Research articles for the 2019-04-05

A Tale of Two Returns: Stock and Investment Returns with Investment Specific Technology Shocks
Jayasuriya, Dulani
This study incorporates capital heterogeneity and investment specific technology (IST) shocks in to a production based asset pricing model to derive the relationship between aggregate stock returns, aggregate investment returns, equipment and structure investment returns. The model is calibrated to annual and quarterly U.S. National Income and Product Account data. Annual structure and equipment investment returns are approximately around 1.003% and 0.99% while the correlation with aggregate stock returns are approximately around 0.62 and -0.41. The risk return trade-off is approximately 47% and 38% for structure and equipment investment returns respectively. Both types of returns significantly forecast economic growth. IST shocks account for approximately 65% of fluctuations in equipment investment returns and around 30% of fluctuations in aggregate investment returns. The model implications support a predictability theory of stock returns. Finally, the results provide considerable support in favour of Q-Theory of Investments.

Ambiguity Aversion in Competitive Insurance Markets with Asymmetric Information
Peter, Richard,Richter, Andreas,Thistle, Paul D.
We analyze the effect of ambiguous loss probabilities on competitive insurance markets with asymmetric information. We characterize equilibria under actuarially fair pricing with preferences that are second-order ambiguity averse (have smooth indifference curves). We also show existence of uniqueness of the second-best contracts and provide a characterization. Non-increasing absolute ambiguity aversion is sufficient for adverse selection in the smooth model. We then determine the effect of ambiguity on equilibrium under ambiguity aversion. There is a coverage effect because ambiguity relaxes the self-selection constraint and raises the available coverage for the low risks, and an ambiguity effect because ambiguity makes ambiguity averse agents worse off. Both effects are conflicting when it comes to their impact on the critical pro-portion of high risks required for a Rothschild-Stiglitz equilibrium to exist and social welfare. We derive conditions that allow to resolve the indeterminate social welfare effect.

Annual Report Readability and Stock Liquidity
Boubaker, Sabri,Gounopoulos, Dimitrios,Rjiba, Hatem
We examine the effect of annual report textual complexity on firms' stock liquidity. Using techniques from computational linguistics, we predict and find that less readable filings are associated with lower stock liquidity. Our study provides evidence that difficult‐to‐read annual reports hinder investors' ability to process and analyze information contained in corporate annual reports, reducing thereby their willingness to trade which decreases stock liquidity. Our findings are robust to a battery of sensitivity tests, including endogeneity, use of alternative estimation techniques, and use of alternative liquidity and readability proxies.

Betting on Leverage
Cornaggia, Kimberly Rodgers,Simin, Timothy T.,Sonmez-Leopold, Fatma
We combine classic corporate finance theory of capital structure with an asset pricing theory of leverage-constrained investors to explain why CAPM beta is negatively related to abnormal stock returns. Current theory explaining this anomaly suggests that leverage constrained investors tilt portfolios towards high-beta stocks. With a stylized analytical model and simulation, we show leverage-constrained investors rationally tilt investment, not towards high-beta firms generally but specifically towards those with high financial leverage. The advantage to adding levered firms, rather than an unlevered firms with comparably high betas, comes through lower covariance of the levered assets with the market portfolio. Informed by a continuous-time capital structure model, we estimate the varying impact of firm-level financial leverage on market risk measures and document two novel contributions. First, we find no remaining evidence of the anomalous low returns to high beta stocks. Second, we formally test an adjusted model of leverage-constrained investors and conclude that such constraints have practical implications for investors and for asset pricing models.

Can Loan Valuation Adjustment (LVA) Approach Immunize Collateralized Debt from Defaults?
Wojakowski, Rafal M.,Ebrahim, M. Shahid,Jaafar, Aziz,Salleh, Murizah Osman
This study focuses on structuring tangible asset backed loans to inhibit their endemic option to default. We adapt the pragmatic approach of a margin loan in the configuring of collateralized debt to yield a quasi‐default‐free facility. We link our practical method to the current Basel III (2017) regulatory framework. Our new concept of the Loan Valuation Adjustment (LVA) and novel method to minimize the LVA converts the risky loan into a quasi risk‐free loan and achieves value maximization for the lending financial institution. As a result, entrepreneurial activities are promoted and economic growth invigorated. Information asymmetry, costly bailouts and resulting financial fragility are reduced while depositors are endowed with a safety net equivalent to deposit insurance but without the associated moral hazard between risk‐averse lenders and borrowers.

