Institutional failure or market failure?

We investigate the effect of the power of creditors, property rights protection, and institutional quality, on bank profits using a panel of 498 banks from 46 countries. Results show that better institutions and stronger property rights protection reduce bank profits, while stronger power of creditors drives up bank profits significantly. Results imply that better institutions and enhanced property rights protection lead to greater flow of credit allowing firms and investors to undertake more profitable ventures. By extension, stronger creditor rights erect steeper barriers to external finance for firms and investors. National indicators of economic freedoms may be more important to lowering the spread than strict creditor rights. Seemingly, credit markets fail when economic institutions fail or when governments intervene into these markets in ways that impede the safety and soundness of financial transactions and private contracting.     

Credit market frictions and the allocation of resources over the business cycle

In a seminal paper, Davis and Haltiwanger (1990) demonstrated that recessions are associated with increased job reallocation. The conventional view has interpreted this as evidence of “cleansing”: less productive jobs are destroyed in recessions, and resources are reallocated to more productive uses. This paper argues instead that in the presence of credit market frictions, reallocation might go the other way, directing resources from more efficient to less efficient uses. This will occur if more efficient production arrangements are also more vulnerable to credit constraints. I show that this pattern arises endogenously in an equilibrium model, and offer some evidence that firms with higher output per worker tend to borrow more, suggesting they are more vulnerable to credit constrains.     

Political connection,market frictions and financial constraints: evidence from China

This paper studies the relationship between market frictions and political connections in determining financial constraints. We develop a novel index to measure the depth of political connections (PC) at the firm level and provide robust empirical evidence that firms in China actively build PC to alleviate the costs of market frictions. Specifically, we find that firms facing severe market frictions are not as financially constrained as expected. This is because these firms also possess strong PC, which alleviate the costs of market frictions. We find that market frictions can significantly affect financial constraints in Chinese firms, but only for those firms with modest levels of PC.     

农村信用社产权制度改革:理论、绩效与出路

农村信用社产权制度改革不仅是一个金融问题,而且是一个复杂的社会问题.长期以来我国农村信用社按照合作制进行规范绩效差的主要原因是,农村信用社产权制度改革的国家偏好和农民的接受程度之间存在着巨大的矛盾.文章建议通过稳定农村信用社的经营、拉长农村信用社产权制度改革的周期、完善农村信用社产权制度改革的外部环境、增加农村信用社产权制度改革的途径等四个方面的措施来推动我国农村信用社的产权制度改革.     

Government spending,political cycles,and the cross section of stock returns

Using a novel measure of industry exposure to government spending, we show predictable variation in cash flows and stock returns over political cycles. During Democratic presidencies, firms with high government exposure experience higher cash flows and stock returns, while the opposite pattern holds true during Republican presidencies. Business cycles, firm characteristics, and standard risk factors do not account for the pattern in returns across presidencies. An investment strategy that exploits the presidential cycle predictability generates abnormal returns as large as 6.9% per annum. Our results suggest market underreaction to predictable variation in the effect of government spending policies.     

Traders’ choice between limit and market orders: evidence from NYSE stocks

In this paper, we examine a trader's order choice between market and limit orders using a sample of orders submitted through NYSE SuperDot. We find that traders place more limit orders relative to market orders when: (1) the spread is large, (2) the order size is large, and (3) they expect high transitory price volatility. A rise in informational volatility appears neither to increase nor decrease the placement of limit orders. We also find that a rise in lagged price volatility decreases the size of spread, which is driven by the increase in the placement of limit orders.     

Privatization,financial development,property rights and growth

This study analyzes how prevailing institutional arrangements i.e., property rights, contracting rights, political institutions, and corporate governance practices affect privatized firms’ performance, capital markets development, and economic growth. Most of the studies surveyed show that privatization enhances privatized firms performance, efficiency, and profitability, which percolates to economic growth. Privatized firms performed better in countries with better regulatory and legal frameworks. Partial privatization may be beneficial in countries with weak institutions, namely, the French civil law countries. The stronger the economic and the governing institutions, the easier it is for privatized firms to thrive and contribute to economic growth. Overall, privatization allows firms to achieve improved efficiency while driving the development of the financial sector.     

