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Underpricing in the Eurozone Corporate Bond Market
... The corporate bond spreads become significantly reduced in several financial market segments (Rischen & Theissen, 2018). ...
We study the timing of the European Corporate Sector Purchase Program and its direct effect on corporate financing decisions. Consistent with the goal of reducing credit premia, more timely purchases are observed for eligible bonds characterized by higher credit risk. Firms effectively targeted increase their relative use of market debt and the maturity of newly issued bonds more than eligible but not (yet) targeted issuers. The estimated effect is not driven by the verified relation between selection and credit risk. The program has fostered the ability to tap credit markets directly especially for eligible corporations whose bonds are actually purchased.
We assess the effect and the timing of the corporate arm of the ECB quantitative easing (CSPP) on corporate bond issuance. Because of several contemporaneous measures, to isolate the programme effects we rely on one key eligibility feature: the euro denomination of newly issued bonds. We find that the significant increase in bonds issuance by eligible firms is due to the CSPP and that this effect took at least six months to unfold. This result holds even when comparing firms with similar ratings, thus providing evidence that unconventional monetary policy can foster a financing diversification regardless of firms’ risk profile. We also highlight the impact of the programme on the real economic activity. The evidence suggests that while all firms increased investment in capital expenditures and intangible assets, the CSPP induced eligible firms to invest in marketable and equity securities, to repurchase their own stocks, to hold cash and to carry out short-term investment.
This paper develops and tests two propositions. We demonstrate that there is a monotone relation between the (expected) underpricing of an initial public offering and the uncertainty of investors regarding its value. We also argue that the resulting underpricing equilibrium is enforced by investment bankers, who have reputation capital at stake. An investment banker who ‘cheats’ on this underpricing equilibrium will lose either potential investors (if it doesn't underprice enough) or issuers (if it underprices too much), and thus forfeit the value of its reputation capital. Empirical evidence supports our propositions.
The underpricing of initial public offerings (IPOs) is generally explained with asymmetric information and risk. We complement
these traditional explanations with a new theory where investors worry also about the after-market illiquidity that may result
from asymmetric information after the IPO. The less liquid the aftermarket is expected to be, and the less predictable its
liquidity, the larger will be the IPO underpricing. Our model blends such liquidity concerns with adverse selection and risk
as motives for underpricing. The model’s predictions are supported by evidence for 337 British IPOs effected between 1998
and 2000. Using various measures of liquidity, we find that expected after-market liquidity and liquidity risk are important
determinants of IPO underpricing.
Recent empirical evidence has shown that internal capital markets within multinational corporations are used to reduce overall financing costs by optimizing the mix of internal and external debt of affiliates in different countries. We show that this cost saving use of internal capital markets is not limited to multinationals, but that domestic business groups actively optimize the internal/external debt mix across their subsidiaries as well. We use both subsidiary and group level financial statement data to model the bank and internal debt concentration of Belgian private business group affiliates and show that a pecking order of internal debt over bank debt at subsidiary level leads to a substantially lower bank debt concentration for group affiliates as compared to stand-alone companies. However, as the group's overall debt level mounts, groups increasingly locate bank borrowing in subsidiaries with low costs of external financing (i.e. large subsidiaries with important collateralable assets) to limit moral hazard and dissipative costs.
Focusing on downgrades as stress events that drive the selling of corporate bonds, we show that the illiquidity of stressed bonds has increased after the Volcker Rule. Dealers regulated by the rule have curtailed their market-making activities and non-Volcker-affected dealers have not offset the decreased activities of Volcker-affected dealers. Furthermore, even Volcker-affected dealers that are not constrained by Basel III and Comprehensive Capital Analysis and Review regulations change their behavior, inconsistent with the effects being driven by these other regulations. Because Volcker-affected dealers have been the main liquidity providers, bonds have become less liquid during times of stress due to the Volcker Rule.