Capital Structure Management by Share Repurchase for Companies in Emerging Markets
Kulik, Julia,Makarova, Svetlana
According to foreign research into developed markets, share repurchasing influences the speed of adjustment of companies’ capital structure to the target level. It is worth noting that the number of such research studies for emerging markets is rather small.On the basis of an empirical study of a selection of 275 companies from BRICS countries involved in share repurchase for the period of 2005 to 2015 we prove here that share repurchase is an efficient method of correcting an existing capital structure, aligning it to approximate a target level in all BRICS countries. It should be noted that in accordance with our results, companies from Brazil and Russia show the highest speed of adjustment (within 63â€"80%). This indicates that these companies are able to achieve the target structure within a very short period. Companies from the other countries (India, China, and South Africa) also show a rather high rate of the speed of adjustment (in the range of 44 to 49%).It is worth noting that apart from the share repurchase itself, characteristic features of the companies (as well as special characteristics of local economic factors where they are relevant) influence the speed of adjustment to the target capital structure. We also found out that the most significant factors which have positive effects on the speed of adjustment are the company size, its growth prospects, share of repurchased shares, economic growth rate, inflation rate in the country which adversely affect to a great extent the speed of adjustment to the target capital structure. For Russian companies the most significant determinants are the company size, share of repurchased shares and inflation rate.An assessment of the speed of adjustment to the target capital structure of companies repurchasing shares showed that for Russian companies (for a balance sheet leverage) and for South African companies (for a market financial leverage) the speed of adjustment is not significant, however in general the countries selection and each sub-selection shows that BRICS countries’ companies are prone to adjust to the target capital structure quicker when the financial leverage is lower than the target value, while companies with an excess debt load optimize much slower.On the basis of the research results we offer an algorithm pertaining to capital structure management for the companies acting in emerging markets using share repurchase in an open market.

Competition and Risk‐Taking in Investment Banking
Degl'Innocenti, Marta,Fiordelisi, Franco,Girardone, Claudia,Radic, Nemanja
How does competition affect the investment banking business and the risks individual institutions are exposed to? Using a large sample of investment banks operating in seven developed economies over 1997–2014, we apply a panel VAR model to examine the relationships between competition and risk without assuming any a priori restrictions. Our main finding is that investment banks' higher risk exposure, measured as a long‐term capital‐at‐risk and return volatility, was facilitated by greater competitive pressures for both boutique investment banks and full‐service investment banks. Overall, we find some evidence that more competition leads to more fragility before and during the recent financial crisis.

Determinants of the Venture Investment Size in Russian IT Companies
Rodionov, Ivan,Semenov, Alexander S.,Seleznev, Vladimir
This study investigates the key determinants of the size of investment in Russian IT companies during follow-on rounds starting from the second round. On a sample of 55 deals (2010â€"2016), which represents the most important deals on Russian market, the research finds out two key factors positively influencing the size of investments: investments in the first round and presence of experienced investor among shareholders. e investor was considered as experienced if she has had success on VC market or has a totally accepted reputation on the same market. Results are consistent with the prior literature including the preliminary results of the authors done on lesser datasets. Additionally, effects of belonging to a particular industry or the time period of investments were proved to be insignificant for Russian VC market for IT companies. New hypothesis proposed by the authors (about impact of the number of founders on the investment in sub-sequent rounds) as well as hypothesis about the impact of target market growth on the investment size are also rejected. The latter is surprising as the target market growth is considered among the most important criteria for the investment decision. The result may be explained by the bias of the dataset as most of the early stage company data is confidential, and the target market growth plays the most significant role at the beginning of investment process.

