Research articles for the 2019-06-04

A New Financial Model of Toll Road Infrastructure
Sihombing, Lukas B.
The development of toll road in developing countries especially in Indonesia was very slow. Although the Government of Indonesia has an accelerated toll road plan for 2020 was 4,000 km, but toll road length in 2013 was still 784 km. Because of that, the gap of toll road length in Indonesia has to be filled; one of the ways is to develop a new financial model as not business as usual. Existing financial model for toll road in Indonesia case had been built by Wibowo and Kochendörfer (2005), the model based on project financial risk at public private partnership delivery especially in build operate transfer (BOT). At the present, the problem of toll road development in Indonesia is more complex, so the model should be adjusted with real problems. This paper wants to develop a new financial model for toll road infrastructure with systematic review and meta analysis method; this new financial model can be expected to accelerate toll road development in Indonesia. The result of this paper is a new financial model that influenced by some factors: land leased, project delivery, tax increment financing, and Value for Money analysis.

Air Pollutions and Environmental Goods trade: Re-visiting the EKC hypothesis
Uddin, Syed,Khan, Sunera
Sustainable Development is the prime concern in development policy making all around the world. Environmental Goods and Services (EGS) play a vital role in sustainable development. Increasing access to and use of EGS can help in reducing air and water-pollution, improving energy and resource-efficiency and facilitating solid waste disposal. Trade liberalization of environmental goods helps promote sustainable economic development by generating economic growth and employment and enabling the transfer of valuable skills, technology, and know-how embedded in such goods and services. This paper focuses on the impact of environmental goods imports on the environment and on the importance of liberalizing trade in environmental goods and services in the context of Bangladesh. The Environmental Kuznets Curve (EKC) along with some other factors as control variables are used to analyze the effect on air pollution of the changes in the share of environmental goods in total imports. This is examined using panel data econometric approach for 72 Countries for the years 1995-2010. Westerlund Error Correction Model panel Cointegration tests are carried out. The findings show that an increase in imports of EGS reduces air pollution.

Asset Pricing with Heterogeneous Beliefs and Illiquidity
Muhle-Karbe, Johannes,Nutz, Marcel,Tan, Xiaowei
This paper studies the equilibrium price of an asset that is traded in continuous time between N agents who have heterogeneous beliefs about the state process underlying the asset's payoff. We propose a tractable model where agents maximize expected returns under quadratic costs on inventories and trading rates. The unique equilibrium price is characterized by a weakly coupled system of linear parabolic equations which shows that holding and liquidity costs play dual roles. We derive the leading-order asymptotics for small transaction and holding costs which give further insight into the equilibrium and the consequences of illiquidity.

Averaging plus Learning in financial markets
Ionel Popescu,Tushar Vaidya

This paper develops original models to study interacting agents in financial markets. The key feature of these models is how interactions are formulated and analysed. Agents learn from their observations and learning ability to interpret news or private information. Central limit theorems are developed but they arise rather unexpectedly. Under certain type of conditions governing the learning, agents beliefs converge in distribution that can be even fractal. The underlying randomness in the systems is not restricted to be of a certain class. Fresh insights are gained not only from developing new non-linear social learning models but also from using different techniques to study discrete time random linear dynamical systems.

CEO Education and the Ability to Raise Capital
Gounopoulos, Dimitrios,Loukopoulos, Panagiotis,Loukopoulos, Georgios
We examine whether heterogeneity of CEO academic qualifications matters in explaining the performance of Initial Public Offerings (IPOs). We find that CEO education attainments perform a signaling role which depends not only on the level but also on the major of education. Specifically, we show that, irrespective of the level of academic achievements, IPO investors have a preference for top managers with practice or business oriented degrees as opposed to liberal arts degrees. Importantly, our findings suggest that both the level and quality of education training tend to reduce IPO underpricing, and this effect is less pronounced for less specialized degrees.

Changing the Channel: The Relation between Information Complexity and Disclosure Channel Richness
Skinner, A. Nicole
I examine the role of information complexity in disclosure channel choice and the implications of the channel decision for market participants. Organizational communication theory suggests that managers who prefer efficient communication match underlying information complexity to internal communication channel richness (e.g. interaction, language variety and cues). Although external disclosures diverge from internal firm communication in important ways, I find evidence consistent with the management theory in the external quarterly reporting setting. Specifically, I find information complexity is associated with the allocation of information across channels with differing richness (e.g. earnings press release and conference call). The positive relation between complexity and richness is mitigated when managers have weakened preferences for (or ability to facilitate) communication efficiency. Moreover, placing complex information in channels with insufficient cues is associated with slower price formation. The results are consistent with managers, on average, choosing disclosure channels to reduce investors’ processing costs.

