Research articles for the 2019-03-06

A Risk-Assessment Framework for Art-Secured Lending
Charlin, Ventura,Cifuentes, Arturo
We identify the three types of risks involved in an art-secured lending operation and present a framework to assess their combined effects via a Monte Carlo simulation. Also, we derive some useful closed-form expressions that are suitable when the collateral consists of only one painting. To help decision-makers and risk managers, we introduce a number of risk-related metrics that provide a detailed characterization of the lending operation risk profile. We conclude that with the customary LTV ratios currently prevalent in the art-based lending business (around 50%), the lender’s exposure is quite bounded. Moreover, the advantages of having a diversified collateral, from a risk perspective, are relevant. Finally, we find that the uncertainty related to the value of the painting is much more important than the uncertainty related to either the credit risk profile of the borrower, or, the artists’ returns during the period the loan remains outstanding.

Anticipating cryptocurrency prices using machine learning
Laura Alessandretti,Abeer ElBahrawy,Luca Maria Aiello,Andrea Baronchelli

Machine learning and AI-assisted trading have attracted growing interest for the past few years. Here, we use this approach to test the hypothesis that the inefficiency of the cryptocurrency market can be exploited to generate abnormal profits. We analyse daily data for $1,681$ cryptocurrencies for the period between Nov. 2015 and Apr. 2018. We show that simple trading strategies assisted by state-of-the-art machine learning algorithms outperform standard benchmarks. Our results show that nontrivial, but ultimately simple, algorithmic mechanisms can help anticipate the short-term evolution of the cryptocurrency market.

Breaking the Word Bank: Effects of Verbal Uncertainty on Bank Behavior
Soto, Paul E.
Banks differ from non-financial firms as banks must communicate to both regulators and shareholders. Also, unlike non-financial firms, banks possess opaque and complex balance sheets and are the main providers of credit to the real economy. In this paper, I propose a new index to detect the idiosyncratic uncertainty banks face at the bank-quarter level by applying natural language processing techniques to earnings conference call transcripts. The index reveals which banks at a given quarter signal more uncertainty about their balance sheets. Higher uncertainty is associated with lower lending and higher trading the next quarter, suggesting active management of uncertainty. The active management of uncertainty is more pronounced during periods of high aggregate volatility and for banks with more skin in the game. Using loan level data and firm fixed effects, I control for demand-side factors and find that higher bank level uncertainty is associated with lower loan issuances the following quarter.

Computational aspects of robust optimized certainty equivalents and option pricing
Daniel Bartl,Samuel Drapeau,Ludovic Tangpi

Accounting for model uncertainty in risk management and option pricing leads to infinite dimensional optimization problems which are both analytically and numerically intractable. In this article we study when this hurdle can be overcome for the so-called optimized certainty equivalent risk measure (OCE) -- including the average value-at-risk as a special case. First we focus on the case where the uncertainty is modeled by a nonlinear expectation penalizing distributions that are "far" in terms of optimal-transport distance (Wasserstein distance for instance) from a given baseline distribution. It turns out that the computation of the robust OCE reduces to a finite dimensional problem, which in some cases can even be solved explicitly. This principle also applies to the shortfall risk measure as well as for the pricing of European options. Further, we derive convex dual representations of the robust OCE for measurable claims without any assumptions on the set of distributions. Finally, we give conditions on the latter set under which the robust average value-at-risk is a tail risk measure.

