Robert McCauley, 26 August 2020

On 23 March 2020, the Federal Reserve announced that it would buy investment grade corporate bonds, and on 9 April set the amount at up to $250 billion and extended the purchase to junk bonds. This column shows that these interventions succeeded in stabilising credit markets: prices lifted and dealing spreads narrowed. However, emergency lending powers provide an inadequate basis for Federal Reserve operations in corporate bonds. In light of these findings, congressional authority to buy and to sell corporate bonds alongside US Treasuries would help to align Federal Reserve operations with what has become a capital-market centred financial system

Davide Delle Monache, Ivan Petrella, Fabrizio Venditti, 24 August 2020

The fast rebound of US stock prices following the Covid-19 shock has reignited discussions over ‘frothiness’ in stock markets. This column examines how asset prices are affected by drastic shocks to the real economy, and what factors drive this relationship. Evidence from the investigation suggests that, from a longer-term perspective, high asset valuations may reflect more than just investor optimism. The greater expected income, in comparison to government bonds, could be the key as to why investors are continuing to trust in the stock market, irrespective of the turbulent wider economic climate.

Robin Döttling, Sehoon Kim, 19 August 2020

Socially responsible investing has been at the centre of recent regulatory scrutiny and academic debate. This column explores how retail investors’ preferences for socially responsible investments respond to market distress, as revealed within mutual fund flows during the COVID-19 pandemic. The results suggest that funds with the highest sustainability ratings experience sharper declines in flows. This suggests that there tends to be a shift away from sustainability among retail investors’ preferences in the face of an economic shock, highlighting a source of fragility in the increasingly popular socially responsible investment  market. 

Gunther Capelle-Blancard, Adrien Desroziers, 19 June 2020

During the COVID-19 pandemic and the related economic fallout, the response of the stock markets has raised concerns as well as questions. This column explores the surprising trends. There is some evidence that shareholders have favoured the less vulnerable firms, and that credit facilities and government guarantees, lower policy interest rates, and lockdown measures mitigated the decline in stock prices. However, fundamentals only explain a small part of the stock market variations at the country level. Overall, it is hard to deny that the links between stock prices and fundamentals have been loose at best.

Olivier Darmouni, Oliver Giesecke, Alexander Rodnyansky, 20 May 2020

The share of firms’ borrowing from bond markets has been rising globally. This column argues that euro area companies with more bond debt are disproportionately affected by surprise monetary shocks, compared to firms with mostly bank debt. This finding stands in contrast to the predictions of a standard bank lending channel and points toward frictions in bond financing. This provides lessons for the conduct of monetary policy in times of hardship such as COVID-19, when the corporate sector suffers from liquidity shortages.

Gbenga Ibikunle, Khaladdin Rzayev, 09 May 2020

Dark pools, which are trading venues that do not offer pre-trade transparency, are often suspected of causing difficulties with price discovery, and of adversely affecting market quality. This column studies the effects of COVID-19-induced volatility on trading in dark pools. Increased volatility is found to be linked with an economically significant shift of market share from dark pools to lit exchanges.

Jordan Schoenfeld, 05 May 2020

Are pandemics systemically important to modern-day financial markets? It is not obvious how a financial market’s myriad interconnected parts would react to a pandemic-induced supply and demand shock. This column shows that the COVID-19 pandemic triggered unprecedented changes in employment levels and the values of stocks, bonds, commodities, and currencies. Corporate managers also systematically underestimated their business-model exposure to pandemics in their annual report risk factors.

Ricardo Caballero, Alp Simsek, 30 April 2020

The Covid-19 shock has caused large turmoil on financial markets. This column argues that non-financial supply shocks such as the current one can endogenously lead to financial shocks and severe contractions in asset valuations and aggregate demand, which substantially amplify a recession. Conventional monetary policy can mitigate the downward pressure as long as the interest rate is unconstrained. If it is, large-scale asset purchases by government facilities are needed to prevent a downward spiral.

Laura Kodres, 28 April 2020

Amid the uncertainty of the COVID-19 pandemic, the movements in equity markets’ around the world have mirrored the spread of the virus and its virulence. Attempts to limit market crashes, volatility, and financial contagion have taken a number of different forms. This column explores the two main policy responses available to financial market regulators – bans on short sales versus circuit breakers – and reviews them in the context of some ‘best practices’ for market regulation.

