Research articles for the 2019-08-22

(Systemic) Risk-taking in the Euro Area Investment Fund Industry
Jin, Xisong,Nadal De Simone, Francisco
Abundant references to threats to financial stability likely posed by (systemic) risk-taking in the euro area investment fund industry in an era of historically persistent low interest rates have not been accompanied by robust supportive empirical evidence. This is the first study that assesses the effects of euro area conventional and unconventional monetary policy shocks on coherent systemic risk measures applied to the investment fund industry. This research finds evidence of systemic risk-taking notably in the forms of both contagion and increased vulnerability. It underpins the need to recognize and measure interconnectedness and contagion in systemic risk measurement. There is heterogeneity in the results as the investment focus is important for assessing investment funds’ contribution to systemic risk. Fund types most affected by significant systemic risk-taking are bond funds, mixed funds and real estate funds. Some evidence of heightened vulnerability in equity funds is also present. Overall, growth rates in assets managed tend to move in tandem with systemic risk-taking. Increases in leverage are part of the risk-taking mechanism under conventional monetary policy shocks. The main policy implication is that persistently accommodative monetary policy geared toward preserving price stability may face a trade-off with financial stability, making it necessary to coordinate monetary and macro-prudential policies.

A Supply and Demand Approach to Equity Pricing
Betermier, Sebastien,Calvet, Laurent E.,Jo, Evan
This paper presents a frictionless neoclassical model of financial markets in which firm sizes, stock returns, and the pricing kernel are all endogenously determined. The model parsimoniously specifies the supply and demand of financial capital allocated to each firm and provides general equilibrium sizes and returns in closed form. We show that the interaction of supply and demand can coherently explain a large number of asset pricing facts. The equilibrium security market line is flatter than the CAPM predicts and can be nonlinear or downward-sloping. The model also generates the size, profitability, investment growth, value, asymmetric volatility, betting-against-beta, and betting-against-correlation anomalies, while also fitting the cross-section of firm characteristics.

Analyzing order flows in limit order books with ratios of Cox-type intensities
Ioane Muni Toke,Nakahiro Yoshida

We introduce a Cox-type model for relative intensities of orders flows in a limit order book. The model assumes that all intensities share a common baseline intensity, which may for example represent the global market activity. Parameters can be estimated by quasi likelihood maximization, without any interference from the baseline intensity. Consistency and asymptotic behavior of the estimators are given in several frameworks, and model selection is discussed with information criteria and penalization. The model is well-suited for high-frequency financial data: fitted models using easily interpretable covariates show an excellent agreement with empirical data. Extensive investigation on tick data consequently helps identifying trading signals and important factors determining the limit order book dynamics. We also illustrate the potential use of the framework for out-of-sample predictions.

Anchoring on Historical High Prices and Seasoned Equity Offerings
Hovakimian, Armen,Hu, Huajing
We document that firms’ financing decisions are affected by historical high prices. The ratio of the monthly high price to the 12-month historical high price positively affects the probability of a Seasoned Equity Offering (SEO). Furthermore, the post-announcement market reaction is muted and the offering discount is smaller if the pre-announcement stock price is high relative to its historical high price. The results suggest that historical high price reference points may help managers rationally time SEOs to take advantage of market reception and minimize issuance costs.

Bank Profits and Margins in a World of Negative Rates
Molyneux, Philip,Reghezza, Alessio,Xie, Ru
By investigating the influence of negative interest rate policy (NIRP) on bank margins and profitability, this paper identifies country- and bank- specific characteristics that amplify or weaken the effect of NIRP on bank performance. Using a dataset comprising 7,359 banks from 33 OECD member countries over 2012-2016 and a difference-in-differences methodology, we find that bank margins and profits fell in NIRP-adopter countries compared to countries that did not adopt the policy. Moreover, this adverse NIRP effect depends on bank specific-characteristics such as size, funding structure, business models, assets repricing and product-line specialization. The effectiveness of the pass-through mechanism of NIRP can also be affected by the characteristics of a country's banking system, namely, the level of competition and the prevalence of fixed/floating lending rates.

