Showing papers in "Review of Financial Studies in 2007"

Expected Stock Returns and Variance Risk Premia

Abstract: We find that the difference between implied and realized variances, or the variance risk premium, is able to explain more than fifteen percent of the ex-post time series variation in quarterly excess returns on the market portfolio over the 1990 to 2005 sample period, with high (low) premia predicting high (low) future returns. The magnitude of the return predictability of the variance risk premium easily dominates that afforded by standard predictor variables like the P/E ratio, the dividend yield, the default spread, and the consumption-wealth ratio (CAY). Moreover, combining the variance risk premium with the P/E ratio results in an R 2 for the quarterly returns of more than twenty-five percent. The results depend crucially on the use of “modelfree”, as opposed to standard Black-Scholes, implied variances, and realized variances constructed from high-frequency intraday, as opposed to daily, data. Our findings suggest that temporal variation in risk and risk-aversion both play an important role in determining stock market returns.

Financial Constraints, Asset Tangibility, and Corporate Investment

Abstract: This paper proposes a new strategy to identify the eect of …nancial constraints on corporate investment. When …rms are able to pledge their assets as collateral, investment and borrowing become endogenous: pledgeable assets support more borrowings that in turn allow for further investments in pledgeable assets. We show that this credit multiplier has a …rst-order eect on investment when …rms face …nancing frictions. In particular, investment-cash ‡ow sensitivities will be increasing in the degree of tangibility of constrained …rms' assets. When …rms are unconstrained, in contrast, investment-cash ‡ow sensitivities are unaected by asset tangibility. This theoretical prediction allows us to use a "dierences in dierences" approach to identify the eect of …nancing frictions on corporate investment: we compare the dierential (marginal) eect of asset tangibility on the sensitivity of investment to cash ‡ow across dierent regimes of …nancial constraints. Using two layers of cross-sectional contrasts sidesteps concerns that cash ‡ows might correlate with a …rm's (residual) investment opportunities when Q fails as a control. We implement our testing strategy on a large sample of …rms drawn from COMPUSTAT between 1971 and 2000. The data strongly support our hypothesis about the role of asset tangibility on corporate investment under …nancial constraints.

Stock Return Predictability: Is it There?

Abstract: We examine the predictive power of the dividend yields for forecasting excess returns, cash flows, and interest rates. Dividend yields predict excess returns only at short horizons together with the short rate and do not have any long-horizon predictive power. At short horizons, the short rate strongly negatively predicts returns. These results are robust in international data and are not due to lack of power. A present value model that matches the data shows that discount rate and short rate movements play a large role in explaining the variation in dividend yields. Finally, we find that earnings yields significantly predict future cash flows. (JEL C12, C51, C52, E49, F30, G12)

Price Informativeness and Investment Sensitivity to Stock Price

Abstract: The article shows that two measures of the amount of private information in stock price—price nonsynchronicity and probability of informed trading (PIN)—have a strong positive effect on the sensitivity of corporate investment to stock price. Moreover, the effect is robust to the inclusion of controls for managerial information and for other information-related variables. The results suggest that firm managers learn from the private information in stock price about their own firms’ fundamentals and incorporate this information in the corporate investment decisions. We relate our findings to an alternative explanation for the investment-to-price sensitivity, namely that it is generated by capital constraints, and show that both the learning channel and the alternative channel contribute to this sensitivity. (JEL G14, G31) Oneofthemainrolesoffinancialmarketsistheproductionandaggregation of information. This occurs via the trading process that transmits informationproducedbytradersfortheirownspeculativetradingintomarketprices [e.g.,Grossman and Stiglitz (1980), Glosten and Milgrom (1985), and Kyle (1985)]. The markets’ remarkable ability to produce information that generates precise predictions about real variables has been demonstrated empirically in several contexts. Roll (1984) showed that private information of citrus futures traders regarding weather conditions gets impounded into citrus futures’ prices, so that prices improve even public predictions of the weather. Relatedly, the literature on prediction markets has shown that

Liquidity and Expected Returns: Lessons From Emerging Markets

Abstract: Given the cross-sectional and temporal variation in their liquidity, emerging equity markets provide an ideal setting to examine the impact of liquidity on expected returns. Our main liquidity measure is a transformation of the proportion of zero daily firm returns, averaged over the month. We find that it significantly predicts future returns, whereas alternative measures such as turnover do not. Consistent with liquidity being a priced factor, unexpected liquidity shocks are positively correlated with contemporaneous return shocks and negatively correlated with shocks to the dividend yield. We consider a simple asset-pricing model with liquidity and the market portfolio as risk factors and transaction costs that are proportional to liquidity. The model differentiates between integrated and segmented countries and time periods. Our results suggest that local market liquidity is an important driver of expected returns in emerging markets, and that the liberalization process has not fully eliminated its impact.

