Research articles for the 2019-05-28

"Quantum Equilibrium-Disequilibrium": Asset Price Dynamics, Symmetry Breaking, and Defaults as Dissipative Instantons
Igor Halperin,Matthew Dixon

We propose a simple non-equilibrium model of a financial market as an open system with a possible exchange of money with an outside world and market frictions (trade impacts) incorporated into asset price dynamics via a feedback mechanism. Using a linear market impact model, this produces a non-linear two-parametric extension of the classical Geometric Brownian Motion (GBM) model, that we call the "Quantum Equilibrium-Disequilibrium" (QED) model. The QED model gives rise to non-linear mean-reverting dynamics, broken scale invariance, and corporate defaults. In the simplest one-stock (1D) formulation, our parsimonious model has only one degree of freedom, yet calibrates to both equity returns and credit default swap spreads. Defaults and market crashes are associated with dissipative tunneling events, and correspond to instanton (saddle-point) solutions of the model. When market frictions and inflows/outflows of money are neglected altogether, "classical" GBM scale-invariant dynamics with an exponential asset growth and without defaults are formally recovered from the QED dynamics. However, we argue that this is only a formal mathematical limit, and in reality the GBM limit is non-analytic due to non-linear effects that produce both defaults and divergence of perturbation theory in a small market friction parameter.

A Detailed Analysis of Core NLP for Information Extraction
Kaur, Simran,Agrawal, Rashmi
The amount of unstructured text present in all electronic media is increasing periodically day after day. In order to extract relevant and succinct information, extraction algorithms are limited to entity relationships. This paper is compendium of different bootstrapping approaches which have their own subtask of extracting dependencies like who did, what, whom, from natural language sentence. This can be extremely helpful in both feature design and error analysis in application of machine learning to natural language processing.

An Analysis of the Impact of ESG Screening on Financial Performance of Selected Indian Companies
Saxena, Swami,Singh, Veerangna
In recent years, increasing Environmental, Social and Governance (ESG) consciousness has necessitated the need to hold companies accountable for social consequences resulting from their activities. This paper focuses on analyzing the impact of ESG screening on financial performance of the companies. The analysis of stock returns and beta of selected NIFTY 50 companies conducted using Shapiro-Wilk test, Wilcoxon test and Paired Sample t test indicate that there is no impact of ESG screening on financial performance and risk profile of the companies.

Autonomous Driving and Residential Location Preferences: Evidence from a Stated Choice Survey
Rico Krueger,Taha H. Rashidi,Vinayak V. Dixit

This paper seeks to advance the understanding of the potential impacts of autonomous vehicles (AVs) on travel behaviour and land use by investigating stated preferences for combinations of residential locations and travel options for the commute in the context of autonomous automobile travel. Our analysis draws from a stated preference survey, which was completed by 512 commuters from the Sydney metropolitan area in Australia, and provides insights into travel time valuations and demand elasticities in a long-term decision-making context. By and large, the findings of our empirical study suggest that the impact of AVs on travel behaviour and residential location preferences may be relatively modest. We estimate that the mean value of travel time savings (VOT) for commuting by AV is 24.0 AUD/h, while the mean VOTs for commuting by conventional car and public transit are 25.3 AUD/h and 19.0 AUD/h, respectively.

CEO and Director Compensation, CEO Turnover and Institutional Investors: Is There Cronyism in the UK?
Chen, Jie,Goergen, Marc,Leung, Woon Sau,Song, Wei
This paper provides new evidence that correlated abnormal compensation of CEOs and directors is symptomatic of agency problems associated with cronyism. We find that director abnormal compensation has a negative impact on the likelihood of CEO turnover and reduces the sensitivity of CEO turnover to poor stock performance. However, for firms with greater institutional ownership the adverse effects of director abnormal compensation are mitigated, and the negative impact of abnormal compensation on firm performance is reduced. These findings suggest that correlated abnormal compensation of CEOs and directors is likely associated with agency problems.

