Credit derivatives are among the fastest growing contracts in the derivatives market. We present a simple, easily implementable model to study the pricing and hedging of two widely traded default-triggered claims: default swaps and default baskets. In particular, we demonstrate how default correlation (the correlation between two default processes) impacts the prices of these claims. When we extend our model to continuous time, we find that, once default correlation has been taken into consideration, the spread dynamics have very little explanatory power.

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 to 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 costs by allocating their collateral across fund families.

We conduct a controlled laboratory experiment in the spirit of Merton (1971), in which subjects dynamically choose their portfolio allocation between a risk-free and risky asset. Using the optimal allocation of an investor with hyperbolic absolute risk aversion (HARA) utility, we fit the experimental choices to characterize the risk profile of our participants. Despite substantial heterogeneity, decreasing absolute risk aversion and increasing relative risk aversion are the predominant types. We also find some evidence of increased risk taking after a gain. Finally, the session level risk attitudes show a different profile than the individual descriptions of risk attitudes.

Recent empirical studies have shown that during the financial crisis of 2007–2008, banks that were more heavily exposed to liquidity risk contracted their supply of credit more sharply. I contribute to the identification of this effect by relying on the use of micro-level data on U.S. mortgage loan applications, which allows me to identify liquidity risk as an important determinant of the contraction of credit in the mortgage market but as separate from the precipitous fall in credit demand, disruptions in the securitization and subprime markets, shifts in asset risk, and changing risk aversion among loan officers.

I compare the U.S. capacity expansion decisions of public and private producers of 7 commodity chemicals from 1989 to 2006. I find that private firms invest differently than public firms. Private firms are more likely than public firms to increase capacity prior to a positive demand shock (an increase in price and quantity) and less likely to increase capacity before a negative demand shock. Potential mechanisms include public firm overextrapolation of past demand shocks and agency problems arising from greater separation between ownership and control.

We examine the cross section of stock returns using an original dataset consisting of annual observations on price, dividends, and shares outstanding for nearly all stocks listed on U.K. exchanges between 1870 and 1913, supplemented with additional information about attrition. The only clear pattern in the historical U.K. data is the high returns of extremely small stocks. Among the largest 99.8% of stocks, the historical U.K. data do not display the pattern found in modern U.S. (CRSP) data of excess returns for small stocks or stocks with poor past performance. Unlike CRSP data, stocks that do not pay dividends do not outperform stocks that pay small dividends during this period. However, as in the modern data, there is a weak relation between dividend yield and performance for stocks that pay dividends.

We show that business microloans to U.S. subprime borrowers have a very large impact on subsequent firm success. Using data on startup loan applicants from a lender that employed an automated algorithm in its application review, we implement a regression discontinuity design assessing the causal impact of receiving a loan on firms. Startups receiving funding are dramatically more likely to survive, enjoy higher revenues, and create more jobs. Loans are more consequential for survival among subprime business owners with more education and less managerial experience.

This paper develops a multi-asset mixture distribution hypothesis model to investigate commonality in stock returns and trading volume. The model makes two main predictions: First, the factor structures of returns and trading volume are independent although they stem from the same valuation fundamentals and jointly depend on a latent information flow; second, cross-sectional positive volatility-volume relations arise solely from the dynamic features of the information flow. Empirical analyses at the market level support these predictions. Furthermore, the results indicate that removing the information flow significantly reduces the return volatility persistence and the extent of the reduction exhibits a size pattern.

The trading of shares of the same firm in multiple markets has become common over the last 30 years, but there is little empirical evidence on the extent to which investors actively exploit multimarket environments. We introduce a volume-based measure of multimarket trading to address this question. Analyzing a large set of cross-listed firms, we find higher multimarket trading among markets with similar designs and strong enforcement of insider trading laws and for firms with higher institutional ownership. These findings are important for firms evaluating the benefits of cross listing and for markets competing for order flow.

We examine market efficiency before and after the 1987 Market Crash using the box spread strategy implemented with European-style S&P 500 Index (SPX) options. Before the Crash, apparent arbitrage opportunities were rare and simulated trades were unprofitable assuming a one-minute execution delay. After the Crash, apparent arbitrage opportunities were frequent and simulated trades were profitable even assuming a five-minute execution delay. Our analysis makes the routine assumption that quotes are good until updated to construct a time series of prevailing quotes sampled at 30-second intervals. If this assumption is valid, then arbitrage profits were actually available. If this assumption is invalid, then such profits could have been illusory. Either scenario, however, implies that SPX market efficiency decreased following the Crash—prevailing price quotes repeatedly failed to satisfy the fundamental parity relation underlying the box spread.

Trading in currencies in order to obtain the best possible exchange rate is known as arbitrage and can broadly be divided into three categories:

1) Space Arbitrage––transactions to take advantage of discrepancies between rates quoted at the same time in different markets.