Portfolio Selection in Stochastic Environments

Abstract: In this article, I explicitly solve dynamic portfolio choice problems, up to the solution of an ordinary differential equation (ODE), when the asset returns are quadratic and the agent has a constant relative risk aversion (CRRA) coefficient My solution includes as special cases many existing explicit solutions of dynamic portfolio choice problems I also present three applications that are not in the literature Application 1 is the bond portfolio selection problem when bond returns are described by ‘‘quadratic term structure models’’ Application 2 is the stock portfolio selection problem when stock return volatility is stochastic as in Heston model Application 3 is a bond and stock portfolio selection problem when the interest rate is stochastic and stock returns display stochastic volatility (JEL G11) There is substantial evidence of time variation in interest rates, expected returns, and asset return volatilities Interest rates change over time, and although expected stock returns are not directly observed, future stock returns seem to be predictable using term structure variables and scaled prices such as dividend yields 1 Similarly, there is well-documented evidence of stochastic volatility, 2 whose existence is also supported by the ‘‘smile curve’’ of volatilities implied by option prices Therefore, any serious study of dynamic portfolio choice must take account of stochastic variation in investment opportunities The seminal work of Merton (1971) establishes the framework for dynamic portfolio choice with stochastic variation in investment opportunities The portfolio weights in Merton’s framework are expressed in terms of the solution to a nonlinear partial differential equation (PDE), and because there is no closed-form solution of a nonlinear PDE in general, explicit portfolio weights are not available in general There are approximate solutions to

Trade Credit: Suppliers as Debt Collectors and Insurance Providers

Abstract: This article examines how in a context of limited enforceability of contracts suppliers may have a comparative advantage over banks in lending to customers because they are able to stop the supply of intermediate goods. Suppliers may act also as liquidity providers, insuring against liquidity shocks that could endanger the survival of their customer relationships. The relatively high implicit interest rates of trade credit are the result of insurance and default premiums that are amplified whenever suppliers face a relatively high cost of funds. I explore these effects empirically for a panel of UK firms.

Executive Compensation: A New View from a Long-Term Perspective, 1936–2005

Abstract: We analyze the long-run trends in executive compensation using a new dataset of top officers of large firms from 1936 to 2005. The median real value of compensation was remarkably flat from the late 1940s to the 1970s, revealing a weak relationship between pay and aggregate firm growth. By contrast, this correlation was much stronger in the past thirty years. This historical perspective also suggests that compensation arrangements have often helped to align managerial incentives with those of shareholders because executive wealth was sensitive to firm performance for most of our sample. These new facts pose a challenge to several common explanations for the rise in executive pay since the 1980s. (JEL G30, J33, M52, N32) The compensation paid to CEOs of large publicly traded corporations rose dramatically during the 1980s and 1990s, stimulating much debate on the determinants of managerial pay (Murphy 1999; Hall and Murphy 2003). The discussion has been largely inconclusive, in part because readily available data only exist for the time period after 1970. By constructing a new long-run time series on executive pay, we are able to consistently document the trends in the level and structure of pay over most of the twentieth century. This historical perspective reveals several new facts that contrast sharply with data from recent decades, allowing us to reassess some of the most popular explanations for the recent surge in compensation. Although the stylized facts on executive pay since the 1970s are well established, only a handful of studies analyzed managerial compensation prior to We would like to thank George Baker, Edward Glaeser, Claudia Goldin, Caroline Hoxby, Lawrence Katz, and Robert Margo for their advice and encouragement throughout this project. Very helpful comments have also been received from Doug Elmendorf, Eric Hilt, Antoinette Schoar, Dan Sichel, Laura Starks, and seminar participants at the DAE NBER meetings, AEA meetings, AFA meetings, and EHA meetings. We also thank Michael Weisbach (our editor) and two anonymous referees. We thank the staff at the Historical Collections and Danielle Barney of Baker Library for making the data collection possible and Brian Hall and Jeff Liebman for providing us with their data. Yoon Chang, Yao Huang, Michele McAteer, Timothy Schwuchow, James Sigel, and Athanasios Vorvis provided outstanding research assistance. The views in this article do not necessarily reflect those of the Board of Governors of the Federal Reserve System or its staff. This work was supported by the Economic