Can Hedge Funds Benefit from CSR Investment?
Duanmu, Jun,Huang, Qiping,Li, Yongjia,McBrayer, Garrett
We explore the extent to which hedge funds incorporate corporate social responsibility (CSR) considerations in the development of their investment strategies. Using an asset-weighted composite measure of CSR by fund, we examine the difference in financial performance between hedge funds with high CSR investment relative to those with low investment and document no statistical difference. Yet, we find that hedge funds increase their exposure to high CSR investments over our sample period, specifically post-financial crisis. We find that the increases in CSR investment are consistent with hedge funds utilizing CSR strategies as a form of risk mitigation. Specifically, hedge funds with higher weighted CSR scores exhibit significantly lower risk factor loadings than funds with lower weighted CSR scores. Our results suggest that hedge funds are able to derive benefits by using CSR considerations as a form of risk-mitigation in their investment policies.

Collateral Affects Return Risk: Evidence From the Euro Bond Market
Helberg, Stig,Lindset, Snorre
Covered bonds and senior bonds are important securities for fixed income investors. Senior bonds are unsecured, while covered bonds are secured and backed by collateral. Our results show that collateral reduces the total risk in individual bonds by more than 70%. Compared to diversified portfolios of senior bonds, diversified portfolios of covered bonds have a significantly lower level of systematic risk. However, the fraction of systematic risk to total risk is higher for covered bonds. By decomposing the variance of bond returns, we find that around 33% of the risk in senior bonds is systematic, versus 53% in covered bonds. Both types of bonds contain instrument specific risk.

Commitment and Borrower Heterogeneity: Evidence from Revolving Consumer Credit
Lukas, Moritz,Noeth, Markus
Based on a unique dataset provided by a retail bank, we analyze borrower heterogeneity in the debt response to interest rate decreases and credit limit increases in revolving consumer credit. Our key findings show that 1) the debt response of borrowers who commit to monthly minimum repayments is about four times as large as the response of uncommitted borrowers when interest rates decrease, 2) committed borrowers demand credit limit increases which are more than twice as high as those of uncommitted borrowers following interest rate cuts, and 3) committed borrowers’ marginal propensity to consume out of credit limit increases is almost 30% stronger. These results are most likely to be caused by sophisticated impatient individuals choosing to commit and shed new light on the role of non-standard borrower preferences in consumer credit.

Deaths in England and Wales are falling â€" Does the Austerity Theory Still Apply?
Jones, Rodney
An alarming rise in deaths since early 2012 has led to a deterioration of life expectancy in the UK and elsewhere in the world. In the UK several studies sought to implicate austerity as the cause of the increased deaths. However, these studies did not cite other studies which document behaviour of deaths inconsistent with the austerity theory. This short paper presents further evidence which is inconsistent with the austerity theory and poses the possibility that deaths are now falling back to levels expected to apply in the original actuarial forecasts. Possible reasons for the temporary blip in deaths are discussed. This paper uses the direct count of deaths to follow the trends rather than age standardized mortality, because complex trends in age-specific changes in deaths suggest that the process of age standardization may be acting to disguise the underlying causes for the trends.

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.

Dynamics and Heterogeneity of Subjective Stock Market Expectations
Heiss, Florian,Hurd, Michael,Rossmann, Tobias,Winter, Joachim,van Rooij, Maarten
Between 2004 and 2016, we elicited individuals' subjective expectations of stock market returns in a Dutch internet panel at bi-annual intervals. In this paper, we develop a panel data model with a finite mixture of expectation types who differ in how they use past stock market returns to form current stock market expectations. The model allows for rounding in the probabilistic responses and for observed and unobserved heterogeneity at several levels. We estimate the type distribution in the population and find evidence for considerable heterogeneity in expectation types and meaningful variation over time, in particular during the financial crisis of 2008/09.

Explaining Equity Anomalies In Frontier Markets: A Horserace of Factor Pricing Models
Zaremba, Adam,Maydybura, Alina,Czapkiewicz, Anna,Arnaut, Marina
[enter Abstract Body]We are the first to compare the explanatory power of the major empirical asset pricing models over equity anomalies in the frontier markets. We replicate over 160 stock market anomalies in 23 frontier countries for years 1996â€"2017, and evaluate their performance with the factor models. The Carhart’s (1997) four-factor model outperforms both the recent Fama and French (2015) five-factor model and the q-model by Hou, Xue, and Zhang (2015). Its superiority is driven by the ability to explain the momentum-related anomalies. Inclusion of additional profitability and investment factors lead to no further major improvement in the performance. Nonetheless, none of the models is able to fully explain the abnormal returns on all of the anomaly portfolios.