Community Matters: Heterogeneous Impacts of a Sanitation Intervention
Laura Abramovsky,Britta Augsburg,Melanie Lührmann,Francisco Oteiza,Juan Pablo Rud

We study the effectiveness of a community-level information intervention aimed at reducing open defecation (OD) and increasing sanitation investments in Nigeria. The results of a cluster-randomized control trial conducted in 247 communities between 2014 and 2018 suggest that average impacts are exiguous. However, these results hide important community heterogeneity, as the intervention has strong and lasting effects on OD habits in poorer communities. This result is robust across several measures of community socio-economic characteristics, and is not driven by baseline differences in toilet coverage. In poor communities, OD rates decreased by 9pp from a baseline level of 75\%, while we find no effect in richer communities. The reduction in OD is achieved mainly through increased toilet ownership (+8pp from a baseline level of 24\%). Finally, we combine our study with data from five other trials of similar interventions to show that estimated impacts are stronger in poorer contexts, rationalizing the wide range of estimates in the literature and providing plausible external validity, with implications for program scale-up. Our findings point to community wealth as a widely available and sufficient statistic for effective intervention targeting.

Contagion in Bitcoin networks
Célestin Coquidé,José Lages,Dima L. Shepelyansky

We construct the Google matrices of bitcoin transactions for all year quarters during the period of January 11, 2009 till April 10, 2013. During the last quarters the network size contains about 6 million users (nodes) with about 150 million transactions. From PageRank and CheiRank probabilities, analogous to trade import and export, we determine the dimensionless trade balance of each user and model the contagion propagation on the network assuming that a user goes bankrupt if its balance exceeds a certain dimensionless threshold $\kappa$. We find that the phase transition takes place for $\kappa<\kappa_c\approx0.1$ with almost all users going bankrupt. For $\kappa>0.55$ almost all users remain safe. We find that even on a distance from the critical threshold $\kappa_c$ the top PageRank and CheiRank users, as a house of cards, rapidly drop to the bankruptcy. We attribute this effect to strong interconnections between these top users which we determine with the reduced Google matrix algorithm. This algorithm allows to establish efficiently the direct and indirect interactions between top PageRank users. We argue that this study models the contagion on real financial networks.

Disequilibrium Adjustments for CAPM
Akopyan, Artashes
In the classical theory of capital assets valuation, based on the works of Garry Markowitz (Markowitz, 1952) and William Sharpe (Sharpe, 1964), there is no analytical framework for transition from the individual choice of the optimal portfolio to the general equilibrium of capital market. Thus, the relationship between the microeconomic level of investment decision-making and the macroeconomic final balance of assets is not defined. And although today this issue is likely to have purely academic interest, however, the algorithm solving this problem in the context of the strong hypothesis of efficient market is presented in this article.

Does It Cost to Be Politically Connected? An Examination of the Grabbing Hand Hypothesis Using Corporate Taxes
Arifin, Taufiq,Hasan, Iftekhar,Kabir, Rezaul
We study a channel through which politicians can use corporate taxes to extract firm’s resources. We find that politically-connected firms pay higher taxes than their non-connected counterparts. Using election as an exogenous shock, we also observe that politically-connected firms pay higher taxes during election years to support the incumbent political regime. The results of the study indicate that favorable economic indicators, e.g. government tax revenue, are important to politicians, and provide rent seeking incentive to achieve their political objective.

Dynamic portfolio optimization with liquidity cost and market impact: a simulation-and-regression approach
Rongju Zhang,Nicolas Langrené,Yu Tian,Zili Zhu,Fima Klebaner,Kais Hamza

We present a simulation-and-regression method for solving dynamic portfolio allocation problems in the presence of general transaction costs, liquidity costs and market impacts. This method extends the classical least squares Monte Carlo algorithm to incorporate switching costs, corresponding to transaction costs and transient liquidity costs, as well as multiple endogenous state variables, namely the portfolio value and the asset prices subject to permanent market impacts. To do so, we improve the accuracy of the control randomization approach in the case of discrete controls, and propose a global iteration procedure to further improve the allocation estimates. We validate our numerical method by solving a realistic cash-and-stock portfolio with a power-law liquidity model. We quantify the certainty equivalent losses associated with ignoring liquidity effects, and illustrate how our dynamic allocation protects the investor's capital under illiquid market conditions. Lastly, we analyze, under different liquidity conditions, the sensitivities of certainty equivalent returns and optimal allocations with respect to trading volume, stock price volatility, initial investment amount, risk-aversion level and investment horizon.

