Banks, Payments, and Coordination

Banks are modeled as Bryant/Diamond-Dybvig "insurers" against the risk of early consumption. Consumption claims must be verified by clearing and settlement. A clearinghouse does this efficiently as long as banks are sufficiently liquid. If liquidity requirements cannot be enforced against all banks then the threat of panics is necessary to induce banks to hold sufficient liquidity. If the clearinghouse can issue emergency currency, then banks can coexist with less liquid institutions. However, if banks′ return to holding reserves is low during "normal times," then there must be times when the return to liquidity is abnormally high. We associate these episodes with the panics of the National Banking Era. Journal of Economic Literature Classification Numbers: 042, 311, 314.     

JRI, JF, and the Internet: Coauthors, New Authors, and Empirical Research

This article examines how the Internet has changed the work of academic researchers and addresses the question of how expanded Internet usage has affected Journal of Risk and Insurance (JRI) and Journal of Finance (JF) articles, including the shift to empirical research, joint authorship, and new authorship. Internet availability significantly increased joint authorship overall (more for JF than for JRI), shifting upwards a strong secular trend toward working with other researchers. Another big impact of the Internet has been to increase the number of new authors (more for JRI than for JF).     

LARCH, Leverage, and Long Memory

We consider the long-memory and leverage properties of a modelfor the conditional variance of an observable stationary sequence X_t, where is the square of an inhomogeneous linear combination of X_s, s < t, withsquare summable weights b_j. This model, which we call linearautoregressive conditionally heteroskedastic (LARCH), specializes,when depends only on X_t–1, to theasymmetric ARCH model of Engle (1990, Review of Financial Studies3, 103–106), and, when depends only on finitely many X_s, to a version of the quadratic ARCH modelof Sentana (1995, Review of Economic Studies 62, 639–661),these authors having discussed leverage potential in such models.The model that we consider was suggested by Robinson (1991,Journal of Econometrics 47, 67–84), for use as a possiblylong-memory conditionally heteroskedastic alternative to i.i.d.behavior, and further studied by Giraitis, Robinson and Surgailis(2000, Annals of Applied Probability 10, 1002–1004), whoshowed that integer powers , =" BORDER="0">2 can have long-memory autocorrelations. We establish conditionsunder which the cross-autocovariance function between volatilityand levels, , decays in the manner of moving average weights of long-memory processes on suitable choiceof the b_j. We also establish the leverage property that h_t <0 for 0 < t k, where the value of k (which may be infinite)again depends on the b_j. Conditions for finiteness of thirdand higher moments of X_t are also established.     

Risk,return, and dividends

Using only the definition of returns, together with a transversality assumption, we demonstrate that given a dividend process, any one of three variables—expected return, return volatility, and the price–dividend ratio—completely determines the other two. By parameterizing only one of these processes, common empirical specifications place strong, and sometimes counter-factual, restrictions on the dynamics of the other variables. Our findings lend insight into the nature of the risk–return relation and the predictability of stock returns.     

Measuring, explaining, and controlling tax evasion: lessons from theory, experiments, and field studies

In this paper, I assess what we have learned about tax evasion since Michael Allingham and Agnar Sandmo launched the modern analysis of tax evasion in 1972. I focus on three specific questions and the answers to these questions that have emerged over the years. First, how do we measure the extent of evasion? Second, how can we explain these patterns of behavior? Third, how can we use these insights to control evasion? In the process, I illustrate my own answers to these questions by highlighting various specific examples of research. My main conclusion is that we have learned many things but that we also still have many gaps in our understanding of how to measure, explain, and control tax evasion. I also give some suggestions—and some predictions—about where promising avenues of future research may lie.     

BETA,SIZE, RISK,AND RETURN

We relate the cross‐section of stock returns to firm size, beta, and total risk. We find that as extreme monthly security returns are censored from the data, the significance level decreases rapidly for the size variable and increases for beta and total risk. An analysis of up and down markets reaffirms our findings. Consequently, average returns relate positively with beta, negatively with total risk, and not at all with firm size. We infer that investors willingly accept a lower average return on high‐total‐risk investments as the trade‐off for buying a chance at an extreme positive return. JEL classification: G1.     

