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What Drives Buyout Booms and Busts?
Buyout activity by financial investors fluctuates substantially over time. In the United States, peak years result in close to one hundred public-to-private buyout transactions and trough years in as few as ten. The typical buyout is primarily funded by debt, hence the term 'leveraged buyout' (or LBO). As a result, analysis of buyout fluctuations has focused on the availability and cost of debt financing. However, in a recent staff report, we find that the overall cost of capital, rather than debt alone, is the primary driver of buyout activity. We argue that it is the common changes in both ...
The Federal Reserve and market confidence
We discover a novel monetary policy shock that has a widespread impact on aggregate financial conditions and market confidence. Our shock can be summarized by the response of long-horizon yields to Federal Open Market Committee (FOMC) announcements; not only is it orthogonal to changes in the near-term path of policy rates, but it also explains more than half of the abnormal variation in the yield curve on announcement days. We find that our shock is positively related to changes in real interest rates and market volatility, and negatively related to market returns and mortgage issuance, ...
Buyout activity: the impact of aggregate discount rates
Buyout booms form in response to declines in the aggregate risk premium. We document that the equity risk premium is the primary determinant of buyout activity rather than credit-specific conditions. We articulate a simple explanation for this phenomenon: a low risk premium increases the present value of performance gains and decreases the cost of holding an illiquid investment. A panel of U.S. buyouts confirms this view. The risk premium shapes changes in buyout characteristics over the cycle, including their riskiness, leverage, and performance. Our results underscore the importance of the ...
Bubbles and the Value of Innovation
Episodes of booming innovation coincide with intense speculation in financial markets leading to bubbles—increases in market valuations and firm creation followed by a crash. We provide a framework reproducing these facts that makes a rich set of predictions on how speculation changes both the private and social values of innovation. We confirm the theory in the universe of U.S. patents issued from 1926 through 2010. Measures based on financial market information indicate that speculation increases the private value of innovation and reduces negative spillovers to competing firms. No ...