Research articles for the 2019-02-14

A Review of Derivatives Research in Accounting and Suggestions for Future Work
Campbell, John L.,Mauler, Landon M.,Pierce, Spencer
This paper provides a review of research on financial derivatives, with an emphasis on and comprehensive coverage of research published in 15 top accounting journals from 1996-2017. We begin with some brief institutional details about derivatives and then summarize studies explaining when and why firms use derivatives. We then discuss the evolution of the accounting rules related to derivatives (and associated disclosure requirements) and studies that examine changes in these requirements over the years. Next, we review the literature that examines the consequences of firms’ derivative use to various capital market participants (i.e., managers, analysts, investors, boards of directors, etc.), with an emphasis on the role that the accounting and disclosure rules play in such consequences. Finally, we discuss the importance of industry affiliation on firms’ derivative use and the role that industry affiliation plays in derivatives research. Overall, our review suggests that, perhaps due to their inherent complexity and data limitations, derivatives are relatively understudied in accounting, and we highlight several areas where future research is needed.

ADR Valuation and Listing of Foreign Firms in U.S. Equity Markets
Li, Shi,Li, Tianze,Mittoo, Usha R.,Song, Xiaoping,Zheng, Steven Xiaofan
We examine the decision to list in the U.S. markets by foreign firms through American Depository Receipts (ADRs). There is a high positive correlation between the valuation of existing ADRs and the number of new ADR listings next year. ADR listing is more likely when existing ADRs are valued higher. The subsequent operating and stock performance of ADR firms listed in hot years is significantly worse than those of ADR firms listed in cold years. These results are consistent with the hypothesis that market timing is an important motivation for foreign firms to list in the U.S. equity markets.

America First? A US-centric View of Global Capital Flows
McQuade, Peter,Schmitz, Martin
Both academic researchers and policymakers posit a unique role for the US in the inter-national financial system. This paper investigates the characteristics and determinants of US cross-border financial flows and examines how these contrast with those of the rest of the world. We analyse the relative importance of US, country-specific, and global variables as determinants of aggregate and bilateral US financial flows and as determinants of country-level cross-border financial flows excluding those directly involving the US. Our results indicate that variation in US variables – notably the VIX and US dollar exchange rate – has a quantitatively important influence on global financial flows, but mostly via US cross-border flows. Global and national risk indicators perform better in explaining “rest of the world†flows. Moreover, we find that the correlation between US and rest of the world flows peaks in periods of elevated uncertainty. We interpret our findings as evidence for the existence of a global financial cycle, only some of which is driven by policies and events in the US.

Banks' Non-Interest Income and Systemic Risk
Brunnermeier, Markus K.,Dong, G. Nathan,Palia, Darius
This paper finds non-interest income to be positively correlated with total systemic risk for a large sample of U.S. banks. Decomposing total systemic risk into three components, we find that non-interest income has a positive relationship with a bank’s tail risk, a positive relationship with a bank’s interconnectedness risk, and an insignificant or positive relationship with a bank’s exposure to macroeconomic and finance factors. These results are generally robust to endogenizing for non-interest income and for trading and other non-interest income activities.

Big is Not Bad
Jain, Ravi,Prasad, Dev,Poudel, Rajeeb
Our study is motivated by the continuing criticism of large banks and their role in the 2008 financial crisis. The need for the government to provide bailouts under the “Too Big to Fail†umbrella led to a negative perception associated with the term ‘big.’ This study provides an alternate perspective by examining the relation between stock market returns and asset size of bank holding companies around the crisis caused by the September 11, 2001 terrorist attacks on the World Trade Center in New York. We find evidence that larger banks experienced lower negative returns following the at-tack. This suggests that maybe “big is not bad.†The larger asset size appears to have acted as a cushion in the aftermath of the unexpected sudden shock.

Bond Liquidity, Risk Taking and Corporate Innovation
Dang, Huong ,Nguyen, Ha
This paper investigates how market liquidity condition of corporate bonds can affect firm investment policy, specifically its risk taking. We hypothesize that bond liquidity can affect firm's risk taking via the disciplinary function of trading. Indeed, we document a positive relationship between bond illiquidity and firms' risk taking, specifically a one standard deviation in Amihud illiquidity measure is associated with nearly 20% increase in investment ratio. Using introduction of TRACE in 2002 as an exogenous shock to bond trading infrastructure, our findings suggest that the relationship is causal. Finally, we document that the shift in risk taking increase the volume but not necessarily the quality of innovation output. Our empirical results have important implications for firms risk policy and growth as well as for designing of market microstructure.

