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During the recent financial crisis, the impact of an impaired supply of bank credit on non-financial firms is minor compared to the impact of leverage-related financial fragility and a general flight to quality. Although banks were sharply affected by the credit crisis in the fall of 2007, the crisis did not negatively affect capital expenditures or net debt issuance of publicly held non-financial firms during its first year. This is true even for small and unrated firms, which are generally viewed as more dependent on bank financing. After September 2008, capital expenditures and net debt issuance fell sharply and firms hoarded cash. Capital expenditures did not fall more for more bank-dependent firms, but they decreased more for firms that were highly levered before the crisis, regardless of whether these firms had previously accessed public debt markets. In contrast to the response expected from a contraction in bank credit per se, the decrease in net equity issuance for small and unrated firms is greater than the decrease in net debt issuance during the crisis.

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We show that money market funds transmitted distress across firm during the European sovereign debt crisis. Using a novel data set of US money market fund holdings, we show that funds with large exposures to Eurozone banks suffered significant outflows between June and August 2011. These outflows have significant short-run spillover effects on other firms: non-Eurobank issuers that typically rely on these funds raise less financing in this period. The results are not driven by issuer riskiness or direct exposure to Europe: for the same issuer, money market funds with greater exposure to Eurozone banks decrease their holdings more than other funds. Our results illustrate that instabilities associated with money market funds persist despite recent changes to the regulations governing them..

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Managers often claim that an important source of value in acquisitions is the acquiring firm’s ability to finance investments for the target firm. This claim implies that targets are financially constrained prior to being acquired and that these constraints are eased following the acquisition. We evaluate these predictions on a sample of 5,187 European acquisitions occurring between 2001 and 2008, for which we can observe the target’s financial policies following the acquisition. We examine whether these post acquisition financial policies reflect improved access to capital. We find that the level of cash target firms hold, the sensitivity of cash to cash flow, and the sensitivity of investment to cash flow all decline significantly, while investment significantly increases following the acquisition. These effects are stronger in deals that are more likely to be associated with financing improvements. These findings are consistent with the view that acquisitions ease financial frictions in target firms.

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It is typically argued that predatory lending generated significant social costs and played a central role in creating the subprime crisis. However, there are few estimates of its true effect. We estimate the effect of predatory lending on the residential mortgage default rate using an anti-predatory program implemented in Chicago in 2006. Under the legislation, risky borrowers and risky mortgages triggered mandatory counseling. Following the legislation, market activity decreased by about 35%, where risky borrowers, risky products, and lenders who typically made riskier loans were most affected. Despite the sharp decline in market activity, 18- and 36-month default rates in the treated group exhibited a relative improvement of 12% and 7%, respectively. We estimate that predatory loans have a 6-7% higher default rate than nonpredatory loans. Our results suggest that predatory lending may have not been instrumental in precipitating the financial crisis as often believed.

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Defining as normal cash holdings the holdings a firm with the same characteristics would have had in the late 1990s, we find that the abnormal cash holdings of U.S. firms after the crisis represent on average 1.86% of assets. While U.S. firms held less cash than comparable foreign firms in the late 1990s, by 2010 they hold more. However, only U.S. multinational firms experience an increase in abnormal cash holdings during the 2000s. U.S. multinational firms had cash holdings similar to those of purely domestic firms in the late 1990s, but they hold over 3% more assets in cash than comparable purely domestic firms after the crisis. Further, U.S. multinationals increased their cash holdings since the late 1990s relative to foreign multinationals by roughly the same percentage as they increased their cash holdings relative to U.S. domestic firms. A detailed analysis shows that the increase in cash holdings of multinational firms cannot be explained by the tax treatment of profit repatriations, that it is intrinsically linked to their R&D intensity, and that firms that become multinational do not increase their abnormal cash holdings after they become multinational. There is no evidence that poor investment opportunities, regulation, or poor governance can explain the abnormal cash holdings of U.S. firms after the crisis.

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Much attention has been paid to the large decreases in value of non-agency residential mortgage-backed securities (RMBS) during the financial crisis. Many observers have argued that the fall in prices was partly driven by decreased liquidity and fire sales. We investigate whether capital requirements and accounting rules at financial institutions contributed to the selling of RMBS at fire sale prices. For financial institutions subject to credit-sensitive capital requirements, capital requirements increase as an asset’s credit becomes impaired. When accounting rules require such an asset’s value to be marked-to-market and the fair value loss to be recognized in earnings, a capital-constrained firm can improve its capital position by selling the credit-impaired asset even if it has to accept a liquidity discount to do so. Using a sample of 5,014 repeat transactions of non-agency RMBS by insurance companies from 2006 to 2009, we show that insurance companies that became more capital-constrained because of operating losses (uncorrelated with RMBS credit quality) and also recognized fair value losses sold comparable RMBS at much lower prices than other insurance companies during the crisis.

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We study the implications of long-run risk type shocks - shocks to the growth rate of productivity - for aggregate investment in a DSGE model. Our model offers an alternative to microfrictions explanation of aggregate investment non-linearities, in particular the heteroscedasticity of investment rate. Additionally, consistent with the data, these shocks imply that investment rate is history dependent (rising through an expansion), investment rate growth is positively autocorrelated, and is positively correlated with output growth at various leads and lags. A standard model with shocks to the level of productivity either predicts the opposite or fails to quantitatively capture these features in the data.

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In standard models wages are too volatile and returns too smooth. We make wages sticky through infrequent resetting, resulting in both (i) smoother wages and (ii) volatile returns. Furthermore, the model produces other puzzling features of financial data: (iii) high Sharpe Ratios, (iv) low and smooth interest rates, (v) time-varying equity volatility and premium, and (vi) a value premium. In standard models, highly pro-cyclical and volatile wages are a hedge. The residual - profit - becomes unrealistically smooth, as do returns. Smoother wages act like operating leverage, making profits more risky. Bad times and unproductive firms are especially risky because committed wage payments are high relative to output.

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Chinese reverse mergers (CRMs) claim to provide easy entry to the U.S. and international markets. Recently, a large number of Chinese firms using reverse merger transactions have been listed on the U.S. stock exchanges. We review the historical use and mechanics of these reverse mergers, and contrast them with initial public offerings (IPOs). We also explore settlements of securities class action lawsuits involving Chinese firms. Our analysis shows that larger, more reputable Chinese firms are significantly less likely to pursue reverse mergers. We also find that CRM firms are more likely to be subject to class action litigation in the U.S and that the settlement amounts are smaller for CRM firms than for Chinese IPO firms. Our analysis further indicates that CRM firms significantly underperform the Chinese IPO firms. Thus, the evidence suggests that CRMs are not substitutes for Chinese IPOs.