We study trading costs and dealer behavior in U.S. corporate bond markets from 2006 to 2016. Despite a temporary spike during the financial crisis, average trade execution costs have not increased notably over time. However, dealer capital commitment, turnover, block trade frequency, and average trade size decreased during the financial crisis and thereafter. These declines are attributable to bank‐affiliated dealers, as nonbank dealers have increased their market commitment. Our evidence indicates that liquidity provision in the corporate bond markets is evolving away from the commitment of bank‐affiliated dealer capital to absorb customer imbalances, and that post‐crisis banking regulations likely contribute.
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Public covered bonds are one of the most important refinancing instruments for banks providing loans to public sector entities and have often been considered almost default-risk-free in the past. Due to the financial crisis following the collapse of Lehman Brothers and in particular due to the sovereign debt crisis, however, this notion has changed in several countries. Against this background, we provide the first study investigating factors influencing risk premiums in the international public covered bond market on a bond-individual level. We show that bond-specific and macroeconomic factors, as well as the recent economic crises and monetary policy measures by the ECB, affect risk premiums. While the two crises had an increasing effect, the first covered bond purchase program lowered risk premiums of public covered bonds. Since the cover pools consist of loans to (mostly domestic) public sector entities, we further show significant differences in the influencing factors between bonds issued in different countries.
Do regulations decrease dealer ability to intermediate trades? Using a unique dataset of dealer-bond-level transactions, we link changes in liquidity of individual U. S. corporate bonds to dealers’ transaction activity and balance sheet constraints. We show that, prior to the financial crisis, bonds traded by more levered institutions and institutions with investment bank like characteristics were more liquid but this relationship reverses after the financial crisis. In addition, institutions that face more regulations after the crisis both reduce their overall volume of trade and have less ability to intermediate customer trades.
This paper provides primary evidence of whether certification via reputable underwriters is beneficial to investors in the corporate bond market. We focus on the high-yield bond market, in which certification of issuer quality is most valuable to investors owing to low liquidity and issuing firms’ high opacity and default risk. We find bonds underwritten by the most reputable underwriters to be associated with significantly higher downgrade and default risk. Investors seem to be aware of this relation, as we further find the private information conveyed via the issuer-reputable underwriter match to have a significantly positive effect on at-issue yield spreads. Our results are consistent with the market-power hypothesis, and contradict the traditional certification hypothesis and underlying reputation mechanism.
In this paper, we document the occurrence of a large pricing anomaly, a basis, in the euro area sovereign bond market between 2008-2012. USD-denominated bonds became substantially cheaper than Euro-denominated bonds issued by the same euro zone country. We find that bond specific liquidity costs and security lending frictions do not explain the observed elevated basis. Interestingly, we find that country specific market factors help to explain cross-sectional differences in the basis. In addition, our results suggest that the European Central Bank (ECB) liquidity facilities and non-standard monetary policy measures play a key role in explaining the basis. Because only EUR-denominated bonds could be used as collateral for liquidity operations with the ECB, a monetary funding premium is embedded in these bonds yields. Moreover, this funding spread might also vary over time, depending on market participants' changing funding needs, on the one hand, and the general liquidity supply conditions partly determined by the ECB policy stance, on the other.
In this paper, we document and rationalize the premium paid by bond issuers in the corporate bond markets. Changes in the bond market over the past thirty years have shifted the new issue pricing risk from investors to banks and back to investors, with large institutional investors acting as a de facto adjunct underwriting group, and this process has required both capital commitment as well as a commitment to taking on unsystematic risk for which investors require compensation. In this paper, we use the superior data prevalent in trades under the TRACE system to compute the New-Issue Premium (NIP) as well as relating the magnitude of that premium to predetermined economic variables: The level of the corporate-bond spread; the future volatility of swap spreads; the prevailing value of unsystematic risk in the bond markets; the spread of the issuer to Treasury market at time of issuance; and the tenor of the new bond issue. We then present a model for the required NIP based on compensation for information uncertainty and the bearing of unsystematic risk. In so doing, we also address the issues of oligopolistic pricing and wealth transfer that occur at time of issuance.