CEO Overconfidence and Corporate Environmental Performances
Qin, Botao
This paper analyzes the impact of managerial attributes such as overconfidence on firms' environmental performance. We hypothesize that overconfident CEOs tend to underestimate firms' environmental risk leading to a low level of ex-ante environmental safeguards and hence, lower environmental performance. We test our hypothesis by using Newsweek green ranking 500 companies from 2014-2016. The results support overconfident executives tend to have lower environmental scores.

Capital Regulation under Price Impacts and Dynamic Financial Contagion
Zachary Feinstein

We construct a continuous time model for price-mediated contagion precipitated by a common exogenous stress to the banking book of all firms in the financial system. In this setting, firms are constrained so as to satisfy a risk-weight based capital ratio requirement. We use this model to find analytical bounds on the risk-weights for assets as a function of the market liquidity. Under these appropriate risk-weights, we find existence and uniqueness for the joint system of firm behavior and the asset prices. We further consider an analytical bound on the firm liquidations, which allows us to construct exact formulas for stress testing the financial system with deterministic or random stresses. Numerical case studies are provided to demonstrate various implications of this model and analytical bounds.

Catering and Dividend Policy: Evidence From the Netherlands Over the Twentieth Century
de Jong, Abe,, Philip Fliers,van Beusichem, Henry
This paper investigates the determinants of Dutch firms’ dividend policies in the 20th century. We identify three distinct episodes and document shifts in dividend policies in the 1930s and 1980s, because firm managers cater to the changing preferences of shareholders. The first episode, prior to the Second World War, was characterized by dividends that were fixed contracts between shareholder and management and the payouts were mechanically determined by earnings. The second epoch of Dutch dividend policy, until the 1980s, was characterized by dividend smoothing. Dividends were still strongly related to earnings, but because of shareholder’s preferences for stable dividend income, earnings changes are incorporated in dividends with a lag. Finally, dividend policy in the most recent episode is inspired by shareholder wealth maximization, based on agency and signalling motives. In this period, dividends have become largely decoupled from earnings.

Compact Finite Difference Scheme with Hermite Interpolation for Pricing American Put Options Based on Regime Switching Model
Chinonso Nwankwo,Weizhong Dai,Ruihua Liu

We consider a system of coupled free boundary problems for pricing American put options with regime switching. To solve this system, we first fix the optimal exercise boundary for each regime resulting in multi-variable fixed domains. We further eliminate the first order derivatives associated with the regime switching model by taking derivatives to obtain a system of coupled partial differential equations which we called the asset-delta-gamma-speed option equations. The fourth-order compact finite difference scheme and Gauss-Seidel iterative method are then employed in each regime for solving the system of the equations. In particular, the third order Hermite interpolation technique is used for estimating the coupled asset and delta options in the set of equations. The numerical method is finally tested with several examples. Our results show that the scheme provides an accurate solution with the convergent rate in space of 2.44 and the rate in time of 1.86, which is accurate and fast in computation as compared with other existing numerical methods.

Cryptocurrencies, Currency Competition, and the Impossible Trinity
Benigno, Pierpaolo,Schilling, Linda,Uhlig, Harald
We analyze a two-country economy with complete markets, featuring two national currencies as well as a global (crypto)currency. If the global currency is used in both countries, the national nominal interest rates must be equal and the exchange rate between the national currencies is a risk-adjusted martingale. We call this result Crypto-Enforced Monetary Policy Synchronization (CEMPS). Deviating from interest equality risks approaching the zero lower bound or the abandonment of the national currency. If the global currency is backed by interest-bearing assets, additional and tight restrictions on monetary policy arise. Thus, the classic Impossible Trinity becomes even less reconcilable.

