Publications

Insurers as Asset Managers and Systemic Risk (with Andrew Ellul, Anastasia Kartasheva, Christian Lundblad, and Wolf Wagner), Review of Financial Studies 35(12), December 2022.

Featured in VOX CEPR Policy Portal.

Financial intermediaries often provide guarantees resembling out-of-the-money put options, exposing them to undiversifiable tail risk. We present a model in the context of the U.S. life insurance industry in which the regulatory framework incentivizes value-maximizing insurers to hedge variable annuity (VA) guarantees, though imperfectly, and shift risks into high-risk and illiquid bonds. We calibrate the model to insurer-level data and identify the VA-induced changes in insurers' risk exposures. In the event of major asset and guarantee shocks and absent regulatory intervention, these shared exposures exacerbate system-wide fire sales to maintain capital ratios, plausibly erasing over half of insurers' equity capital.

 Mutual Fund Trading Style and Bond Market Fragility (with Amber Anand and Kumar Venkataraman), Review of Financial Studies 34(6), June 2021. 

Previously titled “Do Buy-Side Institutions Supply Liquidity in Bond Markets? Evidence from Mutual Funds.”  Featured in BloombergView.

We explore the link between mutual funds and fragility risk in the corporate bond market. We classify a fund’s trading style based on its responses to signals of large dealer inventories. Trading style is persistent and the majority of funds demand liquidity. Notably, a subset of funds earn positive alpha by intentionally supplying liquidity during periods of sustained customer selling (with transitory price effects). Liquidity supplying funds maintain their relative trading style when facing large outflows and elevated market stress, thus alleviating fragility risk. Our results add nuance to existing evidence that mutual funds pose a threat to market stability.

Heterogeneous Taxes and Limited Risk Sharing: Evidence from Municipal Bonds (with Tania Babina, Christian Lundblad, and Tarun Ramadorai), Review of Financial Studies 34(1), January 2021.

Previously titled “Does the Ownership Structure of Government Debt Matter? Evidence from Munis.”  Winner of James A. Lebenthal Memorial Prize for Best Paper at the Fourth Annual Municipal Finance Conference. Featured in Bond Buyer.

We evaluate the impacts of tax policy on asset returns using the U.S. municipal bond market. In theory, tax-induced ownership segmentation limits risk-sharing, creating downward-sloping regions of the aggregate demand curve for the asset. In the data, cross-state variation in tax privilege policies predicts differences in in-state ownership of local municipal bonds; the policies create incentives for concentrated local ownership. High tax privilege states have muni bond yields that are more sensitive to variations in supply and local idiosyncratic risk. The effects are stronger when local investors face correlated background risk and/or diminishing marginal non-pecuniary benefits from holding local assets. 

Governance under the Gun: Spillover Effects of Hedge Fund Activism (with Nickolay Gantchev and Oleg Gredil), Review of Finance 23(6), October 2019 (Editor's Choice Lead Article). 

Finalist for the Review of Finance’s 2019-2020 Best Paper Award in Corporate Finance.

Featured in Harvard Law School Forum on Corporate Governance and Financial Regulation.

Hedge fund activism is associated with improvements in the governance and performance of targeted firms.  In this paper, we show that these positive effects of activism reach beyond the targets, as non-targeted peers make similar improvements under the threat of activism.  Peers with higher threat perception, as measured by director connections to past targets, are more likely to increase leverage and payout, decrease capital expenditures and cash, and improve return on assets and asset turnover.  As a result, their valuations improve, and their probability of being targeted declines. Our results are not explained by time-varying industry conditions or competitive effects whereby improved targets force their product market rivals to become more competitive.

Institutional Trading and Hedge Fund Activism (with Nickolay Gantchev), Management Science (forthcoming).

Previously titled “Hedge Fund Activists: Do They Take Cues from Institutional Exit?” 

This paper investigates the role of institutional trading in the emergence of hedge fund activism – an important corporate governance mechanism. We demonstrate that institutional sales raise a firm’s probability of becoming an activist target. Further, by exploiting the funding circumstances of individual institutions, we establish that such effects occur through a liquidity channel – the activist camouflages his purchases among other institutions’ liquidity sales. Additional evidence supports our conclusion. First, activist purchases closely track institutional sales at the daily frequency. Second, such synchronicity is stronger among targets with lower expected monitoring benefits, suggesting that gains from trading with other institutions supplement these benefits in the activist’s targeting decision. Finally, we find that institutional sales accelerate the timing of a campaign at firms already followed by activists rather than attract attention to unlikely targets. Taken together, our findings offer a novel empirical perspective on the liquidity theories of activism; while activists screen firms on the basis of fundamentals, they pick specific targets at a particular time by exploiting institutional liquidity shocks.

Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading (with Andrew Ellul, Christian Lundblad, and Yihui Wang), Journal of Finance 70(6), December 2015.