Convergence in Corporate Governance Toward US Model? Evidence from Global Petroleum Industries
Megginson, William L.,Sitorus, Romora Edward
The results of our empirical investigation indicate that, on average, corporate governance features in the 80 largest oil and gas companies around the world have changed considerably in the wake of the landmark case of Enron and the 2008 global financial crisis. Both listed non-U.S. firms and listed U.S. oil and gas firms have increased the proportion of outside directors on the board and have reduced CEO-Chairman duality over the period 2005-2015. This decreasing CEO-Chairman duality trend for listed U.S. firms is more pronounced after 2010 than before, possibly reflecting greater sensitivity toward the role of CEO-Chairman in corporate governance issues. Interestingly, on average, during the period 2005-2015, listed U.S. firms have higher proportions of outside directors on the board than listed non-U.S. firms do, but listed U.S. firms are also more likely to have CEO-chairman duality relative to non-listed U.S. firms. Furthermore, the relatively more stable trend of CEO-Chairman duality in listed non-U.S. firms may imply that the corporate governance trend in the listed U.S. firms may not be followed closely by some listed non-U.S. firms.

Determinants of Profitability of Bank Nifty Components, A Quantile Regression Approach
Rawlin, Rajveer
Banking stocks have been selling off of late. Lingering asset quality issues that have plagued the banking sector over the past five years have come to the fore front following a slowing economy and a weakening Rupee. The bank nifty index is a key index comprising of the largest bank stocks in India. It would prove useful to understand the key drivers of profitability of the components of this index which would throw light on the profitability of the banking sector at large. This paper studied the influence of key internal determinants on the profitability of bank nifty components over a ten-year period form 2007-2016. The profitability measure chosen was the Return on Assets. The internal determinants chosen for the study comprised of the logarithm of bank size as measured by stock market capitalization, a key lending measure the deposit/credit ratio, income measures that include interest income/average working funds and non-interest income/average working funds, a key productivity measure in business per employee, a key asset quality measure the %Net NPA and a measure of capital adequacy the capital adequacy ratio. Asset quality, capital adequacy, income measures and bank size proved to be the important drivers of profitability of bank nifty components. Stakeholders of banks should focus on these determinants as they seek to understand the rapidly evolving Indian banking landscape.

Do Fundamentals Drive Cryptocurrency Prices?
Bhambhwani, Siddharth,Delikouras, Stefanos,Korniotis, George M.
We posit that cryptocurrency prices are related to fundamentals like the computing power expended on creating their blockchains and the adoption levels of their respective blockchains. Using data for the most prominent cryptocurrencies, we find evidence of a significant long-run relationship between prices and these two fundamental factors. Conducting factor analysis, we also document that cryptocurrencies are exposed to cryptocurrency factors related to market-level computing power and market-level adoption, even after accounting for the returns of Bitcoin and cryptocurrency price momentum. Overall, our results suggest that cryptocurrencies have intrinsic value, which is related to the computing power and the adoption of their respective blockchains.

Efficient hedging under ambiguity in continuous time
Ludovic Tangpi

It is well known that the minimal superhedging price of a contingent claim is too high for practical use. In a continuous-time model uncertainty framework, we consider a relaxed hedging criterion based on acceptable shortfall risks. Combining existing aggregation and convex dual representation theorems, we derive duality results for the minimal price on the set of upper semicontinuous discounted claims.

Framing Effect of Date Format
Agarwal, Charu
“Framing Effect”, a well-studied bias in behavioral science tells us that the framing of choices influences our preference. This study examines a new frame, called date format, which is shown to affect the information diffusion in information-sensitive asset trading due to portfolio adjustment done at a preset frequency.

Institutional Activism through Jawboning: Evidence on Site Visits and Corporate Dividends
Cao, Xiaping,Wang, Hanyang,Zhou, Sili
We investigate one mode of institutional activism - site visits by institutions on firms. Corporate site visits by institutions significantly increase cash dividend payout. A battery of robust tests pinpoints the causal effect of site visits on corporate dividend pay. The effect is more pronounced at visits by shareholders and with discussions on dividend. Nevertheless, the effect substitutes for corporate internal governance to some extent. We find that the effect of site visits on dividend pay is weaker at firms with high institutional ownership and better governance. This paper suggests the positive role of institutional activism via jawboning.

