Martin C. Schmalz

Asset Pricing with Horizon-Dependent Risk Aversion

We study general equilibrium asset prices in a multi-period endowment economy when agents’ risk aversion is allowed to depend on the maturity of the risk. We find horizon-dependent risk aversion preferences generate a decreasing term structure of risk premia if and only if volatility is stochastic. Our model can thus justify the recent empirical results on the term structure of risk premia if i) the pricing of volatility risk is downward slopping (in absolute value) in the data; and ii) downward-sloping term structures of returns on a given market are solely driven by exposures to volatility risk. We test these predictions both using index options data and by showing that the value premium is related to the exposure to volatility risk.We propose a model that addresses two fundamental challenges concerning the timing and pricing of uncertainty: established equilibrium asset pricing models require a controversial degree of preference for early resolution of uncertainty and do not generate the downward-sloping term structure of risk premia suggested by the data. Inspired by experimental evidence, we construct dynamically inconsistent preferences in which risk aversion decreases with the temporal horizon. The resulting pricing model can generate a term structure of risk premia consistent with empirical evidence, without forcing a particular preference for resolution of uncertainty or compromising the ability to match standard moments.

Common Ownership, Competition, and Top Management Incentives

When one firm’s strategy affects other firms’ value, optimal executive incentives depend on whether shareholders have interests in only one or in multiple firms. Performance-sensitive contracts induce managerial effort to reduce costs, and lower costs induce higher output. Hence, greater managerial effort can lead to lower product prices and industry profits. Therefore, steep managerial incentives can be optimal for a single firm and at the same time violate the interests of common owners of several firms in the same industry. Empirically, managerial wealth is more sensitive to performance when a firm’s largest shareholders do not own large stakes in competitors.

Unionization, Cash, and Leverage

What is the effect of unionization on corporate financial policies? The average unionized firm responds with lower cash and higher leverage to a unionization election than the average firm escaping unionization. However, using a regression discontinuity design I find that the causal effect of unionization is close to zero on average, but heterogeneous across firms. For the subset of large and financially unconstrained firms, the causal effect is positive on leverage and negative on cash; the opposite is true for small and financially constrained firms. These results help reconcile controversially discussed views on how corporate finance and labor interact.Labor adjustment costs make it optimal to retain hard-to-replace employees in bad times, and thus cause an “implicit liability” to pay their wages. The employees’ human capital thus behaves like an illiquid asset of the firm that is financed with fixed coupon payments. Firms optimally hold equity-financed cash to insure against the risk of being unable to follow the optimal labor retention policy. I distinguish my model from existing models of the interaction between corporate finance and labor by identifying the corporate finance response to unionization with a regression discontinuity design. Increased labor adjustment costs due to unionization cause higher cash-to-asset ratios and lower net leverage in financially unconstrained firms. Firms that cannot raise cash “save on risk management,” decrease cash-to-assets and increase net leverage. ∗mschmalz@princeton.edu | +1 609 933 2117 | http://www.princeton.edu/∼mschmalz | Princeton University. I am deeply grateful to my adviser Markus Brunnermeier, as well as to David Sraer and Alexandre Mas for invaluable support, ideas, and advice, and to David Lee and Alexandre Mas for generously providing data. For helpful discussions and comments, I would like to thank José Azar, Thomas Eisenbach, Henry Farber, Edoardo Grillo, Harrison Hong, Bo Honoré, Oleg Itskhoki, Jakub Jurek, Martin Kanz, David Lee, Thomas Mertens, Benjamin Moll, Ulrich Müller, Juan Ortner, Filippos Papakonstantinou, José Scheinkman, and Hyun Song Shin, as well as seminar participants at Princeton. Sergey Zhuk deserves special mention. Laurien Gilbert and Alexis Furuichi provided excellent research assistance. I gratefully acknowledge support through a Fellowship of Woodrow Wilson Scholars.

