2012–2013

Gender Identity and Relative Income within Households

Marianne Bertrand, Chris P. Dialynas Professor of Economics
Emir Kamenica, Associate Professor of Economics and Robert King Steel Faculty Fellow

Summary: We examine the relationship between two important social trends: the reduction in the gap between men and women's labor earnings and the reduction in marital rates. We first observe that the distribution of the share of the household income earned by the wife is inconsistent with standard models of the marriage market and suggests that traditional gender roles play a role in marriage formation and/or earnings within marriage. Using panel survey data, we show that couples where wife earns more than the husband are less satisfied with their marriage and are more likely to divorce. Using census data, we show that in couples where the wife's potential income (based on her demographics) is likely to exceed her husband's, the wife is less likely to be in the labor force, earns less than her potential, and is less likely to have a child. Finally, within a marriage market, when a randomly chosen woman becomes more likely to earn more than a randomly chosen man marriage rates decline.

Do Fixed Patent Terms Distort Innovation? Evidence from Cancer R&D

Eric Budish, Associate Professor of Economics

Summary: Patents award innovators a fixed period of market exclusivity, e.g., 20 years in the United States. Yet, since in many industries firms file patents at the time of discovery ("invention") rather than first sale ("commercialization"), effective patent terms vary: inventions that commercialize at the time of invention receive a full patent term, whereas inventions that have a long time lag between invention and commercialization receive substantially reduced - or in extreme cases, zero - effective patent terms. We present a simple model formalizing how this variation may inefficiently distort research and development (R&D). We then explore this distortion empirically in the context of cancer R&D, where clinical trials are shorter - and hence, effective patent terms longer - for drugs targeting late-stage cancer patients, relative to drugs targeting early-stage cancer patients or cancer prevention. Using a newly constructed data set on cancer clinical trial investments, we provide several sources of evidence consistent with fixed patent terms distorting cancer R&D. Back-of-the-envelope calculations suggest that the number of life-years at stake is large. We discuss three specific policy levers that could eliminate this distortion - patent design, targeted R&D subsidies, and surrogate (non-mortality) clinical trial endpoints - and provide empirical evidence that surrogate endpoints can be effective in practice.

The High-Frequency Trading Arms Race: Implications for Financial Market Design

Eric Budish, Associate Professor of Economics

Summary: We propose frequent batch auctions—uniform-price double auctions conducted, e.g., every one second—as a market design response to the high-frequency trading arms race. Our argument has four parts. First, under the continuous-time limit-order book that is currently predominant in financial markets, market correlations that function properly at human-scale time horizons break down at high-frequency time horizons. Second, we show that this correlation breakdown creates purely technical arbitrage opportunities, which in turn create an arms race to exploit such opportunities. Third, we use a simple theory model to show that the HFT arms race is not only per se wasteful, but leads to wider spreads and thinner markets for fundamental investors. Last, we show that frequent batch auctions mitigate the arms race, narrow spreads and improve market depth, but at the cost of slightly slower price discovery. If the batch auctions are conducted frequently enough, then switching from continuous limit-order books to frequent batch auctions has first-order welfare benefits and only second-order costs.

Punishment by Pillory: The Effects of Malpractice Disclosure to Consumers

Hans Christensen, Associate Professor of Accounting
Christian Leuz, Joseph Sondheimer Professor of International Economics, Finance and Accounting

Summary: The study examines the behavioral effects of disclosing the identity of health-care professionals that have committed serious errors to consumers. In 2006, Denmark introduced a government website that discloses the names and authorization numbers of health care professionals that have been cited by the patient complaint board for serious errors three or more time within five years. We analyze the extent to which the disclosure regime has the intended consequences and can be used as a disciplinary mechanism. Specifically, we examine how the new disclosure regime affects (i) the likelihood of committing three errors within five years, (ii) the behavior of the regulator responsible for assessing potential errors, (iii) services provided by health care professionals, and (iv) the career prospects of health care professionals subject to disclosure. The study is based on proprietary data from the patient complaint board and Danish Health Service.

No News is News: Do Markets Underreact to Nothing?