International Evidence on Cash Holdings and Expected Managerial Agency Problems

Abstract: This paper uses detailed firm-level managerial agency cost data for a sample of over 5000 firms from 31 countries to examine whether the net costs of corporate cash holdings can outweigh the net benefits. In contrast to extant U.S. and international results, we find strong evidence that when external country-level governance is weak, outside shareholders apply a valuation discount to high cash balances carried by firms whose managers are also expected to be entrenched, but do not discount high cash levels in general. Further, in a weak external governance setting we find that dividend payments are valuable for firms whose managers are expected to be entrenched, indicating that dividends are an informative indicator of good governance when investors are least protected. Only when external governance is strong do we find that high cash holdings by entrenched managers are not associated with lower firm values, consistent with the prevailing U.S. and international evidence.

Portfolio Selection with Parameter and Model Uncertainty: A Multi-Prior Approach

Abstract: We develop a model for an investor with multiple priors and aversion to ambiguity. We characterize the multiple priors by a "confidence interval" around the estimated expected returns and we model ambiguity aversion via a minimization over the priors. Our model has several attractive features: (1) it has a solid axiomatic foundation; (2) it is flexible enough to allow for different degrees of uncertainty about expected returns for various subsets of assets and also about the return-generating model; and (3) it delivers closed-form expressions for the optimal portfolio. Our empirical analysis suggests that, compared with portfolios from classical and Bayesian models, ambiguity-averse portfolios are more stable over time and deliver a higher out-of sample Sharpe ratio. (JEL G11) Copyright 2007, Oxford University Press.

Equilibrium Underdiversification and the Preference for Skewness

Abstract: We develop a one-period model of investor asset holdings where investors have heterogeneous preference for skewness. Introducing heterogeneous preference for skewness allows the model's investors, in equilibrium, to underdiversify. We find support for our model's three key implications using a dataset of 60,000 individual investor accounts. First, we document that the portfolio returns of underdiversified investors are substantially more positively skewed than those of diversified investors. Second, we show that the apparent mean-variance inefficiency of underdiversified investors can be largely explained by the fact that investors sacrifice mean-variance efficiency for higher skewness exposure. Furthermore, we show that idiosyncratic skewness, and not just coskewness, can impact equilibrium prices. Third, the underdiversification of investors does not appear to be coincidentally related to skewness. Stocks most often selected by underdiversified investors have substantially higher average skewness--especially idiosyncratic skewness--than stocks most often selected by diversified investors. , Oxford University Press.

Portfolio Performance Manipulation and Manipulation-proof Performance Measures

Abstract: Numerous measures have been proposed to gauge the performance of active management. Unfortunately, these measures can be gamed. Our article shows that gaming can have a substantial impact on popular measures even in the presence of high transactions costs. Our article shows there are conditions under which a manipulation-proof measure exists and fully characterizes it. This measure looks like the average of a power utility function, calculated over the return history. The case for using our alternative ranking metric is particularly compelling for hedge funds whose use of derivatives is unconstrained and whose managers' compensation itself induces a nonlinear payoff.

Optimal long-term financial contracting

Abstract: We develop an agency model of financial contracting. We derive long-term debt, a line of credit, and equity as optimal securities, capturing the debt coupon and maturity; the interest rate and limits on the credit line; inside versus outside equity; dividend policy; and capital structure dynamics. The optimal debt-equity ratio is history dependent, but debt and credit line terms are independent of the amount financed and, in some cases, the severity of the agency problem. In our model, the agent can divert cash flows; we also consider settings in which the agent undertakes hidden effort, or can control cash flow risk.

