Research articles for the 2019-05-07

A Climate Risk Assessment of Sovereign Bonds' Portfolio
Battiston, Stefano,Monasterolo, Irene
The issue of climate-related systemic financial risk has been neglected so far by traditional financial and climate economics models. Here, we develop a climate risk assessment methodology that allows to price forward looking climate transition risks and opportunities in a portfolio of sovereign bonds and to inform climate-aware portfolios' risk management strategies.Our approach combines financial network models with the financial valuation of assets based on forward looking shocks arising from a, possibly disorderly, low-carbon transition. We consider a risk averse investor subject to incomplete information and uncertainty, and endogeneity of climate risk. Our modular approach works with micro-level firm, asset and emissions data. First, we develop novel climate-enhanced financial pricing models for sovereign bonds. Then, we integrate climate in the computation of standard financial risk metrics by introducing the notion of climate spread. Finally, we assess the largest losses (gains) on investor's portfolio.We apply it to the sovereign bonds’ portfolio of the Austrian National Bank, finding that investments’ alignment to a credible 2°C trajectory can strengthen the investor’s financial position by decreasing the climate-related yield on sovereign bonds (i.e. the climate spread). In contrast, a misalignment to 2°C trajectory can increase the climate spread, with potential financial risk implications. Our analysis is intended to support investors and financial supervisors’ understanding of the conditions for the onset of climate-related financial risks and strategies for their mitigation.

A Dual Characterisation of Regulatory Arbitrage for Expected Shortfall
Herdegen, Martin,Khan, Nazem
We study portfolio selection in a one-period financial market with an Expected Shortfall (ES) constraint. Unlike in classical mean-variance portfolio selection, it can happen that no efficient portfolios exist. We call this situation regulatory arbitrage and show that the presence or absence of regulatory arbitrage for ES is intimately linked to the fine structure of equivalent martingale measures (EMMs) for the discounted risky assets. More precisely, we prove that the market does not admit regulatory arbitrage for ES at confidence level α if and only if there exists an EMM Q ≈ P such that ll dQ/dP ll∞ < 1/α.

After the Panic: Are Financial Crises Demand or Supply Shocks? Evidence from International Trade
Benguria, Felipe,Taylor, Alan M.
Are financial crises a negative shock to demand or a negative shock to supply? This is a fundamental question for both macroeconomics researchers and those involved in real-time policymaking, and in both cases the question has become much more urgent in the aftermath of the recent financial crisis. Arguments for monetary and fiscal stimulus usually interpret such events as demand-side shortfalls. Conversely, arguments for tax cuts and structural reform often proceed from supply-side frictions. Resolving the question requires models capable of admitting both mechanisms, and empirical tests that can tell them apart. We develop a simple small open economy model, where a country is subject to deleveraging shocks that impose binding credit constraints on households and/or firms. These financial crisis events leave distinct statistical signatures in the empirical time series record, and they divide sharply between each type of shock. Household deleveraging shocks are mainly demand shocks, contract imports, leave exports largely unchanged, and depreciate the real exchange rate. Firm deleveraging shocks are mainly supply shocks, contract exports, leave imports largely unchanged, and appreciate the real exchange rate. To test these predictions, we compile the largest possible crossed dataset of 200+ years of trade flow data and event dates for almost 200 financial crises in a wide sample of countries. Empirical analysis reveals a clear picture: after a financial crisis event we find the dominant pattern to be that imports contract, exports hold steady or even rise, and the real exchange rate depreciates. History shows that, on average, financial crises are very clearly a negative shock to demand.

Aggregate Analyst Optimism, Information Habitats, and Asset Prices
Khalaf, Sarah
This paper investigates the asset pricing implications of the strategic incentives of analysts. I find that deviations between consensus analyst optimism across forecasts and recommendations for the same firm lead to temporary price movements. For example, among firms with differences between recommendation and forecast optimism, those that are predicted to appeal most (least) to retail investors (i.e. high recommendation optimism) underperform (overperform) annually by a risk-adjusted 1.26% (2.99%). Information habitats created by strategic incentives, generate excess coordinated investor demand, and provide the mechanism for which temporary price movements occur. This habitat-based explanation helps shed light on recent puzzling findings concerning analyst opinions and their impact on market return anomalies.

An Empirical Analysis of Key Audit Matters in the Financial Industry
Loew, Edgar,Mollenhauer, Tim
One outcome of the financial crises with regard to financial statements and their audits has been that both, the European Union and the International Auditing and Assurance Standards Board came out with amendments to their legislations. Hence, the regulators focused on the information gap between the auditor and the stakeholders of financial reports. To close that gap, the implementation of Key Audit Matters (KAM) within the section of the independent auditor´s report became mandatory. 2017 marks the first year in which KAM for all European public interest entities (PIE) can be observed. Based on previous literature and few academic studies the following working paper focuses on KAM within European Banks. Basis of the sample are those significant supervised European Banks that are governed by the European Central Bank (ECB), disclosed by the list of supervised entities published by the ECB as of 1st of January 2018. Reported KAM topics are tested on influential factors for KAM such as bank size and complexity, success, earnings management, region or audit company. Furthermore, text similarities are checked, as one of the goals of the new auditor reports was to individualise the reports. This study therefore, provides a deep insight into both, the most relevant topics auditors are dealing with in European Banks and bank specific dependencies and their influence on KAM.

