Expected exponential utility maximization of insurers with a Linear Gaussian stochastic factor model

In this paper, we consider the problem of optimal investment by an insurer. The wealth of the insurer is described by a Cramér–Lundberg process. The insurer invests in a market consisting of a bank account and m risky assets. The mean returns and volatilities of the risky assets depend linearly on economic factors that are formulated as the solutions of linear stochastic differential equations. Moreover, the insurer preferences are exponential. With this setting, a Hamilton–Jacobi–Bellman equation that is derived via a dynamic programming approach has an explicit solution found by solving the matrix Riccati equation. Hence, the optimal strategy can be constructed explicitly. Finally, we present some numerical results related to the value function and the ruin probability using the optimal strategy.     

Venture Capital and Other Private Equity: a Survey

We review the theory and evidence on venture capital (VC) and other private equity: why professional private equity exists, what private equity managers do with their portfolio companies, what returns they earn, who earns more and why, what determines the design of contracts signed between (i) private equity managers and their portfolio companies and (ii) private equity managers and their investors (limited partners), and how/whether these contractual designs affect outcomes. Findings highlight the importance of private ownership, and information asymmetry and illiquidity associated with it, as a key explanatory factor of what makes private equity different from other asset classes.     

The role of institutional investors in propagating the crisis of 2007–2008

Using novel data on investors' bond portfolios, we study the contagion of the crisis from securitized bonds to corporate bonds. When securitized bonds became “toxic” in August 2007, mutual funds retained the now illiquid securitized bonds and sold corporate bonds. Funds with negative flows or high liquidity needs liquidated more than others. Yield spreads increased more for corporate bonds whose pre-crisis bondholders were more heavily exposed to securitized bonds, compared to same-issuer bonds held by unexposed investors. The findings suggest that liquidity-constrained investors with exposure to securitized bonds played a role in propagating the crisis from securitized to corporate bonds.     

Oligopolistic equilibrium and financial constraints

We model a dynamic duopoly in which firms can potentially drive their rivals from the market. For some parameter values, the Cournot equilibrium outcome cannot be sustained in an infinitely repeated setting. In those cases, there is a Markov perfect equilibrium in mixed strategies in which one firm, eventually, will exit the market with probability one. Producer surplus in the maximum collusive outcome is greater under bankruptcy consideration, because the outcome that maximizes joint profits is skewed in favor of the more efficient firm. Consumer surplus and social welfare also increase in many cases, although those effects are generally ambiguous.     

Are Stars’ Opinions Worth More? The Relation Between Analyst Reputation and Recommendation Values

Using 1994–2009 data, we find that All-American (AA) analysts’ buy and sell portfolio alphas significantly exceed those of non-AAs by up to 0.6 % per month after risk-adjustments for investors with advance access to analyst recommendations. For investors without such access, top-rank AAs still earn significantly higher (by 0.3 %) monthly alphas in buy recommendations than others. AAs’ superior performance exists before (as well as after) they are elected, is not explained by market overreactions to stars, and is not significantly eroded after Reg-FD. Election to top-AA ranks predicts future performance in buy recommendations above and beyond other previously observable analyst characteristics. Institutional investors actively evaluate analysts and update the AA roster accordingly. Collectively, these results suggest that skill differences among analysts exist and AA election reflects institutional investors’ ability to evaluate and benefit from elected analysts’ superior skills. Other investors’ opportunity to profit from the stars’ opinions exists, but is limited due to their timing disadvantage.     

Supply uncertainty of the bond investor base and the leverage of the firm

We examine the effect of the bond capital supply uncertainty of institutional investors (e.g., mutual bond funds and insurance companies) on the leverage of the firm using a novel data set. Our main finding is that the supply uncertainty of the firm's bond investor base — measured as (i) the average portfolio turnover, or (ii) the average flow volatility of investors holding the firm's bonds, or (iii) the prevalence of mutual funds among the firm's bondholders as opposed to insurance companies — has a negative and significant effect on the leverage of the firm. The supply uncertainty of the firm's bond investor base also has a negative and significant effect on the firm's probability of issuing bonds, and a positive and significant effect on the firm's probability of issuing equity and borrowing from banks. We take a multi-pronged approach to address potential endogeneity issues, including use of geography-based instruments and firm fixed effects, subsample analyses, and a placebo test. Our results highlight the fragility of access to the bond market for companies that depend on mutual funds with high turnover/ flow volatility as primary bond investors.     

The Relationship Between Bank Risk and Earnings Management: Evidence from Japan

Using stock price data drawn from the 1990s in Japan, this paper empirically shows that bank risk is negatively associated with discretionary accruals, indicating that investors misinterpreted high reported earnings as favorable information about bank financial health. We also show that the negative relationship was very powerful prior to the major bank failures in late 1997 and 1998, but it diminished subsequent to the failures. We conclude that investors started to anticipate potential manipulation of financial reports by bank managers more rationally after the major bank failures.     

Impact investing

We show that investors derive nonpecuniary utility from investing in dual-objective Venture Capital (VC) funds, thus sacrificing returns. Impact funds earn 4.7 percentage points (ppts) lower internal rates of return (IRRs) ex-post than traditional VC funds. In random utility/willingness-to-pay (WTP) models investors accept 2.5–3.7 ppts lower IRRs ex ante for impact funds. The positive WTP result is robust to fund access rationing and investor heterogeneity in fund expected returns. Development organizations, foundations, financial institutions, public pensions, Europeans, and United Nations Principles of Responsible Investment signatories have high WTP. Investors with mission objectives and/or facing political pressure exhibit high WTP; those subject to legal restrictions (e.g., Employee Retirement Income Security Act) exhibit low WTP.     

Disclosures of material weaknesses by Japanese firms after the passage of the 2006 Financial Instruments and Exchange Law

We investigate the disclosures of material weaknesses in internal control mandated for Japanese firms under the 2006 Financial Instruments and Exchange Law. We find that the presence of a material weakness is more likely for firms that are younger, have better growth prospects, have a volatile operating environment, are financially constrained, and have weak governance structures. We examine the role of Japan’s main banks in this process and find that the likelihood of a material weakness is higher for firms with stronger links with their main banks. We also show that the financial health of the main banks themselves—proxied for by the banks’ BIS ratios and bad loan ratios—increases the likelihood of a material weakness in affiliated firms. This paper provides novel insights into the determinants of material weaknesses of Japanese firms since the passage of the law. Results from this study contribute to the literature on material weaknesses and relationship banking.