Does Sentiment Harm Market Efficiency? An Empirical Analysis Using a Betting Exchange Setting
Merz, Oliver,Flepp, Raphael,Franck, Egon P.
This paper investigates whether the sentimental preferences of investors influence market efficiency. We use a betting exchange market environment to analyze the influence of sentimental bettors on market efficiency in 2,333 soccer matches played between 2006-2014 during the last three hours of the pre-play period. Contrary to bookmaker markets, there is no intermediary in a betting exchange and, thus, the market prices solely reflect the beliefs of person to person betting. We use three different proxy variables to measure the bettor sentiment and find that price changes are more likely to be inefficient for betting events that are more prone to sentiment. Based on that finding, we propose a trading strategy that generates positive returns before considering the transaction costs and commission fees. Although the returns turn negative after considering the transaction costs and commission fees, the proposed trading strategy still outperforms a random betting strategy.

Factor Investing in Corporate Bond Markets: Enhancing Efficacy Through Diversification and Purification!
Heckel, Thomas,Amghar, Zine,Haik, Isaac,Laplenie, Olivier,Carvalho, Raul Leote de
We show that factors from value, quality, low risk and momentum styles play an important role in explaining the cross-section of corporate bond expected returns for the U.S. and Euro Investment Grade and U.S. BB-B non-Financial High Yield universes. We demonstrate the importance of purifying factor data by neutralizing a number of risk biases that are present in the factors: controlling for sectors, option-adjusted spread (OAS), duration and size biases significantly increases the predictive power of style factors. We propose a new simple approach for efficiently neutralizing the biases from multiple risk variables and demonstrate its superiority relative to stratified sampling and optimization as alternative control methods. We also measure the added value from diversifying the number of factors in each style. Finally, we show that the results are robust in relation to transaction costs and can be used to design strategies that aim at outperforming traditional benchmark indexes.

Forecasting e-scooter competition with direct and access trips by mode and distance in New York City
Mina Lee,Joseph Y. J. Chow,Gyugeun Yoon,Brian Yueshuai He

Given the lack of demand forecasting models for e-scooter sharing systems, we address this research gap using data from Portland, OR, and New York City. A log-log regression model is estimated for e-scooter trips based on user age, income, labor force participation, and health insurance coverage, with an adjusted R squared value of 0.663. When applied to the Manhattan market, the model predicts 66K daily e-scooter trips, which would translate to 67 million USD in annual revenue (based on average 12-minute trips and historical fare pricing models). We propose a novel nonlinear, multifactor model to break down the number of daily trips by the alternate modes of transportation that they would likely substitute. The final model parameters reveal a relationship with taxi trips as well as access/egress trips with public transit in Manhattan. Our model estimates that e-scooters would replace at most 1% of taxi trips; the model can explain $800,000 of the annual revenue from this competition. The distance structure of revenue from access/egress trips is found to differ significantly from that of substituted taxi trips.

Impact of Transparency and Accountability of Church Financial Reporting on the Interest of Members’ Church Giving Donations to Church
Munte, Mei,Dongoran, Debora
This research aims to determine the impact of transparency and accountability of the church's financial reporting on the interest of the congregation to donate to the church. However, the transparency and accountability of church finance reporting is something that absolutely must be done to keep the faith of the congregation. Management of church finances that are not transparent and accountable will be able to cause problems in the future between the congregation and the church administrators so that among the congregation itself. The sample used is determined based on the criteria of ever donating more than the amount set by the church and has been a member of the church for at least three years. So the sample is 150 people congregation spread in seven wik. Methods of data analysis used are the classical assumption test, hypothesis test and multiple regression analysis with the help of computer program SPSS version 20.0. The results show that partially transparency has a negative effect while accountability has a positive effect on the interest of the congregation to donate to the church. And, after simultaneous testing, the results show that both simultaneously affect the congregation's interest in donating to the church. Transparency is not an element that can influence the interest of the congregation to donate to the church. Accountability of financial reporting influences the interest of the congregation because this variable is still important for the congregation to know the financial accountability of the church for the congregations’ donation.

