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« Back to Results

Risk Management

Paper Session

Saturday, Jan. 6, 2018 8:00 AM - 10:00 AM

Loews Philadelphia, Commonwealth Hall A2
Hosted By: American Finance Association
  • Chair: Gerard Hoberg, University of Southern California

Sharing R&D Risk in Healthcare Via FDA Hedges

Adam Jorring
,
University of Chicago
Andrew Lo
,
Massachusetts Institute of Technology
Tomas Philipson
,
University of Chicago
Manita Singh
,
Goldman Sachs
Richard Thakor
,
University of Minnesota

Abstract

Firms conducting medical research and development (R&D) face very high costs and amounts of risk, which makes financing more difficult, thus slowing down the pace of medical innovation. We analyze a new class of simple financial instruments, Food and Drug Administration (FDA) hedges, which allow medical R&D investors to better share the pipeline risk associated with FDA approval with broader capital markets. Using historical FDA approval data, we discuss the pricing of FDA hedges and mechanisms under which they can be traded, and estimate issuer returns. Using unique data sources, we find that FDA approval risk has a low correlation across drug classes, as well as with other assets and the overall market. We argue that this zero-beta property of scientific FDA risk could be a source of gains from trade, between developers looking to offload FDA approval risk and issuers of FDA hedges looking for diversified investments. We offer a proof of concept of the feasibility of trading this type of pipeline risk by examining related securities issued around mergers and acquisitions activity in the drug industry. Overall, our argument is that the use of FDA hedges to share risk between investors in medical innovation and the capital markets will ultimately spur medical innovation and improve the health of patients.

Weathering Cash Flow Shocks

James Brown
,
Iowa State University
Matthew Gustafson
,
Pennsylvania State University
Ivan Ivanov
,
Federal Reserve Board

Abstract

We show that unexpectedly severe winter weather, which is arguably exogenous to firm and bank fundamentals, represents a significant cash flow shock for the average bank-borrowing firm. Firms respond to such shocks by increasing credit line use, but do not significantly adjust cash reserves, non-cash working capital, or real activities. The increased credit line use occurs within one calendar quarter of the cash flow shock and is accompanied by an increase in credit line size, for all but the most distressed borrowers. These results highlight the role of banks in mitigating transitory cash flow shocks to firms.

Credit Default Swaps Around the World: Investment and Financing Effects

Sohnke Bartram
,
University of Warwick
Jennifer Conrad
,
University of North Carolina
Jongsub Lee
,
University of Florida
Marti G. Subrahmanyam
,
New York University

Abstract

We analyze the impact of credit default swaps (CDS) introduction on real decision-making within the firm, taking into account differences in the local economic and legal environment of firms. We extend the model of Bolton and Oehmke (2011) in order to consider uncertainty regarding whether the actions taken by the reference entity will trigger credit events for the CDS obligations. We test the predictions of the model in a sample of more than 56,000 firms across 50 countries over the period 2001-2015. We find substantial evidence that the introduction of CDS affects real decisions within the firm, including leverage, investment, and the risk of investments taken by the firm. Importantly, we find that the legal and market environment in which the reference entity operates has an influence on the impact of CDS. The effect of CDS is larger where uncertainty regarding their obligations is reduced, and where they mitigate weak property rights. Our results shed light on the incomplete nature of CDS contracts in international capital markets, related to significant legal uncertainty surrounding the interpretation of underlying credit events.

Is This Time Different? Do Bank CEOs Learn from Crisis Experiences?

Gloria Yu
,
INSEAD

Abstract

This paper studies how the early-career exposure of bank holding company (BHC) CEOs to the 1980s savings and loans (S&L) crisis affects corporate policies and survival of the BHCs they subsequently manage. I measure the “Intensity” of crisis exposure by the bank failure rate in the states where CEOs worked during the S&L crisis. First, I identify the characteristics of BHCs managed by high-Intensity (“experienced”) CEOs and find that such BHCs exhibit lower systemic risk and are less likely to fail: a one-unit increase in Intensity is associated with 0.39% lower systemic risk and an 0.5% lower failure rate. Second, I identify the type of banking policies that account for these results; in particular, experienced CEOs adopt a BHC business model that is less affected by interest rate shocks, they exert more effective control over credit risk. Their BHCs have relatively larger holdings of liquid assets on the balance sheet. At the same time, there are no significant differences between experienced and other CEOs with respect to asset growth and diversification strategies. Finally, I use the exogenous turnover of CEOs to establish that these findings are not driven by bank–CEO matching.
Discussant(s)
Alex Edmans
,
London Business School
Olivier Dessaint
,
University of Toronto
Martin Oehmke
,
London School of Economics
Claudia Custodio
,
Imperial College London
JEL Classifications
  • G3 - Corporate Finance and Governance