Can Small Business Lending Programs Disincentivize Growth? Evidence from India's Priority Sector Lending Program
, Gursharan Bhue,Prabhala, Nagpurnanand,Tantri, Prasanna L.
Programs to direct finance to small firms are ubiquitous. We study their real-side effects for target firms, exploiting the discontinuities in eligibility in such a program in India. We show that small firm lending programs can slow real growth. Several robustness, placebo, heterogeneity, and external validation tests as well as extensive margin tests are consistent with such distortionary effects. These findings collectively show that financial constraints matter: they shape how firms form and grow. Firms give up growth for better financing access but in doing so, they distort their growth trajectories by remaining small for longer periods of time.

Characteristic Function-Based Estimation of Affine Option Pricing Models
Dillschneider, Yannick
In this paper, we derive explicit expressions for certain joint moments of stock prices and option prices within a generic affine stochastic volatility model. Evaluation of each moment requires weighted inverse Fourier transformation of a function that is determined by the risk-neutral and real-world characteristic functions of the state vector. Explicit availability of such moment expressions allows to devise a novel GMM approach to jointly estimate real-world and risk-neutral parameters of affine stochastic volatility models using observed individual option prices. Moreover, the moment expressions may be used to include option price information into other existing moment-based estimation approaches.

Closed-form expansions for option prices with respect to the mixing solution
Kaustav Das,Nicolas Langrené

We consider closed-form expansions for European put option prices within several stochastic volatility frameworks with time-dependent parameters. Our methodology involves writing the put option price as an expectation of a Black-Scholes formula and performing a second-order Taylor expansion around the mean of its argument. The difficulties then faced are computing a number of expectations induced by the Taylor expansion in a closed-form manner. We establish a fast calibration scheme under the assumption that the parameters are piecewise-constant. Furthermore, we perform a sensitivity analysis to investigate the quality of our approximation and show that the errors are well within the acceptable range for application purposes. Lastly, we derive bounds on the remainder term due to the Taylor expansion.

Corporate Governance, Employment, and Financial Performance of Japanese Firms: A Cross-Country Analysis
Arikawa, Yasuhiro,Inoue, Kotaro,Saito, Takuji
This study examines whether the sustained lower profitability and market valuation of Japanese firms compared to global peer firms can be explained by the structure of insider dominate board of directors and the employment system which hinders flexible employment adjustments by using cross-country data. Firstly we show that level of outside director ratio and flexibility of employment adjustment both differ consistently across 27 countries in the analyzed period. We show that these two factors significantly explain observed variation of financial performance across countries significantly. In addition, we show that not only do these two factors have significant explanation power over the relatively poor performance of Japanese firms, but also over the better financial performance and growth rate of US firms.

Determination of the L\'evy Exponent in Asset Pricing Models
George Bouzianis,Lane Hughston

We consider the problem of determining the L\'evy exponent in a L\'evy model for asset prices given the price data of derivatives. The model, formulated under the real-world measure $\mathbb P$, consists of a pricing kernel $\{\pi_t\}_{t\geq0}$ together with one or more non-dividend-paying risky assets driven by the same L\'evy process. If $\{S_t\}_{t\geq0}$ denotes the price process of such an asset then $\{\pi_t S_t\}_{t\geq0}$ is a $\mathbb P$-martingale. The L\'evy process $\{ \xi_t \}_{t\geq0}$ is assumed to have exponential moments, implying the existence of a L\'evy exponent $\psi(\alpha) = t^{-1}\log \mathbb E(\rm e^{\alpha \xi_t})$ for $\alpha$ in an interval $A \subset \mathbb R$ containing the origin as a proper subset. We show that if the initial prices of power-payoff derivatives, for which the payoff is $H_T = (\zeta_T)^q$ for some time $T>0$, are given for a range of values of $q$, where $\{\zeta_t\}_{t\geq0}$ is the so-called benchmark portfolio defined by $\zeta_t = 1/\pi_t$, then the L\'evy exponent is determined up to an irrelevant linear term. In such a setting, derivative prices embody complete information about price jumps: in particular, the spectrum of the price jumps can be worked out from current market prices of derivatives. More generally, if $H_T = (S_T)^q$ for a general non-dividend-paying risky asset driven by a L\'evy process, and if we know that the pricing kernel is driven by the same L\'evy process, up to a factor of proportionality, then from the current prices of power-payoff derivatives we can infer the structure of the L\'evy exponent up to a transformation $\psi(\alpha) \rightarrow \psi(\alpha + \mu) - \psi(\mu) + c \alpha$, where $c$ and $\mu$ are constants.

