Research articles for the 2019-07-10

A Transparent, Numerical Solution to the Joint Estimation of Imputation Credit Value and Cash Dividend Value
Cannavan, Damien,Gray, Stephen,Hall, Jason
Multiple regression analysis leads to coefficient estimates that need to be jointly interpreted. This holds even if correlation amongst independent variables is at a level that researchers typically consider to be tolerable. In estimating the value of imputation credits using multiple regression, experts and regulators have typically considered estimates of the value of imputation credits in isolation. They apply the credit value estimates to pricing models under the assumption that cash is fully valued by the market. We call this problem selective interpretation. We address the challenge of selective interpretation by conducting an advanced “if-then” analysis. We ask if cash and credits are truly valued by investors at x and y, then what range of regression coefficients would occur if the regression could be repeated over and over again? This allows us to estimate confidence intervals for the value of cash dividends and imputation credits by making transparent assumptions about the independence of observations and the non-constant variance of error terms. Our paper has application to any research that relies on multiple regression analysis.The practical implication is that in the current tax regime, under which investors can receive a cash rebate for imputation credits, the market value of imputation credits lies within the range of 0.01 to 0.15. A dollar of cash is valued by the market at somewhere between 87 cents and 92 cents. But, at the lower end of the cash value (0.87), credits are worth between 0.13 and 0.15, and, at the higher end of cash value (0.92), credits are worth between 0.01 and 0.10. The value of imputation credits has moved over time in a direction consistent with the changing tax treatment. Prior to the introduction of the 45-day rule, credits had an estimated value within the range of 0.07 to 0.24, but the value decreased to a range of just 0.00 to 0.02 once the 45-day rule was introduced. Upon the introduction of the cash rebate, the value of credits has increased to a range of 0.01 to 0.15.

Additional Market Risk Shocks: Prepayment Uncertainty and Option-Adjusted Spreads
Bogin, Alexander,Polkovnichenko, Nataliya,Doerner, William M.
Assessments of market risk for economic or regulatory capital typically involve calculating a portfolio’s sensitivity to key risk factor movements. Historically, practitioners have focused on two classical sources of risk, adverse changes in interest rates and volatility. As stress testing has evolved, additional risk factors have been identified, including several specific to fixed-income securities with embedded optionality. These include changes in prepayment rates or any of several other market risk factors, which affect option-adjusted spreads (OAS). We describe an empirical framework for generating shocks to prepayment rates and mortgage security OAS, which are consistent with simultaneous movements in other key risk factors, including the term structure of interest rates and implied volatility. Our prepayment rate shocks capture model misspecification and are calculated using historical performance data from multiple vendor prepayment models. These shocks are well defined, but capture only a portion of prepayment model error. Mortgage security OAS serves as a broader measure of model error, which encompasses both, model misspecification and forecasting errors as well as credit and liquidity risk. Our OAS shocks are calculated using historical six-month changes in spreads derived from multiple vendor quotes.

Answer to 'Supplemental Consultation on Spread and Term Adjustments for Fallbacks in Derivatives Referencing USD LIBOR, CDOR and HIBOR and Certain Aspects of Fallbacks for Derivatives Referencing SOR' issued by ISDA
Henrard, Marc P. A.
This note is an answer to the consultation published by ISDA in May 2019 regarding the amendment of documentation to implement fallbacks for certain key IBORs.

Asset Pricing With and Without Garbage: Resurrecting Aggregate Consumption
Delikouras, Stefanos
This paper challenges the view that alternative consumption measures (garbage, fourth quarter, unfiltered consumption) can address the shortcomings of consumption-based asset pricing. When the CRRA model is confronted with the cross-section of risk premia and the risk-free rate volatility, the fit of the alternative consumption processes is poor. Further, when I introduce a novel discount factor with disappointment aversion that improves the accuracy of the consumption-based framework, the canonical measure of aggregate consumption has a better fit than the alternative ones. I conclude that non-standard preferences are more important in improving the performance of consumption-based models than non-standard consumption measures.

Australian Retirement System: Significance of Pillars 3 and 4 in Achieving an Adequate Standard of Living in Retirement
Evans, John R.
Most research relating to the adequacy of the Australian retirement system has concentrated on Pillars 1 and 2. This paper indicates that there is a high probability that Pillars 3 and 4 will be needed to ensure an adequate standard of living in retirement, and in most scenarios, the contribution to retirement adequacy from Pillars 3 and 4 is very significant. We include an international comparison of equivalent Pillars 1 and 2 costs and conclude this analysis supports our results.

Business Tax Policy under Default Risk
Comincioli, Nicola,Vergalli, Sergio,Panteghini, Paolo M.
In this article we use a stochastic model with one representative firm to study business tax policy under default risk. We will show that, for a given tax rate, the government has an incentive to reduce (increase) financial instability and default costs if its objective function is welfare (tax revenue).

Commemorating the Fifty-Year Anniversary of Ball and Brown (1968): The Evolution of Capital Market Research over the Past Fifty Years
Kothari, S.P.,Wasley, Charles E.
We commemorate the 50th anniversary of Ball and Brown [1968] by chronicling its impact on capital market research in accounting. We trace the evolution of various research paths that post-Ball and Brown [1968] researchers took as they sought to build on the foundation laid by Ball and Brown [1968] to create a body of research on the usefulness, timeliness, and other properties of accounting numbers. We discuss how those paths often link back to the groundwork laid and questions originally posed in Ball and Brown [1968].

