The Information Asymmetry Effects of Expanded Disclosures About Derivative and Hedging Activities

I study the information asymmetry effects of Statement of Financial Accounting Standards Number 161 (SFAS 161), which requires changes to the content and format of derivative and hedging footnote disclosures. Using a difference-in-differences design, I investigate whether these mandatory disclosure changes affected bid-ask spreads. To capture the extent to which firms were likely impacted by SFAS 161, I employ two complementary measures: (1) actual changes in firms’ derivative and hedging disclosures, and (2) pre-SFAS 161 levels of firms’ derivative and hedging activities. Both measures provide consistent evidence that bid-ask spreads decreased more for firms whose disclosures were more likely affected by SFAS 161. I also find that increased qualitative information and more disaggregated quantitative data (i.e., disclosure content) matter more than disclosure grouping and tabular display (i.e., disclosure format) for the observed decrease in bid-ask spreads. Overall, my findings suggest that the disclosure changes required by SFAS 161 reduced information asymmetry among investors regarding the firm value effects of derivative and hedging activities. These results may prove useful to regulators and standard setters as they consider disclosure requirements in other contexts. This paper was accepted by Brian Bushee, accounting.

Beating the market? A mathematical puzzle for market efficiency

The efficient market hypothesis is highly discussed in economic literature. In its strongest form, it states that there are no price trends. When weakening the non-trending assumption to arbitrary short, small, and fully unknown trends, we mathematically prove for a specific class of control-based trading strategies positive expected gains. These strategies are model free, i.e., a trader neither has to think about predictable patterns nor has to estimate market parameters such as the trend’s sign like momentum traders have to do. That means, since the trader does not have to know any trend, even trends too small to find are enough to beat the market. Adjustments for risk and comparisons with buy-and-hold strategies do not satisfactorily solve the problem. In detail, we generalize results from the literature on control-based trading strategies to market settings without specific model assumptions, but with time-varying parameters in discrete and continuous time. We give closed-form formulae for the expected gain as well as the gain’s variance and generalize control-based trading rules to a setting where older information counts less. In addition, we perform an exemplary backtesting study taking transaction costs and bid-ask spreads into account and still observe—on average—positive gains.

The Profitability of Volatility Trading on Exchange-traded Dollar-rupee Options: Evidence of a Volatility Risk Premium?

This article examines the profitability of short volatility strategies in the exchange-traded USDINR options market. Returns from delta-hedged short positions in straddles, strangles and individual call and put options are examined across different trading horizons and volatility regimes. The study finds that short volatility strategies yield significant mean and median returns regardless of the trading horizon and option moneyness before considering transaction costs. This is suggestive of a volatility risk premium priced in USDINR options. However, the returns are found to be insignificant and even negative after accounting for trading costs such as bid-ask spreads and brokerage. The study concludes that although USDINR options appear to be overpriced because of the volatility risk premium, short option strategies can be profitably exploited only by market makers and institutional investors facing low spreads and funding costs. The findings are suggestive of an informationally efficient market.

The Interdependence of FX and Treasury Bonds Markets: The Case of Colombia

We study the interdependence of FX and Treasury Bonds (TES) markets in Colombia. To do this, we estimate a heteroskedasticity identified VAR model on the returns of the COP/USD exchange rate (TRM) and bond prices, as well as event-analysis models for return volatilities, number of quotes, quote volume, and bid/ask spreads. The data under analysis consists of 5-minute intraday bid/ask US dollar prices and bond quotes, for an assortment of bond species. For these species we also have the number of bid/ask quotes as well as their volume. We found, also, that the exchange rate conveys information to the TES market, but the opposite does not completely hold: A one percent COP depreciation leads to a persistent reduction of TES prices between 0.05% and 0.22%. However, a 1% TES price increase has a very small effect and not entirely significant on the exchange rate, i.e. a COP appreciation between 0.001% and 0.009%. Furthermore, TRM return volatility increases do not affect bond return volatility but its liquidity, i.e. the bid/ask quote number and volume. These results are coherent with the fact that the FX market more efficiently reflects the effect of shocks than the TES market, which may be due to its low liquidity and concentration on a specific habitat. These results have implications for the design of financial stability policies as well as for private portfolio design, rebalancing and hedging.

Funding Liquidity and Market Liquidity: The Broker-Dealer Perspective

We provide direct evidence of how dealers’ funding liquidity affects their liquidity provision in securities markets. Worse funding liquidity (higher repo haircuts and rates) leads to larger bid-ask spreads and transaction costs in corporate bonds. We also find that dealers’ relationships with money funds are important determinants of their repo haircuts and rates. Using dealers’ exposure to the 2016 Securities and Exchange Commission (SEC) money fund reform as an instrument, we show that funding liquidity indeed has a causal effect on market liquidity. Finally, dealers with lower funding liquidity tend to have smaller market shares and execute more trades on an agency basis. This paper was accepted by Haoxiang Zhu, finance.

Unallocated Metal Accounts in Russia: Determinants of Quoted Bid-Ask Spreads

Due to economic instability there has been an increase in demand for unallocated metal accounts offered by Russian commercial banks since April 2020. Although opening unallocated metal accounts gives banks an opportunity to expand the range of their products, diversify income, attract new clients and retain old ones, most Russian banks do not provide such services. For those, it is important to understand the determinants of bid-ask spreads (the difference between the quoted metal bid and ask prices), since the demand for unallocated metal accounts and the bank’s income from this service depend on the bid-ask spread. The purpose of this paper is to investigate the main determinants of quoted bid-ask spreads on unallocated metal accounts in commercial banks. Multiple regression models are applied for the period from October 2017 to May 2020. There are very few articles on the determinants of quoted bid-ask spreads on unallocated metal accounts; for this reason the paper is based on the results of studies of bid-ask spreads in other markets. Based on recent theoretical results, which indicate that bid-ask spreads depend on price volatility, we confirm this hypothesis on unallocated metal accounts. Moreover, we reveal that banks’ assets and the share of state participation influence bid-ask spreads on unallocated metal accounts in commercial banks. It is also proven that bid-ask spreads for unallocated metal accounts in gold are, on average, lower than those for palladium, platinum and silver.