Research articles for the 2019-08-17
Aggressive Accounting as a Commitment to be Prudent
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Accounting information provides guidance for real decisions such as whether to liquidate or continue an ongoing project. Ceteris paribus, implementing an accounting system with an aggressive bias leads to inefficient project continuations and causes a higher cost of capital. We show that an aggressive accounting system can nevertheless be beneficial for the manager because the very fact that it induces excessive project continuations permits the manager to commit to abstain from taking excessive risks prior to the continuation decision. In short, we find that creating inefficiencies with respect to interim project continuations can discipline the manager's project choice ex ante, and hence facilitate financing.
SSRN
Accounting information provides guidance for real decisions such as whether to liquidate or continue an ongoing project. Ceteris paribus, implementing an accounting system with an aggressive bias leads to inefficient project continuations and causes a higher cost of capital. We show that an aggressive accounting system can nevertheless be beneficial for the manager because the very fact that it induces excessive project continuations permits the manager to commit to abstain from taking excessive risks prior to the continuation decision. In short, we find that creating inefficiencies with respect to interim project continuations can discipline the manager's project choice ex ante, and hence facilitate financing.
Common Sense Economics
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For decades Wall Street professionals and academics have been perplexed by decreasing interest rates in the United States in an environment of increasing debt. This focus on the supply of debt has led to many failed prognostications regarding impending interest rate increases. The bond vigilantes of 1980 have given way to current incoherent talk of central bank financial repression. This analysis looks at wealth inequality and the demand for debt and shows how it causes interest rates to decrease and how wealth inequality stalls the consumer-demand side of the economy. Wealth inequality leads to an unbalanced economy just as total wealth equality would also lead to an unbalanced economy. Interest rates are the signal telling us about the spread of wealth distribution in the economy and the balance we need to strike.
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For decades Wall Street professionals and academics have been perplexed by decreasing interest rates in the United States in an environment of increasing debt. This focus on the supply of debt has led to many failed prognostications regarding impending interest rate increases. The bond vigilantes of 1980 have given way to current incoherent talk of central bank financial repression. This analysis looks at wealth inequality and the demand for debt and shows how it causes interest rates to decrease and how wealth inequality stalls the consumer-demand side of the economy. Wealth inequality leads to an unbalanced economy just as total wealth equality would also lead to an unbalanced economy. Interest rates are the signal telling us about the spread of wealth distribution in the economy and the balance we need to strike.
Cryptocurrency As Money: A Trading Strategy Solution
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This paper is motivated by a hypothesis that the long term value of a cryptocurrency is determined by its future use as money. For a cryptocurrency to be used as a medium of payment, it has to fulfill three independent functions: medium of exchange, a unit of account, and store of value. Currently, cryptocurrencies are held for investment purposes rather than being used for transactions and thus as a medium of exchange. For cryptocurrency to become widely adopted as a means of payment, it first needs to go through a very volatile period because speculative traders see long-run future value in the cryptocurrency. In order to soften transition from speculative asset to medium of payment a trading strategy is proposed, which provides liquidity and reduces volatility. Similar to pairs trading strategy, the proposed solution is based on cointegration and performed in three steps. The main difference is that proposed solution does not include shorting, but holding cryptocurrencies, thus increasing the total available cash and adding to the equilibrium price. Results from an ongoing experiment suggest that the proposed trading strategy is appealing for about 40% of cryptocurrency investors, as the struggle against volatility problem is accompanied by significant financial gains.
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This paper is motivated by a hypothesis that the long term value of a cryptocurrency is determined by its future use as money. For a cryptocurrency to be used as a medium of payment, it has to fulfill three independent functions: medium of exchange, a unit of account, and store of value. Currently, cryptocurrencies are held for investment purposes rather than being used for transactions and thus as a medium of exchange. For cryptocurrency to become widely adopted as a means of payment, it first needs to go through a very volatile period because speculative traders see long-run future value in the cryptocurrency. In order to soften transition from speculative asset to medium of payment a trading strategy is proposed, which provides liquidity and reduces volatility. Similar to pairs trading strategy, the proposed solution is based on cointegration and performed in three steps. The main difference is that proposed solution does not include shorting, but holding cryptocurrencies, thus increasing the total available cash and adding to the equilibrium price. Results from an ongoing experiment suggest that the proposed trading strategy is appealing for about 40% of cryptocurrency investors, as the struggle against volatility problem is accompanied by significant financial gains.
