Research articles for the 2019-04-16

Active Factor Completion Strategies
Dichtl, Hubert,Drobetz, Wolfgang,Lohre, Harald,Rother, Carsten
Embracing the concept of factor investing, we design a flexible framework for building out different factor completion strategies for given traditional multi-asset allocations. Our notion of factor completion considers a maximally diversified reference portfolio anchored in a multi-asset multi-factor risk model that acknowledges market factors such as equity, duration and commodity as well as style factors such as carry, value, momentum and quality. Yet, the specific nature of a given factor completion strategy varies with investor preferences and constraints. We tailor a select set of factor completion strategies that include factor-based tail hedging, constrained factor completion and a fully diversified multi-asset multi-factor proposition. The presented framework naturally lends itself to exploiting tactical asset allocation signals while not sacrificing the notion of maximum diversification. To illustrate, we additionally tap the common trend style that permeates many asset classes.

Can Capital Structure Influence the Performance of the Firm? Evidence from India
Tripathy, Dr. Sasikanta,Singh, Shailender
In this study, the association between financial performance and capital structure of 56 BSE listed firms is investigated over the period 2000-2017. Here fully modified OLS (FMOLS) and generalized method of moments (GMM) have been applied as two alternative methods of panel data estimation. Results indicate that capital structure is significantly and positively associated with firm performance. Results thus obtained are robust across the estimation methods. The pecking order theory and the static trade-off theory, both seem to explain Indian firms' decisions among the three alternative theories of capital structure. This paper also supports to the agency cost theory.

Causality in Quantiles and Dynamic Relations in Energy Markets
Kyritsis, Evangelos,Andersson, Jonas
In this paper we investigate the dynamic relations between crude oil price returns and a set of energy price returns, namely diesel, gasoline, heating, and the natural gas. This is performed by means of Granger non-causality tests for US spot closing prices over the period from January 1997 to December 2017. In previous studies this has been done by testing for the added predictive value of including lagged values of one energy price return in predicting the conditional expectation of another. In this paper, we instead focus on different ranges of the full conditional distribution within the framework of a dynamic quantile regression model, and identify the quantile ranges from which causality arises. The results constitute a richer set of findings than what is possible by just considering a single moment of the conditional distribution, which can be useful for implementing better substitution investment strategies and effective policy interventions. We find several interesting one-directional dynamic relations between the employed energy prices, especially in the tail quantiles, but also a bi-directional causal relation between energy prices for which the classical Granger non-causality test suggests otherwise. Our results are robust to alternative measures of the price of oil and different data frequencies.

Clearing price distributions in call auctions
M. Derksen,B. Kleijn

We propose a model for price formation in financial markets based on clearing of a standard call auction with random orders, and verify its validity for prediction of the daily closing price distribution statistically. The model considers random buy and sell orders, placed following demand- and supply-side valuation distributions; an equilibrium equation then leads to a distribution for clearing price and transacted volume. Bid and ask volumes are left as free parameters, permitting possibly heavy-tailed or very skewed order flow conditions. In highly liquid auctions, the clearing price distribution converges to an asymptotically normal central limit, with mean and variance in terms of supply/demand-valuation distributions and order flow imbalance. With simulations, we illustrate the influence of variations in order flow and valuation distributions on price/volume, noting the emergence of resistance levels, as well as the distinction between high- and low-volume auction price variance. To verify the validity of the model statistically, we predict a year's worth of daily closing-price distributions for 5~shares in the Eurostoxx 50 index; Kolmogorov-Smirnov statistics and QQ-plots demonstrate with ample statistical significance that the model predicts closing price distributions accurately, and compares favourably with alternative methods of prediction.

Consumer Privacy and Serial Monopoly
V. Bhaskar,Nikita Roketskiy

We examine the implications of consumer privacy when preferences today depend upon past consumption choices, and consumers shop from different sellers in each period. Although consumers are ex ante identical, their initial consumption choices cannot be deterministic. Thus ex post heterogeneity in preferences arises endogenously. Consumer privacy improves social welfare, consumer surplus and the profits of the second-period seller, while reducing the profits of the first period seller, relative to the situation where consumption choices are observed by the later seller.