Downside Risk Sensitivity and Conditional Stochastic Dominance in Euro Area Stock Markets
da Fonseca, José S.
This article compares portfolio selection based on the downside risk sensitivity with portfolio selection based on Sharpe or Treynor ratios. Downside risk sensitivity (DRS) is given by an asset pricing model in which the downside and upside market returns are separated variables relative to target return. While CAPM, Sharpe ratios and Treynor ratios are based on symmetric risk aversion in both sides of the expected return of the market portfolio, the assumption underlying downside risk sensitivity is that investors utility functions weight losses more heavily s than gains relative to the target return.The methodology used consists of making alternate estimations using a downside-upside risk model (DURM) and CAPM. Portfolios based on DRS, Sharpe ratios and Treynor ratios DRS were created and their composition is updated using the output of rolling estimations of the asset pricing models. The ex post returns of portfolios based on the three alternate methods of portfolio selection are evaluated comparatively by conditional Sharpe ratios which provide information about the conditional stochastic dominance between them.We found that portfolio selection based on downside risk sensitivity gives better protection against losses and better global performance than portfolios based on Sharpe ratios and Treynor ratios.

Economic Volatility and Financial Markets: The Case of Mortgage‐Backed Securities
Antinolfi, Gaetano,Brunetti, Celso
The volatility of aggregate economic activity in the United States decreased markedly in the mid‐eighties. The decrease involved several components of GDP and has been linked to a more stable economic environment, identified by smaller shocks, more effective policy, and a diverse set of innovations in technology as well as financial markets. We study one such financial innovation, and document a negative relation between the rapid growth of mortgage‐backed securities and the volatility of GDP and some of its components from the mid‐1970s to the late 1990s. We also document that this relation changed sign, from negative to positive, in the early 2000s.

Faktorët kryesorë, që ndikojnë në kërkesën për kredi hipotekore (The Main Factors That Affect the Mortgage Loans’ Demand)
Bylo, Ardita
Albanian Abstract: Për shumë prej nesh, blerja e një shtëpie është një nga vendimet më të rëndësishme si dhe ndonjëherë transaksioni më i madh financiar që mund të bëhet në jetë. Të qartësosh pyetjet përpara se të zgjedhësh një kredi do të thotë të bësh krahasimin mes marrjes së një kredie që mund ta përballosh dhe humbjen e të drejtës mbi pronën. Zhvillimi dhe zgjerimi i tregut bankar gjatë viteve të fundit, me krijimin e produkteve dhe programeve të reja, e ka bërë të rëndësishëm kuptimin e kushteve të ofruara për të bërë një zgjedhje racionale. Nëse mendojmë të marrim një kredi hipotekore, duhet të konsiderojmë të gjitha mundësitë. Eshtë e rëndësishme që të edukohemi pasi “dija” është “aftësi”.Duke siguruar informacionin e nevojshëm mbi kredinë hipotekore, jemi të aftë për të zgjedhur kushtet më optimale dhe shmangur shpenzimet e tepërta, na jep një bazë teorike dhe praktike njëkohësisht, që do t’na ndihmojë të mësojmë qëllimet e kredive hipotekore avantazhet dhe disavantazhet e marrjes së një kredie të tillë.Në këtë punim gjithashtu është trajtuar edhe ecuria e kredive hipotekore në shqipëri dhe krahasimi me vendet e tjera të europës. Po ashtu edhe ndikimi që kanë këto kredi në çmimin e banesave në treg dhe tregtimi i tyre nga bankat në trajtën e obligacioneve që mbështetën në huatë hipotekore.English Abstract: For many of us, buying a home is one of the most important decisions and sometimes the biggest financial transaction that can be made in life. To clarify such possible questions which arise before choosing a loan, it should be made a comparison between the affordable loan received and the loss of property rights. The banking markets’ development and expansion over the last years, with the creation of new products and programs, have been giving importance to the meaning of loan terms offered in order to make a rational choice.By providing the necessary information on mortgage loans, we are able to choose the most optimal conditions and avoid excessive costs, providing at the same time a theoretical and practical basis, which would be helpful in learning the purpose of mortgage loans, and also the advantages and disadvantages in obtaining such a loan.This paper also deals with the performance of mortgage loans in Albania and the comparison with other European countries, observing also the impact these loans have on the price of housing and their trading by banks as bonds supported by mortgage loans.

Investors’ Choices Between Cash and Voting Rights: Evidence from Dual-Class Equity Crowdfunding
Cumming, Douglas J.,Meoli, Michele,Vismara, Silvio
This paper examines for the first time dual-class equity crowdfunding as a digital ownership model. Unique to this context, companies can set an investment threshold under which no voting rights are granted, making the issuance of Class A vs. Class B shares, depending on individual investors. Using a sample of 491 offerings on the UK platform Crowdcube from 2011 to 2015, we find that a higher separation between ownership and control rights lowers the probability of success of the offering, the likelihood of attracting professional investors, as well as the long-run prospects. Different from small investors, professional investors care about the implementation of a threshold for the attribution of voting rights and often bid the Class A threshold exactly. Family businesses, although less attractive to small investors, are relatively safer investments, because of their lower chances of failure.

