Research articles for the 2019-08-11

A Rookie’s Guide to the Academic Job Market in Finance: The Labor Market for Lemons
Butler, Alexander W.,Crack, Timothy Falcon
We first wrote and circulated our “Rookie’s Guide” paper about the academic labor market for newly minted finance PhDs twenty years ago. It passed hand-to-hand and via photocopies of photocopies sent using snail mail (or, back then, we just called it ‘mail’). Since then, much has changed in our labor market, and much has not. Logistics are easier now due to technological change. But the basic informational frictions that made it difficult for rookies to learn the ropes 20 years ago are still evident, as are the fundamental market frictions that make the bilateral matching between labor demand (hiring schools) and labor supply (the rookies) awkward and challenging. This manuscript refreshes the advice we have given in the past, adds some more specific suggestions for preparing for the intense interview process at the academic meetings, and offers a brief epilogue discussing what a rookie should do at the successful conclusion of the job market. We incorporate by reference some of the basic advice from previous guides (Butler and Crack, 2004, 2005, 2006, 2007, 2012). We begin by offering some truths for the reader to internalize. Then we use an FAQ format to impart additional information. We end with our epilogue and a list of references.

Alternative Usage Areas of Cryptocurrencies
Ahmadova, Sevinj
The emergence of new technologies leads to the reconsideration of business processes identified with older technologies, but many advantages that they promise do not immediately appear. The transfer of the ledgers kept in paper form to the computer environment presents a challenge as a revolution in the field of payments. However, since this change takes place in the form of recording rather than recording the transaction, the processes underlying the transactions remain substantially the same.

Auditor Communication Provisions in Private Loan Agreements: Do They Matter?
Cheng, Lin,Jaggi, Jacob,Michas, Paul N.,Schatzberg, Jeffrey W.
We examine auditor communication provisions (ACPs) in private loan agreements, which are private contracting mechanisms between external auditors and audit clients which establish communication between lenders and their borrowers' auditors. We provide evidence that lenders value privately-contracted auditor communication and often specify multiple ACPs that facilitate lender monitoring. In terms of debt contracting outcomes, we find ACPs are associated with a lower ex ante likelihood of loan covenant violation. We also examine audit fee implications for the borrower and find that ACPs are associated with higher audit fees, which is consistent with auditors responding to the litigation risk these provisions impose. We corroborate this by providing evidence that this relationship is concentrated in samples where the risk of third-party litigation is greater. Finally, we find evidence that ACPs lead auditors to become more conservative as their clients exhibit lower signed discretionary accruals when the risk of third-party litigation is greater.

Bitcoin as an Alternative Digital Currency. Exploring the Public’s Perception vs Experts.
Papathanasiou, Spyros,Papamatthaiou, Nikolaos,Balios, Dimitris
This paper attempts to find out if the view of the public coincides with the opinion of the experts on the Bitcoin’s subject and to determine if is information can be implemented in order to establish a use of Bitcoin in our everyday lives. During the first stage of this research, methods and rules of analysis such as descriptive statistics and tables and charts were used. Firstly, a questionnaire was used and secondly, the answers were gathered and classified according to the participants’ choices. During the second stage, the data was collected with the use of random sampling, while various techniques, such as simple and multiple regressions were utilised for analysing the results. The conclusion is that the public perceives Bitcoin differently than the experts do. Individuals believe that Bitcoin is mainly a means of transactions/payments, contrary to the experts’ opinion, which is that it is foremost an investment asset.

Creating a Euro Area Safe Asset without Mutualizing Risk (Much)
Leandro, Alvaro,Zettelmeyer, Jeromin
This paper explains and evaluates three proposals to create "safe assets" for the euro area based on sovereign bonds, in which sovereign risk is limited through diversification and some form of seniority. These assets would be held by banks and other financial institutions, replacing concentrated exposures to their own sovereigns. The paper focuses on three ideas: (1) to create multitranche "sovereign bond-backed securities" (SBBS), of which the senior tranche would constitute a safe asset; (2) to create a senior, publicly owned financial intermediary that would issue a bond backed by a diversified portfolio of sovereign loans ("E-bonds"); and (3) to issue sovereign bonds in several tranches and induce banks to hold a diversified pool of senior sovereign bonds ("multitranche national bond issuance"). Public attention (including public criticism) has so far focused on the first idea; the other two have not yet been seriously debated.We find that none of the competing proposals entirely dominates the others. SBBS do not deserve most of the criticism to which they have been subjected. At the same time, E-bonds and multitranche national bond issuance have several interesting features -- including inducing fiscal discipline -- and warrant further exploration.

