Itzhak Ben-David

Hedge Fund Stock Trading in the Financial Crisis of 2007-2009

We document a drastic reduction in hedge fund stock ownership during the recent financial crisis. In the two quarters around the Lehman collapse (2008Q3-Q4), hedge funds cut their equity holdings by about 29% and nearly every fourth fund dumped more than 40% of its equity portfolio in each quarter. We directly establish that investor redemptions were a primary driver of these selloffs and provide suggestive evidence that pressure from lenders was also an important determinant of stock sales. These channels were more relevant for funds with low restrictions on investors’ withdrawals and low bargaining power vis-a-vis their brokers. Also consistent with fire sales, hedge funds were more likely to sell high-volatility stocks and liquid stocks. Finally, we show indirect evidence suggesting that part of the stock selloffs occurred because hedge funds reallocated capital to other assets in a flight to quality or in pursuit of profit opportunities. _____________________ * We thank Viral Acharya, Giovanni Barone-Adesi, Alexander Eisele, Vyacheslav Fos, Craig Furfine, YeeJin Jang, Pete Kyle, Jose-Miguel Gaspar, Massimo Massa, Loriana Pelizzon, Alberto Plazzi, Steven Ongena, Tarun Ramadorai, Ronnie Sadka, Rene Stulz, Dimitri Vayanos, and seminar and conference participants at the Ohio State University, the 2 Annual Conference on Hedge Funds in Paris, the 3 Erasmus Liquidity Conference, the Wharton/FIRS pre-conference, the FIRS conference (Florence), LUISS University (Rome), and the C.R.E.D.I.T. Conference (Venice), for helpful comments.

The role of securitization in mortgage renegotiation

We study the effects of securitization on renegotiation of distressed residential mortgages over the current financial crisis. Unlike prior studies, we employ unique data that directly observe lender renegotiation actions and cover more than 60% of the U.S. mortgage market. Exploiting within-servicer variation in these data, we find that bank-held loans are 26–36% more likely to be renegotiated than comparable securitized mortgages (4.2–5.7% in absolute terms). Also, modifications of bank-held loans are more efficient: conditional on a modification, bank-held loans have 9% lower post-modification default rates (3.5% in absolute terms). Our findings support the view that frictions introduced by securitization create a significant challenge to effective renegotiation of residential loans. We also provide evidence supporting the affordability focus of recent policy actions, such as the Home Affordability Modification Program.

Are Investors Really Reluctant to Realize their Losses? Trading Responses to Past Returns and the Disposition Effect

We examine how investor preferences and beliefs affect trading in relation to past gains and losses. The probability of selling as a function of profit is V-shaped; at short holding periods, investors are more likely to sell big losers than small ones. There is little evidence of an upward jump in selling at zero profits. These findings provide no clear indication that realization preference explains trading. Furthermore, the disposition effect is not driven by a simple direct preference for selling a stock by virtue of having a gain versus a loss. Trading based on belief revisions can potentially explain these findings. The Author 2012. 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.

Policy Intervention in Debt Renegotiation: Evidence from the Home Affordable Modification Program

We evaluate the effects of the 2009 Home Affordable Modification Program (HAMP) that provided intermediaries with sizeable financial incentives to renegotiate mortgages. HAMP increased intensity of renegotiations and prevented substantial number of foreclosures but reached just one-third of its targeted indebted households. This shortfall was in large part due to low renegotiation intensity of a few large intermediaries and was driven by intermediary-specific factors. Exploiting regional variation in the intensity of program implementation by intermediaries suggests that the program was associated with lower rate of foreclosures, consumer debt delinquencies, house price declines, and an increase in durable spending.

An integrated approach for risk response development in project planning

The risk response development phase is a major phase in the project risk management process. We present a model that integrates project work contents, risk events, and risk reduction actions and their effects into a comprehensive framework. The model allows the representation of the overlapping effects of multiple risk reduction actions and of the impacts of secondary risk events, and supports the evaluation of the total risk exposure of the project under various combinations of risk reduction actions. The model can be treated with optimisation techniques in order to generate the most cost-effective combination of risk reduction actions. In this work we describe the model, outline a solution procedure and illustrate its application with an example taken from the software industry.