Spin-offs, Divestitures, and Conglomerate Investment

We examine whether spin-offs or divestitures cause improvementsin conglomerate investment efficiency. At issue are endogeneityof these restructuring decisions and correct measurement ofinvestment efficiency. Endogeneity is a problem because thefactors that induce firms to spin off or divest divisions mayalso improve investment efficiency; measurement error is a problembecause efficiency measures employ Tobin’s q as a noisyproxy for investment opportunities. We find important differencesbetween firms that divest or spin off and a control sample.After accounting for these differences and for measurement errorin q, we find no evidence of improvements in investment efficiency.(JEL G31, G34)     

Bank Competition,Risk, and Subordinated Debt

This paper studies a dynamic model of banking in which banks compete for insured deposits, issue subordinated debt, and invest in either a prudent or a gambling asset. The model allows banks to choose their level of risk after the interest rate on subordinated debt is contracted. We show that requiring banks to issue a small amount of subordinated debt can reduce their gambling incentives. Moreover, when equity capital is more expensive than subordinated debt, adding a subordinated debt requirement to a policy regime that only uses equity capital requirements is Pareto improving.

Masculinity,Testosterone, and Financial Misreporting

We examine the relation between a measure of male CEOs’ facial masculinity and financial misreporting. Facial masculinity is associated with a complex of masculine behaviors (including aggression, egocentrism, riskseeking, and maintenance of social status) in males. One possible mechanism for this relation is that the hormone testosterone influences both behavior and the development of the face shape. We document a positive association between CEO facial masculinity and various misreporting proxies in a broad sample of S&P1500 firms during 1996–2010. We complement this evidence by documenting that a CEO's facial masculinity predicts his firm's likelihood of being subject to an SEC enforcement action. We also show that an executive's facial masculinity is associated with the likelihood of the SEC naming him as a perpetrator. We find that facial masculinity is not a measure of overconfidence. Finally, we demonstrate that facial masculinity also predicts the incidence of insider trading and option backdating.     

Abstract, classic, and explicit turnpikes

Portfolio turnpikes state that as the investment horizon increases, optimal portfolios for generic utilities converge to those of isoelastic utilities. This paper proves three kinds of turnpikes. In a general semimartingale setting, the abstract turnpike states that optimal final payoffs and portfolios converge under their myopic probabilities. In diffusion models with several assets and a single state variable, the classic turnpike demonstrates that optimal portfolios converge under the physical probability. In the same setting, the explicit turnpike identifies the limit of finite-horizon optimal portfolios as a long-run myopic portfolio defined in terms of the solution of an ergodic HJB equation.     

Risk aversion,prudence, and compensation

In a standard principal-agent setting, we use a comparative approach to study the incentives provided by different types of compensation contracts, and their valuation by managers with utility function u who are risk averse (u″<0) and prudent (u″′>0). We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. This is because concave contracts concentrate incentives where the marginal utility of risk averse managers is highest, while convex contracts protect against downside risk. Thus, managerial prudence can contribute to explain the prevalence of stock-options in executive compensation. However, convex contracts are not optimal when the principal is sufficiently prudent relative to the manager.     

Securitization,Ratings, and Credit Supply

We develop a framework to explore the effect of credit ratings on loan origination. We show that ratings endogenously shift the economy from a signaling equilibrium, in which banks inefficiently retain loans to signal quality, toward an originate-to-distribute equilibrium with zero retention and inefficiently low lending standards. Ratings increase overall efficiency, provided that the reduction in costly retention more than compensates for the origination of some negative net present value loans. We study how banks' ability to screen loans affects these predictions and use the model to analyze commonly proposed policies such as mandatory “skin in the game.”     

Competition,cooperation, and corporate culture

Cooperation between workers can be of substantial value to a firm, yet its level often varies substantially between firms. We show that these differences can unfold in a competitive labor market if workers have heterogeneous social preferences and preferences are private information. In our model, workers differ in their willingness to cooperate voluntarily. We show that there always exists a separating equilibrium in which workers self‐select into firms that differ in their monetary incentives as well as their level of worker cooperation. Our model highlights the role of sorting and worker heterogeneity in the emergence of heterogeneous corporate cultures. It also provides a new explanation for the coexistence of nonprofit and for‐profit firms.

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Transport,energy, and community design

The world's urban areas have a higherper capita consumption of resources than rural areas—and soon they will contain most of the world's population. The planned development of rational cities, within an integrated transport strategy, holds the key to efficient resource use. Energy consumption can be reduced by designing cities with the accent on accessibility rather than mobility. The problems of urbanisation are worldwide, and require an international agency to coordinate the exchange of information and expertise.     

