Proposal preview

Financial Markets in troubled times

Organizers
Angelo Riva (Private professor at the European Business School-Paris and affiliated researcher at Paris School of Economics; corresponding session organizer)
Caroline Fohlin (professor at the Emory University)
Raphaël Hekimian (Post-doctoral researcher at the Paris Ouest Nanterre University)

A stream of literature has underscored that stock markets are important engines of growth in several countries, from both an historical (Neal, 1990; Michie, 2001; Rousseau, 2002; Rousseau and Sylla, 2003) and comparative points of view (from the seminal paper of Levine and Zervos, 1996, evidences on the link between stock market and growth are a major contribution of the “finance and growth” literature; see Levine, 2005 for a review). Moreover, another important strand of theoretical and empirical literature points to the role of the organization of both individual markets and stock exchange industry as a whole in the performances of the financial market, again both historically (Davis and Neal, 1998; Fohlin, 2016; Gehrig and Fohlin, 2006; Hautcoeur and Riva, 2012; White, 2013) and today (see Biais, Glosten and Spatt, 2005 for a review).
First, the organization can contribute to market liquidity: potential buyers of newly issued debts and equity are more willing to buy and at lower risk premium if they can resell their securities quickly and cheaply ; well-functioning secondary markets then lower the cost of capital for issuers and contribute to the effectiveness of primary markets which, in turn, support investment and growth; moreover, active secondary markets allow holders to post securities as collateral and then obtaining with further funding for their projects; finally, liquidity can reduce market impact of (fire) sales and help in stabilizing price; yet, “over-trading” ( Kindleberger, 1978) might harm stability. Second, price discovery systems play a central role in aggregating information into prices, guiding then the investment, smoothing volatility and improving market efficiency. Third, effective organizations might limit counterparty risk and further mitigate the potential for contagion to other markets.
It is nevertheless difficult to conceive of a microstructure simultaneously accomplishing all those goals; trade-offs must be made among different dimensions of market effectiveness. For example, enlarging the number of market operators can improve trading volumes, but harm counterparty risk management; stringent listing requirements can contain volatility but limit the financing of innovative firms. Furthermore, competition among exchanges may reduce market power but may fragment information and limit price discovery. Thus, the organization of the stock exchange industry as a whole is often relevant in the analysis of the role of financial markets.
While often scholars focus on “normal” periods, in this session, organizers welcome papers dealing with stock exchange (industry) organizations in “troubled times” of extreme swings in prices. Goetzmann (2015) analyzes a large data sample of stock market indices and finds that, if booms in themselves are relatively rare events, crashes are even rarer. Yet the consequences of such crashes might be severe and lasting. What is the role of stock market (industry) organizations in boom, bubble and bursts? How do exchange organizations help in smoothing prices changes? How do organizations support increases in prices while forestalling bubbles and subsequent crashes? What is the role of price discovery systems, trading mechanisms, counterparty risk management, and settlement and delivery process? What is their role in supplying and constraining (over)liquidity? Conversely, what is the role of organizations in the formation of bubbles that turn into crashes and panics? In transforming a crash into a long depression of market prices? How do organizations contribute to or delay the recovery of both prices and the financing of the economy? Moreover, what is the role of organizations in either mitigating or enhancing the transmissions of shocks and the contagion of crisis?

Papers will address these questions drawing from historical experiences from every time and country.
Young scholars (PhD students, post-doctoral fellows and young assistant professors) are particularly invited to submit their original works.

