Research articles for the 2019-06-26

A Delicate Moment in Turkey’s Economic Transition: Can Turkey Survive Mounting Economic Problems without the IMF’s Bailout Package?
Taskinsoy, John
By the mid-19th century, after nearly 600 years of power, the Ottoman Empire’s financial strength weakened considerably exposing the Empire to the risk of losing its territories in the Balkans, Middle East, and Africa. The Ottoman Empire’s involvement in the costly Crimean War (1853-56) was a fatal mistake which marked the beginning of the Empire’s everlasting addiction to foreign borrowing. The creation of the Ottoman Public Debt Administration by Sultan Abdülhamid II in 1881 (similar to the IMF) turned the Ottoman Empire into Britain’s semi-colony and was labeled as ill-man. Mustafa Kemal â€" a brilliant man, military commander, politician, strategist, and genius â€" had initiated the Turkish national resistance movement in the aftermath of World War I to expel occupying armies. Eventually, Mustafa Kemal created an independent Turkish Republic in November 1922 from the ashes of an Empire that existed 623 years. But not without cost, the Paris Conference of 1925 forced Turkey as the new Republic to agree to pay the debt of the Ottoman Empire (last remaining payment was made in 1954). Now the question is to be with the IMF or not to be. Following the Justice and Development Party’s win in the 2007 general elections (47% of parliamentary seats), Prime Minister Recep Tayip ErdoÄŸan said “No IMF in Turkey’s future”. Although Turkey made its final loan payment to the IMF in May 2008, many contend that Turkey’s divorce from the IMF can hardly qualify as a true graduation since the country is on the brink of an economic crisis (financial meltdown), attributable to excessive private and household debt, massive dollarization, a failed coup attempt by a fraction of the Turkish military (July 15, 2016), fast rising unemployment (over 14%), fast devaluation of lira due to repeated speculative attacks and the subsequent cascade of corporate defaults. At the backdrop of multifaceted instability, Turkey’s current gloomy financial situation (high inflation and chronic deficits of current account, budget, and trade) is in desperate need of foreign capital inflows especially when Turkey’s options to finance deficits through external barrowing have become substantially limited. Elongated addictions, whether to the U.S. dollar or to the IMF, are not easy to overcome by a politically oriented decision provided that Turkey has been the IMF’s longest devoted member (since 1947). Turkey is going through very tough times; with low foreign reserves, Turkish economy has become vulnerable to speculative attacks stemming from domestic and external sources.

A Pyramid Scheme Model Based on "Consumption Rebate" Frauds
Yong Shi,Bo Li,Wen Long

There are various types of pyramid schemes which have inflicted or are inflicting losses on many people in the world. We propose a pyramid scheme model which has the principal characters of many pyramid schemes appeared in recent years: promising high returns, rewarding the participants recruiting the next generation of participants, and the organizer will take all the money away when he finds the money from the new participants is not enough to pay the previous participants interest and rewards. We assume the pyramid scheme carries on in the tree network, ER random network, SW small-world network or BA scale-free network respectively, then give the analytical results of how many generations the pyramid scheme can last in these cases. We also use our model to analyse a pyramid scheme in the real world and we find the connections between participants in the pyramid scheme may constitute a SW small-world network.

A Triptych Approach for Reverse Stress Testing of Complex Portfolios
Pascal Traccucci,Luc Dumontier,Guillaume Garchery,Benjamin Jacot

The quest for diversification has led to an increasing number of complex funds with a high number of strategies and non-linear payoffs. The new generation of Alternative Risk Premia (ARP) funds are an example that has been very popular in recent years. For complex funds like these, a Reverse Stress Test (RST) is regarded by the industry and regulators as a better forward-looking risk measure than a Value-at-Risk (VaR). We present an Extended RST (ERST) triptych approach with three variables: level of plausibility, level of loss and scenario. In our approach, any two of these variables can be derived by providing the third as the input. We advocate and demonstrate that ERST is a powerful tool for both simple linear and complex portfolios and for both risk management as well as day-to-day portfolio management decisions. An updated new version of the Levenberg - Marquardt optimization algorithm is introduced to derive ERST in certain complex cases.

