Research articles for the 2019-08-09

Bitcoin Returns and the Weekday Effect
Decourt, Roberto,Chohan, Usman W.,Perugini, Maria Letizia
This paper examines whether the well-known Monday Effect found in stock andTreasury Bills markets also occurs in the Bitcoin market, which differs markedlyfrom other markets due to its continuous trading. The findings of the paper suggestthat the Bitcoin market is not efficient and provides the opportunity to generatestrategies with high abnormal returns. The paper uses a Student’s t-test for astatistically significant difference in the average daily returns of weekdays and find-ing that Tuesday and Wednesday has higher returns as compared with other days.This is corroborated by a regression analysis indicating that there are above averagereturns on Tuesday and Wednesday.

Carbon Taxes and Stranded Assets: Evidence from Washington State
Carattini, Stefano,Sen, Suphi
The climate challenge requires ambitious climate policy. A sudden increase in carbon prices can lead to major shocks to the stock market. Some assets will lose part of their value, others all of it, and hence become â€Å"stranded�. If the markets are not ready to absorb the shock, a financial crisis could follow. How well investors anticipate, and thus how large these shocks may be, is an empirical question. We analyze stock market reactions to the rejection of two carbon tax initiatives by voters in Washington state. We build proper counterfactuals for Washington state firms and find that these modest policy proposals with limited jurisdiction caused substantial readjustments on the stock market, especially for carbon-intensive stocks. Our results reinforce concerns about â€Å"stranded assets� and the risk of financial contagion. Our policy implications support the inclusion of transition risks in macroprudential policymaking and carbon disclosure and climate stress tests as the main policy responses.

Cross-Country Outliers
Adams, John C.,Mansi, Sattar,Reeb, David M.,Wald, John K.
We investigate whether outliers in cross-country samples and the common methods we use to address them affect the trustworthiness of our empirical results. Our analysis begins by documenting recent international business (IB) research practices in the identification and treatment of outliers. We then explore the bias and error from using sample-wide univariate outlier detection and treatment methods in studies that use cross-country datasets. Additional analysis, using cross-country data on profitability, executive compensation, and R&D, demonstrates the magnitude of the bias and error from common outlier approaches in IB research. We propose outlier mitigation strategies at both the sample and country levels.

Economic Harbingers of Political Modernization: Peaceful Explosion of Rights in Ottoman Istanbul
Cansunar, Asli,Kuran, Timur
The modernization drive of the late Ottoman Empire is typically attributed to visionary officials and pressures they faced from foreign powers. This paper ascribes a fundamental role to prior shifts in wealth toward non-Muslims and away from conservative groups, including Muslim clerics. These shifts, all under way in the 1700s, motivated Ottoman political leaders to begin, with the Gülhane Edict of 1839, to dismantle traditional institutions grounded in Islamic law and sultanic customs of governance. Despite its momentous provisions, the edict generated only minor resistance, because it addressed widespread and chronic grievances, legitimated trends unfolding for generations, and offered Muslim political elites, who had been losing ground, opportunities to catch up with rapidly advancing local Christians. The data, which come from Istanbul’s Islamic courts, allow the tracking of changes in the distribution of wealth, as measured by the founding of waqfs (Islamic trusts) and ownership of equities known as gediks.

Fiscal-Financial Vulnerabilities
Schuknecht, Ludger
The paper analyses the linkages from financial developments to public finances. It maps and discusses the transmission channels to fiscal variables. These channels include asset prices, financing conditions, balance sheets of banks, non-banks and central banks and international linkages. The study argues that the fiscal effects via each and all these channels can be very serious in magnitude and can put the sustainability of public finances at risk. However, there is only limited in–depth analysis of these channels and risks.

How Do Social Norms Affect Financial Decisions? Religion and Insider Trading Profits
Contreras, Harold,Korczak, Adriana,Korczak, Piotr
We argue that religiosity is a source of social norms curbing self-interested behavior and, accordingly, it limits insiders’ opportunistic trading on private information. In line with this argument, we find that trades by insiders in firms located in more religious areas are followed by lower abnormal returns, those insiders are less likely to trade on future earnings news, and their trades are less likely to be classified as opportunistic. The effect is concentrated where the impact of local social norms is expected to be stronger. We offer new insights into the effect of social norms and culture on financial decisions.

