Research articles for the 2019-05-23

A Behavioral Explanation for the Negative Asymmetric Return-Volatility Relation
Hibbert, Ann Marie,Daigler, Robert T.,Dupoyet, Brice V.
We examine the short-term dynamic relation between the S&P 500 (Nasdaq 100) index return and changes in implied volatility at both the daily and intraday level. Neither the leverage hypothesis nor the volatility feedback hypothesis adequately explains the results. Alternatively, we propose that the behavior of traders (from the representativeness, affect, and extrapolation bias concepts of behavioral finance) is consistent with our empirical results of a strong daily and intraday negative returnâ€"implied volatility relation. Moreover, both the presence and magnitude of the negative relation and the asymmetry between return and implied volatility are most closely associated with extreme changes in the index returns. We also show that the strength of the relation is consistent with the implied volatility skew.

A CDS Option Miscellany
Richard J Martin

CDS options allow investors to express a view on spread volatility and obtain a wider range of payoffs than are possible with vanilla CDS. We give a detailed exposition of different types of single-name CDS option, including options with upfront protection payment, recovery options and recovery swaps, and also presents a new formula for the index option. The emphasis is on using the Black-76 formula where possible and ensuring consistency within asset classes. In the framework shown here the `armageddon event' does not require special attention.

A Simplified Pricing Model for Volatility Futures
Dupoyet, Brice V.,Daigler, Robert T.,Chen, Zhiyao
We develop a general model to price VIX futures contracts. The model is adapted to test both the constant elasticity of variance (CEV) and the Coxâ€"Ingersollâ€"Ross formulations, with and without jumps. Empirical tests on VIX futures prices provide out-of-sample estimates within 2% of the actual futures price for almost all futures maturities. We show that although jumps are present in the data, the models with jumps do not typically outperform the others; in particular, we demonstrate the important benefits of the CEV feature in pricing futures contracts. We conclude by examining errors in the model relative to the VIX characteristics.

Analysts, Taxes, and the Information Environment
Kim, Sangwan,Schmidt, Andrew,Wentland, Kelly
This paper investigates the extent to which analysts incorporate tax-based earnings information into their earnings forecasts relative to other earnings information. We find that analysts’ mis-reaction to tax-based earnings information is distinct from their mis-reaction to other (non-tax) accounting information, on average. We then show that analysts differ in their mis-estimation of tax and other (non-tax) earnings components only when firms have weak information environments; when firms have strong information environments, analyst forecasts fully incorporate tax-based earnings information and exhibit no difference incorporating tax-based earnings information relative to other accounting information. Our evidence suggests that, on average, forecasting tax-based earnings information is more difficult for analysts relative to forecasting other accounting information. However, access to appropriate information and resources enables analysts to better process tax information. Overall, we contribute to the literature by providing a more complete understanding of the source of analyst tax-related forecast errors.

Asset Pricing With Incomplete Information and Fat Tails
Bidarkota, Prasad V.,Dupoyet, Brice V.,Mcculloch, J. Huston
We study a consumption-based asset pricing model with incomplete information and a- stable shocks. Incomplete information leads to a non-Gaussian filtering problem. Bayesian updating generates fluctuating confidence in the agents’ estimate of the persistent component of the dividends’ growth rate. This has the potential to generate time variation in the volatility of model-implied returns, without relying on discrete shifts in the drift rate of dividend growth rates. A test of the model using US consumption data shows that implied returns display significant volatility persistence of a magnitude comparable to that in the data.

Broker Trading Volume: A Conflict of Interest?
Lehmer, Tiana,Lourie, Ben,Shanthikumar, Devin M.
Using unique new data, we examine whether brokerage trading volume creates a conflict of interest for analysts’ earnings forecasts. We find that forecast optimism is associated with higher brokerage volume, even controlling for forecast and analyst quality, recommendations, and target prices. When analysts change brokerage firms, they bring this trading volume with them, influencing trading volume at the new brokerage house. This indicates that analysts drive the volume effects we observe. Consistent with a reward for generating volume, brokerage houses are less likely to demote analysts who generate more volume. Finally, analysts strategically adjust forecast optimism based on expected volume impact. Analysts become more (less) optimistic if their optimistic forecasts in the prior year were more (less) successful at generating volume. Overall, our results are consistent with a brokerage trading volume conflict of interest moving analysts towards more optimistic earnings forecasts.