Dividend Payouts: Majority Control and Rent Extraction
Besim, Seniha,Adaoglu, Cahit
In Eurasia, Turkey has a “crony†capitalist system with majority control and business groups (BGs) in the hands of a few families. These business groups are often organised around a holding company. We analyse the dividend payouts of family controlled Borsa Istanbul companies, which are affiliated to holding and non-holding BGs. We investigate and quantify the effects of several control-enhancing mechanisms (CEMs) on dividend payouts. We use precise quantitative proxies for CEMs to measure the divergence between control and ownership rights. Supporting the rent extraction hypothesis, holding business group companies have lower dividend payouts as the divergence between control and ownership rights widens and the pyramid wedge increases. However, controlling foreign-family coalitions in holding business group companies curb the rent extraction problem by having a positive effect on the dividend payouts. Overall, for family controlled holding BG companies, the effects of company-specific financial control variables on dividend payouts are stronger than the effects of CEMs. For family controlled non-holding BG companies, there is no empirical support for either the rent extraction or the reputation building hypotheses. The company-specific financial control variables are the main determinants of dividend payouts for family controlled non-holding BG companies.

Does Firm Age Affect Cash Policies?
Poudel, Rajeeb,Luo, Haowen,Jain, Ravi
This study investigates the linkages between firm age and cash holdings. We document that younger firms save more cash from their cash flows, while we do not find any systematic cash saving pattern for older firms. This linkage is robust to controlling for firm size, and other control variables known to affect cash policy. Our finding is consistent with the idea that younger firms face more financing frictions than older firms and hence have stronger need to save cash.

Firms’ Rationales for CEO Duality: Evidence from a Mandatory Disclosure Regulation
Goergen, Marc,Limbach, Peter,Scholz-Daneshgari, Meik
Exploiting the 2009 amendments to Regulation S-K, we provide unique evidence on the first-time disclosure of the reasons firms state for combining (separating) the roles of CEO and chairman. The stated reasons support both agency theory and organization theory. They are more numerous and comprise more words, including more positive words, for firms with duality. Examining the announcement returns to firms’ disclosures, we find that investors evaluate the most frequently cited reasons for CEO duality by considering the firm’s characteristics.

Human Capital, Investor Trust, and Equity Crowdfunding
Barbi, Massimiliano,Mattioli, Sara
In equity crowdfunding, human capital is an important signal of a venture’s quality, as early-stage companies are risky and opaque to the market, and the crowd of investors is financially unsophisticated. Using a sample of 521 funded companies between 2011 and September 2017 on the platform Crowdcube, we show that the education, professional experience, and — more mildly — gender of team members materially affect the total capital raised, as well as the number of investors backing the initiative. Other attributes of human capital (such as volunteering experience) are instead ineffective.

Identifying Fragility for the Stock Market: Perspective from the Portfolio Overlaps Network
Lin, Li,Guo, Xin-Yu
In a financial system, the interconnectedness among entities from investing in common assets (portfolio overlaps) is considered an important channel for the propagation of systemic risk because this interconnectedness can facilitate the contagion of fire sales and lead to widespread sales as well as spiral devaluation of assets. This mechanism also applies to the stock market. Particularly, it is responsible for the presence of fragility, which is defined as the potential global instability of stock prices when confronted by a local negative shock. Thus, we propose to quantitatively explore the temporal pattern of the topological features of the portfolio overlaps network (PON) to identify fragility, with the aim of either capturing a precursor for imminent market crashes or confirming further downward falls during market turmoil. Here, PON is the projected monopartite network used to characterise the mutual overlaps between funds pairs, which is induced from the bipartite network of stocks-funds ownerships. Further, we adopt a solid statistical procedure to construct the validated PON by filtering out mildly risky connections that are not statistically robust. Based on an empirical investigation of the Chinese stock market from 2005--2018 that witnessed collective unquenchable price slumps, we found that the topology of the validated PON can indeed provide some sensible indicators for identifying market fragility. The results suggest that (i) the average closeness centrality and the critical value of effective infection rate could serve as leading indicators of impending market turmoil, and (ii) the simple degree-based measure for nodes and relative frequency measures for links are actual synchronous indicators that could also explain the source of fragility.