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Motivated from investment-based asset pricing, we propose a new factor model consisting of the market factor, a size factor, an investment factor, and a return on equity factor. The new factor model outperforms the Carhart four-factor model in pricing portfolios formed on earnings surprise, idiosyncratic volatility, financial distress, net stock issues, composite issuance, as wellas on investment and return on equity. The new model performs similarly as the Carhart model in pricing portfolios formed on size and momentum, abnormal corporate investment, as well as on size and book-to-market, but underperforms in pricing the total accrual deciles. The new model’s performance, combined with its clear economic intuition, suggests that it can be used as a new workhorse model for academic research and investment management practice..

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Previous studies show that firms with low inventory growth outperform firms with high inventory growth in the cross-section of publicly traded firms. In addition, inventory investment is volatile and procyclical, and inventory-to-sales is persistent and countercyclical. We embed an inventory holding motive into the investment-based asset pricing framework by modeling inventory as a factor of production with convex and non-convex adjustment costs. The augmented model simultaneously matches the large inventory growth spread in the data, as well as the time-series properties of the firm level capital investment, inventory investment, and inventory-to-sales. Our conditional single-factor model also implies that traditional unconditional factor models such as the CAPM should fail to explain the inventory growth spread, although not with the same large pricing errors observed in the data.

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We show that heterogeneity in the composition of the labor force affects asset prices in financial markets in important ways. Theoretically, we combine a standard model of labor heterogeneity (Acemoglu, 2002) with a standard neoclassical q-theory model with labor adjustment costs. We then show that the negative expected return-hiring rate relation documented in previous studies is steeper in industries with higher labor adjustment costs. Using the overall industry level of labor skill as a proxy for the industry specific size of labor adjustment costs, we provide empirical support for this prediction. The negative expected return-hiring rate relation is twice as large among industries with higher labor skills than in industries with lower labor skills. In addition, we uncover a novel unconditional labor skill return spread. Firms in industries with more skilled labor have on average higher stock returns than firms in industries with low skilled labor, but this difference is only large across small firms. According to this result, firms with higher labor skills labor tend to be more risky because skilled labor is more costly to adjust, which in turn affects the firm’s sensitivity to aggregate shocks in the economy.

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We provide estimates of holdings of highly-rated securitization tranches of American bank holding companies ahead of the credit crisis and evaluate hypotheses that have been advanced to explain these holdings. Our broadest estimates include CDOs as well as holdings in off-balance-sheet conduits. While holdings exceeded Tier 1 capital for some large banks, they were economically trivial for the typical U.S. bank. The banks with high holdings were not riskier before the crisis using conventional measures, but their performance was poorer during the crisis. We find that holdings of highly-rated tranches are explained by a bank’s securitization activity. Theories of highly-rated tranches that are unrelated to a bank’s securitization activity, such as “bad incentives,” “bad governance,” or “bad risk management” theories, have no support in the data.

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Financially-constrained borrowers have the incentive to influence the appraisal process in order to increase borrowing or reduce the interest rate. The average valuation bias for residential refinance transactions is above 5%. The bias is larger for highly leveraged transactions, and for transactions mediated through a broker, especially where competition is high. Mortgages with inflated valuations default more often; however, lenders partially account for the valuation bias through pricing.

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Hedge funds significantly reduced their equity holdings during the recent financial crisis. In 2008Q3-Q4,hedge funds sold about 29% of their aggregate portfolio. Redemptions and margin calls were the primary drivers of selloffs. Consistent with forced deleveraging, the selloffs took place in volatile and liquid stocks. In comparison, redemptions and stock sales for mutual funds were not as severe. We show that hedge fund investors withdraw capital three times as intensely as mutual fund investors do in response to poor returns. We relate this stronger sensitivity to losses to share liquidity restrictions and institutional ownership in hedge funds.

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We use earnings forecasts from a cross-sectional model to proxy for cash flow expectations and estimate the implied cost of capital (ICC) for a large sample of firms over 1968-2008. The earnings forecasts generated by the cross-sectional model are superior to analysts’ forecasts in terms of coverage, forecast bias, and earnings response coefficient. Moreover, the model-based ICC is a more reliable proxy for expected returns than the ICC based on analysts’ forecasts. We present evidence on the cross-sectional relation between firm-level characteristics and ex ante expected returns using the model-based ICC.

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We model a dynamic financial market where traders traders submit orders either to a limit order book (LOB) or to a Dark Pool (DP). We show that there is a positive liquidity externality in the DP, that orders migrate from the LOB to the DP, but that overall trading volume increases when a DP is introduced. We also demonstrate that DP market share is higher when LOB depth is high, when LOB spreads are narrow, when the tick size is large and when traders seek protection from price impact. Further, while inside quoted depth in the LOB always decreases when a DP is introduced, quoted spreads can narrow for liquid stocks and widen for illiquid ones. We also show that traders' interaction with both LOB and DP generates interesting systematic patterns in order flow: differently from Parlour (1998), the probability of a continuation is greater than that of a reversal only for liquid stocks. In addition when depth decreases on one side of LOB liquidity is drained from DP. When a DP is added to a LOB, total welfare as well as institutional traders' welfare increase but only for liquid stocks; retail traders' welfare instead always decreases. Finally, when flash orders provide select traders with information about the state of the DP, we show that more orders migrate from the LOB to the DP welfare effects are enhanced.

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CEOs have a conflict of interest when their company is the target of an acquisition attempt: They can bargain for private benefits, such as retention by the acquirer, rather than for a higher premium to be paid to their shareholders. We find that target CEO retention by the bidder does not appear to be driven by the CEO bargaining for his own interests at the expense of shareholders. Retention is not associated with a lower premium. Retention is more likely when it is more valuable to the bidder in running the merged firm, in that the CEO is more likely to be retained when she has skills and knowledge that bidder executives do not have and when the incentives of target insiders are well aligned with those of target shareholders. Regardless of retention, shareholders of acquired firms whose CEO is at retirement age receive lower premiums than shareholders of acquired firms with younger CEOs. This lower premium seems to be explained by the apparent reduced acquisition value of firms led by retirement age CEOs rather than by the target CEO conflict of interest.

