“The Anatomy of Index Rebalancings: Evidence from Transaction Data”, with Mariana Escobar, Lorenzo Pandolfi, and Alvaro Pedraza.

We exploit a novel dataset covering the universe of transactions in the Colombian Stock Exchange to analyze episodes of additions to and deletions from MSCI equity indexes. We find additions and deletions to have large price effects: the median cumulative abnormal return in absolute value is 5.5%. We show that these price effects are due to large demand shocks by different classes of international investors – not only passive funds and ETFs, but also active mutual funds, pension funds and government funds – which are not absorbed by arbitrageurs. Consistent with recent asset pricing models with limits to arbitrage, we estimate stock demand curves to be very inelastic: the demand elasticity for the median stock in our sample is -0.34, implying that a 1% increase in the demand for the stock increases its price by 2.9%.

Drug Money and Bank Lending

“Drug Money and Bank Lending: The Unintended Consequences of Anti-Money Laundering Policies”, with Pablo Slutzky and Mauricio Villamizar-Villegas.

We explore the unintended consequences of anti-money laundering (AML) policies. For identification, we exploit the implementation of the SARLAFT system in Colombia in 2008, aimed at controlling the flow of money from drug trafficking into the financial system. We find that bank deposits in municipalities with high drug trafficking activity decline after the implementation of the new AML policy. More importantly, this negative liquidity shock has consequences for credit in municipalities with little or nil drug trafficking. Banks that source their deposits from areas with high drug trafficking activity cut lending relative to banks that source their deposits from other areas. We show that this credit shortfall negatively impacted the real economy. Using a proprietary database containing data on bank-firm credit relationships, we show that small firms that rely on credit from affected banks experience a negative shock to investment, sales, size, and profitability. Additionally, we observe a reduction in employment in small firms. Our results suggest that the implementation of the AML policy had a negative effect on the real economy.

How ETFs Amplify the Global Financial Cycle in EM

“How ETFs Amplify the Global Financial Cycle in Emerging Markets”, with Nathan Converse and Eduardo Levy Yeyati. Revise and Resubmit (2nd Round) at the Review of Financial Studies.

Featured in Voxeu, and Seeking Alpha.

Since the early 2000s exchange-traded funds (ETFs) have grown to become an important investment vehicle worldwide. In this paper, we study how their growth affects the sensitivity of international capital flows to the global financial cycle. We combine comprehensive micro-level data on investor flows with a novel identification strategy that controls for unobservable time-varying economic conditions at the investment destination. For the emerging market universe, we find that the sensitivity of investor flows to global risk factors for equity (bond) ETFs is 2.5 (2.25) times higher than for equity (bond) mutual funds. In turn, we show that countries where ETFs hold a larger share of financial assets are significantly more sensitive to global risk factors, both in terms of total equity flows and prices. We conclude that the growing participation of ETFs amplifies the incidence of the global financial cycle in emerging markets.

Search for Yield in Large International Corporate Bonds

“Search for Yield in Large International Corporate Bonds: Investor Behavior and Firm Responses”, with Charles Calomiris, Mauricio Larrain and Sergio Schmukler. Revise and Resubmit at the Journal of International Economics.

Featured in the NBER Digest, and The Financial Times.

Emerging market corporations have significantly increased their borrowing in international markets since 2008. We show that this increase was driven by large-denomination bond issuances, most of them with face value of exactly US$500 million. Large issuances are eligible for inclusion in important international market indexes. These bonds appeal to institutional investors because they are more liquid and facilitate targeting market benchmarks. We find that the rewards of issuing index-eligible bonds rose drastically after 2008. Emerging market firms were able to cut their cost of funds by roughly 100 basis points by issuing bonds with a face value equal to or greater than US$500 million relative to smaller bonds. Firms contemplating whether to take advantage of this cost saving face a tradeoff: they can benefit from the lower yields associated with large, index-eligible bonds, but they pay the potential cost of having to hoard low-yielding cash assets if their investment opportunities are less than US$500 million. Because of the post-2008 “size yield discount,” many companies issued index-eligible bonds, while substantially increasing their cash holdings. The willingness to issue large bonds and hoard cash was greater for firms in countries with high carry trade opportunities that reduced the cost of holding cash. We present evidence suggesting that these post-2008 behaviors reflected a search for yield by institutional investors into higher-risk securities. These patterns are not apparent in the issuance of investment grade bonds by firms in developed economies.

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