References
Biais, B., Glosten, L., & Spatt, C. (2005). Market microstructure: A survey of microfoundations, empirical results, and policy implications. Journal of Financial Markets, 8(2), 217-264.
Davis, L., & Neal, L. (1998). Micro rules and macro outcomes: the impact of micro structure on the efficiency of security exchanges, London, New York, and Paris, 1800-1914. The American Economic Review, 88(2), 40-45.
Fohlin, C. (2016). Frictions: Some Lessons from History, in Chambers, D. and E. Dimson (Eds.) Lessons from Financial History, London: CFA Institute.
Gehrig, T., & Fohlin, C. (2006). Trading costs in early securities markets: the case of the Berlin Stock Exchange 1880–1910. Review of Finance, 10(4), 587-612.
Goetzmann, W. N. (2015). Bubble Investing: Learning from History (No. w21693). National Bureau of Economic Research.
Hautcoeur, P. C., & Riva, A. (2012). The Paris financial market in the nineteenth century: complementarities and competition in microstructures. The Economic History Review, 65(4), 1326-1353.
Levine, R., & Zervos, S. (1996). Stock market development and long-run growth. The World Bank Economic Review, 10(2), 323-339.
Kindleberger, C. P. (1978). Manias, panics and crashes: a history of financial crises. Springer.
Michie, R. (2001). The London stock exchange: A history. OUP Catalogue.
Neal, L. (1993). The rise of financial capitalism: International capital markets in the age of reason. Cambridge University Press.
Rousseau, P. L. (2002). Historical perspectives on financial development and economic growth (No. w9333). National Bureau of Economic Research.
Rousseau, P. L., & Sylla, R. (2003). Financial systems, economic growth, and globalization. In Globalization in historical perspective (pp. 373-416). University of Chicago Press.
White, E. N. (2013). Competition among the exchanges before the SEC: was the NYSE a natural hegemon?. Financial History Review, 20(01), 29-48.

Please submit proposals (max 2 pages) and curriculum vitae to raphael.hekimian@psemail.eu Deadline for submission is 29 January 2018.

Organizer(s)

  • Angelo Riva European Business School Paris & Paris School of Economics angeloriva@ebs-paris.com
  • Caroline Fohlin Emory University caroline.fohlin@emory.edu
  • Raphaël Hekimian Paris School of Economics raphael.hekimian@psemail.eu

Session members

  • John Turner, Queen's University Belfast
  • William Quinn, Queen's University Belfast
  • Christopher Coyle, Queen's University Belfast
  • Stephanie Collet, SAFE, Goethe University Frankfurt
  • Elisa Grandi, Paris School of Economics
  • Sebastian Fleitas, University of Leuven
  • Marius Liebald, Goethe University Frankfurt
  • Mariusz Lukasiewicz, University of Leipzig
  • Angelo Riva, European Business School Paris & Paris School of Economics
  • Caroline Fohlin, Emory University
  • Raphaël Hekimian , Paris School of Economics

Discussant(s)

  • Caroline Fohlin Emory University caroline.fohlin@emory.edu
  • Stephanie Collet SAFE, Goethe University Frankfurt collet@safe.uni-frankfurt.de
  • Raphaël Hekimian Paris Ouest Nanterre University raphael.hekimian@psemail.eu
  • Angelo Riva European Business School Paris & Paris School of Economics angeloriva@ebs-paris.com
  • William Quinn Queen's University Belfast w.quinn@qub.ac.uk
  • Christopher Coyle Queen's University Belfast c.coyle@qub.ac.uk
  • Sebastian Fleitas University of Leuven sebastian.fleitas@kuleuven.be
  • Marius Liebald Goethe University Frankfurt liebald@econ.uni-frankfurt.de

Papers

Panel abstract

A stream of literature has underscored that stock markets are important engines of growth in several countries, from both an historical and comparative points of view. Moreover, another important strand of theoretical and empirical literature points to the role of the organization of both individual markets and stock exchange industry as a whole in the performances of the financial market, again both historically and today. First, the organization can contribute to market liquidity: reduction of risk premiums, lower cost of capital and help in stabilizing prices. Second, price discovery systems play a central role in aggregating information into prices, guiding then the investment, smoothing volatility and improving market efficiency. Third, effective organizations might limit counterparty risk and further mitigate the potential for contagion to other markets. While often scholars focus on “normal” periods, in this session, organizers welcome papers dealing with stock exchange (industry) organizations in “troubled times” of extreme

1st half

Market microstructure in troubled times – granular evidence from Germany

Stéphanie Collet and Caroline Fohlin

Historical research holds the key to a better understanding of financial markets and their microstructure. This paper develops and analyzes German stock market historical data to tackle underexplored questions about financial market performance during troubled times. Given the fact that Germany at that time had both a very developed capital market and also an advanced regulatory framework, the paper will answer key questions on the microstructure of the Berlin market in distinct episodes of distress. Using daily stock prices, this paper investigates the microstructure and the performance of financial markets in three periods in German history. First, the 1907 crisis where, like the US, Europe too was contaminated, especially Germany which dismantled the cartel of cast-iron. Secondly, Germany’s hyperinflation which struck the Weimar Republic shortly after WWI. Finally, the 1929 crisis which corresponds to a more global crisis. The objective of this project is to collect and analyze an original...