Economic Policy Uncertainty and Corporate Diversification
Hoang, Khanh,Nguyen, Cuong,Zhang, Hailiang
Recent literature documents various impacts of economic policy uncertainty (EPU) on corporate investment. However, the impact of EPU on corporate diversification has not been paid enough attention. Given the fact that the influence of diversification has been found in the literature on firm value, firm performance, cost of capital, cash holdings, productivity, organizational structure, etc., our research aims to investigate the linkage between corporate diversification and economic policy uncertainty in China since there are three reasons that set the market as a perfect sample for the relationship.First, it comes at a right time that the possible effects of economic policy uncertainty on firms in China’s market are of great interest, mentioning the time of the on-going trade war between China and the United States. Second, the Chinese economy, with the enormous ups and downs of growth and policy changes, offers an eventful data set for testing the relationship between EPU and diversification. Third, the issues of shareholder protection and investment information environments have not been well addressed, which is more critical in the Chinese market than in other developed markets. This setting will provide fascinating findings, which set our research apart from the other current studies in the literature.We find that there is a positive association between economic policy uncertainty and corporate diversification, meaning that high economic policy uncertainty will lead to an increase of diversification for firms. This is consistent with the hypothesis that diversification is encouraged so that risk will be reduced when uncertainty increases. Our empirical results also show that the positive impact of EPU is significant for large-cap and medium cap firms, but not for small-cap ones. The findings also reveal that high EPU is associated with higher diversification, while low EPU is not. Our results are robust through different measures of economic policy uncertainty and corporate diversification and remain significantly unchanged when dealing with endogeneity problems.Further, our analyses do not indicate that block shareholders are crucial in the decision-making process to diversify in firms under the period of high economic policy uncertainty in this market. However, regarding information asymmetry, diversification of the firms with a high number of analyst followers and equity reports will increase when economic policy uncertainty is at its high stage.It is also understandable that uncertainty in economic policies could transform into firm performance’s volatility and obliquely motivates corporate diversification. Under that light, our findings suggest that diversification plays an active role in mitigating economic-policy related risks, thus enhancing firm performance. This is the first research to document the positive influence of EPU on corporate diversification. Our findings enrich the literature on and provide insights into the relationship between economic policy uncertainty and diversification at firm level.

Empirical Asset Pricing with Multi-Period Disaster Risk: A Simulation-Based Approach
Grammig, Joachim,Sönksen, Jantje
We propose a simulation-based strategy to estimate and empirically assess a class of asset pricing models that account for rare but severe consumption contractions that can extend over multiple periods. Our approach expands the scope of prevalent calibration studies and tackles the inherent sample selection problem associated with measuring the effect of rare disaster risk on asset prices. An analysis based on postwar U.S. and historical multi-country panel data yields estimates of investor preference parameters that are economically plausible and robust with respect to alternative specifications. The estimated model withstands tests of validity; the model-implied key financial indicators and timing premium have reasonable magnitudes. These findings suggest that the rare disaster hypothesis can help restore the nexus between the real economy and financial markets when allowing for multi-period disaster events. Our methodological contribution is a new econometric framework for empirical asset pricing with rare disaster risk.

Empirical Survival Jensen-Shannon Divergence as a Goodness-of-Fit Measure for Maximum Likelihood Estimation and Curve Fitting
Mark Levene,Aleksejus Kononovicius

The coefficient of determination, known as $R^2$, is commonly used as a goodness-of-fit criterion for fitting linear models. $R^2$ is somewhat controversial when fitting nonlinear models, although it may be generalised on a case-by-case basis to deal with specific models such as the logistic model. Assume we are fitting a parametric distribution to a data set using, say, the maximum likelihood estimation method. A general approach to measure the goodness-of-fit of the fitted parameters, which is advocated herein, is to use a nonparametric measure for comparison between the empirical distribution, comprising the raw data, and the fitted model. In particular, for this purpose we put forward the Survival Jensen-Shannon divergence ($SJS$) and its empirical counterpart (${\cal E}SJS$) as a metric which is bounded, and is a natural generalisation of the Jensen-Shannon divergence. We demonstrate, via a straightforward procedure making use of the ${\cal E}SJS$, that it can be used as part of maximum likelihood estimation or curve fitting as a measure of goodness-of-fit, including the construction of a confidence interval for the fitted parametric distribution. Furthermore, we show the validity of the proposed method with simulated data, and three empirical data sets.

Enabling Civil Society: Select survey findings
Wood, Jacqueline,Fällman, Karin
Civil society and civil society organisations (CSOs) are important to development co-operation, both as implementing partners for members of the Development Assistance Committee (DAC), and as development actors in their own right. Agenda 2030 is clear on the necessity of mobilising CSOs to implement, and uphold accountability for, the Sustainable Development Goals. The Global Partnership for Effective Development Co operation has committed to ensuring effectiveness in relation to CSOs in development co-operation, inclusive of the provision of CSO enabling environments.Recognising that how DAC members work with CSOs is part of CSO enabling environments, in 2017 the OECD Development Co-operation Directorate (DCD) established a work stream on civil society to provide guidance on DAC member support for civil society and a strategy for engaging with civil society. Under the work stream, a study on how DAC members work with CSOs was launched to identify areas of DAC member support to and engagement with CSOs for which guidance is needed. This paper introduces a selection of key findings and recommendations from two 2018-2019 surveys complemented with DAC statistical data.The paper points to evidence of member effort to work with CSOs in ways that enable CSOs to maximise their contribution to development. However, evidence also shows that members need to continuously examine their practices to ensure coherence between objectives and the many advantages that CSOs are seen to bring to development, and the members' means of support to and engagement with CSOs.

