November 19, 2021
November 19, 2021

Dear EFA Member,

As a current or recent EFA member, we are pleased to forward you the contents of the recently published sixth issue of Volume 25 of the Review of Finance – the EFA’s own journal – along with digests (short summaries) and abstracts.


Authors: Martin M Andreasen, Jens H E Christensen, Simon Riddell

We introduce an arbitrage-free term structure model of nominal and real yields that accounts for liquidity risk in Treasury inflation-protected securities (TIPS). The novel feature of our model is to identify liquidity risk from individual TIPS prices by accounting for the tendency that TIPS, like most fixed-income securities, go into buy-and-hold investors’ portfolios as time passes. We find a sizable and countercyclical TIPS liquidity premium, which helps our model to match TIPS prices. Accounting for liquidity risk also improves the model’s ability to forecast inflation and match surveys of inflation expectations.


Authors: Kose John, Mahsa S Kaviani, Lawrence Kryzanowski, Hosein Maleki

One major consideration for firms’ financing and investment decisions is the probability of an inefficient liquidation. The literature provides two major drivers of inefficient liquidation: the strength of creditor protection rights in the economy, and coordination failure among creditors. Creditor protection law regulate conflicts between the firm and creditors at the event of default. The bankruptcy literature suggests that these rights can be excessive and by increasing liquidation bias, may lead to ex-post inefficiencies. Moreover, the optimal contracting literature highlights that coordination failure among creditors exacerbates the probability of successful renegotiation of distressed debt especially when firms form diverse debt structures by using debts with a variety of contractual features. Despite the centrality of inefficient liquidations in corporate decisions, little is known about how its two main drivers are related.

To address this question, we focus on the debt structure of firms, and develop a trade-off model of debt-type concentration. We posit that firms choose concentrated debt structures based on a trade-off between strategic default and inefficient liquidation. By forming concentrated debt structures at a given level of debt and thus reducing the complexity of debt structures, managers can facilitate coordination among different claimants and increase the probability of successful renegotiation of distressed debt.

Forming concentrated debt structures can also be costly for the firm as it increases the probability of strategic default by the manager, motivating creditors to increase interest rates. Therefore, an optimal debt structure trades off the benefits (increasing the probability of a successful debt renegotiation) and costs (higher probability of strategic default) of a concentrated structure. Based on this trade-off framework, precisely because stronger creditor rights are associated with a higher probability of inefficient liquidation, the trade-off shifts towards minimizing the inefficient liquidation. Thus, firms become more likely to choose concentrated debt structures.

We examine this theoretical prediction by studying the relationship between the strength of creditor rights at the country level and the choice of debt structure concentrations at the firm level. Consistent with the above predictions, we find that the debt structure of firms is significantly more concentrated in countries where creditor rights are better protected. Ceteris paribus, a one-unit increase in the strength of creditor rights increases the debt concentration of firms by 3% to 7%, depending on the specification. This is a large economic effect. For example, a 3% increase in a firm's debt concentration is equivalent to migrating from a debt structure that is equally distributed across seven debt types to one that is equally distributed across only six debt types. Our results remain to a battery of robustness tests that address plausibly endogeneity concerns.

This study extends the literature on the impact of legal institutions on corporate finance, by showing how different levels of creditor protection in a country can influence the corporate debt structures therein. It also extends the literature on the conflicts of interest between different debt holders and how these potential conflicts impact the optimal choice and combination of different debt types.


Authors: Christian Gouriéroux, Alain Monfort, Sarah Mouabbi, Jean-Paul Renne

Recent events suggest that the default of a systemic entity per se may very well constitute a disaster in itself. Indeed, since its inception, the largest drop in the University of Michigan Consumer Sentiment index took place in September 2008, the month when Lehman Brothers went bankrupt. Similarly, the existence of systemic entities is at the core of novel regulations on Systemically Important Financial Institutions.

In this paper, we propose an asset-pricing framework where the default of some entities – called systemic – may have disastrous economic effects. Our paper builds on the growing literature that develops the view that a large part of aggregate fluctuations arises from idiosyncratic shocks to individual firms. In the model, the default of each systemic entity can affect consumption; moreover, such an event can be the source of default cascades. When they materialize, new defaults are likely to reinforce the initial drop in consumption and to contribute to further defaults. The model therefore accommodates amplification mechanisms.

To our knowledge, the present study constitutes the first attempt to measure the macroeconomic influence of contagious corporate defaults. This information is extracted from the joint dynamics of consumption and of the prices of disaster-exposed market instruments. Our contribution is in proposing a tractable asset-pricing model that entails disastrous firms, and in bringing such a model to the data. The model tractability, which is instrumental for our study, allows us to explore the importance of our two key mechanisms (i.e. contagion and macroeconomic effect) in accounting for the joint dynamics of consumption and asset prices.

The empirical application, which is conducted on euro-area data spanning the period from January 2006 to September 2017, demonstrates the ability of our model to capture a substantial share of the joint fluctuations of consumption growth, stock returns and stock and credit derivatives, both in tranquil and stressed periods. Specifically, our estimation involves prices of derivatives written on (i) the EUROSTOXX50 index, one of the main benchmarks of European equity markets, and (ii) the credit portfolio underlying the iTraxx Europe main index, including synthetic CDOs of different maturities and seniority levels. Our estimation procedure assigns all 125 constituent entities of the iTraxx index – the most liquid European investment grade credits – as systemic. We deduce estimates of the influence of systemic defaults on consumption. Our results suggest that the default of a systemic entity is expected to be followed by a 2% decrease in consumption within two years, accounting for contagion effects.

