Research articles for the 2019-05-08

A Dynamic Model of Systemic Bank Runs
Liu, Xuewen
This paper develops a tractable dynamic model to study bank runs in a financial system, featuring the linkage between bank runs and asset market prices. The model speaks to the evolution of a systemic crisis. In our model economy, there are many banks and they share a common asset market. The interim liquidation value of a bank is endogenous and depends on its asset fundamentals, on the status of other banks and hence the aggregate fire sales in the system, and on the endogenous path-dependent market liquidity condition. We analytically characterize the dynamics of the interplay between market liquidity and bank runs. Our model shows runs-illiquidity traps with two steady-state equilibria and a crisis process consisting of an initial gradual decline followed by a sudden sharp crash in the transitional dynamics. Our theory explains empirical facts and gives new policy implications.

A Tale of Two Consequences: Intended and Unintended Outcomes of the Japan TOPIX Tick Size Changes
Ravi Kashyap

We look at the effect of the tick size changes on the TOPIX 100 index names made by the Tokyo Stock Exchange on Jan-14-2014 and Jul-22-2104. The intended consequence of the change is price improvement and shorter time to execution. We look at security level metrics that include the spread, trading volume, number of trades and the size of trades to establish whether this goal is accomplished. An unintended effect might be the reduction in execution sizes, which would then mean that institutions with large orders would have greater difficulty in sourcing liquidity. We look at a sample of real orders to see if the execution costs have gone up across the orders since the implementation of this change.

We study the mechanisms that affect how securities are traded on an exchange, before delving into the specifics of the TSE tick size events. Some of the topics we explore are: The Venue Menu and How to Increase Revenue; To Automate or Not to Automate; Microstructure under the Microscope; The Price of Connections to High (and Faraway) Places; Speed Thrills but Kills; Pick a Size for the Perfect Tick; TSE Tick Size Experiments, Then and Now; Sergey Bubka and the Regulators; Bird`s Eye View; Deep Dive; Possibilities for a Deeper Dive; Does Tick Size Matter? Tick Size Does Matter!

A Unified Theory of the Blockchain Economy
Aoyagi, Jun
In a blockchain economy, the incentive of record keepers and activity of blockchain users interact with each other through general equilibrium effects. On the one hand, users (buyers and sellers of goods) make transactions by using the blockchain protocol to mitigate informational frictions, and this activity pins down the demand for cryptocurrency and affects its price. On the other hand, record keepers maintain the blockchain system and determine how efficiently it can mitigate informational frictions among users, thereby affecting the users' activity and price of cryptocurrency. However, the price of cryptocurrency also affects the record keepers' behavior because they are motivated by a reward that is paid in cryptocurrency. These channels generate a feedback (complementarity) effect that is boiled down to a fixed point problem. We show that multiple equilibria can arise in which collective deviation of miners (e.g., fork) can deteriorate the blockchain's efficiency and consumers' welfare.

Angel Cognition and Active Involvement in BA Groups: A Cross-Country Empirical Analysis
Wirtz, Peter,Bonnet, Christophe,Cohen, Laurence,Capizzi, Vincenzo
The present research sets out to reach a better understanding of the determinants of business angels’ active involvement in making business angel groups accomplish diverse functions and building cognitive resources and shared competencies. We develop a framework where angels’ decision making style and professional experience are key in explaining their degree and type of involvement with diverse business angel group activities. We also posit that institutional and organizational factors might influence the involvement of business angels in group activities. To test the related propositions, we conduct a questionnaire survey with the members of two large business angel groups based in Italy and France. Our results show that business angels with a control-oriented decision-making style, as well as angels with previous Professional experience as a CEO and in marketing and sales, tend to be more actively involved in key angel group activities, both with regard to investment related activities and angel group management activities. Differences between the two angel groups seem to be due to organizational factors rather than to national or regional specificities.

Auction Theory Adaptations for Real Life Applications
Ravi Kashyap

We develop extensions to auction theory results that are useful in real life scenarios.

1. Since valuations are generally positive we first develop approximations using the log-normal distribution. This would be useful for many finance related auction settings since asset prices are usually non-negative.

2. We formulate a positive symmetric discrete distribution, which is likely to be followed by the total number of auction participants, and incorporate this into auction theory results.

3. We develop extensions when the valuations of the bidders are interdependent and incorporate all the results developed into a final combined realistic setting.

4. Our methods can be a practical tool for bidders and auction sellers to maximize their profits. The models developed here could be potentially useful for inventory estimation and for wholesale procurement of financial instruments and also non-financial commodities.

All the propositions are new results and they refer to existing results which are stated as Lemmas.

