Belief-free price formation


Journal of Financial Economics

février 2018, vol. 127, n°2, pp.342-365

Départements : Finance, GREGHEC (CNRS), Economie et Sciences de la décision

Mots clés : Financial market microstructure, Informed dealers, Price volatility, Belief-free equilibria

We analyze security price formation in a dynamic setting in which long-lived dealers re- peatedly compete for the opportunity to trade with short-lived retail traders. We charac- terize equilibria in which dealers’ pricing strategies are optimal irrespective of the private information that each dealer may possess. Thus, our model’s predictions are robust to dif- ferent specifications of the dealers’ information structure. These equilibria reconcile, in a unified and parsimonious framework, price dynamics that are reminiscent of well-known stylized facts: excess price volatility, price to trading flow correlation, stochastic volatility and inventory-related trading

Dynamic Dependence and Diversification in Corporate Credit


Review of Finance

mars 2018, vol. 22, n°2, pp.1-40

Départements : Finance, GREGHEC (CNRS)

Mots clés : Credit risk, Default risk, CDS, Dynamic dependence, Copula

We characterize dependence in corporate credit and equity returns for 215 firms using a new class of large-scale dynamic copula models. Copula dependence and especially tail dependence are highly variable and persistent, increase significantly in the financial crisis, and have remained high since. The most drastic increases in credit dependence occur in July/August of 2007 and in August of 2011 and the decrease in diversification potential caused by the increases in dependence and tail dependence is large. Credit default swap correlation dynamics are important determinants of credit spreads

Financing Capacity Investment Under Demand Uncertainty: An Optimal Contracting Approach


Manufacturing & Service Operations Management

hiver 2018, vol. 20, n°1, pp.85-96

Départements : Finance, GREGHEC (CNRS)

Mots clés : Capacity, Optimal Contracts, Financial Constraints, Newsvendor Model

We study the capacity choice problem of a firm whose access to capital is hampered by financial frictions in the form of moral hazard. The firm must therefore optimize not only its capacity investment under demand uncertainty, but also its sourcing of funds. Ours is the first study of this problem to follow an optimal contracting approach, where feasible source of funds are derived endogenously from fundamentals and include standard financial claims (debt, equity, convertible debt, call and put warrants, etc.) and combinations thereof. We characterize the optimal capacity level. First, we find conditions under which a feasible financial contract exists that achieves first-best. When no such contract exists, we find that under optimal financing, the choice of capacity sometimes exceeds strictly the efficient level. This runs counter to the literature on financing capacity investment in funds and the intuition that by raising the cost of external capital and hence the unit capacity cost, financial market frictions lower the optimal capacity level. We trace the value of increasing capacity beyond the efficient level to a bonus effect and a demand differentiation effect. In contrast to most of the literature on financing capacity, our results are robust to a change of financial contract

Wholesale Funding Dry-Ups


The Journal of Finance

avril 2018, vol. 73, n°2, pp.575-617

Départements : Finance, GREGHEC (CNRS)

We empirically explore the fragility of wholesale funding of banks, using transaction-level data on short-term, unsecured certificates of deposit in the European market. We do not observe a market-wide freeze during the 2008 to 2014 period. Yet, many banks suddenly experience funding dry-ups. Dry-ups predict, but do not cause, future deterioration in bank performance. Furthermore, during periods of market stress, banks with high future performance tend to increase reliance on wholesale funding. We therefore fail to find evidence consistent with adverse selection models of funding market freezes. Our evidence is in line with theories highlighting heterogeneity between informed and uninformed lenders

Catching Falling Knives: Speculating on Liquidity Shocks


Management Science

août 2017, vol. 63, n°8, pp.2573-2591

Départements : Finance, GREGHEC (CNRS)

Mots clés : supply information • nonfundamental uncertainty • market crashes • arbitrage • high-frequency trading

Many market participants invest resources to acquire information about liquidity rather than fundamentals. I show that agents using such information can reduce the magnitude of short-lived pricing errors by trading against liquidity shocks. However, the short-run stabilizing effect of this behavior also makes it more difficult to identify liquidity shocks, a signal-jamming effect that slows down price discovery in the long run. As more agents invest in nonfundamental information, market prices become more resilient to liquidity shocks but also recover more slowly from temporary price deviations.