Knowledge, Fear and Beliefs: Understanding Household Demand for Green Investments
Anderson, Anders,Robinson, David T.
We explore whether households understand the tradeoffs that they face when they invest in funds that purport to be environmentally responsible. We conduct a large scale survey of Swedish households to measure how much they understand about the science behind environmental impact, their financial literacy, as well as their understanding of their own knowledge of these matters. We find only moderate correlation in knowledge between environmental and financial knowledge, but find the correlation of overestimation across domains to be sizable. Overestimation of environmental knowledge crowds out actual knowledge when explaining fears of climate change and reported recycling behavior, and is also strongly associated with beliefs that environmentally sustainable firms generate higher returns and with the willingness to pay higher fees for sustainable mutual funds.

Strategic Trading As a Response to Short Sellers
Di Maggio, Marco,Franzoni, Francesco A.,Massa, Massimo,Tubaldi, Roberto
We study empirically informed traders’ reaction to the presence of short sellers in the market. We find that investors with positive views on a stock strategically slow down their trades when short sellers are present in the same stock. Moreover, they purchase larger amounts to take advantage of the price decline induced by short sellers. Furthermore, they break up their buy trades across multiple brokers, suggesting that they wish to hide from the short sellers. This behavior may impact price discovery, as we find a sizeable reduction of positive information impounding for stocks more exposed to short selling during information sensitive periods. The evidence is confirmed exploiting exogenous variation in short interest provided by the Reg SHO Pilot Program. The findings have relevance for the regulatory debate on the market impact of short selling.

The Effect of Financial Development on Economic Sophistication: Evidence from Panel Data
Chu Khanh, Lan
This paper examines the effect of financial development on economic sophistication. We use domestic credit to private sectors and stock market liquidity variables to measure financial development and Economic Complexity Index to measure the economic sophistication. Using a panel data set of 97 countries from 1968 to 2015 and system generalized method of moments estimation, we find that financial development has a positive effect on economic sophistication.

The Formation of Hidden Negative Capital in Banking: A Product Mismatch Hypothesis
Kostrov, Alexander,Mamonov, Mikhail
This paper investigates the phenomenon of hidden negative capital (HNC) associated with bank failures and introduces a product mismatch hypothesis to explain the formation of HNC. Given that troubled banks tend to hide negative capital in financial statements from regulators to keep their licenses, we attempt to capture this gambling behavior by evaluating product mismatches reflecting disproportions between the allocation of bank assets and the sources of funding. We manually collect unique data on HNC and test our hypothesis using U.S. and Russian banking statistics for the 2004{2017 period (external validity argument). To manage the sample selection concerns, we apply the Heckman selection approach. Our results clearly indicate that product mismatch matters and works similarly in both U.S. and Russian banking systems. Specifically, an increase in mismatch has two e ects: it leads to a higher probability that a bank's capital is negative and raises the conditional size of the bank's HNC. Further, we demonstrate that the mismatch e ect is heterogeneous with respect to bank size being at least partially consistent with the informational asymmetry view. Our results may facilitate improvements in the prudential regulation of banking activities in other countries that share similar features with either the U.S. or Russian banking systems.

The Impact of Business Group Affiliation on Stock Price Informativeness: Evidence from an Emerging Market
Küllü, A. Melih,Dyer, Doug,Yilmaz, Gokhan,Sharma, Zenu
This paper examines the relationship between business group affiliation and stock price informativeness in an emerging market setting. We use stock price synchronicity as a measure, and study the impact of group affiliation ‐specifically the extent of affiliation, ownership structure and existence of group bank‐ on firm specific information content. Results reveal that the amount of firm‐specific information capitalized into stock prices tends to be lower (higher) when the firm is group‐affiliated (unaffiliated), indirectly (directly) owned, and affiliated group has (does not have) a group bank. Additionally, the extent of group affiliation maintains a non‐linear relationship with synchronicity, suggesting that the perception of higher versus lower levels of group ownership differs.

