Market Frictions Research Articles

Testing the waters meetings, retail trading, and capital market frictions

AbstractPre-IPO firms may “test the waters” by meeting privately with investors in order to allow access to management and more time to make an investment decision. However, these meetings have the potential to undermine the SEC’s objectives of protecting investors and supporting market efficiency by allowing institutional investors, but not retail investors, private access to management. We find lower retail trading after IPOs of firms that held testing-the-waters meetings, consistent with the meetings reducing retail investor participation. Moreover, retail investors that still participate in the market in the presence of testing-the-waters meetings have inferior investment outcomes. Nonetheless, we find no evidence of lower overall market liquidity or slower price discovery following testing-the-waters meetings. In fact, we observe a reduction in stock return volatility. Overall our evidence suggests that, while testing-the-waters meetings may harm retail investors, there does not appear to be a negative impact on overall market function.

Comparative Valuation Dynamics in Production Economies: Long-Run Uncertainty, Heterogeneity, and Market Frictions

We compare and contrast production economies exposed to long-run uncertainty with investors that have possibly different preferences and/or access to financial markets. We study the macroeconomic and asset-pricing properties of these models, identify common features, and highlight areas where these models depart from each other. Our framework allows us to investigate more fully the impact of investor heterogeneity, capital heterogeneity, and fluctuations of the growth components to the capital evolution as they affect the dynamics of macroeconomic quantities and asset prices. In our comparisons, we employ an array of diagnostic tools to explore time variation and state dependencies in nonlinear environments.

Merchants of Death: The Effect of Credit Supply Shocks on Hospital Outcomes

This study examines the link between credit supply and hospital health outcomes. We use bank stress tests as exogenous shocks to credit access for hospitals that have lending relationships with tested banks. We find that affected hospitals shift their operations to increase resource utilization following a negative credit shock but reduce the quality of their care to patients across a variety of measures, including a significant increase in risk-adjusted readmission and mortality rates. The results indicate that access to credit can affect the quality of health care hospitals deliver, pointing to important spillover effects of credit market frictions on health outcomes. (JEL G21, G32, I11, I18)

Occupational reallocation within and across firms: Implications for labor market polarization

This study analyzes how labor market frictions interact with firms’ decisions to reallocate workers across different occupations during labor market polarization. We compare the patterns of occupational reallocation within and across firms in the US and Germany in recent years. We find within-firm reallocation contributes significantly to the decline in employment in routine occupations in Germany, but much less so in the US. We construct a general equilibrium model of firm dynamics and find the model with different firing taxes can replicate the difference in firm-level adjustment patterns across these countries. We conduct two counterfactual experiments for each country, highlighting the different roles played by the within-firm cost of reorganizing the occupational mix and across-firm frictions created by firing taxes. The results suggest the latter plays a more significant role in labor market polarization. Higher firing costs would lead to greater and faster polarization in the US.

Does money buy innovation? The effect of the “Innovative City” pilot on firm innovation in China

This study investigates the “Innovative City” pilot in China and its impact on fostering firm innovation by alleviating financial constraints. Employing difference-in-differences-in-differences approach, we provide strong evidence that the policy significantly boosted firm innovation capabilities, measured by increased patenting. A key mechanism is the program's expansion of bank credit access for firms, particularly benefiting financially constrained firms. Furthermore, the positive impact is amplified in regions with more developed banking sectors and for firms with pre-existing bank relationships, highlighting the role of market frictions. These findings highlight the pivotal role of a competitive and transparent credit market.

Firms heterogeneity and intraindustry reallocation: Beyond dichotomous partitioning

AbstractThis paper studies the trade‐induced reallocation of resources beyond the conventional partition in trade models. It challenges the typical partition of firms into domestic‐only and trading entities. The paper demonstrates that reallocation across heterogeneous firms can occur without such dichotomous partitioning. For reallocation to happen, firms must have different exposure to international markets. The paper uses offshoring models with labor market frictions to illustrate this principle. The offshoring model reveals that labor market frictions induce variations in wage and offshoring intensity. These variations then lead to differential impacts from offshoring cost shifts, resulting in reallocation across heterogeneous firms without partition.