Coping with Falling Oil Prices: The Different Fortunes of African Banks
Gueye, Cheikh Anta,Mbelu, Asithandile,Sy, Amadou Nicolas Racine
This paper studies the impact of declining oil prices on banks in sub-Saharan African oil-exporting countries. Results indicate that banks respond differently to an oil shock depending on their ownership: (i) domestic banks are the most adversely impacted and experience a deterioration in asset quality and liquidity; (ii) foreign-owned banks are the most resilient as they are able to improve asset quality and attract deposits but at the same time, they decelerate credit growth; in contrast, (iii) Pan-African Banks help stabilize overall credit but large banks in that segment experience reduced asset quality. These differentiated results suggest a tradeoff between maintaining credit growth and safeguarding financial stability in an oil slump which could be addressed by both micro- and macroprudential policies.

Deep Reinforcement Learning in Financial Markets
Souradeep Chakraborty

In this paper we explore the usage of deep reinforcement learning algorithms to automatically generate consistently profitable, robust, uncorrelated trading signals in any general financial market. In order to do this, we present a novel Markov decision process (MDP) model to capture the financial trading markets. We review and propose various modifications to existing approaches and explore different techniques to succinctly capture the market dynamics to model the markets. We then go on to use deep reinforcement learning to enable the agent (the algorithm) to learn how to take profitable trades in any market on its own, while suggesting various methodology changes and leveraging the unique representation of the FMDP (financial MDP) to tackle the primary challenges faced in similar works. Through our experimentation results, we go on to show that our model could be easily extended to two very different financial markets and generates a positively robust performance in all conducted experiments.

Do-it-Yourself Medicine? The Impact of Light Cannabis Liberalization on Prescription Drugs
Carrieri, Vincenzo,Madio, Leonardo,Principe, Francesco
Governments worldwide are increasingly concerned about the booming CBD (cannabidiol) products. However, little is known about the impact of their liberalization. We exploit a loophole in the Italian legislation that in 2016 unintendedly liberalized light cannabis. In the limited time in which the market was left unregulated, light cannabis availability led to a significant reduction in the sales of anxiolytics, opioids, anti-depressants, and anti-psychotics. Such medical non-adherence is consistent with a rational self-medication hypothesis. Results are informative for regulators and suggest that policies contrasting this “green oil” boom might be welfare-reducing for patients' seeking effective reliefs of their symptoms.

Does 5-Minute RV Outperform Other Realized Measures in the Bitcoin Market?
Hattori, Takahiro
Since the seminal work of Liu et al. (2015), many researchers have computed the realized volatility (RV) using 5-minute intervals. However, cryptocurrency has sharply different features compared with other assets, such as the autocorrelation of the intraday return in Bitcoin. Our paper employs realized kernel, which adjusts the autocorrelation for constructing RV and provides improved performance compared with the 5-minute RV. In addition, our result also shows that a wider interval such as the 30-minute or 90-minute RV also performs well, suggesting that the intraday level of Bitcoin returns could contain greater levels of microstructure noise.

Dutch Shell Companies and International Tax Planning
Lejour, Arjan,Möhlmann, Jan,van 't Riet, Maarten,Benschop, Thijs
This paper uses the financial statements of special purpose entities (SPEs) for explaining the origin and destination of dividend, interest, and royalty flows passing the Netherlands. We find that Bermuda is the most important destination for royalty flows. These flows come from Ireland, Singapore and the United States. For dividend and interest payments the geographical pattern is more widespread. We find a substantial tax reduction for royalties by using Dutch SPEs compared to a direct flow between the origin and destination country. However, we cannot find such tax savings for dividends and interest with an approximation based on statutory tax rates. When controlling for country characteristics in our regression analysis we do find that tax differentials partially explain the geographical patterns of income flows diverted through the Netherlands. This is the case for the likelihood that a route is used, as well as for the size of the flows. This paper is one of the first using bilateral income flows as dependent variables instead of bilateral FDI stocks or flows.

Fragmented Securities Regulation: Neglected Insider Trading in Stand-Alone Banks
Kim, Sehwa,Kim, Seil
We examine whether regulatory fragmentation, by separating disclosure venues, affects stock price efficiency. Publicly traded stand-alone banks submit mandatory filings to bank regulators via FDICconnect rather than to SEC EDGAR. We find that the short-run market reaction to insider-trading filings on FDICconnect is almost non-existent and significantly smaller than for these filings on SEC EDGAR. However, the differences in returns disappear in the long run, suggesting that the short-run difference is not driven by difference in the information content of the filings. Our study shows that regulatory fragmentation significantly affects stock price efficiency.