Deposit Insurance and Financial Intermediation: The Case of Indonesia Deposit Insurance Corporation
Jameaba, Muyanja-Ssenyonga
The article analyzes the impact of the establishment of the Indonesia Deposit Insurance Corporation (IDIC) on financial intermediation in Indonesia. The research uses technical analysis and multiple regression data analysis techniques.Results indicated that in the immediacy of IDIC establishment risk aversion increased among savers and banks alike, as reflected by a shift in the composition of bank deposits from time deposits and demand deposits to savings deposits and rising levels of Bank Indonesia certificates held by banks, respectively. However,increase in bank soundness, coupled with confidence in IDIC effectiveness, while mitigates risk-aversion behavior, it seems to have created opportunity for moral hazard in the banking system. Savers’ behavior is no longer driven by consideration of whether or not the potential custodians of their deposits are sound or other, but expected return (interest rate on deposits offered). The same applies to banks,which no longer consider risk-free Bank Indonesia certificates as a good investment.Risk-taking behavior by savers and banks alike seems to be strengthened by expectations of future government intervention for systemically important banks,raising fears of too systemically important to fail problem and continued political intervention in IDIC policy making. Overall, IDIC establishment by bolstering public confidence in the banking system has reduced the possibility of a repeat of highly destabilizing runs on banks, hence has contributed to better financial intermediation and financial stability. However, rising moral hazard means that future bailouts are still unavoidable.

Do High-Frequency Traders Improve your Implementation Shortfall?
Korajczyk, Robert A.,Murphy, Dermot
We take advantage of a regulatory change that effectively imposed a “tax” on HFT order activity on Canadian equity venues to study the resulting effect on the execution costs of large institutional trades. We find that bid-ask spreads increase and price impact decreases for these trades following the regulatory change. The price impact effect is strongest for informed institutional traders. Our evidence indicates that this tax on high-frequency trading is associated with higher transaction costs for small, uninformed trades and lower transaction costs for large, informed trades. Hence, the tax increased the subsidy for informed traders from uninformed traders.

Expected Market Returns: SVIX, Realized Volatility, and the Role of Dividends
Lof, Matthijs
This note provides a replication of Martin’s (Quarterly Journal of Economics; 2017) finding that the implied volatility measure SVIX predicts US stock market returns up to twelvemonth horizons. I find that this result holds for both S&P 500 and CRSP market returns, regardless of whether returns include or exclude dividends. The predictability largely disappears after the SVIX index is replaced by an exponentially weighted moving average measure of realized volatility, suggesting that SVIX holds incremental forward looking information compared to realized volatility, despite the high correlation between the two volatility measures.

Expense Ratio as an Effect of Fund Attributes’ Impact
Filip, Dariusz
The aim of this paper is to examine if fund attributes such as size, age and family size influence the expense ratio. The study employs multiple regression analysis for cross-section data with the use of three methods of estimation (OLS, Famaâ€"MacBeth and IRLS). The analysis is conducted using data from four segments of Polish mutual funds. The results confirm the existence of small economies of scale in the case of the expenses incurred in connection with the increasing assets under management.

From multi-dimensional black scholes to Hamilton jacobi
Muhammad Naqeeb,Amjad hussain

The first widely used financial model is linked to dynamical Hamilton jacobi model

Future Economic Information Embedded in High Yield Spreads
Francis, Jack Clark,Hessel, Christopher,Wang, Jun
Future Economic Information Embedded in High Yield SpreadsThe financial accelerator mechanism, also called credit channel theory (Bernanke and Gertler [1995] and Bernanke and Gertler, and Gilchrist [1996]), assumes external financing is more costly than internal financing in the absence of full collateralization. The difference between external and internal costs is called “external finance premium” and arises from agency costs associated with asymmetric information about the firm’s net worth, defined as the sum of all liquid and illiquid assets minus debt. The external finance premium is inversely related to the firm’s net worth. Firms with poor credit are at the heart of the financial accelerator mechanism, and one can proxy for “external finance premium” using the spread paid by the poor-quality (high-yield) firms over the high-quality firms. In the parlance of the “financial accelerator mechanism,” a reduction of high-yield spread is the harbinger of future boom, and an increase in high-yield spread predicts a decline in economic activity. This article examines the significance of the spread variable to predict various economic variables. We control for momentum in the economic variable by including the four lagged quarters of the economic variable. We look at the growth rate of a broad spectrum of the economy; having tested the relationship between 84 economic measures and the four lagged measures of growth in high-yield spread, we report that 58 of the economic variables tested have statistically significant coefficients.