Figure: Responses to an unexpected default of a systemic entity



Authors: Lifang Li, Valentina Galvani

This study is the first attempt to explore the mechanism underlying the momentum effect in the corporate bond market. Using TRACE data, we provide direct evidence showing that informed trading is the driving force of the momentum effect. We exploit the informational heterogeneity among the outstanding bonds of a firm, which stems from informed investors distributing their trades unevenly over issues. As institutional investors pay more attention to news than retail investors and may have access to privileged information, our conjecture is that bonds attracting the bulk of institutional trades (i.e., top bonds) are informationally more efficient than the remaining bonds (i.e., non-top bonds). We verify that top bonds indeed attract higher informed trading levels and transmit information faster than non-top bonds. The identification of top and non-top bonds is performed at the issuer level to control for default risk and other issuer characteristics while eschewing discussions over the nature of the private information being diffused.

Building on these findings, we examine momentum profitability in top and non-top bonds and find that fast news spreading causes short-lived and low-peaked momentum in top bonds. In contrast, slow information diffusion in non-top bonds yields long-lasting and high-peaked momentum returns. Further, we document that the differences in the momentum patterns of top and non-top bonds are concentrated in bond-level information-intensive periods, which confirms the role of informed trading in originating the momentum effect. Figure 1 illustrates the relationship between informational efficiency and the momentum effect using top and non-top bonds.

This study also explains the role of illiquidity in generating the momentum effect. Bond-level liquidity affects momentum only by altering the speed at which news spreads, with lower liquidity entailing slower information diffusion and thus stronger momentum returns. However, illiquidity does not directly cause the momentum effect when there is little information to be imbued into prices.

Importantly, our findings provide an explanation for the documented concentration of the momentum effect in non-investment-grade (NIG) and private-issuer bonds, as information asymmetries are severe in these samples. Consistently, the distinctive momentum patterns in top and non-top bonds remain highlighted in the NIG and private-issuer bond groups. In contrast, there is no momentum for both top and non-top bonds in the investment-grade and non-private-issuer bond samples.

Figure 1: The figure plots the average monthly returns, in percentage terms, on momentum strategies in top and non-top bonds with a one-month holding period and formation periods ranging from one to twelve months.



Authors: Alfred Yawson, Huizhong Zhang

We examine how an M&A advisor’s horizontal relationships with other investment banks affects its ability to provide value-enhancing advice for acquiring firms. Like many other financial intermediaries, investment banks are connected vertically to various firms and horizontally to other banks, mostly through co-advisor appointments. These horizontal relationships can give rise to a communication network, allowing an M&A advisor to reach out to network contacts for target-related information and other resources at low cost. Hence, better networked advisors should have a superior ability to obtain information useful for a takeover bid from other investment banks, and use it to create value for acquiring firms.

Network banks could be prevented from sharing clients’ proprietary information with an acquirer advisor because of the fear of a loss of client trust and potential damage to their reputation. However, maintaining the reputation of being trustworthy is costly as banks are forced to restrict their actions to protect sensitive client information that could be otherwise used for their own benefits. Consequently, relationship rents in the form of future business are necessary to provide a continued incentive for a bank to remain loyal to a particular client. In the context of M&As, a bank’s incentive to keep the targets’ information secret is likely diminished as target firms normally cease to exist as standalone companies after successful acquisitions. This together with the verifiability issues makes it possible for private information of target firms to be transmitted between network banks.

Using a collection of centrality measures that describe an M&A advisor’s position in the network of investment banks, we show that acquirers enlisting the services of more centrally positioned advisors enjoy higher announcement abnormal returns. The effects are stronger among acquirers facing greater target information asymmetry such as “loner” acquirers and acquirers undertaking cross-industry deals, and among M&A advisors depending more heavily on networks for information such as small advisors and advisors with low expertise in the target industry.

Network banks may have obtained proprietary firm-, industry- or geographic-specific information about the target firm through either the provision of a wide range of investment banking services, or specialization in particular industries or geographical regions. We find that network contacts are most valuable to an acquirer advisor if they had previously assisted the target firm in equity issuance.

Finally, we show that more centrally positioned acquirer advisors are associated with lower takeover premiums and higher advisory fees. A potential inducement interbank networking can offer in return for the provision of insights is access to future co-advisor appointments: Banks with established ties to the appointed advisor(s) appear to enjoy a significant advantage of competing for future co-advisory mandates, having a higher probability of being chosen as co-advisor than their counterparts with no relationships.

Together, these findings suggest that the information advantage obtained from horizontal networking is an important channel through which central hub advisors create value for acquirers.


Authors: Dan Li, Geng Li

Theoretical models have long recognized the role of investor disagreements in the marketplace, but little evidence is documented regarding how belief dispersion affects trading activities in the broad equity market. Using over three decades of data from a survey of US households, we introduced a novel measure of household macroeconomic belief dispersion and document its positive relationship with market-wide stock trading volume, even after controlling for an array of professional analysts’ belief dispersion. Results are more pronounced for the belief dispersion among households who are more likely to own stocks. Furthermore, we show that the household belief dispersion is priced in the cross-section of stock returns, whereas that among professional analysts is not.


NOTE: This and previous issues of Review of Finance [ISSN 1572-3097 | EISSN 1573-692X] are freely available to current EFA members as a benefit of annual membership.  For information on how to submit a manuscript to Review of Finance, please visit the RF Editorial Office website revfin.org.  Follow us on LinkedIn.

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