Implementing result-based agri-environmental payments by means of modelling
Bartosz Bartkowski,Nils Droste,Mareike Ließ,William Sidemo-Holm,Ulrich Weller,Mark V. Brady

From a theoretical point of view, result-based agri-environmental payments are clearly preferable to action-based payments. However, they suffer from two major practical disadvantages: costs of measuring the results and payment uncertainty for the participating farmers. In this paper, we propose an alternative design to overcome these two disadvantages by means of modelling (instead of measuring) the results. We describe the concept of model-informed result-based agri-environmental payments (MIRBAP), including a hypothetical example of payments for the protection and enhancement of soil functions. We offer a comprehensive discussion of the relative advantages and disadvantages of MIRBAP, showing that it not only unites most of the advantages of result-based and action-based schemes, but also adds two new advantages: the potential to address trade-offs among multiple policy objectives and management for long-term environmental effects. We argue that MIRBAP would be a valuable addition to the agri-environmental policy toolbox and a reflection of recent advancements in agri-environmental modelling.

Institutional Ownership Decomposition and Stock Market Returns
Bulsiewicz, James
Evidence presented in Dasgupta et al. (2011) indicates that financial institutions can be net buyers or sellers of a stock over consecutive quarters, implying the existence of trends in a stock’s institutional ownership. I investigate the relation between institutional ownership and returns after controlling for trends by decomposing a stock’s institutional ownership into level, slope, and residual components. I find that the level, slope, and residual components have, respectively, positive but relatively weak, strongly positive, and strongly negative relations with returns. These relations are strongest within arbitrage-constrained stocks and are the result of financial institutions investing and actively managing their equity positions based on differences and changes in underlying firm fundamentals.

Intra-day Equity Price Prediction using Deep Learning as a Measure of Market Efficiency
David Byrd,Tucker Hybinette Balch

In finance, the weak form of the Efficient Market Hypothesis asserts that historic stock price and volume data cannot inform predictions of future prices. In this paper we show that, to the contrary, future intra-day stock prices could be predicted effectively until 2009. We demonstrate this using two different profitable machine learning-based trading strategies. However, the effectiveness of both approaches diminish over time, and neither of them are profitable after 2009. We present our implementation and results in detail for the period 2003-2017 and propose a novel idea: the use of such flexible machine learning methods as an objective measure of relative market efficiency. We conclude with a candidate explanation, comparing our returns over time with high-frequency trading volume, and suggest concrete steps for further investigation.

Is the Disposition Effect in Bonds As Strong As in Stocks? Evidence From an Emerging Market
Hincapié, Juliana,Agudelo, Diego
Does the disposition effect appear in bond trades as in stocks?. We apply the Odean’s measure (1998) to a proprietary transaction database with unique investor ids from an emerging market exchange that holds both stock and bond trading. We find some disposition effect in treasuries, but much lower than in stocks, and a positive relation between the two measures by investor. In addition, we find a significant disposition effect for local individuals and family offices, in both markets. In contrast, long-term institutions, brokerage firms, and foreign investors do not exhibit this bias. The bias is negatively correlated to trader experience and sophistication in both markets. This is the first study to report evidence of the disposition effect in a fixed-income market.

Linkages and systemic risk in the European insurance sector: Some new evidence based on dynamic spanning trees
Anna Denkowska,Stanisław Wanat

This paper is part of the research on the interlinkages between insurers and their contribution to systemic risk on the insurance market. Its main purpose is to present the results of the analysis of linkage dynamics and systemic risk in the European insurance sector which are obtained using correlation networks. These networks are based on dynamic dependence structures modelled using a copula. Then, we determine minimum spanning trees (MST). Finally, the linkage dynamics is described by means of selected topological network measures.

Market Making with Alpha Signals
Cartea, Álvaro,Wang, Yixuan
We show how a market maker employs information about the momentum in the price of the asset (i.e., alpha signal) to make decisions in her liquidity provision strategy in an order driven electronic market. The momentum in the midprice of the asset depends on the execution of liquidity taking orders and the arrival of news. Buy (resp. sell) market orders (MOs) exert a short-lived upward (resp. downward) pressure on the midprice. We employ Nasdaq high-frequency data to estimate model parameters and to illustrate the performance of the market making strategy. The market maker employs the alpha signal to minimise adverse selection costs, execute directional trades in anticipation of price changes, and to manage inventory risk. As the market maker increases her tolerance to inventory risk, the expected profits that stem from the alpha signal increase because the strategy employs more speculative MOs and performs more roundtrip trades with limit orders.

