I have been meaning to write these posts (I do not know how many they will be) but some things got in the way, mainly Christmas holidays and exam marking. We had a wonderful 6th Emerging Scholars in Banking and Finance conference the 10th and 11th of December last year; 13 papers were presented, and we enjoyed a keynote lecture by David Miles about the half-life of economic injustice and a publication workshop—all that matters to assistant professors is to publish in top journals—by Thorsten Beck and Neeltje Van Horen. Two exhausting but very productive days (although I did not present, I discussed Ishita Sen‘s job market paper, which is a great paper and it seems that many institutions agree with this assessment).
So I wanted to quickly mention some of the papers that were presented. I am going to start with Collateral requirements and corporate policy decisions, presented by Kizkitza Biguri and co-authored by Jorg Stahl. The authors want to empirically assess whether there is a trade-off between risk management and investment decisions due to collateral constraints.
Some firms have limited collateral, and this collateral can be used to hedge risks in the derivative markets (for instance by entering an interest-rate swap or an exchange-rate forward). But the collateral can also be used to borrow (from a bank) and invest into long-term projects. Therefore, at least in theory, firms could face a trade-off in terms of hedging versus investment. This questions is particularly important since the introduction of central clearing, which affects big financial firms and some non-financial corporations as well, given the fact that central clearing of derivatives is associated to a substantial increase in collateral requirements.
The authors test this trade-off empirically for non-financial firms but do not find evidence that it exists. In particular, while financially constrained firms do hedge less, among those firms that are financially constrained, the ones that are pledging some collateral for debt purposes actually hedge more that the ones that are not pledging collateral. Therefore, having some collateral tied-up in debt (in a secured loan, for instance) does not prevent hedging.
Instead, they identify cash as being very relevant for hedging—and not other type of collateral such as properties and equipment—thus introducing a trade-off between liquidity management and (other) risk management. They test this additional trade-off using the Hurricane Katrina as an exogenous shock to liquidity, and they find that firms in states more affected by the hurricane hedge less after the shock.
One thing I find particularly relevant about the paper is the focus on non-financial firms. Most papers on the topic have so far focused on financial institutions because of, well, the mess they made during the financial crisis. But research on non-financial companies is key to properly understand the effects of the new financial regulations; it would not be a great outcome if reforms on the financial sector led to insufficient hedging in the real sector.
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