Financial Characteristics of Cost of Funds Indexed Loans
Greenfield, Patrick,Hall, Arden
Two recent articles by Hancock and Passmore (2016) and Passmore and von Hafften (2017) make several suggestions for improving the home mortgage contract to make homeownership more achievable for creditworthy borrowers. Though the proposals in the two papers differ in some aspects, one common feature is an adjustable rate indexed to a cost of funds (COF) measure. Such indices are based on the interest expense as a fraction of liability balance for one or a group of depository institutions. One of these, the 11th District Cost of Funds (COF) Index, was in wide use in the 1980s and '90s, but use has fallen off since then. COF indices have the advantage that they are less volatile than market-based indices such as the 1-year U.S. Treasury rate, so that borrowers are not exposed to rapid increases in payments in a rising rate environment. We analyze COF-indexed ARMs from the point of view of the lender. First we develop a methodology for constructing a liability portfolio that closely tracks the specific COF index proposed by Hancock and Passmore (2016) and Passmore and von Hafften (2017). We then explore the financial characteristics of this liability portfolio. We show that the liability portfolio, and by implication, the mortgages it would fund, s are a characteristic of fixed-rate mortgages: Values can vary significantly from par if rates change. This creates two problems for lenders: Pricing of COF-indexed ARMs is difficult because it depends not only on current interest rates but also on interest rates when principal is r paid, either through amortization or prepayment. Second, deviations from par make mortgage prepayment options valuable, so that lenders offering the product must manage option risk as well as interest rate risk. We conclude that while mortgages using a COF index have clear benefits for borrowers, they also are more difficult for lenders to price accurately. Further, once they are in lenders' portfolios, they increase the complexity of interest rate risk management. While these issues do not imply that COF indices cannot be part of innovative new mortgage designs, understanding their financial characteristics may contribute to the search for a better mortgage.

Forecasting market states
Pier Francesco Procacci,Tomaso Aste

We propose a novel methodology to define, analyze and forecast market states. In our approach market states are identified by a reference sparse precision matrix and a vector of expectation values. In our procedure, each multivariate observation is associated with a given market state accordingly to a minimization of a penalized Mahalanobis distance. The procedure is made computationally very efficient and can be used with a large number of assets. We demonstrate that this procedure is successful at clustering different states of the markets in an unsupervised manner. In particular, we describe an experiment with one hundred log-returns and two states in which the methodology automatically associates states prevalently to pre- and post- crisis periods with one state gathering periods with average positive returns and the other state periods with average negative returns, therefore discovering spontaneously the common classification of `bull' and `bear' markets. In another experiment, with again one hundred log-returns and two states, we demonstrate that this procedure can be efficiently used to forecast off-sample future market states with significant prediction accuracy. This methodology opens the way to a range of applications in risk management and trading strategies in the context where the correlation structure plays a central role.

Futures Commission Merchants, Customer Funds and Capital Requirements: An Organizational Analysis of the Futures Industry
Emm, Ekaterina E.,Gay, Gerald D.,Shen, Mo
We study futures commission merchants, or “FCMs,” who are the important intermediaries through which institutional, corporate and retail customers conduct trading in interest rate, currency and commodity futures. We construct and examine a data base of FCM financial information including holdings of customer segregated and secured funds intended to support trading on U.S. and foreign futures exchanges over the period 1995âˆ'2018. We find significant industry consolidation as well as structural changes including the increased dominance of FCMs who are bank-affiliated or are dually-registered as broker-dealers. We also examine how these changes have been influenced by regulatory initiatives including those resulting from the 2008 financial crisis as well as by the collapse of notable FCMs due to alleged fraudulent activities and misbehavior involving customer funds. Finally, we investigate the effect of these changes on market concentration and competitiveness.