Liquidity,default, taxes,and yields on municipal bonds

We examine the effects of liquidity, default and personal taxes on the relative yields of Treasuries and municipals using a generalized model with liquidity risk. The municipal yield model includes liquidity as a state factor. Using a unique transaction dataset, we estimate the liquidity risk of municipals and its effect on bond yields. Empirical evidence shows that municipal bond yields are strongly affected by all three factors. The effects of default and liquidity risk on municipal yields increase with maturity and credit risk. Liquidity premium accounts for about 9–13% of municipal yields for AAA bonds, 9–15% for AA/A bonds and 8–19% for BBB bonds. A substantial portion of the maturity spread between long- and short-maturity municipal bonds is attributed to the liquidity premium. Ignoring the liquidity risk effect thus results in a severe underestimation of municipal bond yields. Conditional on the effects of default and liquidity risk, we obtain implicit tax rates very close to the statutory tax rates of high-income individuals and institutional investors. Furthermore, these implicit income tax rates are quite stable across bonds of different maturities. Results show that including liquidity risk in the municipal bond pricing model helps explain the muni puzzle.     

Predictable behavior, profits, and attention

Stocks in the Shanghai market that hit upper price limits typically exhibit three characteristics: high returns, high volumes, and news coverage. We show that these price limit events attract investors' attention. Attention-grabbing events lead active individual investors to buy stocks they have not previously owned. Consistent with lowering investor search costs, events that affect a few (many) stocks lead to increased (decreased) buying. Upper price limit events coincide with initial price increases followed by statistically significant price mean reversion over the following week. Rational traders (statistical arbitrageurs) profit in response to attention-based buying. Smart traders accumulate shares on date t, sell shares on date t + 1, and earn a daily average profit of 1.16%. We show the amount they invest predicts the degree of attention-based buying by individual investors. We end by decomposing individual investor trades in order to estimate losses attributable to behavioral biases.     

Debate: Society,socialism, sociology

This article investigates the implementation of benchmarking in three large acute NHS trusts. The findings concentrate on the attitudes of professional groups towards the preparation and use of management accounting information for performance measurement and comparison in NHS trusts. The problems revealed in developing appropriate costing information in this organizational context suggest difficulties lie ahead as more far-reaching organizational and financial change permeates the NHS.     

Share repurchases,catering, and dividend substitution

We first extend Baker and Wurgler's (2004a) catering theory of dividends to share repurchases. Consistent with the notion that firms cater to investor demand for share repurchases, we report evidence that the market's time-varying repurchase premium positively affects firms' choice to repurchase shares. Next, we use the catering behavior as a novel framework for testing the dividend substitution hypothesis. Consistent with the notion that managers consider dividends and share repurchases to be substitute payout mechanisms, we find that the dividend premium negatively affects the repurchase choice, whereas the repurchase premium negatively affects the choice to pay dividends.     

Risk,Mispricing, and Value Investing

We evaluate the stock return performance of a modified version of the book-to-market strategy and its implications for market efficiency. If the previously documented superior stock return of the book-to-market strategy represents mispricing, its performance should be improved by excluding fairly valued firms with extreme book-to-market ratios. To attain this, we classify stocks as value or glamour on book-to-market ratios and accounting accruals jointly. This joint classification is likely to exclude stocks with extreme book-to-market ratios due to mismeasured accounting book values reflecting limitations underlying the accounting system. Using both 12-month buy-and-hold returns and earnings announcement returns, our results show that this joint classification generates substantially higher portfolio returns in the post-portfolio-formation year than the book-to-market classification alone with no evidence of increased risk. In addition, this superior stock return performance is more pronounced among firms held primarily by small (unsophisticated) investors and followed less closely by market participants (stock price <$10). Finally, and most importantly, financial analysts are overly optimistic (pessimistic) about earnings of glamour (value) stock, and for a subset of firms identified as overvalued by our strategy, the earnings announcement raw return, as well as abnormal return, is negative. These last results are particularly important because it is hard to envision a model consistent with rational investors holding risky stocks with predictable negative raw returns for a long period of time rather than holding fT-bills and with financial analysts systematically overestimating the earnings of these stocks while underestimating earnings of stocks that outperform the stock market.