Listing Gaps, Merger Waves, and the New American Model of Equity Finance
Lattanzio, Gabriele,Megginson, William L.,Sanati, Ali
We document that the U.S. economy has experienced over the last 25 years sharply declining numbers of listed ï¬ rms, extraordinary volumes of mergers and of private equity investments, and abnormally high aggregate valuations for U.S. listed corporations. We synthesize and empirically analyze these trends and their interconnections and document the recent emergence of a new model of equity ï¬ nance in the United States. We show that the listing gap identiï¬ ed by Doidge, Karolyi, and Stulz (2017) was caused by an unprecedented merger wave occurring between 1997-2001, which directly reduced the number of listed ï¬ rms, and by the rise of the private equity industry, which curtailed new listings through IPOs. Our model of equity ï¬ nancing well explains changes in the number of listed U.S. ï¬ rms before and after the 1997-2001 transition to a new equilibrium. We conclude that this new model of equity ï¬ nance has yielded net ï¬ nancial and developmental beneï¬ ts for the U.S. economy, although the merger waves have increased industrial concentration and the privatization of equity ï¬ nance has almost certainly increased income inequality. We conclude by presenting preliminary evidence that this new model of equity ï¬ nancing is emerging in other developed countries.

Market Impact: A Systematic Study of the High Frequency Options Market
Ahmed Bel Hadj Ayed,Emilio Said,Ahmed Bel,Hadj Ayed,Damien Thillou,Jean-Jacques Rabeyrin,Frédéric Abergel

This paper deals with a fundamental subject that has seldom been addressed in recent years, that of market impact in the options market. Our analysis is based on a proprietary database of metaorders-large orders that are split into smaller pieces before being sent to the market on one of the main Asian markets. In line with our previous work on the equity market [Said et al., 2018], we propose an algorithmic approach to identify metaorders, based on some implied volatility parameters, the at the money forward volatility and at the money forward skew. In both cases, we obtain results similar to the now well understood equity market: Square-root law, Fair Pricing Condition and Market Impact Dynamics.

Market and Transaction Multiples’ Accuracy in the European Equity Market
Palea, Vera
In spite of their widespread use in practice, accounting-based multiples are subject of few academic studies. This paper investigates market and transaction multiples’ accuracy in corporate equity valuation by considering a sample of listed companies which are assumed to be private and evaluated according to accounting-based multiples. Since equity valuation is particularly challenging under stressed conditions, it focuses on the core period of the recent financial crisis. Results show that transaction and market multiples perform very poorly at least during financial turmoil, i.e. under the most uncertain information condition, and those relevant firm specific adjustments are necessary. Specifically, equity valuation based on multiples entails measurement errors which tend to overestimate fundamental values and to lead to more results that are volatile.

Measuring Risk Preferences and Asset-Allocation Decisions: A Global Survey Analysis
Lo, Andrew W.,Remorov, Alexander,Ben Chaouch, Zied
We use a global survey of over 22,400 individual investors, 4,892 financial advisors, and 2,060 institutional investors between 2015 and 2017 to elicit their asset allocation behavior and risk preferences. We find substantially different behavior among these three groups of market participants. Most institutional investors exhibit highly contrarian reactions to past returns in their equity allocations. Financial advisors are also mostly contrarian; a few of them demonstrate passive behavior. However, individual investors tend to extrapolate past performance. We use a clustering algorithm to partition individuals into five distinct types: passive investors, risk avoiders, extrapolators, contrarians, and optimistic investors. Across demographic categories, older investors tend to be more passive and risk averse.