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This paper examines unique data on dark pool activity for a large cross-section of US stocks in 2009. Dark pool activity is concentrated in large firms, stocks with high share volume, high price, low spreads, high depth, and low short-term volatility. NASDAQ (AMEX) stocks have significantly higher (lower) dark pool activity than NYSE stocks controlling for size, share volume, and price. For a given stock, dark pool activity is significantly higher on days with higher share volume, higher depth, and lower intraday volatility. Dark pool activity is significantly lower for days with larger order imbalances relative to share volume and larger absolute returns. We find no evidence supporting the hypothesis that dark pool activity has a detrimental effect on market quality.

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Miscalibration is a form of overconfidence examined in both psychology and economics. Although it is often analyzed in lab experiments, there is scant evidence about the effects of miscalibration in practice. We test whether top corporate executives are miscalibrated, and study the determinants of their miscalibration. We study a unique panel of over 11,600 probability distributions provided by top financial executives and spanning nearly a decade of stock market expectations. Our results show that financial executives are severely miscalibrated: realized market returns are within the executives’ 80% confidence intervals only 33% of the time. We show that miscalibration improves following poor market performance periods because forecasters extrapolate past returns when forming their lower forecast bound (“worst case scenario”), while they do not update the upper bound (“best case scenario”) much. Finally, we link stock market miscalibration to miscalibration about own-firm project forecasts and increased corporate investment.

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During the recent financial crisis, financial expertise among independent directors of commercial banks is negatively related to changes in both firm value and cumulative stock returns. Furthermore, financial expertise is positively associated with risk-taking levels in the run-up to the crisis using both balance-sheet and market-based measures of risk. These results are not driven by powerful CEOs who select independent experts to rubber stamp strategies that satisfy their risk appetite. They are, however, consistent with independent directors with financial expertise recognizing the residual nature of shareholders’ claim and supporting a heightened risk profile for their bank.

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This paper investigates whether the securitization of corporate bank loans had an impact on the price of corporate debt. Our results suggest that loan facilities that are subsequently securitized are associated with a 15 basis point lower spread than that of loans that are not subsequently securitized. To identify the particular role of securitization in loan pricing, we employ a difference in differences approach and consider loan characteristics that are associated with the likelihood of securitization. We document that Term Loan B facilities, facilities originated by banks that originate CLOs, and loans of B-Rated firms are securitized more frequently than other loans. Spreads on facilities estimated to be more likely to be subsequently securitized have lower spreads than otherwise similar facilities. The results are consistent with the view that securitization caused a reduction in the cost of capital.

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Average realized returns equal average expected returns plus average unexpected returns. If anomalies are driven by risk, average expected returns should be close to average realized returns. If anomalies are driven by mispricing, unexpected returns should be more important. We estimate accounting-based expected returns to zero-cost trading strategies formed on anomaly variables such as book-to-market, size, composite issuance, net stock issues, abnormal investment, asset growth, investment-to-assets, accruals, earnings surprises, failure probability, return on assets, and short-term prior returns. Our findings are striking. Except for the value premium, expected return estimates differ dramatically from average return estimates. The evidence suggests that mispricing, not risk, is the main driving force of capital markets anomalies.

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Public and private equity waves move together. Using quarterly cash flow data for a large sample of venture capital and buyout funds from 1984-2010, we investigate the implications of this co-cyclicality for understanding private equity cash flows and performance. In the cross-section, varying the beta used to assess relative performance has a large effect near a beta of zero, but only a modest effect for more reasonable beta estimates. For instance, buyout funds outperform the S&P 500 by 18% over the life of the fund, and moving to a beta of 1.5 only reduces this to 12%. A similar message comes through in the time series. Though funds raised in hot markets underperform in absolute terms, this underperformance is sharply reduced by a comparison to the S&P 500, and disappears entirely at the levels of beta recently estimated in the literature. These fndings imply that high private equity fundraising forecasts both low private equity cash flows and low market returns, suggesting a positive correlation between private equity net cash flows and public equity valuations. Indeed, while both capital calls and distributions rise with public equity valuations, distributions are more sensitive than calls, so net cash flows are procyclical and private equity funds are liquidity providers (sinks) when market valuations are high (low). Venture cash flows and performance are considerably more procyclical than buyout. Debt market conditions also have a significant impact on cash flows. At the same time, most cash flow variation is idiosyncratic across funds, and most predictable variation is explained by the age of the fund.

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CEOs have a potential conflict of interest when their company is acquired: They can bargain to be retained by the acquirer and for private benefits rather than for a higher premium to be paid to the shareholders. We investigate the determinants of target CEO retention by the acquirer and whether target CEO retention affects the premium paid by the acquirer. The probability that a CEO is retained increases with a private bidder, the performance of the target, and with the fraction of target shares held by insiders. Regardless of the bidder type, we find no evidence that the premium paid is lower when the CEO is retained by the acquirer. Strikingly, the target stock price increases more at the announcement of an acquisition by a private firm when the CEO is retained than when she is not. This result holds whether the private acquirer is a private equity firm or an operating company and for management buyouts.

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We show empirically that firms behave remarkably similarly to how their CEOs behave personally in the context of leverage choices. Using a database of CEOs' leverage in their most recent home purchases, we find a positive, economically significant, robust relation between personal home leverage and corporate leverage in the cross-section and when we examine CEO turnover. The results are consistent with an endogenous matching of CEOs with firms based on leverage preferences on both sides, as well as with CEOs imprinting their personal preferences on the firms they manage, especially when governance is weaker. Besides extending our understanding of the determinants of corporate leverage, this paper shows empirically that CEOs' behavioral consistency across personal and professional situations can, at least in part, predict the corporate financial behavior of the firms they manage.

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Economic theory, as well as commonly-stated views of practitioners, suggests that macroeconomic conditions can affect both the ability and manner in which firms raise external financing. Theory suggests that downturns should be associated with a shift toward less information-sensitive securities, as well as a ‘flight to quality,’ in which firms can issue high-rated securities but not low-rated ones. We evaluate these hypotheses on a large sample of publicly-traded debt issues, seasoned equity offers, and bank loans. We find that worse macroeconomic conditions lead firms to use less information-sensitive securities. In addition, poor market conditions affect the structure of securities offered, shifting them towards shorter maturities and more security. Furthermore, market conditions affect the quality of securities offered, with worsening conditions substantially lowering the number of low-rated debt issues. Overall, these findings suggest that macroeconomic conditions are important factors in firms’ capital raising decisions.