A simple approach to dual representations of systemic risk measures
Maria Arduca,Pablo Koch-Medina,Cosimo Munari

We describe a general approach to obtain dual representations for systemic risk measures of the "allocate first, then aggregate"-type, which have recently received significant attention in the literature. Our method is based on the possibility to express this type of multivariate risk measures as special cases of risk measures with multiple eligible assets. This allows us to apply standard Fenchel-Moreau techniques to tackle duality also for systemic risk measures. The same approach can be also successfully employed to obtain an elementary proof of the dual representation of "first aggregate, then allocate"-type systemic risk measures. As a final application, we apply our results to derive a simple proof of the dual representation of univariate utility-based risk measures.

Blocktrades in OTC Options Markets: Price Impact and Liquidity Effects
Kiesel, Ruediger,Pietrobono, Alessio
While Over-The-Counter (OTC) markets have widely been studied for equity and interest-rate products, there is only scarce literature on OTC derivative equity markets. In this paper we use a unique Eurex data set to study differences for OTC and regular (meaning exchange traded) derivatives. We consider major German companies in the years before and during the financial crisis 2008. We find significant differences in prices and provided liquidity.

Cashless Society in Thailand
Kraiwanit, Tanpat,Panpon, Panya,Thimthong, Sunattha
The technology development has had both positive and negative disruptive effects on contemporary lifestyle. We therefore investigated the factors influencing access to the cashless society and consumers’ reasons for deciding not to use electronic payment, including lack of confidence in the security and/or confidentiality of personal information. Data were collected from five regions of Thailand using a questionnaire. Quota sampling was used to collect data from 200 respondents in each area (N=1,000). There were 66 respondents who did not use electronic payment, but the remaining 934 cases were used to test the hypotheses through multivariate analysis of variance (MANOVA). The results showed that age, education, income and the use of the internet were associated with access to the cashless society significantly. This study found that the knowledge of electronic payments has led to the adoption of new forms of financial services that are safe and easy to use. We conclude that digital business including finance and banking sector that may disrupt and benefit for cashless society must be participated in promoting people such as the elderlies, who are often slow to respond to technological adoption about electronic payment methods to access the cashless society.

Decomposing Value Globally
Atilgan, Yigit,Demirtas, K. Ozgur,Gunaydin, A. Doruk,KIRLI, Imra
This paper utilizes an international context and revisits the findings which argue that the positive relation between book-to-market ratio and future equity returns is driven by historical changes in firm size in the US. After confirming these results in the US setting both in the original and a more recent sample period, we find that they do not hold in regions outside the US. In the international sample, book-to-market ratio has a significantly positive relation with future equity returns even after changes in firm size are controlled for in regression analyses. This positive relation is again visible when the orthogonal component of book-to-market ratio (which is independent from changes in firm size) is used as a sorting variable in portfolio analyses.

Deposit Insurance and Banks' Deposit Rates: Evidence from the 2009 EU Policy
Gatti, Matteo,Oliviero, Tommaso
In early 2009 the EU increased the minimum deposit insurance limit from €20,000 to €100,000 per bank account. Italy was the only country with a limit already set to €103,291 from 1994. To evaluate the impact of the new directive we run a diff-in-diff analysis and compare the bank-size weighted average deposit interest rates of the Eurozone countries with the Italian ones. We find that the increase of deposit insurance leads to a decrease of deposit rates in European countries relative to Italy between 0.3 and 0.7 percentage points. The drop in deposit rates is confirmed by a diff-in-diff analysis run at bank level after implementing a propensity score matching of Italian banks with European ones. We finally show that this effect mainly come from riskier banks confirming that deposit insurance negatively affects deposit rates by reducing the depositors' required risk-premium.

Executive Gender and Prospect-Value Bias: Evidence from Insider Trading
Sehrish, Saba,Ding, David K.,Visaltanachoti, Nuttawat
This study shows that prospect value influences insider-trading decisions, and the impact is stronger among female executives’ trades. Insiders who buy (sell) when their company's prospect value is above (below) other firms’ prospect values lose 34 (12) basis points over the next month. Female insider trades, as compared with trades by their male counterparts, are affected more by prospect-value bias, and they suffer significantly higher resultant losses. While the findings contradict the overconfidence hypothesis that predicts poor trading decisions by male insiders, the results are consistent with the male insiders’ superior information access hypothesis, suggesting that behavioral biases diminish with knowledge.