Money Markets, Collateral and Monetary Policy
de Fiore, Fiorella,Hoerova, Marie,Uhlig, Harald
Interbank money markets have been subject to substantial impairments in the recent decade, such as a decline in unsecured lending and substantial increases in haircuts on posted collateral. This paper seeks to understand the implications of these developments for the broader economy and monetary policy. To that end, we develop a novel general equilibrium model featuring heterogeneous banks, interbank markets for both secured and unsecured credit, and a central bank. The model features a number of occasionally bind-ing constraints. The interactions between these constraints - in particular leverage and liquidity constraints - are key in determining macroeconomic outcomes. We find that both secured and unsecured money market frictions force banks to either divert resources into unproductive but liquid assets or to de-lever, which leads to less lending and output. If the liquidity constraint is very tight, the leverage constraint may turn slack. In this case, there are large declines in lending and output. We show how central bank policies which increase the size of the central bank balance sheet can attenuate this decline.

Multilevel nested simulation for efficient risk estimation
Michael B. Giles,Abdul-Lateef Haji-Ali

We investigate the problem of computing a nested expectation of the form $\mathbb{P}[\mathbb{E}[X|Y] \!\geq\!0]\!=\!\mathbb{E}[\textrm{H}(\mathbb{E}[X|Y])]$ where $\textrm{H}$ is the Heaviside function. This nested expectation appears, for example, when estimating the probability of a large loss from a financial portfolio. We present a method that combines the idea of using Multilevel Monte Carlo (MLMC) for nested expectations with the idea of adaptively selecting the number of samples in the approximation of the inner expectation, as proposed by (Broadie et al., 2011). We propose and analyse an algorithm that adaptively selects the number of inner samples on each MLMC level and prove that the resulting MLMC method with adaptive sampling has an $\mathcal{O}\left( \varepsilon^{-2}|\log\varepsilon|^2 \right)$ complexity to achieve a root mean-squared error $\varepsilon$. The theoretical analysis is verified by numerical experiments on a simple model problem. We also present a stochastic root-finding algorithm that, combined with our adaptive methods, can be used to compute other risk measures such as Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR), with the latter being achieved with $\mathcal{O}\left(\varepsilon^{-2}\right)$ complexity.

News Release and Volatility Spillover Effects in the Chinese Stock Index Spot Market and Index Future Market
Zhou, Xinmiao,Zhang, Junru,Zhang, Zhaoyong
This paper examines the dynamic of the stock index spot market and the future index market by providing an insight into the price discovery process and the volatility spillover effects between 2006 and 2018 using CSI300, A50 and SSE50 stock indexes, as well as their correspondent future rates in the Chinese markets. The results indicate that the stock index spot rates have the dominant predict power in the price discovery process, whereas the future index rates are not significant vice versa. Also, volatility spillover effects are found significant and bidirectional between the index spot rates and the future index rates, and the conditional volatility between the spot-future markets are highly time-varying and persistent. Our results further confirm the presence of asymmetric volatility effects, where market is more reactive to the same magnitude of shocks and persistent volatility is higher in an uptrend (bull) market than in a downtrend (bear) market. Also, co-volatility spillover effects originated from the spot markets is relatively larger than that from the future markets. Lastly, our results show that news release has significant and positive association with the dynamic conditional correlation between the index spot market and the future index market. For decision-marking, the market participants are more likely to consider macro-economic news, financial market news and firm specific news jointly rather than relying on single type of news. These findings have important implications for market efficiency and portfolio management.

Nudging Citizens through Technology in Smart Cities
Ranchordas, Sofia
In the last decade, several smart cities throughout the world have started employing Internet of Things, big data, and algorithms to nudge citizens to save more water and energy, live healthily, use public transportation, and participate more actively in local affairs. Thus far, the potential and implications of data-driven nudges and behavioral insights in smart cities have remained an overlooked subject in the legal literature. Nevertheless, combining technology with behavioral insights may allow smart cities to nudge citizens more systematically and help these urban centers achieve their sustainability goals and promote civic engagement. For example, in Boston, real-time feedback on driving has increased road safety and in Eindhoven, light sensors have been used to successfully reduce nightlife crime and disturbance. While nudging tends to be well-intended, data-driven nudges raise a number of legal and ethical issues. This article offers a novel and interdisciplinary perspective on nudging which delves into the legal, ethical, and trust implications of collecting and processing large amounts of personal and impersonal data to influence citizens’ behavior in smart cities.

