The Firm's Management of Social Interactions

Consumer choice is influenced in a direct and meaningful way by the actions taken by others. These “actions” range from face-to-face recommendations from a friend to the passive observation of what a stranger is wearing. We refer to the set of such contexts as “social interactions” (SI). We believe that at least some of the SI effects are partially within the firm's control and that this represents an exciting research opportunity. We present an agenda that identifies a list of unanswered questions of potential interest to both researchers and managers. In order to appreciate the firm's choices with respect to its management of SI, it is important to first evaluate where we are in terms of understanding the phenomena themselves. We highlight five questions in this regard: (1) What are the antecedents of word of mouth (WOM)? (2) How does the transmission of positive WOM differ from that of negative WOM? (3) How does online WOM differ from offline WOM? (4) What is the impact of WOM? (5) How can we measure WOM? Finally, we identify and discuss four principal, non-mutually exclusive, roles that the firm might play: (1) observer, (2) moderator, (3) mediator, and (4) participant.     

Return, purchase, or skip? Outcome, duration, and consumer behavior in the rent-to-own market

Rent-to-own (RTO) is attractive to financially distressed consumers. It allows immediate access to merchandise and an opportunity for eventually acquisition. Yet goods can be returned at any point without penalty or other adverse consequences. We use a competing risk methodology that accounts for unobserved consumer heterogeneity to study how contracts conclude, estimating the probabilities of exit??via return, purchase, or skip??and the associated durations. The estimated outcome probabilities highlight the use of the embedded return option by RTO consumers and the trade-offs and cross-subsidization implicit in the RTO contractual arrangement. We offer rational and behavioral explanations of consumer behavior in the RTO market, which we believe can be generalized to other consumer loan markets.     

Rent-to-own agreements: Customer characteristics and contract outcomes

The rent-to-own (RTO) industry, by offering immediate access to household goods for a small periodic fee with no credit check or down payment, has strong appeal to low income and financially distressed consumers. An important policy question is whether an RTO agreement is used as a rental/lease with build-in purchase option or as something more akin to an installment loan. Given the embedded options to return the item or to purchase it early, the actual rent paid by RTO customers is substantially lower than the oft-reported total rent which assumes that agreements go to term. We employ a log-normal censored regression model to analyze the influence of customer demographics as well as the transactional details of the contract on the rent paid by consumers using rent-to-own. Our main conclusions are (1) it is the “working poor” that are likely to pay more rent, (2) there appears to be a clientele effect with customers paying more rent under bi-weekly and monthly, as opposed to weekly, payment schedules, and (3) customers who exhibit delinquency in making contractual payments generally end up paying more rent. Further, our data allows some observations on annual percentage rates by illustrating the business risk present for RTO stores as well as the cross-subsidization of consumers.     

Implied recovery

In the absence of forward-looking models for recovery rates, market participants tend to use exogenously assumed constant recovery rates in pricing models. We develop a flexible jump-to-default model that uses observables: the stock price and stock volatility in conjunction with credit spreads to identify implied, endogenous, dynamic functions of the recovery rate and default probability. The model in this paper is parsimonious and requires the calibration of only three parameters, enabling the identification of the risk-neutral term structures of forward default probabilities and recovery rates. Empirical application of the model shows that it is consistent with stylized features of recovery rates in the literature. The model is flexible, i.e. it may be used with different state variables, alternate recovery functional forms, and calibrated to multiple debt tranches of the same issuer. The model is robust, i.e. evidences parameter stability over time, is stable to changes in inputs, and provides similar recovery term structures for different functional specifications. Given that the model is easy to understand and calibrate, it may be used to further the development of credit derivatives indexed to recovery rates, such as recovery swaps and digital default swaps, as well as provide recovery rate inputs for the implementation of Basel II.     