Central Banks and the Future of Money
Murray, John
Policymaking circles and central banks around the world are now giving serious consideration to the pros and cons of making central bank digital currencies (CBDCs) available to the general public. While the consensus view remains that such a move would be premature, opinion appears to be shifting. Indeed, developments in a number of advanced and emerging economies indicate that the CBDC model is receiving more serious consideration than it has in the past. The numerous speeches and research papers coming from central banks are testament to this growing interest. Moreover, some countries and central banks have moved beyond talking and have taken active steps to push the initiative further.Proponents view the introduction of CBDCs as a potentially positive development rather than a purely defensive reaction. Indeed, they believe CBDCs could materially improve the role of central bank money in the financial system by providing a more stable unit of account, a more efficient medium of exchange and a more secure store of value. Moreover, the potential benefits go well beyond these traditional central bank money functions. Proponents suggest that CBDCs could temper financial instability, improve the implementation and transmission of monetary policy, raise productivity, help finance government deficits, reduce tax evasion and discourage a number of other costly and illegal activities.These positive claims have not gone unchallenged. The most common concern raised is the destabilizing effect that CBDCs might have on the economy in times of financial stress. As a safe and convenient alternative to commercial bank deposits and other types of private financial assets, CBDCs might act as a dangerous accelerant in the context of a bank run, transforming an isolated concern about one bank’s solvency into a system-wide crisis. Another source of concern is the disruptive effect that CBDCs would likely have on the competitive position of commercial banks, other financial institutions and key financial market infrastructures.In the end, the best way forward for Canada and other countries may not involve the introduction of a CBDC. Some active government engagement now would nevertheless seem advisable to ensure the most promising ways forward are not precluded. Simply leaving it to the market to sort out would be very risky. The disruption caused by any policy reversals that might be contemplated at a later stage could prove insurmountable, leaving us in a place we would rather not be. It is important to understand that maintaining the status quo is unlikely to be a practicable option, given the shifting financial landscape. The question is not whether central banks will need to react, but how they should react to these tectonic technological shocks.

Corporate Leverage and the Dynamics of Its Components
Hovakimian, Armen,Hovakimian, Gayané
We investigate the dynamics of observed and target leverage ratios and deviations from the targets. The cross-sectional persistence in observed leverage ratios is driven by highly persistent targets, whereas the time series variation is driven by transitory deviations from targets. Deviations are less persistent for firms that are overlevered and firms that are smaller, younger, focused, or have lower credit ratings. In recessions, excess leverage is less persistent for larger firms and is more persistent for smaller firms. Thus, consistent with dynamic trade-off theories, persistence is higher when the costs of deviating from targets are likely to be lower and when the costs of adjustment are likely to be higher.

Credit Cycles, Expectations, and Corporate Investment
Gulen, Huseyin,Ion, Mihai,Rossi, Stefano
We study the real effects of credit market sentiment on corporate investment and financing for a comprehensive panel of U.S. public and private firms over 1963-2016. In the short term, we find that high credit market sentiment in year t correlates with high corporate investment and debt issuance in year t+1, particularly for financially constrained firms. In the longer term, high credit market sentiment in year t correlates with a decline in debt issuance in years t+3 and t+4; and with a decline in corporate investment in years t + 4 and t + 5. This pattern of increased investment in the short term and declined investment in the longer term is more pronounced for firms with larger analysts' earnings forecast revisions and comes with larger analysts' forecast errors, supporting theories of over-extrapolation of fundamentals into the future. A parsimonious dynamic model where over-extrapolation is the only departure from standard Q-theory does a good job matching the empirical moments of our data.

Credit Unions during the Crisis: Did They Provide Liquidity?
Maskara, Pankaj K.,Neymotin, Florence
Using Consumer Finance Monthly national survey, we demonstrate that credit unions in the US did little to help consumers obtain home equity lines of credit (HELOC) during the recent financial crisis. Our results hold after including a two-stage regression structure using the availability of credit unions as the identifying instrument. Use of Heckman procedure to adjust for possible sample selection bias does not alter our findings. Additionally there is no evidence to suggest that low income households residing in states experiencing housing price declines received more HELOC from CUs. Since credit unions are sometimes lauded for providing liquidity during times of crisis and helping to serve those who are otherwise less able to obtain funds, our results provide an empirical counterpoint to this common conception.

Cryptocurrency Architecture and Interaction With Market Shocks
Corbet, Shaen,Larkin, Charles James,Lucey, Brian M.,Meegan, Andrew,Vigne, Samuel
Blockchain technology appears to be ready to revolutionise a broad number of industries. However, the blockchain itself contains a number of inefficiencies and areas for improvement, namely: transaction fees and transaction speeds. Directed acyclic graphs (DAGs) address, and improve on these inefficiencies and a number of digital currencies utilising this technology have already begun to appear. This paper provides an explanation of the technology behind DAG-based assets, while identifying and highlighting strategic advantages that DAGs possess over traditional blockchains. We conduct a GARCH volatility analysis of a range of blockchain-based and DAG-based cryptocurrencies in the aftermath of a range of market shocks. We find that DAG-based assets become increasingly responsive to market shocks as they mature. Such behavior mirrors that of established cryptocurrencies such as Bitcoin, Ethereum and Litecoin, providing evidence that DAG-based cryptocurrencies now share similar characteristics to traditional blockchain-chain based products.

