Research Descriptions 2008-2009

Course Development: Doing Business in Asia

Brian Barry, Clinical Associate Professor of Economics

Summary: International Business II - Doing Business in Asia. The course examines several overarching trends that will confront managers and investors doing business in or with Asia, especially China and India. These include rapid urbanization in parts of the region; the rise of the mass consumer; the challenges of domestic integration in two giant and fast-developing economies (China and India); and the increasing clout and economic integration of East Asia as a whole.

The course establishes a framework in the first few weeks to help students navigate this breadth and variety. This includes applying economic and related analytical tools, which are taught elsewhere in the GSB curriculum, to Asian markets, institutions and firms.

This project will develop background analyses of several important sectors in Asia, including especially retailing and consumer goods, finance and infrastructure in China and India. These analyses will be used in the latter part of the course, to connect aggregate trends in the region to specific business problems and strategies.

Hedge Funds: Internal Controls, Reporting Systems, and Investor Rights

Joseph Gerakos, Assistant Professor of Accounting

Summary: In contrast with traditional investment vehicles, hedge funds are subject to minimal regulation. Therefore, hedge fund managers are relatively unfettered by regulation in their choices and implementations of internal controls and performance reporting systems, and in their negotiations with investors over fees and redemption rights. Hedge funds thereby provide a setting to examine investment fund structure and financial contracting in an unregulated environment. Using a proprietary database of comprehensive due diligence reports for over 420 hedge funds, Gerakos and his coauthor Gavin Cassar (Wharton) will investigate how hedge fund managers choose and implement internal controls and performance reporting systems, the extent that investors value internal controls and reporting systems, and how investors negotiate with fund managers over fees and redemption rights. Finally, Cassar and Gerakos will investigate the extent to which reporting systems that allow greater managerial discretion are associated with predictable variations in reported performance, which are consistent with manipulation.

Value and Momentum Everywhere

Tobias Moskowitz, Fama Family Professor of Finance and Neubauer Family Faculty Fellow

Summary: Well, almost everywhere. Value and momentum strategies generate significant alpha for stock selection within several countries, selection of stock indices across countries, currency selection, selection of bonds across countries, and commodity selection. Based on this broad evidence, we explore the common value and momentum factors across asset classes to shed light on the underlying economic drivers. A long/short value strategy in one asset class is positively correlated to value strategies in other asset classes, momentum strategies are correlated across asset classes, while value is negatively correlated to momentum strategies in its own and other asset classes. Value and momentum across asset classes are both positively correlated with long-run consumption growth. Value is negatively correlated with global liquidity risk, while momentum is positively correlated. Finally, illiquid securities have stronger value and momentum returns and are more sensitive to global liquidity risk.

The Tip of the Iceberg: What the Market Knows and When

Jeffrey R. Russell, Professor of Economics and Statistics

Summary: A disconnect exists between theoretical models for how trade decisions should effect prices and the way trade data is analyzed. Traders think in terms of and place orders through brokers, but most empirical studies of price impact consider the impact of a single trade without explicitly recognizing it is part of a larger order. I consider a model in which the market views a single trade as the tip of an iceberg - part of a larger order that is yet to be completed. If the market knows that an initial trade by a broker is likely to be followed by similar additional trades in the same asset on the same side of the market, the price impact of a single trade should reflect not only the observed trade size, but also the forecast of the entire order. Using a unique data set of executed orders from Morgan Stanley I examine the how the market learns and updates prices after viewing a single trade that is likely part of a larger order of unknown and random size. Testable conditions underlying the nature of price discovery are established and can be evaluated with the data.

The Paradox of Default Models

Amit Seru, Assistant Professor of Finance

Summary: We contend that while standardization through the use of default models (like credit scores and credit ratings) can help improve the liquidity in the market, it does have a dark side. The argument is that standardization, much in the style of Lucas critique, alters the underlying parameters which determine the relationship between creditworthiness and the likelihood of default. We examine this in the context of securitization market, where standardization has come about due to use of credit scores. The hope of the project is to convincingly demonstrate that default models are not invariant to the strategic behavior of market participants.

House Prices, Consumer Credit and Consumption

Atif Mian, Associate Professor of Finance
Amir Sufi, Associate Professor of Finance

Summary: Our research project seeks to obtain precise estimates of how consumer credit, and ultimately consumption, responds to movements in housing prices. Housing is by far the largest asset for most households in the US. As a result, any link between asset prices and consumer borrowing/consumption is most likely to come through the housing sector. This question of how house prices affect borrowing and consumption is of increased importance given recent turmoil in mortgage markets and aggregate price depreciation of the U.S. residential housing stock. We explore the effect of housing on borrowing and consumption behavior with a unique data set that follows a random sample of 200,000 US consumers over the last eleven years. Our data includes individual borrowing and default decisions broken down by credit type (auto, credit card, mortgage, home equity etc.), as well as house prices at the zip code level. We identify the effect of house price appreciation on consumers already owning a home in 1998 by exploiting supply‐induced within‐county variation in home price appreciation.