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We examine whether institutional investors affect corporate governance by analyzing portfolio holdings of institutions in companies from 23 countries during the period 2003-2008. We find that firm-level governance is positively associated with international institutional investment. Changes in institutional ownership over time positively affect subsequent changes in firm-level governance, but the opposite is not true. Foreign institutions and institutions from countries with strong shareholder protection play a crucial role in promoting governance improvements outside of the U.S. Institutional investors affect not only which corporate governance mechanisms are in place, but also outcomes. Firms with higher institutional ownership are more likely to terminate poorly performing CEOs and exhibit improvements in valuation over time. Our results suggest that international portfolio investment by institutional investors promote good corporate governance practices around the world.

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We demonstrate that financial firms should allocate capital to lines of business based on marginal default values. The marginal default value for a line of business is the derivative of the value of the firm’s option to default with respect to the scale of the line. Marginal default values give a unique allocation of capital that adds up exactly, regardless of the joint probability distribution of returns. Capital allocations follow from the conditions for the bank’s optimal portfolio. The allocations are systematically different from allocations based on VaR or contribution VaR. We also show how regulation based on risk-weighted capital requirements distorts a bank’s investment decisions, even if regulatory arbitrage can be eliminated.

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Though overall bank performance from July 2007 to December 2008 was the worst since at least the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been discussed as having contributed to the poor performance of banks during the credit crisis. More specifically, we investigate whether bank performance is related to bank-level governance, country-level governance, country-level regulation, and bank balance sheet and profitability characteristics before the crisis. Banks that the market favored in 2006 had especially poor returns during the crisis. Using conventional indicators of good governance, banks with more shareholder-friendly boards performed worse during the crisis. Banks in countries with stricter capital requirement regulations and with more independent supervisors performed better. Though banks in countries with more powerful supervisors had worse stock returns, we provide some evidence that this may be because these supervisors required banks to raise more capital during the crisis and that doing so was costly for shareholders. Large banks with more Tier 1 capital and more deposit financing at the end of 2006 had significantly higher returns during the crisis. After accounting for country fixed effects, banks with more loans and more liquid assets performed better during the month following the Lehman bankruptcy, and so did banks from countries with stronger capital supervision and more restrictions on bank activities.

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We document significant persistence in the average announcement returns to acquisitions advised by an investment bank. Advisors in the top quintile of returns over the past two years outperform the bottom quintile by 1.04% over the next two years, compared to a full-sample average return of 0.72%. Persistence continues to hold after controlling for the component of returns attributable to the acquirer. These results suggest that advisors possess skill, and contrast earlier studies which use bank reputation and market share to measure advisor quality and find no link with returns. Our findings thus advocate a new measure of advisor quality – past performance. However, acquirers instead select banks based on market share, even though it is negatively associated with future performance. The publication of league tables based on value creation, rather than market share, may improve both clients’ selection decisions and advisors’ incentives to turn away bad deals.

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Many observers have argued that credit default swaps contributed significantly to the credit crisis. Of particular concern to these observers are that credit default swaps trade in the largely unregulated over-the-counter market as bilateral contracts involving counterparty risk and that they facilitate speculation involving negative views of a firm’s financial strength. Some observers have suggested that credit default swaps would not have made the crisis worse had they been traded on exchanges. I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the credit crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading. Though I argue that eliminating over-the-counter trading of credit default swaps could reduce social welfare, I also recognize that much research is needed to understand better and quantify the social gains and costs of derivatives in general and credit default swaps in particular.

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In this paper, we intend to explain an empirical finding that distressed stocks delivered anomalously low returns. We show that in a model with heterogeneous investors where idiosyncratic skewness is priced, the expected return of risky assets depends on idiosyncratic coskewness betas, which measure the covariance between idiosyncratic variance and the market return. We find that there is a negative (positive) relation between idiosyncratic coskewness and equity returns when idiosyncratic coskewness betas are positive (negative). We construct two idiosyncratic coskewness factors to capture market-wide effect of idiosyncratic coskewness betas. When we control for these two idiosyncratic coskewness factors, the return difference for distress-sorted portfolios becomes insignificant. High stressed firms earn low returns because high stressed firms have high (low) idiosyncratic coskewness betas when idiosyncratic coskewness betas are positive (negative).

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Working with a sizeable, anonymous money manager, we randomly make available for lending two-thirds of the high-loan fee stocks in the manager’s portfolio and withhold the other third to produce an exogenous shock to loan supply. We implement the lending experiment in two independent phases: the first, from September 5 to 18, 2008, with over $580 million of securities lent; and the second, from June 5 to September 30, 2009, with over $250 million of securities lent. The supply shocks are sizeable and significantly reduce lending fees, but returns, volatility, skewness, and bid-ask spreads remain unaffected. Results are consistent across both phases of the experiment and indicate no adverse effects from securities lending on stock prices.

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Using a large, new database of contractual provisions governing the allocation of cash flow rights between venture capitalists (VCs) and entrepreneurs, we investigate how contract design is impacted by VC abilities to monitor and provide value-added services to the entrepreneur. In doing so, this paper is the first to demonstrate that VC characteristics, in addition to portfolio company characteristics, have a significant impact on VC contract design in the U.S. We find that more experienced VCs, who have superior monitoring and value-added abilities and more frequently join the boards of their portfolio companies, obtain weaker downside-protecting contractual cash flow rights than less experienced VCs. This result is robust to extensive controls and several methods to account for endogenous selection effects. The relation between VC experience and downside protections is weaker when entrepreneurial agency problems are less severe and stronger when VC ownership is greater. The results, together with the existing literature, suggest that VCs with better governance abilities optimally focus less on obtaining downside protections, which are costly from a risk-sharing perspective, and more on upside payoffs and obtaining board representation during negotiations with entrepreneurs. The results also imply that previous estimates of the amount entrepreneurs pay for affiliation with high-quality VCs are overstated.

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This paper studies the government reaction to large corporate merger attempts in the European Union during 1997-2006 using hand-collected data. It documents widespread economic nationalism in which the government prefers the target companies remain domestically owned rather than foreign-owned. This preference is stronger at times and places with strong far-right parties, weaker governments, and against countries for which the people in the target country have little affinity. This nationalism has both direct and indirect economic impact on mergers and impedes capital flows. In particular, nationalist government reactions deter foreign companies from bidding for other companies in that country in future.