Analyzing Gold Returns: Indian Perspective
Moradia, Abha,Mehta, Ashish C.
Investors are forever in need of an asset that adds value to the portfolio. Therefore, along with fixed income investments, stocks, gold and other assets are inevitable parts of a balanced portfolio. For Indian investors, gold is not only an investment asset but a commodity with a major importance in the social customs that makes it all the more interesting to study. As an investment asset, it is considered a diversifier asset and a hedging asset. Not only that, it is called a ‘safe-haven’ asset for times of economic distress, meaning that it retains its value when the stock market is giving low or negative returns. In this paper, we analyze the risk-return parameters of both the gold and Sensex for a period from 1992 to 2017 and find out how they perform along with each other. We also do detailed subperiod analysis in terms of Pearson’s correlation coefficient and see how it changes in pre-recession and post-recession period. We analyze whether gold is a diversifier asset, a hedge, a safe haven or all three for Indian investors. It is interesting to note how the exchange rate variability has a great impact on gold’s rate of return.

Banking Goes Digital: The Adoption of FinTech Services by German Households
Jünger, Moritz,Mietzner, Mark
Germany is falling behind its peers in adopting new digital technologies and financial services offered by non-bank high-tech startups (e.g., FinTech). Using survey data, we analyze which FinTech services households are likely to adopt. Our results indicate that a household’s level of trust and comfort with new technologies, financial literacy, and overall transparency impact its propensity to switch to a FinTech. Specifically, households with low levels of trust, good financial education, and preference for transparency are characterized by a higher probability of adopting FinTech. In contrast, household price perceptions do not appear to significantly impact switching probability.

Before the Cult of Equity: New Monthly Indices of the British Share Market, 1829-1929
Campbell, Gareth,Grossman, Richard S.,Turner, John D.
This paper presents new monthly capital gains, dividend yield, and total return indices for common equities quoted on British stock exchanges from 1829 to 1929. As well as creating an all-share index, we create a blue-chip index of the 30 largest companies, which we splice to the Financial Times 30 index to create a near-two-century-long (1829-2018) monthly share index. We use the new indices to examine the timing of British business cycles and compare the returns on home and foreign UK investment. We also construct indices for 22 domestic sectors, and calculate CAPM betas for each sector.

Capturing Energy Risk Premia
Fernandez-Perez, Adrian,Fuertes, Ana-Maria,Miffre, Joëlle
The article models the risk premium present in energy futures markets. This is done first by analyzing the performance of long-short portfolios based on single styles, and then by integrating these styles into an unique portfolio. Aligned with the hedging pressure hypothesis and the theory of storage, investors earn a premium of at least 7.5% a year for bearing hedgers’ risk of price fluctuation and for holding energy futures with low inventories. Integrating the signals into an unique portfolio increases the premium further to 12.4% a year. Out of all the integration approaches considered, the easiest one is also the best in term of performance; it merely consists of giving equal weights to the styles considered within the integrated portfolio. The results are robust to the consideration of transaction costs, alterative specifications of the integrated portfolio, data mining and various sub-periods.

Common Structures of Asset-Backed Securities and Their Risks
Sabarwal, Tarun
In recent years, one area of growing concern in corporate governance is the accounting and transfer of risk using special purpose entities (or trusts). Such entities are used widely in issuing asset-backed securities. This paper provides an overview of the asset-backed securities market, and discusses the common structures used in this market to transform the risks associated with the underlying collateral into risks associated with the issued securities. Understanding these structures is essential to understanding the allocation and transfer of risk among the different parties in an asset-backed transaction â€" the originator, the special-purpose entity, investors, and related parties such as insurance guarantors. Understanding these structures is also essential in proposing potential solutions to regulatory and accounting concerns about the transfer of risks in asset-backed securities.

Corporate Control Around the World
Aminadav, Gur,Papaioannou, Elias
We provide an anatomy of corporate control around the world after tracing controlling shareholders for thousands listed firms from 127 countries between 2004 and 2012. The analysis reveals considerable and persistent differences across and within regions, as well as across legal families. Government and family control is pervasive in civil-law countries. Equity blocks in widely-held corporations are commonplace, but less so in common-law countries. These patterns apply to large, medium, and small listed firms. In contrast, the association between income and corporate control is highly heterogeneous; the correlation is strong among big and especially very large firms, but absent for medium and small listed firms. We then examine the association between corporate control and various institutional features. Shareholder rights against insiders' self-dealing activities correlate strongly with corporate control, though legal formalism and creditor rights less so. Corporate control is strongly related to labor market regulations, concerning, among others, the stringency of employment contracts, the power and extent of unions. The large sample correlations, thus, offer support to both legal origin and political-development theories of financial development.

Credit Default Swaps and Analyst Optimism
Govindaraj , Suresh ,Li, Yubin,Zhao, Chen,Zhong, Zhaodong
This paper investigates whether and how the initiation of Credit Default Swaps (CDS) trading affects analyst optimism. First, we document that analyst forecasts become less optimistic after the initiation of CDS trading. Second, we find that the dampening effect of CDS on analyst optimism is stronger for firms with negative news and for firms with poorer financial performance or higher leverage, supporting a “correction effect” of CDS on non-strategic optimism. Moreover, we find that CDS also has a “disciplining effect” on strategic optimism that arises from incentives to cultivate relation with management or to please institutional investors. Overall, our evidence shows that the CDS market not only provides important information for analysts, but also alters analysts’ reporting incentives.

Discounting the Future: On Climate Change, Ambiguity Aversion and Epstein-Zin Preferences
Olijslagers, Stan,van Wijnbergen, Sweder
We focus on the effect of preference specifications on the current day valuation of future outcomes. Specifically, we analyze the effect of risk aversion, ambiguity aversion and the elasticity of intertemporal substitution on the willingness to pay to avoid climate change risk. The first part of the paper analyzes a general disaster (jump) risk model with a constant arrival rate of disasters. This provides useful intuition in how preferences influence valuation of long-term risk. The second part of the paper extends this model with a climate model and a temperature dependent arrival rate. Since the model yields closed form solutions up to solving an integral, our model does not suffer from the curse of dimensionality of numerical IAMs with several state variables. Introducing Epstein-Zin preferences with an elasticity of substitution higher than one and ambiguity aversion leads to much larger estimates of the social cost of carbon than obtained under power utility. The dominant parameters are the risk aversion coefficient and the elasticity of intertemporal substitution. Ambiguity aversion is of second order importance.

