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Research in Financial Economics: International Capital Flows, Efficiency of Financial Markets and Corporate Governance

Priority areas of development: economics
2015
The project has been carried out as part of the HSE Program of Fundamental Studies.

Goal of research:

  1. The goal of the first research direction is to study transfers of control in firms with non-controlling large shareholders, examine efficiency of the market for corporate control in such firms and analyze effects of takeover regulation.
  2. In the second research direction we analyze optimal execution strategies when multiple traders are simultaneously involved in optimal execution. Our goal is to obtain new equilibrium (in Nash sense) strategies and study their behaviour and features; particularly, under what circumstances strategies are aggressive (predatory) or passive (defensive).
  3. The goal of the third research direction is to establish the consequences of forgiving some of the debt of Greece. This is in terms of the path of consumption and investment for Greece and the path of income for the lender (Germany).
  4. The fourth research direction examines how the price market discipline mechanism restrains moral hazard behavior of banks. We also examine the strength of the price discipline mechanism across regions characterized by different levels of financial development.

Methodology:

  1. We build a theoretical model and use game theory methods to analyze the outcome of the model.
  2. We rely on solution of particular differential game. It thus applies methods of optimal control and game theory elements.
  3. The possibility of default is micro-founded on the moral hazard problem between debtors and creditors. If debtors default, they incur a welfare cost of renegotiating the defaulted-upon amount proportional to the quantity of debt defaulted upon. This cost effectively creates a borrowing constraint and stems from Shubik and Wilson. (1977) and Dubey et al. (2005) and applied in Tsomocos (2003), Goodhart et al. (2005) and Goodhart et al. (2006) and in the real business cycle literature, our model shares similar features to De Walque et al. (2010). We argue that credit-conditions can be adequately captured by an appropriate state variable in order to describe the relationship between loan delinquencies and capital stock. We deviate from much of the collateral literature by allowing default to occur in equilibrium.
  4. We use multiple panel regression method with fixed effects.

Empirical base of research:

  1. The first research direction has no empirical part.
  2. The most recent and relevant piece of research is Vincent Kernel’s and Albert Meldvig paper “High-Frequency Trading around Large Institutional Orders”. In this work authors use both public and proprietary data about large institutional orders to study how high frequency traders act around large institutional trading orders. Interestingly, our model in second research direction is able to explain trading profiles of high-frequency traders which arise when they are encountered with large executions of other traders, namely that initially they trade “against the wind” but later trade “with the wind”. As to our knowledge our model is the first to explain this behaviour.
  3. The fundamental trade-off regarding Greece’s exit from its 7 year old recession regards its national debt. Creditors face the dilemma of whether to provide immediate relief and restructure debt, accepting the immediate loss, or to demand internal reforms in Greece before contemplating further restructuring. The IMF, in its June 26 2015 “Preliminary Draft Debt Sustainability Analysis” strongly argue for restructuring but contrasts with the view of European creditor nations who view that reforms must occur before consideration of restructuring of debt and who unequivocally rule out any nominal haircut.
  4. We use unique and comprehensive data on the deposit products offered by 555 Russian banks to determine how deposit rates fluctuate in relation to the risks banks face.

Results of research:

  1. We assume that potential acquirers differ in their (privately known) ability to create value in the target firm. We show that, in equilibrium, high types go for a tender offer, intermediate types purchase just the blockholder's stake, and low types abstain. The model yields a number of implications. Compared to tender offers, block trades are associated with lower efficiency in equilibrium, which explains lower target announcement returns following block trades. Some equilibrium block trades are value-reducing. We show that the equal opportunity rule (EOR) helps eliminating them, but it needs to go together with a rule allowing to "freeze out" non-tendering shareholders in order to ensure that no value-increasing takeover fails. We obtain that the two rules are complements: introducing one without the other may hurt efficiency. The model also shows that better investor protection raises the incidence of full-scale acquisitions relative to block trades. Yet, when the EOR is present, an increase in investor protection may be detrimental for efficiency as it may prevent some value-increasing takeovers.
  2. We obtain new equilibrium strategies for the case of N risk-averse traders who perfectly know each other positions. Though aggregate equilibrium order flow has some properties analogous to standard Almgren, Chriss strategies,  as we show below individual equilibrium strategies can be quite different from the standard ones obtained in Grinold and Kahn, and Almgren and Chriss. This is because each trader (assumed to be rational) is trying to minimize her trading cost or "implementation shortfall" and therefore takes into account the price impacts caused by herself and all other traders. We also obtain a close form characterization for the dynamic Nash equilibrium in terms of the system of second-order ODEs, which can be solved explicitly. The resulting equilibrium strategies describe different types of predatory and defensive behavior, though the aggregate order flow profile has some properties of standard Almgren, Chriss strategies, e.g. is monotonous and convex. We show that the traders with smaller holdings are involved in predatory strategies, while traders with larger holdings tend to defend themselves against potential predators by following the delayed trading strategies. We also show that depending on liquidity and volatility parameters, predatory traders may be frontrunners or contrarian traders.
  3. We argue that immediate debt restructuring which reduces the present value of debt would benefit both Greece as well as its creditor countries, specifically Germany, over the medium and long term. We establish within a two country RBC model that the default channel, that exacerbates the volatility of consumption, may actually be reduced with more lenient debt restructuring terms. Put another way, we argue that the dilemma is not whether there is a moral duty of creditor nations to transfer resources to Greece, but whether creditors are willing to trade off short-term losses for medium and long-run gains.
  4. Using an index of regional financial development constructed by the Central Bank of Russia we show that the more financial developed is the region the smaller is the premium on uninsured deposits relative to insured deposits. This finding demonstrates that the price market discipline imposes stricter constraints on banks from less financially developed regions. 

Publications:


Bertrand O., Betschinger M., Settles A. The relevance of political affinity for the initial acquisition premium in cross-border acquisitions // Strategic Management Journal. 2015 doi
Peiris U., Vardoulakis A. Collateral and the Efficiency of Monetary Policy // Economic Theory. 2015. Vol. 59. No. 3. P. 579-603. doi
Peiris U., Tsomocos D. International Monetary Equilibrium with Default // Journal of Mathematical Economics. 2015. Vol. 56. P.  47-57.
Stepanov S. Transfers of Corporate Control in Firms with Non-Controlling Blockholders / NRU Higher School of Economics. Series WP9 "Исследования по экономике и финансам". 2015. No. 4.
Булатов А. Э., Ларионов И. Н. Оптимальные Алгоритмы Исполнения для Стратегических Трейдеров // Экономический журнал Высшей школы экономики. 2015. Т. 19. № 4. С. 505.-533.
Boulatov A., Bernhardt D. Robustness of equilibrium in the Kyle model of informed speculation // Annals of Finance. 2015. P. 297-318. doi