Forward-looking P
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We present a forward-looking estimator for the time-varying physical return distribution with minimal prior assumptions about the shape of the distribution and no exogenous assumptions about the economy or preferences. Our estimator, which is based on a neural network, derives its forecasts from option-implied measures and predicts the conditional mean and volatility of returns such that profitable trading strategies can be derived. In contrast to backward-looking estimators and alternative forward-looking parametric and non-parametric approaches, its distribution forecasts cannot be rejected in statistical tests and it features lower prediction errors and higher conditional log likelihood values than the alternatives.
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We present a forward-looking estimator for the time-varying physical return distribution with minimal prior assumptions about the shape of the distribution and no exogenous assumptions about the economy or preferences. Our estimator, which is based on a neural network, derives its forecasts from option-implied measures and predicts the conditional mean and volatility of returns such that profitable trading strategies can be derived. In contrast to backward-looking estimators and alternative forward-looking parametric and non-parametric approaches, its distribution forecasts cannot be rejected in statistical tests and it features lower prediction errors and higher conditional log likelihood values than the alternatives.
Government Spending and Local Demographics: Evidence from Moody's Municipal Ratings Recalibration
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We examine how Moody’s ratings scale recalibration in 2010, which has been linked to higher county-level government spending and income, affects income and population distributions. We find that the recalibration decreases median and average per capita income and increases income inequality and the poverty rate. These effects are driven by population flows. After the recalibration, there is an increase in population, a decrease in average income of population inflows, and an increase in the average income of population outflows. Collectively, our findings suggest that local government spending affects the income distribution through changes in local population composition and income flows due to migration.
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We examine how Moody’s ratings scale recalibration in 2010, which has been linked to higher county-level government spending and income, affects income and population distributions. We find that the recalibration decreases median and average per capita income and increases income inequality and the poverty rate. These effects are driven by population flows. After the recalibration, there is an increase in population, a decrease in average income of population inflows, and an increase in the average income of population outflows. Collectively, our findings suggest that local government spending affects the income distribution through changes in local population composition and income flows due to migration.
Identifying Indicators of Systemic Risk
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We operationalize the definition of systemic risk provided by the IMF, BIS, and FSB and derive testable hypotheses to identify indicators of systemic risk. We map these hypotheses into a two-stage hierarchical test which combines insights from the early-warning literature on financial crises with recent advances on growth-at-risk. Applying it to a set of candidate variables, we find that the Basel III credit-to-GDP gap does not serve the goal of coherently indicating systemic risk across the panel of G7 countries. A composite financial cycle measure does indicate systemic risk up to three years ahead, but its single components like credit growth or house price growth do not pass our test. Our results suggest that, by smoothing the financial cycle, pre-emptive countercyclical macroprudential policy may address vulnerability episodes in boom phases, which then mitigates systemic risk in the future.
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We operationalize the definition of systemic risk provided by the IMF, BIS, and FSB and derive testable hypotheses to identify indicators of systemic risk. We map these hypotheses into a two-stage hierarchical test which combines insights from the early-warning literature on financial crises with recent advances on growth-at-risk. Applying it to a set of candidate variables, we find that the Basel III credit-to-GDP gap does not serve the goal of coherently indicating systemic risk across the panel of G7 countries. A composite financial cycle measure does indicate systemic risk up to three years ahead, but its single components like credit growth or house price growth do not pass our test. Our results suggest that, by smoothing the financial cycle, pre-emptive countercyclical macroprudential policy may address vulnerability episodes in boom phases, which then mitigates systemic risk in the future.