Cryptocurrency, Delivery Lag, and Double Spending History
Kang, Kee-Youn
We develop a general equilibrium model of cryptocurrency to study the optimal design of a cryptocurrency system. Agents trade cryptocurrency using digital wallets, and the cryptocurrency system provides verification of a digital wallet’s history of double spending attempts. Delaying the delivery of goods until payment information is confirmed in the blockchain prevents double spending. However, double spending can be prevented without a delivery lag under some conditions if a wallet has a good reputation in terms of its history of double spending attempts. In particular, as the difficulty of mining work rises, the incentive to engage in double spending with a good wallet decreases. We study the optimal design of the cryptocurrency system in terms of the difficulty of mining work and the supply of cryptocurrency and evaluate the welfare gain that would be captured if the current Bitcoin system adopted the optimal cryptocurrency system.

Decision Making with Machine Learning and ROC Curves
Kai Feng,Han Hong,Ke Tang,Jingyuan Wang

The Receiver Operating Characteristic (ROC) curve is a representation of the statistical information discovered in binary classification problems and is a key concept in machine learning and data science. This paper studies the statistical properties of ROC curves and its implication on model selection. We analyze the implications of different models of incentive heterogeneity and information asymmetry on the relation between human decisions and the ROC curves. Our theoretical discussion is illustrated in the context of a large data set of pregnancy outcomes and doctor diagnosis from the Pre-Pregnancy Checkups of reproductive age couples in Henan Province provided by the Chinese Ministry of Health.

Does Corruption Impact the Demand of Bank Credit? A Study of Discouraged Borrowers in Asian Developing Countries
Statnik, Jean-Christophe,Giang, Vu Thi Le
Two dysfunctions can affect the credit market: credit rationing and firm's discouragement. While the former has been studied in detail for more than 40 years, the latter has only been in the spotlight since 2003. In this work, we contribute to the understanding of this “demand-side failure” by investigating the role played by corruption. In particular, using data coming from Enterprise Surveys conducted by World Bank, we highlight, on the one hand, a significant negative effect of the corruption on “discouraged borrowers” in developing countries, and on the other, that this effect differs according to the level of economic development: in higher (resp. lower) development countries, higher level of corruption will discourage (resp. encourage) firms from applying for loans. We also find burden of government regulation is a channel to explain for this effect. To get over burdens in regulation, firms find corruption as one way to reach their targets at lower costs.

Does Environmental Economics lead to patentable research?
Xiaojun Hu,Ronald Rousseau,Sandra Rousseau

In this feasibility study, the impact of academic research from social sciences and humanities on technological innovation is explored through a study of citations patterns of journal articles in patents. Specifically we focus on citations of journals from the field of environmental economics in patents included in an American patent database (USPTO). Three decades of patents have led to a small set of journal articles (85) that are being cited from the field of environmental economics. While this route of measuring how academic research is validated through its role in stimulating technological progress may be rather limited (based on this first exploration), it may still point to a valuable and interesting topic for further research.

Economic Performance Through Time: A Dynamical Theory
Daniel Seligson,Anne McCants

The central problems of Development Economics are the explanation of the gross disparities in the global distribution, $\cal{D}$, of economic performance, $\cal{E}$, and the persistence, $\cal{P}$, of said distribution. Douglass North argued, epigrammatically, that institutions, $\cal{I}$, are the rules of the game, meaning that $\cal{I}$ determines or at least constrains $\cal{E}$. This promised to explain $\cal{D}$. 65,000 citations later, the central problems remain unsolved. North's institutions are informal, slowly changing cultural norms as well as roads, guilds, and formal legislation that may change overnight. This definition, mixing the static and the dynamic, is unsuited for use in a necessarily time dependent theory of developing economies. We offer here a suitably precise definition of $\cal{I}$, a dynamical theory of economic development, a new measure of the economy, an explanation of $\cal{P}$, a bivariate model that explains half of $\cal{D}$, and a critical reconsideration of North's epigram.

Equity Allocation and Risk-Taking in the Intermediation Chain
Segura, Anatoli,Villacorta, Alonso
We build an equilibrium model of the capital structure and risk-taking in the originate-to-distribute intermediation chain in presence of absolute demand for safety by some investors and limited endowment by equity investors. Loan originators may expand investment by raising funds from intermediaries that diversify idiosyncratic risks to create safe securitized assets. Equity funding allows originators to improve their risk-taking incentives and intermediaries to absorb losses from their exposure to aggregate risk. The competitive allocation of equity renders the equilibrium Pareto constrained efficient. Consistent with the saving glut narrative of the expansion of securitization in the run-up to the crisis, an increase in the demand for safety leads to increases in the overall equity invested in intermediaries, the relative size of the intermediary sector and risk-taking at origination. Government policies that include fiscally neutral guarantees to the issuance of securitized assets lead to Pareto improvements in the economy, have ambiguous risk-taking effects at origination, and are preferable to guarantees to originators because of intermediaries' higher exposure to aggregate risk.

Former Members of the U.S. Congress and Fraud Enforcement: Does it Help to Have Politically Connected Friends on the Board?
Maskara, Pankaj K.,Kuvvet, Emre
We investigate the relationship between the presence of former member of the U.S. Congress on corporate boards and fraud enforcement. We find that corporate fraud in companies with such members on the board stays undetected longer. When caught, such companies pay lower penalties. The appointment of former Congressional members to the board also lessens the probability of the company being subjected to Accounting and Auditing Enforcement Releases by the SEC after they face class-action lawsuits for fraudulent activities. Our results remain robust to the presence of other means of making political connections, such as lobbying, hiring revolving-door lobbyists, and contributing to political campaigns.