Graph-based era segmentation of international financial integration
Cécile Bastidon,Antoine Parent,Pablo Jensen,Patrice Abry,Pierre Borgnat

Assessing world-wide financial integration constitutes a recurrent challenge in macroeconometrics, often addressed by visual inspections searching for data patterns. Econophysics literature enables us to build complementary, data-driven measures of financial integration using graphs. The present contribution investigates the potential and interests of a novel 3-step approach that combines several state-of-the-art procedures to i) compute graph-based representations of the multivariate dependence structure of asset prices time series representing the financial states of 32 countries world-wide (1955-2015); ii) compute time series of 5 graph-based indices that characterize the time evolution of the topologies of the graph; iii) segment these time evolutions in piece-wise constant eras, using an optimization framework constructed on a multivariate multi-norm total variation penalized functional. The method shows first that it is possible to find endogenous stable eras of world-wide financial integration. Then, our results suggest that the most relevant globalization eras would be based on the historical patterns of global capital flows, while the major regulatory events of the 1970s would only appear as a cause of sub-segmentation.

Has the New Bail-In Framework Increased the Yield Spread Between Subordinated and Senior Bonds?
Pablos, Irene
This paper investigates the impact of the introduction and implementation of the new EU bail-in framework on the banks subordinated bond yield spreads over senior unsecured bonds, and links the bond yields developments with the characteristics of the issuing entities and the economic and financial environment. The analysis does not show evidence of a significant and generalized increase in the spreads as a result of a higher risk perception in the sample under review. The results reinforce the relevance of the Tier 1 capital ratio for making subordinated debt safer, while markets price the higher risk of banks with less stable sources of funding in their liability/capital structures. Market conditions and economic environment variables also play a key role in explaining bond spreads. Interestingly, after the introduction of the new bail-in framework, there is a convergence between the bond yields of the GSIBs and the non-GSIBs, which could point out to a reduction in the market perception of the so called “too big to fail” public implicit guarantee. Nonetheless, this convergence is mostly driven by the reduction of the yields of bonds issued by banks not categorized as GSIBs, and not by significant increases in the GSIBs’ bond yields.

How Do Laws and Institutions affect Recovery Rates on Collateral?
Degryse, Hans,Ioannidou, Vasso,Liberti, Jose Maria,Sturgess, Jason
We show that laws and institutions that strengthen creditor protection increase expected recovery rates on collateral using unique internal bank data on ex-ante appraised liquidation values and market values of assets pledged as collateral from secured loans in 16 countries. Stronger creditor protection increases expected recovery rates on movable collateral relative to immovable collateral and shifts the composition of collateral towards movable assets, which increases debt capacity through both higher loan-to-values and attenuating the creditor’s liquidation bias. Our results provide novel evidence confirming key assumptions and predictions of the financial contracting literature and shows that the recovery rate on collateral is an important first-stage mechanism through which creditor protection can improve contracting efficiency and enhance debt capacity and terms of credit.

Inflation Hedging with Commodities: A Wavelet Analysis of Seven Centuries Worth of Data
Zaremba, Adam,Umar, Zaghum,Mikutowski, Mateusz
We perform a test of the inflation hedging properties of commodities on the longest data series ever used for this purpose. We apply wavelet analysis to commodity prices and inflation data from the United Kingdom for the years 1265 through 2017, to detect co-movement across different times and frequencies. We demonstrate robust inflation hedging properties of agricultural, energy, and industrial commodities for the 4- to 8-year horizon through almost the entire seven centuries.

Many-player games of optimal consumption and investment under relative performance criteria
Daniel Lacker,Agathe Soret

We study a portfolio optimization problem for competitive agents with CRRA utilities and a common finite time horizon. The utility of an agent depends not only on her absolute wealth and consumption but also on her relative wealth and consumption when compared to the averages among the other agents. We derive a closed form solution for the $n$-player game and the corresponding mean field game. This solution is unique in the class of equilibria with constant investment and continuous time-dependent consumption, both independent of the wealth of the agent. Compared to the classical Merton problem with one agent, the competitive model exhibits a wide range of highly nonlinear and non-monotone dependence on the agents' risk tolerance and competitiveness parameters. Counter-intuitively, competitive agents with high risk tolerance may behave like non-competitive agents with low risk tolerance.

Maturity Choice and Reference Points
Lukas, Moritz,Noeth, Markus
This paper shows how retail borrowers' focus on recent interest rates as reference points may lead to maturity choices which are inconsistent with normative predictions. A laboratory experiment reveals that borrowers prefer longer maturities when interest rates have fallen and shorter maturities when interest rates have risen. Normative drivers of maturity choice related to borrower characteristics, loan attributes, and pricing variables cannot explain these patterns of maturity choice. Market data from a mortgage broker confirms our findings. Borrowers incur welfare losses when focusing on previous interest rates too narrowly, thereby increasing lenders' profits.

