Essays in Empirical Banking and Finance.

The main focus of the dissertation is on the effect of financial regulation and market design to credit provision, liquidity and social welfare. In Chapter 1 we study how the structure of exchanges related to priority rules affects order execution, social welfare and market fragmentation, while the second chapter investigates the interaction of similar type of orders on different venues, with implications on how to migrate volume back from opaque venues to lit markets. The third chapter studies how financial institutions react to regulation by adjusting the composition of credit granted in order to reduce the cost from structural changes in the contract design between borrowers and lenders. In the first chapter, titled ``Priority Rules'', we study how secondary priority rules to a specific market may serve as a tiebreaker. In most countries, regulation mandates price priority when trading financial assets in fragmented markets. For example, the Securities and Exchange Commission (SEC) rule 611 of Regulation National Market System (also know as the Order Protection Rule or the Trade-through Rule) implements price priority among venues, but do not request time priority. When multiple venues display the best price, a broker can route customer orders to any of those platforms. Two natural questions arise: should time priority be enforced across and within platforms, or are other secondary priority rules preferable? Is there a ``one size fits all' priority rule, or should priority rules be adjusted according to the underlying trading needs? In this paper, we address these questions by studying how priority rules affect investors' mode of market participation (market versus limit orders), investor welfare, and the way how markets fragment. The second chapter titled ``Two Shades of Opacity: Hidden Orders versus Dark Trading'' investigates the interrelation between dark trading and hidden order activity. Traders nowadays have different tools to trade in an opaque way, i.e., without revealing to the public their precise trading intentions. These tools can be divided into two categories. The first one is trading in the dark, i.e., without any pre-trade transparency, away from the lit venues i.e., in alternative trading systems. The second tool to hide trading intentions is that of hidden orders on lit venues, i.e., orders that mask their true size, in otherwise pre-trade transparent order books. We refer to transactions that execute against the hidden part of the book as hidden-order trading. An unanswered economic question is whether hidden orders substitute for dark trading, or whether they complement each other. Theory on competition between trading venues suggests they may be substitutes as both forms of opaque trading take place on different trading venues and could replace each other. Theory on transparency posits they may be complements as both hidden orders and dark trading allow to remain opaque, and traders may consider both of these forms jointly, reinforcing each other. We empirically investigate whether hidden-order trading and dark trading are complements or substitutes, and find that they are substitutes. This is important from a regulatory perspective as influencing the attractiveness of hidden orders, allows to curb dark trading. Put differently, policy makers can incentivize hidden order activity, for instance via make-take fees, in order to gravitate volume in the lit markets and decrease dark trading which in general is associated with negative impact on the function of financial markets. Employing two different empirical methodologies (i.e., a system of simultaneous equations, and two quasi-natural experiments), we find that dark and hidden-order trading are substitutes. In our simultaneous equation approach, in the sample in which all lit venues were active, we find that hidden-order trading and dark trading are substitutes, i.e., if dark (hidden-order) trading increases, hidden-order (dark) trading decreases. Using our two quasi-natural experiments as a source of identification, we learn that the introduction of a mid-point dark pool increases dark trading but (i) reduces hidden-order trading, and (ii) reduces it more in stocks that ex-ante had more hidden-order activity. We further also show that both types of opaque trading increase when markets are volatile and fewer algorithmic trading occurs. Smart order routing increases dark trading but reduces hidden-order activity. In Chapter 3, titled ``Banks and firms: Evidence of a legal reform altering contract design'', we study how legal reforms that aim to improve access to credit, may have unintended consequences leading to credit rationing on particular products and may alter the composition of the credit supply. Small firms are the engine of economic growth. In most countries, banks are central in the credit provision to small and medium sized firms (SMEs). Firms in general and SMEs in particular are often in a weak position relative to their main bank as they have limited access to alternative sources of finance stemming from asymmetric information and limited competition. In this paper, we study the impact of a legal reform that aimed to improve SMEs bargaining position relative to the bank, and investigate the effects on credit provision and the composition of credit (credit lines versus term loans, interest rates, and the maturity of loans). In particular, the act resolved inefficiencies between creditors and borrowers by requesting banks to provide the best-suited loan type to SMEs, and promoted pre-contractual fairness for SMEs by giving to borrowers the right to prepay their (term) loan against a contractually specified penalty of six of months interest rate. The aim was to stimulate access to credit for SMEs by ameliorating their bargaining position, since it would be easier for firms to switch across financial institutions and obtain better loan terms. However at the same time, by embedding in all contracts the possibility to early repay a loan, the act limited the contracting space and depraved SMEs the ability to make credible long-term commitment to a project. This implicitly increases competition across financial institutions, which may lead either to strengthening of bank-firm relationships or to have the opposite effect essentially shifting the banking model from relationship to transactional which reduces credit availability and increases interest rates. Furthermore, banks may have incentives to use their existing bargaining power to shift credit to least affected, (competitively priced) products across borrowers who were marginally indifferent between affected and non affected credit types. In particular, before the law change, banks may have incentives to oversupply term loans as these were protected from prepayments and maximize their loan book. However, in the absence of these incentives, the equilibrium supply volume changes and firms could end up with another type of credit such as credit lines. Using the legal change as a quasi-natural experiment, we show that, while the legal reform increases overall credit availability, banks dampen the effect of the act by tilting their credit supply to loans that are unaffected by the legal change. Using bank-firm-credit data, we show that banks reduce the supply of term loans by 0.7% while credit lines increase by 4%. This effect is more pronounced for borrowers with longer relationships. Our results show that reforms may also lead to unintended consequences since banks strategically try to undo part of the regulation and reduce the regulatory burden.

Jaar van publicatie:2021

Toegankelijkheid:Closed