# Research articles for the 2019-09-25

arXiv

This paper presents a model of capital accumulation for a large number of heterogenous producer-consumers in an exchange space in which interactions depend on agents' positions. Each agent is described by his production, consumption, stock of capital, as well as the position he occupies in this abstract space. Each agent produces one differentiated good whose price is fixed by market clearing conditions. Production functions are Cobb-Douglas, and capital stocks follow the standard capital accumulation dynamic equation. Agents consume all goods but have a preference for goods produced by their closest neighbors. Agents in the exchange space are subject both to attractive and repulsive forces. Exchanges drive agents closer, but beyond a certain level of proximity, agents will tend to crowd out more distant agents. The present model uses a formalism based on statistical field theory developed earlier by the authors. This approach allows the analytical treatment of economic models with an arbitrary number of agents, while preserving the system's interactions and complexity at the individual level. Our results show that the dynamics of capital accumulation and agents' position in the exchange space are correlated. Interactions in the exchange space induce several phases of the system. A first phase appears when attractive forces are limited. In this phase, an initial central position in the exchange space favors capital accumulation in average and leads to a higher level of capital, while agents far from the center will experience a slower accumulation process. A high level of initial capital drives agents towards a central position, i.e. improve the terms of their exchanges: they experience a higher demand and higher prices for their product. As usual, high capital productivity favors capital accumulation, while higher rates of capital depreciation reduce capital stock. In a second phase, attractive forces are predominant. The previous results remain, but an additional threshold effect appears. Even though no restriction was imposed initially on the system, two types of agents emerge, depending on their initial stock of capital. One type of agents will remain above the capital threshold and occupy and benefit from a central position. The other type will remain below the threshold, will not be able to break it and will remain at the periphery of the exchange space. In this phase, capital distribution is less homogenous than in the first phase.

SSRN

We propose a tractable model of a firm's dynamic debt and equity issuance policies in the presence of asymmetric information. Because "investment-grade" firms can access debt markets, managers who observe a bad private signal can both conceal this information and shield shareholders from infusing capital into the firm by issuing new debt to service existing debt, thus avoiding default. The implication is that the "asymmetric information channel" can generate jumps to default (from the creditors' perspective) only for those "high-yield" firms that have exhausted their ability to borrow. Thus, our model deepens the "credit spread puzzle" for investment-grade firms.

SSRN

This research analyzes the constraints in Islamic insurance (takaful) and its impact on performance of takaful operators/industry operating in Islamic countries. It is a qualitative research as it reviews a lots of literatures for identifying issues in a takaful industry of Islamic countries. The Content of twenty four relevant papers was analyzed. The constraints were categorized which is the contribution of this study. Market players by properly addressing the categorized constraints can bring significant growth in takaful sector. According to content analysis, there are following constraints in takaful industry of Islamic countries: takaful concept awareness, lack of education, different takaful models, lack of standardization, scarcity of human resources, real earnings management, corporate governance, technical efficiency, rural market, small penetration rate, inadequate technology capabilities, differences in culture, less number of shariah re-insurance, non- sharaih compliance risk, operating efficiency, human capital, income level of participants, and large size of takaful companies.This study highlights the constraints which can be considered by AAOIFI and IFSB for improving the standards of takaful industry operating at global level. Moreover, takaful operators can also get a view of all the constraints and can work on their policies for surviving with the above mentioned constraints for giving a better performance in the insurance market.

arXiv

Companies try to maximize their profits by recovering returned products of highly uncertain quality and quantity. In this paper, a reverse logistics network for an Original Equipment Manufacturer (OEM) is presented. Returned products are selected for remanufacturing or scrapping, based on their quality and proportional prices are offered to customers. A Mixed Integer Non-linear Programming (MINLP) model is proposed to determine the location of collection centers, the optimum price of returned products and the sorting policy. The risk in the objective function is measured using the Conditional Value at Risk (CVaR) metric. CVaR measures the risk of an investment in a conservative way by considering the maximum lost. The results are analyzed for various values of the risk parameters ({\alpha}, and {\lambda}). These parameters indicate that considering risk affects prices, the classification of returned products, the location of collection centers and, consequently, the objective function. The model performs more conservatively when the weight of the CVaR part ({\lambda}) and the value of the confidence level {\alpha} are increased. The results show that better profits are obtained when we take CVaR into account.

