Does it help to have friends in high places? Bank stock performance and congressional committee chairmanships

Does a politician with power in the U.S. Congress positively affect the value of firms headquartered in their home state? We investigate this question by examining the profitability and stock performance of commercial banks. Banks can be enormously influenced by the political and regulatory environment. We find that banks headquartered in states where a Senator or member of the House of Representatives serves as the chairman on their respective banking committee in Congress outperform banks headquartered in other states. In addition, we find that this “chair effect” is more pronounced when the committee chairs are strongly aligned with other politicians in Congress, when they are more experienced, and when banks are clustered in the home state, suggesting that the potential benefits generated from chairmanship are in more demand. Overall, our results suggest that there are some important value implications of a local politician’s power in Congress.     

The empirical risk–return relation: A factor analysis approach

Existing empirical literature on the risk–return relation uses relatively small amount of conditioning information to model the conditional mean and conditional volatility of excess stock market returns. We use dynamic factor analysis for large data sets, to summarize a large amount of economic information by few estimated factors, and find that three new factors—termed “volatility,” “risk premium,” and “real” factors—contain important information about one-quarter-ahead excess returns and volatility not contained in commonly used predictor variables. Our specifications predict 16–20% of the one-quarter-ahead variation in excess stock market returns, and exhibit stable and statistically significant out-of-sample forecasting power. We also find a positive conditional risk–return correlation.     

Evaluating foreign exchange market intervention: Self-selection,counterfactuals and average treatment effects

Estimating the effect of official foreign exchange market intervention is complicated by the fact that intervention at any point entails a “self-selection” choice made by the authorities and that no counterfactual is observed. To address these issues, we estimate the “counterfactual” exchange rate movement in the absence of intervention by introducing the method of propensity-score matching to estimate the “average treatment effect” (ATE) of intervention. To derive the propensity scores we estimate central bank intervention reaction functions. We estimate the ATE for daily official intervention in Japan over the January 1999–March 2004 period. This sample encompasses a remarkable variation in intervention frequencies as well as unprecedented frequent intervention towards the latter part of the period. We find that only sporadic and relatively infrequent intervention is effective.     

Time-varying risk aversion and asset prices

This paper uses a variant of the consumption-based representative agent model in Campbell and Cochrane [Campbell, J.Y., Cochrane, J.H., 1999. By force of habit: Consumption-based explanation of aggregate stock market behavior. Journal of Political Economy 107, 205–251] to study how investors’ time-varying risk aversion affects asset prices. First, we show that a countercyclical variation of risk aversion drives a procyclical conditional risk premium. Second, we show that with a small value for the volatility of the log surplus consumption ratio, a large value of risk aversion may not determine whether the equity premium and the risk-free rate puzzles can be resolved or not. Third, we show that countercyclical risk aversion may not help explain the predictability of long-horizon stock returns, the univariate mean-reversion of stock prices and the “leverage effect” in return volatility.     

Stock salience and the asymmetric market effect of consumer sentiment news

We document asymmetric announcement effects of consumer sentiment news on United States stock and stock futures markets. While a negative market effect occurs upon the release of bad sentiment news, there is no market reaction for the counterpart good news. This supports the “negativity effect” hypothesis. Notably, this effect seems most likely to occur in salient stocks, which is consistent with the availability heuristic.     

Reprint of: Stock salience and the asymmetric market effect of consumer sentiment news

We document asymmetric announcement effects of consumer sentiment news on United States stock and stock futures markets. While a negative market effect occurs upon the release of bad sentiment news, there is no market reaction for the counterpart good news. This supports the “negativity effect” hypothesis. Notably, this effect seems most likely to occur in salient stocks, which is consistent with the availability heuristic.     

Effects of the volatility smile on exchange settlement practices: The Hong Kong case

The well-documented volatility smile phenomenon in the US options market has affected the option settlement practices of other markets. To settle Hang Seng Index (HSI) options, the Hong Kong Stock Exchange artificially builds in a piecewise linear “smile” or “sneer” volatility function, which is determined daily by market makers rather than directly by market forces. In this study, we investigate the time-varying settlement function and find the following economic determinants of the volatility function: lag parameters, current-day HSI returns, the distribution of HSI returns, transaction costs as proxied by the bid-ask spread, and the “Monday effect”. For evaluation purposes, we use as a benchmark the estimated piecewise linear volatility function as directly driven by market forces. The comparison analyses show that base volatilities set by market makers run somewhat high, while downside slopes are not steep enough. This results in the overpricing of the lion’s share of traded options. An economic determinants analysis of market-force-driven parameters reveals that market makers can better align artificial volatility parameters both by reducing reliance on the function parameters of prior days and by more precisely accounting for current-day HSI returns, option time-to-maturity, bid-ask spreads and buying pressure.     