Basel II: Correlation Related Issues

Basel II aims to aggressively improve on Basel I, and is projected to capitalize on the technological advancements that have permeated the financial industry since Basel I. This paper examines the correlation issues that arise, and provides recommendations on implementation as we move forward. We provide the following results: (1) We demonstrate that fixing asset value correlations by regulators without a specification of business unit granularity and aggregation impacts franchise risk. (2) Loss distributions for credit risk are more sensitive to correlation assumptions that those for market risk; arbitrary, inaccurate correlation specifications can cause large errors in capital requirements. (3) Current regulations do not recognize that credit losses depend on four distinct correlations, not just one. (4) Recovery rates may be determined uniformly across banks. (5) Tail risk comes from LGD correlations and non-Gaussian risks. (6) The 1-year VaR horizon causes distortions especially when regimes and pro-cyclicality are involved. (7) We recommend a quantitative measure for implementing market discipline, the third pillar of the Basel II accord. Therefore, this paper highlights many issues that may be addressed using the tools banks already employ for internal risk management.     

Rent‐to‐Own Pricing: Theory and Empirical Evidence

The rent‐to‐own (RTO) industry given its emphasis on subprime or, at least, financially constrained consumers is often seen as exploitative with excessive financing costs. This paper develops a rational‐expectations competitive equilibrium model to explore the pricing mechanism of an RTO agreement. The model accounts for the contract's embedded options and several bundled services. Using detailed transactional data, we infer how customers exercise these options to calibrate our model for several product categories, contractual lengths and payment periodicity. The resulting predictions provide a justification for the high financing costs observed in the marketplace.     

eInformation: A Clinical Study of Investor Discussion and Sentiment

We examine the information flow for four stocks over seven months to trace the relationship between on-line discussion, news activity, and stock price movements. On-line discussions support numerous unsubstantiated rumors, substantial on-point exchanges, and quick dissemination of imminent and recently released information. Applying language-processing routines to message board postings and news, we create sentiment and disagreement measures or "eInformation." We analyze the determinants of sentiment and disagreement, and trace links between news, eInformation, and stock returns. This intensive clinical study of on-line discussions suggests mechanisms individual investors and groups can use to analyze and digest company information.     

Multiple bids as a consequence of target management resistance: A count data approach

In this article, we focus on the question of target management resistance and the incidence of subsequent bids. A Poisson count data model is used where the dependent variable represents the number of bids (count) received and the independent variables comprise target management actions and firm specific characteristics. Of the target management actions considered, legal defense and the entry of a white knight are associated with additional bids. With respect to firm specific characteristics, we find that a high initial bid premium deters subsequent bids. Firm size is also significant and has an interesting relationship with the number of bids received. Larger target firms tend to receive more bids; however, the number of bids tails off for firms with assets exceedng $12 billion.     

Characteristics and behavior of newly listed firms: Evidence from the Asia-Pacific region

We examine the size, profitability and delisting experience during 1980–1999 of new lists in the Pacific Basin countries. We also examine the impact of the legal environment on post-listing behavior. We find that new lists are more numerous in common law countries. They are smaller than seasoned firms, regardless of legal regime. New lists are more profitable in civil law countries, but this is due to the high profitability of Japanese new lists. Asian new lists have lower rates of delisting compared to U.S. firms. The delisting frequency of seasoned firms exceeds that of new lists for our sample countries.     

Exact solutions for bond and option prices with systematic jump risk

A variety of realistic economic considerations make jump-diffusion models of interest rate dynamics an appealing modeling choice to price interest-rate contingent claims. However, exact closed-form solutions for bond prices when interest rates follow a mixed jump-diffusion process have proved very hard to derive. This paper puts forward two new models of interest-rate dynamics that combine infrequent, discrete changes in the interest-rate level, modeled as a jump process, with short-lived, mean reverting shocks, modeled as a diffusion process. The two models differ in the way jumps affect the central tendency of interest rates; in one case shocks are temporary, in the other shocks are permanent. We derive exact closed-form solutions for the price of a discount bond and computationally tractable schemes to price bond options.