Buying Time: The Legal Case for Italy to Extend Maturities and Its Effective Advantages and Disadvantages
Cramer, Matthew,Saad, Charlie,Thorpe, Brett
This paper argues that Italy possesses the right to unilaterally extend maturities on its outstanding local law bonds under an explicitly established provision of Italian law, putting it in a strong negotiating position with its creditors for a potential restructuring. It also examines the unique ways in which Italy is insulated from legal risk in the event creditors take action, particularly due to a lack of acceleration clauses in some (and possibly all) debt instruments.Unilateral maturity extension would provide several benefits to Italy: first, maturity extensions, as opposed to principal haircuts, would mitigate the harm endured by Italy’s banking sector, which was a primary concern of the Edelen proposal and has grown even more important as Italy’s banking sector has only increased its exposure to Italian debt in recent years; second, Italy’s short-term debt obligations would be reduced, allowing the Italian government greater maneuverability in attempting to restart growth and adopt more reasonable fiscal policies; third, this proposal accomplishes the main objectives of a recovery while reducing legal risk, as it works within explicitly contemplated frameworks, without any ex post alterations or overly coercive and discriminatory measures.Part I of this proposal discusses the background Italian situation with an eye on the law permitting a unilateral extension of maturities on some (if not all) of the local law issued debt instruments. Part II outlines how this maturity extension would affect both Pre-2013 and Post-2013 issued debt instruments based on the presence or absence of the ESM instituted Euro CACs. Part III discusses the synergy between maturity extension, and the remedies available to a potential litigious creditor as a result, particularly with respect to acceleration.

Corrective Trading: An Analysis of Institutional Investors’ Information Advantages
Jiao, Yawen
Investors with future-return-related information use it to correct past decisions that no longer fit. Using this rationale, we decompose institutional trading into corrective (correcting past portfolio decisions) and implied (implied by past portfolio weights) trades. Corrective trades positively predict future stock returns and earnings surprises, whereas implied trades negatively predict returns. The return-predictability of corrective trades is strong across all stock, institution, portfolio turnover, and flow types. It declines over time but persists among institutions with moderate investment horizons. An institutional investor’s tendency to trade correctively and the performance of corrective trades for the top 20% of institutions are highly persistent. The results illustrate the distribution and evolvement of institutional investors’ informational advantages.

Debt Contract Enforcement and Conservatism: Evidence from a Natural Experiment
Aghamolla, Cyrus,Li, Nan
This study provides evidence that the use of conservative accounting in debt contracting depends on the enforceability of the contract. To test the effect of debt contract enforcement on borrowers' timely loss recognition, we exploit the staggered introduction of enhanced debt contract enforcement in Indian states as a natural experiment, where the implementation of the enforcement is exogenous to the accounting choices and borrowing behavior of firms. The main results show that enhanced enforcement has a significant positive effect on the timeliness of loss recognition of borrowing firms. We find that the effect is strongest for firms that increased their overall borrowing and for firms with high levels of tangible assets, consistent with a collateral‐based explanation. This study also provides causal evidence that firms adopt conservative accounting due to lenders' demand.