Olivier Accominotti, Marie Briere, Aurore Burietz, Kim Oosterlinck, Ariane Szafarz, 10 April 2020

For many years, globalisation was on the march, bringing with it the increased risk of financial contagion effects. The Global Crisis reversed this expansion and highlighted the vulnerabilities intrinsic to the globalised international economy. This column takes a historical approach to the debate, analysing how patterns of globalisation and contagion have changed over time. The patterns also suggest that the ongoing Covid-19 pandemic is likely to cause another enormous ‘stress test’ for globalisation, forcing firms and nations to limit traveling and trade, perhaps leading to a reevaluation of the international system.

Ralph De Haas, 22 November 2019

We think about climate policies as moderating or interceding in markets. 
But a new paper implies that when stock markets play a bigger part in the economy, polluting industries become cleaner. Tim Phillips asks Ralph De Haas of the European Bank for Reconstruction and Development whether we already have a green finance initiative under our noses.

Markus Baldauf, Joshua Mollner, 31 October 2019

Financial markets process orders faster than ever before. Although faster speeds are associated with smaller spreads, they may also lead to less informative prices. This column captures this trade-off within a theoretical model of high-frequency trading in modern financial markets. It then uses the model to evaluate some potential market design responses to high-frequency trading that are currently in debate. In particular, it shows that asymmetric speed bumps improve markets by eliminating an inefficient form of high-frequency trading.

Marzio Bassanin, Ester Faia, Valeria Patella, 30 August 2019

Macroeconomic models with credit frictions do a good job of explaining debt falls during financial crises, but fail to account for pre-crisis debt increases and level pro-cyclicality. This column introduces a model in which investors’ beliefs about future collateral values are non-linear. Greater ambiguity optimism during booms and greater aversion during recessions closely model the empirical shifts seen before and during financial crises, highlighting the joint role of financial frictions and beliefs distortions for market developments.

Henri Servaes, 30 May 2019

Performance fee-based contracts, which aim to align the interests of the fund manager with that of the investor, have been controversial in mutual funds markets, and are once again under review in Europe. This column presents empirical evidence showing that performance fee contracts do not improve fund performance, particularly in instances where contracts fail to specify a benchmark for results.

Alex Chinco, Vyacheslav Fos, 14 May 2019

Noise makes financial markets possible. The column investigates an overlooked source of noise, namely, that in modern markets it is computationally infeasible to predict how even simple, rational trading rules interact to create net demand for a stock. For example, empirical data suggest that we can predict whether a stock will be affected by an exchange-traded fund portfolio rebalancing cascade, but not how.

Wolfram Schlenker, Charles Taylor, 02 May 2019

Understanding beliefs about climate change is important, but most of the measures used in the literature are unreliable. Instead, this column uses prices of financial products whose payouts are tied to future weather outcomes in the US. These market expectations correlate well with climate model outputs between 2002 and 2018 and observed weather data across eight US cities, and show significant warming trends. When money is at stake, agents are accurately anticipating warming trends in line with the scientific consensus of climate models.

Bo Becker, Victoria Ivashina, 28 March 2019

In the past 30 years, defaults on corporate bonds in the US have been substantially above the historical average. Using firm-level data, this column shows that the increase in credit risk can be largely attributed to an increase in the rate at which new and fast-growing firms displace incumbents, a phenomenon defined as ‘disruption’. Incumbent revenue growth suffers when there are many IPOs in an industry, and newly issued bonds in high-disruption industries have higher yields.

Nils Friewald, Florian Nagler, 30 January 2019

Previous studies show that conventional factors, such as firm-specific and macroeconomic variables, do a poor job of explaining yield spread changes. Using data from the US corporate bond market, this column shows that over-the-counter frictions explain around 23% in the variation of the common component and one third of the total variation in yield spread changes. The combination of search and bargaining frictions is slightly more important for the dynamics of yield spread changes than inventory frictions. The findings are broadly consistent with leading theories of intermediation frictions in over-the-counter markets.

Jon Danielsson, 02 January 2019

Laura Veldkamp, Maryam Farboodi, 02 January 2019

Technological change is making it possible to process more and more information. This column looks at the implications of this for trading strategies. It finds that growth in the amount of data investors can process is a logical and predictable cause of a shift from fundamentals-based to order flow-based strategies. 

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