Information Acquisition with Heterogeneous Valuations
Rahi, Rohit
We study the market for a risky asset with heterogeneous valuations. Agents seek to learn about their own valuation by acquiring private information and making inferences from the equilibrium price. As agents of one type gather more information, they pull the equilibrium price closer to their valuation and further away from the valuations of other types. Thus they exert a negative learning externality on other types. This, in turn, implies that a lower cost of information for one type induces all agents to produce more information. When evaluating agents' welfare, the learning externality has to be offset against a gains from trade externality, since agents who learn less because their valuation is further away from the price also stand to profit more from trading. In equilibrium, agents' information acquisition decisions are clustered together more than is socially optimal.

Market Efficiency and the Global Financial Crisis: Evidence from Developed Markets
Sabbaghi, Omid,Sabbaghi, Navid
This study aims to provide one of the first empirical investigations of market efficiency for developed markets during the recent global financial crisis. Using the Morgan Stanley Capital International (MSCI) country indices as proxies for national stock markets, the study conducts a battery of econometric tests in assessing weak-form market efficiency for the developed markets. The inferential outcomes are consistent among the different tests. Specifically, the study finds that the majority of developed markets are weak-form efficient while the USA is the sole equity market to be commonly diagnosed as weak-form inefficient across the different tests when using full period data spanning the January 2008-November 2011 period. However, when basing the analysis on one-year subsamples over the identical time period, this study fails to reject weak-form market efficiency for all of the developed markets and presents evidence consistent with the Adaptive Market Hypothesis as described by Urquhart and Hudson (2013). When applying technical analysis for the case of the USA over the full study period, the results indicate that the return predictabilities can be exploited for some horizon of variable length moving average (VMA) trading rules. This study provides one of the first empirical investigations of market efficiency for developed markets during the recent global financial crisis using an extended set of econometric tests. The study contributes to the existing body of empirical research that formally assesses the impact of a financial crisis on stock market efficiency and underlines the significance and relevance of examining market efficiency through subsample analysis.

On Financial Frictions and Firm Market Power
Casares, Miguel,Galdon-Sanchez, Jose E.,Deidda, Luca
We build a static general-equilibrium model with monopolistically competitive firms that borrow funds from competitive banks in an economy subject to financial frictions. These frictions are due to non verifiability of both ex post firm returns and managerial effort. Market power has opposing effects. On one side, firms’ pricing over marginal cost reduces output compared to perfect competition. On the other, by increasing firms’ profitability, market power reduces the impact of financial frictions. The resulting tradeoff is ambiguous. We show that, other things equal, there exists an optimal positive level of market power that maximizes welfare. Such optimal degree of market power increases with moral hazard and decreases with the efficiency of firm liquidation following bankruptcy.

Product Market Threats and Tax Avoidance
Kim, Tae-Nyun,Lee, Pil-Seng
In this paper, we investigate whether product market threats have a significant impact on tax avoidance activities of firms. By adopting the market fluidity measure introduced in Hoberg, Phillips, and Prahbala (2014) as a proxy for product market threats, we find that product market threats increase the level of tax avoidance activities of the firms which are pursuing for such activities more than the target tax avoidance level (actively tax-avoiding firms), whereas that impact is not significant for the firms which have not been involved in tax avoidance activities more than the targeted level. Accordingly, actively tax-avoiding firms delay their adjustment toward optimal target tax avoidance level significantly when facing product market threats. In addition, among these firms with active tax avoidance practice, especially the firms with worse corporate governance structure, lower level of monitoring, higher information asymmetry, and lower financial flexibility are more likely to experience the positive relationship between product market threats and their tax avoidance.

Regulating Financial Networks Under Uncertainty
Ramírez, Carlos
I study the problem of regulating a network of interdependent financial institutions that is prone to contagion when there is uncertainty regarding its precise structure. I show that such uncertainty reduces the scope for welfare-improving interventions. While improving network transparency potentially reduces this uncertainty, it does not always lead to welfare improvements. Under certain conditions, regulation that reduces the risk-taking incentives of a small set of institutions can improve welfare. The size and composition of such a set crucially depend on the interplay between (i) the (expected) susceptibility of the network to contagion, (ii) the cost of improving network transparency, (iii) the cost of regulating institutions, and (iv) investors' preferences.

Risk, Return, and Inflation Expectations
Dossani, Asad
This paper asks how inflation shocks affect the risk and return characteristics of different asset classes. For an unanticipated increase in inflation expectations, returns on equities and on the euro (relative to the dollar) increase, while returns on bonds and on gold decrease. Based on option implied volatility and skewness, bonds become more risky, equities and gold become less risky, and the impact on the euro’s riskiness is ambiguous. These findings support the following conclusions: In response to inflation shocks, equities are the most attractive asset class, while bonds are the least attractive. The euro and gold are somewhere in between.

