Are hedge funds active market liquidity timers?

This paper investigates liquidity timing behaviour of hedge funds that invest globally in foreign investment assets. We expect these hedge funds to manage currencies exposure differently, depending on the extent they treat them as an asset class. In this paper, we investigate if actively timing foreign exchange (FX) liquidity adds value to hedge funds' investments. Unlike the existing studies where fund managers are assumed to either time or not time the market over the entire study period, we argue that fund managers may strategically choose to be active market liquidity timers based on the market condition at the time. To test this hypothesis, we develop a state-dependent liquidity timing model embedded with a Markov regime switching process and identify changes in the FX liquidity timing behaviour among the Global Derivatives hedge funds over an eighteen-year period. Our findings reveal that such regime changes in timing behaviour are driven by the underlying FX liquidity condition. A further analysis to compare the changes in the timing behaviour over time shows that hedge funds that are active market liquidity timers outperform those that engage in liquidity timing less frequently in all strategies categories.     

Stock liquidity and investment opportunities: New evidence from FTSE 100 index deletions

This paper examines the relationship between stock liquidity and investment opportunities in a sample of firms experiencing a negative exogenous liquidity shock, captured by deletion from the FTSE 100 stock index. We find no statistical association between stock liquidity and investment opportunities. These findings are in sharp contrast to the positive relation between liquidity and investment opportunities reported in US equity markets. This unique result in the London Stock Exchange suggests that deletion from a major stock index does not influence corporate investment decisions because there is no significant change in the cost of capital.     

Optimal liquidity management and bail-out policy in the banking industry

We characterize the profit-maximizing reserves of a commercial bank, and the generated probability of a liquidity crisis, as a function of the penalty imposed by the Central Bank, the probability of depositors' liquidity needs, and the return on outside investment opportunities. We demonstrate that banks do not fully internalize the social cost associated with the bail-out policy if the liquidity needs of individuals are correlated, and that competitive interbank markets will induce banks to raise their reserves under reasonable conditions. The marginal benefits from an interbank market decrease as the correlation between the liquidity shocks of banks increases.     

The seeds of a crisis: A theory of bank liquidity and risk taking over the business cycle

We examine how the banking sector could ignite the formation of asset price bubbles when there is access to abundant liquidity. Inside banks, to induce effort, loan officers are compensated based on the volume of loans. Volume-based compensation also induces greater risk taking; however, due to lack of commitment, loan officers are penalized ex post only if banks suffer a high enough liquidity shortfall. Outside banks, when there is heightened macroeconomic risk, investors reduce direct investment and hold more bank deposits. This ‘flight to quality’ leaves banks flush with liquidity, lowering the sensitivity of bankers’ payoffs to downside risks and inducing excessive credit volume and asset price bubbles. The seeds of a crisis are thus sown.     

Stock Liquidity and Investment Opportunities: Evidence from Index Additions

We examine the relation between stock liquidity and investment opportunities in a sample of firms experiencing an exogenous liquidity shock. We find a positive relation between changes in capital expenditures and changes in stock liquidity, indicating that stock liquidity influences corporate investment decisions. This relation is robust to alternative measures of growth opportunities, and is consistent with a liquidity premium in equity returns. That is, an increase in liquidity effectively expands the set of positive NPV projects because it reduces the cost of capital. The results suggest that liquidity-enhancing events benefit shareholders by increasing the pool of viable growth opportunities.     

Investment commitment and the valuation of underwriting agreements for rights issues

I extend the option pricing framework for the underwriting of rights issues, by considering that the funds received at maturity may already have been committed to a project at the time of signing of the underwriting agreement (investment commitment). The model yields valuations that are up to several times the amount implied by no investment commitment, and this is most pronounced for large issues. An upper bound for the model’s explanatory power is obtained by assuming that all issues exhibit full investment commitment; under this assumption, the model explains 40–65% of the overpricing of underwriting agreements in the United Kingdom.     

Cash Holdings and Corporate Diversification

This paper studies the relation between corporate liquidity and diversification. The key finding is that multidivision firms hold significantly less cash than stand‐alone firms because they are diversified in their investment opportunities. Lower cross‐divisional correlations in investment opportunity and higher correlations between investment opportunity and cash flow correspond to lower cash holdings, even after controlling for cash flow volatility. The effects are strongest in financially constrained firms and in well‐governed firms, and correspond to efficient fund transfers from low‐ to high‐productivity divisions. Taken together, these results bring forth an efficient link between diversification and corporate liquidity.     

