the information provided by D&O insurers provides investors with an unbiased signal of the firm's governance risk. The signal is unbiased because it comes from an entity (i.e. the insurer) that has a direct financial incentive to correctly assess an organization's governance risk, in contrast to other ad hoc governance measures and indices.     

What explains corporate sukuk primary market spreads?

This study investigates the determining factors of international corporate sukuk pricing in the primary market for the period of 2004–2015. We present novel evidence for a unique data set covering all 63 international corporate sukuk issuances consisting of both a fixed margin rating as well a credit rating score. Our cross-sectional analysis indicates that both credit rating and maturity are significant factors which reduce issue spreads, whereas sukuk margin rating increases issue spreads. More prominently, Shari’ah scholar reputation and the type of sukuk are not statistically significant factors in the explanation of the issue spread. Our results are comparable with determinants of conventional bond pricing, and our findings further confirm existing sukuk market practices.     

Does capital market drive corporate investment efficiency? Evidence from equity lending supply

The increased equity lending supply (ELS) in the equity loan market, available for short sellers to borrow, exposes a firm to greater short selling threats. Considering short sellers' strong incentives to uncover firm-specific information and monitor managers, we hypothesize that short selling threats, proxied by ELS, enhance corporate investment efficiency. We find that ELS significantly reduces managerial tendencies to underinvest (overinvest) especially for firms prone to underinvest (overinvest). The effect of ELS on investment efficiency is stronger for firms with higher information asymmetry and weaker corporate governance, confirming short sellers' role in mitigating information and agency costs. However, short selling risk weakens the effect of ELS. Our evidence is robust to endogeneity checks and suggests that corporate investment can be driven by a particular capital market condition: the amount of lendable shares in the equity loan market.     

What is the risk of European sovereign debt defaults? Fiscal space,CDS spreads and market pricing of risk

We estimate the pricing of sovereign risk for fifty countries based on fiscal space (debt/tax; deficits/tax) and other economic fundamentals over 2005–10. We focus in particular on five countries in the South-West Eurozone Periphery, Greece, Ireland, Italy, Portugal and Spain. Dynamic panel estimates show that fiscal space and other macroeconomic factors are statistically and economically important determinants of sovereign risk. However, risk-pricing of the Eurozone Periphery countries is not predicted accurately either in-sample or out-of-sample: unpredicted high spreads are evident during global crisis period, especially in 2010 when the sovereign debt crisis swept over the periphery area. We match the periphery group with five middle income countries outside Europe that were closest in terms of fiscal space during the European fiscal crisis. Eurozone Periphery default risk is priced much higher than the matched countries in 2010, even allowing for differences in fundamentals. One interpretation is that these economies switched to a “pessimistic” self-fulfilling expectational equilibrium. An alternative interpretation is that the market prices not on current but future fundamentals, expecting adjustment challenges in the Eurozone periphery to be more difficult for than the matched group of middle-income countries because of exchange rate and monetary constraints.     

Is the venture capital market liquid? Evidence from India

This paper models investment duration in the Indian venture capital (VC) market, by industry and exit route. We examined 3416 investment and exit transactions in India during the period 2000–2017 and found that the probability of staying invested for more than ten years was 70%. Exit probabilities were low in most sectors. Investment duration was not positively associated with the investment valuation; rather, it was impossible to exit from the majority of investments because of the illiquidity of the VC market.     

Can habit formation under complete market integration explain the cross-section of international equity risk premia?

In this article, we analyse whether the prominent habit formation model of Campbell and Cochrane (1999) can explain the cross-section of the G7 equity risk premia when formulated under the assumption of complete capital market integration. We test the conditional covariance representation of the model using a combined GARCH and GMM approach in the spirit of Bali (2008) and find that in comparison to the CAPM and the standard power utility CCAPM the habit model has superior explanatory power. It explains more than 90% of the cross-sectional variation in risk premia. Overall, our findings suggest that global consumption-based recession indicators and not returns of reference portfolios are key risk factors driving equity risk premia.