Does Leverage Influence on Investment Decision: Evidence From Pakistan
Ali, Furman
This paper inspects, the link between leverage and investment by using a panel data approach for non-financial Pakistani listed companies under Karachi Stock exchange over the period from 2008 to 2017. We find a negative link between leverage and investment in the context of the Pakistani market. However, this negative relationship does not hold similar for higher growth and lower growth opportunities firm. We find that leverage has a significantly negative effect on investment for lower growth opportunities for firms than higher growth opportunities firms.

Does Mutual Fund Working Experience Affect Private Fund Performance?
Huang, Ying,Liang, Bing,Wu, Kai
We evaluate how prior mutual fund working experience affects private fund managers' performance. Using a novel Chinese private fund database from 2012 to 2016, we document significantly lower excess returns and higher left-tail risks for private fund managers with prior mutual fund working experience. Such effect is concentrated in switched managers with lower performance ranks in mutual funds. Additionally, the underperformance is attributable to reduced research support, change in investment styles, and deteriorated market timing skills, while incentive schemes help alleviate such underperformance. Our findings demonstrate the key role of industry-specific human capital in the asset management industry.

Does the Lack of Financial Stability Impair the Transmission of Monetary Policy?
Acharya, Viral V.,Imbierowicz, Bjorn,Steffen, Sascha,Teichmann, Daniel
We investigate the transmission of central bank liquidity to bank deposits and loan spreads in Europe over the January 2006 to June 2010 period. We find evidence consistent with an impaired transmission channel due to bank risk. Central bank liquidity does not translate into lower loan spreads for high-risk banks, even as it lowers deposit rates for both high-risk and low-risk banks. This adversely affects the balance sheets of high-risk bank borrowers, leading to lower payouts, lower capital expenditures, and lower employment. Overall, our results suggest that banks’ capital constraints at the time of an easing of monetary policy pose a challenge to the effectiveness of the bank lending channel and the effectiveness of the central bank as a lender of last resort.

Financial Inclusion and Its Determinants in Zimbabwe
Ngoma, Gerald
Financial inclusion has taken a centre stage in academia and policy circles in developing countries due to its ability to drive economic growth, reduce poverty and inequality as well as facilitate savings. This study provided evidence on the determinants of financial inclusion in Zimbabwe using a binary logit model. This study established that individual characteristics: age, income, gender, education and employment status were the determinants of financial inclusion in Zimbabwe. In addition, this study established that trust in financial institutions was the major reason why the majority remained unbanked. Against these findings, promoting an allinclusive financial sector to cover existing gaps is essential for the nation and implementing policies effective in boosting confidence and trust in financial institutions remains critical for Zimbabwe.

Friendly Directors and the Cost of Regulatory Compliance
Wintoki, M. Babajide,Xi, Yaoyi
We present evidence that, following the passage of the Sarbanes-Oxley Act, firms responded to the increased requirement for outside director monitoring by substituting insiders with outside directors who have social or professional connections to their CEOs. This substitution was most significant in firms that have higher outside director monitoring costs â€" small, young firms, firms outside the S&P 1500 index, and firms with low analyst scrutiny. The addition of these “friendly” directors did not reduce firm performance, suggesting that it may have been an efficient response by firms aimed at lowering the additional monitoring costs imposed by the new regulations. Our findings suggest that, as with many other aspects of board composition, the determinants and consequences of appointing friendly directors vary with the costs and benefits of outside director monitoring and advice.

Happiness, Corporate Investment and Innovation: Evidence across Countries
Heo, Yuna,Hou, Fangfang,Park, Seongkyu Gilbert
This paper studies how people in certain country view their status relate to corporate investment decisions. Utilizing the data from the World Happiness Report published by the United Nations Sustainable Development Solutions Network, we find that country’s overall happiness is positively correlated with the firm’s capital expenditure. We also show that firms in happier countries are more innovative. However, dispersion of happiness within the country is negatively correlated with capital expenditure while innovation is positively correlated. This suggests that investment decision is based on overall market while innovation is driven by a subset of total population. Taken together, our findings support the view that happiness is an important factor of corporate activity and economic outcomes.

How Does Family Owner Authority Influence Firm Efficiency? An Issue of National Power Distance
Breuer, Wolfgang,Knetsch, Andreas
The cultural dimension of power distance moderates the extent to which owner families can extract private benefits and achieve preferential treatment for the firm in securing resources for investments. For an international sample of listed and unlisted family firms, we find that power distance curtails underinvestment among family firms, while it decreases their operating performance. The latter effect is more pronounced for family-owned firms than for nonfamily firms and the former effect depends on family management involvement. Moreover, family firms in high power distance countries are more commonly led by family members and they pay lower costs of debt.

Impact of an Aggregation Tree Over the Skewness of the Final Risk Distribution
Dal Moro, Eric
Following the implementation of Solvency 2 in Europe and other parts of the world, many (re)insurance companies decided to put in place Internal Models. The central part of an internal model is its aggregation tree and the calibration of the aggregation tree has been the subject of many articles. Among the different articles, “Estimating copula for insurance from scarce observations, expert opinion and prior information: a Bayesian approach”, ASTIN Bulletin (2012) by Arbenz et al. sets a general framework for estimating dependencies.In practice, most of the calibration exercises focus on elements which are similar in nature to “correlation” as this is the easiest part of the dependence structure: Practitioners (including underwriters, claims managers, actuaries and finance managers) usually understand and have a slight feeling for correlations if relevant explanations are provided. But the other impacts of these calibration choices are usually forgotten as practitioners do not have a view on these elements. In particular, the number of layers of the aggregation tree as well as the order of the aggregation play a role on both the overall volatility and the overall skewness of the final risk distribution. But, usually, these elements are not discussed in detail. As volatility and skewness are the main determinants of the risk measure (Value at Risk or Expected Shortfall), understanding the impact of the calibration choices on these elements is certainly important and should also be in the focus of the calibration exercise.As a consequence, this article aims at estimating the impact of the different choices of calibration of the aggregation tree on both volatility and skewness of the overall risk distribution. Examples of calibration are provided to demonstrate the impact of the different (forgotten) elements of choice in a calibration exercise.