2) Time Arbitrage––transactions to take advantage of discrepancies between forward margins for different maturities.

3) Interest Arbitrage––transactions to take advantage of discrepancies between yield on short-term investments in different currencies. This form of arbitrage can be split into (a) Covered and (b) Uncovered (speculative) interest arbitrage. The former variety uses today's forward rate for forward conversion back into our holding currency; the latter allows the dealer to use the spot rate existing in the future.

I examine the ability of the U.S. investor protection regime to limit insider trading returns, absent Section 16(b) of the Securities Exchange Act of 1934 (the short-swing rule). I find that in this setting, U.S. insiders execute short-swing trades that i) beat the market by approximately 15 basis points per day and ii) systematically divest ahead of disappointing earnings announcements. These results indicate that the bright-line rule restricting short-horizon round-trip insider trading plays a substantial role in protecting outside investors from privately informed insiders in the United States.

Capital structure choice based on costs associated with asymmetric information is examined in order to present a new perspective on the standard pecking order and trade-off theories. In the model, both the face value of debt and the restrictiveness of the associated debt covenants are chosen as part of the financial structure, allowing a more complete characterization of this decision. Debt structure choice balances ex ante adverse selection against ex post moral hazard, providing a natural integration of the pecking order and trade-off theories and the development of interesting empirical implications.

We develop a method for defining groups of peer firms on the basis of joint analyst coverage. Besides industry boundaries, analysts’ coverage choices reflect other aspects of firm relatedness such as business model. We find that the analyst-based method produces substantially more homogeneous groups of firms compared to common industry classifications, and has a number of other desirable properties. The paper has two broader implications. First, it demonstrates the advantages of a self-organizing approach to classification, as opposed to a hierarchical system. Second, it illustrates a new positive information production externality generated by the institution of security market analysis.

A temporary trading suspension in a listed security represents a temporal discontinuity in a continuous auction market. Although the SEC occasionally suspends trading in specific securities, the NYSE itself administratively halts trading in individual NYSE issues. The latter occur quite frequently (almost three per day on average), and typically last about two hours. NYSE-initiated suspensions are the focus of the present paper.

We study how minimum trading unit changes on the Tel-Aviv Stock Exchange impact a stock's trading activity, price volatility, and value. The value effects are consistent with Merton's (1987) model, i.e., an increase in the investor base (trading volume) and a decrease in price noisiness affect stock value positively. Our results extend Amihud, Mendelson, and Uno's (1999) tests of Merton by demonstrating a clear relation between price noisiness changes and stock value changes, and by showing that the response to a minimum trading unit decrease becomes less favorable (and arguably even negative) in the thinnest trading stocks.

This paper empirically examines the underinvestment problem and the use of dividends to expropriate lenders' wealth. Rather than analyzing the market's reaction to potential wealthexpropriating events, a different aspect of potential conflicts of interest is addressed: do managers who control dividends act in a manner consistent with wealth expropriation? If so, then debt issues should be followed by increases in dividends. Two samples of firms are used: those issuing straight debt and those issuing convertible debt. The study finds no evidence that firms manipulate dividend policy to transfer wealth from the bondholders to stockholders. Two possible explanations are suggested. First, wealth expropriation may be a potential problem, but existing bond covenants restricting a firm's ability to pay dividends are effective. Second, firms may believe that reputation has greater value than what can be transferred from creditors in a one-time expropriation of wealth. Since the paper fails to find support for the covenant argument, it concludes that reputation is the most plausible explanation.

We develop a multivariate credit risk model that accounts for joint defaults of banks and allows us to disentangle how much of banks’ credit risk is systemic. We find that the United States and United Kingdom differ not only in the evolution of systemic risk but, in particular, in their banks’ systemic exposures. In both countries, however, systemic credit risk varies substantially, represents about half of total bank credit risk on average, and induces high risk premia. The results suggest that sovereign and bank systemic risk are particularly interlinked in the United Kingdom.

We study changes in independent director behavior and labor-market outcomes after the experience of a forced Chief Executive Officer (CEO) turnover. We find that independent directors are more willing to fire CEOs of underperforming firms, hire outside CEOs after a firing, and encourage better board-meeting attendance by fellow directors. We also find that the shareholders of poorly performing firms react positively when experienced directors join the board. It does come with a small cost for directors, in terms of additional directorships, although the cost is not as great as that for directors who do not fire the CEO of a poorly performing firm.

We examine liquidity transformation by funds of hedge funds (FoFs) by developing a new measure, illiquidity gap, that captures the mismatch between the liquidity of their portfolios and the liquidity available to their investors. We find that higher liquidity transformation is driven by FoFs’ incentives to attract more capital and earn higher compensation. Greater liquidity transformation is associated with higher exposure to investor runs and worse performance during crisis periods. Finally, FoFs mitigate the risks associated with liquidity transformation by maintaining higher cash buffers.