Stefano Giglio, Assistant Professor of Finance
Kelly Shue, Assistant Professor of Finance

Summary: As illustrated in the tale of "the dog that did not bark," the absence of news and the pure passage of time often contain information. We test whether markets fully incorporate the information content of "no news" using the empirical context of mergers. Following the initial merger announcement, uncertainty relating to merger completion can take many months to be resolved. We find that the pure passage of time during this interim period is informative about the probability of merger completion. For example, once six months have passed after announcement, the probability that the merger will ever complete falls rapidly. We show that the variation in hazard rates of completion during the 12 months after announcement strongly predicts returns. This is consistent with a limited attention model in which markets underreact to the information content of the passage of time. We also show that our findings cannot be explained by event time variation in systematic risk, downside risk, or idiosyncratic risk. Specifically, we construct a trading strategy that invests in deals during event windows when completion hazard rates are high. Controlling for risk, our strategy outperforms a strategy that invests in deals when completion hazard rates are low by 100 basis points per month.

Migrants Networks and the Patterns of Trade and Growth

Tarek Hassan, Assistant Professor of Finance

Summary: To test whether the existence of migrants networks facilitate trade of US States and Canadian Provinces with Eastern and Central European countries following the fall of the iron curtain, we collect four main datasets, two for the US and two for Canada: 

  • US decennial Census: we extract data on the country of origin of the person, their parents, or grandparents. Since 1980, a question has been added about ancestry, which we collect as well.

  • Canadian Population Census: we also extract data about the country of origin.

  • US trade: the Foreign Division of the US Census Bureau collects data on import and export by US State, destination/origin country, and product category.

  • Canadian trade: Statistics Canada also collects data on imports and exports by Canadian Provinces, origin/destination country (or US State), and product category. 

We complement these datasets with data on aggregate bilateral trade flows between country pairs, but product category, as well as national accounts data (GDP and sector sizes), and geographic information. Those data come from the UN COMTRADE database. Several of these datasets are not freely accessible but have to be purchased. In addition, some of the data are not available in a readily accessible format. The decennial censuses for instance contain information on pdf files, from which the data have to be extracted. Some trade data that are freely accessible only allow for very simple queries, which have to then be automated and repeated. Those tasks require some labor intensive inputs for which we will hire Research Assistants.

Grasping the Large or Grabbing the Large?

Chang-Tai Hsieh, Phyllis and Irwin Winkelried Professor of Economics
Michael Song, Assistant Professor of Economics

Summary: Starting in the late 1990s, China restructured its management of the largest state owned firms. This process, widely known as "corporatization" in China, typically entailed carving out the parts of the state owned firms that were commercially viable, either listing these subsidiaries in stock markets (either in China or abroad) or introducing outside minority shareholders, and generally forcing these firms to compete vigorously in the market place. This project will document the nature of the restructuring of these firms and the changes in their economic performance over the last 15 years. In addition, we will measure the extent to which the restructuring improved the economic performance of the firms and the extent to which the performance of these firms can be explained by preferential access to resources and greater market power.

Some Facts about Income Inequality at the Top End

Steven Kaplan, Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance

Summary: Josh Rauh and I plan to update our previous work on the top end of the income distribution in the US as well as look at some evidence on the top end outside of the US. In this paper, we will consider how much of the inequality today at the top end of the income distribution can be attributed to different sectors of the economy – top executives of non-financial firms, financial services sector employees, investors, lawyers, and professional athletes. We also will discuss how those contributions have varied over time. Finally, we will discuss how our results relate to different theories of the source of income inequality.

Mortgage Selection and Refinancing Decisions

Anil K Kashyap, Edward Eagle Brown Professor of Economics and Finance

Summary: In many countries the pass through from changes in the stance of monetary policy to mortgage rates is an important part of the monetary transmission mechanism. We use a unique UK data set showing the universe of individual mortgage loans to study how different people choose the form of their mortgage and which people decide to refinance their mortgages.

What Do Options Imply About Sector-wide Government Guarantees?