Is the Supply Curve for Commodity Futures Contracts Upward Sloping?
Yan, Lei,Irwin, Scott H.,Sanders, Dwight R.
Annual rebalancing of the S&P GSCI index provides a novel and strong identification to estimate the shape of supply curves for commodity futures contracts. Using the 24 commodities included in the S&P GSCI for 2004â€"2017, we show that cumulative abnormal returns (CARs) reach a peak of 59 basis points in the middle of the week following the rebalancing period, but the impact is temporary as it declines to near zero within the next week. The findings provide clear evidence that the supply curve for commodity futures contracts is upward sloping in the short-run but almost flat in the longer-run.

Managing to Target: Dynamic Adjustments for Accumulation Strategies
Estrada, Javier
Planning for retirement, particularly during the accumulation period, largely consists of setting a target value for the retirement portfolio and implementing a policy aimed at hitting that target. Financial plans are inevitably based on expected returns, which are likely to be different from those an individual experiences during the accumulation period. Thus, when the portfolio deviates from the path outlined in the plan, the individual can choose between a static policy of sticking to his plan and simply hope to hit the target, or dynamic policies designed to keep the portfolio close to its path. This article evaluates three types of such dynamic policies, broadly referred to as ‘managing to target’ (M2T), that adjust the periodic contributions or the portfolio’s asset allocation. The results reported show that some of the dynamic policies outlined outperform a static policy, and adjusting contributions is far superior to adjusting the asset allocation.

Multiple-interaction kinetic modelling of a virtual-item gambling economy
Giuseppe Toscani,Andrea Tosin,Mattia Zanella

In recent years, there has been a proliferation of online gambling sites, which made gambling more accessible with a consequent rise in related problems, such as addiction. Hence, the analysis of the gambling behaviour at both the individual and the aggregate levels has become the object of several investigations. In this paper, resorting to classical methods of the kinetic theory, we describe the behaviour of a multi-agent system of gamblers participating in lottery-type games on a virtual-item gambling market. The comparison with previous, often empirical, results highlights the ability of the kinetic approach to explain how the simple microscopic rules of a gambling-type game produce complex collective trends, which might be difficult to interpret precisely by looking only at the available data.

Off-Balance Sheet Activities, Inefficiency and Market Power of U.S. Banks
Wheelock, David C.,Wilson, Paul W.
The Lerner index is a well-established measure of firms' market power, but estimation and interpretation present several challenges, especially for banks. We estimate Lerner indices for U.S. banks for 2001-2016 while (i) accounting for banks' off-balancesheet activities, (ii) estimating cost and profit functions nonparametrically to avoid mis-specification inherent in parametric estimation of translog functions on banking data, and (iii) allowing for cost and profit inefficiency that can otherwise bias index estimates. We find that banks have more market power than previous studies found, and that failure to account for off-balance-sheet activities or inefficiency can seriously bias estimates of market power.

Partial Moments for Quadratic Forms in Non-Gaussian Random Vectors: A Parametric Approach
Broda, Simon A.,Arismendi Zambrano, Juan
Countless test statistics can be written as quadratic forms in certain random vectors, or ratios thereof. Consequently, their distribution has received considerable attention in the literature. Except for a few special cases, no closed-form expression for the cdf exists, and one resorts to numerical methods. Traditionally the problem is analyzed under the assumption of joint Gaussianity; the algorithm that is usually employed is that of Imhof (1961). The present manuscript generalizes this result to the case of multivariate generalized hyperbolic (MGHyp) random vectors. The MGHyp is a very flexible distribution which nests, among others, the multivariate t, Laplace, and variance gamma distributions. An expression for the first partial moment is also obtained, which plays a vital role in financial risk management. The proof involves a generalization of the classic inversion formula due to Gil-Pelaez (1951). Two numerical applications are considered: first, the finite-sample distribution of the 2SLS estimator of a structural parameter. Second, the Value at Risk and Expected Shortfall of a quadratic portfolio with heavy-tailed risk factors. An empirical application is examined, where a portfolio of of Dow Jones Industrial Index (DJIA) stock options is optimised by minimising the expected shortfall. The empirical results show the benefits of the analytical expression.

