Forthcoming Articles

Option-Based Estimation of the Price of Co-Skewness and Co-Kurtosis Risk

Peter Christoffersen, Mathieu Fournier, Kris Jacobs, and Mehdi Karoui

We show that the prices of risk for factors that are nonlinear in the market return can be obtained using index option prices. The price of co-skewness risk corresponds to the market variance risk premium, and the price of co-kurtosis risk corresponds to the market skewness risk premium. Option-based estimates of the prices of risk lead to reasonable values of the associated risk premia. An analysis of factor models with co-skewness risk indicates that the new estimates of the price of risk improve the models’ performance compared to regression-based estimates.

Does Political Corruption Impede Firm Innovation? Evidence from the United States

Qianqian Huang and Tao Yuan

We examine how local political corruption affects firm innovation in the United States. We find that firms located in highly corrupt areas are less innovative as measured by their patenting activities. The results are robust to the inclusion of a broad set of regional characteristics, instrumental variable analysis, matching analysis, difference-in-differences test, and alternative proxies for local corruption. Further analysis shows that reduced innovation incentives due to high extortion risk and decreased threat of competition could be the possible economic channels through which corruption affects innovation. Overall, our results indicate that local political corruption impedes corporate innovation in the U.S.

 

Financial Flexibility: At What Cost?

Mark J. Garmaise and Gabriel Natividad

Firms strategically borrow in different locations. Approximately one quarter of Peruvian companies with operations in multiple areas source their financing from more than one province. Mining windfalls generate finance supply shocks leading to the provision of more credit at lower average rates, and we show that firms exploit geographical financial flexibility by concentrating their borrowing in booming locations. Firms are less likely to initiate borrowing in new markets when their current borrowing provinces are thriving. The pursuit of flexibility in borrowing markets, however, degrades a firm’s relationships with its existing lenders, thereby heightening its risk of future financial distress.

Trading in Fragmented Markets

Markus Baldauf and Joshua Mollner

We study fragmentation of equity trading using a model of imperfect competition among exchanges. In the model, increased competition drives down trading fees. However, additional arbitrage opportunities arise in fragmented markets, intensifying adverse selection. These opposing forces imply that the effects of fragmentation are context-dependent. To empirically investigate the ambiguity in a single context, we estimate key parameters of the model with order-level data for an Australian security. At the estimates, the benefits of increased competition are outweighed by the costs of multi-venue arbitrage. Compared to the prevailing duopoly, we predict the counterfactual monopoly spread to be 23% lower.

Debt Renegotiation and Debt Overhang: Evidence from Lender Mergers

Yongqiang Chu

This paper studies whether debt renegotiation mitigates debt overhang and increases corporate investment. Using mergers between lenders participated in the same syndicated loans as natural experiments that reduce the number of lenders and thus make renegotiation easier, I find that firms affected by the mergers become more likely to renegotiate the loans and increase capital investment. The effect is stronger for firms with higher Q and firms in financial distress, supporting the hypothesis that the lender mergers mitigate the debt overhang problem.

Tri-Party Repo Pricing

Grace Xing Hu, Jun Pan, and Jiang Wang

We document the central role of collateral in the pricing of tri-party repos. Markets are competitive for repos with safe collateral, but are severely segmented for repos with risky collateral such as equities and low-grade corporate bonds. Fund families are the sole contributors of the segmentation, and collateral concentration is the main determinant in the substantial variation in repo pricing, both across and within segments. The segmented structure points to Fidelity as a systemically important player and the markets potential fragility. Facing market segmentation, dealers optimize financing cost by allocating their collateral across fund families.

 

The Predictive Power of the Dividend Risk Premium

Davide E. Avino, Andrei Stancu, and Chardin Wese Simen

We show that the dividend growth rate implied by the options market is informative about (i) the expected dividend growth rate and (ii) the expected dividend risk premium. We model the expected dividend risk premium and explore its implications for the predictability of dividend growth and stock market returns. Correcting for the expected dividend risk premium strengthens the evidence of dividend growth and stock market return predictability both in- and out-of-sample. Economically, a market timing investor who accounts for the time varying expected dividend risk premium realizes an additional utility gain of 2.02% per year.

Liquidity-Constrained Real Option Valuation in Multiple Dimensions Using Poisson Optional Stopping Times

Rutger-Jan Lange, Daniel Ralph, and Kristian Støre

We provide a new framework for valuing multidimensional real options where opportunities to exercise the option are generated by an exogenous Poisson process; this can be viewed as a liquidity constraint on decision times. This approach, which we call the Poisson Optional Stopping Times (POST) method, finds the value function as a monotone sequence of lower bounds. In a case study, we demonstrate that the frequently used quasi-analytic method yields a suboptimal policy and an inaccurate value function. The proposed method is demonstrably correct, straightforward to implement, reliable in computation and broadly applicable in analyzing multidimensional option-valuation problems.