Financial Literacy, Cognitive Biases and Payday Lending

Marianne Bertrand, Fred G. Steingraber/A. T. Kearney Professor of Economics
Adair Morse, Assistant Professor of Finance

Summary: Our goal is to provide some new insights on the rationality of high-interest payday borrowing by assessing the relative merits of two opposite views of payday borrowing: Either individuals borrow rationally to smooth income/expenditure shocks, or borrowing behavior reflects one or more cognitive limitation(s) (e.g., an inability to understand the fee structure, a lack of self-control, overconfidence about repayment ability, etc.). We have obtained unique access to a large payday lender, where we will survey customers' concerning their education, level of self-control, need for the loan, and expectation of payback time. We then intend to perform a simple randomized field experiment, which will allow us to directly estimate the effect of financial literacy and biased expectations (if any) on individuals' ability to repay payday loans quickly. Combining the survey with the experiment results should enable us to better understand the circumstances under which people borrow from payday lenders and to determine whether further (and which specific) policy interventions in the industry have the potential to be welfare-enhancing.

State and Local Government Pension Funding and Investment Strategies: Risk and the Distribution of Intergenerational Transfers

Robert Novy-Marx, Assistant Professor of of Finance
Joshua Rauh, Assistant Professor of Finance

Summary: This research examines the extent of intergenerational transfers from future to current taxpayers due to funding and investment strategies in state and local defined benefit (DB) pension plans. We compile a unique and comprehensive dataset of funding, asset allocation, and demographics of the plans from government reports and other sources. We develop plausible discounting assumptions that approximate the true risk profile of accrued state pension promises. The underfunding of accrued benefits in state pension plans is clearly larger than the $798 billion of outstanding US state bonds, and may be as high as $2 trillion if the pension benefits are viewed as more secure than state general obligations. We calculate distribution of future pension funding outcomes (fund-by-fund and in aggregate) given variance-covariance matrices of the different pension fund asset classes and calibrated assumptions about how pension liabilities vary with the asset pricing risk factors. Implied intergenerational transfers are very large under current policies.

Which Investor Characteristics and Abilities Matter?

Steven Kaplan, Neubauer Family Professor of Entrepreneurship and Finance

Summary: As a follow up to our previous paper on CEO assessments, Morten and I will use assessments of candidates for private equity investor positions (PE) - buyout (LBO) and venture capital (VC). We intend to study how investor characteristics and abilities relate to hiring decisions and subsequent performance. PE investors are assessed in five general areas - leadership, personal, intellectual, motivational, interpersonal - and in areas specific to PE investing. This will add to our knowledge of how to measure ability.

Intrafirm Trade and International Macro Dynamics

Brent Neiman, Assistant Professor of Economics

Summary: About forty percent of all U.S. international trades occurs between related parties, or intrafirm, such as trades between a parent and subsidiary of the same multinational corporation. Despite a rich theoretical literature on the determinants of vertical integration, very little empirical work has aimed at explaining its repercussions for cross-country relative price fluctuations and shock transmission. Using a good-level dataset that distinguishes arm's length from intrafirm trades, I study differences in the behavior of intrafirm prices with respect to price duration, synchronization, and exchange rate pass through.

Who Use Fair-value Accounting for Non-financial Assets Following IFRS Adoption?

Hans B. Christensen, Assistant Professor of Accounting
Valeri Nikolaev, Assistant Professor of Accounting

Summary: The benefits of fair value accounting are heavily debated by regulators and practitioners around the world. The Security and Exchange Commission has recently announced its consideration of mandatory adoption of International Financial Accounting Standards (IFRS) in the US which, if adopted, will extensively expand US firms' opportunities to use fair value accounting for nonfinancial assets. While conceptually sound, fair value accounting has received a lot of criticism on the grounds of its subjectivity and the lack of verifiability. This study will examine whether and why firms prefer to recognize non-financial assets on their balance sheets at fair value rather than historical cost in a setting where they are provided with an opportunity to choose between the two valuation methods. Specifically, we will exploit changes in valuation practices around mandatory IFRS adoption in the United Kingdom and Germany, aiming to understand practitioners' preferences for fair value accounting.

The Effects of Stock Lending

Steven Kaplan, Neubauer Family Professor of Entrepreneurship and Finance

Summary: There has always been a great deal of interest in the costs and benefits of allowing short selling. That interest has intensified in recent months. It is difficult to isolate the effect of short selling because it is very difficult to run a controlled experiment with real data. In this research effort, Berk Sensoy will run such an experiment.

Working with a sizeable (and anonymous) money manager, we will randomly lend out some of the stocks in the manager's portfolio while randomly withholding or not lending out a matched sample of stocks in the portfolio. We will then compare the subsequent returns and volatility of the two samples to study the effects of making shares available.