Exponential utility with non-negative consumption
Roman Muraviev

We offer mathematical tractability and new insights for a framework of exponential utility with non-negative consumption, a constraint often omitted in the literature giving rise to economically unviable solutions. Specifically, using the Kuhn-Tucker theorem and the notion of aggregate state price density (Malamud and Trubowitz (2007)), we provide a solution to this problem in the setting of both complete and incomplete markets (with random endowments). Then, we exploit this result to provide an explicit characterization of complete market heterogeneous equilibria. Furthermore, we construct concrete examples of models admitting multiple (including infinitely many) equilibria. By using Cramer's large deviation theorem, we study the asymptotics of equilibrium zero coupon bonds. Lastly, we conduct a study of the precautionary savings motive in incomplete markets.

Heads We Both Win, Tails Only You Lose: the Effect of Limited Liability On Risk-Taking in Financial Decision Making
Ahrens, Steffen,Ciril, Bosch-Rosa,
One of the reasons for the recent crisis is that financial institutions took \"too much risk\" (Brunnermeier, 2009; Taylor et al., 2010). Why were these institutions taking so much risk is an open question. A recent strand in the literature points towards the \"cognitive dissonance\" of investors who, because of the limited liability of their investments, had a distorted view of riskiness (e.g., Barberis (2013); Benabou (2015)). In a series of laboratory experiments we show how limited liability does not affect the beliefs of investors, but does increase their willing exposure to risk. This results points to a simple explanation for the over-investment of banks and hedge-funds: When incentives are not aligned, investors take advantage of the moral hazard opportunities.

How Does a Firm Adapt in a Changing World? The Case of Prosper Marketplace
Li, Xinlong,Ching, Andrew T.
In a rapidly changing world, older data is not as informative as the most recent data. This is known as a concept drift problem in statistics and machine learning. How does a firm adapt in such an environment? To address this research question, we propose a generalized revealed preference approach. We argue that by observing a firm’s choices, we can recover the way the firm uses the past data to make business decisions. We apply this approach to study how Prosper Marketplace, an online P2P lending platform, adapts in order to address the concept drift problem. More specifically, we develop a two-sided market model, where Prosper uses the past data and machine learning techniques to assess borrowers’ and lenders’ preferences, borrowers’ risks, and then set interest rate for their loans to maximize his expected profits. By observing his interest rate choices over time and using this structural model, we infer that Prosper assigns different weights to past data points depending on how close the economic environments that generate the data are to the current environment. In the counterfactual, we demonstrate that Prosper may not be using the past data optimally, and it could improve its revenue by changing the way it uses data.

Infinitesimal perturbation analysis for risk measures based on the Smith max-stable random field
Erwan Koch,Christian Y. Robert

When using risk or dependence measures based on a given underlying model, it is essential to be able to quantify the sensitivity or robustness of these measures with respect to the model parameters. In this paper, we consider an underlying model which is popular in spatial extremes, the Smith max-stable random field. We study the sensitivity properties of risk or dependence measures based on the values of this field at a finite number of locations. Max-stable fields play a key role, e.g., in the modelling of natural disasters. As their multivariate density is generally not available for more than three locations, the likelihood ratio method cannot be used to estimate the derivatives of the risk measures with respect to the model parameters. Thus, we focus on a pathwise method, the infinitesimal perturbation analysis (IPA). We provide a convenient and tractable sufficient condition for performing IPA, which is intricate to obtain because of the very structure of max-stable fields involving pointwise maxima over an infinite number of random functions. IPA enables the consistent estimation of the considered measures' derivatives with respect to the parameters characterizing the spatial dependence. We carry out a simulation study which shows that the approach performs well in various configurations.