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.     

The association between legal regime and the value-relevance of accounting information: a Japan-U.K. comparison

Prior research has shown that there is an association between the legal regime of a firm’s country of domicile and the value-relevance of its accounting information. However, it is still unclear whether it is the difference in the properties of accounting information (“the supply effect”), or alternatively, if it is the difference in the way the investors in certain jurisdictions interpret and apply that information (“the demand effect”) that is mainly driving this phenomenon. Since the observed pattern in value-relevance is less likely to be observed in a particular capital market that belongs to a single legal regime (where the demand effect is assumed to be constant) in case the demand effect is mainly driving the association, I test for a marginal impact of the supply effect in a single capital market setting. Using U.S. stock price data, I find that the accounting numbers of U.K. firms, prepared under U.K. GAAP, are more value-relevant than those of Japanese firms, reported under Japanese GAAP. This result lends support to the supply hypothesis and suggests that the legal regime does have a marginal impact on the value-relevance of the accounting information.     

The power of bad: The negativity bias in Australian consumer sentiment announcements on stock returns

This paper examines the equity market reaction to the monthly release of Australian consumer sentiment news. Our results indicate that consumer sentiment has valuable information content. Further, we document a version of the “negativity effect” (from the psychology literature) in which, upon announcement of bad (good) sentiment news, the equity market experiences a significant negative (no) announcement day effect. Notably, we find that the market recovers from the bad news shock relatively quickly post-announcement. The results are robust to a broad range of additional tests.     

Did the crisis induce credit rationing for French SMEs?

This paper focuses on the access of independent French SMEs to bank lending and analyzes whether the observed evolution of credit to SMEs over the recent period was “demand driven” as a result of the decrease in firms’ activity and investment projects or was “supply driven” with an increase in credit “rationing” stemming from a more cautious behavior of banks. Based on a sample of around 60,000 SMEs, we come to the conclusion that, despite the stronger standards used by banks when granting credit, French SMEs do not appear to have been strongly affected by credit rationing since 2008. This result goes against the common view that SMEs suffered from a strong credit restriction during the crisis but is perfectly in line with the results of several surveys about the access to finance of SMEs recently conducted in France.     

Earnings management,market discounts and the performance of private equity placements

Private equity placement data allow us to determine whether sophisticated investors can uncover the true value of firms. This can be done by defining sophisticated investors as those who meet the stringent participation requirements of the private equity market. Our results show private equity issuing firms overstate their earnings in the quarter preceding private equity placement announcements and that sophisticated investors do not ask for a fair discount when purchasing the shares of the private issuing firms. We also find evidence showing that the reversal of the effects of pre-issue earnings management is a significant determinant of the long-term performance of private issues. Results further show that post-issue stock performance and operating performance of firms using “aggressive” earnings management significantly underperform those using more “conservative” earnings management.     

Do they do it for the money?

Using a sample of all top management who were indicted for illegal insider trading in the United States for trades during the period 1989-2002, we explore the economic rationality of this white-collar crime. If this crime is an economically rational activity in the sense of Becker (1968), where a crime is committed if its expected benefits exceed its expected costs, “poorer” top management should be doing the most illegal insider trading. This is because the “poor” have less to lose (present value of foregone future compensation if caught is lower for them). We find in the data, however, that indictments are concentrated in the “richer” strata after we control for firm size, industry, firm growth opportunities, executive age, the opportunity to commit illegal insider trading, and the possibility that regulators target the “richer” strata. We thus rule out the economic motive for this white-collar crime, and leave open the possibility of other motives.     

Asset market linkages: Evidence from financial, commodity and real estate assets

We use a general Markov switching model to examine the relationships between returns over three different asset classes: financial assets (US stocks and Treasury bonds), commodities (oil and gold) and real estate assets (US Case-Shiller index). We confirm the existence of two distinct regimes: a “tranquil” regime with periods of economic expansion and a “crisis” regime with periods of economic decline. The tranquil regime is characterized by lower volatility and significantly positive stock returns. During these periods, there is also evidence of a flight from quality - from gold to stocks. By contrast, the crisis regime is characterized by higher volatility and sharply negative stock returns, along with evidence of contagion between stocks, oil and real estate. Furthermore, during these periods, there is strong evidence of a flight to quality - from stocks to Treasury bonds.     