Investment and the WACC: New Micro Evidence for France
Carluccio, Juan,Mazet-Sonilhac, Clément,Mésonnier, Jean-Stéphane
We exploit a new dataset of consolidated balance sheets for some 1,850, mostly nonlisted,French corporate groups, in order to investigate the relationship between corporate investment and the cost of capital. Our empirical model is motivated by a standard Q-theory of investment and relates the rate of investment to a proxy for profits, the cost of capital and firm- and sector-level controls. We notably construct firm-level measures of the weighted average cost of capital (WACC) that account for industry-specific values of the cost of equity and reflect the actual capital structure of firms. We find a confirmation that a high WACC drags down investment: a one SD increase in the real WACC (+2 pp) is associated on average with a reduction by 0.65 pp in the investment rate. The effect is somewhat larger for manufacturing firms and when firms are highly leveraged or more dependent on external finance. We also investigate the impact of lower competition or higher uncertainty on business investment and do not find evidence in support of any role of these two factors in France in recent years.

Learning the population dynamics of technical trading strategies
Nicholas Murphy,Tim Gebbie

We use an adversarial expert based online learning algorithm to learn the optimal parameters required to maximise wealth trading zero-cost portfolio strategies. The learning algorithm is used to determine the relative population dynamics of technical trading strategies that can survive historical back-testing as well as form an overall aggregated portfolio trading strategy from the set of underlying trading strategies implemented on daily and intraday Johannesburg Stock Exchange data. The resulting population time-series are investigated using unsupervised learning for dimensionality reduction and visualisation. A key contribution is that the overall aggregated trading strategies are tested for statistical arbitrage using a novel hypothesis test proposed by Jarrow et al. on both daily sampled and intraday time-scales. The (low frequency) daily sampled strategies fail the arbitrage tests after costs, while the (high frequency) intraday sampled strategies are not falsified as statistical arbitrages after costs. The estimates of trading strategy success, cost of trading and slippage are considered along with an offline benchmark portfolio algorithm for performance comparison. The work aims to explore and better understand the interplay between different technical trading strategies from a data-informed perspective.

Mergers of Service Firms
Agarwal, Charu
The paper presents the theoretical framework explaining the primary cause of mergers of the service-oriented firms. Using the example of equity analyst firms, I analyze the motivation behind these mergers. The analysis is not limited to the aforementioned type of firms and could be extended to other high-skill service-offering firms with similar characteristics (e.g., market consultants, business advisory, strategy consultant). Most of the service firms have a steady pool of client firms acquired over the years. I propose that service firms can benefit from the mergers when they expect the performance of its long-term client firms to fall in the future and the acquisition of new clients (after accounting for acquisition cost) cannot compensate for the expected drop in revenues from the existing clients. The paper also presents the empirical models to test the rationale mentioned herein.

Multiple Barrier-Crossings of an Ornstein-Uhlenbeck Diffusion in Consecutive Periods
Jiang, Yupeng,Macrina, Andrea,Peters, Gareth
We investigate the joint distribution and the multivariate survival functions for the maxima of an Ornstein-Uhlenbeck (OU) process in consecutive time-intervals. A PDE method, along- side an eigenfunction expansion is adopted, with which we are able to calculate the distribution and the survival functions for the maxima of a homogeneous OU-process in a single interval. By a deterministic time-change and a parameter translation, this result can be extended to an inhomogeneous OU-process. Moreover, we derive a general formula for the joint distribution and the survival functions for the maxima of a continuous Markov process in consecutive periods. With these results, one can obtain semi-analytical expressions for the joint distribution and the multivariate survival functions for the consecutive maxima of an OU-process with piecewise constant parameter functions. The joint distribution and the survival functions can be evaluated numerically by an iterated quadrature scheme, which can be implemented efficiently by matrix multiplications. Moreover, we show that the computation can be further simplified to the product of single quadratures if the filtration is enlarged with additional conditions. Such results may be used for the modelling of heat waves and related risk management challenges.