Lead-lag Relationships in Foreign Exchange Markets
Lasko Basnarkov,Viktor Stojkoski,Zoran Utkovski,Ljupco Kocarev

Lead-lag relationships among assets represent a useful tool for analyzing high frequency financial data. However, research on these relationships predominantly focuses on correlation analyses for the dynamics of stock prices, spots and futures on market indexes, whereas foreign exchange data have been less explored. To provide a valuable insight on the nature of the lead-lag relationships in foreign exchange markets here we perform a detailed study for the one-minute log returns on exchange rates through three different approaches: i) lagged correlations, ii) lagged partial correlations and iii) Granger causality. In all studies, we find that even though for most pairs of exchange rates lagged effects are absent, there are many pairs which pass statistical significance tests. Out of the statistically significant relationships, we construct directed networks and investigate the influence of individual exchange rates through the PageRank algorithm. The algorithm, in general, ranks stock market indexes quoted in their respective currencies, as most influential. Altogether, these findings suggest that all market information does not spread instantaneously, contrary to the claims of the efficient market hypothesis.

Limit order books, diffusion approximations and reflected SPDEs: from microscopic to macroscopic models
Ben Hambly,Jasdeep Kalsi,James Newbury

Motivated by a zero-intelligence approach, the aim of this paper is to connect the microscopic (discrete price and volume), mesoscopic (discrete price and continuous volume) and macroscopic (continuous price and volume) frameworks for the modelling of limit order books, with a view to providing a natural probabilistic description of their behaviour in a high to ultra high-frequency setting. Starting with a microscopic framework, we first examine the limiting behaviour of the order book process when order arrival and cancellation rates are sent to infinity and when volumes are considered to be of infinitesimal size. We then consider the transition between this mesoscopic model and a macroscopic model for the limit order book, obtained by letting the tick size tend to zero. The macroscopic limit can then be described using reflected SPDEs which typically arise in stochastic interface models. We then use financial data to discuss a possible calibration procedure for the model and illustrate numerically how it can reproduce observed behaviour of prices. This could then be used as a market simulator for short-term price prediction or for testing optimal execution strategies.

Multi-Agent Deep Reinforcement Learning for Liquidation Strategy Analysis
Wenhang Bao,Xiao-yang Liu

Liquidation is the process of selling a large number of shares of one stock sequentially within a given time frame, taking into consideration the costs arising from market impact and a trader's risk aversion. The main challenge in optimizing liquidation is to find an appropriate modeling system that can incorporate the complexities of the stock market and generate practical trading strategies. In this paper, we propose to use multi-agent deep reinforcement learning model, which better captures high-level complexities comparing to various machine learning methods, such that agents can learn how to make the best selling decisions. First, we theoretically analyze the Almgren and Chriss model and extend its fundamental mechanism so it can be used as the multi-agent trading environment. Our work builds the foundation for future multi-agent environment trading analysis. Secondly, we analyze the cooperative and competitive behaviours between agents by adjusting the reward functions for each agent, which overcomes the limitation of single-agent reinforcement learning algorithms. Finally, we simulate trading and develop an optimal trading strategy with practical constraints by using a reinforcement learning method, which shows the capabilities of reinforcement learning methods in solving realistic liquidation problems.

On the monotone stability approach to BSDEs with jumps: Extensions, concrete criteria and examples
Dirk Becherer,Martin Büttner,Klebert Kentia

We show a concise extension of the monotone stability approach to backward stochastic differential equations (BSDEs) that are jointly driven by a Brownian motion and a random measure for jumps, which could be of infinite activity with a non-deterministic and time inhomogeneous compensator. The BSDE generator function can be non convex and needs not to satisfy global Lipschitz conditions in the jump integrand. We contribute concrete criteria, that are easy to verify, for results on existence and uniqueness of bounded solutions to BSDEs with jumps, and on comparison and a priori $L^{\infty}$-bounds. Several examples and counter examples are discussed to shed light on the scope and applicability of different assumptions, and we provide an overview of major applications in finance and optimal control.