From Sicilian mafia to Chinese "scam villages"
Jeff Yan

Inspired by Gambetta's theory on the origins of the mafia in Sicily, we report a geo-concentrating phenomenon of scams in China, and propose a novel economic explanation. Our analysis has some policy implications.

Fundamental Theorem of Asset Pricing under fixed and proportional transaction costs
Martin Brown,Tomasz Zastawniak

We show that the lack of arbitrage in a model with both fixed and proportional transaction costs is equivalent to the existence of a family of absolutely continuous single-step probability measures, together with an adapted process with values between the bid-ask spreads that satisfies the martingale property with respect to each of the measures. This extends Harrison and Pliska's classical Fundamental Theorem of Asset Pricing to the case of combined fixed and proportional transaction costs.

Geopolitical Risk and Corporate Investment
Dissanayake, Ruchith,Mehrotra, Vikas,Wu, Yanhui
Shocks to geopolitical risk are known to adversely affect real activity, as well as a flight to safety by invested capital. In this study we explore the channels via which this occurs. We find that firms respond to geopolitical risk by cutting back on capital investments. This effect is stronger for firms with more irreversible investments and foreign operations. Geopolitical threats appear to influence investments more than geopolitical acts do, perhaps because acts are perceived as resolving uncertainty. Dividends, another use of cash by firms, are not adversely affected by changes in geopolitical risk, indicating finite half-lives for geopolitical shocks.

Global Banks, Dollar Funding, and Regulation
Aldasoro, Iñaki,Ehlers, Torsten,Eren, Egemen
We document that non-US global banks are increasingly heterogeneous in their dollar banking activities and dollar demand. We study the implications for dollar funding markets using data on security-level money market fund holdings. We find that funds charge higher prices to banks with weaker bargaining positions, consistent with theories of over-the-counter markets. For identification, we use exogenous variation in bargaining power due to window-dressing at quarter-ends and the US money market fund reform. We show that post-crisis regulations have reduced competition in certain segments of dollar funding markets and have generated incentives for regulatory arbitrage, with potentially adverse unintended consequences.

Heterogeneous Spillovers of Housing Credit Policy
Pidkuyko, Myroslav
We study the spillovers from government intervention in the mortgage market on households’ consumption. After an expansionary mortgage market operation, the consumption response of homeowners with mortgage debt is large and significant, while the consumption response of homeowners without the mortgage debt is small and insignificant. Non-homeowners also increase their consumption but less than mortgagors. We also find that expansionary policy significantly increases consumption inequality of mortgagors. We explain these facts through the lens of a life-cycle model with incomplete markets and endogenous housing choice. Reduction in credit rates creates extra wealth for the mortgagors while the reduction in interest rates shifts this wealth towards consumption. Increase in wealth is bigger for those with larger mortgage- this exacerbates consumption inequality.

High-performance stock index trading: making effective use of a deep LSTM neural network
Chariton Chalvatzis,Dimitrios Hristu-Varsakelis

We present a deep long short-term memory (LSTM)-based neural network for predicting asset prices, together with a successful trading strategy for generating profits based on the model's predictions. Our work is motivated by the fact that the effectiveness of any prediction model is inherently coupled to the trading strategy it is used with, and vise versa. This highlights the difficulty in developing models and strategies which are jointly optimal, but also points to avenues of investigation which are broader than prevailing approaches. Our LSTM model is structurally simple and generates predictions based on price observations over a modest number of past trading days. The model's architecture is tuned to promote profitability, as opposed to accuracy, under a strategy that does not trade simply based on whether the price is predicted to rise or fall, but rather takes advantage of the distribution of predicted returns, and the fact that a prediction's position within that distribution carries useful information about the expected profitability of a trade. The proposed model and trading strategy were tested on the S&P 500, Dow Jones Industrial Average (DJIA), NASDAQ and Russel 2000 stock indices, and achieved cumulative returns of 340%, 185%, 371% and 360%, respectively, over 2010-2018, far outperforming the benchmark buy-and-hold strategy as well as other recent efforts.

Hong Kong - Shanghai Connect / Hong Kong - Beijing Disconnect (?), Scaling the Great Wall of Chinese Securities Trading Costs
Ravi Kashyap

We utilize a fundamentally different model of trading costs to look at the effect of the opening of the Hong Kong Shanghai Connect that links the stock exchanges in the two cities, arguably the biggest event in international business and finance since Christopher Columbus set sail for India. We design a novel methodology that compensates for the lack of data on trading costs in China. We estimate trading costs across similar positions on the dual listed set of securities in Hong Kong and China, hoping to provide useful pieces of information to help scale 'The Great Wall of Chinese Securities Trading Costs'. We then compare actual and estimated trading costs on a sample of real orders across the Hong Kong securities in the dual listed pair to establish the accuracy of our measurements.

The primary question we seek to address is 'Which market would be better to trade to gain exposure to the same (or similar) set of securities or sectors?' We find that trading costs on Shanghai, which might have been lower than Hong Kong, might have become higher leading up to the Connect. What remains to be seen is whether this increase in trading costs is a temporary equilibrium due to the frenzy to gain exposure to Chinese securities or whether this phenomenon will persist once the two markets start becoming more and more tightly coupled.