Performance and Persistence in Private Equity Infrastructure Funds
Haran, Martin,Lo, Daniel,Milcheva, Stanimira
Private Equity Infrastructure Funds (PEIFs) have played an increasingly prominent role in facilitating institutional investment into infrastructure projects over the course of the last decade. In the post-GFC period, circa 10% of global infrastructure investment has been channeled into direct infrastructure via such vehicles. The unlisted infrastructure assets under management stood at $373bn at the end of December 2017 (Preqin, 2018). In spite of the marked expansion in PEIFs, there has been no rigorous evidence-based academic research analysing the performance characteristics of unlisted infrastructure funds. This paper uses individual funds’ cash flow data from Preqin to construct three measures of performance – the internal rate of return (IRR), a multiple of the total value to paid-in capital (TVPI), and a public market equivalent (PME). Similar to previous studies on private equity, the results show that the IRR does is not a good guide for explaining cash flows within the unlisted infrastructure fund industry. This can be attributed to the irregularities in cash flow timings (or reported timings ) as well as the impact that net asset value (NAV) inflation/deflation has on IRR. Using PME instead increases cash flow predictability and affords a more robust performance indicator - particularly when funds have closed but have not liquidated. Controlling for a host of fund-level variables and fixed effects, the results show that follow-on funds outperform new market entrants suggesting a momentum and learning effect in fund manager’s performance. This finding can be explained by the limited investment opportunities in the public infrastructure space as well as fund managers with multiple funds under management being able to draw upon existing networks and experience. We also find that returns persist strongly across immediate successor funds at fund manager level. However, persistence levels weaken between the initial fund and follow-up funds which are not the immediate successor - similar to what has been observed in the unlisted fund industry. Our results demonstrate that the capacity of PEIFs to raise capital is enhanced when infrastructure funds are outperforming other asset classes consistent with general literature. It is in particular the larger funds that exhibit a greater propensity to attract capital.

Rentabilidad de los Fondos de Inversión en España, 2003-2018 (Return of Mutual Funds in Spain, 2003-2018)
Fernandez, Pablo,Fernández Acín, Juan,Martinez, Mar
Spanish Abstract: La rentabilidad media de los fondos de inversión en España en los últimos 15 años (2,39%) fue inferior a la inversión en bonos del estado español a 15 años (4,55%) y a la inversión en el IBEX 35 (5,33%). 69 fondos de los 642 con 15 años tuvieron una rentabilidad superior a la de los bonos del estado a 15 años y 45 a la del IBEX 35. 17 tuvieron rentabilidad negativa. El fondo más rentable proporcionó en los últimos 15 años a sus partícipes una rentabilidad total del 282% (promedio 9,35%) y el menos rentable del -59% (promedio -5,8%). English Abstract: The average return on investment funds in Spain in the last 15 years (2.39%) was lower than investment in government bonds to 15 years (4.55%) and investment in the IBEX 35 (5.33%). 69 of the 642 funds with 15 years had a higher return than 15-year government bonds . The most profitable fund provided in the last 15 years to its investors a total return of 282% (average 9.35%) and the least profitable of -59% (average -5.8%).

Risk Premium of Social Media Sentiment
Houlihan, Patrick,Creamer, Germán G.
This research investigates the predictive capability of sentiment extrapolated from three dictionaries; financial, social media and mood states. Our findings show 1) through the Fama-Macbeth regression method, social media based sentiment measures can be used as risk factors in an asset pricing framework; 2) these sentiment measures have predictive capability when used as features in a machine learning framework, and 3) adjusting returns for market effects result in positive alpha.

Risk management with machine-learning-based algorithms
Simon Fecamp,Joseph Mikael,Xavier Warin

We propose some machine-learning-based algorithms to solve hedging problems in incomplete markets. Sources of incompleteness cover illiquidity, untradable risk factors, discrete hedging dates and transaction costs. The proposed algorithms resulting strategies are compared to classical stochastic control techniques on several payoffs using a variance criterion. One of the proposed algorithm is flexible enough to be used with several existing risk criteria. We furthermore propose a new moment-based risk criteria.