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Investors’ reaction to stock recommendations is often incomplete so that there is a predictable post-recommendation drift. I investigate whether investor inattention contributes to this drift by using turnover as a proxy for investor attention. I find that the recommendation drift of firms with low prior turnover is more than double in magnitude compared to that of firms with high prior turnover. Additional proxies for attention, such as analyst coverage, institutional ownership, the amount of distracting news in a day, or a measure of residual turnover that controls for liquidity and uncertainty, produce similar results. Volume reactions around the recommendation event show that investors fail to react promptly to recommendations on low attention stocks. Together, the evidence suggests that investor inattention is a plausible explanation for investors’ underreaction to stock recommendations.

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The U.S. Chapter 11 bankruptcy system has long been viewed as debtor friendly, with frequency of absolute priority deviations (APD) in favor of equity holders commonplace, as high as 75%, before 1990. In the 1991-2005 period, we find a secular decline in the frequency of APD to 22%, with the frequency as low as 9% for the period 2000-2005. We identify the increasing importance of debtor-in-possession (DIP) financing and key employee retention plans (KERP) in bankruptcy as the key drivers of this secular decline. We also find management turnover in Chapter 11 has increased by 65% since 1990 and that APD are more likely when management has substantial share holdings in the firm. The time spent in bankruptcy has also declined from about 23 months before 1990 to 16 months after 2000. Collectively, these results are consistent with the thesis that Chapter 11 has increasingly become creditor friendly over the years. We discuss the implications of our results for models that assume that equity has a valuable dilatory option in the bankruptcy process.

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We examine 1,098 Nasdaq firms delisted in 1999-2002 that subsequently traded in the OTC Bulletin Board and/or the Pink Sheets. Market quality deteriorates significantly after delisting: share volume declines by two-thirds; quoted spreads almost triple from 12.1 to 33.9 percent; and effective spreads triple from 3.3 to 9.9 percent. Volatility triples from 4.4 to 14.3 percent, but quickly reverts to slightly elevated levels. Deterioration is significantly larger for more severe violations (e.g. bankruptcy) than for lesser infractions (e.g. minimum bid price). We find the OTC Bulletin Board provides a "soft landing" for delisted firms relative to the Pink Sheets. Although the delisting process takes at least 90 days, the drop in market quality is concentrated on the delisting date, highlighting the benefits of Nasdaq listing and the economic rationale for tiered listing fees. We argue that the increased costs resulting from enforcing Nasdaq’s minor (non-core) listing criteria outweigh the benefits.

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Using hedge fund indices representing eight different styles, we find strong evidence of contagion within the hedge fund sector: controlling for a number of risk factors, the average probability that a hedge fund style index has extreme poor performance (lower 10% tail) increases from 2% to 21% as the number of other hedge fund style indices with extreme poor performance increases from zero to seven. We investigate how changes in funding and asset liquidity intensify this contagion, and find that the likelihood of contagion is high when prime brokerage firms have poor performance (which would be expected to affect hedge fund funding liquidity adversely) and when stock market liquidity (a proxy for asset liquidity) is low. Finally, we examine whether extreme poor performance in the stock, bond, and currency markets is more likely when contagion in the hedge fund sector is high. We find no evidence that contagion in the hedge fund sector is associated with extreme poor performance in the stock and bond markets, but find significant evidence that performance in the currency market is worse when hedge fund contagion is high, consistent with the effects of an unwinding of carry trades.

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We examine the determinants of appointments of outside CEOs to boards and how these appointments impact the appointing companies. We find that CEOs are most likely to join boards of large established firms that are geographically close, pursue similar financial and investment policies, and have comparable governance mechanisms to their own firms. It is also more likely that CEOs join firms with low insider ownership and firms with boards that already have other CEO directors. Except for the case of board interlocks, there is no evidence supporting the view that CEO directors have any impact on the appointing firm during their tenure, either positively or negatively. Appointments of CEO directors do not have a significant impact on the appointing firm’s operating performance, its decision-making, the compensation of its CEO, or on the monitoring of management by the board. However, operating performance drops significantly for CEO director appointments when the CEO of the appointing firm already sits on the board of the appointee’s firm.

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Asbestos litigation is one of the most important mass tort litigations in the history of the United States. I analyze a comprehensive sample of 270 firms that were exposed to an unprecedented wave of asbestos litigation in the wake of U.S. Supreme Court decisions in Amchem (1997) and Ortiz (1999). Due to insurance coverage, most firms in the sample have manageable cash outflows and do not suffer materially from the litigation. Because of the long delay between exposure to asbestos and its related illnesses, the remaining firms with substantial cash outflows and liabilities offer a rare natural experiment to study financial distress unrelated to economic distress. When analyzing this sub-sample throughout the distress period, I find little evidence of indirect costs of financial distress. This surprising result can be directly related to the strategic use of Chapter 11 as it provides a safe harbor through the stay in litigation and the "channeling injunction", which allows for a definitive solution for the legal liabilities. There is also evidence of a positive role for the disciplinary effects of financial distress as firms subject to increased bank monitoring and increased legal liabilities actively restructure and refocus on core operations.

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On March 21, 2007, the Securities and Exchange Commission (SEC) adopted Exchange Act Rule 12h-6 which makes it easier for foreign private issuers to deregister and terminate the reporting obligations associated with a listing on a major U.S. exchange. We examine the characteristics of 59 firms that immediately announced they would deregister under the new rules, their potential motivations for doing so, as well as the economic consequences of their decisions. We find that these firms experienced significantly slower growth and lower stock returns than other U.S. exchange-listed foreign firms in the years preceding the decision. There is weak evidence that firms experience negative stock returns when they announce deregistration and stronger evidence that the stock-price reaction is worse for firms with higher growth. When we examine stock-price reactions around events associated with the passage of the Sarbanes-Oxley Act (SOX), we find negative average stock-price reactions with some specifications but not others. Further, there is no evidence that deregistering firms were affected more negatively by SOX than foreign-listed firms that did not deregister. Our evidence supports the hypothesis that foreign firms list shares in the U.S. in order to raise capital at the lowest possible cost to finance growth opportunities and that, when those opportunities disappear, a listing becomes less valuable to corporate insiders so that firms are more likely to deregister and go home.