Investor Attention and Asset Pricing Anomalies
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We comprehensively examine the relation between investor attention and widely studied financial market anomalies. We find that anomaly-based arbitrage strategies generate greater abnormal returns following days of high investor attention. This result is robust after controlling for risk factors and in a natural experiment setting in which the rounding of stock prices generates exogenous variations in investor attention. We further document that large-order imbalances are consistent with arbitrageurs' trading more aggressively on anomalies following days of high investor attention. The evidence supports the hypothesis that investor attention serves as a coordination device for arbitrageurs who face synchronicity risk.
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We comprehensively examine the relation between investor attention and widely studied financial market anomalies. We find that anomaly-based arbitrage strategies generate greater abnormal returns following days of high investor attention. This result is robust after controlling for risk factors and in a natural experiment setting in which the rounding of stock prices generates exogenous variations in investor attention. We further document that large-order imbalances are consistent with arbitrageurs' trading more aggressively on anomalies following days of high investor attention. The evidence supports the hypothesis that investor attention serves as a coordination device for arbitrageurs who face synchronicity risk.
Me Too: Does Workplace Sexual Harassment Hurt Firm Value?
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We investigate the impact of workplace sexual harassment on firm value. We estimate the incidence of sexual harassment in U.S. firms through textual analysis of employees’ online job reviews, and find that a high sexual harassment score leads to lower future stock returns. During 2011-2017, the value-weighted portfolio of firms in the top quantiles (top 1% to 5%) of the SH score earned a five-factor annualized alpha ranging from -8.7% to -23.6%, or an annual shareholder value loss of $1.0 billion to $2.4 billion per harassment-prone firm. We also find evidence that high sexual harassment scores are associated with sharp declines in operating profitability and increases in labor costs. These results indicate that sexual harassment has a strong damaging impact on firm value, but investors are not fully aware of the costs of sexual harassment.
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We investigate the impact of workplace sexual harassment on firm value. We estimate the incidence of sexual harassment in U.S. firms through textual analysis of employees’ online job reviews, and find that a high sexual harassment score leads to lower future stock returns. During 2011-2017, the value-weighted portfolio of firms in the top quantiles (top 1% to 5%) of the SH score earned a five-factor annualized alpha ranging from -8.7% to -23.6%, or an annual shareholder value loss of $1.0 billion to $2.4 billion per harassment-prone firm. We also find evidence that high sexual harassment scores are associated with sharp declines in operating profitability and increases in labor costs. These results indicate that sexual harassment has a strong damaging impact on firm value, but investors are not fully aware of the costs of sexual harassment.
Non-Salient Fees in the Mortgage Market
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This paper studies supply-side product pricing when consumers underreact to non-salient fees. Using comprehensive data on issued and offered mortgages in the UK, I document that lenders differ substantially in the fees they charge, and that borrowers appear less overall cost-sensitive to products with fees. In order to distinguish from demand factors such as unobservable preferences or product characteristics, I show that lenders pass on firm-specific funding cost shocks via fees, but not interest rates, consistent with strategic pricing of fees, and maintaining competitive prices in the salient price dimension, interest rates. I further find heterogeneity in pricing across lenders: those who rely on high fees tend to have higher funding cost, lower return on equity and larger branch networks, in line with a specialization equilibrium in which high-cost lenders are able to match with less cost-sensitive consumers.
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This paper studies supply-side product pricing when consumers underreact to non-salient fees. Using comprehensive data on issued and offered mortgages in the UK, I document that lenders differ substantially in the fees they charge, and that borrowers appear less overall cost-sensitive to products with fees. In order to distinguish from demand factors such as unobservable preferences or product characteristics, I show that lenders pass on firm-specific funding cost shocks via fees, but not interest rates, consistent with strategic pricing of fees, and maintaining competitive prices in the salient price dimension, interest rates. I further find heterogeneity in pricing across lenders: those who rely on high fees tend to have higher funding cost, lower return on equity and larger branch networks, in line with a specialization equilibrium in which high-cost lenders are able to match with less cost-sensitive consumers.
