Research articles for the 2019-04-02

Acquiring Divestors
Nguyen, Giang,Pham, Viet Hung
This paper examines the relationship between targets’ asset divestitures and takeover premiums. We find that divesting targets (divestors) receive lower offered premiums, experience less positive announcement returns, and have a trade discount relative to non-divesting targets. We show that the efficiency of divestitures explains the effects. Specifically, they are more pronounced when targets divest assets more efficiently, operate in non-competitive industries, or announce divestitures before Sarbanes Oxley Act. We further document that the neo-agency view “eat or be eaten” is only partially supported. Asset divestitures have no significant effects on transaction synergies and acquirer announcement returns. Overall, our findings support the view that asset divestitures increase target efficiency that deter the interest of potential bidders.

Answer to 'Consultation on Certain Aspects of Fallbacks for Derivatives Referencing GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR and BBSW' Issued by ISDA
Henrard, Marc P. A.
This note is an answer the consultation published by ISDA regarding the amendment of documentation to implement fallbacks for certain key IBORs. The answers refer to many technical issues. More details about those issues can be found in the technical note 'A quant perspective on IBOR fallback proposals'.

Asymmetric Loan Loss Provisioning
Basu, Sudipta,Vitanza, Justin,Wang, Wei
Banks’ loan loss provisions have a V-shaped relation with changes in loan portfolio quality, i.e., decreases in nonperforming loans are associated with increases in loan loss provisions. The accounting for loan charge-offs partly explains this asymmetry. We argue that the residual asymmetry is caused by conditional conservatism. Loan loss provision asymmetry is greater for banks with more high-risk construction loans, shorter-maturity loans and for public banks, and is more pronounced during economic downturns and in the fourth quarter, consistent with the predictable effects of conditional conservatism. Modeling this asymmetry changes inferences from prior banking research that incorrectly assumed linearity.

Bayesian Trading Cost Analysis and Ranking of Broker Algorithms
Vladimir Markov

We present a formulation of the transaction cost analysis (TCA) in the Bayesian framework for the primary purpose of comparing broker algorithms using standardized benchmarks. Our formulation allows effective calculation of the expected value of trading benchmarks with only a finite sample of data relevant to practical applications. We discuss the nature of distribution of implementation shortfall, volume-weighted average price, participation-weighted price and short-term reversion benchmarks. Our model takes into account fat tails, skewness of the distributions and heteroscedasticity of benchmarks. The proposed framework allows the use of hierarchical models to transfer approximate knowledge from a large aggregated sample of observations to a smaller sample of a particular algorithm.

Being True to Trulia: Do Disclosure-Only Settlements in Merger Objection Lawsuits Harm Shareholders?
Dari‐Mattiacci, Giuseppe,Talley, Eric L.
A significant debate within mergers and acquisitions law concerns the explosive popularity of the “merger objection lawsuit” (MOL), a shareholder action seeking to enjoin an announced deal on fiduciary duty grounds. MOLs blossomed during the Financial Crisis, becoming popularly associated with “shareholder shakedowns,” whereby quick-triggered plaintiff attorneys would file against â€" and then rapidly settle with â€" acquirers, typically on non-monetary terms containing modest added disclosures in exchange for blanket class releases and attorney fee awards. This practice unleashed a torrent of criticism from lawyers, commentators, academics, and (ultimately) judges, culminating in a doctrinal shift in Delaware law in the January 2016 Trulia opinion, which virtually prohibited disclosure-only settlements. This paper investigates the implications of this doctrinal shock from a shareholder welfare perspective. We argue that â€" notwithstanding the intuitive appeal of prohibiting / discouraging disclosure settlements â€" it is far from clear whether doing so helps or hurts target shareholders ex ante, since the threat of MOLs interacts with other intra-corporate agency costs (such as those of managers and buyers negotiating deals). Reducing the credibility of a litigation threat may deter shakedowns at the cost of reduced deal premia and shareholder value â€" consequences inconsistent with conventional commitments of corporate law. We develop a theoretical model of company acquisitions formally demonstrating that the competing equilibrium effects of Trulia are indeterminate, an insight that hoists a flag of caution regarding the doctrinal innovation. Moreover, our model delivers testable implications related to Trulia, which we investigate empirically. Our empirical analysis suggest that the recent doctrinal shock does not appear to have resulted in a discernible increase to target shareholder welfare.