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We study a model in which future financing constraints leas firms to have a preference for investments with sorter payback periods, investments with less risk, and investments that utilize more pledgeable assets. The model also shows how investment distortions towards more liquid, safer assets vary with the marginal cost of external financing and with firm internal cash flows. Our theory helps reconcile and interpret a number of patterns reported in the empirical literature, in areas such as risk-taking behavior, capital structure choices, hedging strategies, and cash management policies. For example, contrary to Jensen and Meckling (1976), we show that firms may reduce rather than increase risk when leverage increases exogenously. Furthermore, firms in economies with less developed financial markets will not only take different quantities of investment, but will also take different kinds of investment (safer, short-term projects that are potentially less profitable). We also point out to several predictions that have not been empirically examined. For example, our model predicts that investment safety and liquidity are complementary: constrained firms are specially likely to decrease the risk of their most liquid investments.

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A large loss is not evidence of a risk management failure because a large loss can happen even if risk management is flawless. I provide a typology of risk management failures and show how various types of risk management failures occur. Because of the limitations of past data in assessing the probability and the implications of a financial crisis, I conclude that financial institutions should use scenarios for credible financial crisis threats even if they perceive the probability of such events to be extremely small.

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We explore the effects of mandatory third-party review of mortgage contracts on the terms, availability,and performance of mortgage credit. Our study is based on a legislative pilot carried out by the State of Illinois in a selected set of zip codes in 2006. Mortgage applicants with low FICO scores were required to attend loan reviews by financial counselors. Applicants with higher FICO scores had to attend counseling only if they chose “risky mortgages.” We find that low-FICO applicants for whom counselor review was mandatory did not materially change their contract choice. Conversely, applicants who could avoid counseling by choosing less risky mortgages did so. Although ex post default rates among low-FICO borrowers in the pilot program declined by 25%, we find that the educational component of counselor review played only a minor role. Instead, external review presented strong incentives for lenders to impose tighter ex ante screening on low-credit-quality borrowers.

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Models of information acquisition predict that investors learn about a common risk factor and apply that information to valuations of stocks exposed to the risk factor (category learning). Category learning leads to higher levels of investor interest in stocks exposed to the factor, with investors forgoing portfolio diversification. Industry exposure is a candidate for category learning. Consistent with these predictions, we find that the number of institutions holding a stock is positively associated with the stock’s industry exposure. Moreover, institutional investors systematically overweight (underweight) high (low) industry exposure stocks. Investor preferences for industry exposure are greatest among smaller institutions and institutions that follow a transient investment style, and most pronounced in industries where the returns to learning about industry risk are greatest. Our results are consistent with the notion that investors do engage in category learning.

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Finding conditional moments and derivative prices is a common application in continuous-time financial economics, but these quantities are known in closed-form only for a few specific models. Recent research identifies a large class of models for which solutions to such problems have convergent power series, allowing approximation even when not known in closed-form. However, such power series may converge slowly or not at all for long time horizons, limiting their practical use. We develop the method of time transformation, in which the variable representing time is replaced by a non-linear function of itself. With appropriate choice of the time transformation, power series often converge for much longer time horizons, and also much faster, sometimes uniformly for all time horizons. For applications such as bond pricing, in which the time-to-maturity may be many years, rapid convergence is very important for practical application. The ability to approximate solutions accurately and in closed-form simplifies the estimation of non-a±ne continuous-time term structure models, since the bond pricing problem must be solved for many different parameter vectors during a typical estimation procedure. We show through several examples that the series are easy to derive, and, using term structure models for which bond prices are known explicitly, also show that the series are extremely accurate over a wide range of interest rate levels for arbitrarily long maturities; in some cases, they are many orders of magnitude more accurate than series constructed without time transformations. Other potential applications include pricing of callable bonds and credit derivatives.

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Dai and Singleton (2000) study a class of term structure models for interest rates that specify the short rate as an affine combination of the components of an N-dimensional affine diffusion process. Observable quantities of such models are invariant under regular affine transformations of the underlying diffusion process. In their canonical form, the models in Dai and Singleton (2000) are based on diffusion processes with diagonal diffusion matrices. This motivates the following question: Can the diffusion matrix of an affine diffusion process always be diagonalized by means of a regular affine transformation?
We show that if the state space of the diffusion is of the form D = Rm+ x RN - m for integers 0 = m= N satisfying m = 1 or m = N - 1, there exists a regular affine transformation of D onto itself that diagonalizes the diffusion matrix. On the other hand, we provide examples of affine diffusion processes with state space R2+ x R2 whose diffusion matrices cannot be diagonalized through regular affine transformation. This shows that for 2 = m = N - 2, the assumption of diagonal diffusion matrices may impose unnecessary restrictions and result in an avoidable loss of generality.

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We investigate corporate governance experts’ claim that it is detrimental to a firm to reappoint former CEOs as directors after they step down as CEOs. We find that more successful and more powerful former CEOs are more likely to be reappointed to the board multiple times after they step down as CEOs. Firms benefit on average from the presence of former CEOs on their boards. Firms with former CEO directors have better accounting performance, have higher relative turnover-performance sensitivity of the successor CEO, and can rehire their former CEO directors as CEOs after extremely poor firm performance under the successor CEOs.

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Many applications in continuous-time financial economics require calculation of conditional moments or contingent claims prices, but such expressions are known in closed-form for only a few specific models. Power series (in the time variable) for these quantities are easily derived, but often fail to converge, even for very short time horizons. We characterize a large class of continuous-time non-a±ne conditional moment and contingent claim pricing problems with solutions that are analytic in the time variable, and that therefore can be represented by convergent power series. The ability to approximate solutions accurately and in closed-form simplifies the estimation of latent variable models, since the state vector must be extracted from observed quantities for many different parameter vectors during a typical estimation procedure.

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We find that the announcement gain to target shareholders from acquisitions is significantly lower if a private firm instead of a public firm makes the acquisition. Non-operating firms like private equity funds make the majority of private bidder acquisitions. On average, target shareholders receive 55% more if a public firm instead of a private equity fund makes the acquisition. There is no evidence that the difference in premiums is driven by observable differences in targets. We find that target shareholder gains depend critically on the managerial ownership of the bidder. In particular, there is no difference in target shareholder gains between acquisitions made by public bidders with high managerial ownership and by private bidders. Such evidence suggests that the differences in managerial incentives between private and public firms have an important impact on target shareholder gains and that managers of firms with diffuse ownership may pay too much for acquisitions.