Market-Based Loss Mitigation Practices for Troubled Mortgages Following the Financial Crisis

The meltdown in residential real-estate prices that commenced in 2006 resulted in unprecedented mortgage delinquency rates. Until mid-2009, lenders and servicers pursued their own individual loss mitigation practices without being significantly influenced by government intervention. Using a unique dataset that precisely identifies loss mitigation actions, we study these methods—liquidation, repayment plans, loan modification, and refinancing— and analyze their effectiveness. We show that the majority of delinquent mortgages do not enter any loss mitigation program or become a part of foreclosure proceedings within 6 months of becoming distressed. We also find that it takes longer to complete foreclosures over time, potentially due to congestion. We further document large heterogeneity in practices across servicers, which is not accounted for by differences in borrower population. Consistent with the idea that securitization induces agency conflicts, we confirm that the likelihood of modification of securitized loans is up to 70% lower relative to portfolio loans. Finally, we find evidence that affordability (as opposed to strategic default due to negative equity) is the prime reason for redefault following modifications. While modification terms are more favorable for weaker borrowers, greater reductions in mortgage payments and/or interest rates are associated with lower redefault rates. Our regression estimates suggest that a 1 percentage point decline in mortgage interest rate is associated with a nearly 4 percentage point decline in default probability. This finding is consistent with the Home Affordable Modification Program (HAMP) focus on improving mortgage affordability.

Do ETFs Increase Volatility

Recent literature suggests that trading by institutional investors may affect the first and second moments of returns. Elaborating on this intuition, we conjecture that arbitrageurs can propagate liquidity shocks between related markets. The paper provides evidence in this direction by studying Exchange Traded Funds (ETFs), an asset class that has gained paramount importance in recent years. We report that arbitrage activity occurs between ETFs and the underlying assets. Then, we show that ETFs increase the volatility of the underlying assets, and that the prices of the underlying assets are affected by shocks to ETFs. Finally, we present findings consistent with the idea that ETFs served as a conduit for shock propagation between the futures market and the equity market during the Flash Crash on May 6, 2010. Overall, our results suggest that arbitrage activity may induce contagion.

Collateral Valuation and Borrower Financial Constraints: Evidence from the Residential Real Estate Market

Financially constrained borrowers have the incentive to influence the appraisal process in order to increase borrowing or reduce the interest rate. We document that the average valuation bias for residential refinance transactions is above 5%. The bias is larger for highly leveraged transactions, around critical leverage thresholds, and for transactions mediated through a broker. Mortgages with inflated valuations default more often. Lenders account for 60%-90% of the bias through pricing. This paper was accepted by Wei Jiang, finance.

Acquirer Valuation and Acquisition Decisions: Identifying Mispricing Using Short Interest

We use short interest as an investor-based measure of over- or undervaluation that distinguishes between the misvaluation and Q-theories of mergers. Using this measure, we find that misvaluation is a strong determinant of merger decision-making. Firms in the top quintile of short interest are 54% more likely to engage in stock acquisitions and 22% less likely to engage in cash acquisitions. Stock (but not cash) acquirers have higher short interest than their targets. Overall, our results suggest that the previously documented underperformance of stock acquirers and the overperformance of cash acquirers can be explained by misvaluation, as captured by short interest.

High Leverage and Willingness to Pay: Evidence from the Residential Housing Market

In pursuit of understanding the mechanism that relates the expansion in credit to the increase in real-estate prices during the real-estate bubble, I explore transaction-level data for 1994-2008. I document a strong correlation between borrowing at high leverage (>95% loan to value) and paying the full listing price or above. Homebuyers in these transactions pay prices that are higher than market prices by 3.4% (