Fair Pricing of Variable Annuities with Guarantees under the Benchmark Approach
Jin Sun,Kevin Fergusson,Eckhard Platen,Pavel V. Shevchenko

In this paper we consider the pricing of variable annuities (VAs) with guaranteed minimum withdrawal benefits. We consider two pricing approaches, the classical risk-neutral approach and the benchmark approach, and we examine the associated static and optimal behaviors of both the investor and insurer. The first model considered is the so-called minimal market model, where pricing is achieved using the benchmark approach. The benchmark approach was introduced by Platen in 2001 and has received wide acceptance in the finance community. Under this approach, valuing an asset involves determining the minimum-valued replicating portfolio, with reference to the growth optimal portfolio under the real-world probability measure, and it both subsumes classical risk-neutral pricing as a particular case and extends it to situations where risk-neutral pricing is impossible. The second model is the Black-Scholes model for the equity index, where the pricing of contracts is performed within the risk-neutral framework. Crucially, we demonstrate that when the insurer prices and reserves using the Black-Scholes model, while the insured employs a dynamic withdrawal strategy based on the minimal market model, the insurer may be underestimating the value and associated reserves of the contract.

Financial Innovation, Economic Growth, and the Consequences of Macroprudential Policies
Bernier, Maxence,Plouffe, Michael
We leverage a ‘catch-all’ measure of financial innovation â€" research and development spending in the financial sector â€" to assess the net relationship between financial innovation and economic growth and evaluate the influence of macroprudential policy on this relationship. Using a panel of 23 countries over the period of 1996-2014, our results demonstrate a net-positive relationship between financial innovation and gross capital formation. We find no evidence of a net-negative impact of financial innovation on economic growth, challenging the popular and political stigma surrounding financial innovation. We also find little robust evidence of macroprudential policy influencing the relationship between financial innovation and economic growth. Our results support a functional approach to the regulation of financial innovation, which improves the intermediation process, leading to increased capital formation.

For Whom the Bell (Curve) Tolls: A to F, Trade Your Grade Based on the Net Present Value of Friendships with Financial Incentives
Ravi Kashyap

We discuss a possible solution to an unintended consequence of having grades, certificates, rankings and other diversions in the act of transferring knowledge; and zoom in specifically to the topic of having grades, on a curve. We conduct a thought experiment, taking a chapter (and some more?) from the financial markets, (where we trade pollution and what not?), to create a marketplace, where we can trade our grade, similar in structure to the interest rate swap. We connect this to broader problems that are creeping up, unintentionally, due to artificial labels we are attaching, to ourselves. The policy and philosophical implications of our arguments are to suggest that all trophies that we collect (including certificates, grades, medals etc.) should be viewed as personal equity or private equity (borrowing another widely used term in finance) and we should not use them to determine the outcomes in any selection criteria except have a cutoff point: either for jobs, higher studies, or, financial scholarships, other than for entertainment or spectator sports. We suggest alternate methods for grading and performance assessment and put forth tests for teaching and learning similar to the Turing Test for intelligence.

Generalized Expected Discounted Penalty Function at General Drawdown for L\'{e}vy Risk Processes
Wenyuan Wang,Ping Chen,Shuanming Li

This paper considers an insurance surplus process modeled by a spectrally negative L\'{e}vy process. Instead of the time of ruin in the traditional setting, we apply the time of drawdown as the risk indicator in this paper. We study the joint distribution of the time of drawdown, the running maximum at drawdown, the last minimum before drawdown, the surplus before drawdown and the surplus at drawdown (may not be deficit in this case), which generalizes the known results on the classical expected discounted penalty function in Gerber and Shiu (1998). The results have semi-explicit expressions in terms of the $q$-scale functions and the L\'{e}vy measure associated with the L\'{e}vy process. As applications, the obtained result is applied to recover results in the literature and to obtain new results for the Gerber-Shiu function at ruin for risk processes embedded with a loss-carry-forward taxation system or a barrier dividend strategy. Moreover, numerical examples are provided to illustrate the results.

Governance of the Facebook Privacy Crisis
Trautman, Lawrence J.
In November 2018, The New York Times ran a front-page story describing how Facebook covered up knowledge and disclosure of Russian-linked activity and exploitation resulting in Kremlin led disruption of the 2016 and 2018 U.S. elections, through the use of global hate campaigns and propaganda warfare. By mid-December 2018, it becomes clear that the Russian efforts leading up to the 2016 U.S. elections were much more extensive than previously thought. Two studies conducted for the United States Senate Select Committee on Intelligence (SSCI), by: (1) Oxford University’s Computational Propaganda Project and Graphika; and (2) New Knowledge, provide considerable new information and analysis about the Russian Internet Research Agency (IRA) influence operations targeting American citizens. By early 2019 it has become apparent that a number of influential and successful high growth social media platforms have been used by nation states for propaganda purposes. Over two years earlier, Russia was called out by the U.S. intelligence community for their meddling with the 2016 American presidential elections. The extent to which prominent social media platforms has been used either willingly or without their knowledge by foreign powers continue to be investigated as this Article goes to press. Reporting by The New York Times suggests that it wasn’t until the Facebook board meeting held September 6, 2017 that board audit committee Chair Erskin Bowles became aware of Facebook’s internal awareness of the extent to which Russian operatives had utilized the Facebook and Instagram platforms for influence campaigns in the United States. As this Article goes to press, the degree to which the allure of advertising revenues blinded Facebook to their complicit role in offering access to Facebook users to the highest bidder is not known. This Article can not be a complete chapter in the corporate governance challenge of managing, monitoring, and oversight of individual privacy issues and content integrity on prominent social media platforms. The full extent of Facebook’s experience is just now becoming known, with new revelations yet to come. All interested parties: Facebook users; shareholders; the board of directors at Facebook; government regulatory agencies such as the Federal Trade Commission (FTC) and Securities and Exchange Commission (SEC); and Congress, must now figure out what has transpired and what to do about it. These and other revelations have resulted in a crisis for Facebook, the leading global social media platform. American democracy has been and continues to be under attack. This article contributes to the literature by providing background and an account of what is known to date and posits recommendations for corrective action.