It would be interesting to see if this pioneering policy will lead to securities exchanges across the globe linking up one another, creating a trade anything, anywhere and anytime marketplace. Looking beyond mere trading costs, such studies can be used to gather some evidence on what effect the mode of governance and other aspects of life in one country have on another country, once they start joining up their financial markets.

Horizontal Shareholding within the European Competition Law Framework: Assessment and a Way Forward
Fadiga, Riccardo
Horizontal shareholding engenders significant anticompetitive effects which current economic trends are exacerbating. Literature and institutions in Europe have yet to establish whether a suitable instrument within European competition law exists which may be applied to horizontal shareholding in order to curtail its intrinsic anticompetitive effects. This Article evaluates the state of the debate, analyses European competition law instruments, and shows that no adequate instrument is available. Ultimately, it proposes a novel approach to the notion of collective dominance suitable to support enforcement against horizontal shareholding on the basis of Article 102 TFEU.This material was first published by Thomson Reuters, trading as Sweet & Maxwell, 5 Canada Square, Canary Wharf, London, E14 5AQ, in European Competition Law Review and is reproduced by agreement with the publishers.

NASDAQ and the NYSE: A Trade Reporting Facility Comparison
Cox, Justin
In this article, I study the differences in off-exchange trades reported between the NASDAQ and NYSE Trade Reporting Facility (TRF). I examine the differences in market quality and preferencing for trades reported in each TRF and show that trades reported in the NASDAQ TRF have both higher effective and realized spreads as well as a higher preferencing measure. This result is particularly strong in NYSE-listed stocks and in large-cap stocks. I also construct a matched sample of NYSE- and NASDAQ-listed stocks, finding similar results. My findings support regulatory concerns aimed at how the NASDAQ TRF handles and preferences customer orders.

Nonlinear dependencies on Brazilian equity network from mutual information minimum spanning trees
A. Q. Barbi,G. A. Prataviera

Mutual information minimum spanning trees are used to explore nonlinear dependencies on Brazilian equity network in the periods from June/01/2015 to January/26/2016, in which Brazil was under the government of President Dilma Rousseff, and from January/27/2016 to September/08/2016 which includes the government transition from President Dilma Rousseff to President Michel Temer. Minimum spanning trees from mutual information and linear correlation between stocks returns were obtained and compared. Mutual information minimum spanning trees present higher degree of robustness and evidence of power law tail in the weighted degree distribution, indicating more risk in terms of volatility transmission than it is expected by the analysis based on linear correlation. In particular, a remarkable increase of stock returns nonlinear dependencies indicates that the period including the government transition is more risky in terms of volatility transmission network structure. Also, we found evidence of network structure and stock performance relationship. Besides, those results emphasize the usefulness of mutual information network analysis for identification of Financial Markets features due to nonlinear dependencies.

Online reviews can predict long-term returns of individual stocks
Junran Wu,Ke Xu,Jichang Zhao

Online reviews are feedback voluntarily posted by consumers about their consumption experiences. This feedback indicates customer attitudes such as affection, awareness and faith towards a brand or a firm and demonstrates inherent connections with a company's future sales, cash flow and stock pricing. However, the predicting power of online reviews for long-term returns on stocks, especially at the individual level, has received little research attention, making a comprehensive exploration necessary to resolve existing debates. In this paper, which is based exclusively on online reviews, a methodology framework for predicting long-term returns of individual stocks with competent performance is established. Specifically, 6,246 features of 13 categories inferred from more than 18 million product reviews are selected to build the prediction models. With the best classifier selected from cross-validation tests, a satisfactory increase in accuracy, 13.94%, was achieved compared to the cutting-edge solution with 10 technical indicators being features, representing an 18.28% improvement relative to the random value. The robustness of our model is further evaluated and testified in realistic scenarios. It is thus confirmed for the first time that long-term returns of individual stocks can be predicted by online reviews. This study provides new opportunities for investors with respect to long-term investments in individual stocks.

Pockets of Risk in European Housing Markets: Then and Now
Kelly, Jane,Le Blanc, Julia,Lydon, Reamonn
Using household survey data, we document evidence of a loosening of credit standards in Euro area countries that experienced a property price boom-and-bust cycle. Borrowers in these countries exhibited significantly higher loan-to-value (LTV) and loan-to-income (LTI) ratios in the run up to the financial crisis, and an increasing tendency towards longer-term loans compared to borrowers in other countries. In recent years, despite the long period of historically low interest rates and substantial house price increases in some countries, we do not find similar credit easing as before the crisis. Instead, we find evidence of a considerable change in borrower characteristics since 2010: new borrowers are older and have higher incomes than before the crisis.

Portfolio Liquidity: Is the Whole More Than the Sum of Its Parts?
Pham, Son Duy,Marshall, Ben R.,Nguyen, Nhut (Nick) Hoang,Visaltanachoti, Nuttawat
A tradable security basket should theoretically be more liquid than its underlying stocks because of the role of diversification. In the presence of informed investors, uninformed investors would rather trade the basket than an individual security as the basket is more diversified and diversification helps reduce information asymmetry related to idiosyncratic risk in the basket. However, we find the ETF liquidity is lower than its weighted average underlying liquidity and diversification has a negative impact on ETF liquidity. Our study bridges the gap between the theoretical model and empirical evidence and answers the question why many ETFs tracking the same stock basket have different liquidity by shedding more light on the sources of portfolio liquidity beyond the liquidity of its constituents.