This paper provides primary empirical evidence on whether certification through reputable underwriters is beneficial for bond investors in the short and long run. We examine high-yield corporate bonds for which certification is most valuable for investors due to their low liquidity and the issuing firms’ high opacity and default risk. In line with recent theory and anecdotal evidence, we document a significant positive relation between underwriter reputation (measured by market shares) and bonds’ probabilities of rating downgrades and defaults. Downgrades on bonds promoted by the most dominant underwriters are found to occur faster. Investors seem to be aware of this relation as we further report that the private information conveyed via the issuer- reputable underwriter matching significantly increases at-issue yield spreads. While supporting the underwriter market-power hypothesis, results cast further doubt on the reputation mechanism.
Ceteareths, used in a large number of cosmetics as surfactants, are the polyethylene glycol (PEG) ethers of Cetearyl Alcohol (q,v.). To supplement the limited available data on Ceteareths, previous findings from the safety assessment of Polyethylene Glycol (PEG), several fatty alcohols (Cetearyl Alcohol, Cetyl Alcohol, and Stearyl Alcohol), and Steareths were considered. These data indicate little evidence of toxicity. Although various metabolites of monoalkyl ethers of ethylene glycol are reproductive and developmental toxins, given the methods of manufacture of Ceteareth compounds, there is no likelihood of such compounds being present as impurities. Further, there would be only limited ethylene glycol monomer linked by an ether group to the Ceteareth moiety for the PEG-5 compounds, little for the PEG-10 compounds, and virtually none for the PEG-20 and higher compounds. Even if linked to ethylene glycol monomer, it was considered unlikely that the Ceteareth moieties would be metabolized (e,g., via β-oxidation) to simple methyl, ethyl, propyl, or butyl alkyl groups. As the current data indicate, such short alkyl chains are needed in order for the production of toxic alcohol or aldehyde dehydrogenase metabolites. For longer alkyl chains there is evidence of diminishing toxicity, and extrapolation to much longer chains such as expected in the Ceteareth moieties suggests that there is no reproductive or developmental hazard posed by these Ceteareth compounds. The principal clinical finding related to PEGs is based on data in bum patients— PEGs were mild irritants/sensitizers and there was evidence of nephrotoxicity. No such effects were seen in animal studies on intact skin. Cosmetic manufacturers should adjust product formulations containing Polyethylene Glycol to minimize any untoward effects when products are used on damaged skin. In the absence of specific impurities data, the possible presence of 1,4-dioxane and ethylene oxide impurities was of concern. The importance of using the necessary purification procedures to remove these impurities was stressed. Creams containing Ceteareth-20 enhanced drug absorption. Ceteareth-15 (10% in formulation) was minimally irritating to rabbits after a single dermal exposure. In ocular studies, ethoxylated Cetearyl Alcohol solution was a severe irritant to unrinsed rabbit eyes and moderately irritating to rinsed eyes. In clinical studies, Ceteareth-15 (1.5 % in formulation) produced minimal irritation when tested in both a 4- and 21-day patch test, and was not a sensitizer when tested (1.35% in formulation) in a repeat-insult patch test. Based on the limited data on Ceteareths and the extensive data on chemically related ingredients, it was concluded that these ingredients are safe as used in cosmetic formulations. These ingredients, however, should not be used on damaged skin.
This study examines dealer behavior and trading activity for a sample of 3,181 newly issued corporate bonds, focusing on underpricing at issuance and subsequent price dispersion. Unlike the equity market, the measured underpricing is the result of both an ex-ante pricing decision made by the bonds' underwriters and significant price dispersion that occurs in the after-market for trading corporate bonds. For the full sample, underpricing averages 45 basis points (BP) for investment grade and 124 BP for high yield offerings. In the aftermarket, customers purchasing a bond on the same day from the same dealer frequently pay prices differing by over $2 (per $100 face amount). However, the introduction of transparency is associated with a reduction in underpricing and aftermarket price dispersion. Whether these gains are potentially passed on to issuing companies is less clear, as non-syndicate member dealers account for a significant proportion of after-market trading activity and price dispersion. Finally, regardless of transparency regime, there is no evidence that dealers in newly issued bonds accumulate significant inventory positions, even when issues subsequently trade below the offering price.
