Faculty from the Department of Finance, Investment, and Banking at the Wisconsin School of Business share key ideas from their research as featured on the Forward Thinking blog.
Professor Dean Corbae: Competition Reduces Bank Stability—But Enhanced Governance Can Mitigate It
In a working paper presented at the August 2018 Jackson Hole Economic Policy Symposium, Corbae and co-author Ross Levine of the University of California, Berkeley, examined issues of competition and stability in the banking industry. Specifically, their study questioned: Does greater competition reduce bank stability? In cases of competition fragility, can regulatory policy continue to encourage competition while mitigating any negative effects? And finally, does bank competitiveness affect the transmission of monetary policy to the real side of the economy?
Corbae’s study yielded three main findings, including this one: better bank governance and tighter leverage requirements can preserve competition’s efficiency benefits. We can think about governance as trying to align the interests of both shareholders and bank managers, Corbae says. Regulatory and legal reforms can help bank decision-makers focus more on the long-term health of the bank rather than short-term objectives, thereby increasing efficiency and stability. Tighter leverage requirements also boost stability, and combining these measures with enhanced governance multiplies both efficiency and stability.
Associate Professor Ivan Shaliastovich: Good and Bad Uncertainty: A Q&A with WSB’s Ivan Shaliastovich
I’ve been working on this idea of how we think about uncertainty since my Ph.D. years. We’re not sure what’s going to happen in the future. As humans, we’re adverse to this—psychologically, we don’t like it. In daily life alone, we’re faced with a lot of uncertainty that affects our decision-making about things like our finances, jobs, and families. Putting the discussion back into a financial context, how can we then think about anxiety and uncertainty more broadly from an economic perspective in terms of workable models? What are the quantitative and qualitative effects of uncertainty, and to what degree is their impact? These are the kinds of questions I’ve been examining throughout my career, playing with these different aspects of uncertainty.
In our research, we’re trying to show that it’s important to separate these two—good and bad—aspects of uncertainty. They have very different impacts on the economic markets. Investors also view these types of uncertainty differently, not just quantitatively but qualitatively. If we put both good and bad uncertainty into the same bundle of variance, you’re going to miss these effects.
Today, we’re seeing more and more in research this notion of uncertainty as being important. In the 20th century, there was a lot of work done in finance and the stock market. Of course, uncertainty is not a new concept, but in the 21st century, we started hearing about it from an economic point of view. There also appears to be a greater appreciation of the subject not just from a statistical or a finance point of view, but even from a broader academic and social standpoint. Uncertainty is not just a sideshow. It can have a first-order impact on human behavior.
Associate Professor Oliver Levine: Reallocating Investment Opportunities: 4 Things to Know About Targets and Acquirers
In the merger and acquisition (M&A) market, conventional wisdom holds that M&A deals are a way to reallocate physical capital from low productivity firms to high productivity firms. The thinking is that, theoretically at least, the acquirer’s more productive way of operating will make the target’s assets that much more profitable.
In my own research, I looked at the characteristics of firms that are acquirers and those that are targets. I also developed a model that moves away from the old economy scenario described above and toward a more modern setting. In this interpretation, it’s not just about tangible and physical assets; it also incorporates the intangibles and productive opportunities—things like ideas, proprietary methods, and product formulas.
In the study, I show that the target and the acquirer have distinct characteristics in ways that contrast with the typical old-economy view of M&A. Firms that are targets have higher than average productivity, sales growth, and investment rates, which suggests that they have quality projects. They may have low profitability, which indicates that their costs are higher than average. Conversely, firms that are acquirers have both high productivity and low costs.
Assistant Professor Roberto Robatto: How We Face Risk: Personal Preference or Evolutionary Hardwiring?
Idiosyncratic risk is risk that affects each individual differently, while aggregate risk affects everyone in an equal manner. The key question of our paper is whether or not people behave differently when faced with one type of risk versus the other.
The answer is, it depends. Past literature showed that people behave differently when facing all types of risks, aggregate or idiosyncratic, across all circumstances. We wrote a more general mathematical model than those used in previous studies that includes a larger set of scenarios. We find that people behave differently only in some scenarios, whereas they behave equally in others.
Our paper takes a biological approach in the sense that, if evolution determines physical characteristics, it can also determine behavioral choices. Even though the challenges that we face today are vastly different from those of our early ancestors, we still posit that these preferences and ways of decision-making are inborn, part of our genetic makeup. So we can think about these choices really more as extensions of optimal evolutionary behaviors—things our species have carried forward with us through time—rather than deliberate rational choices or personal preferences that we make. This is a departure from most other economic models that incorporate preferences as a given.
Get to know all of WSB’s finance, investment, and banking faculty.