Pricing Tranches in a CAPM-like World
Forbes, Keith
Slicing a loss distribution into tranches creates 'slice' risk in the sense that the original pool may have superior Sharpe ratio to its individual tranche components. We aim to determine the equilibrium price to tranches in a CAPM-like buy-and-hold world where neither slice risk nor idiosyncratic risk is compensated. In our simple world there is a constant excess return only to systematic risk. Systematic risk cannot potentially be eliminated by either completing the capital structure (as for slice risk) or diversification (as for idiosyncratic risk). First the case without idiosyncratic risk is considered: a perfectly diversified portfolio is tranched, and the equilibrium price is derived. Next, the approach is generalised to tranches of pools containing idiosyncratic risk.

Project Finance and Risk Modeling Using a System Dynamics Approach: A Toll Road Project
Sihombing, Lukas B.
In a build, operate, and transfer (BOT) scheme, as Project Finance (PF), equity investors are concerned about the adequacy of their returns. On the other hand, the timeliness of the project debt service payments focuses to the lenders. Consequently, an important role is played by PF and risk modeling to ensure that structure of the project management is a prerequisite. Nevertheless, the complexity of future infrastructure project will become more complicated. Not only will the limitations of stakeholders to understand others when evaluating a project will become more prevalent, but also the competition force the bidders to become increasingly innovative in their financing modeling. The aim of this paper is to propose a new technique to calculate project finance and risks using System Dynamics (SD) approach with sysdea modeling. The model builds confidence and its policy implications. This paper results is PF and risk modeling should use an SD approach in toll road projects.

Project Financing Models for Toll Road Investments: A State-of-the-Art Literature Review
Sihombing, Lukas B.,Latief, Yusuf,Rarasati, Ayomi D.,Wibowo, Andreas
In greenfield toll-road projects, financial sustainability has been a major issue. Many toll roads cannot be operated. Although most of Indonesia’s 24 toll road concessions have already been signed by the Toll Road Authority, most of them were caused by financing problems. Three problems have been identified as potential sources of this unsustainability, such as the uncertainty of long-term project revenues, budget constraints provided by the government, and inadequate government support for land acquisitions. This paper aims to investigate the state-of-the-art innovative financing models recently introduced to address financial problems by using a deskstudy and meta-analysis. The findings are an earmarked tax revenue system, deep discount bonds, take-out financing, tax increment financing, land leases, deferred debts, and private donations.

Relevant Stylized Facts About Bitcoin: Fluctuations, First Return Probability, and Natural Phenomena
C. R. da Cunha,R. da Silva

Bitcoin is a digital financial asset that is devoid of a central authority. This makes it distinct from traditional financial assets in a number of ways. For instance, the total number of tokens is limited and it has not explicit use value. Nonetheless, little is know whether it obeys the same stylized facts found in traditional financial assets. Here we test bitcoin for a set of these stylized facts and conclude that it behaves statistically as most of other assets. For instance, it exhibits aggregational Gaussianity and fluctuation scaling. Moreover, we show by an analogy with natural occurring quakes that bitcoin obeys both the Omori and Gutenberg-Richter laws. Finally, we show that the global persistence, originally defined for spin systems, presents a power law behavior with exponent similar to that found in stock markets.

Short-Term Reversals and Trading Activity
Chiang, I-Hsuan Ethan,Kirby, Chris,Nie, Ziye Zoe
Using a sample that excludes micro-cap stocks, we find that short-term reversals in monthly stock returns are strongly linked to prior monthly trading activity. Stocks with low turnover display a pronounced reversal effect, whereas those with high turnover display a continuation effect (momentum). The results are similar if we restrict the sample to large-cap stocks. Our analysis suggests that turnover is linked to short-term autocorrelation patterns in returns because it proxies for the flow of news that spurs speculative trading, and that the likelihood of short-term reversals falls as the proportion of turnover that is driven by news increases.

Solving the Equity Risk Premium Puzzle and Inching Towards a Theory of Everything
Ravi Kashyap

The equity risk premium puzzle is that the return on equities has far exceeded the average return on short-term risk-free debt and cannot be explained by conventional representative-agent consumption based equilibrium models. We review a few attempts done over the years to explain this anomaly: 1. Inclusion of highly unlikely events with low probability (Ugly state along with Good and Bad), or market crashes / Black Swans. 2. Slow moving habit, or time-varying subsistence level, added to the basic power utility function. 3. A separation of the inter-temporal elasticity of substitution and risk aversion, combined with long run risks which captures time varying economic uncertainty. We explore whether a fusion of the above approaches supplemented with better methods to handle the below reservations would provide a more realistic and yet tractable framework to tackle the various conundrums in the social sciences: 1. Unlimited ability of individuals to invest as compared to their ability to consume. 2. Lack of an objective measuring stick of value 3. Unintended consequences due to the dynamic nature of social systems 4. Relaxation of the transversality condition to avoid the formation of asset price bubbles 5. How durable is durable? Accounting for durable goods since nothing lasts forever The world we live in produces fascinating phenomenon despite (or perhaps, due to) being a hotchpotch of varying doses of the above elements. The rationale for a unified theory is that beauty can emerge from chaos since the best test for a stew is its taste. Many long standing puzzles seem to have been resolved using different techniques. The various explanations need to stand the test of time before acceptance; but then unexpected outcomes set in and new puzzles emerge. As real analysis and limits tell us: We are getting Closer and Closer; Yet it seems we are still Far Far Away...