This submission discusses implications for the quality and safety of financial markets of proposed rules implementing the market-making provisions of section 13 of the Bank Holding Company Act, commonly known as the “Volcker Rule.” The proposed rules1 have been described by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Securities and Exchange Commission. The Agencies’ proposed implementation of the Volcker Rule would reduce the quality and capacity of market making services that banks provide to U.S. investors. Investors and issuers of securities would find it more costly to borrow, raise capital, invest, hedge risks, and obtain liquidity for their existing positions. Eventually, non-bank providers of market-making services would fill some or all of the lost market making capacity, but with an unpredictable and potentially adverse impact on the safety and soundness of the financial system. These near-term and longer-run impacts should be considered carefully in the Agencies’ cost-benefit analysis of their final proposed rule. Regulatory capital and liquidity requirements for market making are a more cost effective method of treating the associated systemic risks.
We investigate how investment bankers use indications of interest from their client investors to price and allocate new issues. We model the process as an auction constructed to induce asymmetrically informed investors to reveal what they know to the underwriter. The analysis yields a number of empirical implications, including that new issues will be underpriced and that distributional priority will be given to an underwriter's regular investors. We also find that tension between an underwriter's propensity to presell an issue and an issuing firm's desire to obtain maximum proceeds affects the type of underwriting contract chosen.
Empirical evidence suggests the existence of ‘hot-issue’ markets for initial public offerings: in certain periods and in certain industries, new issues are underpriced and rationing occurs. This paper develops a model consistent with this observation, which assumes the firm itself best knows its prospects. In certain circumstances, firms with the most favorable prospects find it optimal to signal their type by underpricing their initial issue of shares, and investors know that only the best can recoup the cost of this signal from subsequent issues.
We analyze the empirical power and specification of test statistics designed to detect abnormal bond returns in corporate event studies, using monthly and daily data. We find that test statistics based on frequently used methods of calculating abnormal monthly bond returns are biased. Most methods implemented in monthly data also lack power to detect abnormal returns. We also consider unique issues arising when using the newly available daily bond data, and formulate and test methods to calculate daily abnormal bond returns. Using daily bond data significantly increases the power of the tests, relative to the monthly data. Weighting individual trades by size while eliminating noninstitutional trades from the TRACE data also increases the power of the tests to detect abnormal performance, relative to using all trades or the last price of the day. Further, value-weighted portfolio-matching approaches are better specified and more powerful than equal-weighted approaches. Finally, we examine abnormal bond returns to acquirers around mergers and acquisitions to demonstrate how the abnormal return model and use of daily versus monthly data can affect inferences. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.
This article examines underpricing of initial public offerings (IPOs) and seasoned offerings in the corporate bond market.
We investigate whether underpricing represents a solution to an information problem or a liquidity problem. We find that underpricing
occurs with both IPOs and seasoned offerings and is highest among riskier, unknown firms. Our evidence suggests that information
problems drive underpricing, with support for both the bookbuilding view of underpricing and the asymmetric information theory.
We do not find evidence in favor of the Rock model of underpricing or any evidence that illiquidity causes underpricing.
This study examines the initial-day and aftermarket price performance of corporate straight debt IPOs. The authors find that initial public offereings (IPOs) of speculative grade debt are underpriced like equity IPOs, while those rated investment grade are overpriced. IPOs of investment grade debt are typically issued by firms listed on the major exchanges and underwritten by prestigious underwriters. In contrast, junk bond IPOs are more likely to be handled by less prestigious underwriters and are typically issued by over-the-counter firms. The authors' analysis also reveals that bond rating, market listing of the firm, and investment banker quality are significant determinants of bond IPO returns. Copyright 1997 by American Finance Association.