Accounting rules, through their interactions with capital regulations, affect financial institutions' trading behavior. The insurance industry provides a laboratory to explore these interactions: life insurers have greater flexibility than property and casualty insurers to hold speculative-grade assets at historical cost, and the degree to which life insurers recognize market values differs across U.S. states. During the financial crisis, insurers facing a lesser degree of market value recognition are less likely to sell downgraded asset-backed securities. To improve their capital positions, these insurers disproportionately resort to gains trading, selectively selling otherwise unrelated bonds with high unrealized gains, transmitting shocks across markets.

Why Do Term Structures in Different Currencies Co-move? (with Anh Le and Christian Lundblad), Journal of Financial Economics 115(1), 58-83, January 2015.

Yield curve fluctuations across different currencies are highly correlated. This paper investigates this phenomenon by exploring the channels through which macroeconomic shocks are transmitted across borders. Macroeconomic shocks affect current and expected future short-term rates as central banks react to changing economic environments. Investors could also respond to these shocks by altering their required compensation for risk. Macroeconomic shocks thus influence bond yields both through a policy channel and through a risk compensation channel. Using data from the US, the UK, and Germany, we find that world inflation and US yield level together explain over two-thirds of the covariance of yields at all maturities. Further, these effects operate largely through the risk compensation channel for long-term bonds.

Mark-to-Market Accounting and Systemic Risk: Evidence from the Insurance Industry (with Andrew Ellul, Christian Lundblad, and Yihui Wang), Economic Policy 29(78), 297-341, April 2014.

One of the most contentious issues raised during the recent crisis has been the potentially exacerbating role played by mark-to-market accounting.  Many have proposed the use of historical cost accounting, promoting its ability to avoid the amplification of systemic risk.  We caution against focusing on the accounting rule in isolation, and instead emphasize the interaction between accounting and the regulatory framework. First, historical cost accounting, through incentives that arise via interactions with complex capital adequacy regulation, does generate market distortions of its own. Second, while mark-to-market accounting may indeed generate fire sales during a crisis, forward-looking institutions that rationally internalize the probability of fire sales are incentivized to adopt a more prudent investment strategy during normal times which leads to a safer portfolio entering the crisis. Using detailed, position- and transaction-level data from the U.S. insurance industry, we show that (a) market prices do serve as ‘early warning signals’, (b) insurers that employed historical cost accounting engaged in greater degrees of regulatory arbitrage before the crisis and limited loss recognition during the crisis, and (c) insurers facing mark-to-market accounting tend to be more prudent in their portfolio allocations. Our identification relies on the sharp difference in statutory accounting rules between life and P&C companies as well as the heterogeneity in implementation of these rules within each insurance type across U.S. states. Our results indicate that regulatory simplicity may be preferred to the complexity of risk-weighted capital ratios that gives rise, through interactions with accounting rules, to distorted risk-taking incentives and potential build-up of systemic risk. 

How Do Foreign Investors Impact Domestic Economic Activity? Evidence from China and India (with Christian Lundblad and Tarun Ramadorai), Journal of International Money and Finance 39, 89-110, December 2013.

There has been renewed advocacy for restrictions on international financial flows in the wake of the recent financial crisis. Motivated by this trend, we explore the extent to which cross-border flows affect real economic activity. Unlike previous research efforts that focus on aggregated capital flows, we exploit novel data on forced trading by global mutual funds as a plausible source of exogenous flow shocks. Such forced trading is known to generate large liquidity and price effects, but its real impacts have not been studied extensively. We find that both country- and firm-level investment growth rates are significantly affected by these exogenous capital shocks, and that their effect is more pronounced for firms whose marginal investment decisions are more equity-reliant.

Asset Fire sales and Purchases and the International Transmission of Funding Shocks (with Christian Lundblad and Tarun Ramadorai), Journal of Finance 67(6), 2015-2050, December 2012.

Featured in Economist.

We identify a new channel for the transmission of shocks across international markets. Investor flows to funds domiciled in developed markets force significant changes in these funds’ emerging market portfolio allocations. These forced trades or “fire sales” affect emerging market equity prices, correlations, and betas, and are related to but distinct from effects arising purely from fund holdings or from overlapping ownership of emerging markets in fund portfolios. A simple model and calibration exercise highlight the importance to these findings of “push” effects from funds’ domicile countries and “co-ownership spillover” between markets with overlapping fund ownership.

Regulatory Pressure and Fire Sales in the Corporate Bond Market (with Andrew Ellul and Christian Lundblad), Journal of Financial Economics 101(3), 596-620, September 2011. 

This paper investigates fire sales of downgraded corporate bonds induced by regulatory constraints imposed on insurance companies. As insurance companies hold over one-third of investment-grade corporate bonds, the collective need to divest downgraded issues may be limited by a scarcity of counterparties. Using insurance company transaction data, we find that insurance companies that are relatively more constrained by regulation are more likely to sell downgraded bonds. Bonds subject to a high probability of regulatory-induced selling exhibit price declines and subsequent reversals. These price effects appear larger during periods when the insurance industry is relatively distressed and other potential buyers' capital is scarce.