Stock Volatility Predictability in Bull and Bear Markets
Li, Xingyi,Zakamulin, Valeriy
Recent literature on stock return predictability suggests that it varies substantially across economic states being strongest during bad economic times. In line with this evidence, we document that stock volatility predictability is also state dependent. In particular, using a large data set of high-frequency data on individual stocks and a few popular time-series volatility models, in this paper we comprehensively examine how volatility forecastability varies across bull and bear states of the stock market. We find that the volatility forecast horizon is substantially longer when the market is in a bear state than when it is in a bull state. In addition, the volatility forecast accuracy is higher and forecast bias is lower when the market is in a bear state. Our study concludes that the stock volatility predictability is strongest during bad economic times proxied by bear market states.

Targeting Financial Stability: Macroprudential or Monetary Policy?
Aikman, David,Giese, Julia,Kapadia, Sujit,McLeay, Michael
This paper explores monetary-macroprudential policy interactions in a simple, calibrated New Keynesian model incorporating the possibility of a credit boom precipitating a financial crisis and a loss function reflecting financial stability considerations. Deploying the countercyclical capital buffer (CCyB) improves outcomes significantly relative to when interest rates are the only instrument. The instruments are typically substitutes, with monetary policy loosening when the CCyB tightens. We also examine when the instruments are complements and assess how different shocks, the effective lower bound for monetary policy, market-based finance and a risk-taking channel of monetary policy affect our results.

Terrorism Financing, Recruitment and Attacks: Evidence from a Natural Experiment
Limodio, Nicola
I present empirical evidence showing that terrorism financing and recruitment promote terrorist attacks. Pakistan offers an ideal setting for this research due to a natural experiment inducing exogenous variation in terrorism financing. In line with terrorist organisations facing financial frictions, I find a correspondence between the timing and location of finance and the attacks by organisations exposed to this transfer. The effect of financing on attacks increases in recruitment, measured by combining dark web data and machine learning. These results suggest that financial counter-terrorism lowers attacks, which I quantify by estimating the elasticity of terrorist attacks to financing (0.25).

The Effects of Conventional and Unconventional Monetary Policy on Forecasting the Yield Curve
Eo, Yunjong,Kang, Kyu H.
The period of unconventional monetary policy in the low-interest rate environment since the Great Recession has suggested that unconventional policy has a different transmission mechanism to the term structure of interest rates from that of conventional policy. We study how conventional and unconventional monetary policies affect forecasting performance of individual yield curve models and their mixtures. The individual models considered here are the dynamic Nelson-Siegel model, the arbitrage-free Nelson-Siegel model, and the random-walk model. Out-of-sample forecasts for U.S. bond yields show that the arbitrage-free Nelson-Siegel model and its mixtures with other models perform well in the period of conventional monetary policy, whereas the random-walk model outperforms all the other models in the period of unconventional monetary policy. We show that the tightly constrained cross-equation restrictions of the no-arbitrage condition are associated with high correlations of bond yields across different maturities. The diminishing role of the no-arbitrage restriction in forecasting the yield curve since 2009 can be attributed to unconventional monetary policy, which involved direct purchases of long-term bonds while the short-term interest rates were stuck near zero. This policy resulted in low correlations between short- and long-term bond yields and little variation in the short-term bond yields. The random-walk model performs well when the yields are less correlated and exhibit little variation over time. During the period of the maturity extension program ("Operation Twist") in 2011--2012, which moved short- and long-term bond yields in opposite directions, the superiority of the random-walk forecasts is more pronounced; these results reinforce our finding that the monetary policy framework affects yield curve forecasts.

The Exclusive Role of Centralized Fund Family Management
Hunter, David L.,Sun, Jennifer,Benson, Karen L.
Fund families are centrally managed, and can directly control resource allocations between funds. We quantify multiple manageable fund family attributes, and examine their combined effects upon returns and investor flows. We focus upon five attributes that are exclusively manageable by fund families: marginal fee economies of scale, star fund offerings, mixed high and low risk product offerings, within-family manager scope, and manager outsourcing. We find sensitivity differences during financial crisis and non-crisis time periods. Management of these exclusive attributes significantly improve a fund family’s returns and investor flows, benefiting fund families and their investors during both normal and financial crisis periods. We find that investors reward fund families with greater performance sensitive inflows and weaker performance sensitive outflows, indicating that investors identify greater utility in centrally managed fund families.