Detection of Chinese Stock Market Bubbles with LPPLS Confidence Indicator
Min Shu,Wei Zhu

This paper aims to present an advance bubble detection methodology based on LPPLS confidence indicator for the early causal identification of positive and negative bubbles in the Chinese stock market using the daily data on the Shanghai Shenzhen CSI 300 stock market index from January 2002 through April 2018. We account for the damping condition of LPPLS model in the search space and implement the stricter filter conditions for the qualification of the valid LPPLS fits by taking account of the maximum relative error, Lomb log-periodic test of the detrended residual, and unit-root tests of the logarithmic residual based on both the Phillips-Perron test and Dickey-Fuller test to improve the performance of LPPLS confidence indicator. Our analysis shows that the LPPLS detection strategy diagnoses the positive bubbles and negative bubbles corresponding to well-known historical events, implying the detection strategy based on the LPPLS confidence indicator has an outstanding performance to identify the bubbles in advance. We find that the probability density distribution of the estimated beginning time of bubbles appears to be skewed and the mass of the distribution is concentrated on the area where the bubbles start to have a super-exponentially growth. This study presents that it is possible to detect the potential positive and negative bubbles and crashes ahead of time, which provides a prerequisite for limiting the bubble sizes and eventually minimizing the damage from the bubble crash.

Diagnosis and Prediction of the 2015 Chinese Stock Market Bubble
Min Shu,Wei Zhu

In this study, we perform a detailed analysis of the 2015 financial bubble in the Chinese stock market by calibrating the Log Periodic Power Law Singularity (LPPLS) model to two important Chinese stock indices, SSEC and SZSC, from early 2014 to June 2015. The back tests of 2015 Chinese stock market bubbles indicates that the LPPLS model can readily detect the bubble behavior of the faster-than-exponential increase corrected by the accelerating logarithm-periodic oscillations in the 2015 Chinese Stock market. The existence of log-periodicity is detected by applying the Lomb spectral analysis on the detrended residuals. The Ornstein-Uhlenbeck property and the stationarity of the LPPLS fitting residuals are confirmed by the two Unit-root tests (Philips-Perron test and Dickery-Fuller test). According to our analysis, the actual critical day t_c can be well predicted by the LPPLS model as soon as two months before the actual bubble crash. Compared to the traditional optimization method used in LPPLS model, the covariance matrix adaptation evolution strategy (CMA-ES) may have a significantly lower computation cost. The CMA-ES is recommended as an alternative algorithm in the LPPLS model. Moreover, the exponent m does not show a remarkable feature of change when the start day t1 is fixed while the end day t2 is moved towards the actual critical time t_c in the expanding windows. In the LPPLS fitting with expanding windows, the gap (tc -t2) shows a significant decrease when the end day t2 approaches the actual bubble crash time. The change rate of the gap (tc -t2) may be used as an additional indicator besides of the key indicator tc to improve the prediction of bubble burst.

Fundamental Surprises, Market Structure, and Price Formation in Agricultural Commodity Futures Markets
Du, Xiaodong,Kane, Stephen A
Our study seeks to provide a better understanding of price formation process and determining factors of price volatility in agricultural commodity markets. We focus on corn and soybean futures traded in CBOT (Chicago Board of Trade). We innovatively construct two sets of variables to represent fundamental changes and market structure of the commodity markets. Fundamental changes are captured by the deviations of the supply and demand condition estimates released by USDA from the pre-announcement analysts’ forecasts published by Bloomberg. We employ the transaction databases of CFTC (Commodity Futures Trading Commission) to construct the percentage shares of detailed participation group trading in the market. While fundamental changes are based on public observations and analysis, transaction percentage shares of trader groups are private information of individual traders. Both the fundamental surprises and the market structure related variables are found to have statistically significant effects on price and price volatility. Furthermore, the impacts vary across quantiles of the conditional distributions.

Information, Prices and Efficiency in An Online Betting Market
Elaad, Guy,Reade, J. James,Singleton, Carl
We study the odds (or prices) set by fifty-one online bookmakers for the result outcomes in over 16,000 association football matches in England since 2010. Adapting a methodology typically used to evaluate forecast efficiency, we test the Efficient Market Hypothesis in this context. We find odds are generally not biased when compared against actual match outcomes, both in terms of favourite-longshot or outcome types. But individual bookmakers are not efficient. Their own odds do not appear to use fully the information contained in their competitors' odds.

