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Finance

Finance

    • May 2014
    • Article

    Dynamics of Demand for Index Insurance: Evidence from a Long-Run Field Experiment

    By: Shawn A. Cole, Daniel Stein and Jeremy Tobacman

    This paper estimates how experimentally-manipulated experiences with a novel financial product, rainfall index insurance, affect subsequent insurance demand. Using a seven-year panel, we develop three main findings. First, recent experience matters for demand, consistent with overinference from small samples. Second, spillovers also matter, in the sense that the recent payout experience of village co-residents affects insurance demand about as much as one's own recent payout experience. Third, the spillover effect decays as time passes while the effect of one's own experience does not. We discuss implications of this analysis for commercial sustainability of this complicated but promising risk management technology.

    • May 2014
    • Article

    Dynamics of Demand for Index Insurance: Evidence from a Long-Run Field Experiment

    By: Shawn A. Cole, Daniel Stein and Jeremy Tobacman

    This paper estimates how experimentally-manipulated experiences with a novel financial product, rainfall index insurance, affect subsequent insurance demand. Using a seven-year panel, we develop three main findings. First, recent experience matters for demand, consistent with overinference from small samples. Second, spillovers also matter, in the...

    • 2014
    • Article

    Expectations of Returns and Expected Returns

    By: Robin Greenwood and Andrei Shleifer

    We analyze time-series of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated with model-based expected returns. The evidence is not consistent with rational expectations representative investor models of returns.

    • 2014
    • Article

    Expectations of Returns and Expected Returns

    By: Robin Greenwood and Andrei Shleifer

    We analyze time-series of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated...

    • August 2014
    • Article

    Mortgage Convexity

    By: Samuel G. Hanson

    Most home mortgages in the United States are fixed-rate loans with an embedded prepayment option. When long-term rates decline, the effective duration of mortgage-backed securities (MBS) falls due to heightened refinancing expectations. I show that these changes in MBS duration function as large-scale shocks to the quantity of interest rate risk that must be borne by professional bond investors. I develop a simple model in which the risk tolerance of bond investors is limited in the short run, so these fluctuations in MBS duration generate significant variation in bond risk premia. Specifically, bond risk premia are high when aggregate MBS duration is high. The model offers an explanation for why long-term rates could appear to be excessively sensitive to movements in short rates and explains how changes in MBS duration act as a positive-feedback mechanism that amplifies interest rate volatility. I find strong support for these predictions in the time series of US government bond returns.

    • August 2014
    • Article

    Mortgage Convexity

    By: Samuel G. Hanson

    Most home mortgages in the United States are fixed-rate loans with an embedded prepayment option. When long-term rates decline, the effective duration of mortgage-backed securities (MBS) falls due to heightened refinancing expectations. I show that these changes in MBS duration function as large-scale shocks to the quantity of interest rate risk...

    • 2014
    • Working Paper

    Financial Repression in the European Sovereign Debt Crisis

    By: Bo Becker and Victoria Ivashina

    By the end of 2013, the share of government debt held by the domestic banking sectors of Eurozone countries was more than twice its 2007 level. We show that this type of increasing reliance on the domestic banking sector for absorbing government bonds generates a crowding out of corporate lending. For a given domestic firm, new debt is less likely to be a loan—i.e., the loan supply contracts—when local banks have purchased more domestic sovereign debt and when that debt is risky (as measured by CDS spreads). These effects are most pronounced in the period following the second Greek bailout in early 2010.

    • 2014
    • Working Paper

    Financial Repression in the European Sovereign Debt Crisis

    By: Bo Becker and Victoria Ivashina

    By the end of 2013, the share of government debt held by the domestic banking sectors of Eurozone countries was more than twice its 2007 level. We show that this type of increasing reliance on the domestic banking sector for absorbing government bonds generates a crowding out of corporate lending. For a given domestic firm, new debt is less likely...

Faculty Unit

The Finance Unit produces research addressing issues of present and future importance to managers, regulators, and policy-makers.
Finance Unit

Our intellectual roots are based in a long line of scholars from Robert Merton whose collaborative work on risk management and option pricing won him the Nobel Prize in Economics in 1997, to John Lintner who co-created the Capital Asset Pricing Model and made significant contributions to dividend policy, and Gordon Donaldson whose work helped shape the field of corporate finance. We strive to understand how managers and firms make value-enhancing decisions; and how financial institutions, markets, and instruments contribute to this process. Our approach to research is distinguished by its unique combination of theory, empirical analysis, mathematical modeling, and field observations at companies.