Government Ownership and the Capital Structure of Firms: Analysis of An Institutional Context from China
Huang, Xiaohong,Kabir, Rezaul,Zhang, Lingling
Emerging economies provide interesting scenarios for examining how institutional context influences the financing behavior of firms. In this study, we examine the capital structure of Chinese listed firms following the Split-Share Structure Reform of 2005. This reform allowed a reduction of government ownership by making government shares tradable. We find that the impact of government ownership on leverage is dependent on whether the government is the largest shareholder in a firm and whether the government ownership is through a parent state-owned enterprise. In addition, we document that the largest non-government shareholder positively influences leverage. Overall, our results reveal that the largest controlling shareholder, either government or non-government, has a significant impact on the capital structure of Chinese firms.

Gross Profitability and Mutual Fund Performance
Kenchington, David G.,Wan, Chi,Yuksel, H. Zafer
We find that mutual funds holding a larger concentration of high gross profitability stocks generate better future performance. The outperformance of these funds is not driven by a profitability-related risk premium and is not a byproduct of fund managers’ exploitation of other well-known investment strategies. We show that fund managers who trade on the gross profitability anomaly possess greater skill and create value by attracting future fund inflows and by growing fund assets under management. We contribute to both the mutual fund and market anomaly literatures by providing strong evidence that a sizable subset of mutual fund managers profit from an important market anomaly.

Hierarchical adaptive sparse grids and quasi Monte Carlo for option pricing under the rough Bergomi model
Christian Bayer,Chiheb Ben Hammouda,Raul Tempone

The rough Bergomi (rBergomi) model, introduced recently in [4], is a promising rough volatility model in quantitative finance. This new model exhibits consistent results with the empirical fact of implied volatility surfaces being essentially time-invariant. This model also has the ability to capture the term structure of skew observed in equity markets. In the absence of analytical European option pricing methods for the model, and due to the non-Markovian nature of the fractional driver, the prevalent option is to use Monte Carlo (MC) simulation for pricing. Despite recent advances in the MC method in this context, pricing under the rBergomi model is still a time-consuming task. To overcome this issue, we design a novel, alternative, hierarchical approach, based on i) adaptive sparse grids quadrature (ASGQ), specifically using the same construction in [22], and ii) Quasi Monte Carlo (QMC). Both techniques are coupled with Brownian bridge construction and Richardson extrapolation. By uncovering the available regularity, our hierarchical methods demonstrates substantial computational gains with respect to the standard MC method, when reaching a sufficiently small relative error tolerance in the price estimates across different parameter constellations, even for very small values of the Hurst parameter. Our work opens a new research direction in this field, i.e. to investigate the performance of methods other than Monte Carlo for pricing and calibrating under the rBergomi model.

Horizontal Shareholding within the European Competition Law Framework: Discussion of the Proposed Solutions
Fadiga, Riccardo
The literature shows that horizontal shareholding engenders significant anticompetitive effects and that no suitable instrument exists within European competition law which reliably and effectively can be applied to curtail such intrinsic effects. This Article analyses several proposals which have been put forward by the scholarship and the institutions in order to compare and contrast their advantages and disadvantages, and shows that enforcement against horizontal shareholding on the basis of Article 102 TFEU affords substantial benefits compared to other solutions, with no comparable disadvantages.

Insider Trading with Penalties
Carre, Sylvain,Collin-Dufresne, Pierre,Gabriel, Franck
We establish existence and uniqueness of equilibrium in a generalised one-period Kyle (1985) model where insider trades can be subject to a size-dependent penalty. The result is obtained by considering uniform noise and holds for virtually any penalty function. Uniqueness is among all non-decreasing strategies. The insider demand and the price functions are in general non-linear, yet tractable.We apply this result to regulation issues. We show analytically that the penalty functions maximising price informativeness for given noise traders' losses eliminate small rather than large trades. We generalise this result to cases where a budget constraint distorts the set of penalties available to the regulator.

Interest Rates and Investment Under Competitive Screening and Moral Hazard
Dosis, Anastasios
This paper studies the effect of (market) interest rate changes on investment under competitive screening and moral hazard. Lower (higher) rates ease (hinder) the provision of incentives to entrepreneurs with positive NPV projects to invest in their best project but hinder (ease) banks’ efforts to distinguish them from entrepreneurs with negative NPV projects. This might result in a hump-shaped investment curve. Under low rates, screening through limit pricing leaves insufficient profits to low-wealth entrepreneurs to invest in their best project, and consequently, several project qualities might co-exist in equilibrium. Several testable and other implications on the effectiveness of unconventional monetary policy to boost investment are discussed.