How Do Diversity of Opinion and Information Asymmetry Affect Acquirer Returns

Abstract: We examine the theoretical predictions that link acquirer returns to diversity of opinion and information asymmetry. Theory suggests that acquirer abnormal returns should be negatively related to information asymmetry and diversity-of-opinion proxies for equity offers but not cash offers. We find that this is the case and that, more strikingly, there is no difference in abnormal returns between cash offers for public firms, equity offers for public firms, and equity offers for private firms after controlling for one of these proxies, idiosyncratic volatility. (JEL G31, G32, G34) This article examines whether variables suggested by diversity-of-opinion models and information asymmetry models are helpful in understanding the cross-sectional variation in acquirer announcement returns using a sample of pure equity offers and pure cash offers for public and private firmsfrom1980to2002.Wedocumentthatthesevariables,theuncertainty proxies, explain a significant fraction of the cross-sectional variation in acquirer announcement returns. Perhaps most strikingly, after controlling for the uncertainty proxies, there is no difference in abnormal returns between cash offers for public firms, equity offers for public firms, and equity offers for private firms. Using two proxies for diversity of opinion employed previously in the literature, the standard deviation of analyst forecasts and breadth of ownership, we show that bidder abnormal returns for acquisitions of

Industry Information Diffusion and the Lead-lag Effect in Stock Returns

Abstract: I argue that the slow diffusion of industry information is a leading cause of the lead-lag effect in stock returns. I find that the lead-lag effect between big firms and small firms is predominantly an intra-industry phenomenon. Moreover, this effect is driven by sluggish adjustment to negative information, and is robust to alternative determinants of the lead-lag effect. Small, less competitive and neglected industries experience a more pronounced lead-lag effect. The lead-lag effect is related to the post-announcement drift of small firms following the earnings releases of big firms within the industry.

Financial Intermediation and the Costs of Trading in an Opaque Market

Abstract: Municipal bonds trade in opaque, decentralized broker-dealer markets in which price information is costly to gather. We analyze a database of trades between broker-dealers and customers in municipal bonds. These data were only released to the public with a lag; the market was opaque. Dealers earn lower average markups on larger trades, even though dealers bear a higher risk of losses with larger trades. We estimate a bargaining model and compute measures of dealer?s bargaining power. Dealers exercise substantial market power. Our measures of market power decrease in trade size and increase in the complexity of the trade for the dealer.

Transparency and Liquidity: A Controlled Experiment on Corporate Bonds

Abstract: This article reports the results of an experiment designed to assess the impact of lastsale trade reporting on the liquidity of BBB corporate bonds Overall, adding transparency has either a neutral or a positive effect on liquidity Increased transparency is not associated with greater trading volume Except for very large trades, spreads on newly transparent bonds decline relative to bonds that experience no transparency change However, we find no effect on spreads for very infrequently traded bonds The observed decrease in transaction costs is consistent with investors’ ability to negotiate better terms of trade once they have access to broader bond-pricing data (JEL codes: G14, G18, G23, G24, G28) Although larger than the market for US Government or municipal bonds, the corporate bond market historically has been one of the least transparent securities markets in the United States, with neither pretrade nor posttrade transparency Corporate bonds trade primarily over-the-counter, and until recently, no centralized mechanism existed to collect and disseminate posttransaction information This structure changed on July 1, 2002, when the National Association of Securities Dealers (NASD) began a program of increased posttrade transparency for corporate bonds, known as the Trade Reporting and Compliance Engine (TRACE) system As part of this structural change, only a selected subset of bonds initially was subject to public dissemination of trade information The resulting experiment enables us to observe the effects of increased posttrade transparency on market liquidity in a controlled setting

Do Investors Trade More When Stocks Have Performed Well? Evidence from 46 Countries

Abstract: This article investigates the dynamic relation between market-wide trading activity and returns in 46 markets. Many stock markets exhibit a strong positive relation between turnover and past returns. These findings stand up in the face of various controls for volatility, alternative definitions of turnover, differing sample periods, and are present at both the weekly and daily frequency. The relation is more statistically and economically significant in countries with high levels of corruption, with short-sale restrictions, and in which market volatility is high. © The Author 2006.

Valuation in Over-the-Counter Markets

Abstract: We provide the impact on asset prices of search-and-bargaining frictions in over-the-counter markets. Under certain conditions, illiquidity discounts are higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, or when risk aversion, volatility, or hedging demand is larger. Supply shocks cause prices to jump, and then 'recover' over time, with a time signature that is exaggerated by search frictions: The price jump is larger and the recovery is slower in less liquid markets. We discuss a variety of empirical implications. , Oxford University Press.