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In this study, we present empirical evidence on the productive efficiency of electric utilities in the United States over the period, 1990-2004. This is a period marked by major attempts to introduce competition in the industry with the expectation that it will lead firms to improve their productive efficiency and ultimately to lower consumer prices. The actual experience has been surprising, since electricity prices have either fallen little or even risen sharply in some states. Relying on recent advances in the estimation of productive efficiency, we find that firms in jurisdictions that adopted competitive mechanisms have lower productive efficiency compared to firms in jurisdictions where rate-of-return regulation was retained. Furthermore, we provide evidence that firms in states that adopted competition have experienced decreases in productive efficiency, while firms in states with traditional regulation saw increases in efficiency over time. Since the introduction of deregulation has brought greater discretion to managers, we also examine the impact of various organizational choices on productive efficiency. Interestingly, the separation of the generation function from other functions, a hallmark of the effort to deregulate the industry, is associated with an adverse impact on productive efficiency. These findings question the claim that competition necessarily fosters higher productive efficiency. Alternatively, true competition may have been circumvented.

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From 1988 to 2003, the average change in managerial ownership is significantly negative every year for American firms. We find that managers are more likely to significantly decrease their ownership when their firms are performing well, but not more likely to increase their ownership when their firms have poor performance. Because investors learn about the total change in managerial ownership with a lag, changes in Tobin’s q in a period can be affected by changes in managerial ownership in the previous period. In an efficient market, it is unlikely that changes in managerial ownership in one period are caused by future changes in q. When controlling for past stock returns, we find that large increases in managerial ownership increase q. This result is driven by increases in shares held by officers, while increases in shares held by directors appear unrelated to changes in firm value. There is no evidence that large decreases in ownership have an adverse impact on firm value. We argue that our evidence cannot be wholly explained by existing theories and propose a managerial discretion theory of ownership consistent with our evidence.

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We construct a firm-level governance index that increases with minority shareholder protection. Compared to U.S. matching firms, only 12.68% of foreign firms have a higher index. The value of foreign firms falls as their index decreases relative to the index of matching U.S. firms. Our results suggest that lower country-level investor protection and other country characteristics make it suboptimal for foreign firms to invest as much in governance as U.S. firms do. Overall, we find that minority shareholders benefit from governance improvements and do so partly at the expense of controlling shareholders.

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We uncover similar cross-country and time-series patterns in co-movement or "commonality" in stock returns, liquidity, and trading activity across 40 developed and emerging countries. The extent to which the liquidity and turnover of individual stocks within a country move together is related to the same institutional characteristics as is comovement in stock returns. Commonality is greater in countries with weaker investor protection and a more opaque information environment. Monthly variation in commonality in returns, liquidity, and turnover is also driven by common determinants. Commonality increases during times of high market volatility, large market declines, and high interest rates, and is negatively related to capital market openness. Our results are consistent with theoretical models in which changes in the wealth and collateral value of traders and financial intermediaries endogenously affect liquidity, trading, and pricing.

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Utilizing a large sample with unique data gathered directly from private placement contracts, we address two important questions that remain unresolved in the literature. First, what types of relationships connect private placement investors and issuers, and how do these relationships affect issuer performance, deal structure and corporate governance? Second, do relationships between issuers and investors, or a lack thereof, shed light on the performance "puzzle" associated with private placements? Our primary finding is a strong, positive association between new relationships formed around the time of a placement and issuer performance at announcement and post-placement. The vast majority of new relationships are governance-related, so our findings are consistent with increased monitoring and/or stronger governance creating value for investors. We also find that relationship investors are more likely to gain governance influence than other investors. Issuers in "new economy" industries and with high specific risk grant investors more governance influence than other issuers, suggesting that access to governance is especially valuable when information asymmetries and/or specific investments are important.

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We re-examine the co-movements of index options and futures quotes first studied in Bakshi, Cao, and Chen (2000). We show that the frequency of quote co-movements that are inconsistent with standard option pricing models is significantly higher around option trades. We examine empirically two explanations for these co-movements. First, we show that in simulations the stochastic volatility model can generate approximately the right frequency of inconsistent co-movements when its parameters are chosen to match observed option prices. But even allowing for different regimes in trade and no-trade periods the model generates virtually the same frequency of inconsistent co-movements. Second, we examine the quote co-movements in event-time around trades and show that they are consistent with either traders picking off stale option quotes or with traders submitting aggressive limit orders. Our evidence suggest that inconsistent co-movements reflect both departures from the univariate diffusion model and market microstructure frictions.

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Merton Miller was at the center of the transformation of academic finance from a descriptive field to a science. His principal contribution to this transformation was the introduction of arbitrage arguments which underlie most theoretical contributions in finance and remain central to the way financial economists analyze finance problems to this day. These arbitrage arguments underlie his and Franco Modigliani's famous irrelevance propositions.

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The objective of this article is to outline what we, as researchers, know and, more importantly, what we do not yet know about the consequences of terrorism for financial markets. I argue that a number of the efforts used to assess quantitatively the risk of terrorist attacks are limited in scope and are hampered by the limits of the databases used to operationalize such models. I also describe some of the most recent research that has sought to measure the magnitude of the impact of terrorist attacks on financial markets. Most of them have focused on the events surrounding the September 11, 2001 attacks, though a few have broadened the perspective over time and for countries beyond the U.S.

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I develop and test the theoretical predictions that when investor overreaction to market-wide news is larger, firm valuations in the cross section become more dispersed and stocks earn lower expected returns. Consistent with these predictions, measures of cross-sectional dispersion of firm valuations are negatively related to subsequent market and portfolio excess returns, especially for sets of firms with highly subjective valuations and significant limits to arbitrage. Further, these firms underperform those with the opposite characteristics in periods when beginning-of-period firm valuation dispersion is high. In contrast, they overperform when beginning-of-period firm valuation dispersion is low.

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This paper specifies and tests an equilibrium asset pricing model with liquidity risk at the global level. The analysis encompasses 25,000 individual stocks from 48 developed and emerging countries around the world from 1988 to 2004. Though we cannot find evidence that the liquidity adjusted capital asset pricing model of Acharya and Pedersen (2005) holds in international financial markets, cross-sectional as well as time-series tests show that liquidity risks arising from the covariances of individual stocks' return and liquidity with local and global market factors are priced. Furthermore, we show that the US market is an important driving force of world-market liquidity risk. We interpret our evidence as consistent with an intertemporal capital asset pricing model (Merton (1973)) in which stochastic shocks to global liquidity serve as a priced state variable.