International Financial Integration and International Diversification Gains When Considering Financial Crises: Evidence from A Conditional CI-GCAPM
Atef, Wasli,Mamoghli, Chokri
In this paper, we are interested in the study of the effect of financial crises/ period of turmoils on the international financial integration and on the expected gains of international diversification strategies. The sample consists of 4 developed markets in addition of the world market portfolio. The study period lasts between January 1988 and December 2015. This period is then divided in three sub periods (pre crises period, crises period and post crises period). To do that, we have developed and tested a conditional version of CI-GCAPM in order to study the effect, simultaneously, of fluctuations in exchange rates and the crises periods as imperfections, on the financial integration and on the gains associated with international diversification strategies. The results show that financial integration essentially goes through the effect of the world market portfolio. Currency risk is not priced. However, the international diversification gains are more important in the post crises periods.

Kinetic Market Model: An Evolutionary Algorithm
Evandro Luquini,Nizam Omar

This research proposes the econophysics kinetic market model as an evolutionary algorithm's instance. The immediate results from this proposal is a new replacement rule for family competition genetic algorithms. It also represents a starting point to adding evolvable entities to kinetic market models.

Left Behind: Partisan Identity and Wealth Inequality
Ke, Da
Using longitudinal household data, I document that Democrats are less likely than Republicans to invest in the stock market under Democratic presidencies, precisely when stock market return is substantially higher. This pattern contains even for college-educated and financially sophisticated individuals, and is best explained by their partisan identity. Moreover, the gap in stock market participation between Democrats and Republicans accounts for about half of their discrepancy in wealth accumulation over presidential cycles. A profound implication of these findings is that rising political polarization in the U.S. may be fueling wealth inequality.

Local versus Non-Local Effects of Chinese Media and Post-Earnings Announcement Drift
Kim, Jeong-Bon,Li, Liuchuang,Yu, Zhongbo,Zhang, Hao
Taking advantage of the institutional difference in capture between local and non-local media in China, we examine the association between media capture and post-earnings announcement drift (PEAD). Using both portfolio and regression analyses, we find that, for the same firms, non-local media coverage is negatively associated with PEAD but that there is no association between local media coverage and PEAD except for non-state-owned firms. Given that in China non-local media are less captured or more independent than local media, the negative association observed for non-local media coverage can be interpreted as an indication that media independence plays a role in reducing PEAD or improving informational efficiency in the stock market.

Managerial Entrenchment and Debt Specialization
Tut, Daniel
Why do some firms borrow from multiple creditors and employ multiple debt types? This paper shows that entrenched managers exploit the coordination failure and free riding problem amongst multiple creditors. We find that firms with entrenched management have a higher proclivity to employ multiple debt types and have a dispersed debt structure. On the other hand, firms that are well-managed have a tendency to concentrate debt and borrow predominantly from a few creditors. We also find that while bank debt is negatively related to debt specialization, market debt is positively related to debt specialization. Overall, the findings suggest that creditors can discipline managers through debt specialization.

Market Making and Latency
Xuefeng Gao,Yunhan Wang

This paper studies optimal market making for large--tick assets in the presence of latency. We formulate the problem using Markov Decision Processes. We provide explicit characterizations of the order value and the structure of the value functions. We use such characterizations to study when a market maker can earn a positive net profit and investigate the effect of latency. Numerical experiments are conducted to illustrate our results.

Mootness Fees
Cain, Matthew D.,Fisch, Jill E.,Davidoff Solomon, Steven,Thomas, Randall S.
We examine the latest development in merger litigation: the mootness fee. Utilizing a hand-collected sample of 2,320 unique deals from 2003-2018, we find that Delaware’s crackdown on merger litigation substantially altered the merger litigation landscape. Although merger litigation rates remain high, and in 2018 83% of deals experienced litigation, plaintiffs’ lawyers have fled Delaware. In 2018 only 5% of completed deals experienced merger litigation in Delaware compared to 50%-60% in prior years. These cases have migrated to federal court where in 2018 92% of deals with litigation experienced a filing. We find that at least 65% of these federal filings resulted in voluntary dismissal of the case after a supplemental disclosure coupled with the payment of a mootness fee to plaintiffs’ attorneys.These mootness dismissals, in most cases, occur without an adversarial process, meaningful judicial oversight or an evaluation of whether the complaint even states a colorable claim. Many of these supplemental disclosures provide little or no value to plaintiff shareholders. We argue that these payments are a form of blackmail antithetical to the spirit and principles of civil procedure and that they perpetuate litigation that imposes substantial costs on the judicial system and public companies.The article proposes that courts address these concerns by requiring transparency of mootness fees and overseeing the circumstances in which such fees are paid. We argue that the Federal Rules of Civil Procedure should be amended to require disclosure and judicial approval of the payment of a mootness fee when a proposed class action is voluntarily dismissed. We further argue that courts should only approve the payment of such a fee when the supplemental disclosures that moot the litigation are “clearly material.”