Redistributive taxation and social insurance under adverse selection in the insurance market

This paper extends the analysis of optimal income taxation under uncertainty studied by Cremer and Pestieau (International Tax and Public Finance, 3, 281–295, 1996). We introduce asymmetric information in the insurance market whereby private insurance companies cannot identify the risk probability of the agents, and we examine its effect on public policy. We consider the separating equilibrium of Rothschild and Stiglitz (Quarterly Journal of Economics, 90, 629–649, 1976) and Riley (Econometrica, 47, 331–359, 1979) where the low risk agent is only partially insured. The presence of the distortion in the insurance market changes the affinity of labor, and in some cases, we show that the scope of redistribution and the resulting social welfare are higher under asymmetric information than under full information. We also show that the increase in social insurance affects the utility and labor incentive of the low risk type by relaxing the self-selection constraint in the insurance market. The policy implications of the redistributive taxation and social insurance are analytically and numerically examined.      

Adverse selection in the annuity market with sequential and simultaneous insurance demand

This paper investigates the effect of adverse selection on the private annuity market in a model with two periods of retirement and two types of individuals, who differ in their life expectancy. In order to introduce the existence of time-limited pension insurance, we consider a model where for each period of retirement separate contracts can be purchased. Demand for the two periods can be decided sequentially or simultaneously. We show that only a situation where all risk types choose sequential contracts is an equilibrium and that this outcome is favourable for the long-living, but is unfavourable for the short-living individuals. JEL Classification D82 · D91 · G22     

Audit opinions and information asymmetry in the stock market

This study analyses the relationship between the content of the audit reports and information asymmetry levels in the stock market for a sample of Spanish firms. By implementing an association study, we document (1) that firms with audit qualifications show higher information asymmetry levels than those with unqualified opinions; (2) firms with non‐quantified qualifications show higher informational asymmetry than firms with quantified qualifications; and (3) we find a stronger effect on the level of informational asymmetry in the case of going concern qualifications. Our findings suggest that audit qualifications reporting more uncertainty on firm accounting statements result in higher adverse selection risk.     

Price impact and bursts in liquidity provision

This paper analyses brief episodes of high-intensity quote turnover and revision—‘bursts’ in quotes—in the US equity market. Such events occur very frequently, several hundred times a day for actively traded stocks. We find significant price impact associated with these market maker initiated events, about five times higher than during non-burst periods. Bursts in quotes are concurrent with short-lived structural breaks in the informational relationship between market makers and market takers. During bursts, market makers no longer passively impound information from order flow into quotes—a departure from the traditional market microstructure paradigm. Rather, market makers significantly impact prices during bursts in quotes. Further analysis shows that there is asymmetry in adverse selection between the bid and ask sides of the limit order book and only a sub-population of market makers enjoys an informational advantage during bursts. Market makers on the side opposite the burst suffer elevated adverse selection costs, while market makers on the side of the burst realize positive spread, irrespective of the order flow direction. Our results call attention to the need for a new microstructure perspective in understanding modern high-frequency limit order book markets and the quote manipulation strategies at the disposal of the fast market makers.     

Adverse selection and the market for annuities

Adverse selection is often blamed for the malfunctioning of the annuities market. We simulate the impact of adverse selection on the consumption allocation of annuitants under alternative parameter values, and explore the resulting welfare implications. We show that, for most parameter values, the welfare losses associated with equilibriums that are subject to adverse selection correspond to a loss of wealth of around one percent in a first-best equilibrium. These losses are smaller than the corresponding losses associated with equilibriums with no access to an annuity market by an order of magnitude of ten. The existence of substitutes for annuities such as a bequest motive or a social security system intensifies the adverse selection but reduces its welfare impact.

City goes dark: Dark trading and adverse selection in aggregate markets

We investigate the impact of dark trading on adverse selection in an aggregate market for trading UK stocks. Dark trading is linked to lower adverse selection risk and improved informational efficiency and liquidity in the aggregate market, even as liquidity declines in the lit market with dark trading. However, there is a trading value-based threshold when dark trading starts to induce adverse selection. We estimate that this threshold varies from around 9% for the most liquid stocks to 25% for the least liquid stocks. The overall average threshold for the 288 FTSE 350 stocks in our sample is 14%.     