Journal of Financial and Quantitative Analysis

septembre 2017, vol. 52, n°5, pp.2183–2215

Départements : Finance, GREGHEC (CNRS)

Mots clés : Collateral, Counterparty Risk, Derivatives Markets, Extreme Dependence

We present CoMargin, a new methodology to estimate collateral requirements in derivatives central counterparties (CCPs). CoMargin depends on both the tail risk of a given market participant and its interdependence with other participants. Our approach internalizes trading externalities and enhances the stability of CCPs, thus, reducing systemic risk concerns. We assess our methodology using proprietary data from the Canadian Derivatives Clearing Corporation that includes daily observations of the actual trading positions of all of its members from 2003 to 2011. We show that CoMargin outperforms existing margining systems by stabilizing the probability and minimizing the shortfall of simultaneous margin-exceeding losses

Financial Transaction Taxes, Market Composition, and Liquidity


The Journal of Finance

décembre 2017, vol. 72, n°6, pp.2685–2716

Départements : Finance, GREGHEC (CNRS)

Mots clés : Financial transaction tax, institutional trading, liquidity, high-frequency trading

We use the introduction of a financial transaction tax (FTT) in France in 2012 to test competing theories on the impact of FTTs. We find no support for the idea that an FTT improves market quality by affecting the composition of trading volume. Instead, our results are in line with the idea that a lower trading volume reduces liquidity, and thereby market quality. Consistent with theories of asset pricing under transaction costs, we document a shift in security holdings from short-term to long-term institutional investors. More generally, our findings confirm that moderate aggregate effects on market quality can mask large adjustments made by individual market participants

Health Cost Risk: A Potential Solution to the Annuity Puzzle


Economic Journal

aout 2017, vol. 127, n°603, pp.1598–1625

Départements : Finance, GREGHEC (CNRS)

Mots clés : Life-cycle portfolio choice;retirement;post-retirement investment

We find that health cost risk lowers optimal annuity demand at retirement. If medical expenses can be sizeable early in retirement, full annuitisation at retirement is no longer optimal because agents do not have enough time to build a liquid wealth buffer. Furthermore, large deviations from optimal annuitisation levels lead to small utility differences. Our results suggest that health cost risk can explain a large proportion of empirically observed annuity choices. Finally, allowing additional annuitisation after retirement results in welfare gains of at most 2.5% when facing health cost risk, and negligible gains without this risk

Housing Collateral and Entrepreneurship


The Journal of Finance

février 2017, vol. 72, n°1, pp.99-132

Départements : Finance

We show that collateral constraints restrict firm entry and postentry growth, using French administrative data and cross-sectional variation in local house-price appreciation as shocks to collateral values. We control for local demand shocks by comparing treated homeowners to controls in the same region that do not experience collateral shocks: renters and homeowners with an outstanding mortgage, who (in France) cannot take out a second mortgage. In both comparisons, an increase in collateral value leads to a higher probability of becoming an entrepreneur. Conditional on entry, treated entrepreneurs use more debt, start larger firms, and remain larger in the long run.

Investor Horizon and the Life Cycle of Innovative Firms: Evidence from Venture Capital


Management Science

septembre 2017, vol. 63, n°9, pp.3021-3043

Départements : Finance

Mots clés : finance; innovation; venture capital; entrepreneurship; investor horizon

This paper studies whether and how the contractual horizon of venture capital funds affects their investments in innovative firms. I find that funds with a longer remaining horizon select younger companies at an earlier stage of their development, which grow their patent stock significantly more than companies financed by funds with a shorter horizon. The sensitivity of investment decisions to horizon is stronger among experienced venture capital firms, who allocate investments across a larger number of fund vintages. Finally, I find that the interaction of funds’ fixed horizon with their option-like compensation structure affects their investment decisions: when early performance has been high, fund managers target less innovative companies. These findings shed light on the drivers of venture capital investment decisions and on their implications for the type of companies that receive venture capital financing