with Jens Dick-Nielsen and Obaidur Rehman
We examine how dealer network position affects transaction costs when dealers provide immediacy by taking bonds into inventory. Dealers with central network positions provide more immediacy and revert deviations from their desired inventory faster than peripheral dealers do. The cost of immediacy decreases with centrality for customer trades (centrality discount) and increases with centrality for interdealer trades (centrality premium). These findings support recent network models in which central dealers have a comparative advantage in managing inventory. We isolate the inventory management channel and avoid confounding effects from adverse selection and heterogeneous customer clienteles by using trades around bond index exclusions.
The investment premium - the finding that firms with low asset growth deliver high average returns - is an integral part of recent factor models. I document empirically that the investment premium (1) reflects leverage, (2) does not exist among zero-leverage firms, and (3) increases with firms' refinancing intensities. This new evidence challenges prominent explanations of the investment premium including the q-theory of investment and behavioral finance. To explain the evidence, I develop a model in which firms make both optimal investment and financing decisions. The model shows that the investment premium reflects both leverage and refinancing intensities consistent with my empirical findings.
with Peter Feldhütter
We document cross-sectional variation in bid-ask spreads in the U.S. corporate bond market and use the variation to test OTC theories of the bid-ask spread. Bid-ask spreads, measured by realized transaction costs, increase with maturity for investment grade but not for speculative grade bonds. For short-maturity bonds, spreads increase with credit risk while long-maturity bonds rated AAA/AA+ have significantly higher spreads than other investment grade bonds. We find that dealer inventory is the most important determinant of the variation in bid-ask spreads. How bond sales travel through the network of dealers also explains part of the variation, particularly for speculative grade bonds. In contrast, search-and-bargaining frictions and asymmetric information have limited explanatory power.
Why Does Debt Dispersion Affect Yield Spreads?
work in progress
I study predictions of rollover risk models and strategic debt service models on the negative relationship between corporate bond yield spreads and debt dispersion. Rollover risk models predict a more negative relationship for financially constrained firms, whereas strategic debt service models predict a less negative relationship. To test these predictions I run panel regressions of yield spreads on debt dispersion interacted with measures of financial constraints. I find that the relationship between yield spreads and debt dispersion is more negative for financially constrained firms consistent with rollover risk models.