Bryan T. Kelly, Assistant Professor of Finance

Summary: We examine the pricing of financial crash insurance during the 2007-2009 financial crisis in US option markets. A large amount of aggregate tail risk is missing from the price of financial sector crash insurance during the financial crisis. The difference in costs of out-of-the-money put options for individual banks and puts on the financial sector index increases fourfold from its pre-crisis 2003-2007 level. We provide evidence that a collective government guarantee for the financial sector, which lowers index put prices far more than those of individual banks, explains the divergence in the basket-index put spread.

The Information Content of SEC Filings: A Text-based Approach to Cross-Sectional Asset Pricing

Bryan T. Kelly, Assistant Professor of Finance
Ralph S. J. Koijen, Associate Professor of Finance and Neubauer Family Faculty Fellow
Matthew Taddy, Associate Professor of Econometrics and Statistics

Summary: The goal of this research project is to understand the relationship between the text content of firms' financial statements (especially 10-K and other SEC filings) and the behavior of firm-level fundamentals and asset returns. A central question is whether text data in these statements are useful for characterizing expected returns and expected cash flows beyond the typical information sources used in empirical asset pricing (past realized prices and cash flows). 

Bank Monitoring and Collateral: Large Sample Evidence from the US

Michael Minnis, Assistant Professor of Accounting

Summary: In this study we will examine the relation between monitoring and collateral in the bank debt market. While an extensive literature has shown that collateral and monitoring are prominent features of bank debt separately, surprisingly little is known about the joint interaction of these features. The primary issue is a lack of data, particularly with respect to a lender's monitoring efforts. We will address this issue using a proprietary database of tens of thousands of loans from hundreds of US banks. The data set uniquely matches the content, frequency, and method of lender-borrower interaction with an extensive description of collateral allowing us to identify the equilibrium mix of monitoring and collateral with unprecedented detail. Coupled with cross sectional variation in bank size and firm characteristics, we will be able to test various theories on the joint interaction between monitoring and collateral.

The Influence of Disclosure and Managerial Traits on Market Responses to M&A Activity

Michael Minnis, Assistant Professor of Accounting
Sarah Zechman, Associate Professor of Accounting and Neubauer Family Faculty Fellow

Summary: This study examines whether particular disclosure and managerial characteristics explain aspects of abnormal short- and long-run capital market responses to merger and acquisition announcements. Assuming that capital markets respond to various disclosure characteristics, these should influence the abnormal market responses to M&A activity. Similarly, if managerial traits are associated with M&A decisions, the traits should be associated with longer-run performance. Further, this setting provides an opportunity to improve our understanding of the relation between the manager's traits and the firm's disclosure characteristics.

The Societal Value to Foreclosures

Adair Morse, Associate Professor of Finance
Margarita Tsoutsoura, Assistant Professor of Finance

Summary: In the United States and many other countries, the ability to foreclose on a house is taken as fundamental to the institution of mortgages. When crisis strikes a family, a region, or even a country, however, one of the first reactions from consumers and their advocates is to villainize those foreclosing on homes and the "unfairness" of the process. We take up a very basic question: what is the value to society that financial institutions have the power to foreclose? We study what happens to home loan applications facing an indefinite suspension of all foreclosure activities in the context of an indefinite foreclosure moratorium in Greece. Our goal is to provide a societal welfare calculation: (iii) Internal Margin: All else equal, how much is the same family paying more for the same house? (iv) External Margin: What is the decrease in housing stock that is not supported by lending? We then generalize to outside the Greek context.

Health Insurance and Financial Protection

Matthew J. Notowidigdo, Neubauer Family Assistant Professor of Economics

SummaryWe study the effect of hospitalizations on financial well-being and the extent to which health insurance mitigates the negative financial effects of such adverse health events. To do this, we use a unique data set drawn from the universe of hospitalizations in the state of California merged with individual credit reports to investigate the evolution of individuals' credit profiles before and after hospitalizations. The rich data on the credit reports will allow us to view a variety of proxies for financial well-being such as credit availability, collections, liens, foreclosures, and personal bankruptcy.