Optimal Liquidation under Partial Information with Price Impact
Katia Colaneri,Zehra Eksi,Rüdiger Frey,Michaela Szölgyenyi

We study the optimal liquidation problem in a market model where the bid price follows a geometric pure jump process whose local characteristics are driven by an unobservable finite-state Markov chain and by the liquidation rate. This model is consistent with stylized facts of high frequency data such as the discrete nature of tick data and the clustering in the order flow. We include both temporary and permanent effects into our analysis. We use stochastic filtering to reduce the optimal liquidation problem to an equivalent optimization problem under complete information. This leads to a stochastic control problem for piecewise deterministic Markov processes (PDMPs). We carry out a detailed mathematical analysis of this problem. In particular, we derive the optimality equation for the value function, we characterize the value function as continuous viscosity solution of the associated dynamic programming equation, and we prove a novel comparison result. The paper concludes with numerical results illustrating the impact of partial information and price impact on the value function and on the optimal liquidation rate.

Predictability concentrates in bad times. And so does disagreement
de Oliveira Souza, Thiago
Within a standard risk-based asset pricing framework with rational expectations, realized returns have two components: Predictable risk premiums and unpredictable shocks. In bad times, the price of risk increases. Hence, the predictable fraction of returns – and predictability – increases. "Disagreement" (dispersion in analyst forecasts) also intensifies in bad times if (i) analysts report (close to) risk-neutral expectations weighted by state prices, which become more volatile, or (ii) dividend volatility changes with the price of risk – for example, because consumption volatility changes. In both cases, individual analysts produce unbiased forecasts based on partial information.

Price Dynamics and Trader Overconfidence
Ahrens, Steffen,Ciril, Bosch-Rosa,,Roulund, Rasmus
Overconfidence is one of the most important biases in financial markets and commonly associated with excessive trading and asset market bubbles. So far, most of the finance literature takes overconfidence as a given, \"static\" personality trait. In this paper we introduce a novel experimental design which allows us to track different measures of overconfidence during an asset market bubble. The results show that overconfidence co-moves with asset prices and points towards a feedback loop in which overconfidence adds fuel to the flame of existing bubbles.

Return on Equity (ROE), Return on Capital Employed (ROCE), Economic Profit (EP) and Economic Value Added (EVA) (Presentation Slides)
Casielles, Jorge
This paper includes the following topics:1. The Return On Equity (ROE): What is ROE? How do we know if the ROE of a company is good or not? What should be the relationship between ROE and cost of equity(Ke)? What are the ROEs of the different industries?2. The Return On Capital Employed (ROCE): What is ROCE? The ROCEs of different industries3. The relationship between ROE and ROCE and the effect of debt. When the use of debt improves ROE?4. The ROCE depends on operating margin and turnover of capital employed. Therefore, how the ROCE can be improved?5. The ROE depends on ROCE and debt level. Therefore, how the ROE can be improved?6. The ROE depends on net profit margin, turnover of CE and financial leverage. When financial leverage improves the ROE?7. The ROE vs. Ke and ROCE vs. WACC. What relationship should be between ROE and Ke? What is the WACC? What relationship should be between ROCE and WACC? The ROE vs Ke and ROCE vs WACC of the different industries8. The Economic Profit (EP) and the Economic Value Added (EVA). What is the EP and what does it indicate? What is EVA an what does it indicate?9. How to estimate the cost of equity (Ke): the Capital Asset Pricing Model (CAPM). What is the CAPM and how to estimate Ke using it. What are the problems of the CAPM?10. Practice questionsMultiple exercises with real companies like Apple, Amazon, Microsoft, Google, Bayer, Mazda and Orange are included.

Silicon Valley Venture Capitalist Confidence Indexâ„¢ Q1 2019
Cannice, Mark
The Silicon Valley Venture Capitalist Confidence Index™ (Bloomberg ticker symbol: SVVCCI) is based on a recurring quarterly survey (since Q1 2004) of Silicon Valley/San Francisco Bay Area venture capitalists. The Index measures and reports the opinions of professional venture capitalists on their estimations of the high-growth venture entrepreneurial environment in the San Francisco Bay Area over the next 6 - 18 months. The Silicon Valley Venture Capitalist Confidence Index™ for the first quarter of 2019, based on a March 2019 survey of 26 San Francisco Bay Area venture capitalists, registered 3.63 on a 5-point scale (with 5 indicating high confidence and 1 indicating low confidence). This quarter’s Index measurement climbed significantly from the previous quarter’s Index reading of 3.20 which was the lowest level since Q1 2009.

