Finance and Insurance Seminar SS 2013
Prof. Dr. Konstantin Milbradt, MIT, Sloan School of Management
"Quantifying Liquidity and Default Risks of Corporate Bonds over the Business Cycle"(joint work with Hui Chen, Rui Cui and Zhiguo He)
This paper introduces time-varying liquidity frictions into a structural model of corporate bond pricing. We feature a combination of procyclical liquidity conditions and countercyclical macroeconomic fundamentals in characterizing the risks of corporate bonds over the business cycle. When calibrated to the historical moments of default probabilities and empirical measuresof secondary market liquidity, our model matches the observed credit spreads of corporate bonds across high-grade to high-yield ratings, as well as measures of non-default components including Bond-CDS spreads and bid-ask spreads. In addition, we propose a novel structural decomposition scheme that captures the interaction between liquidity frictions and corporate default decisions via the rollover channel. We use this framework to quantitatively evaluate the effects of liquidity provision policies during crisis time. Our structural approach identifies important economic forces that were previously overlooked by empirical researches in corporate bonds.
"The Trend is Your (Imaginary) Friend: A Behavioral Perspective on Technical Analysis (joint work with Sebastian Ebert)"
Technical analysts, or chartists, aim at predicting future prices from past prices. To this means, for example, they draw resistance levels and moving average (MA) lines into stock price charts. We analyze the prospect theory utility from trading based on the widely employed MA rule. Specifically, we study MA for a highly unattractive stock whose price is not predictable and does not move in trends. Therefore, any reasons for why MA might be profitable are violated by assumption. Nevertheless, trading MA is attractive to many prospect theory investors because it shapes the distribution of trading proceeds in a way they appreciate. While chartists often argue that market participants not being fully rational may in part explain why technical analysis is profitable, this paper shows that technical analysis may be attractive---even though not profitable---to investors who are less than fully rational.
Prof. Dr. Marc Oliver Rieger, University of Trier
"The Behavioral Foundations of Corporate Dividend Policy – A Cross-Country Analysis" (joint work with Wolfgang Breuer and Can Soypak)
We study a model that relates dividend payout policy to behavioral issues based on the ideas of mental accounting. A panel analysis across 31 countries and over 46,000 firm-years demonstrates that our model hypotheses can be verified empirically. Our paper seems to be the first that highlights empirically in a straightforward way the relevance of behavioral patterns as important determinants for corporate dividend policy, while previous empirical studies could tackle this issue only indirectly. With several robustness tests we also address potential doubts concerning the quality of our data and analyze further implications of our theory.
We propose a method of model selection for pricing and hedging purposes called “Robust Calibration”, which uses time series data and derivatives' price data simultaneously: model parameters invariant under equivalent measure changes are estimated from time series, whereas non-invariant parameters are calibrated to derivatives' prices. For the estimation of invariant parameters certain Fourier techniques, as introduced by Malliavin-Mancino, are proposed. In this talk we present the theory and some applications of Fourier techniques to estimate instantaneous covariance in the presence of jumps.
|Prof. Dr. Phillipe Müller, LSE |
"Mortgage Hedging in Fixed Income Markets”
We study the feedback from mortgage portfolios hedging on the level and volatility of interest rates. We incorporate the supply effects resulting from hedging into an otherwise standard dynamic term structure model, and derive two sets of predictions which are strongly supported by the data: First, the duration of mortgage-backed securities (MBS) positively predicts excess bond returns, especially for longer maturities. Second, MBS convexity increases the volatility of all yields, and this effect has a hump-shaped term structure. Empirically, neither duration, nor convexity are spanned by yield factors. A calibrated version of our model replicates salient features of first and second moments of bond yields.
Prof. Dr. Axel Kind, University of Basel
| "The Value of Corporate Voting Rights Embedded in Prices of American Single-Stock Options" |
We propose and test a new method to extract the value of corporate voting rights from market prices of American-style single-stock options. The method models voting-right values as non-cash dividends and backs them out via numerical optimization from prices of equity options. Simulation experiments show that the method is accurate and outperforms existing option-based approaches by reducing their measurement error from 17.2% to 1.57% in terms of root mean squared errors and almost eliminates their bias. The paper also contributes an empirical analysis of corporate voting-right values in European companies in the time period between 2003 and 2010. Voting rights have an annualized average value of 0.37% of the share price and are significantly worth more in months in which either ordinary or extraordinary general meetings take place but no single shareholder holds a majority stake in the company. Finally, voting values are higher in companies incorporated in French-civil-law countries (France and the Netherlands) than in German-civil-law countries (Germany and Switzerland).