Moral Licensing and Socially Responsible Investment Decisions
Brunen, Ann-Christine
Does an individual's (un)conscious consumer behavior reveal his appreciation of a socially responsible investment? To explore how socially responsible behavior as consumer and investor relate to each other, I combine 287 investors' portfolio data with proxies evaluating their responsible consumer behavior derived from a one-year consumption record. I observe inconsistent behavior, finding that conscious consumers are not socially responsible investors. Rather than mistrusting socially responsible investments (SRI) or refusing to delegate investment decisions to fund managers in the first place, conscious consumers' moral credits seem to best explain these results. Assuming that an individual's morality and accompanying willingness to pay a price-premium are limited, conscious consumers can draw on moral credits when optimizing their portfolio under purely financial considerations. Less conscious consumers, on the contrary, purchase a letter of indulgence by complementing their portfolio with an SRI fund. This paper aims to improve the understanding of socially responsible investors' non-financial motives.

On the K\"ahler Geometry of Certain Optimal Transport Problems
Gabriel Khan,Jun Zhang

Let $X$ and $Y$ be domains of $\mathbb{R}^n$ equipped with respective probability measures $\mu$ and $ \nu$. We consider the problem of optimal transport from $\mu$ to $\nu$ with respect to a cost function $c: X \times Y \to \mathbb{R}$. To ensure that the solution to this problem is smooth, it is necessary to make several assumptions about the structure of the domains and the cost function. In particular, Ma, Trudinger, and Wang established regularity estimates when the domains are strongly \textit{relatively $c$-convex} with respect to each other and cost function has non-negative \textit{MTW tensor}. For cost functions of the form $c(x,y)= \Psi(x-y)$ for some convex function $\Psi$, we find an associated K\"ahler manifold whose orthogonal anti-bisectional curvature is proportional to the MTW tensor. We also show that relative $c$-convexity geometrically corresponds to geodesic convexity with respect to a dual affine connection. Taken together, these results provide a geometric framework for optimal transport which is complementary to the pseudo-Riemannian theory of Kim and McCann.

We provide several applications of this work. In particular, we find a complete K\"ahler surface with non-negative orthogonal bisectional curvature that is not a Hermitian symmetric space or biholomorphic to $\mathbb{C}^2$. We also address a question in mathematical finance raised by Pal and Wong on the regularity of \textit{pseudo-arbitrages}, or investment strategies which outperform the market.

Optimal Disclosure Regulation for Entrepreneurial Public Financing with Post-Financing Moral Hazard
Lyu, Chen
This paper studies optimal disclosure regulation for entrepreneurial public financing with post-financing moral hazard problem. I show that partial disclosure can improve social welfare over full disclosure through reducing efficiency loss caused by the moral hazard problem. As a result, a properly designed partial disclosure rule would be optimal without assuming any disclosure cost. This remains true after allowing for endogenous entrepreneur types with adverse selection concerns. With (constrained) Bayesian persuasion tools, the optimal disclosure rule is fully characterized. Although the paper is developed mainly around entrepreneur equity financing, its intuition is more generally applicable. For instance, I also adapt the basic model to debt financing and an application to banking system disclosure is provided.

Option Pricing in Regime-Switching Frameworks With the Extended Girsanov Principle
Godin, Frédéric,Trottier, Denis-Alexandre
The recent work of Godin et al. (2019) on derivatives pricing under regime-switching frameworks highlights that traditional pricing methods produce path-dependent prices for vanilla options when regimes are latent. Since such a feature is deemed inconvenient, the latter paper provides the construction of several risk-neutral measures circumventing this problem so as to yield path-independent pricing. The current paper aims at complementing the work of Godin et al. (2019) by providing the construction of an additional risk-neutral measure based on the Extended Girsanov Principle (EGP) which also purges the path-dependence effect. The advantage of the EGP approach lies in its implementation simplicity and its clear interpretability in terms of consistency with hedging agents locally minimizing their risk-adjusted discounted squared hedging errors.