Monetary Stabilization in Cryptocurrencies - Design Approaches and Open Questions
Ingolf G.A. Pernice,Sebastian Henningsen,Roman Proskalovich,Martin Florian,Hermann Elendner,Björn Scheuermann

The price volatility of cryptocurrencies is often cited as a major hindrance to their wide-scale adoption. Consequently, during the last two years, multiple so called stablecoins have surfaced---cryptocurrencies focused on maintaining stable exchange rates. In this paper, we systematically explore and analyze the stablecoin landscape. Based on a survey of 24 specific stablecoin projects, we go beyond individual coins for extracting general concepts and approaches. We combine our findings with learnings from classical monetary policy, resulting in a comprehensive taxonomy of cryptocurrency stabilization. We use our taxonomy to highlight the current state of development from different perspectives and show blank spots. For instance, while over 91% of projects promote 1-to-1 stabilization targets to external assets, monetary policy literature suggests that the smoothing of short term volatility is often a more sustainable alternative. Our taxonomy bridges computer science and economics, fostering the transfer of expertise. For example, we find that 38% of the reviewed projects use a combination of exchange rate targeting and specific stabilization techniques that can render them vulnerable to speculative economic attacks - an avoidable design flaw.

Noise Fit, Estimation Error and a Sharpe Information Criterion: Linear Case
Dirk Paulsen,Jakob Söhl

When the in-sample Sharpe ratio is obtained by optimizing over a k-dimensional parameter space, it is a biased estimator for what can be expected on unseen data (out-of-sample). We derive (1) an unbiased estimator adjusting for both sources of bias: noise fit and estimation error. We then show (2) how to use the adjusted Sharpe ratio as model selection criterion analogously to the Akaike Information Criterion (AIC). Selecting a model with the highest adjusted Sharpe ratio selects the model with the highest estimated out-of-sample Sharpe ratio in the same way as selection by AIC does for the log-likelihood as measure of fit.

Optimal Capital Structure (OCS) with a Finite Cash Flow: A Simple Numerical Illustration
Tham, Joseph
In this note, we present a simple numerical example, with a finite cash flow, to illustrate the concept of the Optimal Capital Structure (OCS). First, we assume that the discount rate for the tax benefits KTB equals the return to unlevered equity KU. The cost of debt KD is a simple linear function of the percent debt %D and the leverage costs LC are proportional to the percent debt %D. With this stringent assumption about the value of KTB, over the life of the FCF (Free Cash Flow), we obtain constant annual debt-equity ratios D/E; the return to levered equity KE and the FCF WACC are also constant over the three years. The FCF WACC decreases and then increases after the value of the maximum percent debt. We also analyze the cases where the value of KTB equals the cost of debt KD and the return to levered equity KE. We recognize that the risk profile of the tax shields is complex, and it may not be possible to capture all the benefits of the tax savings from debt financing with a single discount rate. Nevertheless, we ignore our own admonitions, and present a model that may have pedagogical value and provide insights for valuation.

Passing the Dividend Baton: The Impact of Dividend Policy on New CEOs’ Initial Compensation
Chen, Jie,Song, Wei,Goergen, Marc
We examine how firms’ dividend policy affects the initial compensation of their newly appointed CEOs. We focus on newly appointed CEOs to isolate the effect of dividends on compensation and to provide new insights into an aspect largely neglected by compensation research. We show that the dividend payout is positively related to new CEO compensation. Further, the positive effect of dividends is stronger for firms with no dividend cuts over the past two, three and four years, firms with relatively high institutional ownership, and those with strong boards, consistent with new CEOs receiving higher pay as compensation for greater dividend pressure.