Credit Market Frictions and the Linkage Between Dispersion and Macro Uncertainty

Cross-sectional dispersion and macro uncertainty (volatility of aggregate economic variables) are conceptually distinct. However, empirically, they both comove and are countercyclical. This paper builds a general equilibrium model and demonstrates that credit market frictions allow cross-sectional dispersion to drive time-varying macro uncertainty endogenously. In the model, as firm-level productivity becomes more dispersed, more firms are pushed to the left tail of the productivity distribution, resulting in more defaults and a depletion in aggregate net worth. This mechanism generates countercyclical leverage and aggregate volatility. The model implies that the government can inject equity in economic downturns to stabilize aggregate volatility. This paper was accepted by Lukas Schmid, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.00166 .

The impact of employee satisfaction on company's labour investment efficiency

This study examines the impact of employee satisfaction on company's labour investment efficiency (CLIE) using a sample of 2,333 company-year observations associated with 302 companies listed in the UK between 2008 and 2020. Arguments based on human relations theory suggest that satisfied employees are likely to be motived to exert greater efforts and exhibit lower turnover, thereby reducing employer's exposure to labour market frictions. In contrast, agency theory argues that satisfied employees may become entrenched and thus harm organisational outcomes, including CLIE. We measure satisfaction with employers across our sample companies using 164,341 employees' ratings posted on Glassdoor UK. We observe a positive impact of employee satisfaction on CLIE, demonstrating the validity of underlying human relations theory for the present business context characterised by labour shortages. We also find the positive impact of employee satisfaction on CLIE to be stronger for companies with higher labour intensity, more reliance on skilled labour, and more competitive industry environments. Our study contributes to research investigating the determinants of efficient investment in workforce. We also demonstrate the informational value of employee' online reviews for understanding a company's performance, particularly in assessing the efficiency of its employment decisions.

Furloughing Employees with Uncertain Return? Management of Labor Frictions and Inventory Under Demand Shock

We assess how a retailer can manage inventories and labor under an extreme condition such as a temporary negative demand shock due to a pandemic or an economic turmoil. This analysis incorporates labor market frictions whereby firms incur deadweight costs associated with hiring and firing employees, as well as the option to furlough labor. We examine the impact of these frictions on a retail firm's optimal operating policies around inventory level, furlough, and layoffs. We find that labor market frictions condition the inventory and the level of employment in two ways. First, they lead to underinvestment in inventories, which limits recovery and employment in the postshock period. Second, high labor market frictions motivate the firm to conservatively downsize workforce during the negative demand period leading to higher employment, when compared to downsizing without friction. A significant contribution of our study lies in delineating the optimal furlough decisions and quantifying the impact of the furlough option on inventory and labor decisions. We demonstrate the conditions under which it is optimal for the retailer to either (i) fully downsize labor and leverage the furlough option in the labor market, or (ii) maintain excess labor while also opting to furlough a portion of the workforce. During an extreme event such as a temporary negative demand shock, our results highlight the need for a coordinated effort when implementing governmental subsidy policies on alleviating labor and inventory reductions by accounting for labor market frictions and furlough support.

Price spillovers and interdependences in China's agricultural commodity futures market: Evidence from the US-China trade dispute

We examine the effects of the US-China trade dispute on price spillovers and interdependencies among the ten most liquid agricultural futures contracts traded on China's commodity exchanges by employing the time-varying connectedness framework modified by Antonakakis, Chatziantoniou, and Gabauer (2020). We find that the overall market frictions increase modestly due to the clustering of mixed informational disturbances caused by the trade dispute. This lowers the gross spillovers in the entire asset system by reducing the efficiency of general price signal transmission. Notably, subsidiary products of rapeseed and soybean contribute the most to the total and net directional spillovers in the whole market, acting as shock transmitters before the trade dispute. The RBD palm market gains a dominant role as a shock transmitter during the trade dispute and its role strengthens further after the trade agreement was reached. Additionally, the average intensity of pairwise spillovers declines considerably during the trade dispute, suggesting weakening asset interconnectedness. The responsiveness of shock transmission channels to the trade dispute impacts is found to vary across industrial chains and the presence of delayed economic effects is detected in the structural changes of market interdependences.