Machine Learning Tree and Exact Integration for Pricing American Options in High Dimension
Ludovic Goudenège,Andrea Molent,Antonino Zanette

In this paper we modify the Gaussian Process Regression Monte Carlo (GPR-MC) method introduced by Gouden\`ege et al. proposing two efficient techniques which allow one to compute the price of American basket options. In particular, we consider basket of assets that follow a Black-Scholes dynamics. The proposed techniques, called GPR Tree (GRP-Tree) and GPR Exact Integration (GPR-EI), are both based on Machine Learning, exploited together with binomial trees or with a closed formula for integration. Moreover, these two methods solve the backward dynamic programming problem considering a Bermudan approximation of the American option. On the exercise dates, the value of the option is first computed as the maximum between the exercise value and the continuation value and then approximated by means of Gaussian Process Regression. Both the two methods derive from the GPR-MC method and they mainly differ in the method used to approximate the continuation value: a single step of binomial tree or integration according to the probability density of the process. Numerical results show that these two methods are accurate and reliable and improve the results of the GPR-MC method in handling American options on very large baskets of assets.

Managerial Compensation and Stock Price Manipulation
Schroth, Josef
This paper studies the role of optimal managerial compensation in reducing uncertainty about manager reporting objectives. It is shown that, paradoxically, firm owners allow managers with higher propensity to manipulate the short‐term stock price to push for higher powered and more short‐term‐focused equity incentives. Such managers also work harder, and manipulate more, but may not generate higher firm profits. The model is consistent with existing empirical findings about the relationship between manipulation and equity pay, suggesting that heterogeneity in manager manipulation propensities may be an important driver of heterogeneity in pay. Novel testable predictions are developed.

Negative News and Investor Trust: The Role of $Firm and #CEO Twitter Use
Elliott, W. Brooke,Grant, Stephanie M.,Hodge, Frank D.
We examine how CEOs can facilitate the development of investor trust that helps mitigate the effects of negative information. Results from an experiment show that investors trust the CEO more and are more willing to invest in the firm when the CEO communicates firm news followed by a negative earnings surprise through a personal Twitter account than when the news and surprise comes from the CEO via a website or from the firm's Investor Relations Twitter account or website. A follow‐up experiment shows that repeating the negative news does not incrementally affect investors who received the news from the CEO's Twitter account, but does further negatively impact investors who received the news via other disclosure mediums, especially those who received the news via the Investor Relations Twitter account. Our results have implications for firms and executives considering the costs and benefits of communicating with investors via Twitter.

Notas para una mejor educación financiera (Notes for a Better Financial Education)
Zunzunegui, Fernando
Spanish Abstract: La educación financiera es una de las repuestas para conseguir que los consumidores adopten decisiones con conocimiento de causa. La orientación financiera es un complemento fundamental. Los estudios sobre la efectividad de la mejora en la adopción de decisiones como consecuencia de la educación financiera no son concluyentes. Sin duda, la educación es una buena medida para mejorar la comunicación entre los consumidores y el personal de la banca. Hay que mantener la educación financiera combinándola con planes de orientación financiera y con una mejora en los estándares de asesoramiento financiero.English Abstract: Financial education is one of the keys to get consumers to make informed decisions. Financial guidance is essential. Studies on the efficiency of an improvement in the decision-making as a consequence of financial education are inconclusive. Undoubtedly, education is a good measure to improve communication between consumers and banking staff. Financial education must be provided by combining it with financial guidance plans and with an improvement in financial advisory standards.

Obligations with Physical Delivery in a Multi-Layered Financial Network
Zachary Feinstein

This paper provides a general framework for modeling financial contagion in a system with obligations in multiple illiquid assets (e.g., currencies). In so doing, we develop a multi-layered financial network that extends the single network of Eisenberg and Noe (2001). In particular, we develop a financial contagion model with fire sales that allows institutions to both buy and sell assets to cover their liabilities in the different assets and act as utility maximizers.