Consistent Inference for Predictive Regressions in Persistent Economic Systems
Andersen, Torben G.,Varneskov, Rasmus Tangsgaard
This paper studies standard predictive regressions in economic systems governed by persistent vector autoregressive dynamics for the state variables. In particular, all -- or a subset -- of the variables may be fractionally integrated, which induces a spurious regression problem. We propose a new inference and testing procedure -- the local spectrum (LCM) approach -- for joint significance of the regressors, that is robust against the variables having different integration orders. The LCM procedure is based on fractional filtering and band spectrum regression using a suitably selected set of frequency ordinates. Contrary to existing procedures, we establish a uniform Gaussian limit theory and a standard χ2-distributed test statistic. Using the LCM inference and testing techniques, we explore predictive regressions for the realized return variation. Standard least squares inference indicates that popular financial and macroeconomic variables convey valuable information about future return volatility. In contrast, we find no significant evidence using our robust LCM procedure. If anything, our tests support a reverse chain of causality, with rising financial volatility predating adverse innovations to key macroeconomic variables. Simulations are employed to illustrate the relevance of the theoretical arguments for finite-sample inference.

Consumption Growth Predictability and Asset Prices
Roh, Tai-Yong,Lee, Changjun,Min, Byoung-Kyu
We derive and test a consumption-based intertemporal asset pricing model in which an asset earns a risk premium if it performs poorly when expected future consumption growth deteriorates. The predictability of consumption growth combined with the recursive preference delivers news about future consumption growth an additional risk factor, in addition to news about current consumption growth. We model the consumption growth dynamics using a vector autoregressive (VAR) structure with a set of instrumental variables commonly used for forecasting future economic growth. Our VAR estimation provides strong empirical support for future consumption growth predictability. The cross-sectional test shows that the model explains reasonably well the dispersion in average excess returns of 25 portfolios sorted on size and book-to-market, as well as 25 portfolios sorted on size and long-term return reversal. Growth stocks and long-term winners underperform value stocks and long-term losers, respectively, because growth stocks and long-term winners hedge adverse changes in the future consumption growth opportunities.

Determinants of Financial Inclusions: Comparing High, Middle, and Low-Income Countries
Chu Khanh, Lan
The objective of this paper is to examine determinants of financial inclusion in high, middle, and low-income countries. We use the World Bank’s 2017 Global Financial Inclusion database and apply probit estimation for different measures of financial inclusion, including account, payment, saving, and borrowing. For the combined sample, we find that being a man, more educated, richer, employed, and older to a certain age increases the likelihood of access to formal financial services. For the three subsamples, the impact of education and income on the likelihood of saving and borrowing formally is highest in high-income countries and lowest in low-income countries but the ranking is reverted for formal account and payment. However, the magnitude of impact increases with the level of education and income in each of sub-group country for all four formal financial inclusion measurements. Our finding also supports the view that substitution between formal and informal credit is based on income level.

Determinants of Public Debt and the Role of Energy: A Cross-Country Analysis
Sadik-Zada, Richard Elkhan,Gatto, Andrea
This paper investigates the major drivers of the public debt growth in 184 countries. Our analysis consists in a cross-country survey, which is conducted on the basis of the improved compilation of datasets on the central government debt for 2013. In order to differentiate between developing/transition and advanced countries, we generate dummy variables for the different country groups. Following existing literature, we employ military expenditure as a share of GNP, as a proxy of existent or potential conflict, induced driver of the public expenditure. The study finds that oil abundance, economic growth rate, the share of mineral rent in the total revenue, interest rate payments for foreign borrowings, and developing country dummy have statistically significant impact on the growth of the public debt. In contrast, defense spending, unemployment rate, and inflation rate do not have a statistically significant positive impact on the public debt rate.

Disaster Risk Finance in Developing Countries: An Overview With Particular Reference to Indonesia
Courty, Laurent,He, Chusu,Hillier, John,Lock, Russell,Milne, Alistair,Park, Seyoung,Slater, Louise,Soetanto, Robby
While an ‘ex-ante’ approach to natural disasters is always desirable, in most developing countries this requires external provision of disaster risk finance. Indonesia is different. Its large economy means it can largely diversify its substantial exposure to natural disaster losses at national level, through government budgeting or private insurance. Simple ‘economic capital’ based catastrophe finance calculations price risk transfer instruments sufficiently well for application in developing countries. This with data from Indonesia’s active community mapping movement and InaSafe software developed for Indonesian disaster management can help overcome substantial institutional barriers to the adoption of insurance or other risk transfer instruments.