The Income Elasticity of Mortgage Loan Demand
Delis, Manthos D.,Hasan, Iftekhar,Tsoumas, Chris
One explanation for the emergence of the housing market bubble and the subprime crisis is that increases in individuals' income led to higher increases in the amount of mortgage loans demanded, especially for the middle class. This hypothesis translates to an increase in the income elasticity of mortgage loan demand before 2007. Using applicant‐level data, we test this hypothesis and find that the income elasticity of mortgage loan demand in fact declines in the years before 2007, especially for the mid‐ and lower‐middle income groups. Our finding implies that increases in house prices were not matched by increases in loan applicants' income.

The Information Content of Commodity Futures Markets
Alves, Rómulo,Szymanowska, Marta
We find that commodity futures returns contain information relevant to stock market returns and macroeconomic fundamentals for a large number of countries. Commodity futures returns predict stock market returns in 65 out of 70 countries and macroeconomic fundamentals in 62 countries. This predictability is not concentrated in the energy and industrial metals sectors, as it is economically and statistically significant across all sectors. Surprisingly, we find that the role of countries' dependence on commodity trade is limited in its ability to account for this predictability. This holds true even when considering new measures that take into account indirect exposures through financial and trade linkages between countries. We find much stronger evidence of predictability being related to the ability of commodities to forecast inflation rates. Overall, our evidence is consistent with commodity markets having a truly global information discovery role in relation to financial markets and the real economy.

Time to Buy or Just Buying Time? Lessons from October 2008 for the Cross-Border Bailout of Banks
King, Michael R.
This paper studies the country-level reaction of bank credit default swap (“CDS”) spreads and stock prices to bailout announcements in the US and five European countries in October 2008. Bailouts announcements are associated with bank CDS spreads narrowing, both for domestic and foreign banks, pointing to an important role for cross-border exposures. Movements in bank stock prices show mixed reactions, both domestically and cross-border, with banks receiving favorable government support outperforming foreign rivals. By January 2010, bank CDS spreads had stabilized at higher levels reflecting greater default risk, while bank stock prices remained significantly below their pre-crisis levels.

Time-Series Momentum: A Monte-Carlo Approach
Cheng, Enoch,Struck, Clemens
This paper develops a Monte-Carlo backtesting procedure for risk premia strategies and employs it to study Time-Series Momentum (TSM). Relying on time-series models, empirical residual distributions and copulas we overcome two key drawbacks of conventional backtesting procedures. We create 10,000 paths of different TSM strategies based on the S&P 500 and a cross-asset class futures portfolio. The simulations reveal a probability distribution which shows that strategies that outperform Buy-and-Hold in-sample using historical backtests may out-of- sample i) exhibit sizable tail risks, ii) under-perform or outperform. Our results are robust to using different time-series models, time periods, asset classes, and risk measures.

Trustee Reputation in Securitization: When Does it Matter?
Deku, Solomon,Kara, Alper,Marques-Ibanez, David
We consider the role of trustees–who are nominated to protect the interests of investors–in securitization pricing and whether investors rely on them to mitigate risks. In particular, we examine the effect of trustee reputation on initial yield spreads of European mortgage‐backed security (MBS) issuances between 1999 and the first half of 2007. We find that engaging reputable trustees led to lower spreads during the credit boom period prior to the 2007–2009 financial crisis. Our findings suggest that trustees' reputation was considered by investors to be more important when risk assessment became more challenging.

What is the Impact of Problem Loans on Japanese Bank Productivity Growth?
Mamatzakis, Emmanuel,Matousek, Roman,Vu, Anh Nguyet
This paper examines for the first time the impact of problem loans on Japanese productivity growth. We exploit a new data set of Japanese problem loans classified into two categories: bankrupt and restructured loans. We opt for a novel and flexible productivity growth decomposition that allows to measure the direct impact of these problem loans on productivity growth. The results reveal that Japanese bank productivity growth was severely constrained by bankrupt and restructured loans early in 2000s, whilst some persistence of the negative impact of problem loans on productivity growth is observed in the late 2000s. Thereafter, there is only some partial recovery in the productivity growth from 2012 to 2015. Further, we also perform cluster analysis to examine convergence or divergence across regions and over time. We observe limited convergence, though Regional Banks seem to form clusters in some regions.