Predictable End-of-Month Treasury Returns
Hartley, Jonathan,Schwarz, Krista
We document a distinct pattern in the timing of excess returns on coupon Treasury securities. Average returns are positive and highly significant in the last few days of the month, and are not significantly different from zero at other times. A long Treasury position for just the last few days of each month gives a high annualized Sharpe ratio of around 1. We attribute this pattern to window dressing and portfolio rebalancing. We find evidence in quantities that aggregate insurer transactions contribute to the end-of-month price pattern. In particular life insurers are large net buyers of Treasury securities on benchmark index rebalancing dates.

Quantitative portfolio selection: using density forecasting to find consistent portfolios
N. Meade,J.E. Beasley,C.J. Adcock

In the knowledge that the ex-post performance of Markowitz efficient portfolios is inferior to that implied ex-ante, we make two contributions to the portfolio selection literature. Firstly, we propose a methodology to identify the region of risk-expected return space where ex-post performance matches ex-ante estimates. Secondly, we extend ex-post efficient set mathematics to overcome the biases in the estimation of the ex-ante efficient frontier. A density forecasting approach is used to measure the accuracy of ex-ante estimates using the Berkowitz statistic, we develop this statistic to increase its sensitivity to changes in the data generating process. The area of risk-expected return space where the density forecasts are accurate, where ex-post performance matches ex-ante estimates, is termed the consistency region. Under the 'laboratory' conditions of a simulated multivariate normal data set, we compute the consistency region and the estimated ex-post frontier. Over different sample sizes used for estimation, the behaviour of the consistency region is shown to be both intuitively reasonable and to enclose the estimated ex-post frontier. Using actual data from the constituents of the US Dow Jones 30 index, we show that the size of the consistency region is time dependent and, in volatile conditions, may disappear. Using our development of the Berkowitz statistic, we demonstrate the superior performance of an investment strategy based on consistent rather than efficient portfolios.

Quantum Algorithms for Portfolio Optimization
Iordanis Kerenidis,Anupam Prakash,Dániel Szilágyi

We develop the first quantum algorithm for the constrained portfolio optimization problem. The algorithm has running time $\widetilde{O} \left( n\sqrt{r} \frac{\zeta \kappa}{\delta^2} \log \left(1/\epsilon\right) \right)$, where $r$ is the number of positivity and budget constraints, $n$ is the number of assets in the portfolio, $\epsilon$ the desired precision, and $\delta, \kappa, \zeta$ are problem-dependent parameters related to the well-conditioning of the intermediate solutions. If only a moderately accurate solution is required, our quantum algorithm can achieve a polynomial speedup over the best classical algorithms with complexity $\widetilde{O} \left( \sqrt{r}n^\omega\log(1/\epsilon) \right)$, where $\omega$ is the matrix multiplication exponent that has a theoretical value of around $2.373$, but is closer to $3$ in practice. We also provide some experiments to bound the problem-dependent factors arising in the running time of the quantum algorithm, and these experiments suggest that for most instances the quantum algorithm can potentially achieve an $O(n)$ speedup over its classical counterpart.

Re-Shaping Demand Landscapes: How Firms Change Customer Preferences to Better Fit Their Products
Vinokurova, Natalya
What strategies do firms use to change their customers’ preferences? This paper addresses this question by developing a conceptual model that combines the representation of customer preferences as a demand landscape with research on marketing and psychology. I suggest that in addition to repositioning their products to accommodate customer preferences, firms also change the distribution of customer preferences to accommodate the firms’ products. Specifically, I argue that firms alter customer preferences by adding, removing, and transforming the dimensions of the demand landscape. I illustrate the model with an historical case study of the U.S. market for mortgage-backed securities (MBS) between 1968 and 1987, a period during which MBS issuers succeeded in reshaping the bond demand landscape to promote the acceptance of MBS as bonds.