Economic Consequences of Corporate Governance Disclosure: Evidence from the 2006 SEC Regulation on Related-Party Transactions
Hope, Ole-Kristian,Lu, Haihao
This paper examines economic consequences of a 2006 Securities and Exchange Commission regulation that mandated public firms to disclose their governance policies on related-party transactions (hereafter RPTs). Employing hand-collected RPT data for S&P 1500 firms, we find that the initiation of RPT governance disclosure significantly reduces the occurrence of RPTs and that the reduction in RPTs is negatively associated with the implied cost of capital (ICC) and positively related to Tobin’s Q. These effects are more pronounced for low-monitored firms and for firms with RPTs that are more likely to be opportunistic. We further find that firms with a formal written policy, a designated committee to review and approve RPTs, or more extensive disclosure on RPT governance benefit in terms of lower ICC.

Fighting Uncertainty with Uncertainty: Time Value of Knowledge and the Net Present Value (NPV) of Knowledge Machines
Ravi Kashyap

We formulate one methodology to put a value or price on knowledge, using well accepted techniques from finance. We then apply this valuation to the decision problem of selecting papers for publication from an overall pool of submissions. Our initial analysis shows that one of the better solutions, we can accomplish with regards to the creation and dissemination of knowledge, might be described by the prescription, "Don't Simply Optimize, Also Randomize; best described by the term - Randoptimization". We specifically show that the best decision we can make, with regards to the selection of articles by journals, requires us to formulate a cutoff point, or, a region of optimal performance and randomly select from within that region of better results. The policy implication (for all fields) is to randomly select papers, based on publication limitations (journal space, reviewer load etc.) from an overall pool of submissions, that have a single shred of knowledge (or one unique idea) and have the editors and reviewers coach the authors to ensure a better final outcome.

Latency and Liquidity Risk
Álvaro Cartea,Sebastian Jaimungal,Leandro Sánchez-Betancourt

Latency (i.e., time delay) in electronic markets affects the efficacy of liquidity taking strategies. During the time liquidity takers process information and send marketable limit orders (MLOs) to the exchange, the limit order book (LOB) might undergo updates, so there is no guarantee that MLOs are filled. We develop a latency-optimal trading strategy that improves the marksmanship of liquidity takers. The interaction between the LOB and MLOs is modelled as a marked point process. Each MLO specifies a price limit so the order can receive worse prices and quantities than those the liquidity taker targets if the updates in the LOB are against the interest of the trader. In our model, the liquidity taker balances the tradeoff between missing trades and the costs of walking the book. We employ techniques of variational analysis to obtain the optimal price limit of each MLO the agent sends. The price limit of a MLO is characterized as the solution to a new class of forward-backward stochastic differential equations (FBSDEs) driven by random measures. We prove the existence and uniqueness of the solution to the FBSDE and numerically solve it to illustrate the performance of the latency-optimal strategies.

Managing the Complexity of Processing Financial Data at Scale -- an Experience Report
Sebastian Frischbier,Mario Paic,Alexander Echler,Christian Roth

Financial markets are extremely data-driven and regulated. Participants rely on notifications about significant events and background information that meet their requirements regarding timeliness, accuracy, and completeness. As one of Europe's leading providers of financial data and regulatory solutions vwd processes a daily average of 18 billion notifications from 500+ data sources for 30 million symbols. Our large-scale geo-distributed systems handle daily peak rates of 1+ million notifications/sec. In this paper we give practical insights about the different types of complexity we face regarding the data we process, the systems we operate, and the regulatory constraints we must comply with. We describe the volume, variety, velocity, and veracity of the data we process, the infrastructure we operate, and the architecture we apply. We illustrate the load patterns created by trading and how the markets' attention to the Brexit vote and similar events stressed our systems.

On the Compound Beta-Binomial Risk Model with Delayed Claims and Randomized Dividends
Aparna B. S,Neelesh S Upadhye

In this paper, we propose the discrete time Compound Beta-Binomial Risk Model with by-claims, delayed by-claims and randomized dividends. We then analyze the Gerber-Shiu function for the cases where the dividend threshold $d=0$ and $d>0$ under the assumption that the constant discount rate $\nu \in (0,1)$. More specifically, we study the discrete time compound binomial risk model subject to the assumption that the probabilities with which the claims, by-claims occur and the dividends are issued are not fixed(constant), instead the probabilities are random and follow a Beta distribution with parameters $a_{i}$ and $b_{i}$, $i = 1, 2, 3$. Recursive expressions for the Gerber-Shiu function corresponding to the proposed model are obtained. The recursive relations are further utilized to obtain significant ruin related quantities of interest. Recursive relations for probability of ruin, the probability of the deficit at ruin, the generating function of the deficit at ruin and the probability of surplus at ruin and for the probability of the claim causing ruin are obtained.