Regime Shifts in a Dynamic Term Structure Model of U.S. Treasury Bond Yields

Abstract: This article develops and empirically implements an arbitrage-free, dynamic term structure model with ‘‘priced’’ factor and regime-shift risks. The risk factors are assumed to follow a discrete-time Gaussian process, and regime shifts are governed by a discrete-time Markov process with state-dependent transition probabilities. This model gives closed-form solutions for zero-coupon bond prices, an analytic representation of the likelihood function for bond yields, and a natural decomposition of expected excess returns to components corresponding to regime-shift and factor risks. Using monthly data on U.S. Treasury zero-coupon bond yields, we show a critical role of priced, state-dependent regime-shift risks in capturing the time variations in expected excess returns, and document notable differences in the behaviors of the factor risk component of the expected returns across high and low volatility regimes. Additionally, the state dependence of the regime-switching probabilities is shown to capture an interesting asymmetry in the cyclical behavior of interest rates. The shapes of the term structure of volatility of bond yield changes are also very different across regimes, with the well-known hump being largely a low-volatility regime phenomenon. (JEL G12) This article develops and empirically implements an arbitrage-free, dynamic term structure model (DTSM) with ‘‘priced’’ factor and regimeshift risks. The risk factors are assumed to follow a discrete-time Gaussian process, and regime shifts are governed by a discrete-time Markov process with state-dependent transition probabilities. Agents are assumed to know both the current state of the economy and the regime they are currently in. This leads to regime-dependent risk-neutral pricing and an equilibrium term structure that reflects the risks of both changes in the state and shifts in regimes.

Asymmetries in Stock Returns: Statistical Tests and Economic Evaluation

Abstract: We provide a model-free test for asymmetric correlations in which stocks move more often with the market when the market goes down than when it goes up, and also provide such tests for asymmetric betas and covariances. When stocks are sorted by size, book-to-market, and momentum, we find strong evidence of asymmetries for both size and momentum portfolios, but no evidence for book-to-market portfolios. Moreover, we evaluate the economic significance of incorporating asymmetries into investment decisions, and find that they can be of substantial economic importance for an investor with a disappointment aversion (DA) preference as described by Ang, Bekaert, and Liu (2005).

Governance Mechanisms and Bond Prices

Abstract: We investigate the effects of shareholder governance mechanisms on bondholders and document two new findings. First, the impact of shareholder control (proxied by large institutional blockholders) on credit risk depends on takeover vulnerability. Shareholder control is associated with higher (lower) yields if the firm is exposed to (protected from) takeovers. In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 66 basis points. Second, event risk covenants reduce the credit risk associated with strong shareholder governance. Therefore, without bond covenants, shareholder governance, and bondholder interests diverge. , Oxford University Press.

Option Market Activity

Abstract: This article uses a unique option data set to provide detailed descriptive statistics on the purchased and written open interest and open buy and sell volume of several classes of investors. We also show that volatility trading through straddles and strangles accounts for a small fraction of option trading volume and presents evidence that a large percentage of call writing is part of covered call positions. Finally, we find that during the stock market bubble of the late 1990s and early 2000 the least sophisticated investors in the data set substantially increased their purchases of calls on growth but not value stocks.

The Real Effects of Asset Market Bubbles: Loan- and Firm-Level Evidence of a Lending Channel

Abstract: This article studies how a shock to the financial health of banks, caused by a decline in the asset markets, affects the real economy. The land market collapse in Japan provides an ideal testing field in separating the impact of a loan supply shock from demand shocks. I find that banks with greater real estate exposure have to reduce lending. Firms' investment and market valuation are negatively associated with their top lender's real estate exposure. The lending channel is economically important: it accounts for one-third of lending contraction, one-fifth of the decline in investment, and a quarter of value loss.

Options and Bubbles

Abstract: The Black-Scholes-Merton option valuation method involves deriving and solving a partial differential equation (PDE). But this method can generate multiple values for an option. We provide new solutions for the Cox-Ingersoll-Ross (CIR) term structure model, the constant elasticity of variance (CEV) model, and the Heston stochastic volatility model. Multiple solutions reflect asset pricing bubbles, dominated investments, and (possibly infeasible) arbitrages. We provide conditions to rule out bubbles on underlying prices. If they are not satisfied, put-call parity might not hold, American calls have no optimal exercise policy, and lookback calls have infinite value. We clarify a longstanding conjecture of Cox, Ingersoll, and Ross.