Dispersion of Beliefs, Ambiguity, and the Cross-Section of Stock Returns
Lee, Deok-Hyeon,Min, Byoung-Kyu,Kim, Tong Suk
We examine whether ambiguity is priced in the cross-section of expected stock returns. Using the cross-sectional dispersion in real-time forecasts of real GDP growth as a measure for ambiguity, we find that high ambiguity beta stocks earn lower future returns relative to low ambiguity beta stocks. This negative predictive relation between the ambiguity beta and future returns is consistent with theory, which predicts the marginal utility of consumption to rise when ambiguity is high. We further show that the ambiguity premium remains significant after controlling for exposures to expected real GDP growth, VIX, and financial market dislocations index.

Estimating Cost Savings from Early Cancer Diagnosis
Zura Kakushadze,Rakesh Raghubanshi,Willie Yu

We estimate treatment cost-savings from early cancer diagnosis. For breast, lung, prostate and colorectal cancers and melanoma, which account for more than 50% of new incidences projected in 2017, we combine published cancer treatment cost estimates by stage with incidence rates by stage at diagnosis. We extrapolate to other cancer sites by using estimated national expenditures and incidence rates. A rough estimate for the U.S. national annual treatment cost-savings from early cancer diagnosis is in 11 digits. Using this estimate and cost-neutrality, we also estimate a rough upper bound on the cost of a routine early cancer screening test.

Fund Flow Diversification: Implications for Asset Stability, Fee-Setting and Performance
Casavecchia, Lorenzo,Kang, Byoung Uk,Tiwari, Ashish
We provide new evidence on the economic benefits to mutual fund families from having a portfolio of funds with diversified investor fund flows. We show that diversified fund families enjoy greater stability of assets under management, and experience significantly lower net cash outflows during an economic downturn. Given concave advisory fee schedules, the dominant industry fee structure, a reduction in asset volatility is potentially advantageous for family-level fee revenues. Consistent with this notion, we show that fund families with more diversified fund flows are able to strategically charge more competitive advisory fees across their funds. Our findings suggest that the diversification of fund families’ asset flows is an important source of net performance gains for fund shareholders. These gains arise mostly in the more competitive industry segments.

International Debt Shifting: The Value Maximizing Mix of Internal and External Debt
Møen, Jarle,Schindler, Dirk,Schjelderup, Guttorm,Tropina, Julia
We study the capital structure of multinationals and expand previous theory by incorporating international debt tax shield effects from both internal and external capital markets. We show that: (i) multinationals' firm value is maximized if both internal and external debt are used to save tax; (ii) the use of internal and external debt is independent of each other; (iii) multinationals have a tax advantage over domestic firms, which cannot shift debt across international borders. We test our model using a large panel of German multinationals and find that internal and external debt shifting are of about equal importance.

KiwiSaver Fund Performance and Asset Allocation Policy
Dang, Huong D.
This study examines the performance and asset allocation policy of 70 KiwiSaver funds labelled as Growth, Balanced or Conservative over the period October 2007- June 2016. On average, funds underperform their respective benchmarks, with the mean quarterly excess return (after management fees) of -0.15% (Growth), -0.63% (Balanced) and -0.83% (Conservative). Benchmark returns variability, on average, explains 43%-78% of fund’s across-time returns variability, and this is primarily driven by fund’s exposures to global capital markets. Differences in benchmark policies, on average, account for 18.8%-39.3% of among-fund returns variation while differences in fees and security selection may explain the rest. About 61% of Balanced and 47% of Growth funds’ managers make selection bets against their benchmarks. There is no consistent evidence that more actively managed funds deliver higher after-fee risk-adjusted performance. Superior performance is often due to randomness and does not attract additional managed funds, except for the top quintile of Growth funds.