Global Asset Market Interdependencies: A Dynamic Interaction
Kusen, Alex,Rudolf, Markus
Currency carry trading presents a widespread trading strategy and refers to the forward premium puzzle. Investors borrow low-yielding currencies with the aim to invest in high-yielding ones in order to benefit from arbitrage opportunities. This implies that a one-to-one relationship does not exist between interest rate differentials and expected changes in exchange rates. On this basis, we explore the interaction between currency carry trade, futures, exchange rates, and commodities through structural shocks. Investors desire a higher risk premium for interest differentials. Therefore, spillovers to prices of futures contracts and an appreciation of exchange rates are in line with the forward premium puzzle. Findings support that currencies with higher interest rates appreciate more often than currencies with lower rates. Furthermore, commodity prices and currency carry trading have a mutual impact due to monetary policy implications as well as real interest rate expectations. However, a simple relationship does not exist and the interconnection is complex in nature.

How Sub-Optimal Are Age-Based Life-Cycle Investment Products?
Khemka, Gaurav,Steffensen, Mogens,Warren, Geoff
We investigate the conditions under which life-cycle investment strategies based on age may be ‘near enough’ to optimal, focusing on the treatment of the pension account balance and assumptions about risk aversion. We show that dynamically adjusting the strategy in response to fluctuations in the balance as well as age can lead to moderate improvements over product designs currently seen in the market; although most of the potential gains might be captured by specifying the glide path with reference to a measure of expected value of balance over time. The risk aversion assumption emerges as a far more important consideration, with much greater utility losses arising from mismatches between the risk aversion of the investor and that underpinning the glide path design. Our analysis points towards possibilities for improving life-cycle or target date funds, and highlights the benefit of offering a suite of such funds that tailor for members with differing risk aversion.

Indirect Inference with a Non-Smooth Criterion Function
David T. Frazier,Tatsushi Oka,Dan Zhu

Indirect inference requires simulating realisations of endogenous variables from the model under study. When the endogenous variables are discontinuous functions of the model parameters, the resulting indirect inference criterion function is discontinuous and does not permit the use of derivative-based optimisation routines. Using a change of variables technique, we propose a novel simulation algorithm that alleviates the discontinuities inherent in such indirect inference criterion functions, and permits the application of derivative-based optimisation routines to estimate the unknown model parameters. Unlike competing approaches, this approach does not rely on kernel smoothing or bandwidth parameters. Several Monte Carlo examples that have featured in the literature on indirect inference with discontinuous outcomes illustrate the approach, and demonstrate the superior performance of this approach over existing alternatives.

Insurance Policy Thresholds for Economic Growth in Africa
Asongu, Simplice,Odhiambo, Nicholas
This study investigates the role of insurance in economic growth on a panel of forty-eight countries in Africa for the period 2004-2014. The research question the study seeks to answer is the following: what thresholds of insurance penetration positively affect economic growth in Africa? The empirical evidence is based on Generalized Method of Moments. Life insurance increases economic growth while the effect of non-life insurance is not significant. Increasing both life insurance and non-life insurance has negative net effects on economic growth. From an extended analytical exercise, 4.149 of life insurance premium (% of GDP) is the minimum critical mass required for life insurance to positively affect economic prosperity while 1.805 of non-life insurance premium (% of GDP) is the minimum threshold required for non-life insurance to positively affect economic prosperity. Thresholds are also provided from the Hansen (1999) Panel Threshold Regression technique using a balanced sample of 28 countries.

Investors’ Financial Health and Municipal Bond Liquidity Risk
Chen, Tao,Kamiya, Shinichi,Lou, Pingyi
This study examines whether the financial health of municipal bond investors can affect the municipal bond yield by especially focusing on the liquidity component. We find that the deterioration of the financial health of bond investors widens the liquidity spread of municipal bonds, and this relationship was stronger during the Lehman crisis. Using Hurricane Sandy as an exogenous shock to the financial health of insurers, we find that the municipal bonds held by insurers, who suffered losses due to the hurricane, experienced a larger increase in liquidity spreads in the quarter of Hurricane Sandy. We further find that insurers affect the liquidity spreads of municipal bonds by affecting the pure liquidity cost and commonality.

Language and Innovation: The Real Effect of Informal Institutions
Kong, Dongmin,Wang, Jialong,Wang, Yanan,Zhang, Jian
Strong future-time reference (FTR) languages require speakers to grammatically mark future events, while weak-FTR languages do not. Using data from 33 countries, we find that firms in countries where strong-FTR languages are spoken are less likely to engage in innovative activities than those in countries where weak-FTR languages are spoken. Further evidence shows that strong-FTR languages affect inventors’ perceptions and beliefs around the future rewards from innovation. Moreover, due to interactions between people speaking different languages, globalization attenuates the negative impact of language FTR on innovation. To further support these findings, we provide evidence from a single country with a multilingual environment to control for omitted country-level characteristics. Our study emphasizes the impact of language on corporate innovation and sheds light on the importance of informal institutions on economic outcomes.

Leasing as a Risk-Sharing Mechanism
Li, Kai,Tsou, Chi-Yang
This paper argues leasing is a risk-sharing mechanism: risk-tolerant lessors (capital owners) provide insurance to financially constrained risk-averse lessees (capital borrowers) against systematic capital price fluctuations. We provide strong empirical evidence to support this novel risk premium channel. Among financially constrained stocks, firms with a high leased capital ratio earn average returns 7.35% lower than firms with a low leased capital ratio, which we call it the negative leased capital premium. We develop a general equilibrium model with heterogeneous firms and financial frictions to quantify this channel. Our study also provides a caveat to the recent leasing accounting change of IFRS 16: lease induced liability and financial debt should not be treated equally on firms' balance sheet, as their implications for firms' equity risks and cost of equity are opposite.