Historical research holds the key to a better understanding of financial markets and their microstructure. This paper develops and analyzes German stock market historical data to tackle underexplored questions about financial market performance during troubled times. Given the fact that Germany at that time had both a very developed capital market and also an advanced regulatory framework, the paper will answer key questions on the microstructure of the Berlin market in distinct episodes of distress. Using daily stock prices, this paper investigates the microstructure and the performance of financial markets in three periods in German history. First, the 1907 crisis where, like the US, Europe too was contaminated, especially Germany which dismantled the cartel of cast-iron. Secondly, Germany’s hyperinflation which struck the Weimar Republic shortly after WWI. Finally, the 1929 crisis which corresponds to a more global crisis. The objective of this project is to collect and analyze an original database for the Berlin Stock Market. Daily stock data are collected for the 3 periods (1907-1908, 1921-1924, 1929-1930) and 3 benchmark years (1865, 1895, 1927). Using daily data, we can compute covariance-based liquidity measures. As a new approach, we also collect data for the Berlin stock exchange’s particular labeling variables from their order book that provide insight into the market liquidity for each stock traded.

Prices and Informed Trading: Evidence from an Early Stock Market

Graeme G. Acheson, Christopher Coyle and John D. Turner

Using novel trading data from a major company on the London Stock Exchange at the turn of the twentieth century, we examine how measures of adverse selection and liquidity respond to the presence of informed trading. The main finding is that bid-ask spreads increased in the presence of informed trades. However, spreads narrowed during periods of informed trading when such trades were timed to periods of large uninformed volume. We also find that spreads increased during the closure of the London Stock Exchange in 1914. Our results provide support for the classical microstructure theories of informed trading.

Using novel trading data from a major company on the London Stock Exchange at the turn of the twentieth century, we examine how measures of adverse selection and liquidity respond to the presence of informed trading. The main finding is that bid-ask spreads increased in the presence of informed trades. However, spreads narrowed during periods of informed trading when such trades were timed to periods of large uninformed volume. We also find that spreads increased during the closure of the London Stock Exchange in 1914. Our results provide support for the classical microstructure theories of informed trading.

Riding the Bubble or Taken for a Ride? Investors in the British Bicy-cle Mania

William Quinn and John D. Turner

Clientele-based theories explaining asset price bubbles are often easily testable when the identities of investors can be tracked over time, but the availability of such data is generally limited. This paper tests these theories using a hand-collected sample of 12,000 investors during an asset price reversal in the shares of British bicycle companies in the period 1895-1900. Initial investors do not appear to have come from disproportionately naïve occupational groups, but there is a systematic reduction in the number of shares held by better informed groups during the crash. These findings support the model of Abreu and Brunnermeier (2002), which suggests that informed investors, rather than imme-diately correcting any mispricing, may attempt to ‘ride’ a bubble.

Clientele-based theories explaining asset price bubbles are often easily testable when the identities of investors can be tracked over time, but the availability of such data is generally limited. This paper tests these theories using a hand-collected sample of 12,000 investors during an asset price reversal in the shares of British bicycle companies in the period 1895-1900. Initial investors do not appear to have come from disproportionately naïve occupational groups, but there is a systematic reduction in the number of shares held by better informed groups during the crash. These findings support the model of Abreu and Brunnermeier (2002), which suggests that informed investors, rather than imme-diately correcting any mispricing, may attempt to ‘ride’ a bubble.

How do financial crises affect bank-industry relationships? Evidence from the French chemical sector in the 1930s

Elisa Grandi, Raphaël Hekimian, Angelo Riva and Stefano Ungaro

The paper studies the effect of bank-industry relationship on the performance of chemical firms through the analysis of their interlocking directorates before and after the 1929 crisis. At the time, the chemical industry was a major innovative business coming out of the second industrial revolution. We study the effect of the crisis on this relationship by constructing two datasets of board members: one in 1927 and the other in 1933. We find that the crisis had a concentration effect on the chemical sector. More precisely, the network’s configuration changes shape after the crisis, connecting formerly separate clusters into a one large network. Moreover, we analyze the way in which sharing one or more boards members with banks affected the chemical companies performance, both in terms of book performance (return on equity) and market performance (total returns). We find that network variables have a positive impact on firm’s performance after the...