Perception towards Electric Vehicles and the Impact on Consumers' Preference
Milad Ghasri,Ali Ardeshiri,Taha Rashidi

Relative advantage, or the degree to which a new technology is perceived to be better than an existing technology which is being replaced, has a significant impact on individuals decisions on when, how and to what extent to adopt. An integrated choice and latent variable model is used, in this paper, to explicitly investigate the cognitive process underlying the formation of electric vehicles perceived advantages over the conventional internal combustion engine vehicles. The analysed data is obtained from a stated preference survey including 1,076 residents in New South Wales, Australia. According to the results, the latent component of the model disentangles the perceived advantages across three dimensions of vehicle design, impact on the environment, and safety. These latent variables are interacted with price, driving range and body type, respectively, to capture the impact of perception on preference. The developed model is then used to examine different scenarios, in order to explore the effectiveness of several support schemes. The results show higher probability of adopting electric vehicles for generation Y, compared to generation X and Z. Generation Y is found to be the least sensitive cohort to purchase price, and generation X to be the most sensitive cohort to this attribute. People are more sensitive to incentives for the initial price compared to ongoing incentives for operating costs. Also, offering financial incentives to consumers as a rebate on the purchase price is more effective than allocating the same incentive to manufactories to reduce the purchase price.

Quasi-Dark Trading: The Effects of Banning Dark Pools in a World of Many Alternatives
Johann, Thomas,Putniņš, Tālis J.,Sagade, Satchit,Westheide, Christian
We show that “quasi-dark” trading venues, i.e., markets with somewhat non-transparent trading mechanisms, are important parts of modern equity market structure alongside lit markets and dark pools. Using the European MiFID II regulation as a quasi-natural experiment, we find that dark pool bans lead to (i) volume spill-overs into quasi-dark trading mechanisms including periodic auctions and order internalization systems; (ii) little volume returning to transparent public markets; and consequently, (iii) a negligible impact on market liquidity and short-term price efficiency. These results show that quasi-dark markets serve as close substitutes for dark pools and consequently mitigate the effectiveness of dark pool regulation. Our findings highlight the need for a broader approach to transparency regulation in modern markets that takes into consideration the many alternative forms of quasi-dark trading.

Rational Bubbles and Middlemen
Awaya, Yu,Iwasaki, Kohei,Watanabe, Makoto
This paper develops a finite-period model of rational bubbles where trade of an asset takes place through a chain of middlemen. We show that there exists a unique equilibrium, and a bubble can occur due to higher-order uncertainty. Under reasonable assumptions, the equilibrium price is increasing and accelerating during bubbles although the fundamental value is constant over time. Bubbles may be detrimental to the economy; however, bubble-bursting policies affect agents’ beliefs and it turns out that they have no effect on welfare. We also demonstrate that the possibility that middlemen obtain more information leads to larger bubbles.

Regime Detection Based Risk Modeling of Asset Classes
Chakravorty, Gaurav,Sirohiya, Anshul,Srivastava, Sonam,Agrawal, Nikhil,Singhal, Mansi
In this work, we have found a risk model that improves the performance of Risk Targeting. Risk Targeting in portfolio construction is implemented to improve capital utilization in growing markets and systematically step away from risk scenarios. However, the performance of risk targeting varies with different implementations of risk estimation. Risk Targeting using recent backward volatility estimates is the most popular risk targeting mechanism but it could not have anticipated a deep crisis like 2008 and it would hurt in range bound situations like the February 2018 drop and bounce back or the December 2018 drop and January 2019 bounce back. The drawbacks of recent volatility are that in such a risk model, short-term volatility is being used to detect a long-term risk event with and short term mean reversion effects are ignored .In this work, we will try to separate risk estimation into two risk models, a long-term risk model that predicts extreme risk scenarios based on macroeconomic data and a short-term risk model that adjusts risk based on short-term mean reversion effects. We then combine the output of the two risk models into a risk measure that enables a risk targeted allocation strategy to outperform static allocation in both crisis periods like 2008 and mean-reverting periods like 2018.Note that risk for a real-money investor is not an expectation of volatility but a measure of the probability of losing money if one is allocated to that asset class. Hence, we try to forecast a risk value which, if interpreted as a probability of loss, outperforms a baseline estimate of risk.

Revisiting Feller Diffusion: Derivation and Simulation
Ranjiva Munasinghe,Leslie Kanthan,Pathum Kossinna

We propose a simpler derivation of the probability density function of Feller Diffusion using the Fourier Transform and solving the resulting equation via the Method of Characteristics. We also discuss simulation algorithms and confirm key properties related to hitting time probabilities via the simulation.