The Coevolution of Banks and Corporate Securities Markets: The Financing of Belgium's Industrial Take-Off in the 1830s
Stefano Ugolini

Recent developments in the literature on financial architecture suggest that banks and markets not only coexist, but also coevolve in ways that are non-neutral from the viewpoint of optimality. This article aims to analyse the concrete mechanisms of this coevolution by focusing on a very relevant case study: Belgium (the first Continental country to industrialize) at the time of the very first emergence of a modern financial system (the 1830s). The article shows that intermediaries played a crucial role in developing secondary securities markets (as banks acted as securitizers), but market conditions also had a strong feedback on banks' balance sheets and activities (as banks also acted as market-makers for the securities they had issued). The findings suggest that not only structural, but also cyclical factors can be important determinants of changes in financial architecture.

The Econometrics of Redenomination Risk
Cherubini, Umberto
We use the quotes of European sovereign CDS with the 2014 credit event definitions, including redenomination, and those with the 2003 definition, that excludes redenomination for the G-7 countries, to simultaneously estimate the implied redenomination risk and the dependence between redenomination and default risk. With positive dependence the so called ISDA basis, that is the difference between the two CDS spreads, systematically underestimates redenomination risk. The estimation, carried out with the MLE on transformed data technique for Italy, France and Germany, shows evidence of statistically significant, albeit moderate, dependence berween default and redenomination risk, ranging around 10%. Even this low level of correlation is sufficient to provide a material bias in the simple CDS spread difference used in the market. For Italy, the bias reaches 20 bp in the end of the sample. In order to apply the measure backward before 2014, to cover the whole crisis period, we propose a new measure called relative asset swap basis measure (R-ASW basis), that shows a remarkably high degree of correlation, at least for Italy, with the ISDA basis in the period in which both are available. This measure, applied across the crisis period, shows that redenomination risk levels in the end of the sample, 2018-2019, are comparable with those reached at the peak of the Italian crisis, in 2011-2012. The difference is that in 2018-2019 the level of redenomination risk, for the first time and for both Italy and France, is about the same as default risk, that instead was much higher in 2011-2012. A cross border analysis shows that redenomination risk of France plays a key role for the survival of the Euro. In fact, redenomination risk of France is both associated with that of Italy and Germany, that are instead independent. A measure of "end of the Euro" probability, based on a Marshall-Olkin model of the simultaneous redenomination of the three countries, shows that redenomination of France is largely systemic, and is associated to the end of the Euro, while redenomination of Italy is largely idiosyncratic, and so it is mostly associated to country-specific shocks.

The Syntax of the Accounting Language: A First Step
Frederico Botafogo

We review and interpret two basic propositions published by Ellerman (2014). The propositions address the algebraic structure of T accounts and double entry bookkeeping (DEB). The paper builds on this previous contribution with the view of reconciling the two, apparently dichotomous, perspectives of accounting measurement: the one that focuses preferably on the stock of wealth and to the one that focuses preferably on the flow of income. The paper claims that T-accounts and DEB have an underlying algebraic structure suitable for approaching measurement from either or both perspectives. Accountants preferences for stocks or flows can be framed in ways which are mutually consistent. The paper is a first step in addressing this consistency issue. It avoids the difficult mathematics of abstract algebra by applying the concept of syntax to accounting numbers such that the accounting procedure qualifies as a formal language with which accountants convey meaning.

Under Pressure: Listing Status and Disinvestment in Japan
French, Joseph J.,Fujitani, Ryosuke,Yasuda, Yukihiro
We provide the first large sample comparisons of disinvestment by listed and unlisted firms. This study focuses on Japanese firms from 2001-2017, as this was a period of economic stagnation and financial reforms encouraging companies to restructure. We show that stock market listing is positively related to disinvestment. Listed firms disinvest 1.9% more than similar unlisted firms. Disinvestment activities of listed companies are also more sensitive to investment opportunities. Additionally, firms that disinvest show improvements in ROA and increases in future investment. Finally, we find that foreign (financial institution) ownership is positively (negatively) related to disinvestment.