Mandatory CSR Disclosure and Analyst Forecast Properties: Evidence from a Quasi-Natural Experiment in China
Shi, Haina,Song, Byron Y.,xu, huifeng
Based on a quasi-natural experiment that mandates a subset of listed firms to issue stand-alone corporate social responsibility (CSR) reports, we examine whether the mandatory CSR disclosure improves analysts’ information set. We focus on two properties of analysts’ earnings forecasts: forecast error and forecast dispersion. We find that the mandatory issuance of stand-alone CSR reports is related to more accurate and less dispersed forecasts, and the improvement varies with the quality of the CSR reports. Cross-sectional tests show that the improvements are mainly driven by firms that (i) are not covered by star analysts and (ii) have a high level of stock price synchronicity. Further analyses show that the market reacts significantly to forecast revisions after mandatory CSR disclosure. Our findings provide evidence that the mandatory CSR reports play an important informational role for analysts.

Market Monitoring and Influence: Evidence from Deposit Pricing and Liability Composition from 1986 to 2013
Guo, Lin,Prezas, Alexandros P.
We examine the monitoring and ex-post influence of depositors on risk-taking of U.S. bank holding companies (BHCs) from September 1986 to December 2013. As the basis for our empirical analysis, we develop a theoretical model which shows that under risky lending and deposit insurance, a bank’s liability and asset choices are interrelated through its probability of insolvency. Our empirical results are as follows. First, for the sub-sample of the ten largest (Top10) BHCs, deposit risk pricing only exists over some sub-periods prior to the 2007 financial crisis. However, interest rates on insured deposits and uninsured deposits for the Non-Top10 BHCs increase with bank risk over the whole sample period. Moreover, the growth rates of insured and uninsured deposits tend to decrease as bank risk increases for Non-Top10 BHCs over the entire sample period, but only in some sub-periods for the Top10 institutions. Second, although Top10 BHCs do not increase the insured deposits-to-liabilities ratio to weaken market discipline over the entire sample period, all other institutions engage in such regulatory arbitrage in some sub-periods. Third, higher risk premium embedded in current deposit interest rates is more likely to reduce future insolvency risk of troubled BHCs. This suggests that depositors monitor the riskiness of BHCs while also exerting strong ex-post influence on risk-taking of problem institutions. Fourth, in the post-Dodd-Frank Act/Basel III period, the interest rates, the shares, and the growth rate of insured deposits for the Top10 BHCs are significantly negatively related to bank insolvency risk. This could be due to strengthened regulatory oversight on the largest high-risk institutions and is consistent with a substitution relationship between depositor discipline and regulatory oversight.

Measuring Euro Area Monetary Policy
Altavilla, Carlo,Brugnolini, Luca,Gürkaynak, Refet S.,Motto, Roberto,Ragusa, Giuseppe
We study the information flow from the ECB on policy dates since its inception, using tick data. We show that three factors capture about all of the variation in the yield curve but that these are different factors with different variance shares in the window that contains the policy decision announcement and the window that contains the press conference. We also show that the QE-related policy factor has been dominant in the recent period and that Forward Guidance and QE effects have been very persistent on the longer-end of the yield curve. We further show that broad and banking stock indices' responses to monetary policy surprises depended on the perceived nature of the surprises. We find no evidence of asymmetric responses of financial markets to positive and negative surprises, in contrast to the literature on asymmetric real effects of monetary policy. Lastly, we show how to implement our methodology for any policy-related news release, such as policymaker speeches. To carry out the analysis, we construct the Euro Area Monetary Policy Event-Study Database (EA-MPD). This database, which contains intraday asset price changes around the policy decision announcement as well as around the press conference, is a contribution on its own right and we expect it to be the standard in monetary policy research for the euro area.

Michael Milken: The Junk Dealer
Kashyap, Ravi
We take a closer look at the life and legacy of Micheal Milken. We discuss why Michael Milken, also know as the Junk Bond King, was not just any other King or run-of-the-mill Junk Dealer, but ”The Junk Dealer”. We find parallels between the three parts to any magic act and what Micheal Milken did, showing that his accomplishments were nothing short of a miracle. His compensation at that time captures to a certain extent the magnitude of the changes he brought about, the eco-system he created for businesses to flourish, the impact he had on the wider economy and also on the future growth and development of American Industry. We emphasize two of his contributions to the financial industry that have grown in importance over the years. One was the impetus given to the Private Equity industry and the use of LBOs. The second was the realization that thorough research was the key to success, financial and otherwise. Perhaps an unintended consequence of the growth in junk bonds and tailored financing was the growth of Silicon valley and technology powerhouses in the California bay area. Investors witnessed that there was a possibility for significant returns and that financial success could be had due to the risk mitigation that Milken demonstrated by investing in portfolios of so called high risk and low profile companies. We point out the current trend in many regions of the world, which is the birth of financial and technology firms and we suggest that finding innovative ways of financing could be the key to the sustained growth of these eco-systems.