Wage employment, unemployment and self-employment across countries

Poor countries have low wage employment and high self-employment. This paper shows that they also have high unemployment relative to wage employment, and that self-employment increases with this ratio. To understand the sources of these patterns, I build a search and matching model with choice between job search and self-employment and with learning about matches, and calibrate it to match all transition rates between wage employment, unemployment and self-employment as well as separation hazards by job duration, separately for all 37 countries with available data. Quantitative analysis of the model shows that labor market frictions affect self-employment as much as unemployment. Labor market frictions also reduce aggregate output, not only by raising unemployment, but also by worsening the average quality of both wage employment matches and active self-employment projects.

Monetary Policy and Unemployment in Morocco: A DSGE Model Approach with Labor Market Frictions and Nash Wage Bargaining

Monetary Policy and Unemployment in Morocco: A DSGE Model Approach with Labor Market Frictions and Nash Wage Bargaining

Unraveling the impact of patent transfers on regional innovation: Empirical insights through the lens of entity relationships

Over the past two decades, the market for patent transfers (PT) has experienced substantial growth in China, driven by the expansion of main relationship types, including inter-firm, industry-university-research (IUR), and individual-to-firm PTs. This growth raises critical questions regarding the influence of these diverse PT types on regional innovation. Utilizing data mining on 1,914,750 PT events, this study constructs panel data models for China's 31 provinces from 2011 to 2020, investigating the presence, dimensions, effect decomposition, and threshold determinations of PTs on regional innovation. Findings reveal heterogeneous impacts of PT types on innovation, with individual-to-firm PT being most effective and IUR PTs the least. Among the dimensions of impact, PT strength demonstrates the most circumscribed promotional effect, predominantly within patent inflows, and particularly hinders IUR PTs due to market frictions. The importance of PT breadth mainly appears in patent outflows, suggesting geographic expansion of PT enhances innovation remuneration, critical for sustaining innovation momentum in hub provinces. PT depth uniformly affects innovation across all PT categories irrespective of patent inflows or outflows, underscoring the significance of diversified technology transfers. A universal observation across PT types is that surpassing regional thresholds of digitalization significantly amplifies the promotion of PT on regional innovation.

Research on the Pricing Model of Financial Derivatives

Based on the importance of the pricing model of financial derivatives, this paper points out the defects and risks of the current model and proposes some possible solutions. The research method is mainly to summarize the framework of the existing model by searching the academic literature and commercial examples related to the pricing model. The final conclusion is that an obvious flaw of the pricing model is that it is based on an idealized market state and cannot predict hidden market trends, but through random volatility, consideration of market friction, and the development of mathematical technology, the market can refine the pricing model. Research and forecast risk premium, market liquidity and asset price changes in advance when considering pricing. In addition, the market is also supported to consider the application of large machines in the portfolio as well as the issue of options panels, so as to deepen the understanding of the movement of financial products.

Fiscal financing with labour markets frictions

AbstractIn this paper, we study the effect of search and matching frictions, i.e., equilibrium unemployment, on fiscal financing decisions in the United States. We build a Real Business Cycle model with labour market frictions and a rich set of fiscal tools and estimate the model using Bayesian methods on US data for various fiscal rule specifications. Most importantly, we find that the model with unemployment, output and debt in the fiscal rules fits the data best. Under the fiscal rule that best fits the data, the reaction of fiscal instruments to output and debt are significantly quantitatively different than a rule that ignores unemployment. Fiscal instruments react stronger to cyclical factors except transfers. These changes also affect model dynamics in response to fundamental non‐fiscal shocks.

The impact of judicial prejudice in bankruptcy on creditors and local financial development

In this research, we explore the implication of judicial prejudice in bankruptcy for creditor interests and local financial market development. Based on prefecture-level data, we find compelling evidence that judicial prejudice leads to capital market frictions. Regions with stronger judicial prejudice have higher borrowing costs. Moreover, judicial prejudice is negatively related to local financial market development. In sum, our research sheds light on the impact of judicial prejudice on financial market development.