Expropriation risk and technology

This paper develops a unified framework to analyze the dynamics of firm investment in countries with poor legal enforcement. The firm's technology edge over the government generates endogenous property rights. Industry variation in the technology gap predicts a sectoral pecking-order of expropriations. Long-run investment distortions may be Pareto superior relative to persistent investment at the static optimum. The dynamics of investment and transfers depend on whether incentives (backloading) or efficiency (frontloading) concerns dominate at the initial division of surplus. An increase in government efficiency may reduce its welfare. The model provides a technology-driven rationale for the widespread use of conglomerate structures in emerging market countries.     

The impact of short-selling and margin-buying on liquidity: Evidence from the Chinese stock market

We propose a framework based on limit order book to analyze the impact of short-selling and margin-buying on liquidity. We show that when short-sellers are perceived as informed, adverse selection may lead to uninformed traders withdrawing their limit orders. Given that the Chinese stock market has strong information asymmetry and a high proportion of uninformed traders, we predict that the pilot program launched in March 2010, which lifts restrictions on short-selling and margin-buying for a designated list of stocks, may have a negative impact on liquidity. We perform difference-in-differences tests and show evidence that allowing for short-selling and margin-buying indeed has a significantly negative impact on liquidity for stocks on the designated list. In particular, the negative impact on liquidity is more pronounced for stocks with high information asymmetry. Nevertheless, when short-selling volume dries up due to regulation changes in August 2015, i.e., the “T+1” trading rule on short-selling, we show that consistent with model predictions, lifting restrictions on short-selling and margin-buying has a positive effect on liquidity.     

The impact of foreign equity flows on market volatility during politically tranquil and turbulent times: The Egyptian experience

Since the popular uprising of January 2011, a series of momentous events has rocked Egypt’s political order, jeopardising the country’s economic and financial stability. This study examines the role of foreign capital flows in the volatility of the Egyptian equity market, and whether this role has changed due to the recent domestic political unrest. These issues are empirically addressed in the context of GMM estimation. The results suggest that, unlike those of foreign individual investors, trades of foreign institutional investors contribute to market fluctuations, whether prior to or following the January 2011 uprising. Sell trades by foreign individual and institutional investors exert a significant influence on volatility. Further, when volume is split into its anticipated and unanticipated components, the results show that surprises in trading activity by either group tend to exacerbate volatility in periods of calm and turmoil. These findings are broadly insensitive to volatility measures and robust, even after controlling for a variety of relevant determinants of market volatility. The evidence documented in this study provides important implications for policy markers.     

Risk selection in the London political risk insurance market: the role of tacit knowledge,trust and heuristics

This study demonstrates that the basis of decision-making and risk selection in the London Political Risk Insurance (PRI) market is a combination of Art and Science with such factors as trust and reputation playing an important role. The study breaks new ground by uncovering and examining different methods and strategies of political risk underwriting employed in the insurance market, which does not rely on statistical tools as seen in more traditional insurance types. Adopting a grounded theory approach, the data was generated through 14 semi-structured and unstructured interviews conducted with PRI experts from five PRI companies and two leading political risk broking houses. The data also included documentation reviews and observations.     

Data preprocessing and data parsimony in corporate failure forecast models: evidence from Australian materials industry

The present study, based on data for delisted and active corporations in the Australian materials industry, is an attempt to develop a systematic way of selecting corporate failure‐related features. We empirically tested the proposed procedure using three datasets. The first dataset contains 82 financial economic factors from the corporation's financial statement. The second dataset comprises 73 relevant financial ratios, which either directly or indirectly measure a corporation's propensity to fail, and are conciliated from the first dataset. The third dataset is a parsimonious dataset obtained from the application of combining a filter and a wrapper to preprocess the first dataset. The robustness of this preprocessed dataset is tested by comparing its performance with the first and second datasets in two statistical (logistic regression and naïve‐Bayes) and two machine learning (decision tree, neural network) classes of prediction models. Tests for prediction accuracies and reliabilities, using the computational (ROC curve, AUC) and the statistical (Cochran's Q statistic) criteria show that the third dataset outperforms the other two datasets in all four predicting models, achieving various accuracies ranges from 81 per cent to 84 per cent.