Retail Insider Trading and Market Price Efficiency: Evidence from Hacked Earnings News
Akey, Pat,Gregoire, Vincent,Martineau, Charles
Over six years, a group of convicted traders accessed upcoming earnings press releases hours before the official announcement through a series of cyber intrusions into the main newswire services. This setting allows us to investigate how efficient are markets at learning about insider's private information and which stocks are more susceptible to insider trading. Pre-announcement stock returns of firms exposed to hacks predict earnings surprises. Also, the after-hours return responsiveness to surprises decreases by 20%. The effects is predominantly found in medium-sized firms, on days with a high number of earnings announcements, and for large surprises.

Return and Volatility Spillovers Among Asian Stock Markets
Joshi, Prashant
The study examines the return and volatility spillover among Asian stock markets in India, Hong Kong, Japan, China, Jakarta, and Korea using a six-variable asymmetric generalized autoregressive conditional heteroscedasticityâ€"Baba, Engle, Kraft, and Kroner (GARCH-BEKK) model during February 2, 2007, to February 29, 2010. The author finds evidence of bidirectional return, shock, and volatility spillover among most of the stock markets. The magnitude of volatility linkages is low indicating weak integration of Asian stock markets. The study finds that own volatility spillover is higher than cross-market spillover. The overall persistence of stock market volatility is highest for Japan (0.931) and lowest for China (0.824). The implication of weak integration is that investors will benefit from reduction of diversifiable risk.

Takeovers and Endogenous Labor Reallocation
Agrawal, Ashwini K.,Tambe, Prasanna
Existing work studies the effects of corporate events â€" such as mergers and acquisitions (M&A) â€" on workers by examining changes in labor activity before and after the event. Using new data on individual job search behavior, we examine the timing of labor market activity around M&A events. We provide evidence for a significant amount of endogenous worker selection: job search activity for employees of M&A targets begins to increase ten months prior to a takeover announcement. In contrast, stock prices of target companies begin to rise only one month before an announcement. M&A announcements, therefore, appear to mark an intermediate point in the labor reallocation process, rather than the beginning. We show that shifting the window of analysis significantly changes estimates of labor supply parameters during takeovers. The findings illustrate that accounting for endogenous worker selection prior to corporate events such as M&A is critical for correctly estimating their effects on labor.

The Cost of Capital for Banks
Dick-Nielsen, Jens,Gyntelberg, Jacob,Thimsen, Christoffer
Expected returns based on analyst earnings forecasts show that when the tier 1 ratio increases the cost of equity and debt capital for banks decreases whereas total cost of capital remains unchanged. These findings are consistent with the conservation of risk principle (Modigliani and Miller, 1958). Empirically, the disadvantages of equity funding are small; a 10 pp increase in the tier 1 ratio preserves total risk but causes a 2.3% loss of firm value due to the lower tax shield. The loss is equivalent to a 2-8 bps increase in borrowing rates. These findings have important implications for the cost of substantially heightened capital requirements.

The Limits of Lending? Banks and Technology Adoption Across Russia
Bircan, Cagatay,De Haas, Ralph
We exploit historically-determined variation in local credit markets to identify the impact of bank lending on firm innovation across Russia. We find that deeper credit markets increase firms' use of bank credit, their adoption of new products and technologies, and productivity growth. This relationship is more pronounced in industries further from the technological frontier; more exposed to import competition; and that export more. These impacts are also stronger for firms near historical R&D centers or railways, and in regions with supportive institutions. Consistent with these results, credit markets contribute to economic growth in such regions.