Modeling, discretization, and hyperchaos detection of conformable derivative approach to a financial system with market confidence and ethics risk
Baogui Xin,Wei Peng,Yekyung Kwon,Yanqin Liu

A new chaotic financial system is proposed by considering ethics involvement in a four-dimensional financial system with market confidence. A five-dimensional conformable derivative financial system is presented by introducing conformable fractional calculus to the integer-order system. A discretization scheme is proposed to calculate numerical solutions of conformable derivative systems. The scheme is illustrated by testing hyperchaos for the system.

Parliamentary Elections and Frontier Stock Markets: Evidence from Stock Market Reaction to General Elections in the Commonwealth Caribbean
Robinson, C Justin,Bangwayo-Skeete, Prosper
This study is the first to investigate stock price reaction to parliamentary elections in the Commonwealth Caribbean. The study finds that parliamentary elections have a statistically significant effect on stock prices in the Bahamas, Barbados, Jamaica and Trinidad and Tobago, but no effect in the Eastern Caribbean and Guyana. The evidence suggests that equity investors in the Bahamas, Barbados, Jamaica and Trinidad and Tobago have an opinion on the prospects for their investments under different political administrations and these opinions are expressed through the trading of shares around the election cycle. However, the results do not provide support for the notion of an ‘election cycle pat- tern’, that is, a general increase in stock prices around the election cycle, and except in the case of Jamaica, where the stock market appears to disapprove of the People’s National Party (PNP), the results do not provide support for a ‘political party pattern’, that is, a preference among equity inves- tors for a particular political party across the different countries.

Policy News and Stock Market Volatility
Baker, Scott R.,Bloom, Nicholas,Davis, Steven J.,Kost, Kyle
We create a newspaper-based Equity Market Volatility (EMV) tracker that moves with the VIX and with the realized volatility of returns on the S&P 500. Parsing the underlying text, we find that 72 percent of EMV articles discuss the Macroeconomic Outlook, and 44 percent discuss Commodity Markets. Policy news is another major source of volatility: 35 percent of EMV articles refer to Fiscal Policy (mostly Tax Policy), 30 percent discuss Monetary Policy, 25 percent refer to one or more forms of Regulation, and 13 percent mention National Security matters. The contribution of particular policy areas fluctuates greatly over time. Trade Policy news, for example, went from a virtual nonfactor in equity market volatility to a leading source after Donald Trump’s election and especially after the intensification of U.S-China trade tensions. The share of EMV articles with attention to government policy rises over time, reaching its peak in 2017-18. We validate our measurement approach in various ways. For example, tailoring our EMV tracker to news about petroleum markets yields a measure that rises and falls with the implied and realized volatility of oil prices.

Price Pressure and Efficiency on FOMC Announcements
Boguth, Oliver,Gregoire, Vincent,Martineau, Charles
We examine the impact of the surge in trading activity following FOMC announcements on price discovery in the equity market, in particular in the highly liquid S&P 500 E-mini futures. In contrast to the hypothesis that all trading reflects learning about these public news announcements, we find that trading is associated with a decrease in price informativeness and order imbalances generate substantial price reversals reaching 60 basis points even at horizons of several hours. Our findings show that price pressure is prevalent in the most liquid assets following public news and have direct implications for measuring the impact of monetary policy news on equity prices.

Quintet Volume Projection
Vladimir Markov,Olga Vilenskaia,Vlad Rashkovich

We present a set of models relevant for predicting various aspects of intra-day trading volume for equities and showcase them as an ensemble that projects volume in unison. We introduce econometric methods for predicting total and remaining daily volume, intra-day volume profile (u-curve), close auction volume and special day seasonalities and emphasize a need for a unified approach where all sub-models work consistently with one another. Historical and current inputs are combined using Bayesian methods, which have the advantage of providing adaptive and parameterless estimations of volume for a broad range of equities while automatically taking into account uncertainty of the model input components. The shortcomings of traditional statistical error metrics for calibrating volume prediction are also discussed and we introduce Asymmetrical Logarithmic Error (ALE) to overweight an overestimation risk.