Estimating Returns to Scale in Active Management

Lubos Pastor, Charles P. McQuaid Professor of Finance

Summary: We estimate the extent of returns to scale in asset management through the lens of a theoretical model of active management. The model is related to the models presented in the recent papers by Berk and Green (JPE 2004) and Pastor and Stambaugh (JPE 2012). In the model, investors decide how much capital to commit to active funds and active fund managers decide what fees to charge. We solve for the equilibrium fund sizes, fees, and return volatilities for a cross-section of mutual funds. We then take the model to the data. We explore various implications of our model, especially those related to economies of scale in active management. Estimating the degree of returns to scale in active asset management is a major part of our empirical analysis. This analysis, which is ongoing as of October 2012, uses mutual fund data from both CRSP and Morningstar.

Inconsistent Regulators: Evidence from Banking

Amit Seru, Associate Professor of Finance

Summary: Regulators may implement identical rules inconsistently because of differences in their institutional design and incentives. The objective of this paper is to illustrate this phenomenon and its consequences by analyzing supervisory decisions of US banking regulators. We exploit a legally determined rotation policy assigning federal and state supervisors to the same bank at exogenously fixed time intervals to identify differences in implementation across regulators. We evaluate the consequences of these differences by assessing their relation with outcomes such as bank performance and bank failures. We conclude by offering evidence on some of the drivers of regulator behavior.

Incentives to Increase Firm Risk: Evidence from Multi-Year Option Grant Cycles

Kelly Shue, Assistant Professor of Finance

Summary: Popular media outlets frequently allege that the growth in stock option compensation over the past two decades incentivized executives to take on more risk, thereby contributing to economic instability. We explore the effect of stock option grants on executive behavior using a natural experiment that exploits institutional kinks in the design of multi-year option grant cycles. Kinks in option grant cycles induce large quasi-exogenous variation in the value of annual stock option grants across executives. We examine the effect of stock options on leverage, acquisitions activity, investments, and other proxies for executive decision-making.

Labor Productivity and Wage Rigidity During the Great Recession

Kelly Shue, Assistant Professor of Finance

Summary: How do firms adjust their employment policies in response to demand shocks and financial shocks? On the extensive margin, are firms able to retain their more productive workers during mass layoffs and do they hire new productive workers? On the intensive margin, how do firms adjust the incentive schemes for rank and file employees? We propose to explore these questions using new proprietary data covering individual-level compensation contracts and productivity measures for 65,940 sales employees and managers at 222 large US firms from 2007 to 2011. Our data contains detailed information about the features of fixed- and variable-compensation schedules along with managerial hierarchies and team composition.

Bank Risk and Reporting vs. Bank Executives' Off-The-Job Behavior

Abbie Smith, Boris and Irene Stern Distinguished Service Professor of Accounting

Summary: We examine whether the financial reporting and risk-taking behaviors of US banks vary in an intuitive way with bank executives' off-the-job behavior. We identify CEO and CFO "type" on the basis of two aspects of their lifestyle, the ownership of luxury goods (frugal versus unfrugal) and a clean/unclean prior legal record. We expect banks run by frugal executives and by executives with a clean legal record to have more transparent financial reporting, fewer enforcement actions published by OCC, FDIC and the Fed, and less aggressive risk-taking cultures (weaker risk-taking incentives, less risk-shifting as reflected in deposit-insurance option values, a lower rate of bank failure or bailouts, less tail risk (value at risk), and a smaller contribution to systemic risk). We consider whether the deregulation of banks was associated with a shift in top executive type relative to nonbanks, and whether the predicted relation between executive type and bank behavior is more pronounced after bank deregulation.

Asymmetric Information in Used Car Markets

Johannes Stroebel, Neubauer Family Assistant Professor of Economics

Summary: We analyze the impact of asymmetric information between buyers and sellers in used car markets, by testing how much of publicly available signals about sellers' information is priced into transaction prices. If buyers perfectly infer the information contained in a seller's desire to sell, the subsequent depreciation of a car (conditional on purchase price) should be independent of the previous seller's tenure. We test whether this is the case and to what degree this depends on (i) the scope for asymmetric information between buyers and sellers and (ii) the demographic characteristics of market participants.