Missing the Mark: House Price Index Accuracy and Mortgage Credit Modeling
Bogin, Alexander,Doerner, William M.,Larson, William
We make two contributions to the study of house price index and mortgage credit modeling accuracy. First, we assess the predictive power of house price indices calculated at different levels of geographic aggregation. Lower levels of aggregation offer superior fit when appreciation rates vary substantially across submarkets and the indices are based on a sufficient number of transactions. Second, we estimate a competing options credit model using 15 years of mortgage performance data in the United States. Model accuracy is highest when using indices at a city or lower level of aggregation to construct current loan-to-value ratios. Fit is weaker when using state or national price indices. Overall, this research highlights the benefits of using more localized house price indices when predicting property values and mortgage performance.

Model Misspecification in ABC: Consequences and Diagnostics
David T. Frazier,Christian P. Robert,Judith Rousseau

We analyze the behavior of approximate Bayesian computation (ABC) when the model generating the simulated data differs from the actual data generating process; i.e., when the data simulator in ABC is misspecified. We demonstrate both theoretically and in simple, but practically relevant, examples that when the model is misspecified different versions of ABC can yield substantially different results. Our theoretical results demonstrate that even though the model is misspecified, under regularity conditions, the accept/reject ABC approach concentrates posterior mass on an appropriately defined pseudo-true parameter value. However, under model misspecification the ABC posterior does not yield credible sets with valid frequentist coverage and has non-standard asymptotic behavior. In addition, we examine the theoretical behavior of the popular local regression adjustment to ABC under model misspecification and demonstrate that this approach concentrates posterior mass on a completely different pseudo-true value than accept/reject ABC. Using our theoretical results, we suggest two approaches to diagnose model misspecification in ABC. All theoretical results and diagnostics are illustrated in a simple running example.

Momentum with Volatility Timing
Malitskaia, Yulia
The growing adoption of factor investing simultaneously prompted the active topic of factor timing approaches for the dynamic allocation of multi-factor portfolios. The trend represents a natural development of filling the gap between passive and active management. The paper addresses this direction by introducing the volatility-timed winners approach that applies past volatilities as a timing predictor to mitigate momentum factor underperformance for time intervals spanning the market downturn and post-crisis period. The proposed approach was confirmed with Spearman rank correlation and demonstrated in relation to different strategies including momentum volatility scaling, risk-based asset allocation, time series momentum and MSCI momentum indexes. The corresponding analysis generalized existing volatility scaling strategies and brought together the two branches of the smart-beta domain, factor investing and risk-based asset allocation.

Nonlinear Price Dynamics of S&P 100 Stocks
Caginalp, Gunduz,DeSantis, Mark
The methodology presented provides a quantitative way to characterize investor behavior and price dynamics within a particular asset class and time period. The methodology is applied to a data set consisting of over 250,000 data points of the S&P 100 stocks during 2004-2018. Using a two-way fixed-effects model, we uncover trader motivations including evidence of both under- and overreaction within a unified setting. A nonlinear relationship is found between return and trend suggesting a small, positive trend increases the return, while a larger one tends to decrease it. The shape parameters of the nonlinearity quantify trader motivation to buy into trends or wait for bargains. The methodology allows the testing of any behavioral finance bias or technical analysis concept.

Nonlinear price dynamics of S&P 100 stocks
Gunduz Caginalp,Mark DeSantis

The methodology presented provides a quantitative way to characterize investor behavior and price dynamics within a particular asset class and time period. The methodology is applied to a data set consisting of over 250,000 data points of the S&P 100 stocks during 2004-2018. Using a two-way fixed-effects model, we uncover trader motivations including evidence of both under- and overreaction within a unified setting. A nonlinear relationship is found between return and trend suggesting a small, positive trend increases the return, while a larger one tends to decrease it. The shape parameters of the nonlinearity quantify trader motivation to buy into trends or wait for bargains. The methodology allows the testing of any behavioral finance bias or technical analysis concept.

Note on the Fiscal Implications of Strategic Investment Funds
Halland, Havard
Strategic investment funds (SIFs) are instruments of economic and financial policy, and the operations of these funds have important fiscal implications. A SIF’s fiscal implications span the fully cycle of its operations, from funding, through capital allocation, to operations and maintenance of the invested assets. SIFs with a capacity to deploy capital efficiently have the potential to increase the effectiveness of the public expenditure programs in the SIFs’ respective home countries. However, the establishment and operations of SIFs also carry important fiscal risks, which need to be recognized and addressed. This note considers the flows of capital into and out of SIFs, the relationship of these flows to the fiscal framework and macro-fiscal context of the SIFs’ home countries, as well as fiscal liabilities that can result from SIFs’ activities, and from their possible insolvency and bankruptcy. The note offers suggestions for how these risks can be mitigated.

Optimal Fiscal Spending and Reserve Accumulation Policies Under Volatile Aid
Moldovan, Ioana,Yang, Shu-Chun Susan,Zanna, Luis-Felipe
This paper assesses the optimal setting of fiscal spending and foreign exchange rate intervention policies in response to volatile foreign aid, in a small open economy model that incorporates typical features of low-income countries. Within a class of policy rules, it jointly considers the optimal aid spending and international reserve accumulation policies. The results show that it is optimal to adjust government spending gradually in response to unpredictable fluctuations in aid, while partially accumulating foreign exchange reserves to offset Dutch disease effects. Also, allocating relatively more of the government spending to productive public investment, and less to government consumption, is welfare improving.