Prof. Dr. Rainer Haselmann, University of Bonn
“The Political Economy of Bank Bailouts” (joint work with Markus Behn, Thomas Kick and Vikrant Vig)
In this paper, we investigate the effect of political determinants of public bailout policies. For a sample of 148 distress events of German savings banks, we find that politicians’ interests and ideology have a significant impact on their decision to bail out distressed banks. The probability of politicians injecting taxpayers’ money in a distressed bank is 30 percent lower in the year before compared to the years after an election. High competition in the electoral process reduces the probability of a public bailout by 15 percent. We also show that ideology affects bailout decisions – capital injections are 17 percent less likely if the politician is a member of the conservative party. Politicians tend to refrain from capital injections if their community is highly indebted. Banks that are bailed out by politicians experience less restructuring and lower long run performance in the years following the event compared to banks that are bailed out by the saving bank association. Our findings have important implications on efficient design of banking regulation.
Prof. Dr. Alexander Szimayer, University of Hamburg
“Optimal Share-Based Payments”
We investigate the design of optimal share-based incentive contracts by formulating a stochastic differential game between a listed company and a representative manager in continuous time. The value maximizing company can grant share-based payments to the manager as incentive component of the total salary package at a premium. The manager is assumed to maximize utility from investment and consumption net of the costs for work effort. The information asymmetry is built into the model by allowing the manager to observe the level of share-based payments granted by the company. However, the effort exercised by the manager and her investment and consumption decision cannot be observed by the company. Accordingly we obtain a stochastic differential game of Stackelberg type. For this setting we identify a Stackelberg equilibrium that is a subgame perfect Nash equilibrium in the given context. Based on the equilibrium strategies we derive the optimal contract design. The results are discussed emphasizing the effect of company characteristics such as volatility and size, and manager characteristics, such as work productivity. We find that company size and manager ability are the dominating factors. In particular, overall remuneration and the fraction of share-based payments are increasing in the company size. A more skilled manager is expected to receive a higher overall compensation with higher fraction of share-based payments.
Prof. Dr. Eva Lütkebohmert, University of Freiburg
“Optimal Debt Maturity Structure in the Presence of Liquidity Risk”
We present a structural model for credit and liquidity risk where default occurs when the firm's asset value process falls below a certain threshold. The firm's asset value follows a Heston stochastic volatility model. The financial institution finances its risky assets by a mixture of short- and long-term debt as well as equity. Short-term creditors have the possibility not to renew their funding at certain roll-over dates. Thereby, the fi?rm is exposed to liquidity risk through possible bank runs. The firm's coupon payments to its creditors are derived endogenously depending on the firm's credit and liquidity risk. Equity holders have to bear the gains and losses from rolling over short-term debt. They choose the default threshold such that the expected equity value is maximized subject to their limited liability. The firm's optimal debt maturity structure is determined by a trade off between lower financing costs and higher bankruptcy costs when increasing short-term financing.
Prof. Dr. Thomas Langer, University of Münster
“Does it pay to set up a prediction market?” (joint work with Andrea Jacobs and Enrico Diecidue)
Prediction Markets (PM) have been shown to consistently outperform consensus forecasts. Through the trading mechanism they do not only aggregate best guesses but also the strength of the beliefs. The improved prediction quality comes at the cost of organizational complexity, however. We experimentally investigate whether forecasts of similar quality could be generated by individually assessing best guesses, strength of beliefs, competence, and other variables, and applying appropriate aggregation schemes. We find PMs to be superior.
Thomas Kruse, MSc., University of Bonn (HCM)
“Optimal position closure in a market with stochastic liquidity” (joint work with S. Ankirchner and M. Jeanblanc)
Liquidity in financial markets usually is not constant - it varies randomly in time and sometimes faces shocks. We consider the problem of closing a large asset position in a market with stochastic liquidity. We provide a probabilistic solution of the associated control problem by means of a Backward Stochastic Differential Equation (BSDE). The novelty of our solution approach is that the BSDE possesses a singular terminal condition. We prove that a solution of the BSDE exists and perform a verification. For special cases we determine optimal trading strategies explicitly.