Sovereign Wealth Funds: Portfolio Tilt, Corporate Governance and Real Economy Impacts

Adair Morse, Assistant Professor of Finance

Summary: A significant and increasing portion of world capital flows are going through entities known as sovereign wealth funds (SWF). Fueled by growing foreign exchange reserves in Asia and oil surpluses in the Middle East and elsewhere, SWFs already have an estimated $2.5 to $3 trillion in assets under management today, thus exceeding that of private equity and hedge funds preleverage) (Jen, 2008). The size of SWFs will only grow in the future, with most analysts projecting net additions of at least a trillion per year over the next decade. How do these actors allocate their resources today? How are they likely to do so in the future? Most importantly, how will the emergence into prominence of these state controlled players affect established actors in these markets, financial markets more generally, and ultimately the real economy?

Identifying Lender Moral Hazard: Evidence from Subprime Loan Defaults

Amit Seru, Assistant Professor of Finance

Summary: Identifying lender moral hazard is empirically a challenging task. The changing nature of servicing and restructuring activity in the subprime market allows us a unique opportunity to provide insights on moral hazard activity of subprime lenders. The results show that ownership of risk of a loan has a causal impact on whether the loan is monitored. Our empirical strategy allows us to isolate confounding considerations such as borrower screening and lender strategic adverse selection. By doing so, we demonstrate the potential costs of taking the central ingredient of monitoring - risk bearing -- outside the boundaries of the firm.

Access to Markets in Developed and Emerging Economies

Brian Barry, Clinical Associate Professor of Economics
Raghuram Rajan, Eric J. Gleacer Distinguished Service Professor of Finance

Summary: We plan to write a book on the political economy of markets in developed and emerging economies. It will explore the role that competition and access to markets play in raising the welfare of poor and middle-income people, and the additional benefits that these forces could deliver if better policies were pursued. The book will also attempt to offer some broadly applicable ideas about why such policies are not pursued all that consistently in democratic countries, and why they so often tend to be opposed by political parties and other groups that draw most of their support from poor and middle-income citizens.

Voting and Ideology

Emir Kamenica, Assistant Professor of Economics

Summary: In most democratic societies, the mean income is well above the median income. Why do the poorer voters not engage in large-scale expropriation through redistribution? Why do they vote against redistributive measures? Many observers, such as Thomas Frank in his book What's the Matter with Kansas?, claim that the poor are duped into voting against their self-interest. This claim, however, fails to recognize that rational self-interested voters are individuals and not necessarily members of a voting block. If there is any ideological utility obtained from casting a particular vote, rational individuals will vote solely on the basis of their ideology rather than their monetary self-interest because the probability of being marginal is extremely small. The Voting and Ideology project analyzes the importance of this consideration for redistributive outcomes by running laboratory experiments that compare votes cast in a referendum to those cast when the individual voter is a dictator.

Who is Targeted for Say on Pay?

Steven Kaplan, Neubauer Family Professor of Entrepreneurship and Finance

Summary:Say-on-Pay proposals have become increasingly popular, particularly in the last two years. There are two possible motivations for these proposals. First, some claim the proposals are motivated to challenge pay policies that are not in shareholder interest. Alternatively, others argue that the proposals are motivated by political considerations. In this paper, we intend to distinguish between these two motivations by studying whether the companies targeted for Say-on-Pay type votes overpay their CEOs, do not pay their CEOs based on stock performance, are underperformers, and have unionized employees, all relative to non-targeted companies.

The Industrial Organization of K Street: What Do Lobbyists Do? How Much are They Paid and Why?

Francesco Trebbi, Associate Professor of Finance

Summary: Theoretical work on lobbying abounds and posits radically diverging views on the role of lobbying and economic special interest influence. Under certain assumptions lobbying exerts a welfare-diminishing role (say, because policy is bought by lobbies, a view prevalent among economists), while under different assumptions lobbying is welfare-enhancing (say, because lobbyists provide information, a view prevalent among political scientists). This is an open empirical question whose answer we hope to contribute.

The purpose of this research project is to provide a detailed study of the industrial organization of the U.S. federal lobbying sector using an almost untapped information source and to provide a methodology to exploit the richest lobbying report data set available to shed light on the different potential roles played by lobbyists. This fundamental component of the political process is, as of now, basically obscure to both Political Scientists and Economists and to the best of our knowledge lacks a detailed systematic empirical characterization.

Educational Attainment, Productivity and Growth

Luigi Zingales, Robert C. McCormick Professor of Entrepreneurship and Finance

Summary: In this project we study the relationship between educational attainment and economic performance by measuring both the direct and indirect effects of education. We plan to collect data on education among the population of different Italian cities going back several generations ago and then correlate today performance across cities to measures of education of the currently productive population as well as the education of generations that are no longer productive or even generations that have already passed. By using this micro dataset, we plan to study the effect of changes in education on GDP, productivity and growth.

The Effects of Educational Syles

Luigi Zingales, Robert C. McCormick Professor of Entrepreneurship and Finance

Summary: With IGM funding we collected data from 825 students of 47 different nationality on the educational style of the schools they attended. We are now seeking additional funding to explore two angles. First, the correlation of this educational style with the family of origin of a country legal system. Second, the correlation between educational style and the performance in the PISA evaluation tests.