Forthcoming Articles

Attitudes Towards Non-Compliance and the Demand for External Finance

Robert Davidson and Christo Pirinsky

We study the link between individual propensity to violate moral principles and demand for finance based on two data sets – the World Values Survey and a data set with the legal records of CEOs of U.S. publicly traded companies. We find that individuals who are more tolerant of moral principle violations are more likely to borrow. Corporate executives with legal records are also associated with larger mortgages (both in absolute terms and relative to the value of their home). The results are economically significant. Reverse causality and individual attitudes towards risk are unlikely explanations of our findings. We contend that non-compliance relaxes participation constraints in capital markets by lowering the psychological costs of entering and breaking a contract.

A Shadow Rate or a Quadratic Policy Rule? The Best Way to Enforce the Zero Lower Bound in the United States

Martin Andreasen and Andrew Meldrum

We study whether it is better to enforce the zero lower bound (ZLB) in models of U.S. Treasury yields using a shadow rate model or a quadratic term structure model. We show that the models achieve a similar in-sample fit and perform comparably in matching conditional expectations of future yields. However, when the recent ZLB period is included in the sample, the models? ability to match conditional expectations away from the ZLB deteriorates because the time-series dynamics of the pricing factors change. In addition, neither model provides a reasonable description of conditional volatilities when yields are away from the ZLB.

High-Frequency Trading Competition

Jonathan Brogaard and Corey Garriott

Theory on high-frequency traders (HFT) predicts that market liquidity for a security decreases in the number of HFT trading the security. We test this prediction by studying a new Canadian stock exchange, Alpha, that experienced the entry of 11 HFT firms over four years. Bid-ask spreads on Alpha converge to those at the Toronto Stock Exchange as more HFT trade on Alpha. Effective and realized spreads for nonHFT improve as HFT firms enter the market. To explain the contrast with theory, which models HFT as a price competitor, we provide evidence more consistent with HFT fitting a quantity competitor framework.

The Information Content of Sudden Insider Silence

Claire Yurong Hong and Frank Weikai Li

We present evidence of investors underreacting to the absence of events in financial markets. Routine-based insiders strategically choose to be silent when they possess private information not yet reflected in stock prices. Consistent with our hypothesis, insider silence following routine sell (buy) predict positive (negative) future return as well as fundamentals. The return predictability of insider silence is stronger among firms with poor information environment and facing higher arbitrage costs, and a large fraction of abnormal returns concentrates on future earnings announcements. A long-short strategy that exploits insiders’ strategic silence behavior generates abnormal returns of 6% to 10% annually.

The Effect of Investment Constraints on Hedge Fund Investor Returns

Juha Joenväärä, Robert Kosowski, and Pekka Tolonen

This paper examines the effect of investor-level real-world investment constraints, including several which had not been studied before, on hedge fund performance and its persistence. Using a large consolidated database, we demonstrate that hedge fund performance persistence is significantly reduced when rebalancing rules reflect fund size restrictions and liquidity constraints, but remains statistically significant at higher rebalancing frequencies. Hypothetical investor portfolios that incorporate additional minimum diversification constraints, minimum investment requirements, and focus on open funds suggest that the performance and its persistence documented in earlier studies of hedge funds is not easily exploitable, especially by large investors.

Price Drift before U.S. Macroeconomic News: Private Information about Public Announcements?

Alexander Kurov, Alessio Sancetta, Georg Strasser, and Marketa Halova Wolfe

We examine stock index futures and Treasury futures around the release time of 30 U.S. macroeconomic announcements. Nine of the 20 announcements that move markets show evidence of substantial informed trading before the official release time. Prices begin to move in the “correct” direction about 30 minutes before the release time. The pre-announcement price drift accounts on average for about 40% of the total price adjustment. This implies that some traders have private information about macroeconomic fundamentals. Preannouncement drift might originate from a combination of information leakage and superior forecasting that incorporates proprietary data.

Optimal Consumption and Investment under Time-Varying Liquidity Constraints

Seryoong Ahn, Kyoung Jin Choi, and Byung Hwa Lim
We study consumption and investment decisions given realistic time-varying constraints on borrowing. We first consider the case where borrowing is constrained by a maximum debt-to-income ratio. We then consider collateral borrowing, with a maximum loan-to-value ratio. The resulting implications for optimal policies differ considerably from those obtained in the existing literature based on fixed borrowing limits, but are consistent with those documented in the empirical literature.

Employment, Corporate Investment and Cash Flow Risk

Saad Alnahedh, Sanjai Bhagat, and Iulian Obreja
We highlight the role of cash flow uncertainty on corporate employment and investment. We find that a 1% increase in cash flow uncertainty leads to a 0.62% decrease in tangible investment, a 1.39% decrease in intangible investment, and a 3.67% decrease in corporate employment growth. Our results are statistically and economically significant. We further find that these relationships are stronger during economic recessions. Our findings have significant policy implications. To wit, if policy makers would like corporations to increase their employment and investment, they should focus on policies that decrease corporate cash flow uncertainty.