Slow and Steady Wins the Race: The Impact of Chasing Returns on Quartile Rankings
Malladi, Rama,Brodmann, Jennifer
This paper explores whether passive fund managers who aim to be in the 1st quartile by chasing higher returns (i.e. higher risk) are more likely to achieve their goal compared with those that chase somewhat lesser returns (i.e. lower risk). Using monthly historical returns from 01/01/1979 to 01/01/2018, we show that if a fund’s goal is to achieve higher assets under management (AUM), it should aim to be in the 1st quartile every year. However, if a fund’s long-term goal is to stay in the 1st quartile, it should aim to be in the 2nd quartile every year.

Tenure Choice, Portfolio Structure and Long-Term Care - Optimal Risk Management in Retirement
Fehr, Hans,Hofmann, Maurice
We study the interplay between tenure decisions, stock market investment and the public social security system. Housing equity not only serves a dual purpose as a consumption good and as an asset, but also provides insurance to buffer various risks in retirement. Our life cycle model captures these links in order to explain why homeownership in Germany is so low. Our simulation results indicate that the public long-term care as well as the pension system reduce the homeownership rate in Germany by 10-15 percentage points.

The Geography of Mortgage Lending in Times of FinTech
Basten, Christoph,Ongena, Steven
We analyze how banks’ allocations of mortgage credit across regions change when an online platform enables them to offer to regions where they have no branches, staff or legacy. Unique data from an online platform with offers from different banks to each mortgage application yield three novel findings. First, banks offer more and cheaper credit to borrowers in less competitive offline markets. Second, banks offer more credit to more distant locations, where house prices appear less over-heated, and past price growth is less correlated with that in their existing portfolio. Third, over time offers become more automated, lowering operational costs.

The Influence of Loan Officers on Loan Contract Design and Performance
Bushman, Robert M.,Gao, Janet,Martin, Xiumin,Pacelli, Joseph
We investigate the extent to which loan officers generate individual effects on the design and performance of syndicated loan deals. We construct a novel database containing the identities of 6,821 loan officers involved in structuring syndicated loan deals. This data allow us to exploit movement of loan officers across banks to disentangle loan officer effects from bank fixed effects and estimate loan officers’ influence on both lending terms and loan performance. We find that loan officers have a significant influence on loan terms and loan performance that is incremental to bank and borrower characteristics. Our evidence suggests that loan officers exert less influence over interest spreads than over covenant package design. We also provide evidence consistent with recent comparable loan deals embedding hard information that induces variation in loan spreads that is beyond the control of loan officers. In contrast, we find no evidence that recent comparables induce non-discretionary variation in covenant design. Finally, we provide evidence consistent with covenant package design serving as a channel through which loan officers influence loan performance.

The Scope of Audit Committee Oversight and Financial Reporting Reliability: Are Audit Committees Overloaded?
Ashraf, Musaib,Choudhary, Preeti,Jaggi, Jacob
Audit committee (AC) responsibilities have been increasing over time, prompting concerns that overloading ACs may impair their effectiveness. Using new measures to capture AC responsibilities based on AC charters, we find that greater AC responsibilities are associated with improved financial statement reliability. Contrary to overload concerns, this association is strongest when ACs have very high levels of responsibilities. Cross-sectional analyses indicate greater AC responsibilities improve financial statement reliability at complex firms, following significant governance lapses, when AC members are capable and experienced, and when ACs also meet often to carry out their oversight duties. Further analysis suggests that our AC responsibility results are driven by duties related to financial reporting while, in stark contrast, allocating responsibilities unrelated to financial reporting to the AC (e.g., risk management) detracts from monitoring effectiveness by decreasing financial statement reliability. The latter is consistent with an overload effect driven by responsibilities that distract the AC from its core financial reporting oversight mandate. Our results inform recent regulatory changes at some exchanges to expand AC oversight.