We prove that, under standard assumptions and without market impacts, equilibrium portfolio holdings exist and are unique. However, with market impacts, we prove that equilibrium portfolio holdings and market prices exist which clear the multi-layered financial system. In general, though, these clearing solutions are not unique. We extend this result by considering the t\^atonnement process to find the unique attained equilibrium. The attained equilibrium need not be continuous with respect to the initial shock; these points of discontinuity match those stresses in which a financial crisis becomes a systemic crisis. We further provide mathematical formulations for payment rules and utility functions satisfying the necessary conditions for these existence and uniqueness results.

We demonstrate the value of our model through illustrative numerical case studies. In particular, we study a counterfactual scenario on the event that Greece re-instituted the drachma on a dataset from the European Banking Authority.

One Market to Rule Them All - How Financial Integration Influenced Inequality in the European Union
Burghof, Hans-Peter,Gehrung, Marcel
With the recent discussion of income inequality and the widening of the gap between top and bottom incomes, the influence of financial markets and especially banks, which are a first source of credit supply for entrepreneurs and economic agents, on these factors, has been of pronounced interest for the academic literature. Financial development and the design of financial markets have been regarded as a major driver of economic growth and wealth for a long time and have later been extended to the effects on income inequality by means of natural experiments regarding bank branch deregulation in the U.S. and large-scale entry of foreign banks in India. However, another prominent example of financial integration and liberalization, so far, has been ignored in the scientific discussion: the introduction and progression of the European Single Market.By using a difference-in-difference design, we investigate the effects of the Single Banking License introduced in 1993 on economic growth and several inequality measures. This directive or ”banking passport” abolished any cross-country restrictions on banks in EU member states and allowed them to freely branch into other member states and offer their banking services there. This Single Market Initiative constitutes a fundamental change in the competitive environment for financial markets. Our findings show that the European Single Market positively influenced economic growth across a variety of subsamples. The effects on income inequality are not that clear, but indicate that inequality across EU member states was reduced. Additional regressions with the unemployment rate and top and bottom 20% income shares support this preliminary finding and show a reduction of unemployment in previously less developed countries accompanied with an increase in the bottom income shares across all subsamples.

Ownership Concentration and Stock Liquidity in an Emerging Market
Tran, Nam,Nguyen, Cuong,Le, Dat Chi
This study explores the liquidity influence of ownership concentration in the Vietnamese stock market where equity holdings are highly concentrated and under weak protection for minority shareholders. We find that stocks of firms with higher concentrated ownership are less traded in terms of lower share turnover and trading volume. This effect implies the real friction channel, rather than the information friction channel, of ownership concentration impairing stock liquidity. It is from the emerging market context of Vietnam that large shareholders are usually institutional investors who have long-term investment horizons. The result is robust to the different types of blockholders, alternative measures of ownership concentration and stock liquidity, and several regression estimators. It is arguable that Vietnamese firms face a trade-off between the monitoring benefit and the liquidity detriment when opting for concentrated ownership structures.

Real-time Prediction of Bitcoin bubble Crashes
Min Shu,Wei Zhu

In the past decade, Bitcoin has become an emerging asset class well known to most people because of their extraordinary return potential in phases of extreme price growth and their unpredictable massive crashes. We apply the LPPLS confidence indicator as a diagnostic tool for identifying bubbles using the daily data of Bitcoin price in the past two years. We find that the LPPLS confidence indicator based on the daily data of Bitcoin price fails to provide effective warnings for detecting the bubbles when the Bitcoin price suffers from a large fluctuation in a short time, especially for positive bubbles. In order to diagnose the existence of bubbles and accurately predict the bubble crashes in the cryptocurrency market, this study proposes an adaptive multilevel time series detection methodology based on the LPPLS model. We adopt two levels of time series, 1 hour and 30 minutes, to demonstrate the adaptive multilevel time series detection methodology. The results show that the LPPLS confidence indicator based on the adaptive multilevel time series detection methodology have not only an outstanding performance to effectively detect the bubbles and accurately forecast the bubble crashes, but can also monitor the development and the crash of bubbles even if a bubble exists in a short time. In addition, we discover that the short-term LPPLS confidence indicator greatly affected by the extreme fluctuations of Bitcoin price can provide some useful insights into the bubble status on a shorter time scale, and the long-term LPPLS confidence indicator has a stable performance in terms of effectively monitoring the bubble status on a longer time scale. The adaptive multilevel time series detection methodology can provide real-time detection of bubbles and advanced forecast to warn of an imminent crash risk in not only the cryptocurrency market but also the other financial markets.