Oil Prices and Stock Market Anomalies
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This paper examines the relationship between oil prices and stock market anomalies in China, the largest oil importer country in the world. Prior literature documents both a positive and negative relationship between oil prices and the stock market. The explanation of a positive relationship is supported by the argument that rising oil prices are interpreted as a positive signal by investors, especially when the rise in oil prices is associated with a higher demand for oil. Consequently, rising oil prices lead stock prices above their fundamental values and that they subsequently correct. Therefore, we hypothesise that stock market anomalies are stronger following rising oil prices when the rise in oil prices is due to the higher demand for oil since returns associated with anomalies reflect mispricing. The results, consistent with the hypothesis, show stronger return predictability for individual anomalies following an increase in oil prices than for a decrease in oil prices. The results are even stronger once we construct a mispricing score based on composite mispricing of all the anomalies.
SSRN
This paper examines the relationship between oil prices and stock market anomalies in China, the largest oil importer country in the world. Prior literature documents both a positive and negative relationship between oil prices and the stock market. The explanation of a positive relationship is supported by the argument that rising oil prices are interpreted as a positive signal by investors, especially when the rise in oil prices is associated with a higher demand for oil. Consequently, rising oil prices lead stock prices above their fundamental values and that they subsequently correct. Therefore, we hypothesise that stock market anomalies are stronger following rising oil prices when the rise in oil prices is due to the higher demand for oil since returns associated with anomalies reflect mispricing. The results, consistent with the hypothesis, show stronger return predictability for individual anomalies following an increase in oil prices than for a decrease in oil prices. The results are even stronger once we construct a mispricing score based on composite mispricing of all the anomalies.
Shock Waves and Golden Shores: The Asymmetric Interaction between Gold Prices and the Stock Market
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Gold is often considered a safe haven asset providing negative return correlation with the stock market in times of distress, while in more calm periods the correlation between the two is close to zero. We study the dynamic inter-linkage of gold prices and the stock market. Specifically, we model the log-prices of gold and a stock index as jump-diffusive processes, with the jumps arriving with mutually exciting intensities. Hence, the occurrence of a negative shock to the stock index spills over into a higher probability of positive shocks to the gold price and vice versa. To perform the empirical analysis, we consider daily data on gold prices and daily closing prices on the SPX index. Utilizing the knowledge that the moment conditions of the model are computed efficiently in closed form, we use the generalized method of moments to estimate the parameters of the model. We document the existence of cross-excitation between the stock index and gold prices, with the channel from the stock index to gold prices being the most pronounced. Finally, we study the power of the proposed jump model to predict future price jumps and find good performance.
SSRN
Gold is often considered a safe haven asset providing negative return correlation with the stock market in times of distress, while in more calm periods the correlation between the two is close to zero. We study the dynamic inter-linkage of gold prices and the stock market. Specifically, we model the log-prices of gold and a stock index as jump-diffusive processes, with the jumps arriving with mutually exciting intensities. Hence, the occurrence of a negative shock to the stock index spills over into a higher probability of positive shocks to the gold price and vice versa. To perform the empirical analysis, we consider daily data on gold prices and daily closing prices on the SPX index. Utilizing the knowledge that the moment conditions of the model are computed efficiently in closed form, we use the generalized method of moments to estimate the parameters of the model. We document the existence of cross-excitation between the stock index and gold prices, with the channel from the stock index to gold prices being the most pronounced. Finally, we study the power of the proposed jump model to predict future price jumps and find good performance.
Should All Blockchain-Based Digital Assets be Classified under the Same Asset Class?