Reliance on Third Party Verification in Bank Supervision
Gopalan, Yadav,Imdieke, Andy,Schroeder, Joseph H.,Stuber, Sarah
We examine how third party verification of internal controls over financial reporting (ICFR) affects bank supervision by exploiting a change in size thresholds for required FDICIA-related internal control audits. We document that affected banks have higher reported levels of non-performing loans after the removal of internal control audit requirements compared to unaffected banks. This increase in non-performing loans is not accompanied by increases in past due loans, indicating more forthcoming reporting by management rather than operational deterioration. Furthermore, we find that the effects are concentrated in periods of heightened regulatory scrutiny and in banks with less stringent oversight in the pre-period. Examiners increase the length of targeted examinations and downgrade regulatory ratings, indicating an increase in stringency after the elimination of third-party verification of internal controls over financial reporting. Our findings suggest that third-party verification of internal controls is an imperfect substitute for bank supervision and efforts to rely upon externally generated assurance may heighten bank risk.

Shareholder Value(s): Index Fund Activism and the New Millennial Corporate Governance
Barzuza, Michal,Curtis, Quinn,Webber, David H.
The most pressing current debate in corporate governance is whether index funds, now the largest shareholders in many large companies, have incentives to provide effective shareholder oversight. Index funds don’t seek to outperform the market and so, according to critics, cannot be expected to invest in improving shareholder value by disciplining management. Others have highlighted market features that could incentivize index funds to invest in at least some value-enhancing governance activities. The consensus of the literature is that index funds can be expected to engage, at most, in undertaking low-risk, high-value interventions that don’t risk upsetting managers. This Article argues that the current debate is misguided. In focusing on the conventional framework of shareholder value maximization, critics have overlooked that index funds have been outspoken, confrontational, and effective advocates of activist campaigns oriented to social responsibility. We show that these funds have challenged management and voted against directors to advance these ends. Most prominently, index funds have been instrumental in bringing gender diversity to the boards of large companies. They have also been out front in demanding that firms address issues related to sustainability. We argue that this social activism reflects a transformative development: Index funds are locked in a fierce contest to win the soon-to-accumulate assets of the Millennial generation, and, as we show, Millennials place a premium on social values in their investments. Index funds, which have exhausted price competition and cannot compete on performance compete fiercely, we show, in responding to these preferences. The importance of this development should not be understated: The largest pools of assets in our economy are being deployed to advance the social goals of investors using the traditional powers of share ownership. We marshall evidence for this new dynamic, situate it within the existing literature, and consider the implications for the debate over index funds as shareholders and corporate law generally.

The Cost of Anonymous Lemons
Bhide, Amar
Rules that restrict information required in negotiated private transactions have spurred a vast increase in the scope of anonymous financial markets, particularly in the US. The subtle costs of the information restricting rules raise questions about the social value of “completing” anonymous markets that would not naturally survive and did not historically exist.

The Effects of the Volcker Rule on Corporate Bond Trading: Evidence from the Underwriting Exemption
Allahrakha, Meraj,Cetina, Jill,Munyan, Benjamin,Watugala, Sumudu W.
Using a novel within-dealer, within-security identification strategy, we examine intended and unintended effects of the Volcker rule on covered firms' corporate bond trading using dealer-identified regulatory data. We use the underwriting exemption to isolate the Volcker rule's effects separate from other post-crisis changes in bank regulation and broader trends in market liquidity. We find no evidence of the rule's intended reduction in the riskiness of covered firms' trading in corporate bonds. We find significant adverse liquidity effects on covered firms' corporate bond trading with 20-45 basis points higher costs for customers even for roundtrip trades of shorter duration. These effects do not appear to be transitional. The Volcker rule appears to have increased the cost of the liquidity provided by covered firms and has not decreased the liquidity risk exposure of covered firms. Finally, the Volcker rule has decreased the market share of covered firms. Customers appear to be trading more with non-bank dealers, who are exempt from the Volcker rule but also lack access to emergency liquidity support at the Fed's discount window.

The Information Content of ITM-Options for Risk-Neutral Skewness and Informed Trading
Mohrschladt, Hannes,Schneider, Judith C.
While the standard to calculate model-free option-implied skewness (MFIS) relies on out-of-the-money (OTM) options, we examine the empirical implications of using in-the-money (ITM) options. First, we show that discarding ITM-options based on liquidity arguments appears unreasonable for individual stock options. Second, we show that the information content of ITM-options provides new economic insights. The positive short-term return predictability of OTM-based MFIS significantly reverses if ITM-options are used instead. This return pattern allows to better attribute the return predictability of MFIS to superior information of investors embedded in option prices rather than skewness preferences. Based on these findings, we introduce a new measure of sophisticated option trading called Delta-MFIS.