Product Market Threats and the Value of Corporate Cash Holdings

We construct a model to show that predatory strategies by a financially strong rival can cause a financially weak firm to underinvest. This threat intensifies when the two firms produce similar products and share similar future investment opportunities. We show that cash holdings become more valuable by providing liquidity to fund investment opportunities as they emerge, thereby mitigating the underinvestment problem. Empirical evidence supports these model predictions. The value of cash is significantly higher for firms facing higher predatory threats. The results are robust to various controls for financial constraints, corporate governance, risk factors, and industry‐level measures of product market competition. An identification strategy that exploits exogenous variation in financial constraints further corroborates the causal effect of predatory threats on the value of cash.     

Debt Dynamics

We develop a dynamic trade‐off model with endogenous choice of leverage, distributions, and real investment in the presence of a graduated corporate income tax, individual taxes on interest and corporate distributions, financial distress costs, and equity flotation costs. We explain several empirical findings inconsistent with the static trade‐off theory. We show there is no target leverage ratio, firms can be savers or heavily levered, leverage is path dependent, leverage is decreasing in lagged liquidity, and leverage varies negatively with an external finance weighted average Q. Using estimates of structural parameters, we find that simulated model moments match data moments.     

Coinsurance effect and bank lines of credit

The coinsurance effect hypothesis predicts that firm diversification reduces financial constraints through imperfectly correlated cash flows among segments. We empirically test the hypothesis by studying the relation between coinsurance effect and bank lines of credit. We find that coinsurance effect is associated with a higher availability of bank lines of credit, and that diversified firms hold a higher level of bank lines of credit if they have higher investment opportunities and if they are bank-dependent. We find that diversified firms hold a higher fraction of corporate liquidity in the form of bank lines of credit due to the coinsurance effect. The findings are consistent with the coinsurance effect hypothesis and contribute to the debate on the value consequence of firm diversification by disclosing a specific channel through which firm diversification affects financial constraints.     

Relationship Banking, Liquidity, and Investment in the German Industrialization

Close bank relationships are thought to ameliorate firms' liquidity constraints—a phenomenon frequently measured by liquidity sensitivity of investment. Using German firms during the formative years of universal banking (1903–1913), this paper shows that, even controlling for selection bias, investment is more sensitive to internal liquidity for bank-networked firms than unattached firms. The firm exhibiting the greatest liquidity sensitivity, however, faced no apparent liquidity constraint. The findings yield two implications: they support recent research rejecting a linear relationship between liquidity sensitivity and financing constraints, and they suggest that relationship banking provides no consistent lessening of firms' liquidity sensitivity.     

Stockpiling cash when it takes time to build: Exploring price differentials in a commodity boom

Some projects take time to build or are slow to yield cash flows. This may impact the dynamics of investment and liquidity management, although few studies test their financial implications. We exploit the peculiar advantages of copper mines as a laboratory to identify cash-flow sensitivities. In this context, investment decisions depend on the expectations of the long run price of the commodity, while the spread between the spot price and this long run expectations shifts current cash-flows. For this study we compiled a sample of copper firms between 2002 and 2012. We do not find significant effects of cash flow on current capital expenditures, but we do observe a systematic cash flow sensitivity of cash holdings, meaning that some of these transitory earnings are retained as liquidity. This cash stockpiling is stronger among financially constrained firms. In a context of time-to-build, our findings support financial theories emphasizing the salience of cash as buffer stock for liquidity in preparation for future investment opportunities.     

Liquidity preference under uncertainty: A model of dynamic investment in illiquid opportunities

Whereas frictionless exchange markets provide a high degree of liquidity for financial assets, investments in real assets and productive capacity may be very costly to modify, and thus effectively irreversible in the short-run. This paper addresses the problem of an investor (individual or enterprise) who must allocate a limited resource to productive investments over time. Investment opportunities arrive in a random sequence and are irreversible in the short-run: thus investment decisions are made under uncertainty as to future opportunities (which may have to be foregone). The analysis demonstrates that a rational investor will demand a higher return on long-lasting opportunities than on those which are instantaneously reversible. The liquidity premium increases with the average duration of the non-liquid investments.     

Investment timing and optimal capital structure under liquidity risk

Deterioration in debt market liquidity reduces debt values and affects firms' decisions. Considering such risk, we develop an investment timing model and obtain analytic solutions. We carry out a comprehensive analysis in optimal financing, default, and investment strategies, and stockholder–bondholder conflicts. Our model explains stylized facts and replicates empirical findings in credit spreads. We obtain six new insights for decision makers. We propose a ‘new trade-off theory’ for optimal capital structure, a new tax effect, and new explanations of ‘debt conservatism puzzle’ and ‘zero-leverage puzzle’. Failure in recognizing liquidity risk results in substantially over-leveraging, early bankruptcy or investment, overpriced options, and undervalued coupons and credit spreads. In addition, agency costs are surprisingly small for a high liquidity risk or a low project risk. Interestingly, the risk shifting incentive and debt overhang problem decrease with liquidity risk under moderate tax rates while they increase under high tax rates.     