Ordinal Tax To Sustain a Digital Economy
Nate Dwyer,Sandro Claudio Lera,Alex Sandy Pentland

Recently, the French Senate approved a law that imposes a 3% tax on revenue generated from digital services by companies above a certain size. While there is a lot of political debate about economic consequences of this action, it is actually interesting to reverse the question: We consider the long-term implications of an economy with no such digital tax. More generally, we can think of digital services as a special case of products with low or zero cost of transportation. With basic economic models we show that a market with no transportation costs is prone to monopolization as minuscule, random differences in quality are rewarded disproportionally. We then propose a distance-based tax to counter-balance the tendencies of random centralisation. Unlike a tax that scales with physical (cardinal) distance, a ranked (ordinal) distance tax leverages the benefits of digitalization while maintaining a stable economy.

The Empirical Analysis of Bitcoin Market in the General Equilibrium Framework
Aoyagi, Jun,Hattori, Takahiro
This paper firstly pursues the fundamental price of Bitcoin in the general equilibrium framework and its empirical characteristics. Our theoretical model predicts that (i) the Bitcoin price and the total hash rate are determined simultaneously in the long-run and (ii) the hash rate of Bitcoin Granger-causes Bitcoin prices in the short-run. Using a cointegration framework, our empirical analysis provides consistent results with these theoretical predictions. Our empirical results suggest that the Bitcoin market has been under a fundamental value instead of speculative bubbles.

The Future or Fancy? An Empirical Study of Public Benefit Corporations
Dorff, Michael B.,Hicks, James,Davidoff Solomon, Steven
The public benefit corporation ("PBC") is one of the most hyped developments in corporate law. The reason is the PBC’s potential social purpose. PBC directors are required under their fiduciary duties to consider purposes other than profits in decision-making. These new forms are hailed by their champions as offering a new hope for a reformed capitalism. Critics have assailed them as unworkable, and a thin disguise for ordinary corporate profit-seeking behavior. What has been lacking in this debate is evidence. We aim to fill this gap by conducting an empirical study of early-stage investment in PBCs. Early-stage investment, consisting of venture capital and similar funds, presents an interesting test case for PBC funding, because the investors often have profit-maximizing incentives and fiduciary duties of their own. Using our novel dataset, we can discern whether for-profit investment is occurring in PBCs, and if so, whether it is different in kind from ordinary early stage investment. We find that PBCs are receiving investment at significant rates, and that investment is coming from typical sources of venture capital including traditional, profit-seeking VC firms â€" Sequoia Capital, Andreessen Horowitz, and others. We also find that venture capital funds are investing in more consumer-facing industries, as well as investing smaller amounts than traditional investments.We conclude that PBCs are attracting for-profit investment, supporting arguments that these new forms may be able to earn an acceptable rate of return while serving various purposes. We use these results to develop a theory of future PBC development, which asserts that investment in PBCs is likely to remain siloed in smaller, newly-formed firms. We conclude that widespread adoption of the form will take time, as network effects build and experience with the form becomes embedded within the entrepreneurial ecosystem. The PBC is not a failure. But it is in its infancy and any full embrace will take a significant period of time.

They’re Back! Post-financialization Diversification Benefits of Commodities
Gagnon, Marie-Hélène,Manseau, Guillaume,Power, Gabriel
Do alternative assets such as commodities improve portfolio diversification? The empirical evidence is generally positive but mixed, and almost exclusively focuses on U.S. data. Using several distinct commodity indexes over the period 1993-2019, we investigate the case of an investor in Canada, a commodity-currency country where equities are already exposed to commodity beta. We use spanning tests and several out-of-sample performance measures for both risk-averse and disappointment-averse investors. Overall, we find that while the diversification potential of commodities was limited in Canada before and during financialization, the post-financialization period offers new opportunities. The evidence suggests that portfolio performance is significantly improved using some, but not all, commodity indexes. Thus, the choice of a relevant commodity index matters as a vehicle for diversification. Finally, compounding an international component to the sectorial diversification of the portfolio can significantly improve its performance.