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Despite the disappearance of formal barriers to international investment across countries, we find that the average home bias of U.S. investors towards the 46 countries with the largest equity markets did not fall from 1994 to 2004 when countries are equally weighted but fell when countries are weighted by market capitalization. This evidence is inconsistent with portfolio theory explanations of the home bias, but is consistent with what we call the optimal insider ownership theory of the home bias. Since foreign investors can only own shares not held by insiders, there will be a large home bias towards countries in which insiders own large stakes in corporations. Consequently, for the home bias to fall substantially, insider ownership has to fall in countries where it is high. Poor governance leads to concentrated insider ownership, so that governance improvements make it possible for corporate ownership to become more dispersed and for the home bias to fall. We find that the home bias of U.S. investors decreased the most towards countries in which the ownership by corporate insiders is low and countries in which ownership by corporate insiders fell. Using firm-level data for Korea, we find that portfolio equity investment by foreign investors in Korean firms is inversely related to insider ownership and that the firms that attract the most foreign portfolio equity investment are large firms with dispersed ownership.

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We develop an empirical framework that allows us to analyze the effects of heterogeneity across large shareholders, and we construct a new blockholder-firm panel data set in which we can track all unique blockholders among large U.S. public firms. We find statistically significant and economically important blockholder fixed effects in investment, financial, and executive compensation policies. This evidence suggests that blockholders vary in their beliefs, skills, or preferences. Different large shareholders have distinct investment and governance styles: they differ in their approaches to corporate investment and growth, their appetites for financial leverage, and their attitudes towards CEO pay. We also find blockholder fixed effects in firm performance measures, and differences in style are systematically related to firm performance differences. Our results are consistent with influence for activist, pension fund, corporate, individual, and private equity blockholders, but consistent with systematic selection for mutual funds. Finally, we analyze sources of the heterogeneity, and find that blockholders with a larger block size, board membership, direct management involvement as officers, or with a single decision maker are associated with larger effects on corporate policies and firm performance.

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This paper examines the role that advertising plays in the mutual fund industry and whether advertising affects investors’ fund and portfolio choices. Content analysis shows that only a small fraction of fund advertising is directly informative about characteristics relevant for rational investors, such as fund fees. Higher quantities of advertising do not signal ex ante higher unobservable fund manager ability, because funds that advertise more are not associated with higher post-advertising excess returns. Fund advertising is shown to affect investors’choices, although it provides little information. These results do not seem to be driven by the endogeneity of advertising, and are robust to a series of robustness checks. Finally, advertising is found to steer people towards portfolios with higher fees and more risk, through higher exposure to equities, more active management, more "hot" sectors, and more home bias. This evidence has implications for welfare analysis, asset pricing and public policy, and may serve as a starting point for broader analysis of marketing and persuasion efforts in financial markets.

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Subordination levels are of critical importance in the classic senior-subordinated structure for securitized financing (such as collateralized debt obligations and commercial mortgage-backed securities). Subordination levels determine the amount of credit support that the senior bonds (or tranches) require from the subordinated bonds (or tranches) and are provided by the rating agencies. Thus, ratings agencies play an important role in the pricing and risk management of structured finance products.
The finance literature has numerous studies examining whether securities with higher risk (as predicted by asset pricing models, such as the CAPM) earn higher ex-post average returns. In a similar vein, it is of interest to examine whether securities (or tranches) with greater levels of subordination experience higher ex-post levels of delinquencies and default. In this paper, we examine whether bonds (or tranches) with greater levels of subordination do, in fact, experience higher ex-post levels of delinquencies and default.
Recent studies have found that rating agencies follow a "learning by doing" approach in subordination structuring (Riddiough and Chiang, 2004). As expected, the rating agencies were conservative in the early stages with regard to subordination levels given the paucity of information about delinquencies, defaults and prepayments on loans. As time progresses and more information is available regarding loan performance,subordination levels adjusted to new levels. This paper focuses on cross sectional differences in subordination levels. We examine if this relationship between subordination and ex-post delinquencies and defaults is conforming to rational expectation.
We perform both a deal level and a loan level analysis using commercial mortgage-backed securities (CMBS). Our results show that the expected loss for CMBS pools are a statistically significant factor in explaining both AAA and BBB bond subordinations; however, expected loss accounts for less than 30 percent of the variation. Even considering the rating agencies’ practice of incorporating differences in loan terms, borrower quality, deal structural and information quality into their subordination structure, the empirical fit is still too low. These findings indicate the difficulty in determining subordination levels apriori.

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I study managers' risk-taking behavior and how it is affected by equity-based compensation. I find that in response to an exogenous increase in takeover protection in Delaware during the mid-1990s, managers lower firm risk by 5%. I also find that the decrease in firm risk is concentrated among firms with low managerial equity-based incentives. In particular, firms with low CEO portfolio sensitivity to stock return volatility experience more than 10% reduction in risk. Further, firms respond to the increased protection accorded by the regime shift with greater incentives for risk-taking.

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Many goods are marketed after first stating a list price, with the expectation that the eventual sales price will differ. In this paper we first extend search theory to include the seller setting a list price. Holding constant the mean of the buyers’ distribution of potential offers for a good, we assume that the greater the list price, the slower the arrival rate of offers but the greater is the maximal offer. This tradeoff determines the optimal list price, which is set simultaneously with the seller’s reservation price. Comparative statics are derived through a set numerical sensitivity tests, where we show that the greater the variance of the distribution of buyers’ potential offers, the greater is the ratio of the list price to expected sales price. Thus, sellers of atypical goods will tend to set a relatively high list price compared with standard goods. We test this hypothesis using data from the Columbus, Ohio housing market and find substantial support. Other applications could include the market for fine art or autos.

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Option theory predicts that mortgage default or prepayment will be exercised if the call or put option is "in the money." We extend our analysis to commercial mortgages using data from commercial mortgage-backed securities (CMBS). The paper presents a model of the competing risks of mortgage termination (default and prepayment) using data from commercial mortgage-backed securities (CMBS) deals. Our results show that the option model explains both default and prepayment for commercial mortgages. We find that loan specific variables (such as loan-to-value ratio, debt service coverage ratio, loan-rate spread and prepayment prevention) are important explanatory variables for both default and prepayment. We also find that default and prepayment vary across regions of the country; given that regional economies do not move in perfect lock-step, we would expect there to be cross-sectional variation in default rates. However, the degree of variation across regions in terms of prepayments is not as predictable. The largest differences are across property types, both in terms of default and prepayment risk.