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It is predicted that blockchain will become commonplace in the near future. Currently, various blockchain-related projects have been implemented. Many of them involved the creation and deployment of the digital assets. Although, it is reasonably accepted that these blockchain-based digital assets should constitute a new asset class, the literature has been rather silent about the distinction among them and whether each type of them should be classified under the same or different asset classes. The paper contributes to the literature by pointing out that each type of the blockchain-based digital assets (in this case, the digital tokens) differ in the way they are created and initially distributed. Although currently, most of them are treated indistinguishably in the secondary markets by the market participants, some of them do have distinguishable risk and return profiles. The authors take a view that these digital tokens take (or will take) different roles in the financial system and thus should be classified under different asset classes. They should be subject to different sets of regulations (although some may overlap) and perhaps by different regulators.
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It is predicted that blockchain will become commonplace in the near future. Currently, various blockchain-related projects have been implemented. Many of them involved the creation and deployment of the digital assets. Although, it is reasonably accepted that these blockchain-based digital assets should constitute a new asset class, the literature has been rather silent about the distinction among them and whether each type of them should be classified under the same or different asset classes. The paper contributes to the literature by pointing out that each type of the blockchain-based digital assets (in this case, the digital tokens) differ in the way they are created and initially distributed. Although currently, most of them are treated indistinguishably in the secondary markets by the market participants, some of them do have distinguishable risk and return profiles. The authors take a view that these digital tokens take (or will take) different roles in the financial system and thus should be classified under different asset classes. They should be subject to different sets of regulations (although some may overlap) and perhaps by different regulators.
The Dark Side of Low Financial Reporting Frequency: Investors’ Reliance on Alternative Sources of Earnings News and Excessive Information Spillovers
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This paper examines how low financial reporting frequency affects investors’ reliance on alternative sources of earnings information. We find that the returns of semi-annual earnings announcers (i.e. low reporting frequency stocks, “LRFâ€) are almost twice as sensitive to the earnings announcement returns of US industry bellwether peers for non-reporting periods compared to reporting periods. Strikingly, these heightened spillovers are followed by return reversals when investors finally observe own-firm earnings at the subsequent semi-annual earnings announcement. This indicates that investors periodically overreact to peer-firm earnings news in the absence of own-firm earnings disclosures in interim periods. We also find elevated price volatility and trading volume, around these announcements for non-reporting periods, consistent with theories of investor overconfidence. Collectively, our results suggest that investors are unable to successfully offset the information loss arising from low reporting frequency, thus impairing their ability to value firms and adversely affecting the quality of financial markets.
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This paper examines how low financial reporting frequency affects investors’ reliance on alternative sources of earnings information. We find that the returns of semi-annual earnings announcers (i.e. low reporting frequency stocks, “LRFâ€) are almost twice as sensitive to the earnings announcement returns of US industry bellwether peers for non-reporting periods compared to reporting periods. Strikingly, these heightened spillovers are followed by return reversals when investors finally observe own-firm earnings at the subsequent semi-annual earnings announcement. This indicates that investors periodically overreact to peer-firm earnings news in the absence of own-firm earnings disclosures in interim periods. We also find elevated price volatility and trading volume, around these announcements for non-reporting periods, consistent with theories of investor overconfidence. Collectively, our results suggest that investors are unable to successfully offset the information loss arising from low reporting frequency, thus impairing their ability to value firms and adversely affecting the quality of financial markets.