Institutional Presence in Secondary Bank Bond Markets: How Does It Affect Liquidity and Volatility?
Oprica, Silviu,Weistroffer, Christian
Using newly available information on euro area sectoral holdings of securities, this paper investigates to what extent the presence of institutional investors affects volatility and liquidity in secondary bank bond markets. We find that non-bank financial intermediaries, in particular money market funds (MMFs), have a positive impact on secondary bank bond markets’ liquidity conditions, at the cost of significantly increasing volatility of daily returns. The effect translates to more than a 19% improvement in liquidity conditions and up to 57% increase in daily-return volatility, assuming MMFs hold about 10% of the notional amount in the secondary market of a representative euro area bank bond. The effect is relative to the impact the non-financial private sector has on markets. Investment funds, insurance corporations and pension funds are found to similarly affect market conditions, though to a lesser magnitude. We find a trade-off between volatility and liquidity, where the stronger presence of institutional investors at the same time improves liquidity and increases volatility. The results suggest that possible structural shifts in investor composition matter for market conditions and should be monitored by financial stability authorities.

Is SOFR better than LIBOR?
Jermann, Urban J.
It is expected that in the near future USD LIBOR will be replaced by a rate based on SOFR. Loans indexed to LIBOR offer lenders insurance against funding shocks; SOFR does not have this property. In this paper, I develop a stylized model to study this mechanism and to take a first look at quantitative magnitudes. In my model, under normal conditions, an economy using SOFR behaves similarly to an economy using LIBOR. Under more extreme financial conditions, differences can be nontrivial.

Labor Income Risk and Stock Returns: The Role of Horizon Effects
Eiling, Esther,De Jong, Frank,Laeven, Roger J. A.,Sperna Weiland, Rob C.
This paper shows that the impact of labor income risk on the cross-section of expected stock returns depends crucially on the horizon. Using a flexible empirical approach that allows us to include multiple horizons simultaneously, we find robust evidence that the two- to four-year horizon strongly dominates. Labor income risk at this medium term horizon carries a highly significant price of risk, while at other horizons it does not. A simple two-factor model that includes the equity market return and labor income risk at the medium term horizon can explain a striking 71% of the cross-sectional variation of 25 size book-to-market and 25 size-investment portfolios. This is a significant improvement over the standard human capital CAPM with quarterly labor income growth that has an R-squared of only 7%. Also, labor income risk generates significant adjustments to the composition of the optimal risky equity portfolio at the medium term horizon. These results are consistent with wage stickiness, where wages are reset every two to four years.

Monetary Policy, Credit Institutions and the Bank Lending Channel in the Euro Area
Altavilla, Carlo,Andreeva, Desislava,Boucinha, Miguel,Holton, Sarah
As the euro area has a predominantly bank-based financial system, changes in the composition and strength of banks’ balance sheets can have very sizeable implications for the transmission of monetary policy. This paper provides an overview of developments in banks’ balance sheets, profitability and risk-bearing capacity and analyses their relevance for monetary policy. We show that, while the transmission of standard policy interest rate cuts to firms and households was diminished during the crisis, in a context of financial market stress and weak bank balance sheets, unconventional monetary policy measures have helped to restore monetary policy transmission and pass-through to interest rates. We also document the extent to which these non-standard measures were successful in stimulating lending and which bank business models were more strongly affected. Finally, we show that the estimated impact of recent monetary policy measures on bank profitability does not appear to be particularly strong when all the effects on the macroeconomy and asset quality are taken into account.

New Venture Teams and Acquisition: Team Composition Matters
Soleimani, Leila,Stauffer, Ryan
This study examines the relationship between the composition of new venture founder teams and acquisition likelihood as a coveted exit route for entrepreneurs and investors. We find that gender diversity and the average education level of team members are positively related to acquisition likelihood. In addition, our results indicate a negative effect of industry experience level diversity on acquisition likelihood. This study provides insight into the significant role of founder characteristics in team-founded ventures as it relates to acquisition likelihood and the results may be of interest to both founders and external investors.

On Comparing Asset Pricing Models
Chib, Siddhartha,Zeng, Xiaming,Zhao, Lingxiao
We revisit the framework of Barillas and Shanken (2018) (BS henceforth) to point out that the Bayesian marginal likelihood based model comparison method in that paper is unsound. We show that in this comparison of asset pricing models, the priors on the nuisance parameters across models must satisfy a certain change of variable property for densities that is violated by the off-the-shelf Jeffreys priors used in the BS method. Hence, the BS "marginal likelihoods" are non-comparable across models and cannot be used to locate the (traded) risk factors. We conduct extensive simulation exercises in two designs: one with 8 potential pricing factors and a second with 12 factors, in each case matching the factors to real world factors that arise in this setting. As expected, the BS method performs unsatisfactorily, even when epic (and practically unattainable) sample sizes of .12 and 1.2 million are used to conduct the model comparisons. In a notable advance, we derive a new class of improper priors on the nuisance parameters, starting from a single improper prior, which leads to valid marginal likelihoods, and valid model comparisons. The empirical performance of our marginal likelihoods is substantially better, opening doors to reliable Bayesian work on which factors are risk factors in asset pricing models.