Opportunity Zones: An Analysis of the Policy's Implications
Lester, Rebecca,Evans, Cody,Tian, Hanna
This article summarizes the Opportunity Zone incentive in the Tax Cuts and Jobs Act by providing descriptive statistics on the selected zones, outlining considerations for investors, and using data on the New Markets Tax Credit to inform expectations of investors' responses to this policy.

Optimal Climate Strategy with Mitigation, Carbon Removal, and Solar Geoengineering
Mariia Belaia

Until recently, analysis of optimal global climate policy has focused on mitigation. Exploration of policies to meet the 1.5{\deg}C target have brought carbon dioxide removal (CDR), a second instrument, into the climate policy mainstream. Far less agreement exists regarding the role of solar geoengineering (SG), a third instrument to limit global climate risk. Integrated assessment modelling (IAM) studies offer little guidance on trade-offs between these three instruments because they have dealt with CDR and SG in isolation. Here, I extend the Dynamic Integrated model of Climate and Economy (DICE) to include both CDR and SG to explore the temporal ordering of the three instruments. Contrary to implicit assumptions that SG would be employed only after mitigation and CDR are exhausted, I find that SG is introduced parallel to mitigation temporary reducing climate risks during the era of peak CO2 concentrations. CDR reduces concentrations after mitigation is exhausted, enabling SG phasing out.

Pension Fund Board Governance and Asset Allocation: Evidence from Switzerland
Bregnard, Nadège,Salva, Carolina
We study whether pension fund board governance relates to asset allocation and show that well-governed boards have greater international diversification and lower cash holdings. In particular, boards that establish comprehensive investment policies invest more in risky assets, in foreign assets and hold less cash. These results are consistent with prudent behavior and can be explained by the limits that a comprehensive investment policy puts on the liability of trustees and by the financial expertise embedded in the process. Also, the presence of external financial experts is associated with greater diversification but their role in lowering cash holdings is limited.

Piketty's second fundamental law of capitalism as an emergent property in a kinetic wealth-exchange model of economic growth
D. S. Quevedo,C. J. Quimbay

We propose in this work a kinetic wealth-exchange model of economic growth by introducing saving as a non consumed fraction of production. In this new model, which starts also from microeconomic arguments, it is found that economic transactions between pairs of agents leads the system to a macroscopic behavior where total wealth is not conserved and it is possible to have an economic growth which is assumed as the increasing of total production in time. This last macroeconomic result, that we find both numerically through a Monte Carlo based simulation method and analytically in the framework of a mean field approximation, corresponds to the economic growth scenario described by the well known Solow model developed in the economic neoclassical theory. If additionally to the income related with production due to return on individual capital, it is also included the individual labor income in the model, then the Thomas Piketty's second fundamental law of capitalism is found as a emergent property of the system. We consider that the results obtained in this paper shows how Econophysics can help to understand the connection between macroeconomics and microeconomics.

Post-Privatization State Ownership and Bank Risk-Taking: Cross-Country Evidence
Boubakri, Narjess,El Ghoul, Sadok,Guedhami, Omrane,Hossain, Mahmud
We examine the relation between state residual ownership and bank risk-taking for privatized banks from 45 countries. Applying propensity score matching, we find that privatized banks exhibit higher risk-taking after privatization than their publicly listed counterparts. When we focus on the sample of privatized banks, we find that partially privatized banks show greater risk-taking than fully privatized banks. We also observe a positive and significant relation between residual state ownership and risk-taking. These findings are consistent with the distorted objectives associated with government control. This distortion can be mitigated by the quality of a country’s institutional and regulatory environments. Finally, our results show that the effect of state ownership on risk-taking is more pronounced in countries with a higher dominance of state-owned enterprises, and during the global financial crisis.