Optimal Risk-Sharing Across a Network of Insurance Companies
Ettlin, Nicolas,Kull, Andreas,Smirnow, Alexander
This paper investigates risk transfer in the context of a network of insurance companies. The starting point is an economic view on risk transfer considering capital costs and capital constraints at the level of individual insurance companies. We demonstrate that the optimisation of profitability across the network can be achieved through risk transfer but that there is no unique solution when considering individual insurance companies. However, from a network perspective, there exists a unique fair solution in the sense of cooperative game theory. Implications for risk transfer within insurance groups are discussed.

Ownership Structure and Profitability of Listed Firms in an Emerging Market
Kotey, Richard,Kusi, Baah,Akomatey, Richard
Motivated by the agency theory and the need to examine the effect of separation of ownership and management, this study examines the determinants of profitability in different firm ownership structures and how different ownership structures impact the profitability of listed firms between 2003 and 2013, using pooled annual data of 23 Ghanaian listed firms. Employing a number of static models (OLS, Random Effects and 3 Stage Least Squares), we find evidence that while profit determinants vary for listed firms given their ownership structures, ownership structures also affected profitability differently. Specifically, for listed firms, profitability was determined by capital intensity, liquidity, financial risk, age and GDP; for non-family owned listed firms, profitability was determined by capital intensity, liquidity, market share and age; for foreign-owned firms, profitability was determined by capital intensity, liquidity, age and GDP; and for non-foreign ownership, profitability was determined by capital intensity, liquidity, financial risk, growth, age and GDP. When we examine the impact of ownership structure on profitability and find that family-owned listed firms make 30% less profits compared to non-family owned ones, whilst foreign-owned firms make 13% more profits than non-foreign owned ones. These findings confirm the agency theory which posits that separation of ownership and management, though may lead to agency problems, can positively affect profits. The study recommends that family-owned listed firms should consider diluting ownership in order to grow more profits.

Portfolio Mean-Variance Approach Modifications: Modulus Function, Principles of Compromise, and 'Min-Max' Approach
Karpovich, Alexey,Rymanov, Alexander
We offer a variant for the problem of portfolio selection, based on the modification of the quadratic function. It reduces overestimation of the contribution of large deviations of the market condition from the expected return. Further, we examine the modified "min-max" approach to portfolio structure. We obtain the analytical expressions to solve the portfolio selection model for a few cases. Finally, we offer certain compromise principles between criterial values of the expected return/risk.

Pricing Electricity Forwards under Future Information on the Stochastic Mean-Reversion Level
Hess, Markus
We extend the arithmetic multi-factor electricity spot price model proposed by Benth, Kallsen & Meyer-Brandis by adding stochastic mean-level processes to their model and by taking additional information on the future behavior of these mean-level processes into account. The available anticipative information is modeled by an initially enlarged filtration in our paper. We further derive pricing formulas for electricity forwards under future information and investigate the associated information premium.

Relationships between different Macroeconomic Variables using VECM
Saannidhya Rawat

Through this paper, an attempt has been made to quantify the underlying relationships between the leading macroeconomic indicators. More clearly, an effort has been made in this paper to assess the cointegrating relationships and examine the error correction behavior revealed by macroeconomic variables using econometric techniques that were initially developed by Engle and Granger (1987), and further explored by various succeeding papers, with the latest being Tu and Yi (2017). Gross Domestic Product, Discount Rate, Consumer Price Index and population of U.S are representatives of the economy that have been used in this study to analyze the relationships between economic indicators and understand how an adverse change in one of these variables might have ramifications on the others. This is performed to corroborate and guide the belief that a policy maker with specified intentions cannot ignore the spillover effects caused by implementation of a certain policy.

Riding the Blockchain Mania: Public Firms’ Speculative 8-K Disclosures
Cheng, Stephanie F.,De Franco, Gus,Jiang, Haibo,Lin, Pengkai
This paper provides evidence on public firms’ initial 8-K disclosures that mention Blockchain and investors’ response to these disclosures. We categorize the description of Blockchain activities in firms’ 8-Ks as Speculative (e.g., a vague future plan that involves Blockchain) or Existing (e.g., a description of Blockchain product). We document a sharp increase in the number of initial 8-K disclosures of Blockchain, particularly by Speculative firms, coinciding with the rise of Bitcoin prices and excitement in Blockchain technology in the last quarter of 2017. Investors react positively to the Blockchain 8-Ks issued by Speculative firms in the initial seven-day event window, although the reaction is mostly reversed over the 30 days following the disclosure. The reaction is stronger when Bitcoin returns are more positive. Overall, our results are consistent with a situation that troubles the SEC and the financial press: investors overreact to a firm’s first 8-K disclosure of a potential foray into Blockchain technology and that the overreaction is a function of the Bitcoin price bubble.