Stock Market Liquidity and the Trading Costs of Asset Pricing Anomalies
Briere, Marie,Lehalle, Charles‐Albert,Nefedova, Tamara,Raboun, Amine
Using a large database of the US institutional investors’ trades, this paper revisits the question of anomalies-based portfolio transaction costs. The real costs paid by large investors to implement the well-identified size, value, and momentum anomalies are lower than what has been documented in the previous studies. We find that the average investor pays an annual transaction cost of 17bps for size, 24bps for value, and 274bps for momentum. The three strategies generate statistically significant returns of respectively 5.21%, 2.79% and 2.77% after accounting for transaction costs. When the market impact is taken into account, transaction costs reduce substantially the profitability of the well-known anomalies for large portfolios, however, these anomalies remain profitable for average size portfolios. The break-even capacities in terms of fund size are $ 206 billion for size, $ 16.1 billion for value and $ 310 million for momentum.

The Effect of Possible EU Diversification Requirements on the Risk of Banks’ Sovereign Bond Portfolios
Craig, Ben R.,Giuzio, Margherita,Paterlini, Sandra
Recent policy discussion includes the introduction of diversification requirements for sovereign bond portfolios of European banks. In this paper, we evaluate the possible effects of these constraints on risk and diversification in the sovereign bond portfolios of the major European banks. First, we capture the dependence structure of European countries’ sovereign risks and identify the common factors driving European sovereign CDS spreads by means of an independent component analysis. We then analyze the risk and diversification in the sovereign bond portfolios of the largest European banks and discuss the role of “home bias,” i.e., the tendency of banks to concentrate their sovereign bond holdings in their domicile country. Finally, we evaluate the effect of diversification requirements on the tail risk of sovereign bond portfolios and quantify the system-wide losses in the presence of fire-sales. Under our assumptions about how banks respond to the new requirements, demanding that banks modify their holdings to increase their portfolio diversification may mitigate fire-sale externalities, but it may be ineffective in reducing portfolio risk, including tail risk.

The Effect of Possible EU Diversification Requirements on the Risk of Banks' Sovereign Bond Portfolios
Craig, Ben R.,Giuzio, Margherita,Paterlini, Sandra
Recent policy discussion includes the introduction of diversification requirements for sovereign bond portfolios of European banks. In this paper, we evaluate the possible effects of these constraints on risk and diversification in the sovereign bond portfolios of the major European banks. First, we capture the dependence structure of European countries' sovereign risks and identify the common factors driving European sovereign CDS spreads by means of an independent component analysis. We then analyze the risk and diversification in the sovereign bond portfolios of the largest European banks and discuss the role of "home bias," i.e., the tendency of banks to concentrate their sovereign bond holdings in their domicile country. Finally, we evaluate the effect of diversification requirements on the tail risk of sovereign bond portfolios and quantify the system-wide losses in the presence of fire-sales. Under our assumptions about how banks respond to the new requirements, demanding that banks modify their holdings to increase their portfolio diversification may mitigate fire-sale externalities, but it may be ineffective in reducing portfolio risk, including tail risk.

The Policy Risk Premium in Equity Derivatives
Vecchio, Giovanni Gabriele
This paper introduces a model that allows to measure the impact of policy risk on the dynamics of the S&P 500 index using option data. I quantify the impact of policy risk on the whole P-distribution of assets, not just on volatility, as most literature on policy risk does. I document that this type of risk is priced and has a sizeable impact on expected returns, volatilities, skewness and kurtosis. A one percent increase in the Economic Policy Uncertainty index leads to a 2.25 percentage points increase in the Equity Risk Premium.

The Role and Importance of Independent Audit and Annual Integrated Reports as Corporate Tools in Communication with Stakeholders from the Investor Relations Perspectives: An Examination upon Turkish Banks
Kartal, Mustafa Tevfik
Although there are globalization and digitalization trends affecting all companies, some things can never be changed. Similarly, when speaking about investor relations, although there are new tools, annual reports are the main communication tools with the stakeholders. One of the most important issues with them is independent assurance and timely sharing with stakeholders. Also, there is a new trend named as integrated report regarding annual reports. So, in this study, it is aimed at evaluating the role and importance of independent audit and annual integrated reports as corporate communication tools from the point of view of investor relations. It is concluded that annual reports are still main corporate communication tools with the stakeholders for companies although there are other instruments like web site, social media and investor presentations. Integrated report trend is intensifying this role. Therefore, independent audit has a substantially important role in providing assurance to stakeholders regarding integrity of information in annual (integrated) reports.