Information Diffusion Effects in Individual Investors' Common Stock Purchases: Covet Thy Neighbors' Investment Choices

Abstract: We study the relation between households' stock purchases and stock purchases made by their neighbors. A ten percentage point increase in neighbors' purchases of stocks from an industry is associated with a two percentage point increase in households' own purchases of stocks from that industry. The effect is considerably larger for local stocks and among households in more social states. Controlling for area sociability, households' and neighbors' investment style preferences, and the industry composition of local firms, we attribute approximately one-quarter to one-half of the correlation between households' stock purchases and stock purchases made by their neighbors to word-of-mouth communication.

Asset Prices and Exchange Rates

Abstract: In this paper we study the implications of introducing demand shocks and trade in goods into an otherwise standard international asset pricing model. Trade in goods gives rise to an additional channel of international propagation|through the terms of trade|absent in traditional single-good asset pricing models. The inclusion of demand shocks helps overturn many unrealistic implications of existing international flnance models in which productivity shocks are the sole source of uncertainty. Our model generates a rich set of implications on how stock, bond, and foreign exchange markets co-move. We solve the model in closed-form, which yields a system of equations that can be readily estimated empirically. Our estimation validates the main predictions of the theory.

Risk and Return in Fixed-Income Arbitrage: Nickels in Front of a Steamroller?

Abstract: We conduct an analysis of the risk and return characteristics of a number of widely used fixed-income arbitrage strategies. We find that the strategies requiring more ‘‘intellectual capital’’ to implement tend to produce significant alphas after controlling for bond and equity market risk factors. These positive alphas remain significant even after taking into account typical hedge fund fees. In contrast with other hedge fund strategies, many of the fixed-income arbitrage strategies produce positively skewed returns. These results suggest that there may be more economic substance to fixedincome arbitrage than simply ‘‘picking up nickels in front of a steamroller.’’ During the hedge fund crisis of 1998, market participants were given a revealing glimpse into the proprietary trading strategies used by a number of large hedge funds such as Long-Term Capital Management (LTCM). Among these strategies, few were as widely used—or as painful—as fixedincome arbitrage. Virtually every major investment banking firm on Wall Street reported losses directly related to their positions in fixed-income arbitrage during the crisis. Despite these losses, however, fixed-income arbitrage has since become one of the most popular and rapidly growing sectors within the hedge fund industry. For example, the Tremont/TASS (2005) Asset Flows Report indicates that total assets devoted to fixed-income arbitrage grew by more than $9.0 billion during 2005 and that the total

Does Anonymity Matter in Electronic Limit Order Markets

Abstract: We develop a model in which limit order traders possess volatility information. We show that in this case the size of the bid-ask spread is informative about future volatility. Moreover, if volatility information is in part private, we establish that (i) the size of the bid-ask spread and (ii) its informativeness about future volatility should change in the same direction when limit order traders' identifiers stop being disclosed. We test these predictions using data from the Paris Bourse. As expected, we find that the average quoted spread and its informativeness are significantly smaller when limit order traders' identifiers are concealed. These findings suggest that the limit order book is a channel for volatility information.

Relationship Banking, Fragility, and the Asset-Liability Matching Problem

Abstract: We address a fundamental question in relationship banking: why do banks that make relationship loans finance themselves primarily with core deposits and when would it be optimal to finance such loans with purchased money? We show that not only are relationship loans informationally opaque and illiquid, but they also require the relationship between the bank and the borrower to endure in order for the bank to add value. However, the informational opacity of relationship loans gives rise to endogenous withdrawal risk that makes the bank fragile. Core deposits are an attractive funding source for such loans because the bank provides liquidity services to core depositors and this diminishes the likelihood of premature deposit withdrawal, thereby facilitating the continuity of relationship loans. That is, we show that banks will wish to match the highest value-added liabilities with the highest value-added loans and that doing so simultaneously minimizes the bank's fragility owing to withdrawal risk and maximizes the value the bank adds in relationship lending. We also examine the impact of interbank competition on the bank's asset-liability matching and extract numerous testable predictions.