Faculty Unit

The Finance Unit produces research addressing issues of present and future importance to managers, regulators, and policy-makers.

Finance Unit

Recent Publications

On the Direct and Indirect Real Effects of Credit Supply Shocks

By: Laura Alfaro, Manuel García-Santana and Enrique Moral-Benito
  • March 2021 |
  • Article |
  • Journal of Financial Economics
We explore the real effects of bank-lending shocks and how they permeate the economy through buyer-supplier linkages. We combine administrative data on all Spanish firms with a matched bank-firm-loan dataset of all corporate loans from 2003 to 2013 to estimate firm-specific credit supply shocks for each year. We compute firm-specific measures of exposure to bank lending shocks of customers (upstream propagation) and suppliers (downstream propagation). Our findings suggest that credit supply shocks have sizable direct and downstream propagation effects on employment, investment, and output, especially during the 2008-2009 crisis, but no significant impact on employment during the expansion. We provide evidence that both trade credit extended by suppliers and price adjustments in general equilibrium explain downstream propagation of credit shocks.
Keywords: Credit Supply Shocks; Bank Lending Channel; Input-output Linkages; Output; Mechanisms; Trade Credits; Price Effects; Economics; Credit; System Shocks; Employment; Investment; Spain
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Alfaro, Laura, Manuel García-Santana, and Enrique Moral-Benito. "On the Direct and Indirect Real Effects of Credit Supply Shocks." Journal of Financial Economics 139, no. 3 (March 2021): 895–921.

How Venture Capitalists Make Decisions

By: Paul A. Gompers, Will Gornall, Steven Kaplan and Ilya Strebulaev
  • March–April 2021 |
  • Article |
  • Harvard Business Review
For decades now, venture capitalists have played a crucial role in the economy by financing high-growth start-ups. While the companies they’ve backed—Amazon, Apple, Facebook, Google, and more—are constantly in the headlines, very little is known about what VCs actually do and how they create value. To pull the curtain back, Paul Gompers of Harvard Business School, Will Gornall of the Sauder School of Business, Steven N. Kaplan of the Chicago Booth School of Business, and Ilya A. Strebulaev of Stanford Business School conducted what is perhaps the most comprehensive survey of VC firms to date. In this article, they share their findings, offering details on how VCs hunt for deals, assess and winnow down opportunities, add value to portfolio companies, structure agreements with founders, and operate their own firms. These insights into VC practices can be helpful to entrepreneurs trying to raise capital, corporate investment arms that want to emulate VCs’ success, and policy makers who seek to build entrepreneurial ecosystems in their communities.
Keywords: Venture Capital; Investment; Decision Making
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Gompers, Paul A., Will Gornall, Steven Kaplan, and Ilya Strebulaev. "How Venture Capitalists Make Decisions." Harvard Business Review 99, no. 2 (March–April 2021).

Tariff Passthrough at the Border and at the Store: Evidence from U.S. Trade Policy

By: Alberto Cavallo, Gita Gopinath, Brent Neiman and Jenny Tang
  • March, 2021 |
  • Article |
  • American Economic Review: Insights
We use micro data collected at the border and the store to characterize the price impact of recent US trade policy on importers, exporters, and consumers. At the border, import tariff passthrough is much higher than exchange rate passthrough. Chinese exporters did not lower their dollar prices by much, despite the recent appreciation of the dollar. By contrast, US exporters significantly lowered prices affected by foreign retaliatory tariffs. In US stores, the price impact is more limited, suggesting that retail margins have fallen. Our results imply that, so far, the tariffs' incidence has fallen in large part on US firms.
Keywords: Trade Policy; Tariffs; Exchange Rate Passthrough; Economics; Trade; Policy; Currency Exchange Rate; Price; United States
Citation
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Cavallo, Alberto, Gita Gopinath, Brent Neiman, and Jenny Tang. "Tariff Passthrough at the Border and at the Store: Evidence from U.S. Trade Policy." American Economic Review: Insights 3, no. 1 (March 2021).