The paper studies the effect of bank-industry relationship on the performance of chemical firms through the analysis of their interlocking directorates before and after the 1929 crisis. At the time, the chemical industry was a major innovative business coming out of the second industrial revolution. We study the effect of the crisis on this relationship by constructing two datasets of board members: one in 1927 and the other in 1933. We find that the crisis had a concentration effect on the chemical sector. More precisely, the network’s configuration changes shape after the crisis, connecting formerly separate clusters into a one large network. Moreover, we analyze the way in which sharing one or more boards members with banks affected the chemical companies performance, both in terms of book performance (return on equity) and market performance (total returns). We find that network variables have a positive impact on firm’s performance after the crisis.

2nd half

La bourse, les banques et l’or: Johannesburg’s French Connection and the Paris Krach of 1895

Mariusz Lukasiewicz

South Africa’s deep-level mining revolution of the early 1890s changed the nature and global significance of mining finance. Johannesburg established itself as global financial centre with numerous local, colonial and international banks operating inside the South African Republic, with many of their managers and employees functioning as Johannesburg Stock Exchange (JSE) members.1 By the beginning of 1895 most established European, American and Australian stock exchanges followed the price developments on the JSE, with some trading in South African registered companies and JSE-listed stocks. Despite the positive developments in Johannesburg, most of the marketing for deep-level South African securities was done in London. Using an extensive network of joint-stock banks and clearing houses, the London financial market was also able to promote investments in London-listed mining securities on the European continent. London might have hosted the most capitalised mining market of the 19th century, but it was far from being the...

South Africa’s deep-level mining revolution of the early 1890s changed the nature and global significance of mining finance. Johannesburg established itself as global financial centre with numerous local, colonial and international banks operating inside the South African Republic, with many of their managers and employees functioning as Johannesburg Stock Exchange (JSE) members.1 By the beginning of 1895 most established European, American and Australian stock exchanges followed the price developments on the JSE, with some trading in South African registered companies and JSE-listed stocks. Despite the positive developments in Johannesburg, most of the marketing for deep-level South African securities was done in London. Using an extensive network of joint-stock banks and clearing houses, the London financial market was also able to promote investments in London-listed mining securities on the European continent. London might have hosted the most capitalised mining market of the 19th century, but it was far from being the only one available to a growing pool of international speculators. With consistently lower interest rates, Paris was a particular favourite with London’s international investment banks and finance houses. Parisian bankers who were already heavily involved in promoting South African mining securities since the early 1890’s, colluded with London brokers to advance funds in the form of three-month bills on London to finance their orders to the ‘Kaffir Market.’2 The bills would then be offered to the London money market by the same banks and discount houses offering South African securities in Paris. Considering the popularity and availability of South African securities in Paris in the early 1890s, it is very surprising that the involvement of Europe’s second largest exporter of financial capital to southern Africa in the 19th century has received very little scholarly attention. According to estimates by Hubert Meredith,3 in 1895 French investors held more than £ 100 million in South African mining stocks and purchased more than 30% of all securities issued since 1887.4 Paris was a crucial market for mining securities and soon enough, became consumed by the ‘Kaffir Circus.’ This paper circumnavigates the ‘tale of the two cities’ to expose the direct financial links to the City of Gold, Johannesburg. The investigation follows the rise of French financial intermediaries that eventually disturbed the already fragile balance of power between British capital, South African gold exports and Pretoria’s growing political influence in Johannesburg. Although the intention here is not to solve the mystery around why massive portfolios of South African mining stocks were suddenly sold in Paris in the famous Krach of 1895,5 the paper will expose how personal and institutional connections stemming from the JSE, turned France into the centre of attention for all South African gold mining stakeholders. Viewing the JSE as the institutional and financial crossroad between South African gold mines and the French investor, this investigation will ultimately map, illustrate and analyse the relationship of French capitalists with South Africa on the eve of the largest international capital boom in Johannesburg’s young financial history.