Using a ten-year sample of IPOs undertaken on Euronext with various mechanisms, our study examines the relationship between initial returns and post-listing liquidity, and tests whether it is influenced by ownership structure and information asymmetry. According to most of our findings, post-listing liquidity is positively related to initial underpricing, but we fail to prove that this relation is formed through ownership dispersion. It is more likely attributable to the interest underpriced stocks generate. Information asymmetry is negatively linked to the level of initial underpricing, suggesting that more public information is produced on more underpriced IPOs.
I assess the role of wealth and systemic risk in explaining future asset returns. I show that the residuals of the trend relationship among asset wealth and human wealth predict both stock returns and government bond yields. Using data for a set of industrialized countries, I find that when the wealth-to-income ratio falls, investors demand a higher risk premium for stocks. As for government bond returns: (i) when they are seen as a component of asset wealth, investors react in the same manner; (ii) if, however, investors perceive the increase in government bond returns as signalling a future rise in taxes or a deterioration of public finances, then investors interpret the fall in the wealth-to-income ratio as a fall in future bond premia. Finally, I show that the occurrence of crises episodes (in particular, systemic crises) amplifies the transmission of housing market shocks to financial markets and the banking sector.
This paper examines the returns earned by subscribing to initial public offerings of equity. K. Rock (1986) suggests that initial public offerings of equity returns are required by uninformed investors as compensation for the risk of trading against superior information. The authors show that initial public offerings of equity with more informed investor capital require higher returns. The marketing underwriter's reputation reveals the expected level of "informed" activity. Prestigious underwriters are associated with lower risk offerings. With less risk there is less incentive to acquire information and fewer informed investors. Consequently, prestigious underwriters are associated with initial public offerings of equity that have lower returns. Copyright 1990 by American Finance Association.
This paper develops a signaling model with two signals, two attributes, and a continuum of signal levels and attribute-types to explain new issue underpricing. Both the fraction of the new issue retained by the issuer and its offering price convey to investors the unobservable "intrinsic" value of the firm and the variance of its cash flows. Many of the model's comparative statics results are novel, empirically testable, and consistent with the existing empirical evidence on new issues. In particular, the degree of underpricing, which can be inferred from observable variables, is positively related to the firm's postissue share price. Copyright 1989 by American Finance Association.
The authors model reputation acquisition by investment banks in the equity market. Entrepreneurs sell shares in an asymmetrically informed equity market either directly or using an investment bank. Investment banks, who interact repeatedly with the equity market, evaluate entrepreneurs' projects and report to investors in return for a fee. Setting strict evaluation standards (unobservable to investors) is costly for investment banks, inducing moral hazard. Investment banks' credibility, therefore, depends on their equity-marketing history. Investment banks' evaluation standards, their reputations, underwriter compensation, the market value of equity sold, and entrepreneurs' choice between underwritten and nonunderwritten equity issues emerge endogenously. Copyright 1994 by American Finance Association.
Recent empirical evidence has shown that internal capital markets within multinational corporations are used to reduce overall financing costs by optimizing the mix of internal and external debt of affiliates in different countries. We show that this cost saving use of internal capital markets is not limited to multinationals, but that domestic business groups actively optimize the internal/external debt mix across their subsidiaries as well. We use both subsidiary and group level financial statement data to model the bank and internal debt concentration of Belgian private business group affiliates and show that a pecking order of internal debt over bank debt at subsidiary level leads to a substantially lower bank debt concentration for group affiliates as compared to stand-alone companies. However, as the group's overall debt level mounts, groups increasingly locate bank borrowing in subsidiaries with low costs of external financing (i.e. large subsidiaries with important collateralable assets) to limit moral hazard and dissipative costs.
On the Determinants of Underpricing in Corporate Bond Offerings
- Björn Aronsson
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Measuring abnormal bond performance
- Hendrik Bessembinder