Finance: Research, Policy and Anecdotes

While in lock-down, I have been able to finally read papers that I have meant to read for a long time as well as papers that I was supposed to discuss at conferences that have now been cancelled.  Here are some of them:

Davidson Heath, Matthew Ringgenberg, Merhdad Samadi, and Ingrid Werner recent paper “Reusing Natural Experiments” might turn into quite an influential paper as they shed doubts on our profession’s habit of reusing natural experiments as identification strategy in several studies. The identification challenge in economics and finance can be addressed in different ways, one of them being natural experiments, where a certain policy is introduced for some firms, states, households but not others, or is introduced at different points in time, again in a manner that is quasi-random.  Given that the universe of such natural experiments is limited, they are being reused. However, as the authors show, this leads to false positives.  As the ultimate null hypothesis being tested in these different paper is the same (what was the effect of the experiment?), the different tests are not independent of each other.  The good news is that there is a solution, developed by Romano and Wolf (2005), in the form of using adjusted t-statistics to control for the “family-wise error rate”.  While the authors focus on two specific natural experiments in finance (enactment of state business laws and regulation SHO), this is obviously a much broader concern. One of the natural experiments that I have used in a paper with Ross Levine and Alex Levkov is the branch deregulation episode in the US, widely used in many previous papers. While I am reasonably confident in the robustness of our findings (among other reasons due to the use of different datasets than previous papers in the literature), it certainly makes me think.  Maybe an idea for a PhD student to explore this or other policy-related natural experiments and gauge their robustness.  There is also an interesting parallel to the legal origin literature (started by La Porta et al.), which has shown that there are differences between Civil and Common Code countries along a variety of policy areas (media freedom, labour laws, creditor and minority shareholder rights, business registration etc.). Given that legal origin is related to so many policy areas, it cannot really be used as instrument for any of these.  More generally, it is now widely recognised in the institution-growth literature that it is hard to identify the causal impact of a specific policy on real sector outcomes if you use a natural experiment as instrument, given that a given natural experiment has impact on many policy outcomes.

This paper, however, also sheds light on a broader concern in the finance and economics profession: once a natural experiment has been “discovered” in the profession, there is an army of research economists and PhD students applying this experiment in different settings. While our profession has “learned” to cluster standard errors and saturate regression models with fixed effects, which often makes some significant effects turn insignificant, this paper certainly challenges us in new ways on the robustness of empirical studies.

Edoardo Acabbi, Ettore Panetti and Alessandro Sforza have an interesting paper on “The Financial Channels of Labor Rigidities: Evidence from Portugal”, an interesting addition to the emerging labour and finance literature.  Using the Lehman Brothers shock resulting in an interbank market freeze in late 2008, they find that the credit shock explains about a third of the employment losses among large Portuguese firms between 2008 and 2013, an effect that is larger for more labour intensive firms, but independent of their productivity level (so no cleansing effect of the crisis). They explain this effect with liquidity constraints emerging from lower credit supply and their inability to easily adjust wage costs due to labour market rigidities.   A nice paper using micro-level data on credit, corporates and employees.

April Knill, Baixiao Liu and John McConnell have and interesting paper on the influence of media on real sector decisions. In their paper Media Partisanship and Fundamental Corporate Decisions, they show that  during the presidency of George W. Bush, firms led by Republican-leaning managers headquartered in regions into which Fox was introduced shift upward their total investment expenditures, R&D expenditures, and leverage. Comparing managers who donate more to Republicans than Democrats in areas with Fox News to Republican-leaning in areas with no Fox News, there is a significant differences in these corporate outcomes, while there is no such differences for non-Republican-leaning managers.

Finally, CEPR has launched a new online peer-reviewed review to disseminate emerging scholarly work on the Covid-19 epidemic – Covid Economics, with papers that are not peer-reviewed but evaluated by a large editorial board. In the first issue, there are interesting papers on the historical evidence on the effects of pandemics on return on assets, who can and who cannot work at home across different geographies and stock market reactions to COVID-19 news.

Overview