Alessio Saretto

Why Did Auction Rate Bond Auctions Fail During 2007-2008?

The auction rate bond market grew from inauspicious beginnings in 1985 to representing a significant fraction of the municipal bond market in 2007, with a total of 603 issuances raising more than

Leverage and the Interaction between Firms and Non-Financial Stakeholders: Evidence from Contract Negotiations and Union Strikes

35 billion in capital. Since March of 2008 not a single auction rate bond has been issued. The last issuance coincided with a wave of “failures” of auction rate bond auctions during the early winter of 2008. Pundits have attributed the auction failures to a “frozen” market and hint that irrationality on the part of investors precipitated the auction failures. Missing from the headlines is that all auction rate bonds have interest rate caps that limit their yields. The authors find that, contrary to the impression given by news headlines, not all auctions failed and that investors rationally discriminated among bonds such that it was primarily those with low caps that experienced high failure rates. They further conclude that, in the absence of such caps, few if any auctions would have failed.

p-Hacking: Evidence from Two Million Trading Strategies

We use contract negotiation data to study how leverage affects the interaction between firms and an important non-financial stakeholder, labor unions. Consistent with the idea that leverage diminishes the bargaining position of labor, we find that unions are less likely to strike when a firm has high leverage or increases leverage prior to a contract negotiation. Consistent with the idea that firms intentionally use leverage to improve their bargaining position, we find that firms facing a high likelihood of a strike increase their leverage, as do firms that have recently experienced a strike.We use contract negotiation data to study how leverage affects the interaction between firms and an important nonfinancial stakeholder, labor unions. Consistent with the idea that leverage diminishes the bargaining position of labor, we find that unions are less likely to strike when a firm has high leverage or increases leverage prior to a contract negotiation. We also find large leverage increases after a strike, consistent with the idea that firms intentionally use leverage to improve their bargaining position. This poststrike increase in leverage is particularly pronounced when the union wins the strike. Moreover, we do not find any clear indication that such increases in leverage are linked to changes in investments. In addition, firms that experience a strike subsequently invest more internationally and in right-to-work states where union are afforded fewer legal protections, and they increase their disposal of production units that are located in states where strikes have occurred. This paper was accepted by Brad Barber, finance .

Firm Policies and the Cross-Section of CDS Spreads

Abstract We use information from over 2 million trading strategies randomly generated using real data and from strategies that survive the publication process to infer the statistical properties of the set of strategies that could have been studied by researchers. Using this set, we compute t-statistic thresholds that control for multiple hypothesis testing, when searching for anomalies, at 3.8 and 3.4 for time-series and cross-sectional regressions, respectively. We estimate the expected proportion of false rejections that researchers would produce if they failed to account for multiple hypothesis testing to be about 45%.

Does Hedging with Derivatives Decrease the Cost of Corporate Debt? The Role of Basis Risk

We solve the credit spread puzzle with a structural model of firm’s policies that endogenously replicates the empirical cross-section of credit spreads. Structural estimation of the models parameters reveals that the model cannot be rejected by the data, and that endogenous investment decisions are major determinants of CDS spreads. We also verify that controlling for financial leverage, CDS spreads are positively related to operating leverage, and negatively related to growth opportunities. Consistent with the idea that growth options reduce credit risk, investments are negatively correlated with changes in CDS spreads.

Does Hedging with Derivatives Reduce the Market's Perception of Credit Risk?

Non-financial corporations typically cite risk management as the primary reason for their derivatives use. If hedging programs are effective, then firms using derivatives should have lower credit risk than those that do not. Consistent with this idea, we find that CDS spreads are lower for firms with derivatives positions that are designated as accounting hedges (typically low basis risk) compared to firms without the accounting hedge designation as well as firms that do not use derivatives. Surprisingly, we find that firms with derivatives positions without a hedge accounting designation have higher CDS spreads than firms that do not hedge with derivatives at all. We do not find evidence that these non-designated positions are associated with future credit realizations, as captured by changes in either credit ratings or CDS spreads. We examine alternative explanations and find evidence that is consistent with a market penalty for high basis risk positions when overall market conditions are poor.

Cross-section of option returns and volatility

Risk management is the most widely-cited reason that non-financial corporations use derivatives. If hedging programs are effective, then firms using derivatives should have lower credit risk than those that do not. Surprisingly, we find that firms with derivative positions without a hedge accounting designation (typically higher basis risk) have higher CDS spreads than firms that do not hedge at all. We do not find evidence that these non-designated positions are associated with future credit realizations. We examine alternative explanations and find evidence that is consistent with a market penalty for high basis risk positions when overall market conditions are poor.