Religion and Terrorism: Evidence from Ramadan Fasting
Roland Hodler,Paul Raschky,Anthony Strittmatter

We study the effect of religion and intense religious experiences on terrorism by focusing on one of the five pillars of Islam: Ramadan fasting. For identification, we exploit two facts: First, daily fasting from dawn to sunset during Ramadan is considered mandatory for most Muslims. Second, the Islamic calendar is not synchronized with the solar cycle. We find a robust negative effect of more intense Ramadan fasting on terrorist events within districts and country-years in predominantly Muslim countries. This effect seems to operate partly through decreases in public support for terrorism and the operational capabilities of terrorist groups.

Sentiment Stocks
Dong, Hang,Gil-Bazo, Javier
We study how investor sentiment at the firm level affects stock returns. Using more than 58 million social media messages in the Chinese market, we construct a measure of individual stock sentiment and find that positive investor sentiment predicts higher stock risk-adjusted returns in the very short term followed by price reversals. Such a link between stock sentiment and stock returns is not explained by our sentiment measure capturing news about firm fundamentals. Exploiting a specific feature of the Chinese stock market, we isolate the causal impact of sentiment on stock returns. Furthermore, we find that the impact of investor sentiment on stock returns is mainly driven by positive sentiment. Consistent with the notion that less sophisticated investors are more prone to sentiment, we show that the impact of investor sentiment on returns is larger when sentiment is estimated using social media messages posted by non-professional investors. Finally, we find limited evidence supporting the hypothesis that the impact of sentiment is stronger for stocks that are harder to arbitrage. In sum, we find evidence that stock-specific investor sentiment affects stock prices, above and beyond the impact of market-wide sentiment.

Smoking Hot Portfolios? Self-Control and Investor Decisions
Uhr, Charline,Meyer, Steffen,Hackethal, Andreas
Self-control failure is among the major pathologies (Baumeister et al. (1994)) affecting individual investment decisions which has hardly been measurable in empirical research. We use cigarette addiction identified from checking account transactions to proxy for low self-control and compare over 5,000 smokers to 14,000 nonsmokers. Smokers self-directing their investment trade more frequently, exhibit more biases and achieve lower portfolio returns. We also find that smokers, some of which might be aware of their limited levels of self-control, exhibit a higher propensity than nonsmokers to delegate decision making to professional advisors and fund managers. We document that such precommitments work successfully.

Social Media and Political Power: Their Impact on Financial Markets
Ichev, Riste,Marinc, Matej,Massoud, Nadia
We investigate President Donald J. Trump’s unprecedented use of social media, notably Twitter, to attack, pressure, and compliment specific firms. Our results show that Trump is more likely to tweet firms from his business network, and firms that could help him in implementing or justifying his economic policy. Our study offers a setting for studying the impact of social media posts on the capital market when there is a change in political power. The findings provide new evidence showing that investors are more likely to react to social media posts released by an influential source; for example, the market’s reactions to Trump’s posts were significantly and economically stronger after he won the 2016 presidential election. Our results suggest that investors are very sophisticated in processing the relevance for firm value of information transmitted on social media.

Strict Local Martingales and the Khasminskii test for Explosions
Philip Protter,Aditi Dandapani

We exhibit sufficient conditions such that components of a multidimensional SDE giving rise to a local martingale $M$ are strict local martingales or martingales. We assume that the equations have diffusion coefficients of the form $\sigma(M_t,v_t),$ with $v_t$ being a stochastic volatility term.