Reconciling Indirect and Long-Horizon Tests of Return Predictability
McLoughlin, James
The statistical evidence supporting the hypothesis that returns are predictable is mixed when returns are directly regressed on the dividend-price ratio. One response in the literature has been to employ indirect tests, which use a present-value identity to transpose the null hypothesis that returns are unpredictable onto dividend-growth forecasting regressions. By bootstrapping asymptotically pivotal test statistics that incorporate all of the uncertainty in parameter estimates, I show that indirect tests do not provide more significant evidence against the null hypothesis. Similarly, I show that in the context of the standard return forecasting model with a persistent endogenous regressor, long-horizon return predictability tests produce results that are nearly identical, at all horizons, to tests that use one-period regressions.

Stock Selection Timing
Jiang, George J.,Zaynutdinova, Gulnara R.,Zhang, Huacheng
We argue that active fund managers can pick stocks only when the market presents such opportunities. We propose measures of stock selection opportunity and show evidence that a significant portion of mutual funds time stock selection, i.e., trading more when stock selection opportunities are present. We show that positive timers outperform negative timers by about 1% in annualized four-factor alpha over the subsequent six-month horizon and, more importantly, stock selection timing adds value to investors even after controlling for fund manager stock-picking talent. Finally, we show that funds with higher expense ratios and larger family size exhibit stronger timing skills.

The CAPM Holds
Hasler, Michael,Martineau, Charles
When investors' hedging demands are equal to zero, the conditional risk premium of an asset is equal to its conditional market beta times the conditional risk premium of the market (Merton, 1973). We empirically test this dynamic CAPM relation on portfolios and individual stocks using both daily and monthly returns. We show that regressing an asset excess return onto the product of its conditional beta and the market excess return yields an intercept of zero, a slope of one, and an R2 of about 80%. That is, the data lend support to the null hypothesis that the dynamic CAPM holds.

The Cape of Good Homes: Exchange Rate Depreciations, Foreign Demand and House Prices
Davids, Allan,Georg, Co-Pierre
We study the discount foreign investors receive buying real estate in an emerging market following large sudden exchange rate depreciations using transaction level data for the city of Cape Town, South Africa. Foreign non-residents purchase properties in more expensive, coastal suburbs, and purchase more expensive properties within these suburbs. While foreign non-residents do not pay higher prices on average, they realize significantly lower capital gains than residents upon resale. Using historically large depreciations as positive shocks to foreign non-resident demand, we find that areas with large pre-existing populations of foreign born citizens experience notable quality-adjusted price increases relative to other geographically close areas in the month following the depreciations. Despite this, we find no evidence that this increase in demand leads to increases in prices for local buyers.

The Information Content of Quotes in High Frequency Order Driven Markets
Pani, Sudhanshu Sekhar
This paper investigates the information content present in the quotes in an order driven market without the presence of designated market makers. A representation is proposed that recognises the ability of participants in such markets to observe market events and calibrate their quoting activity. The public signal of the asset price formed after a general consensus among participants is seen to be a part of the price system. Information aggregates into the public signal with a low frequency to negate microstructure and trading effects.

The Information Provision in the Corporate Acquisition Process: Why Target Firms Obtain Multiple Fairness Opinions
Liu, Tingting
Using a hand-collected dataset for takeovers from 1996 to 2013, I examine why some target firms obtain a second fairness opinion and the associated wealth effects of doing so. I find that multiple opinions are more likely to be used in deals in which management/investment bank conflicts of interest are high -- e.g., buyouts and stapled financing deals. In addition, the use of a second opinion has a significantly positive impact on target shareholders’ wealth in these two types of deals. Fairness opinion valuation predominantly relies on accounting data and the benefit of seeking a second opinion increases with a firm’s earnings quality. Collectively, the results suggest that a second opinion is used to facilitate transactions.

The Relationship Dilemma: Organizational Culture and the Adoption of Credit Scoring Technology in Indian Banking
Mishra, Prachi,Prabhala, Nagpurnanand,Rajan, Raghuram G.
Credit scoring was introduced in India in 2007. We study the pace of its adoption by new private banks (NPBs) and state-owned or public sector banks (PSBs). NPBs adopt scoring quickly for all borrowers. PSBs adopt scoring quickly for new borrowers but not for existing borrowers. Instrumental Variable (IV) estimates and counterfactuals using scores available to but not used by PSBs indicate that universal adoption would reduce loan delinquencies significantly. Evidence from old private banks suggests that neither bank size nor government ownership fully explains adoption patterns. Organizational culture, possibly from formative experiences in sheltered markets, explains the patterns of technology adoption.