On the K\"ahler Geometry of Certain Optimal Transport Problems
Gabriel Khan,Jun Zhang

Let $X$ and $Y$ be domains of $\mathbb{R}^n$ equipped with respective probability measures $\mu$ and $ \nu$. We consider the problem of optimal transport from $\mu$ to $\nu$ with respect to a cost function $c: X \times Y \to \mathbb{R}$. To ensure that the solution to this problem is smooth, it is necessary to make several assumptions about the structure of the domains and the cost function. In particular, Ma, Trudinger, and Wang established regularity estimates when the domains are strongly \textit{relatively $c$-convex} with respect to each other and cost function has non-negative \textit{MTW tensor}. For cost functions of the form $c(x,y)= \Psi(x-y)$ for some convex function $\Psi$, we find an associated K\"ahler manifold whose orthogonal holomorphic bisectional curvature is proportional to the MTW tensor. We also show that relative $c$-convexity geometrically corresponds to geodesic convexity with respect to a dual affine connection. Taken together, these results provide a geometric framework for optimal transport which is complementary to the pseudo-Riemannian theory of Kim and McCann.

We provide several applications of this work. In particular, we find a complete K\"ahler surface with non-negative orthogonal bisectional curvature that is not a Hermitian symmetric space or biholomorphic to $\mathbb{C}^2$. We also address a question in mathematical finance raised by Pal and Wong on the regularity of \textit{pseudo-arbitrages}, or investment strategies which outperform the market.

Quantifying the Value of Heterogeneous Preference: An Empirical Matching Model of Peer-to-Peer Lending
Jiang, Yang,Zheng, Jinyang,Tan, Yong,Yan, Xiangbin
This paper focuses on an essential, but previously underexplored, mechanism that underlies the operation of peer-to-peer (P2P) lending markets: lender-borrower matching. We model the formation of lender-borrower matches as an endogenous matching process in which agents strategically choose their partners based on their preferences. Using data from a large online lending site, we empirically investigate the determinants of lender-borrower matching and explore their importance. Our structural estimates suggest that heterogeneous preference leads to various matching patterns across different types of lenders and borrowers. Experienced, hasty, and male lenders exhibit more tolerance toward borrowers with a lower credit score than do their counterparts. Based on these estimates, we perform counterfactual analyses to quantify the economic value of P2P lending. Note that P2P lending differs from traditional lending by following a decentralized matching process under which heterogeneous preference is maintained. We quantify the matching value from the decentralized matching process in P2P lending and compare it to that of its centralized counterpart for which heterogeneous preference is not respected. We find that P2P lending gains value from heterogeneous preference and that a more centralized matching process hurts large and active markets less than for small and inactive markets. Further, an agent-level analysis shows that more experienced lenders and low credit score borrowers are more vulnerable to a credit-score-ruled centralized matching process. Our findings offer managerial implications for credit scoring and information disclosure policy.

Redemptions and Asset Liquidations in Corporate Bond Funds
Dötz, Niko,Weth, Mark Andreas
Mutual funds’ exposure to corporate bonds has brought concerns about risks arising from liquidity transformation back to the fore. With a focus on fund asset liquidity and investors, this paper explores the flow-performance relationship and the liquidity management of funds in the presence of net redemptions. We highlight the response of fund liquidity because the vulnerability to outflows is found to depend on asset liquidity and fund ownership. We construct a unique panel of German corporate bond funds by merging data on asset liquidity with information on fund ownership. First, conditional on underperformance, illiquid funds dominated by retail investors are more exposed to outflows than illiquid funds primarily owned by institutional investors. Large investors are reluctant to withdraw most likely because they internalise the fire-sale-driven loss that a withdrawal inflicts on an illiquid fund. Within institutional-oriented funds, the flow response to bad performance is only significant if fund assets are sufficiently liquid. Second, the way that fund managers liquidate their bonds to meet redemptions is found to differ across ownership structures and depends on the degree of macroeconomic uncertainty: in times of high uncertainty, managers of institutional-oriented funds sell bonds in a liquidity pecking order style, thereby preserving short-term performance. At the same time, retail-based funds do not let portfolio liquidity deteriorate â€" presumably to attenuate incentives for runs.

Regulation A+: What Do We Know So Far?
Knyazeva, Anzhela
The Commission amended Regulation A, an exemption from securities registration, as ​part of implementing the JOBS Act. These amendments (Regulation A+) became effective on June 19, 2015. ​This paper examines offering activity in the Regulation A+ market during June 2015-October 2016 and provides preliminary evidence on the impact of the 2015 amendments.

Risky Bank Guarantees
Mäkinen, Taneli,Sarno, Lucio,Zinna, Gabriele
Applying standard portfolio-sort techniques to bank asset returns for 15 countries from 2004 to 2018, we uncover a risk premium associated with implicit government guarantees. This risk premium is intimately tied to sovereign risk, suggesting that guaranteed banks, defined as those of particular importance to the national economy, inherit the risk of the guarantor. Indeed, this premium does not exist in safe-haven countries. We rationalize these findings with a model in which implicit government guarantees are risky in the sense that they provide protection that depends on the aggregate state of the economy.

Scelte di Portafoglio: Approccio Media-Varianza Stati di Natura Continui (Mean-Variance Portfolio Choice)
Miceli, Maria-Augusta
Italian Abstract:L'obiettivo di queste note è evidenziare il metodo di ottimizzazione del portafoglio unico per cui l'investitore massimizza la sua funzione di utilità in media e varianza del portafoglio rispetto al vincolo della frontiera efficiente dei possibili pesi in cui le attività finanziarie disponibili sono detenute nel portafoglio. Tale frontiera sarà una retta, la "capital market line", se esiste un'attività risk-free o una curva se vi sono solo attività rischiose. Il CAPM non è altro che il primo caso, ma dove la CML è tangente alla frontiera efficiente delle attività rischiose. Essendo tale punto il portafoglio dominante dovrà essere l'indice di mercato. Tale tangenza definisce i "beta" come i coefficienti di regressione del rendimento di un'attività finanziaria qualunque verso l'eccesso di rischio presento sul mercato. Di conseguenza tale regressione calcola il rendimento medio atteso per un'attività finanziaria che abbia correlazione "beta" verso il rischio di mercato.English Abstract: The aim of these notes is to highlight the method of portfolio optimization, when the investor maximizes his mean-variance utility function subject to the constraint represented by the efficient frontier of the possible weights in which the available financial assets available are held. This frontier will be a straight line, the "capital market line", when there is a risk-free asset or a curve when there are only risky assets. The CAPM is nothing else than the first case, but where the CML is tangent to the efficient frontier of risky activities. Since the tangency condition defines the dominant portfolio, this must be the market index. This tangency defines also the "betas" as the regression coefficients of the return of any financial asset towards the excess risk present on the market. Consequently, this regression calculates the expected average return for a financial asset that has a "beta" correlation with market risk.