The Evolution of European (EU) Banking Law under the Influence of (Public) International Banking Law: A Comprehensive Overview
Gortsos, Christos
The present study undertakes a comprehensive overview of the evolution of European (EU) banking law under the influence of public international banking law. It is structured in two Chapters. Chapter I, entitled “Public International Financial Law (Regulation)” contains four Sections: Section A gives the definition, presents the branches and undertakes a brief overview of the historical evolution of public international financial law (PIFL), in three periods. The following Section B discusses the four levels of the making and enforcement of public international financial law (political decision-making â€" adoption of the rules â€" coordination â€" indirect enforcement of rules) and its sources, with emphasis on the ‘Compendium of Standards and Codes’ of the Financial Stability Board (FSB). Section C presents then the international fora adopting international financial standards and the Committee on the Global Financial System. The Basel Committee on Banking Supervision, which is the main forum setting standards pertaining to public international banking law, is discussed in more details in Section D. Chapter II, entitled “European (EU) Banking Law (Regulation)” is more detailed and structured in six Sections: Section A gives the definition and the branches of EU financial law and then undertakes a brief overview of its historical evolution, in four periods. Appendix I discusses in more details the procedure for the making of EU financial law after the recent (2007-2009) international financial crisis. Section B presents the developments in EU financial law as a result of the ongoing fiscal crisis in the euro area, which leads to the presentation of the European Banking Union (EBU), including the pending issues in relation thereto. The following Sections C and D present, in turn and briefly, the two main pillars of the EBU, namely the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM). Section E contains then an analysis of the Deposit Guarantee Schemes Directive (DGSD) of 2014 and Section F briefly presents the Emergency Liquidity Assistance (ELA) mechanism, which refers to last resort lending to viable credit institutions in the euro area by the national central banks â€" members of the Eurosystem.

The Information Content of Fundamental News vs. Traders’ Positions in Grain Futures Markets: Evidence from WASDE and COT Reports
Bosch, David
To compare the impact of fundamental news with the publication of traders’ positions in an event study framework, a generalized autoregressive conditional heteroscedasticity (GARCH) model with t-distributed error terms is applied to corn, soybean, and wheat futures returns from January 1996 to June 2014. While fundamental news remain an important source of information for market partici-pants in grain futures markets, the results of this analysis reveal that the information content of traders’ positions from the Commitments of Traders (COT) report has gained importance in the corn and wheat futures market. The impact of traders’ positions seems to be more pronounced in grain futures markets, where the presence of commodity index traders is higher and those of professional speculators (money managers) lower.

Why Do UK Firms Repurchase Their Own Shares?
Dedman, Elisabeth,Hua, Shan,Kungwal, Thanamas
We examine the practice of share repurchases in the UK. We find that an important regulatory reform in 2003, which relaxed previously strict rules about repurchases, was followed by a significant increase in repurchase activity by UK listed firms. However, unlike in the US, repurchases remain a small proportion of total distributions to shareholders. We test five key hypotheses from prior literature. Our analysis of a large sample of firms from 2000 to 2016 provides strong support, across both regulatory regimes, for both the free cash flow and the investment hypotheses. We find some support for both the undervaluation and the leverage/capital structure hypothesis in the first regime only. In contrast to the US, the dividend substitution hypothesis is not supported. In the UK, the extent of share repurchases remains relatively small, and they appear to be used as a complement to regular dividends, being made regularly, in an amount positively associated with dividends paid.

Wikipedia and Digital Currencies: Interplay Between Collective Attention and Market Performance
Abeer ElBahrawy,Laura Alessandretti,Andrea Baronchelli

The production and consumption of information about Bitcoin and other digital-, or 'crypto'-, currencies have grown together with their market capitalisation. However, a systematic investigation of the relationship between online attention and market dynamics, across multiple digital currencies, is still lacking. Here, we quantify the interplay between the attention towards digital currencies in Wikipedia and their market performance. We consider the entire edit history of currency-related pages, and their view history from July 2015. First, we quantify the evolution of the cryptocurrency presence in Wikipedia by analysing the editorial activity and the network of co-edited pages. We find that a small community of tightly connected editors is responsible for most of the production of information about cryptocurrencies in Wikipedia. Then, we show that a simple trading strategy informed by Wikipedia views performs better, in terms of returns on investment, than classic baseline strategies for most of the covered period. Our results contribute to the recent literature on the interplay between online information and investment markets, and we anticipate it will be of interest for researchers as well as investors.