Population aging, pensions, informality and labor market frictions in Lebanon. Reforms and policy choices

We evaluate the effects of population aging on the macroeconomic evolution of the Lebanese economy and the financial sustainability of its major pension schemes. We use an OLG model with labor market frictions as in de la Croix et al. (2013). Individuals are differentiated by their origin, age, gender, and education and choose the sector of activity, which implies that the size of the informal sector is endogenous. We assess the long-run implications of population aging and show that the public sector pension scheme is unsustainable. In contrast, the private sector scheme is insufficient to ensure decent living standards for the elderly. Finally, we evaluate the effects of two pension reforms. We first propose a mix of measures that guarantee the sustainability of the public sector scheme. Then, we evaluate the impact of the pension reform introduced in December 2023 and of an alternative reform aiming at increasing the size of the private sector scheme to improve the living standards for the elderly.

Offshoring, firm-level adjustment and labor market outcomes

This paper studies how the China shock affects unemployment rates and wage inequality across high-skilled and low-skilled workers in the United States, with particular emphasis on the dynamic and general equilibrium channels of firms' production locations and entry decisions. To shed light on the subject, I build a two-country trade-in-task model with firm heterogeneity, search-and-matching labor market frictions, and firms' endogenous selections into entry and offshoring. The model, consistent with evidence from vector autoregression analyses, uncovers important dynamics with implications for the impact of the China shock on U.S. worker inequality. Namely, it shows association between a decrease in offshoring costs and a short-lived increase in low-skilled unemployment in the source country, a longer-term decline in high-skilled unemployment, a transient expansion of the wage gap between high- and low-skilled workers, and an increase in firm entry.

Portfolio management under capital market frictions: a grey clustering approach

International portfolio management is influenced by the existence of “frictions”, factors or events that interfere with trade, which are linked in financial literature to market-specific factors, such as available information, restrictions, investor protection, or market liquidity. Given the wide variety of factors that can be included in these categories, scientific studies typically focus on a reduced number of indicators at a time in order to offer an in depth analysis of their impact. We offer a consolidated view of the perspectives observed in financial literature by proposing a novel index for market frictions that includes all these four components and rank fifteen post-communist East European capital markets based on their index values. We then constructed various scenarios by assuming different levels of importance for the criteria used in index construction. By employing grey clustering analysis, we cluster these capital markets into three categories—strongly recommended, recommended with some reserve, and not recommended—based on the importance given by the decision maker to these factors. The results show that some of the studied markets are in the same cluster, irrespective of the chosen scenario. The only market always included in the “strongly recommended” category is Hungary, indicating that it is a good investment option for international participants. Bulgaria and Slovakia are always regarded as “recommended with reserve” markets, whereas the Republic of Moldova is part of the “not recommended” category. The other markets show a degree of variability that can be explained by different investor perspectives. This study contributes to the existing literature by combining the advantages of grey clustering and portfolio analysis. Investors can use this approach during the decision-making process related to their investments.

Measuring Portfolio Gains: The Case of Earnings Announcement Trading Signals

ABSTRACT This study offers solutions to help address practical issues researchers generally overlook when assessing gains from a trading signal. Specifically, the methodologies used in previous research generally ignore investor risk aversion when forming portfolios, do not update portfolios as signals arrive, exploit look-ahead biases, do not assess the incremental gains of a new signal, and do not consider market frictions. We examine trading signals based on post-earnings announcement drift (PEAD), the earnings announcement premium (EAP), and earnings announcement rescheduling (RES). Using our proposed approach, we find that portfolios that incorporate the individual signals produce higher Sharpe ratios than equal-weighted portfolios; however, the gains for each signal are concentrated to a few days around the announcement. The EAP and RES signals do not provide incremental portfolio gains over the PEAD signal. After considering market frictions, portfolio performance rapidly attenuates and becomes similar to the SPY ETF as the portfolio size increases. JEL Classifications: G12; G14; G17.