This Time Is Different: Facebook’s Libra Can Improve Both Financial Inclusion and Global Financial Stability As a Viable Alternative Currency to the U.S. Dollar
Taskinsoy, John
The propagation of high-magnitude crises since the late 1990s have cost over $30 trillion and pushed about one percent of the world population into poverty. In the aftermath of the 2008 global financial crisis, the worst financial catastrophe of the 21st century, accelerated the speed of money’s inevitable evolution into cryptocurrencies. Blockchain and distributed ledgers are a revolutionary innovation; as antecedents, they could lead to foreseeable and unforeseeable impacts on the definition of central bank money and online payment systems. As with any new technology, Facebook’s Libra as the new kid on the block (but without block) is going to disrupt the existing cryptocurrency models and the ecosystem they have created for a decade. Libra clearly has an advantage over 2,400 cryptocurrencies sprouted since the first successful Bitcoin in January 2009; furthermore, Libra’s vast scale (close to a three billion user base) sets itself apart from even the most dominant Bitcoin with 68% of the market share. Bitcoin’s arduous journey to the stardom in the digital cash world has been constantly subject to immense criticism and the question whether Bitcoin is a digital coin or just an investment asset class has never been put to rest. Facebook assures that at least Libra is not going to have the same predicament as Bitcoin since Libra will be backed by a basket of stable currencies (dollar, euro, pound, and yen) as well as low-risk government bonds and central bank reserve assets; of course, this alone does not shield Libra from market fluctuations and exchange rate risks. Although Libra is promoted to be a very stable digital coin contrary to peers (i.e. Bitcoin), but Libra or its 28-member governing body the Libra Association will not eliminate all of cyberattacks or the default risk of securities and member-firms which happen to be for-profit companies. Libra’s another stability feature, unlike Bitcoin and over 2,400 altcoins, Libra will be a liability of individuals and entities plus it will be backed by a central bank like authority (the Libra Association) responsible for Libra’s stability. The downside is that Facebook has had a troubled past regarding privacy and the exploitation of users’ data; however Facebook assures that Libra will be operated by Facebook’s subsidiary Calibra and sensitive financial data including the Libra account holders’ any part of transaction history will not be shared with Facebook unless authorized by the account owners.

Time Value of Money and Optimal Portfolio Diversification
Shanbhag, Maneesh
Investing is putting money to work today in exchange for more money tomorrow, and the present value formula precisely defines this trade off. This formula also contains the primary economic factors that drive asset class returns and are fundamental to optimal portfolio diversification: expected growth, expected inflation, and a discount rate. This paper shows that there is far greater impact from diversifying to growth and inflation surprises than from holding a little bit of all global asset classes.

Toward Better Measurement of Financial Performance: A Robust OEVA-TEVA Alternative to Biased EVA
Ibragimov, Rauf,Velez-Pareja, Ignacio
We demonstrate analytically and illustrate with examples that the conventional measures of the residual operating income such as the Economic Value Added (EVA) are biased by design and so may yield a misleading assessment of financial performance. Fundamentally, the magnitude of the measurement error depends on the amount of realized interest tax shields and the book to value ratio. Other potentially significant sources of distortions induced by the EVA design are identified as well. We propose a robust alternative that is a concurrent evaluation of the firm’s operating and total performance by means of two related metrics, the Operating EVA (OEVA) and the Total EVA (TEVA). Coherent implementation of the OEVAâ€"TEVA technique is simpler than the EVA both analytically and computationally. It is also able to provide additional information for the management decision making. The overall consistency of the OEVAâ€"TEVA approach is supported by a formally proved equivalence of the corresponding OEVAâ€"TEVA valuation model to the fundamental valuation by the cash flow discounting.

Unpacking the Roles of Shareholder Engagement Intermediaries: A Case Study of an Engagement Process on Carbon Risk
Gond, Jean-Pascal,Sjöström, Emma
Many institutional investors are spending considerable resources on engaging with companies on environmental, social, and governance (ESG) issues through dialogue, to promote the adoption of enhanced sustainability practice and reporting. At the same time, little is known about the roles played by intermediary organizations to which such engagement is often delegated, nor about how the use of an intermediary may shape the engagement process. To address this question, we conducted a qualitative case study of a three-year thematic engagement project on carbon risk focused on twenty energy companies and conducted by a single manager at one intermediary organization. Relying on a unique archival access capturing the log of dialogues between an engagement intermediary and twenty multinational corporations (MNCs) and supporting interviews, we identify and conceptualize four roles performed by engagement intermediaries to elicit companies’ responses: business diplomats, communication managers, soft regulators, and free sustainability coach and consultant. Our results highlight how these roles are mobilized through the engagement process in ways that help manage saliency in practice to enhance the impact of engagement on companies.