The Human-Centred Business Model and Hybrid Business Forms: A Primer and a Roadmap
Lenzi, Diletta,Zorzi, Andrea
The paper was written as part of the preliminary research for the Human Centred Business Model Project, a project developed within the Global Forum on Law, Justice and Development and now supported by the OECD Development Centre. In a preliminary fashion, the paper skims the surface of ‘social’ businesses, in the broadest sense, around the world, identifying some general trends and commonalities and some differences. The paper covers jurisdictions from North and South America, Europe, Asia and Australia and describes the organisations that can be used to carry out social business.

The mitigating role of regulation on the concentric patterns of broadband diffusion. The case of Finland
Jaume Benseny,Juuso Töyli,Heikki Hämmäinen,Andrés Arcia-Moret

This article analyzes the role of Finnish regulation in achieving the broadband penetration goals defined by the National Regulatory Authority. It is well known that in the absence of regulatory mitigation the population density has a positive effect on broadband diffusion. Hence, we measure the effect of the population density on the determinants of broadband diffusion throughout the postal codes of Finland via Geographically Weighted Regression. We suggest that the main determinants of broadband diffusion and the population density follow a spatial pattern that is either concentric with a weak/medium/strong strength or non-concentric convex/concave. Based on 10 patterns, we argue that the Finnish spectrum policy encouraged Mobile Network Operators to satisfy ambitious Universal Service Obligations without the need for a Universal Service Fund. Spectrum auctions facilitated infrastructure-based competition via equitable spectrum allocation and coverage obligation delivery via low-fee licenses. However, state subsidies for fiber deployment did not attract investment from nationwide operators due to mobile preference. These subsidies encouraged demand-driven investment, leading to the emergence of fiber consumer cooperatives. To explain this emergence, we show that when population density decreases, the level of mobile service quality decreases and community commitment increases. Hence, we recommend regulators implementing market-driven strategies for 5G to stimulate local investment. For example, by allocating the 3.5 GHz and higher bands partly through local light licensing.

Trend-Following CTAs vs Alternative Risk-Premia (ARP) Products: Crisis Beta vs Risk-premia Alpha
Sepp, Artur,Dezeraud, Louis
We propose a quantitative model to explain the risk of systematic investment strategies by accounting for their exposures to equity tail risk, such as shorting volatility and credit protection. We apply this model to the cross-sectional risk attribution of about 200 composite indices of hedge funds and alternative risk premia (ARP) products. We show that there is a strong linear relationship between risk-premia alpha and the tail risk of systematic ARP strategies. We demonstrate that our model explains nearly 90% of the risk-premia for volatility strategies and about 35% of the risk-premia for hedge fund and ARP products. In this way, most ARP and hedge fund type products are seen as risk-seeking strategies. We illustrate that trend-following CTAs are exceptions since they belong to defensive strategies with negative market betas in bear regimes, yet risk-premia alphas for CTAs are insignificant. CTAs cannot be seen either as ARP products with positive risk-premia alpha from exposures to tail risk, or as defensive products with negative risk-premia designed to reduce tail risk, such as long volatility strategies. Instead, trend-following CTAs should be viewed as an actively managed defensive strategy with the goal to deliver protective negative market betas in strongly downside markets along with risk-seeking positive market betas in strongly upside markets. Finally, we show that because of the negative protective betas in bear markets, trend-followers well deserve their place as diversifiers in alternative portfolios to improve risk-adjusted performance and capture risk-premia alpha on a portfolio level.

Univariate and Multivariate Claims Reserving with Generalised Link Ratios
Portugal, Luis,Pantelous, Athanasios A.,Verrall, R. J.
In this paper, a regression modelling setting is introduced to estimate loss development factors, and its multivariate counterpart considers contemporaneous correlation between each regression equation within the triangles with homoscedastic or heteroscedastic errors, respectively. Within this framework, the prediction error is derived in a matrix form avoiding the calculation of the corresponding developments using computationally expensive recursive formulas. The classical link ratio method is extended to the univariate Generalized Link Ratios (GLR) one, where the appropriate method selection is related with the minimization of the prediction errors for each and every triangle. In addition, the Multivariate Generalized Link Ratios (MGLR) method is proposed with contemporaneous correlations between each regression equation within the triangles, using also the minimization of the prediction error as a way to select the appropriate method for one triangle. Mathematical expressions for the case of homoscedastic and hetero-scedastic errors derive for some labelled (such as the chain ladder, vector projector and simple average) as well as for many other unnamed methods. Numerical examples with irregular, regular, and real data illustrate the applicability of our treatment.

Was Boeing’s Compensation Committee Sufficiently Independent in Judging the Business Risk of the 737 Max?
Fischer, Dov
Boeing’s 2011 launch of the 737 Max has been a disastrous decision for the company and could even threaten its long-term viability. In the 2011 letter to shareholder, the CEO said it will “reduce our business risk substantially for the next decade.” The CEO also convinced his compensation committee to factor “risk reduction” into its measure of economic profit and company performance score. Consequently, CEO pay rose from less than $20 million in the two years preceding 2011, to over $26 million in the three years after 2011. Coincidentally, the CEO was a long-term veteran of General Electric, as were two of the four members of the compensation committee. This case study illustrates that management can capture the compensation committee and put into place compensation incentives that can harm the company in the long-run.