Is it the weather? Response

Kamstra, Kramer and Levi (KKL) in their comment seem to miss the main point of our paper. Many things are correlated with the seasons so it is difficult to distinguish between them when we try to explain the well-known summer winter pattern in stock returns. Finding an isolated seasonal affective disorder (SAD) effect without proper control variables does not disprove our point but strengthens it. To sidestep all of the issues they raise and take our point to the extreme, we show using plain vanilla regressions that the seasonal stock market pattern they attribute to SAD can also be “explained” by variables like ice cream consumption or airline travel. The new variations of SAD variables (“onset” and “incidence”) KKL propose in their recent work for North America are even more problematic than the original SAD variables. We find that these new SAD proxies are not significant in countries where according to KKL they should be: Canada and the United States.     

Price trends and patterns in technical analysis: A theoretical and empirical examination

While many technical trading rules are based upon patterns in asset prices, we lack convincing explanations of how and why these patterns arise, and why trading rules based on technical analysis are profitable. This paper provides a model that explains the success of certain trading rules that are based on patterns in past prices. We point to the importance of confirmation bias, which has been shown to play a key role in other types of decision making. Traders who acquire information and trade on the basis of that information tend to bias their interpretation of subsequent information in the direction of their original view. This produces autocorrelations and patterns of price movement that can predict future prices, such as the “head-and-shoulders” and “double-top” patterns. The model also predicts that sequential price jumps for a particular stock will be positively autocorrelated. We test this prediction and find that jumps exhibit statistically and economically significant positive autocorrelations.     

Practical methods for measuring and managing operational risk in the financial sector: A clinical study

This paper analyzes the implications of the advanced measurement approach (AMA) for the assessment of operational risk. Through a clinical case study on a matrix of two selected business lines and two event types of a large financial institution, we develop a procedure that addresses the major issues faced by banks in the implementation of the AMA. For each cell, we calibrate two truncated distributions functions, one for “normal” losses and the other for the “extreme” losses. In addition, we propose a method to include external data in the framework. We then estimate the impact of operational risk management on bank profitability, through an adapted measure of RAROC. The results suggest that substantial savings can be achieved through active management techniques.     

Foreign bank entry,credit allocation and lending rates in emerging markets: Empirical evidence from Poland

Earlier studies have documented that foreign banks charge lower lending rates and interest spreads than domestic banks. We hypothesize that this may stem from the superior efficiency of foreign entrants that they decide to pass onto borrowers (“performance hypothesis”), but could also reflect a different loan allocation with respect to borrower transparency, loan maturity and currency (“portfolio composition hypothesis”). We are able to differentiate between the above hypotheses thanks to a novel dataset containing detailed bank-specific information for the Polish banking industry. Our findings demonstrate that banks differ significantly in terms of portfolio composition and we attest to the “portfolio composition hypothesis” by showing that, having controlled for portfolio composition, there are no differences in lending rates between banks.     

Bias in estimating the systematic risk of extreme performers: Implications for financial analysis, the leverage effect, and long-run reversals

We show how bias can arise systematically in the beta estimates of extreme performers when long-run return reversals are present and partly, or wholly, due to sign changes in unanticipated factor realizations. Our evidence is consistent with this bias being responsible for the large shifts in the beta estimates of extreme performers, more so than the leverage effect, which has been the predominant explanation in prior literature. Bias in these contemporaneous realized betas, estimated with the same returns that are to be risk adjusted, arises due to the general problem of “overconditioning,” where betas are estimated conditional on information that is not yet known. Several methods for conditioning betas on out-of-sample returns are evaluated and found to be lacking, although some offer improvement under certain circumstances. We also show evidence of this bias in the Fama-French Three-factor loadings of extreme performers. Our findings indicate not only that previous studies of long-run reversals understate contrarian profits but that bias is prevalent in the OLS beta estimates of extreme performers, and this has implications for estimating the cost of capital and measuring long-run performance. We offer recommendations for identifying when this bias is likely present, as well as general methods to correct for it.     

Short sales and speed of price adjustment: Evidence from the Hong Kong stock market

We present empirical evidence that short sales contribute to market efficiency by increasing the speed of price adjustment to not only private/public firm-specific information but also market-wide information. Shortable stocks are characterized by weaker trade continuity and stronger quote reversals. They adjust faster to new information than non-shortable counterparts. These findings remain robust even in an “up” market condition in which short sales are not binding. The amount of information incorporated in each trade is also significantly higher for shortable than non-shortable stocks in both “up” and “down” market conditions. After controlling for firm size, trading volume, liquidity, price and option trading, short sales stand out as one of the significant factors that speed up the price adjustment.