The Rodney White Center’s newsletter, A Bite of Finance, is designed to highlight some of the Finance Department’s current research in a way that is interesting, relevant, and comprehensible to both academic and general audiences. Each month the topics will range from current trends to customary themes relating to financial economics. Scroll down for the latest issue.
THE RODNEY WHITE CENTER FOR FINANCIAL RESEARCH
A Bite Of Finance: The Latest From Wharton
The role of FinTech in small business lending
In view of tightening bank regulations, there has been growing concern that traditional banks may not be able to offer a wide enough range of products to meet small and medium-sized enterprises’ (SMEs’) financing needs. Could FinTech platforms, not subject to similar regulatory capital requirements, complement the banking system and provide SMEs access to bank credit? In this study, Professor Huan Tang exploits administrative and commercial datasets on the French SME lending market and unveils a mechanism called the “collateral channel”: SMEs use the junior unsecured loans from FinTechs to acquire assets that they then pledge to banks as collateral. Between 2014 and 2019, this phenomenon allowed French SMEs to increase their bank credit by 20% following a FinTech loan origination.
The threat of AI collusion
The integration of algorithmic trading and reinforcement learning, known as AI-powered trading, has fundamentally reshaped the structure of capital markets. Amid the rapid adoption of this technology, financial regulators have directed their attention toward understanding how Artificial Intelligence can potentially compromise competition and market efficiency. Here, Professors Itay Goldstein and Winston Dou contribute to this debate by providing a model of imperfect competition among informed speculators with asymmetric information to explore the implications of AI-powered trading strategies on informed traders’ market power and price informativeness. Their results demonstrate that informed AI traders can collude and generate substantial profits by strategically manipulating low order flows, even without explicit coordination that violates current antitrust regulations.
Does investor expertise add value to renewable power projects?
The United States has overcome the high fixed costs of clean energy development by providing extensive tax incentives to attract private investors. Often, direct project sponsors do not have enough taxable income to fully use these credits, so they turn to “tax equity” investors with high taxable income, typically large banks. In this study, Professor Daniel Garrett investigates whether and how tax equity investors add value to renewable power projects. Using a sample of 529 solar and wind plants from 2006-2022, he finds that projects with tax equity are built faster and produce 5% closer to capacity. Through two natural experiments, the study demonstrates that this greater efficiency is due to monitoring or up-front contracting by tax equity investors and not merely to project selection.
The importance of commitment to capital regulation policies
Traditionally, the macro-finance literature models bank deposits as one-period debt. However, the majority of United States bank deposits lack explicit maturity dates and often remain untouched for extended periods, resulting in a disparity between theory and reality. Professor Urban Jermann bridges this gap by introducing a dynamic banking model with non-maturity deposits and documents how the regulator’s commitment to future policies affects bank defaults. Overall, a financial regulator that can commit ex-ante to a high bank leverage in the future can reduce bank defaults today without increasing leverage too aggressively in the present. This policy creates a smooth debt path beneficial for the liquidity value of bank deposits.
Skewed business cycles
During recessions, the distribution of the growth rate of firm-level outcomes has been extensively characterized by a negative impact to the mean (on average, firms grow less) and a positive shock to the variance (more uncertainty). Using firm-level panel data from the United States and almost fifty other countries, Professor Sergio Salgado goes one step further and details the impact of recessionary shocks to the skewness of the distribution. His findings suggest that the distribution’s skewness is strongly procyclical, meaning that during economic downturns, a subset of firms does extremely badly (creating a large left tail of negative growth rates). Furthermore, Professor Salgado observes that firms internalize this phenomenon when determining their expectations about future sales growth. At the onset of the COVID pandemic, before all the decline in sales realized, firms expected the median sales growth to remain close to zero but significantly declined their expectations at the bottom of the distribution. This striking observation suggests that firms do not perceive recessions as periods in which sales will decline on average, but in which if things go badly, they will go really badly for the firm.
Recent Past Issues
In this issue: looking at how much ESG investing there really is, post-COVID stimulus measures, exploring the “factor zoo” and the robustness of stock return anomalies, trade credits, and how interest rates react to financial instability.
In this issue: preventing bank failures, mortgage lock-in, the feedback loop between financial distress and competition, stablecoin runs, and the benefits of bank diversification.
In this issue: the sources of extreme wealth, 170 years of economic sentiment, the effects of the minimum wage on low-income workers, the advantages of trading with expert dealers, and asset concentration in OTC markets.
In this issue: racial bias in bankruptcies, imperfect competition in the repo market, behavioral biases in the housing market, optimal strategies for crypto issuers, and the value of undiversified shareholder engagement.
In this issue: How does democracy impact the stock market? Do growth stocks really have higher growth? How does under-diversification affect the economy? Who owns government debt? How passive are passive ETF
In this issue: a challenge to the risk-return tradeoff, the sources of wealth inequality, the effects of underfunded state pensions on households, the sensitivity of bank deposits to transparency, and arms sales in financial markets.
In this issue: the impacts of impact investing, collusion in the distressed-loan market, the macro effects of aging, new predictability in stock market returns, and political pushback to ESG.
In this issue: the economic effects of Roe v. Wade, the active side of passive ETFs, the post-LIBOR world, risk anomalies in stock returns, and the effects of interest rates on bank lending.
In this issue: the link between volatility and liquidity; the unintended consequences of Quantitative Easing; why some households hold more stocks than others; how size matters in bond trading; and the effects of technological progress on rent-seeking.
In this issue: paying off the national debt, the effect of rising sea levels on muni bonds, gold’s value as an investment, the effects of capital controls on currency crises, and the environmental impacts of private equity.
Reassessing stock versus bond performance, synergies in FinTech lending, fracking’s long-term effects, the performance of ESG strategies, and PE investors’ effects on healthcare costs
Professor Erik Gilje organized a Virtual Conference on Climate and Commodities that took place on April 23 and included a panel discussion with Professor Jeremy Siegel.
Research includes important studies on inflation risks for investors and the recent behavior of the Yuan; a truly insightful new discussion on how government intervention can impact the renegotiation of private debts and help stop default waves across linked borrowers; as well as a historical assessment of the role of banks in pre-WWI sovereign defaults.
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