Targeted Price Controls on Supermarket Products

By: Alberto Cavallo and Diego Aparicio
  • March 2021 |
  • Article |
  • Review of Economics and Statistics
We study the impact of targeted price controls for supermarket products in Argentina from 2007 to 2015. Using web scraping, we collected daily prices for controlled and non-controlled goods and measured the differential effects on inflation, product availability, and price dispersion. We first show that, although price controls are imposed on goods with significant CPI weight, they have a temporary effect on aggregate inflation and no downward effect on other goods. Second, contrary to common beliefs, we find that controlled goods are consistently available for sale. Third, firms compensate for price controls by introducing new product varieties at higher prices. This behavior, which increases price dispersion within narrow categories, is consistent with a standard vertical differentiation model in the presence of price controls.
Keywords: Prices; Controls; Price Dispersion; Economics; Price; Cost Management; Goods And Commodities; Retail Industry; Argentina
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Cavallo, Alberto, and Diego Aparicio. "Targeted Price Controls on Supermarket Products." Review of Economics and Statistics 103, no. 1 (March 2021): 60–71.

Barbarians at the Gate or Turnaround Gurus? Private Equity and the Rise of the LBO

By: Tom Nicholas and John Masko
  • February 2021 |
  • Case |
  • Faculty Research
During the 1980s, leveraged buyouts (LBOs) and the private equity (PE) firms responsible for carrying them out revolutionized both investment and management in the U.S. Between 1980 and 1989, buyout activity in the U.S. surged from $1 billion per year to $60 billion. There was widespread agreement that the PE industry created enormous value, but who exactly was it creating that value for? PE firms claimed that LBOs not only benefitted investors, but also the target companies, which became leaner and more focused as PE firms turned them around. But critics argued that on balance, the PE industry left target companies foundering under mountains of debt as investors realized huge returns. In this case study, students will grapple with PE’s complex legacy while learning its history. The case will trace PE’s two main ingredients (the limited partnership and the LBO), examine the auspicious conditions of the 1980s that brought them together, and discuss the experiences of two very different early players in the PE field—KKR and Bain Capital.
Keywords: Leveraged Buyouts; Mergers And Acquisitions; Business Conglomerates; Restructuring; Borrowing And Debt; Private Equity; Bonds; Investment Return; Institutional Investing; Profit Sharing; Business History; Management Style; Private Ownership; Performance Effectiveness; Value Creation; Financial Services Industry; United States
Citation
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Nicholas, Tom, and John Masko. "Barbarians at the Gate or Turnaround Gurus? Private Equity and the Rise of the LBO." Harvard Business School Case 821-016, February 2021.

Lidya: Bringing Nigerian FinTech Innovation to Global Small and Medium Enterprises

By: Lauren Cohen and Spencer C.N. Hagist
  • February 2021 |
  • Case |
  • Faculty Research
Lidya CEO Tunde Kehinde must size up options for the expansion of his novel lending practices that drastically reduce the credit cycle in his developing Nigeria, and determine if expansion into Eastern Europe will prove successful or disasterous.
Keywords: Economics; Entrepreneurship; Finance; Strategy; Nigeria
Citation
Educators
Related
Cohen, Lauren, and Spencer C.N. Hagist. "Lidya: Bringing Nigerian FinTech Innovation to Global Small and Medium Enterprises." Harvard Business School Case 221-083, February 2021.

China Rapid Finance: The Collapse of China’s P2P Lending Industry

By: William C. Kirby, Bonnie Yining Cao and John P. McHugh
  • February 2021 |
  • Case |
  • Faculty Research
Keywords: Financial Services; P2p Lending; Government And Business; Regulation; Finance; Governing Rules, Regulations, And Reforms; Strategy; Financial Services Industry; China
Citation
Educators
Related
Kirby, William C., Bonnie Yining Cao, and John P. McHugh. "China Rapid Finance: The Collapse of China’s P2P Lending Industry." Harvard Business School Case 321-124, February 2021.

The Chinese Debt Trap Is a Myth: The Narrative Wrongfully Portrays Both Beijing and the Developing Countries It Deals With.