Measuring Corpotate Liquidity Risk

This article presents the outline of a framework for evaluating liquidity risk (at the corporate level) with risk measures that are intuitive and economically relevant. In particular, the risk measures are designed explicitly to show the effectiveness of a company's risk management program in helping the firm to (1) avoid financial distress or default and (2) ensure its ability to undertake all strategic investments. For managers attempting to quantify liquidity risks, this paper proposes that the risk measures have two important features: One is to make the liquidity risk estimate depend on some measure of the firm's balance sheet strength, one that reflects the role of the balance sheet as a risk buffer. The second is to provide a useful estimate of the opportunity costs associated with a given liquidity shortage—one that reflects the value of the investment opportunities that liquidity problems could jeopardize. The author illustrates the application of the proposed risk measures with an example of a company evaluating a hedging strategy designed to accompany a substantial increase in its investment budget. Using the risk measures discussed in this paper, the author shows how to assess the effectiveness of a proposed hedge in terms of its expected ability to reduce costly cash shortfalls in scenarios in which the firm's debt capacity is also expected to be depleted.     

Banks' home bias in government bond holdings: Will banks in low‐rated countries invest in European safe bonds (ESBies)?

This paper offers two new explanations for banks' home bias in government bond holdings: a sovereign‐based rating cap on corporates and the existence of a ‘bank tax.’ These are complementary to the four explanations offered in the literature: risk‐shifting, gambling for resurrection, moral suasion, and a means to store liquidity for financing future investment. Collectively, they cast doubt on the European Union's demand‐led approach to investment in European safe bonds (ESBies) by banks in low‐rated countries. Bank regulations such as constraints on large exposure or risk‐based capital on credit risk concentration will be needed if the objective is to break the so‐called ‘deadly embrace.’     

The systematic pricing of market sentiment shock

ABSTRACT

We show that market sentiment shocks create demand shocks for risky assets and a systematic risk for assets. We measure a market sentiment shock as the unexpected portion of the University of Michigan Consumer Sentiment Index’s growth. This shock prices stock returns in arbitrage pricing theory framework at 1% after controlling for market, size, value, momentum, and liquidity risk factors. Its premium lowered the implied risk aversion by 97.9% to 11.46 between 1978 and 2009 in our sentiment consumption-based capital-asset-pricing model. Merton’s [1973. “An Intertemporal Capital Asset Pricing Model.” Econometrica 41: 867–887]. intertemporal capital-asset-pricing model reconfirms our finding that this market sentiment shock is a systematic risk factor that provides investment opportunities.     

货币政策调整对企业投资的差异性效应——理论分析与经验证据

基于国有与非国有企业并存的二元所有制结构背景,本文分析宽松货币政策对企业投资偏离的总量经济效应与所有制差异效应,运用2008年至2019年中国A股上市公司数据进行实证检验,结果表明:(1)当企业面临较高的投资机会时,宽松货币政策通过流动性效应降低了企业外部融资约束,对投资不足产生显著抑制效应;(2)宽松货币政策对不同所...     

The deregulation of capital markets in France

This paper investigates how the deregulation of French capital markets affected corporate investment in the 1980s. Access to public financial markets may be less important in countries that have traditionally relied on institutional investors to finance their corporate investment projects. This should be true for France where, contrary to the US, banks and government agencies have always been involved in firms’ long term activities. In this study, French firms are categorized based on their ownership structure and trading characteristics. Two investment models are augmented with measures of corporate liquidity in order to test the role of internal funds on investment. Empirical results show that only small French firms trading on the secondary stock market have to rely on liquid assets to finance their capital expenditures. French firms with strong bank ties avoid this constraint since they are allowed to maintain higher debt levels.     

The Elastic Provision of Liquidity by Private Agents

I study a model of investment by financially constrained firms that are heterogeneous with respect to their exposure to an aggregate liquidity shock. A firm that is susceptible to the shock will mitigate its exposure by purchasing claims issued by a firm that is not. Liabilities of an unaffected firm may earn a liquidity premium due to their fungibility, and because they are backed by productive investment, their supply is elastic to the demand. This segmentation implies that an aggregate liquidity shock has different consequences across sectors of the economy.