Forthcoming Articles

Sustainability Preferences Under Stress: Evidence from COVID-19

Robin Döttling and Sehoon Kim

We document fragile demand for socially responsible investments (SRI) by retail mutual fund investors. Using COVID-19 as an economic shock, we show funds with higher sustainability ratings experienced sharper declines in retail flows during the pandemic, controlling for fund characteristics. The decline in retail SRI fund flows is sharper than that of institutional flows, more pronounced when economies are hit harder by COVID-19, and unlikely to be driven by fund performance, past flows and size, or shifting investor attention. Corroborated by out-of-sample survey evidence, our findings highlight high sensitivity of SRI demand by retail investors with respect to income shocks.

The Impact of Uncertainty on Investment: Empirical Challenges and a New Estimator

Delong Li and Yiguo Sun

This paper proposes a new method for examining the impact on a firm’s investment of uncertainty reflected in its stock-return volatility. We simultaneously address the endogeneity of uncertainty and mismeasurement in Tobin’s q , but earlier empirical work often neglects one of the two issues. Our nonparametric estimates further suggest that the relation between investment and uncertainty is significantly decreasing and strongly concave. This result contrasts with the existing literature that widely adopts linear regressions. Ignoring nonlinearity or measurement error in q can lead to a substantial estimation bias. However, the bias due to the endogeneity of uncertainty is small.

Monetary Policy and Bond Prices with Drifting Equilibrium Rates

Carlo Favero, Alessandro Melone, and Andrea Tamoni

We study drift and cyclical components in U.S. Treasury bonds. We find that bond yields are drifting because they reflect the drift in monetary policy rates. Empirically, modeling the monetary policy drift using demographics and productivity trends, plus long-term inflation expectations, leads to cyclical deviations of bond prices from their drift that predict bond returns in- and out-of-sample. These bond cycles can originate from term premia or temporary deviations from rational expectations in a behavioral framework. Through the lens of our model, we detect a significant role of the latter in determining the cyclical properties of yields with short maturities.

Standing Out from the Crowd via CSR Engagement: Evidence from Non-Fundamental-Driven Price Pressure

Lei Gao, Jie (Jack) He, and Juan (Julie) Wu

We test the signaling view of corporate social responsibility (CSR) engagement using two complementary quasi-natural experiments that impose exogenous negative pressure on stock prices. Firms under such adverse price pressure increase CSR activities compared to otherwise similar firms. This effect concentrates among firms with stronger signaling incentives, namely, those facing greater information asymmetry, more product market competition, higher shareholder litigation risk, and higher stock price crash risk. Firms under the exogenous negative price pressure mainly improve CSR strengths, including costly environmental investments. We also find that CSR engagement attracts socially responsible investors and lowers cost of capital for signaling firms.

Initial Public Offerings Chinese Style

Yiming Qian, Jay R. Ritter, and Xinjian Shao

This paper provides a survey of China’s IPO market, focusing on IPO pricing, bids and allocation, and aftermarket trading. We show that strict regulations result in suppressed IPO offer prices and high initial returns, causing a high cost of going public. Investors treat IPOs as lotteries with extremely high short-term returns, with little attention to the long-term. The auction selling method, however, works in the way it is supposed to. Mutual funds bid in a more informative way than other investors, and their advantages are unlikely to be due to underwriters’ preferential treatment. We also discuss the latest registration-system reform.

Trader Competition in Fragmented Markets: Liquidity Supply Versus Picking-Off Risk

Alejandro Bernales, Nicolas Garrido, Satchit Sagade, Marcela Valenzuela, and Christian Westheide

By employing a dynamic model with two limit order books, we show that fragmentation is associated with reduced competition among liquidity suppliers and lower picking-off risk of limit orders. Due to these countervailing channels, the impact of fragmentation on liquidity and welfare differs with asset volatility: when volatility is high (low), liquidity and aggregate welfare in a fragmented market are higher (lower) than in a single market. However, fragmentation always shifts welfare away from agents with exogenous trading motives and towards intermediaries. We empirically corroborate our model’s predictions about liquidity. Our model reconciles the mixed results in the empirical literature.

Cash Induced Demand

Huaizhi Chen

I show that cash distributions through cash mergers, dividend payments, and stock buybacks are, in principle, similar to investor fund flows in generating demand for investable assets. Abnormal returns on certain assets can be forecasted because delegated investors predictably reinvest cash returns toward certain holdings. Novel measures of stock-level demand constructed using proportional reinvestments by mutual funds predict abnormal returns and issuances in non-cash-paying stocks. These results highlight an alternative and substantial source of price fluctuations in the cross section of equities.

Central Counterparty Default Waterfalls and Systemic Loss

Samim Ghamami, Mark Endel Paddrik, and Simpson Zhang

Central counterparty default waterfalls act as the last lines of defense in over-the-counter markets by managing and allocating resources to cover payment defaults. This paper examines the impact of variations in waterfall design on financial system losses in the presence of payment network dependencies and frictions in the cleared and non-cleared portion of the system. Through the development of a structural model, we draw several theoretical conclusions about the effectiveness of CCP default waterfalls under severe payment stress. These findings are empirically quantified by testing the model using supervisory data for the U.S. credit default swap market.