By: Deborah Brautigam and Meg Rithmire
  • February 6, 2021 |
  • Editorial |
  • The Atlantic (website)
Our research shows that Chinese banks are willing to restructure the terms of existing loans and have never actually seized an asset from any country, much less the port of Hambantota. A Chinese company’s acquisition of a majority stake in the port was a cautionary tale, but it’s not the one we’ve often heard. With a new administration in Washington, the truth about the widely, perhaps willfully, misunderstood case of Hambantota Port is long overdue.
Keywords: Financing And Loans; Developing Countries And Economies; International Relations; China
Citation
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Brautigam, Deborah, and Meg Rithmire. "The Chinese Debt Trap Is a Myth: The Narrative Wrongfully Portrays Both Beijing and the Developing Countries It Deals With." The Atlantic (website) (February 6, 2021).

Bairong and the Promise of Big Data

By: Lauren Cohen, Xiaoyan Zhang and Spencer C.N. Hagist
  • February 2021 |
  • Case |
  • Faculty Research
Bairong CEO Felix Zhang, in launching his credit scoring start-up that incorporates 74,000 variables per individual, found strong initial success. However, the shifting regulatory environment, growing breadth of competitors, difficulties in retaining top talent, and uncertainty around the accumulation and protection of data that fuels the company all threaten the company's stability during its IPO. Defining exactly how his firm will make its mark, and remain indispensible amongst a massive and ever sharpening FinTech landscape, will test Zhang's abilities at the helm and make or break his corner of the industry.
Keywords: Finance; China
Citation
Educators
Related
Cohen, Lauren, Xiaoyan Zhang, and Spencer C.N. Hagist. "Bairong and the Promise of Big Data." Harvard Business School Case 221-068, February 2021.

A Dynamic Theory of Multiple Borrowing

By: Daniel Green and Ernest Liu
  • February 2021 |
  • Article |
  • Journal of Financial Economics
Multiple borrowing—a borrower obtains overlapping loans from multiple lenders—is a common phenomenon in many credit markets. We build a highly tractable, dynamic model of multiple borrowing and show that, because overlapping creditors may impose default externalities on each other, expanding financial access by introducing more lenders may severely backfire. Capital allocation is distorted away from the most productive uses. Entrepreneurs choose inefficient endeavors with low returns-to-scale. These problems are exacerbated when investments become more pledgeable or when borrowers have access to more lenders, explaining why increased access to finance does not always improve outcomes.
Keywords: Commitment; Multiple Borrowing; Common Agency; Misallocation; Microfinance; Investment; Mathematical Methods
Citation
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Green, Daniel, and Ernest Liu. "A Dynamic Theory of Multiple Borrowing." Journal of Financial Economics 139, no. 2 (February 2021): 389–404.
More Publications

Faculty

Laura Alfaro
Benjamin C. Esty
Kenneth A. Froot
Stuart C. Gilson
Paul A. Gompers
Robert S. Kaplan
W. Carl Kester
Josh Lerner
Robert C. Merton
Andre F. Perold
Richard S. Ruback
William A. Sahlman
→See All

Seminars & Conferences

Mar 05
  • 05 Mar 2021
Finance/Economics Ph.D. Lunch Seminar
Hillary Stein, Harvard Business School
Mar 12
  • 12 Mar 2021
Finance/Economics Ph.D. Lunch Seminar
David Zhang, Harvard Business School
→Seminars & Conferences

HBS Working Knowlege

    • 08 Feb 2021

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    by Marco Di Maggio, Angela Ma, and Emily Williams
    • 26 Jan 2021

    A New Way to Cut Credit Card Debt: Pay Off One Purchase at a Time

    by Kristen Senz
    • 06 Dec 2020

    'Repayment-by-Purchase' Helps Consumers to Reduce Credit Card Debt

    by Grant E. Donnelly, Cait Lamberton, Stephen Bush, Zoe Chance, and Michael I. Norton
→More Articles

Harvard Business Publishing

    • June 2014
    • Article

    The Capitalist's Dilemma

    By: Clayton M. Christensen and Derek C. M. van Bever
    • January 2021
    • Case

    Bespoken Spirits: Disrupting Distilling

    By: Benjamin C. Esty and Daniel Fisher
    • 2017
    • Book

    HBR Guide to Buying a Small Business: Think Big, Buy Small, Own Your Own Company

    By: Richard S. Ruback and Royce Yudkoff
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