Seeking Rationality: $500 Bills and Perceptual Obviousness
Felin, Teppo,Felin, Mia
The concept of bounded rationalityâ€"and the work of Herbert Simon, Daniel Kahneman, Richard Thaler, and many others in behavioral economicsâ€"has provided a much-needed counterweight to rational expectations theory in economics. In this chapter we revisit the contrast between rational expectations and bounded rationality, specifically as they relate to the psychology of perception and the nature and origins of value. We use the proverbial $500 bill as a way to informally discuss perception, obviousness and value. We highlight some perceptual concerns with existing arguments about the idea of obviousness and bias (by Kahneman, Thaler, Sunstein and colleagues), as well as heuristics (by Gigerenzer and colleagues)â€"linking this to empirical findings in cognitive psychology and behavioral economics. We point toward some theoretical alternatives by building on insights from biology and the psychology of perception. We specifically discuss two key issues related to perception and rationality: (a) perception and the organism-environment relationship and (b) seeking or “looking for” rationality. We conclude with a discussion of the economic implications of our argument by discussing perception, belief heterogeneity and the origins of value in markets.

Sentiment Versus Liquidity Pricing Effects in the Cross-Section of UK Stock Returns
O'Sullivan, Niall ,Zhu, Sheng,Foran, Jason
This study examines the asset pricing role of ‘sentiment risk’ in stock returns in the case of the UK stock market. We define sentiment risk as the sensitivity of stock returns to investor sentiment in financial markets. We incorporate a broad range of financial market variables in measuring financial conditions and use this as a proxy for market-wide investor sentiment. The paper distinguishes between rational and irrational (noisy) investor sentiment. Initial findings indicate a strong role for rational sentiment risk in the returns of FTSE All Share stocks. However, our paper makes a key contribution by identifying that this evidence largely disappears after controlling for the liquidity risk features of stocks. No evidence of sentiment risk pricing is found among the subgroups of FTSE 250 and FTSE 100 stocks. More generally, our findings point to a strong relation between sentiment risk and liquidity risk in returns and the need for careful disentangling of sentiment versus liquidity effects.

Some Gains Are Riskier Than Others: Volatility Changes, Belief Revisions, and the Disposition Effect
Vasudevan, Ellapulli
I examine whether an increase in a stock’s volatility during the holding period triggers a revision in investors’ beliefs as to the stock’s risk level. This revision makes loss-averse investors more willing to sell a riskier stock with a paper gain as the likelihood of having to sell it at a loss later increases. An analysis of a large dataset on the holdings and trades of individual investors yields empirical support for this prediction: a one standard deviation increase in volatility is associated with an 11% increase in the disposition effect. The effect primarily emerges from investors’ increased propensity to sell stocks with small paper gains.

The Economic Geography of Fossil Fuel Divestment, Environmental Policies and Oil and Gas Financing
Cojoianu, Theodor,Ascui, Francisco,Clark, Gordon L.,Hoepner, Andreas G. F.,Wojcik, Dariusz
This paper explores how fossil fuel divestment commitments and environmental policies have shaped the geography of capital flows into the oil and gas sector, based on the analysis of syndicated lending, equity and bond underwriting across 33 countries from 2000 to 2015. We find that the value of total assets pledged for divestment in a given country is negatively associated with capital flows to domestic oil and gas companies, particularly when divestment is led by regional or sovereign governments. Amongst environmental policy instruments, emissions trading schemes and renewables feed-in tariffs have been most impactful in reducing oil and gas sector capital inflows.

The Effect of Disclosure Opacity on Trading Opacity: New Evidence from ADR Trades in Dark Pools
Boulton, Thomas Jason,Braga-Alves, Marcus V.,Chakrabarty, Bidisha
As volume increasingly migrates away from exchanges to dark pools, we revisit the link between disclosure opacity and volume, conditional on the choice to trade in a dark venue. We exploit the exogenous variation in home-country reporting opacity to examine how disclosure quality affects the fraction of ADR volume traded in dark pools. Using multiple metrics for reporting quality and controlling for firms’ information environment, we find that dark pool volume is positively correlated with home-country reporting opacity. This relationship holds after controlling for observable differences between ADRs and other securities that trade in dark pools (matched sample analysis) and the possible endogenous determination of home-country reporting opacity and dark pool volume. The positive relation is stronger for ADRs held by institutions with low turnover and diversified holdings, and weaker for ADRs with greater ownership by institutions with large and stable ownership positions. Bid-ask spreads are positively correlated with dark pool volume for ADRs, consistent with research that finds a negative effect of dark pool trading on market quality.

The FOMC and the Mortgage Market
Giacoletti, Marco,Ramcharan, Rodney ,Yu, Edison
Using daily data on mortgage applications from over two decades, this paper shows that applications increase sharply in the days just before the Federal Open Market Committee (FOMC) meetings, and decline sharply in the days after the FOMC. Bond market uncertainty also increases in the days before these meetings. And the evidence shows that this increase in bond market uncertainty helps explain the rise in applications, as risk averse households rush to contract ahead of the meeting, rather than gamble on interest rate outcomes after the FOMC meeting.

