Finance and Insurance Seminar WS 2013/14

Donnerstag, 19.12.2013, 12.00-13.00 Uhr in der Faculty Lounge

Philipp Strack: Endogenous Risk and Financial Competition

Abstract: This paper analyzes the consequences of competition between fund managers. Typically the compensation of a fund manager is a fixed fraction of the size of the fund. A fund manager, interested in maximizing his compensation, thus aims at maximizing the size of his fund. If investors decide, based on past relative performance, in which fund to invest, it is in the best interest of a compensation maximizing fund manager to maximize his relative rank. This paper analyzes the welfare consequences of such a situation. Our main findings are, that competing fund manager create endogenous risk which decreases social welfare. In this case market competition is bad for investors and welfare losses are substantial.


Tilman Drerup: Recommendation Revisions and the Persistence of Past Earnings Surprises

Abstract: This article shows that sell-side analysts’ recommendation revisions are in- formative about the persistence of past earnings surprises. While upgrades following better-than-expected earnings and downgrades following worse-than-expected earnings are indicative of exceptionally persistent earnings surprises, downgrades following better- than-expected earnings and upgrades following worse-than-expected earnings indicate exceptionally transitory earnings surprises. Cross-sectional differences in market responses to recommendation revisions show that investors extract this information and use it to reassess their own estimate of earnings persistence. In addition, more experienced analysts and analysts from larger brokerages seem to be better at assessing differences in earnings persistence, and variation in the market’s response to their recommendations suggests investors are aware of these differences.


Jasmin Gider: Do SEC Detections Deter Insider Trading? Evidence from Earnings Announcements.

The paper explores the consequences of SEC detection of illegal insider trading on subsequent insider trading activities. We hypothesize that individuals with private information update their subjective probabilities of getting caught and are less likely to exploit material, non-public information about pending earnings announcements. The hypothesis is tested using a unique hand-collected sample of 398 insider trading episodes publicly detected by the Securities and Exchange Commission (SEC) and data on earnings announcements. Based on a difference-in-differences approach where we compare firms with a detection event, their industry peers and firms in remote industries, we document a statistically and economically significant deterrence effect: In the vicinity of the detection target the run-ups prior to earnings announcements are significantly reduced by 0.7% post detection.


Markus Behn: Risk-weights, lending and financial stability: The limits of model-based capital regulation

Abstract: Model based regulation is considered to be one of the key innovations of BASEL II. This innovation was argued to improve the efficiency of regulation by making capital charges more risk-sensitive and lead to better allocation of resources. Using data of the German credit register, we empirically show that this reform did indeed result in a change of the quantity and composition of bank lending. In particular, we find that credit supplied by banks that introduced the internal rating-based (IRB) approach exhibits a higher sensitivity to model based PDs as compared to other firms. Interestingly, however, we find that IRB institutes’ risk models systematically underpredict actual default rates by about 0.5% to 1%. There is no systematic measurement error in the PDs for the banks that do not follow the SA-based approach. Our findings suggest that model-based risk weights have failed to regulate the risk of financial intermediaries.


Tobias Berg: Playing the devil's advocate: The causal effect of risk management on loan quality

 Abstract: Casual observation suggests that many banks do not try to align loan officer incentives with those of the bank (i.e. grant positive NPV loans). Instead, they deliberately assign opposing incentives to loan officers (loan volume) and risk management (risk). Decisions are then driven by competition of loan officers and risk management trying to defend their particular causes. Using 75,000 retail mortgage applications at a major European bank, I analyze the effect of risk management involvement on loan defaults. The bank requires risk management approval for loans that are considered risky based on hard information, using a sharp threshold that changes during the sample period. I apply a difference-in-difference estimator as well as a regression discontinuity design to show that risk management involvement reduces default rates by more than 50%. These results add to the understanding of agency conflicts within banks and point to the crucial importance of risk management in resolving internal agency conflicts.


Eva Schliephake: When Banks strategically react to Regulation: Market Concentration as a Moderator for Stability

Abstract: Minimum capital requirement regulation forces banks to refund a substantial amount of their investments with equity. This creates a buffer against losses, but also increases the cost of funding. If higher refunding costs translate into higher loan interest rates, then borrowers are likely to become more risky, which may destabilize the lending bank. This paper argues that, in addition to the buffer and cost effect of capital regulation, there is a strategic effect. A binding capital requirement regulation restricts the lending capacity of banks, and therefore reduces the intensity of loan interest rate competition and increases the banks’ price setting power as shown in Schliephake and Kirstein (2013). This paper discusses the impact of this indirect effect from capital regulation on the stability of the banking sector. It is shown that the enhanced price setting power can reverse the net effect that capital requirements have under perfect competition.


Erik Theissen: GDP Mimicking Portfolios and the Cross-Section of Stock Returns

Abstract: The components of GDP (residential investment, durables, nondurables, equipment and software, and business structures) display a pronounced lead-lag structure. We investigate the implications of this lead-lag structure for the cross-section of asset returns. We find that the leading GDP components perform well in explaining the returns of 25 size and book-to-market portfolios and do reasonably well in explaining the returns of 10 momentum portfolios. The lagging components do a poor job at explaining the returns of 25 size and book-to-market portfolios but explain the return of momentum portfolios very well. A three-factor model with the market risk premium, one leading and one lagging GDP component compares very favorably with the Carhart four-factor model in jointly explaining the returns on 25 size/book-to-market portfolios, 10 momentum portfolios and 30 industry portfolios.