Amiyatosh K. Purnanandam

Originate-to-Distribute Model and the Subprime Mortgage Crisis

An originate-to-distribute (OTD) model of lending, where the originator of a loan sells it to various third parties, was a popular method of mortgage lending before the onset of the subprime mortgage crisis. We show that banks with high involvement in the OTD market during the pre-crisis period originated excessively poor-quality mortgages. This result is not explained away by differences in observable borrower quality, geographical location of the property, or the cost of capital of high- and low-OTD banks. Instead, our evidence supports the view that the originating banks did not expend resources in screening their borrowers. The effect of OTD lending on poor mortgage quality is stronger for capital-constrained banks. Overall, we provide evidence that lack of screening incentives coupled with leverage-induced risk-taking behavior significantly contributed to the current subprime mortgage crisis. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Market Pricing of Deposit Insurance

We provide an approach to the market valuation of deposit insurance that is based on reduced-form methods for the pricing of fixed-income securities under default risk. By reference to bank debt prices as well as qualitative-response models of the probability of bank failure, we suggest how a risk-neutral valuation model for deposit insurance can be applied both to the calculation of fair-market deposit insurance premia and to the valuation of long-term claims against the insurer.

Determinants of the floating-to-fixed rate debt structure of firms.

We analyze the effects of managerial incentive, monitoring, firm characteristics and market-timing on floating-to-fixed rate debt structure of firms. We find that the CFOs (not CEOs) incentive has a strong influence on a firms debt structure. When CFOs have incentives to increase (decrease) firm-risk, firms obtain volatility-increasing (decreasing) debt structure. Internal monitoring by the CEO and independent board members as well as external monitoring through corporate control market weakens the link between CFOs incentive and debt structure. Our findings suggest that agency problems at the level of non-CEO executives may be an important driver of various corporate decisions.

Seasoned Equity Offerings, Corporate Governance, and Investments

We find weak governance is a primary reason investors react negatively to the announcement of seasoned equity offerings (SEOs). Using a difference-in-differences approach, we find investors worry about nonproductive use of SEO proceeds when external pressure for good governance lifts due to an external shock. Investors react negatively only when treated firms raise funds to increase capital investments. Market reaction is more negative when issuers have prior records of value-reducing acquisitions and weaker managerial wealth sensitivity to shareholder value. The magnitudes of these governance effects are surprisingly large, explaining most of the previously documented negative market reactions to primary SEOs.We find weak governance is a primary reason investors react negatively to the announcement of seasoned equity offerings (SEOs). Using a difference-in-differences approach, we find investors become worried about non-productive use of SEO proceeds when changes in the law weaken external pressure for good governance. We also identify a channel through which governance causes heterogeneous reactions--unproductive capital expenditures. Investors react negatively to SEO announcements only when firms with weakened governance raise funds to increase capital investments. In addition, market reaction is more negative when issuers have prior records of value-reducing acquisitions and weaker alignment of managerial incentives to shareholder value. The magnitudes of these impacts are surprisingly large, explaining most of negative market reactions to primary offerings. This Draft: April 24, 2011 JEL classification: G32, G34

Design of Financial Securities: Empirical Evidence from Private-Label RMBS Deals

We study the key drivers of security design in the residential mortgage-backed security (RMBS) market during the run-up to the subprime mortgage crisis. We show that deals with a higher level of equity tranche have a significantly lower delinquency rate conditional on observable loan characteristics. The effect is concentrated within pools with a higher likelihood of asymmetric information between deal sponsors and potential buyers of the securities. Further, securities sold from high-equity-tranche deals command higher prices conditional on their credit ratings. Overall, our results show that the goal of security design in this market was not only to exploit regulatory arbitrage, but also to mitigate information frictions that were pervasive in this market. (JEL G20, G30)Received August 26, 2014; accepted May 3, 2016, by Editor Itay Goldstein.

Corporate Hedging, Investment and Value

We consider the effect of hedging with foreign currency derivatives on Brazilian firms in the period 1997 through 2004, a period that includes the Brazilian currency crisis of 1999. We find that, derivative users have valuations that are 6.7-7.8% higher than non-user firms. Hedging with currency derivatives allows firms to sustain larger capital investments, and also removes the sensitivity of investment to internally generated funds. Thus, it mitigates the underinvestment friction of Froot, Scharfstein, and Stein (1993), at a time when capital in the economy as a whole is scarce. We further show that hedging increases the foreign currency debt capacity of a firm, and that foreign debt is a cheaper source of capital than domestic debt during our period of study.

Growth Option Exercise and Capital Structure

We document that firms decrease their leverage when they convert growth options into tangible assets. We argue that the act of growth option exercise decreases information asymmetry about the firm, which in turn reduces the relative cost of issuing information-sensitive securities such as equity. We show that leverage is negatively correlated with unexpected capital expenditure, our proxy for growth option conversion. The negative relationship becomes stronger when the information environment of a firm deteriorates following a reduction in analyst coverage after a brokerage house merger. Overall, our findings are contrary to standard trade-off and pecking order theories, but are consistent with recent work on signaling and growth options.

Can Markets Discipline Government Agencies? Evidence from the Weather Derivatives Market

We analyze the role of financial markets in shaping the incentives of government agencies using a unique empirical setting: the weather derivatives market. We show that the introduction of weather derivative contracts on the Chicago Mercantile Exchange improves the accuracy of temperature measurement by 13-20% at the underlying weather stations. We argue that temperature-based financial markets generate additional scrutiny of the temperature data measured by the National Weather Service, which motivates the agency to minimize measurement errors. Our results have broader implications: the visibility and scrutiny generated by financial markets can potentially improve the efficiency of government agencies.

Measuring Systemic Risk with Network Connectivity: Extended Abstract

Measuring connectedness among financial institutions is an important aspect of monitoring systemwide risk development and identifying systemically risky institutions. In this work, we present a novel statistical method for measuring connectivity among firms using publicly available time series of firm-level characteristics. The proposed method relies on a Lasso penalized estimation of high-dimensional vector autoregressive models (VAR) and provides a principled framework for estimating network topology of linkages among firms. We apply our method to analyze connectivity among stock returns of leading financial firms in the U.S. before, during and after the financial crisis of 2007-2009, and show that centrality measures of the estimated networks can be used to identify important systemic events and systemically risky institutions.