Ð"етерминанты эффективности международных сделок по приобретению компаний из стран Европейского союза (Determinants of M&A Effectiveness in Acquisition of EU Companies)
Maslennikova, Marina,Patrin, Ilya
Russian Abstract: Сделки слияний и поглощений всегда являлись драйверами развития международного биз-неса. Рост объемов международных сделок делает тему M&A актуальной. в статье рассма-триваются детерминанты эффективности международных сделок M&A при приобретении компаний из стран ес в период с 2006 по 2014 г., исключая кризис.для исследования международного рынка M&A на теоретической основе выбраны детер-минанты: способ оплаты сделки, дружественность или враждебность поглощения, принад-лежность к одной отрасли, публичный или частный статусе компании, языковые различия, количество сделок в секторе за последний год и финансовый рычаг компанииâ€"покупателя. метод CAR на краткосрочном интервале позволяет обнаружить интересные взаимосвязи за-висимой переменной с детерминантами эффективности сделок. Разные окна событий пока-зывают различия в накопленной доходности в периоде за 15 дней до, во время и за 15 дней после события. Новизна исследования заключается в разделении выборки на кластеры. Компании-цели явля-ются резидентами стран ес на момент заключения сделки, а компании-покупатели делятся на три кластера: развитые рынки США и Канады, развивающиеся страны BRICS, развитые страны УC. Развитые страны разбиты на кластеры, чтобы проследить преимущества деятель-ности в рамках еврозоны. анализ всей выборки показывает, что значимыми факторами являются способ оплаты сделки и принадлежность к одной отрасли. значимость переменной принадлежности к развитому/развивающемуся рынку обуславливает дальнейшее деление выборки на кластеры.при исследовании международных сделок M&A с участием США и Канады выявлено, что оплата сделки акциями и долговыми инструментами является наиболее значимым фактором и положительно влияет на значение CAR. принадлежность к одной отрасли, частный ста-тус компании â€" цели и использование одинакового языка увеличивает эффективность сделки M&A.На развивающихся рынках стран BRICS факторы принадлежности к одной отрасли и значе-ния финансового рычага компании-покупателя увеличивают избыточную накопленную до-ходность. Наиболее сильное негативное влияние оказывают языковые различия.анализ компаний-покупателей из развитых стран евросоюза показывает значимость един-ственной переменной â€" способа оплаты сделки на всех окнах события, что означает, что оплата сделки акциями повышает значение CAR на краткосрочном временном интервале.English Abstract: M&A deals have always been the drivers of international business development. Growth of international M&A deals volume puts the scrutinized issue on the front burner. Under this article the key effectiveness determinants of international M&A deals with the participation of EU countries are analyzed on the data period from 2006 to 2014, excluding financial crisis.For international M&A deals research the following determinants are chosen on the basis of theoretical background: method of payment, friendliness or hostility of merger, belonging to the same industry, public or private status of the company, language differences, amount of M&A deals in the industry in the past year and financial leverage of the acquiring company. Method of CAR (Cumulated abnormal return) in the short-run period allows finding puzzling interconnections between dependent variable and the determinants of effectiveness. Different event-windows give the opportunity to analyze differences in CAR-values in 15 days before event, in the time of event and 15 days after event.novelty of the paper lies in the division on the sample in clusters. Target-companies are all EU-residents on the moment of deal, but acquiring companies are divided into 3 groups by the country of residence: developed markets of USA and Canada, developing BRICS countries and developed countries of EU. Developed countries were graded to indicate advantages of European-zone residence.whole sample analysis shows that significant factors are payment method and belonging to the same industry. Significance of dummy-variable «cluster» determines partial group analysis. International M&A deals effectiveness with USA and Canada is strongly influenced by method of payment â€" stocks and debt instruments increase CAR-value of the acquiring company. Belonging to the same industry, private status of the target-company and the same language positively influence M&A effectiveness. Belonging to the same industry and financial leverage of the acquiring-companies positively affect CAR in deals with developing markets of BRICS countries. The strongest negative effect is made by language differences. analysis of EU acquiring companies shows the significance of the single variable â€" method of pay-ment in all event â€" windows. as a result, payment with stocks increases CAR-value for the acquiring company in the short-run period.