Retail Responses to House Price Changes

Johannes Stroebel, Neubauer Family Assistant Professor of Economics
Joseph S. Vavra, Assistant Professor of Economics and Robert King Steel Faculty Fellow

Summary: We explore the response of retail prices and sales to local house price changes by linking zip code level retail scanner data with zip code level housing data. Using this local data we can answer questions that are difficult to address with aggregate time-series data. How does demand respond to asset price changes? What's the relationship between asset price inflation and retail price inflation? Does price stickiness change in response to changing house prices? Do retail pricing strategies vary with the condition of local housing market? Do any of these effects spillover to neighboring zip codes and regions? Do retail prices amplify or dampen the effects of house price changes on gentrification? How much does gentrification matter for local and neighboring retailers and what is the spatial distribution of these effects?

Field Study on In-school Nutritional Information Interventions

Oleg Urminsky, Associate Professor of Marketing

Summary: We plan to test and develop robust and broadly applicable information interventions for helping consumers make lower-calorie food consumption decisions. Although disclosure of calorie information has been mandated by law in some locations in the US, the results of these policy interventions has been mixed. This might be because many consumers (particularly less experienced consumers) either do not have a mental scale by which to judge calories, or might find it cognitively taxing to do so. Using the idea of channel factors we have developed a low-cost mapping intervention that makes the welfare consequences of choices easily evident to the decision maker. Specifically, our ongoing research suggests that providing decision makers with "exercise equivalents" reduces the amount of calories chosen, and the effect is robust across different types of consumers. We plan to test and implement this intervention, in an age-appropriate manner, in school lunch programs to help instill healthier lower-calorie eating habits in children.

Pass-through Across Products and Time

Joseph S. Vavra, Assistant Professor of Economics and Robert King Steel Faculty Fellow

SummaryHow do import prices respond to exchange rate changes, and does this response vary across products or across time? We document two new and related facts: 1. Individual items with high price change variance have greater exchange rate pass-through. 2. During times when the cross-sectional variance of price change is high, there is greater exchange rate pass-through. We show that these results are not driven by differences in the frequency of adjustment across products or time. We explore the extent to which these facts can be explained by time-varying product level volatility and their implications for aggregate inflation and monetary policy. Existing work has documented that trade prices declined only modestly in 2008 at the same time that trade volumes collapsed. Our evidence makes this fact even more puzzling, since pass-through is unusually high during this same period.

Borrower Transparency and Participation by Institutions in Syndicated Loans

Regina Wittenberg-Moerman, Associate Professor of Accounting

Summary: In this paper, we plan to investigate the role of borrowers' transparency in determining the interest rate spreads on syndicated loan facilities that include non-bank institutions. This paper will synthesize and extend two developing literatures. The first examines the extent to which non-bank institutions profit from insider trading by exploiting private information about the borrower that they acquired in their capacity as private lenders. The second literature seeks to understand when institutional investors choose to participate in syndicated loans and what determines the interest rate spreads they demand for their participation. We hypothesize that spreads on institutional facilities will increase in the transparency of the borrower. The idea is that borrowers with low levels of transparency provide more opportunities for institutional investors to exploit private information gained in their capacity as lenders, and that such opportunities should be reflected in lower spreads. We also plan to investigate whether firms borrowing from institutions increase or suppress their level of voluntary disclosure around loan renegotiations, which are typically associated with significant flows of private information to lenders. On the one hand, borrowers may increase their voluntary disclosure levels to protect themselves from legal risk due to potential insider trading by institutions (Regulation FD provides an exemption for the communication of private information with creditors only when creditors are abiding by a confidentiality agreement). On the other hand, firms borrowing from institutions may delay voluntary disclosure to protect the institutions' opportunities to trade on private information around renegotiations. Such behavior could emerge as part of an implicit contract where the borrower seeks to establish a reputation for delaying disclosure in order to keep open the possibility of attaining "subsidized" institutional financing in the future.