Self-Selection in Mutual Fund Strategies
Buffa, Andrea M.,Javadekar, Apoorva
This paper develops a theory of self-selection of mutual fund managers into picking and timing investment strategies. While a picking strategy involves multiple idiosyncratic bets at a time, a timing strategy entails betting on the aggregate market. This distinction implies that, in the presence of adverse selection, investors can more easily learn about the skill of a picker than the skill of a timer. Our equilibrium model with endogenous fund flows, delivers a hybrid semi-separating equilibrium in which high-skill managers always pick, while low-skill managers time with positive probability. We validate the self-selection mechanism in the data and confirm the predictions that pickers generate more value for investors, are larger, and exhibit higher flow-performance sensitivity than timers. We also confirm that market volatility causes a higher fraction of low-skill managers to time the market, while increasing the cross-sectional performance of both picking and timing strategies.

Societal Trust and Corporate Investment Efficiency
Adza, Solomon Wise Dodzidenu
The prior literature establishes that trust affects investment, however, whether it leads to investment efficiency is unaddressed. This study seeks to investigate the relationship between societal trust and corporate investment efficiency. The study documents a positive association between societal trust and corporate investment efficiency. Using data from 30 diverse countries, we present evidence that societal trust is positively related to firm’s overinvestment but has a negative relationship with firm’s under-investment. Further analysis of this study also posits a stronger relationship between trust and firm's investment efficiency for financing constraint firms. We interpret these findings as supportive evidence that higher trust is related to favorable outcomes, some being good earnings quality and greater reliability of earnings news. Furthermore, this study from the perspective of social capital literature provides an alternative explanation to investors investment decisions regarding the economic consequences of enhanced trust.

State-owned firms behind China’s corporate debt
Molnar, Margit,Lu, Jiangyuan
While China’s overall debt-to-GDP ratio is not particularly high, its non-financial corporate debt relative to GDP is higher than in other major economies. State-owned enterprises account for over three quarters of that debt with a size exceeding GDP. This paper provides insights into the size of debt, leverage and debt service burden by various non-financial SOE groupings including by size, extent of state ownership, level of the owner, broad and detailed sector and region. Although the debt stock of local SOEs increased the fastest, firms under government agencies leveraged up more quickly and their debt service burden also grew most rapidly. SOEs in services industries increased their debt fastest, in particular in social services, transportation, real estate and construction. In turn, warehousing and real estate firms have the highest leverage. Firms in the three provinces of Xinjiang, Shanxi and Qinghai rank among the top five in all the three indicators of debt to revenues, leverage and debt service burden. Large SOEs owe most debt and leveraged up, while small and medium-size ones reduced their leverage. The surge in the debt service burden of small SOEs coincided with an increase in state assets in this group of firms. Sector-wise, state assets increased most in competitive industries. Empirical analysis shows that higher leverage and labour productivity are more conducive to a surge in SOE debt. Such surges appear to be triggered by falling interest costs, pointing to the role for easy monetary conditions in the rapid SOE debt accumulation. Recent corporate governance reforms of SOEs will likely act as disciplining device on SOE borrowing.

Strategic Risk Management - A Trail of Two Strategies
McConnell, Patrick J.
In late 2012, two of the world’s Systemically Important Banks (SIBs), Barclays and Deutsche Bank, announced new Corporate Strategies at almost the same time. These announcements provide a rare opportunity in business research to study the development and execution of ‘strategy’ over time as the banks concerned operate in the same international markets with similar products. The banks are of a comparable size, operate within the same global regulatory frameworks and, while they have different national regulators, their regulatory pressures are broadly the same.Studying ‘strategy’ over time is difficult because the outcomes are situation dependent, contingent on (inter alia) the state of market competition at the time that strategy was announced, economic conditions as the strategy evolves and the achievement (or otherwise) of firm-specific objectives. In business, there are no static ‘control groups’ against which a particular strategy can be evaluated. However, the two banks studied here allow a cross-sectional, longitudinal case study of how the banks manage their ‘Strategic Risks’ i.e. risks in the environment that may derail their respective strategies. This paper is the second, in a planned sequence of four, analyzing the evolution of the two strategies over time. After summarizing the first paper in the series, which discussed Strategy Development, this paper describes, using Annual Reports and other disclosures, the state of Strategic Execution for each bank at roughly the midpoint of their chosen strategic timeframes. No judgments are made as to the likely success, or otherwise, of each bank’s strategy although it is apparent that Deutsche is progressing fairly well as regards its stated objectives, whereas Barclays is facing heavier weather in its progress. The success, or otherwise, of the long-term strategy of any ‘Too Big to Fail’ bank is important not only for shareholders but also for regulators and the general economy so the paper makes some suggestions as to how regulators may approach the monitoring of a bank’s Strategic Risks.