Optimal Dynamic Strategies on Gaussian Returns
Nick Firoozye,Adriano Koshiyama

Dynamic trading strategies, in the spirit of trend-following or mean-reversion, represent an only partly understood but lucrative and pervasive area of modern finance. Assuming Gaussian returns and Gaussian dynamic weights or signals, (e.g., linear filters of past returns, such as simple moving averages, exponential weighted moving averages, forecasts from ARIMA models), we are able to derive closed-form expressions for the first four moments of the strategy's returns, in terms of correlations between the random signals and unknown future returns. By allowing for randomness in the asset-allocation and modelling the interaction of strategy weights with returns, we demonstrate that positive skewness and excess kurtosis are essential components of all positive Sharpe dynamic strategies, which is generally observed empirically; demonstrate that total least squares (TLS) or orthogonal least squares is more appropriate than OLS for maximizing the Sharpe ratio, while canonical correlation analysis (CCA) is similarly appropriate for the multi-asset case; derive standard errors on Sharpe ratios which are tighter than the commonly used standard errors from Lo; and derive standard errors on the skewness and kurtosis of strategies, apparently new results. We demonstrate these results are applicable asymptotically for a wide range of stationary time-series.

Optimal Stopping under Model Ambiguity: a Time-Consistent Equilibrium Approach
Yu-Jui Huang,Xiang Yu

An unconventional approach for optimal stopping under model ambiguity is introduced. Besides ambiguity itself, we take into account how ambiguity-averse an agent is. This inclusion of ambiguity attitude, via an $\alpha$-maxmin nonlinear expectation, renders the stopping problem time-inconsistent. We look for subgame perfect equilibrium stopping policies, formulated as fixed points of an operator. For a one-dimensional diffusion with drift and volatility uncertainty, we show that every equilibrium can be obtained through a fixed-point iteration. This allows us to capture much more diverse behavior, depending on an agent's ambiguity attitude, beyond the standard worst-case (or best-case) analysis. In a concrete example of real options valuation under volatility uncertainty, all equilibrium stopping policies, as well as the best one among them, are fully characterized. It demonstrates explicitly the effect of ambiguity attitude on decision making: the more ambiguity-averse, the more eager to stop---so as to withdraw from the uncertain environment. The main result hinges on a delicate analysis of continuous sample paths in the canonical space and the capacity theory. To resolve measurability issues, a generalized measurable projection theorem, new to the literature, is also established.

Retail Shareholder Participation in the Proxy Process: Monitoring, Engagement, and Voting
Brav, Alon,Cain, Matthew D.,Zytnick, Jonathon
This paper studies U.S. retail shareholder voting using a detailed sample of anonymized retail shareholder voting records over the period 2015-2017. We find that retail voters tend to vote more when the firm itself is smaller, when their ownership stake in the portfolio firm is higher and, consistent with informed choice, when the shareholder receives more information from the firm about the agenda. On the choice of how to vote, we find a positive association between retail shareholder support for management and recent performance, which is substantially greater than that for institutional investors. The association between retail shareholder support for management and ISS recommendations is lower than that for institutional investors. Small retail shareholders oppose management to a greater extent than do large retail shareholders, and retail shareholders in general oppose management more at small companies than large ones. Finally, we observe that, on average, voting support for ESG-related proposals is lower among large retail investors than institutional investors. Our results provide support for the idea that retail shareholders are an important force in firm voting, and that institutional voting differs substantially from retail shareholder voting. Thus, the voting choices of fund managers can be a poor proxy for the choices of their ultimate beneficiaries.

Rise and Fall of Interest Rate Futures in Indian Derivative Market
Panda, Pradiptaarthi,Thiripalraju, Dr. M.
Derivative products are popular financial instruments to hedge against the risk associated with the underlying. Interest rate derivatives are the most traded and widely accepted derivative instrument in the international market. But this product is not popular in Indian derivative market. In 1999, the Over the counter (OTC) interest rate derivative products introduced in Indian derivative market. This product was successful in terms of volumes. To overcome the drawbacks of the OTC derivative market, Indian financial market introduced exchange-traded interest rate derivative in 2003, 2009 and 2014. While two times (in 2003 and 2009) this product failed, in the third time (in 2014) the initial volumes are sharply declining in three exchanges viz. MCX-SX, NSE, and BSE. In this backdrop, this study attempts to analyse the past, present, and future of interest rate futures in the Indian derivative market using the volumes, values and the open interest of Interest rate derivatives for three exchanges.

Russia’s Financial Sector: How to Build a Forecast
Vedev, Alexey
The issue of long-term forecasting for the Russian financial sector has come to the fore after the economy and the financial system have suffered substantial shocks in recent years. It is extremely important for economic agents to understand what the Russian financial system would be on the horizon. The effect of non-economic (“geopolitics”) and technology (digital technologies) factors on the financial sector must be factored in when making forecast scenarios.

Secondary Market Liquidity and Primary Market Pricing of Corporate Bonds
Goldstein, Michael A.,Hotchkiss, Edith S.,Pedersen, David
This paper studies the link between secondary market liquidity for a corporate bond and the bond’s yield spread at issuance. Using ex-ante measures of expected liquidity at the time of issuance, based on the characteristics of the underwriting syndicate, we find an economically large impact of liquidity on yield spreads. We estimate that a 10% increase in expected liquidity implies a decrease in the yield spread at issuance of between 8% and 14%. Our results suggest that liquidity has an important effect on firms’ cost of capital, and they contribute to the literature which examines the impact of liquidity on asset prices.