Underspecification of the Empirical Return-Factor Model and a Factor Analytic Augmentation as a Solution to Factor Omission
Szczygielski, Jan,Brummer, Leon,Wolmarans, Hendrik
Factor omission in time-series models that relate asset returns to pre-specified factor sets is a common problem. A proposed solution to underspecification is the use of a residual market factor which is assumed to be a catch-all proxy for omitted factors. This study shows that a specification that incorporates a set of carefully selected macroeconomic factors will be underspecified and that underspecification has extensive consequences for model estimation and interpretation. Moreover, the inclusion of residual market factors will alleviate but not eliminate the consequences of underspecification. To ensure that an approximation of the diagonality assumption holds, a factor analytic augmentation should be included. Although the early use of factor analytically derived factor scores in factor models has been criticized, augmenting a model comprising pre-specified factors with statistical factors derived from the residuals results in an accurately specified model.

Why Do Firms Engage in Politics? The Role of External Oversight
Podolski, Edward,Veeraraghavan, Madhu
We examine the association between external managerial oversight and corporate political donations. Employing a propensity score matching methodology with firm fixed effects, we find that oversight by institutional investors as well as equity analysts is positively associated with political donations. These results suggest that corporate political donations benefit shareholders and are a form of strategic investment. In additional analysis, we find that political contributions benefit the donating firm’s stock price performance when the firm operates in a highly regulated environment, and that donating firms receive more federal government support. Our results suggest that corporate political activism is a value enhancing endeavor.

Ð"оходност на пенсионните фондове и осигурените в тях (2001-2018) (Pension Savers Real Returns & Costs in Bulgaria through 2018)
Christoff, Lubomir
Bulgarian Abstract: Ð"оходността, получена от осигурените в пенсионни фондове в Ð'ългария не е известна, дори и на регулатора. Публикувам номиналната и реална доходност, получена от всички осигурени в универсални и доброволни фондове у нас от 2001 до 2018 г. и за последните 1, 3, 7 и 10 години, завършващи на 31.12.2018 г., изчислена по парично-претегления метод.

Реалната доходност, получена от осигурените в УПФ е 0.0 % (2001-2018)
Реалната доходност, получена от осигурените в Ð"ПФ е отрицателна и равна на -0.6 % средногодишно (2001-2018)Пенсионните фондове в Ð'ългария са неизгоден пенсионен продукт, тъй като демонтстрират доходност под пазарната срещу такси над пазарните. Осигурените биха могли да получат по-добра доходност при по-нисък риск и такси от пасивно управляван портфейл от само два борсово търгувани фонда. 
УПФ са и негоден пенсионен продукт, който не може да осигури допълнителна пенсия и вместо това намалява пенсионните доходи на мнозинството от осигурените. Причината е по-ниската от необходимата доходност, която да позволи пенсия от УПФ да компенсира намалението на пенсията от държавното обществено осигуряване за тези, които се осигуряват в УПФ.Ð"ПФ - доброволни пенсионни фондове;УПФ - универсални пенсионни фондове.English Abstract: 
Pension savers real return credited on their accounts are unknown both, publicly and to the regulator. Therefore, published here are nominal and real returns, received by pension savers in universal and voluntary funds in Bulgaria in 2001-2018 and for the last 1, 3, 7 and 10 years, calculated as money-weighted returns.The real pension savers return in universal pension funds in 2001-2018 was 0.0 %.The real pension savers return in voluntary pension funds in 2001-2018 was negative 0.6 %.Pension funds in Bulgaria have proven unremunerative pension product over the past seventeen years as their returns have been lower while fees and charges - higher than could have been obtained from a passively managed portfolio, implemented with just two ETFs.In addition universal pension funds are unfit as they stand no chance of securing supplementary pensions to their customers due to their insufficient returns and, therefore, inability to offset the state pesnion reduction for those who have “insured” in universal pension funds.