The Impact of Bank Herding on Systemic Risk
Heo, Yuna
We find that the level of bank herding in real estate loans during boom period is substantially higher than the level of bank herding in commercial and industrial loans or consumer loans. More importantly, we find that bank herding significantly increases systemic risk. In particular, herding in real estate loans by big banks contribute more to systemic risk. We find bank herding interacts with boom period to provide a stronger predictive power of systemic risk to next period beyond what is predicted by bank herding and boom period individually. We attribute these results to evidence of too-many-and-big-to-fail.

The Impact of Business Strategy on Corporate Cash Policy
Magerakis, Efstathios,Tzelepis, Dimitris
Purpose â€" The purpose of this study is to explore the association between cash holdings and business strategy for non-financial US firms, over the period from 1970 to 2016.Design/Methodology/Approach â€" We use Miles and Snow’s (1978, 2003) theoretical background and follow Bentley et al. (2013) to construct the strategy index. Thus, we distinguish two extreme corporate strategies, Prospectors and Defenders, based on resource allocation and investment behavior patterns. Following the methodology of Bates et al. (2009) on cash holdings, we use multiple regression analysis to explore the relationship between strategy and corporate liquidity.Findings â€" The empirical results suggest that the business strategy index affects positively corporate liquidity. Furthermore, the deviation from the target cash seems to be higher for Prospectors than Defenders, who adjust quicker to the optimal cash levels. Cash-holding adjustment speed for Prospectors is slower than for Defenders’. As a result, Prospectors seem to hold more cash than Defenders, which results in a lower firm’s market value. Research Limitations/Implications â€" The results of this work have valuable implications for researchers, who develop a conceptual framework to identify the firms’ cash holding behavior of different strategic types. This study, however, is limited to US non-financial firms; future research could focus on an international sample of firms.Practical Implications â€" The findings of this paper could be useful to corporate managers, in order to pursue a successful business strategy and maximize firm value through the adoption of an effective liquidity policy. Strategic planning along with optimal cash management should guide firms to significantly improve their input’s use efficiency and their default risk minimization.Originality/Value â€" The main contribution of this study emerges from the first-time investigation of the relationship between cash holdings and business strategy and the augmentation of the empirical research on the strategy’s effect on cash policy, excess cash valuation, and hence, firm value.

The International Monetary and Financial System
Gourinchas, Pierre-Olivier,Rey, Hélène,Sauzet, Maxime
International currencies fulfill different roles in the world economy with important synergies across those roles. We explore the implications of currency hegemony for the external balance sheet of the United States, the process of international adjustment, and the predictability of the US dollar exchange rate. We emphasize the importance of international monetary spillovers, of the exorbitant privilege, and analyse the emergence of a new `Triffin dilemma'.

The Low-Minus-High Portfolio
Andrei, Daniel,Cujean, Julien,Fournier, Mathieu
Anomalies in the cross section of returns should not be regarded as evidence against the CAPM. Regardless whether the CAPM is rejected for valid reasons or by mistake, a single long-short portfolio will always explain, together with the market, 100% of the cross-sectional variation in returns. Yet, this portfolio need not proxy for fundamental risk. We show theoretically how factors based on valuation ratios (e.g, book-to-market), or on investment rates, can be proxies for this portfolio. More generally, the empiricist can uncover an infinity of proxies for this portfolio, thus unleashing the factor zoo.

The Non-Neutrality of Debt in Investment Timing: A New NPV Rule
Sabarwal, Tarun
Limited liability debt financing of irreversible investments can affect investment timing through an entrepreneur’s option value, even after compensating a lender for expected default losses. This non-neutrality of debt arises from an entrepreneur’s unique investment opportunity, and it is shown in a standard model of irreversible investment that is enhanced in a straightforward manner to include the equilibrium effect of a competitive lending sector. The analysis is partial, in that it takes as exogenously given an entrepreneur’s use of debt. Intuitively, limited liability lowers downside risk for the entrepreneur by truncating the lower tail of risks, thereby lowering the investment threshold. Compensating the lender for expected default losses reduces project profitability to the entrepreneur, thereby increasing the investment threshold. The net effect is negative, because lower downside risk has an additional impact on the option value of delaying investment. The standard NPV rule in real options theory implicitly assumes debt to be neutral. With non-neutrality of debt, an investment threshold is higher than investment cost, but lower than the standard NPV rule. Comparisons with other standard investment thresholds show similar relationships.

The Politics of CEOS
Cohen, Alma,Hazan, Moshe,Tallarita, Roberto,Weiss, David
CEOs of public companies have influence over the political spending of their firms, which has been attracting significant attention since the Supreme Court decision in Citizens United. Furthermore, the policy views expressed by CEOs receive substantial consideration from policymakers and the public. The political preferences of CEOs, we argue, are therefore important for a full understanding of U.S. policymaking and politics. To contribute to this understanding, we provide empirical evidence on the partisan leanings of public-company CEOs.

The Value of Connections: Network Effects on Stock Market Participation
Balakina, Olga,Parakhonyak, Anastasia
We introduce an equilibrium model of the stock market participation rate with a social network to study how information sharing through a network affects the decision to enter the stock market. We analyze how the equilibrium participation level depends on the number of stock-investing agents and the intensity of social interactions, and provide an algorithm for finding the equilibrium stock market participation level. We test the predictions from the model using Facebook county-level connectivity data. We find the model with social networks outperforms standard models without networks in predicting heterogeneity of equilibrium stock market participation over the income distribution.