Temperature Volatility Risk
Donadelli, Michael,Jüppner, Marcus,Paradiso, Antonio,Schlag, Christian
We produce novel empirical evidence on the relevance of temperature volatility shocks for the dynamics of macro aggregates and asset prices. Using two centuries of UK temperature data, we document that the relationship between temperature volatility and the macroeconomy varies over time. First, the sign of the causality from temperature volatility to TFP growth is negative in the post-war period (i.e., 1950-2015) and positive before (i.e., 1800-1950). Second, over the pre-1950 (post-1950) period temperature volatility shocks positively (negatively) affect TFP growth. In the post-1950 period, temperature volatility shocks are also found to undermine equity valuations and other main macro aggregates. More importantly, temperature volatility shocks are priced in the cross section of returns and command a positive premium. We rationalize these findings within a production economy featuring long-run productivity and temperature volatility risk. In the model temperature volatility shocks generate non-negligible welfare costs. Such costs decrease (increase) when associated with immediate technology adaptation (capital depreciation).

The Altman ‘Z’ is ‘50’ and Still Young: Bankruptcy Prediction and Stock Market Reaction Due to Sudden Exogenous Shock
Poudel, Rajeeb,Prasad, Dev,Jain, Ravi
This study is motivated by the continuing popularity of the Altman Z-score as a measure of distress risk. Altman first introduced the ‘Z’ score in 1968 and 50 years later it is still going strong as a means to predicting bankruptcy. During these 50 years, academicians have studied the usefulness of the Z-score in a variety of countries and scenarios including various financial crises. This study contributes to the literature by providing a hitherto unexplored perspective through the examination of the relationship between stock market returns and the probability of bankruptcy due to an unexpected sudden shock. The terrorist attacks on September 11, 2001 on the World Trade Center in New York led to a financial crisis. Following the attack, the US stock market dropped dramatically. We find evidence that firms which had higher bankruptcy risk experienced greater negative returns following the attack. This study suggests that the Altman Z-score is likely to be useful in identifying firms with a higher risk of financial failure and consequent larger negative stock returns in the event of an exogenous sudden shock. This should prove to be useful to investors, creditors, board members and managers.

The Risk and Return Effect of a New S&P Sector
Poudel, Rajeeb,Rogers, Nina,Jain, Ravi
Changes to the S&P 500 Index have been found to provide a wealth effect to the firms included or removed from the Index. On November 10, 2014 the S&P Dow Indices announced the addition of the first new GICS sector in the S&P 500 since technology stocks became a separate sector in 1999. Equity Real Estate Investment Trusts (eREITs) would be separated from the Finance Sector creating an 11th sector. We examine the return and risk effect of the creation of the new sector. We find a divergence in the risk of firms in the new sector and the non-S&P eREITs relative to the market. The eREITs in the S&P 500 Index maintained a lower risk, while the eREITs not in the Index increased in risk.

Trend and Reversal of Idiosyncratic Volatility Revisited
Leippold, Markus,Svaton, Michal
We reexamine the evolution of the idiosyncratic volatility (IV) of US firms between 1962 and 2016. We theoretically identify three fundamental drivers for the IV: market concentration, average variance, and average correlation. Exploring the separate impacts of these drivers on IV, we find that most of the increase in IV between 1960 and 2000 documented in earlier studies is a result of microstructural biases contained in the daily returns. Consequently, the subsequent introduction of quote decimalization in 2001 caused the reversal of IV. We conclude that studies analyzing volatilities and correlations using daily data from before 2001 should be carefully revisited.