Sense and Sentiment: A Behavioral Approach to Risk Premium Modelling
García Petit, Juan José,Rúa Vieites, Antonio,Vaquero Lafuente, Maria Esther
Estimates of risk premium derived from classical financial theory have consistently shown deviations from the observed levels. These limitations have been linked to the rational foundations of these theories that rely on asset prices as the main source of information. This article focuses on the need to increase the information available through the consideration of behavioral factors.Therefore, the paper proposes an alternative methodology to estimate risk premium incorporating investor sentiment as a source of additional information.This model is tested on the US market with the objective of obtaining a more accurate measure of risk premium that the one provided by classical financial approaches. It also offers an alternative explanation to risk-return relationship based on investor’s sentiment. Finally, the use of behavioral approaches to the treatment of the risk premium will favor the control of market anomalies such as the momentum effect.

The Anatomy of the Transmission of Macroprudential Policies
Acharya, Viral V.,Bergant, Katharina,Crosignani, Matteo,Eisert, Tim,McCann, Fergal J.
We analyze the effect of regulatory limits on household leverage on residential mortgage credit, house prices, and banks' portfolio choice. Combining supervisory loan level and house price data, we examine the introduction of loan-to-income and loan-to-value limits on residential mortgages in Ireland. Mortgage credit is reallocated from low- to high-income borrowers and from high- to low-house price appreciation areas, cooling down, in turn, "hot'' housing markets. Consistent with a bank portfolio choice channel, banks more affected by the limits drive this reallocation and increase their risk-taking in their securities holdings and corporate credit, two asset classes not targeted by the policy.

Trading in Complex Networks
Felipe M. Cardoso,Carlos Gracia-Lazaro,Frederic Moisan,Sanjeev Goyal,Angel Sanchez,Yamir Moreno

Global supply networks in agriculture, manufacturing, and services are a defining feature of the modern world. The efficiency and the distribution of surpluses across different parts of these networks depend on choices of intermediaries. This paper conducts price formation experiments with human subjects located in large complex networks to develop a better understanding of the principles governing behavior. Our first finding is that prices are larger and that trade is significantly less efficient in small-world networks as compared to random networks. Our second finding is that location within a network is not an important determinant of pricing. An examination of the price dynamics suggests that traders on cheapest -- and hence active -- paths raise prices while those off these paths lower them. We construct an agent-based model (ABM) that embodies this rule of thumb. Simulations of this ABM yield macroscopic patterns consistent with the experimental findings. Finally, we extrapolate the ABM on to significantly larger random and small world networks and find that network topology remains a key determinant of pricing and efficiency.

Two Resolutions of the Margin Loan Pricing Puzzle
Alex Garivaltis

This paper supplies two possible resolutions of Fortune's (2000) margin-loan pricing puzzle. Fortune (2000) noted that the margin loan interest rates charged by stock brokers are very high in relation to the actual (low) credit risk and the cost of funds. If we live in the Black-Scholes world, the brokers are presumably making arbitrage profits by shorting dynamically precise amounts of their clients' portfolios. First, we extend Fortune's (2000) application of Merton's (1974) no-arbitrage approach to allow for brokers that can only revise their hedges finitely many times during the term of the loan. We show that extremely small differences in the revision frequency can easily explain the observed variation in margin loan pricing. In fact, four additional revisions per three-day period serve to explain all of the currently observed heterogeneity. Second, we study monopolistic (or oligopolistic) margin loan pricing by brokers whose clients are continuous-time Kelly gamblers. The broker solves a general stochastic control problem that yields simple and pleasant formulas for the optimal interest rate and the net interest margin. If the author owned a brokerage, he would charge an interest rate of $(r+\nu)/2-\sigma^2/4$, where $r$ is the cost of funds, $\nu$ is the compound-annual growth rate of the S&P 500 index, and $\sigma$ is the volatility.

When a Master Dies: Speculation and Asset Float
Penasse, Julien,Renneboog, Luc,Scheinkman, José
The death of an artist constitutes a negative supply shock to his future production. Intuition would thus suggest that this supply shock reduces the future auction volume of this artist. In finance terms, this supply shock reduces this artist’s float. If collectors have heterogeneous beliefs and speculate about fundamental value, a reduction in float may increase subsequent volume and prices (Hong et al., 2006). Since collectors cannot sell short, prices overweigh optimists’ beliefs and reflect a speculative bubble. The size of the bubble and trading volume are therefore proportional to the asset’s float, so that a negative supply shock increases prices and volume. We find strong support for this prediction in the data.

Why We Fail to Catch Money Launderers 99.9 Percent of the Time
Comeau, Kevin
The fight against money laundering in Canada will require tougher measures that shine a light on the perpetrators who now operate in the shadows, says a new report from the C.D. Howe Institute. In “Why We Fail to Catch Money Launderers 99.9 percent of the Time,” author Kevin Comeau supports the creation of a publicly accessible registry of beneficial ownership, and mandatory declarations of beneficial ownership with meaningful sanctions for false declarations.