Risk Price Dynamics
Borovička, Jaroslav,Hansen, Lars Peter,Hendricks, Mark,Scheinkman, José
We present a novel approach to depicting asset pricing dynamics by characterizing shock exposures and prices for alternative investment horizons. We quantify the shock exposures in terms of elasticities that measure the impact of a current shock on future cash-flow growth. The elasticities are designed to accommodate nonlinearities in the stochastic evolution modeled as a Markov process. Stochastic growth in the underlying macroeconomy and stochastic discounting in the representation of asset values are central ingredients in our investigation. We provide elasticity calculations in a series of examples featuring consumption externalities, recursive utility, and jump risk.

Rules and Discretion(s) in Prudential Regulation and Supervision: Evidence from EU Banks in the Run-Up to the Crisis
Maddaloni, Angela,Scopelliti, Alessandro
Prior to the financial crisis, prudential regulation in the EU was implemented non-uniformly across countries, as options and discretions allowed national authorities to apply a more favorable regulatory treatment. We exploit the national implementation of the CRD and derive a country measure of regulatory flexibility (for all banks in a country) and of supervisory discretion (on a case-by-case basis). Overall, we find that banks established in countries with a less stringent prudential framework were more likely to require public support during the crisis. We instrument some characteristics of bank balance sheets with these prudential indicators to investigate how they affect bank resilience. The share of non-interest income explained by the prudential environment is always associated with an increase in the likelihood of financial distress during the crisis. Prudential frameworks also explain banks’ liquidity buffers even in absence of a specific liquidity regulation, which points to possible spillovers across regulatory instruments.

Technological Learning and Innovation Gestation Lags at the Frontier of Science: from CERN Procurement to Patent
Andrea Bastianin,Paolo Castelnovo,Massimo Florio,Anna Giunta

This paper contributes to the literature on the impact of Big Science Centres on technological innovation. We exploit a unique dataset with information on CERN's procurement orders to study the collaborative innovation process between CERN and its industrial partners. After a qualitative discussion of case studies, survival and count data models are estimated; the impact of CERN procurement on suppliers' innovation is captured by the number of patent applications. The fact that firms in our sample received their first order over a long time span (1995-2008) delivers a natural partition of industrial partners into "suppliers" and "not yet suppliers". This allows estimating the impact of CERN on the hazard to file a patent for the first time and on the number of patent applications, as well as the time needed for these effects to show up. We find that a "CERN effect" does exist: being an industrial partner of CERN is associated with an increase in the hazard to file a patent for the first time and in the number of patent applications. These effects require a significant "gestation lag" in the range of five to eight years, pointing to a relatively slow process of absorption of new ideas.

The Business Case for ESG
Boze, Brandon, Krivitski, Margarita,Larcker, David F.,Tayan, Brian,Zlotnicka, Eva
Recently, there has been debate among corporate managers, board of directors, and institutional investors around how best to incorporate ESG (environmental, social, and governance) factors into strategic and investment decision-making processes. In this Closer Look, we examine a framework informed by the experience of ValueAct Capital and include case examples.We ask:• What is the investment horizon prevalent among most companies today?• Do companies miss long-term opportunities because of a focus on short-term costs?• How many companies have an opportunity to profitably invest in ESG solutions?• What factors determine whether a company can profitably invest in ESG solutions? • Can investors earn competitive risk-adjusted returns through ESG investments?• If so, how widespread is this opportunity?