Risk Premia, Asset Price Bubbles, and Monetary Policy
Jarrow, Robert,Lamichhane, Sujan
We develop a dynamic equilibrium asset pricing model with heterogeneous beliefs to study the effects of monetary policy on prices, risk premia, asset price bubbles, and financial stability. Bubble risk premia arise from an interaction between disagreements among investors and dynamic trading constraints. Under a non-accommodative monetary policy, liquidity adjusted risk and bubble risk premia increase. We propose a new framework for monetary policy with respect to bubbles. What matters for policy is the trading constrained fraction/mass of agents that disagree about fundamentals (i.e. optimists/pessimists). Accommodative policy can lead to a larger fraction of trading constrained agents that disagree, larger bubbles, and increased systemic risk. Policy implementation issues are discussed.

Shareholder Engagement by Large Institutional Investors
Gomtsian, Suren
While shareholder engagement has captured much attention recently, the evidence on the role of large institutional investors remains relatively scarce. Large asset managers have become an increasingly powerful force since the financial crisis of 2008, with the top 20 managers controlling together almost 22% of votes in the FTSE 350 companies. The prevailing view, however, holds that large fund families avoid active shareholder engagement. This study aims to contribute to the ongoing discussions about the stewardship role of large institutional investors by identifying the biggest investors in UK listed companies and revealing how these institutional investors behave and vote at shareholders’ meetings. The results show growing shareholder stewardship efforts by large asset managers, including index (often described as passive) fund managers, over the last five years and thus challenge some common assumptions about large institutional investors. The study also reveals that the primary target of these engagement efforts has been corporate governance standards, rather than business strategy or performance. These findings have important implications and will better inform discussions and efforts to build regulatory frameworks for effective shareholder engagement in publicly-traded companies. The results suggest that regulators need to remain realistic by not placing impractical engagement expectations on large institutional investors alone. To go beyond corporate governance engagement, regulatory efforts need to take a broader approach towards investor stewardship and shareholder rights. In particular, hedge funds and other shareholder activists can improve corporate strategy and performance engagement by supplying large asset managers with firm-specific information through activist demands.

Simple Way of Conservatively Estimating Credit Exposure under Dynamic Initial Margins
Borue, Vadim
It is now common to use dynamic initial margins (DIM) to offset counterparty credit risk in listed, cleared and OTC derivative markets as well as prime brokerages. Typically those initial margins are designed to cover counterparty portfolio value move during margin period of risk (MPOR) period of 10 business days at least at the level of 99\% percentile. If DIM is calibrated to stress time period percentile would be even higher for current levels of volatilities. Brute force model calculation in this case of residual small potential future exposure (PFE) is rather cumbersome and inefficient numerically. Here we propose instead of computing residual future potential exposure just set it equal to a fixed proportion of future DIM computed according to PFE model. Estimating future DIM is generally easier problem than computing PFE under high DIM. We argue that using 1\% of future model consistent DIM will be sufficiently conservative estimation of PFE. We also argue that the only consistent way to handle future DIM would be using the same model used for PFE calculation, provided it could be demonstrated that this model is conservative enough but less conservative then DIM model. This way future DIM also could be conservatively estimated as $99\%$ of unconditional counterparty portfolio move during MPOR within the model used. With this simple proposal one can use existing PFE framework with minimum modification for computing PFE under DIM.

The Annuity Puzzle: How Big is the Free Lunch Being Left on the Table?
White, James,Haghani, Victor
The looming Savings Crisis is usually attributed to people either not saving enough or making poor investment choices, but we believe there's another culprit. Many investors could benefit from a 'free lunch' of pooling their longevity risk with others, but due to market inefficiencies, they do not. We quantify the size of this missed opportunity gap using an Expected Utility framework to compare self-managed savings versus the purchase of a zero-fee annuity.

The Blurring of Corporate Investor Nationality and Complex Ownership Structures
Alabrese, Eleonora,Casella, Bruno
Recent years have seen a significant increase in complexity of multinational enterprises (MNEs) ownership structures. Complex corporate structures raise concerns on the effectiveness of national and international investment policies, based on the notion of investors' nationality. This motivates this research effort aimed at analysing the ownership structures of some 700 thousand foreign affiliates (FAs). A new methodology, the bottom-up approach, is introduced. The main objective is to empirically map the "shareholder space" of FAs, along the vertical dimension, from the direct shareholders to the ultimate owners. We find that FAs are often part of transnational investment chains; more than 40% of foreign affiliates have direct and ultimate shareholders in different jurisdictions ("double or multiple passports"). Based on shareholders' nationality, we then propose and empirically analyse the salient features of four main archetypes of FAs ownership structure: plain foreign, conduit structures, round-tripping and domestic hubs. Each poses specific challenges to the policy-maker.

The Glass Pyramid: Informal Gender Status Hierarchy on Boards
Markóczy, Lívia,Sun, Sunny Li,Zhu, Jigao
Drawing on the status characteristic theory, we investigate the effect of gender on board directors’ status ranking and find that all else being equal, female directors’ status ranking is 81.48% of one position lower than that of male directors, a discrepancy that is attributable to gender. We theorize on the mechanism that determines the ways in which the status value of gender on a board affects board interactions and predict how this mechanism influences firm outcomes, including excessive managerial spending, social responsibility performance, and firm risk. We test our hypotheses in Chinese firms using an unbalanced panel that includes 5,396 firm-year observations (86,019 director-year observations) for a period of six years and find them supported.