Housing Collateral and Entrepreneurship: Housing Collateral and Entrepreneurship

We show that collateral constraints restrict firm entry and post-entry growth, using French administrative data and cross-sectional variation in local house-price appreciation as shocks to collateral values. We control for local demand shocks by comparing treated homeowners to controls in the same region that do not experience collateral shocks: renters, and homeowners with an outstanding mortgage, who (in France) cannot take out a second mortgage. In both comparisons, an increase in collateral value leads to a higher probability of becoming an entrepreneur. Conditional on entry, treated entrepreneurs use more debt, start larger firms, and remain larger in the long run. This article is protected by copyright. All rights reserved

Fund Flows and Market States

This paper establishes a new empirical fact: Mutual funds’ flow-performance sensitivity is a hump-shaped function of aggregate risk-factor realizations. Explanations based on extant theories can explain only a fraction of the pattern. We thus develop a new parsimonious model. It assumes Bayesian investors who are uncertain about the degree to which fund returns are exposed to systematic risk. Fund performance is then less informative about manager skill when factor realizations are larger in absolute value. The data also support the out-of-sample prediction that the hump shape is more pronounced for funds with more uncertain risk loadings.Received October 24, 2014; editorial decision October 11, 2016 by Editor Itay Goldstein.

Ultimate Ownership and Bank Competition

We use a uniquely extensive branch-level dataset on deposit account interest rates, maintenance fees, and fee thresholds, and document substantial time-series and cross-sectional variation in these prices. We then examine whether variation in bank concentration helps explain the variation in prices. The standard measure of concentration, the HHI, is not correlated with any of the outcome variables. We then construct a generalized HHI (GHHI) that captures both common ownership (the degree to which banks are commonly owned by the same investors) and cross-ownership (the extent to which banks own shares in each other). The GHHI is strongly correlated with all prices. We use the growth of index funds as an arguably exogenous source of cross-sectional variation of county-level common ownership growth to suggest a causal link from the GHHI to higher prices for banking products.

The Term Structure of the Price of Variance Risk

We estimate the term structure of the price of variance risk (PVR), which helps distinguish between competing asset-pricing theories. First, we measure the PVR as proportional to the Sharpe ratio of short-term holding returns of delta-neutral index straddles; second, we estimate the PVR in a Heston (1993) stochastic-volatility model. In both cases, the estimation is performed separately for different maturities. We find the PVR is negative and decreases in absolute value with maturity; it is more negative and its term structure is steeper when volatility is high. These findings are inconsistent with calibrations of established asset-pricing models that assume constant risk aversion across maturities.

Anxiety, overconfidence, and excessive risk-taking

We provide a model that can explain empirically relevant variations in confidence and risk taking by combining horizon-dependent risk aversion (“anxiety�?) and selective memory in a Bayesian intrapersonal game. In the time series, overconfidence is more prevalent when actual risk levels are high, while underconfidence occurs when risks are low. In the cross section, more anxious agents are more prone to biased confidence and their beliefs fluctuate more. This systematic variation in confidence levels can lead to objectively excessive risk taking by “insiders�? with the potential to amplify boom-bust cycles.

Reply to: 'Common Ownership Does Not Have Anti-Competitive Effects in the Airline Industry'

Dennis, Gerardi, and Schenone (2017) (DGS) claim to replicate the data construction and results of Azar, Schmalz, and Tecu (forthcoming) (AST). While their implementation of the main specifications in AST generates qualitatively similar results, they claim that AST’s baseline results are driven 1) by the use of passenger volume as regression weights and 2) largely by the top fifth percentile of markets in the passenger count distribution. In this note, we show that these claims are factually incorrect. First, because DGS do not in fact replicate the data construction described in AST, their paper is of limited usefulness in showing the effect of deviations from AST’s empirical specifications. Second, we show that ASTs results are qualitatively robust to not weighting regressions. Third, ASTs results also hold on subsamples excluding the top fifth percentile of markets by passenger count. Additional evidence we present in this note suggests that DGSs erroneous conclusions are driven by an incorrect treatment of ownership data as well as other differences in their samples characteristics compared to ASTs.

Why) Do Central Banks Care about Their Profits

We document that central banks are significantly more likely to report slightly positive profits than slightly negative profits, especially amid greater political pressure, the public’s receptiveness to more extreme political views, and when governors are reappointable. The propensity to report small profits over small losses is correlated with more lenient monetary policy and higher inflation. We conclude that profitability concerns, although absent from standard theory, are present and effective in practice. These findings inform a debate about the political economy of central banking, monetary stability, and the effectiveness of non-traditional central banking.