Working papers

The Term Structure of Municipal Bond Yields, Local Economic Conditions, and Local Stock Returns

This study shows that the municipal yield curve is informative about local economic outcomes. Controlling for Treasury yields, a flatter municipal yield curve not only predicts deteriorating local economic conditions, such as higher unemployment rates and more macroeconomic uncertainty, but also signals greater risk for locally headquartered firms. An investment strategy that exploits this fact by buying (selling) firms located in states where municipal yield curve is relatively flat (steep) earns an excess return that exceeds 5% per annum. These novel empirical results indicate that the municipal debt market provides valuable information about the trajectories and risks of local economies.

  The Kuldeep Shastri Outstanding Doctoral Student Paper

  SWFA Best Doctoral Student Paper in Investments

The Utilization Premium

  With Gill Segal

Firms that underutilize their capital are riskier. An investment strategy that longs (shorts) equities with low (high) utilization rates earns 5% p.a. We reconcile this novel utilization premium quantitatively using a production model. Beyond explaining the premium, the model suggests that flexible utilization is key for matching the cross-sectional distribution of investment and stock prices jointly. A model without flexible utilization yields many counterfactuals, such as investment’s dispersion being too low, and its skewness bearing the wrong sign. Flexible utilization can address these moments by making depreciation rates fluctuate endogenously. Overall, utilization tightens the link between firms’ production and valuation.

Counterparty Risk: Implications for Network Linkages and Asset Prices

  With Yunzhi Hu and Gill Segal

This paper studies the relation between trade credit, risk, and the dynamics of production network linkages. We find that firms that extend more trade credit earn 7% p.a. lower risk premia, and maintain longer relationships with their customers. We also document that suppliers with longer-duration links to their customers command lower expected returns. We quantitatively explain these facts using a production-based model. Trade credit helps to hedge customers against liquidity risks, thereby reducing suppliers’ exposures to costs incurred in finding new customers. Overall, trade credit is informative about the lifespan of supplier-customer links, the production network’s density, and macroeconomic risk.

A New Lease on Firm Behavior

  With Matteo Binfarè, Robert Connolly, and Crocker Liu

In contrast to other types of debt, the value of operating leases on the firm’s balance sheet is set by the firm. Using new information on operating leases from ASC 842, we examine firm behavior in valuing these leases, specifically, discount rate choices. Based on benchmarks we develop, we find that 20% of firms choose higher discount rates than expected. We consider potential motives for these choices. We find that financially fragile firms systematically choose higher discount rates, apparently to appear healthier. These firms also tend to be more informationally opaque and are less-heavily monitored by outsiders.

Investment and Valuation under Supply-Chain Uncertainty

  With Gill Segal

We show empirically and theoretically that uncertainty’s impact on firms depends on its source in the supply-chain. We construct a real-option model predicting that upstream (downstream) uncertainty negatively (zero or positively) affects firms’ investment and valuations. This asymmetry arises because upstream uncertainty about input-prices from suppliers affects firms in the short-run, while downstream uncertainty about sale-prices to customers affects the longer-run, following a time-to-build period. We confirm these firm-level predictions using production-network data. At the macro-level, upstream and downstream uncertainty oppositely affect growth and investors’ marginal utility. Lastly, uncertainty associated with COVID-19 is predominantly downstream, which need not hinder recovery.

Real-time Forecasts of State and Local Government Budgets with an Application to COVID-19

  With Eric Ghysels and Nazire Özkan

Using a sample of the 48 contiguous United States, we consider the problem of forecasting state and local governments’ revenues and expenditures in real time using models that feature mixed-frequency data. We find that single-equation mixed-data sampling (MIDAS) regressions that predict low-frequency fiscal outcomes using high-frequency economic data historically outperform both traditional fiscal forecasting models and theoretically motivated multi-equation models. We also consider an application of forecasting fiscal outcomes in the face of the economic uncertainty induced by the 2019–2020 coronavirus pandemic. Overall, we show that MIDAS regressions provide a simple tool for predicting fiscal outcomes in real time.

Works in progress