Foreclosed Real Estate and the Supply of Mortgage Credit by Building and Loans during the 1930s

Price Fishback, Sebastian Fleitas, Jonathan Rose and Ken Snowden

Since Bernanke (1983) demonstrated that bank failures had real impacts on economic activity during the 1930s, there has been general recognition that disruptions in credit channels contributed to the deflationary forces that were at work during the Great Depression. This paper analyzes the source and impacts of credit disruptions within the mortgage market during the severe housing crisis that accompanied the Depression. We examine the impact that foreclosed real estate owned (REO) on the balance sheet had on new lending activity within the Building & Loan (B&L) industry. B&Ls were the nation’s most important institutional home mortgage lender in 1930. As foreclosure rates rose during the 1930s, REO increased to unprecedented levels as a share of B&L assets and new lending activity was reduced. Our hypothesis is that B&Ls reduced their lending activity taking into account expected future losses generated by the presence of bad assets in their balance sheets....

Since Bernanke (1983) demonstrated that bank failures had real impacts on economic activity during the 1930s, there has been general recognition that disruptions in credit channels contributed to the deflationary forces that were at work during the Great Depression. This paper analyzes the source and impacts of credit disruptions within the mortgage market during the severe housing crisis that accompanied the Depression. We examine the impact that foreclosed real estate owned (REO) on the balance sheet had on new lending activity within the Building & Loan (B&L) industry. B&Ls were the nation’s most important institutional home mortgage lender in 1930. As foreclosure rates rose during the 1930s, REO increased to unprecedented levels as a share of B&L assets and new lending activity was reduced. Our hypothesis is that B&Ls reduced their lending activity taking into account expected future losses generated by the presence of bad assets in their balance sheets. This constitutes a supply-side channel for the reduced number of new loans, different to the demand factors that also influenced lending during this period. To assess the presence and magnitude of this supply-side credit restriction, detailed annual balance sheet and new lending activity were collected for 653 B&Ls operating in Iowa, New York, North Carolina, and Wisconsin during the 1930s. We examine the panel in models that include detailed measures of each institution’s assets and liabilities, B&L and market-by-year fixed effects to control for institution-specific characteristics and for factors such as changes in county income and local shocks within housing markets. The results show that REO had a statistically significant negative impact on new lending by B&Ls during the 1930s. A one standard deviation in the REO share variable caused a decrease of 4.7 percentage points in new loans as a share of total assets, which is roughly about one-third of the mean value at the time. Between 1930 and 1935 the rapid rise in mean REO share of assets contributed to over 80 percent of the reduction in the mean value of new loans as a percentage of assets.

Capital Structures in Troubled Times

Marius Liebald and Uwe Walz

The financial crisis of of 2007-2009 came as a complete surprise to most and brought about widespread condemnation of Wall Street and the lack of regulatory oversight of the financial system: How could financial markets and institutions fail so dramatically? Many demanded governments to take action to stave off the next crisis. This recent episode echoes crises that came before; the Great Depression, and the slew of regulations and institutions created in response, being the foremost example where the pattern of financial crisis, public outcry, and regulatory response can be observed (e.g. Bordo, 2008). For Germany, the Hyperination in 1923 represents another critical episode from a similar magnitude. Compared to January 1923, prices had increased by more than 126 trillion percent by December of the same year shaking the foundation of the German economy (Bresciani-Turroni, 1937). Most empirical research on the determinants of capital structures is conducted by means of...