The Procyclicality of Banking: Evidence from the Euro Area
Huizinga, Harry,Laeven, Luc
Loan loss provisions in the euro area are negatively related to GDP growth, i.e., they are procyclical. Loan loss provisions tend to be more procyclical at larger and better capitalized banks. The procyclicality of loan loss provisions can explain about two-thirds of the variation of bank capitalization over the business cycle. We estimate that provisioning procyclicality in the euro area is about twice as large as in other advanced economies. This difference reflects a larger procyclicality of provisioning in euro area countries already prior to euro adoption, and the divergent growth experiences of euro area countries following the global financial crisis.

The Role of the Federal Housing Administration in the Reverse-Mortgage Market
Office, Congressional Budget
The Federal Housing Administration’s Home Equity Conversion Mortgage (HECM) program guarantees repayment on qualifying reverse mortgages made by private lenders. Reverse mortgages let older homeowners borrow money by using the equity in their home as collateral. The borrowed funds can be used to repay an existing mortgage or to fund other expenses. In this report, CBO examines how the HECM program works, how it affects the federal budget, and how various policy changes might reduce costs and risks to the government or to borrowers.

Under-Diversification and the Size Effect
Levy, Moshe,Levy, Haim
Asness et. al. (2018) recently resurrect the size effect, concluding that it “…should be restored as one of the central cross-sectional empirical anomalies for asset pricing theory to explain”. We suggest a theoretical explanation for the size effect, based on the observation that many investors hold only a small number of stocks in their portfolios. Mean-variance investors require compensation for a stock’s marginal contribution to their portfolio’s variance, i.e. for the stock’s “beta” relative to the portfolio. The role of a stock’s own variance in “beta” is approximately proportional to the stock’s weight in the portfolio. It is therefore negligible in the CAPM, where all weights are very small, but can be substantial if only a small number of stocks are held in the portfolio. As small stocks tend to have higher variances, they command higher expected returns than predicted by their CAPM betas. Thus, the size effect is theoretically justified as a risk-premium and is therefore here to stay. We empirically estimate the magnitude of the under-diversification induced size effect, and show that it can fully explain the size anomaly.

Variable annuities in a L\'evy-based hybrid model with surrender risk
Laura Ballotta,Ernst Eberlein,Thorsten Schmidt,Raghid Zeineddine

This paper proposes a market consistent valuation framework for variable annuities with guaranteed minimum accumulation benefit, death benefit and surrender benefit features. The setup is based on a hybrid model for the financial market and uses time-inhomogeneous L\'evy processes as risk drivers. Further, we allow for dependence between financial and surrender risks. Our model leads to explicit analytical formulas for the quantities of interest, and practical and efficient numerical procedures for the evaluation of these formulas. We illustrate the tractability of this approach by means of a detailed sensitivity analysis of the price of the variable annuity and its components with respect to the model parameters. The results highlight the role played by the surrender behaviour and the importance of its appropriate modelling.

Venture Philanthropy: A Case Study of the Cystic Fibrosis Foundation
Kim, Esther,Lo, Andrew W.
Advances in biomedical research have created significant opportunities to bring to market a new generation of therapeutics. However, early-stage assets often face a dearth of funding, as they have a high risk of failure and significant development costs. Historically, this has been particularly true for assets intended to treat rare diseases, where market sizes are often too small to attract much attention and funding. Venture philanthropy (VP) â€" which, for the purpose of this paper, is defined as a model in which nonprofit, mission-driven organizations fund initiatives to advance their objectives and potentially achieve returns that can be reinvested toward their mission â€" offers an alternative to traditional funding sources like venture capital or the public markets. Here we highlight the Cystic Fibrosis (CF) Foundation, widely considered to be the leading VP organization in biotech, which facilitated the development of Kalydeco, the first disease-modifying therapy approved to treat cystic fibrosis. We evaluate the CF Foundation’s example, including its agreement structures and strategy, explore the challenges that other nonprofits may have in adopting this strategy, and draw lessons from the CF Foundation for other applications of VP financing.