The Impact Of Self-attribution Bias and Overconfidence Bias on Perceived Market Efficiency
Ali, Wajid
This study examines the mechanism by which self-attribution bias and overconfidence bias influences perceived market efficiency. For this purpose we use questionnaire and collect data from 200 investors of Islamabad Stock Exchange (ISE). Most studies focus on well-developed financial markets and very little is known about investor’s behavior in less developed financial markets or emerging markets. The present study contributes to filling this gap in the literature. The findings suggest that self-attribution bias and overconfidence bias have significant negative impacts on perceived market efficiency.

Understanding Sovereign Credit Ratings: Text-Based Evidence From the Credit Rating Reports
Slapnik, Ursula,Loncarski, Igor
In this paper we apply a novel approach to identifying the qualitative judgement of the rating committee in sovereign credit ratings. We extend the traditional regression with new measures - sentiment and subjectivity scores - obtained by textual sentiment analysis methods. By using an ordered logit with random effects for 98 countries in the period from 1996 to 2017, we find evidence that the subjectivity score provides additional information not captured by previously identified determinants of sovereign credit ratings, even after controlling for political risk, institutional strength and potential bias. The results from the bivariate and multivariate analysis confirm differences in textual sentiment between emerging markets and advanced economies, as well as before and after the 2008 global financial crisis.

We Need No Dime from the IMF: Is This a Temporary Illusion or Can the Turkish Economy Recover from the Current Recession without the IMF Loans?
Taskinsoy, John
IMF praised the Turkish financial system for escaping the 2008 global financial crisis with a minor dent in its economy, the success was attributable to significant capital buffers built up in the aftermath of the 2001 economic crisis, more effective fiscal and monetary management, strengthened banking regulation and supervision, and commitment to fiscal rules. Turkey’s strengthened banking system is capable of absorbing endogenous and exogenous shocks under highly adverse market conditions. Thanks to the relentless work by the Banking Regulation and Supervision Agency of Turkey (BRSA, or BDDK in Turkish), prolonged political stability (one-party government since 2002) coupled with much improved global investor confidence have enabled Turkey to become one of the G-20 nations. The gradually improving positive image of Turkey has changed with President (then Prime Minister) Recep Tayip Erdoğan’s remarks of “No IMF in Turkey’s future”, Erdoğan has also said that the “IMF chapter will not be reopened”. Connected or a mere coincidence, Turkey’s protracted (i.e. over half a century) bid for its accession to the EU was blocked by Cyprus in December 2009. Since the repeated speculative attacks on Turkish lira in August 2018, lira’s value against the dollar has plummeted (lira has depreciated more than 80% of its value in a matter of a month) and the country’s foreign reserves have shrunk noticeably; consequently, the Turkish economy has debilitated and found itself in an inevitable financial emergency. Although Turkey had made the last remaining payment from its 19th standby agreement to the IMF in May 2008, at the backdrop of Turkey’s fractured economy, Turkey’s divorce from the IMF can hardly qualify as a true graduation since the country is on the brink of an economic crisis, attributable to excessive private and household debt, a failed coup attempt on July 15, 2016 by a fraction of the Turkish army, massive dollarization (close to $200 billion), fast rising unemployment (over 14%), continued speculative attacks on lira, and a cascade of corporate defaults. Since the IMF bailout package is out of possibilities, the Turkish financial authorities must find fresh capital immediately to avoid its highly fragile economy being pushed into an economic slump.

¿Agrega valor el modelo Black-Litterman en portafolios del Mercado Integrado Latinoamericano (MILA)? (Does the Black-Litterman Model Add Value in Portfolios of the Integrated Latin American Market (MILA)?)
Luna-Ramírez, Susana,Agudelo, Diego
Spanish Abstract:El modelo de Black-Litterman (BL) ha sido propuesto como alternativa al de media-varianza de Markowitz para la estructuración de portafolios de activos financieros, permitiendo incorporar perspectivas de analistas fundamentales y garantizando un alto grado de diversificación. Se aplica este modelo con frecuencia trimestral, a portafolios de acciones de los países del MILA: Colombia, Chile, México y Perú tomando como base el universo de acciones de sus principales índices principales. Como perspectivas, se emplean las recomendaciones históricas de analistas de Bloomberg para el período 2008-2016. Se encuentra que los portafolios conformados con BL agregan valor en los países al índice de referencia respectivo, tanto en términos de rendimiento promedio como de alfa. Además se conforma un portafolio BL regional con los de cada país y se comprueba que supera a un Benchmark regional, ambos medidos en dólares, en cada una de tres alternativas de cobertura frente al dólar English Abstract:The Black-Litterman model (BL) has been offered as an alternative to the classical Markowitz Mean-Variance framework, to structure well-diversified portfolios that incorporate visions from fundamental analysts. We apply this model to stock portfolios in the countries of the Mercado Integrado Latinoamericano (MILA): Colombia, Chile, Mexico and Peru, starting from the constituents of the main stock market indexes. As perspectives, we use the historical analyst ́s recommendations in Bloomberg for the period 2008-2016. We find that portfolios created with BL outperform the main index, both in average return and in alpha, in each of the four countries. Moreover, a regional BL portfolio that combines the four BL country portfolios, outperforms a regional Benchmark, measured in dollars, in each one of three alternatives of Us dollar hedge.