The Impact of Brexit on UK Firms
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We use a major new survey of UK firms, the Decision Maker Panel, to assess the impact of the June 2016 Brexit referendum. We identify three key results. First, the UK’s decision to leave the EU has generated a large, broad and long-lasting increase in uncertainty. Second, anticipation of Brexit is estimated to have gradually reduced investment by about 11% over the three years following the June 2016 vote. This fall in investment took longer to occur than predicted at the time of the referendum, suggesting that the size and persistence of this uncertainty may have delayed firms’ response to the Brexit vote. Finally, the Brexit process is estimated to have reduced UK productivity by between 2% and 5% over the three years after the referendum. Much of this drop is from negative within-firm effects, in part because firms are committing several hours per week of top-management time to Brexit planning. We also find evidence for smaller negative between-firm effects as more productive, internationally exposed, firms have been more negatively impacted than less productive domestic firms
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We use a major new survey of UK firms, the Decision Maker Panel, to assess the impact of the June 2016 Brexit referendum. We identify three key results. First, the UK’s decision to leave the EU has generated a large, broad and long-lasting increase in uncertainty. Second, anticipation of Brexit is estimated to have gradually reduced investment by about 11% over the three years following the June 2016 vote. This fall in investment took longer to occur than predicted at the time of the referendum, suggesting that the size and persistence of this uncertainty may have delayed firms’ response to the Brexit vote. Finally, the Brexit process is estimated to have reduced UK productivity by between 2% and 5% over the three years after the referendum. Much of this drop is from negative within-firm effects, in part because firms are committing several hours per week of top-management time to Brexit planning. We also find evidence for smaller negative between-firm effects as more productive, internationally exposed, firms have been more negatively impacted than less productive domestic firms
The Role and Involvement of the State in the Insurance Market â€" The Insurance Market in a European and National Context
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The emergence of insurance is related to the need for people to help each other in the case of the ever increasing damages, and of the reinsurance to support among them those who manage the insurance funds and activities. In the context of the market economy, of the current challenges at global level (such as climate change), insurance is a segment of services, having multiple valences. Their fundamental role is to protect goods and people against different risks. The man has always been concerned about the future, and the fear combined with caution has led him to create insurance since ancient times. The insurance market is the organizational and methodological framework in which the insurance operations are carried out. In this market are met: the insurance request, which comes from the natural and legal insurable persons, as beneficiaries of the insurance and who choose to conclude various types of insurance and the insurance offer, supported by specialized organizations, authorized to operate in this field and capable under financial report to carry out such activity. Moreover, given that insurance is one of the financial instruments supporting the safety and security of the individual and of businesses at a global level.
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The emergence of insurance is related to the need for people to help each other in the case of the ever increasing damages, and of the reinsurance to support among them those who manage the insurance funds and activities. In the context of the market economy, of the current challenges at global level (such as climate change), insurance is a segment of services, having multiple valences. Their fundamental role is to protect goods and people against different risks. The man has always been concerned about the future, and the fear combined with caution has led him to create insurance since ancient times. The insurance market is the organizational and methodological framework in which the insurance operations are carried out. In this market are met: the insurance request, which comes from the natural and legal insurable persons, as beneficiaries of the insurance and who choose to conclude various types of insurance and the insurance offer, supported by specialized organizations, authorized to operate in this field and capable under financial report to carry out such activity. Moreover, given that insurance is one of the financial instruments supporting the safety and security of the individual and of businesses at a global level.
Underwriter Certification, Issuer-Underwriter Matching, and SEO Performance
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The introduction of deal types for issues of seasoned equity in which the offer follows quickly after the announcement highlights the role of underwriter certification in the performance of SEOs. Controlling for the matching between underwriters and issuing firms, we find that the quality of the underwriter has a positive relation to the market's response to the announcement of these accelerated SEOs. For the accelerated and bought deals, the discount of the offer price from the closing price the day before the offering (which represents a cost to the issuing firm) is significantly negatively related to underwriter quality. For fully marketed deals, however, these relationships are not significant. Issuing firms pay for the value provided by higher quality underwriters in the form of higher total fees.
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The introduction of deal types for issues of seasoned equity in which the offer follows quickly after the announcement highlights the role of underwriter certification in the performance of SEOs. Controlling for the matching between underwriters and issuing firms, we find that the quality of the underwriter has a positive relation to the market's response to the announcement of these accelerated SEOs. For the accelerated and bought deals, the discount of the offer price from the closing price the day before the offering (which represents a cost to the issuing firm) is significantly negatively related to underwriter quality. For fully marketed deals, however, these relationships are not significant. Issuing firms pay for the value provided by higher quality underwriters in the form of higher total fees.
