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Market-Based Solutions to Vital Economic Issues


Kenan Institute 2022 Annual Theme: Stakeholder Capitalism
Market-Based Solutions to Vital Economic Issues

risk management


Scholars continue to debate whether voice and silence are opposites or distinct constructs. This ambiguity has prevented meaningful theoretical advancements about employees’ voice and silence at work. We draw on the behavioral activation and behavioral inhibition systems perspective to provide a conceptual framework for the independence of voice and silence and explicate how two key antecedents—perceived impact and psychological safety—more strongly relate to voice and silence, respectively. We further differentiate voice and silence by identifying their unique effects on employee burnout. 

We analyze how Dodd-Frank-mandated risk retention affects the information investors extract from issuers’ retention choices in the CMBS market. We show that the required retention level is both binding and stringent.

We find that Credit Rating Agencies (CRAs) see through transitory shocks to credit risk that stem from transitory shocks to equity prices, while market-based measures of credit risk do not. For a given stock return, CRAs are significantly less likely to downgrade firms with transitory shocks than those with permanent shocks. However, credit default swap spreads and model-implied default probabilities do not distinguish between such shocks. 

We investigate whether institutional ownership (IO) plays a role in transmitting systemic risk through banks. We find robust evidence suggesting that IO is positively associated with future systemic risk. We find this relationship is stronger during economic downturns at the economy-wide level, as well as for banks demonstrating greater capital needs. Our results also suggest a trading mechanism through which active, and transient institutions in particular, play a role in propagating systemic risk.

We propose a new theory of systemic risk based on Knightian uncertainty (“ambiguity”). Because of uncertainty aversion, bad news on one asset class worsens investors’ expectations on other asset classes, so that idiosyncratic risk creates contagion, snowballing into systemic risk.

We analyze the impact of CDS introduction on real decision-making within the firm, taking into account differences in the local economic and legal environment of firms. We extend the model of Bolton and Oehmke (2011) in order to consider uncertainty in whether actions taken by the reference entity will trigger CDS obligations.

We show that blockchain can be more effective than pricing strategy in eliminating the post-purchase regret and improving social welfare.

Although the non-financial corporate sector accounts for the lion’s share of the post-Global Financial Crisis surge in emerging-market leverage, there is little systematic research on factors that impact corporate distress risk in emerging markets. Existing bankruptcy risk models developed using US data have low predictive power when applied to emerging market firms. We suggest that these models do not account for emerging market vulnerabilities to global shocks such as advanced economy monetary policy changes, US dollar movements, or shifts in global liquidity and risk-aversion.

Mar 31, 2018

Short Selling Risk

Short selling is a risky business. Short sellers must identify mispriced securities, borrow shares in the equity lending market, postcollateral, and pay a loan fee each day until the position closes. In addition to the standard risks that many traders face, such as margin calls and regulatory changes, short sellers also face the risk of loan recalls and the risk of changing loan fees.

Since 1965, average idiosyncratic risk (IR) has never been lower than in recent years. In contrast to the high IR in the late 1990s that has drawn considerable attention in the literature, average market-model IR is 44% lower in 2013-2017 than in 1996-2000. Macroeconomic variables help explain why IR is lower, but using only macroeconomic variables leads to large prediction errors compared to using only firm-level variables. As a result of the dramatic change in the number and composition of listed firms since the late 1990s, listed firms are larger and older. Larger and older firms have lower idiosyncratic risk. Models that use firm char-acteristics to predict firm-level idiosyncratic risk estimated over 1963-2012 can largely or completely ex-plain why IR is low over 2013-2017. The same changes that bring about historically low IR lead to unusu-ally high market-model R-squareds.

We study creative destruction in production networks and its implication for firms' risk profiles. Empirically, upstream firms with the longest distance to consumers earn an excess return of 105 basis points per month relative to downstream consumption producers. We explain this novel spread quantitatively using a general equilibrium model with multiple layers of production. The spread arises endogenously due to vertical creative destruction -- innovations by direct and indirect suppliers devalue the installed capital of customer firms. Consistent with our model predictions, the spread is smaller among firms that belong to supply chains with lower competition, and is larger among firms whose assets-in-place account for a larger fraction of firm value.

Puerto Rico’s unique characteristics as a U.S. territory allow us to examine the channels through which (sub)sovereign default risk can have real effects on the macroeconomy. Post-2012, during the period of increased default probabilities, the cointegrating relationship between real activity in Puerto Rico and the U.S. mainland breaks down and Puerto Rico spirals into a significant decline. We exploit the cross-industry variation in default risk exposure to identify the impact of changes in default risk on employment. The evidence suggests that there are significantly higher employment growth declines in government demand and external finance dependent industries. An additional real effect of default anticipation is that heightened default risk Granger causes Puerto Rico’s austerity measures. An event study analysis using government bond yields and stock returns confirms that news of increased default risk increases the cost of capital for the Puerto Rican government and for publicly traded Puerto Rican firms.