The International Medium of Exchange
Chahrour, Ryan,Valchev, Rosen
We propose a model of endogenous, persistent coordination on the international medium of exchange. An asset becomes the dominant international medium because it is widely held, and remains widely held because it is dominant. The country issuing the dominant asset is a net debtor, but earns an “exorbitant privilege” on its position. In a calibrated model, only steady states with one dominant asset are stable. The dominant country experiences a significant welfare gain, most of which is accrued during its rise to dominance. A mild trade war reduces privilege slightly, while a protracted or deep trade war eliminates it altogether.

The Risk Return Relationship: Evidence from Index Returns and Realised Variances
Yang, Minxian
This paper provides new evidence on the risk return relationship by jointly analysing index return and realised variance (RV) series. It is argued that the contemporaneous correlation (CC) between the return and RV, which has been largely overlooked in the literature, is a crucial component in the empirical risk return relationship. Based on daily and weekly time series from 21 international market indices, the findings support the predictions of the risk premium, volatility feedback and statistical balance. However, little support is found for the short-memory-volatility-component risk premium. It is argued that the empirical risk return relationship is primarily shaped by the CC and the vastly-different autocorrelation structures of the return and RV.

Total positivity and the classification of term structure shapes in the two-factor Vasicek model
Martin Keller-Ressel

Using methods from the theory of total positivity, we provide a full classification of attainable term structure shapes in the two-factor Vasicek model. In particular, we show that the shapes normal, inverse, humped, dipped and hump-dip are always attainable. In certain parameter regimes up to four additional shapes can be produced. Our results show that the correlation and the difference in mean-reversion speeds of the two factor processes play a key role in determining the scope of attainable shapes. The mathematical tools from total positivity can likely be applied to higher-dimensional generalizations of the Vasicek model and to other interest rate models as well.

Valuing Bets and Hedges: Implications for the Construct of Risk Preference
Frederick, Shane,Levis, Amanda,Malliaris, Steven G.,Meyer, Andrew
Risk attitudes implied by valuations of risk-increasing assets depart markedly from those implied by valuations of risk-reducing assets. For instance, many are unwilling to pay the expected value for a risky asset or for its perfect hedge. Although nearly every theory of risk preference (and logic) demands a negative correlation between valuations of bets and hedges, we observe positive correlations. This inconsistency is difficult to expunge.

Why Does Skewness Matter? Ask Kurtosis.
Stein, Roberto
I investigate the relationship between measures of skewness and expected stock returns. Forcing the data to fit a linear model, past research finds only a negative relationship between these variables. Using a novel methodology that endogenously estimates breakpoints in the relationship between two variables, I find three distinct zone. Expected returns are decreasing in skewness, but only for a region of relatively low absolute values of skewness. For distributions which are highly left- or right-skewed, the relationship is actually positive. Moreover, I find that kurtosis plays a major role in mediating this relationship. Adding measures of the fourth moment to all models tested turns all skewness coefficients negative, and most statistically insignificant. Relying on probability theory, I provide a theoretical framework that supports all empirical findings.

`Regression Anytime' with Brute-Force SVD Truncation
Christian Bender,Nikolaus Schweizer

We propose a new least-squares Monte Carlo algorithm for the approximation of conditional expectations in the presence of stochastic derivative weights. The algorithm can serve as a building block for solving dynamic programming equations, which arise, e.g., in non-linear option pricing problems or in probabilistic discretization schemes for fully non-linear parabolic partial differential equations. Our algorithm can be generically applied when the underlying dynamics stem from an Euler approximation to a stochastic differential equation. A built-in variance reduction ensures that the convergence in the number of samples to the true regression function takes place at an arbitrarily fast polynomial rate, if the problem under consideration is smooth enough.