To What Extent Are Investment Bank-Differentiating Factors Relevant for Firms Floating Moderate-Sized IPOs?
Kulkarni, Kedar,Sabarwal, Tarun
One explanation provided for the relatively high and increasingly stable spreads for moderate - sized IPOs ($20-$80 million) documented in Chen and Ritter (2000) is that issuing firms focus less on price and more on a combination of investment bank-differentiating factors (such as underwriter prestige, analyst coverage, industry expertise, under-pricing, price stabilization activities, liquidity provision, and so on,) and banks use industry-based differentiation as a source of market power. Using a new approach developed in a model of firm location choice due to Ellison and Glaeser (1997), this paper presents some evidence on the combined relevance of such bank-differentiating factors, over and above bank size, for firms choosing investment banks for floating IPOs. For moderate-sized IPOs, there is a little, but not much evidence that such factors are a good explanation for high and increasingly stable spreads. Other than in a few of the largest industries, bank-differentiating factors are not significantly relevant for a large proportion of industries. Moreover, one aggregate measure of differentiation is declining over time.

Trade Credit, Cash Holdings, and Product Market Competition
Zhang, Rongrong
We explore how trade credit complements cash holdings in product market competition. First, similar to cash to cash flow sensitivity (Almeida, Campello, and Weisbach 2004), we report that trade credit is sensitive to internal cash flows and this sensitivity is moderated by firms’ financial strength, market power, and relationship specific investments. We show that both trade credit and cash holdings are strategically valuable in product market competition and their valuations are moderated by a common set of factors. Using Differences-in-difference framework, we establish causality between trade credit practices and product market competition. We also show that the value of trade credit depends on whether suppliers are in relation with principal customers.

Understanding the Effects of Alternative Cost-of-Equity Proxies on Corporate Investment and Financing
Byoun, Soku,Wu, Kai
Previous research shows that the implied cost of capital (factor model-based estimates for the cost of equity) have a negative (positive) effect on investment. Our paper documents that these alternative cost-of-equity proxies also have opposite effects on external financing activities. We show that the ICC has negative effects on investment and external financing by capturing the firm-specific discount rate news, whereas the factor model-based proxies has positive effects on these decisions by capturing the cash flow news. Furthermore, the negative effects of the ICC are more pronounced for firms with high private information and equity dependence, whereas the positive effects of the factor model-based estimates are more pronounced for firms with low private information and equity dependence. Thus, the opposite effects of the cost-of-equity proxies can be explained by their distinctive information contents.

What is a Hedge or Safe Haven Asset for Bitcoin Investors?
Sakemoto, Ryuta,Ho, Alden,Ichikawa, Yoshihiko
This paper investigates a hedge and safe haven asset for Bitcoin investors. Bitcoin has been receiving high attention from finance investors because of its high upside return and volatility. The recent finance literature focused upon Bitcoin characteristics as an alternative asset. We take Bitcoin investors’ perspectives and consider how to manage the high volatility of Bitcoin. We employ the definitions of hedge and safe haven based on the finance literature and conduct the respective statistical analyses. Our definition distinguishes a weak and strong hedge (safe haven). Our empirical results show that traditional assets such as global equities and global bonds are weak hedges for Bitcoin. Furthermore, we observe that gold acts as a strong hedge against Bitcoin during an extreme bearish Bitcoin market, although the impact is marginal. There is no strong safe haven asset identified in our data period. Our results imply that the fundamental value of Bitcoin is still unclear, and it is difficult for Bitcoin investors to manage their portfolio risk.

Where does active travel fit within local community narratives of mobility space and place?
Alec Biehl,Ying Chen,Karla Sanabria-Veaz,David Uttal,Amanda Stathopoulos

Encouraging sustainable mobility patterns is at the forefront of policymaking at all scales of governance as the collective consciousness surrounding climate change continues to expand. Not every community, however, possesses the necessary economic or socio-cultural capital to encourage modal shifts away from private motorized vehicles towards active modes. The current literature on `soft' policy emphasizes the importance of tailoring behavior change campaigns to individual or geographic context. Yet, there is a lack of insight and appropriate tools to promote active mobility and overcome transport disadvantage from the local community perspective. The current study investigates the promotion of walking and cycling adoption using a series of focus groups with local residents in two geographic communities, namely Chicago's (1) Humboldt Park neighborhood and (2) suburb of Evanston. The research approach combines traditional qualitative discourse analysis with quantitative text-mining tools, namely topic modeling and sentiment analysis. The analysis uncovers the local mobility culture, embedded norms and values associated with acceptance of active travel modes in different communities. We observe that underserved populations within diverse communities view active mobility simultaneously as a necessity and as a symbol of privilege that is sometimes at odds with the local culture. The mixed methods approach to analyzing community member discourses is translated into policy findings that are either tailored to local context or broadly applicable to curbing automobile dominance. Overall, residents of both Humboldt Park and Evanston envision a society in which multimodalism replaces car-centrism, but differences in the local physical and social environments would and should influence the manner in which overarching policy objectives are met.

Zipf's Law for Atlas Models
Ricardo T. Fernholz,Robert Fernholz

A set of data with positive values follows a Pareto distribution if the log-log plot of value versus rank is approximately a straight line. A Pareto distribution satisfies Zipf's law if the log-log plot has a slope of -1. Since many types of ranked data follow Zipf's law, it is considered a form of universality. We propose a mathematical explanation for this phenomenon based on Atlas models and first-order models, systems of positive continuous semimartingales with parameters that depend only on rank. We show that the stable distribution of an Atlas model will follow Zipf's law if and only if two natural conditions, conservation and completeness, are satisfied. Since Atlas models and first-order models can be constructed to approximate systems of time-dependent rank-based data, our results can explain the universality of Zipf's law for such systems. However, ranked data generated by other means may follow non-Zipfian Pareto distributions. Hence, our results explain why Zipf's law holds for word frequency, firm size, household wealth, and city size, while it does not hold for earthquake magnitude, cumulative book sales, the intensity of solar flares, and the intensity of wars, all of which follow non-Zipfian Pareto distributions.