The financial crisis of of 2007-2009 came as a complete surprise to most and brought about widespread condemnation of Wall Street and the lack of regulatory oversight of the financial system: How could financial markets and institutions fail so dramatically? Many demanded governments to take action to stave off the next crisis. This recent episode echoes crises that came before; the Great Depression, and the slew of regulations and institutions created in response, being the foremost example where the pattern of financial crisis, public outcry, and regulatory response can be observed (e.g. Bordo, 2008). For Germany, the Hyperination in 1923 represents another critical episode from a similar magnitude. Compared to January 1923, prices had increased by more than 126 trillion percent by December of the same year shaking the foundation of the German economy (Bresciani-Turroni, 1937). Most empirical research on the determinants of capital structures is conducted by means of either cross-sectional, time series or panel data covering the period starting from 1950 (e.g. DeAngelo and Roll, 2015; Baker and Wurgler, 2002; Flannery and Rangan, 2006; Tong and Green, 2005). Consecutive to the irrelevance theorem of Modigliani and Miller (1958), four main theories have evolved taking into account market imperfections. Whereas the pecking order theory argues that, due to their relative costs, retained earnings are preferred over debt and newly issued equity for refinancing purposes (Myers, 1984), the trade-off theory considers capital structures to be determined by the relative benefits (tax savings (Kraus and Litzenberger, 1973), increased monitoring (Jensen and Meckling, 1976), added discipline to the management (Jensen, 1986)) and costs (costs of financial distress (Scott, 1976), the debt overhang problem (Myers, 1977)) of debt. Apart from that, some articles claim additional validity for the market timing as well as the and managerial entrenchment theory. On the contrary, only a few studies on the determinants of corporate capital structures exist taking into account data from earlier periods. Yet, as the first half of the 20th century is characterized by comparably much more extreme economic conditions, investigating corporate capital structure decisions in this period potentially can add knowledge to the current state of research. As illustrated in Figure 1 in the Appendix, real GDP per capita, used as proxy for economic stability, was more volatile during these years in post-war Germany in comparison to the US as well as to later decades. In fact, during the 16 years after World War I, real GDP growth in Germany switched from extreme negative (-13.29 percent in 1919 as direct war consequence, -17.46 percent in 1923 in the course of the hyperinflation, and -8.11 percent in 1931 due to the economic shock triggered by great depression in the US) to extreme positive (10.09 percent in 1921, 16.35 percent in 1924, and 8.51 percent in 1934) three times. Whereas existing studies covering this period are focused on the US market (e.g. Graham et al.,2015), the proposed paper will concentrate on Germany during the interwar period. Firm level data will be examined to assess whether, and if so, which one of the four outlined theories can be supported by historical data. Moreover, it will be revealed if the findings by Graham et al. (2015) exhibiting relatively low leverage ratios of US American companies in the 1920s and 30s compared to more recent decades also hold true for Germany. The dataset fundamental to the intended analysis is being created at this point in time. Alongside detailed balance sheet and profit and loss data, it, among others, includes information on management and supervisory board members of all joint-stock companies in Germany for the period from 1920 to 1940. Hard copies of the annually published Handbuch der deutschen Aktiengesellschaften totalling to more than 160,000 single pages serve as data basis. After the hard copies are electronically copied and digital images of each page are created, the image quality has to be improved to enable better data extraction results in subsequent steps.2 Following this, the publicly available Optical Character Recognition (OCR) Software Tesseract is used to convert the images into digitally readable text files. Based on the usage of uncommon font types in the Handbuch der deutschen Aktiengesellschaften, the software has to be manually trained to adapt to font type-specific characteristics. This is one type of machine learning (Mohri et al., 2012). Once the text is digitalized, the data has to be structured and filtered. Various Python libraries are used to extract only the data needed. Furthermore, to secure a high data quality, the single time series are automatically checked for outliers. Based on first results,an overall recognition rate of 99 percent is feasible. On the basis of anecdotal evidence, historians argue that during the hyperin ation period it was not uncommon for large companies to pursue aggressive expansion strategies implemented by debt financed Mergers and Acquisitions (M&A) (Widdig, 2001). Such strategies, leading to large-scale conglomerates in Germany, were enabled by the German central bank, which essentially offered large industrials nearly unlimited access to new debt (Taylor, 2013). On the one hand, the broad scope of the underlying dataset will allow for the first time to assess the true extent of such strategic M&A activities. On the other hand, accounting for this peculiarity, the proposed project additionally sheds light on potential long-term effects on capital structures of the described monetary policies. Historical research holds the key to a better understanding of financial cycles and regulatory frameworks. It allows to analyze tendencies and highlights a state's as well as the companies' reactions on systemic criticalities. There is a small but growing body of research on the impact of financial crises on financial market microstructure, corporate governance (e.g. their capital structure) and company valuations (share prices). This project expands the current state of knowledge on the determinants of firms' capital structures by introducing an additional perspective based on a new dataset covering German joint-stock companies between 1920 and 1940.