SSRN

French Abstract: Depuis les travaux prÃ©curseurs de Watts et Zimmerman (1979) et DeAngelo (1981), la qualitÃ© de lâ€™audit demeure un concept difficile Ã opÃ©rationnaliser et lâ€™Ã©valuation de ses consÃ©quences Ã©conomiques reste prÃ©sente. Dans un contexte dâ€™audit conjoint, cette recherche Ã©tudie la relation entre la qualitÃ© des auditeurs, les caractÃ©ristiques des collÃ¨ges dâ€™auditeurs et la perception des investisseurs. Ã€ partir dâ€™un Ã©chantillon de 1 254 observations de firmes issues de l'indice CAC All-Tradable (anciennement appelÃ© SBF 250), pendant la pÃ©riode 2006 â€" 2013, nous obtenons les principaux rÃ©sultats suivants. En premier lieu, dans un collÃ¨ge dâ€™auditeurs composÃ© dâ€™au moins un cabinet Big, lâ€™indÃ©pendance du commissaire aux comptes Leader â€" celui percevant relativement le plus dâ€™honoraires et de mandats dâ€™audit, est mieux apprÃ©ciÃ©e par les investisseurs. Par contre, les investisseurs sanctionnent lâ€™indÃ©pendance de lâ€™auditeur Leader dans le cas dâ€™un collÃ¨ge dâ€™auditeurs composÃ© que de cabinets Non Big. En second lieu, nous observons des effets inverses, lorsquâ€™il sâ€™agit de lâ€™indÃ©pendance de lâ€™auditeur Follower â€" celui percevant relativement le moins dâ€™honoraires et de mandats dâ€™audit au sein du collÃ¨ge. Nous rÃ©sultats suggÃ¨rent des consÃ©quences Ã©conomiques hÃ©tÃ©rogÃ¨nes de lâ€™indÃ©pendance individuelle des auditeurs au sein dâ€™un collÃ¨ge de co-commissariat aux comptes.English Abstract: Since the seminal studies of Watts and Zimmerman (1979), and DeAngelo (1981), the operationalization of audit quality remains critical for researchers and the valuation of its economic consequences still a major concern. For a given auditing setting (eg. France), This paperâ€™s main purpose is to examine the relation between auditorsâ€™ quality, auditors-pair choice and the perception of investors. For a sample of 1,254 firms-year observations from firms included in the CAC All-Tradableâ€™s index (the former SBF 250) over the period of 2006 â€" 2013, we find the following evidence. Firstly, we show that in the case of both two Big-Firm Auditors Pairs, One BigFirm Auditor paired with another Non Big-Firm Auditor, the independence of Leader auditor â€" that perceives higher fees and number of tenures, is better valued by investors. By contrast, investors penalize the independence of the Leader in the case of two Non Big-Firm Auditors Pairs. Secondly, we suggest a reverse effect about the Follower auditor â€" that perceives lower fees and number of tenures. We suggest heterogeneous economic effects of the single independence of auditors.

SSRN

Using security-level data, we analyse the effects of the Bank of Englandâ€™s multiple rounds of gilt purchases (aka Quantitative Easing, QE) and its Corporate Bond Purchase Scheme (aka Credit Easing, CE) on corporate bond prices and issuance. This allows direct estimation of (i) QEâ€™s cross-asset supply effects and (ii) the joint supply effects of QE and CE. We show that in the case of QE alone, the pass-through of the gilt supply shock to corporate bond prices is significant, is larger in the longer-run than at announcement, and is often limited to the default-free component of the corporate yield. In the case of the joint conduct of QE and CE, we find that the CE is more effective than QE in reducing credit spreads, especially for higher-rated bonds, and in stimulating corporate bond issuance, which responds quite rapidly to the corporate bond supply shock.

SSRN

Traditionally, the development of investment strategies has required domain-specific knowledge as well as access to restricted datasets. This has meant that investment opportunities are not researched by the majority of data scientists, because they lack either or both of these requirements. In this article, the authors discuss the merits of tournaments as a crowdsourcing paradigm for investment research. Tournaments can overcome the two research barriers (domain-specific knowledge and data barriers), hence enabling the wide population of data scientists to contribute to the development of investment strategies.Key Points:1. There are four flaws with the development of investment strategies: domain-specific knowledge barrier, budgetary constraints and confidentiality restrictions, inability to monetize the value of data, and backtest overfitting.2. Tournaments offer a solution for overcoming the four flaws associated with developing investment strategies.3. The modern investment process suggested allows data scientists without an investment background to contribute forecasts to a systematic asset manager.

arXiv

We propose a deep neural network framework for computing prices and deltas of American options in high dimensions. The architecture of the framework is a sequence of neural networks, where each network learns the difference of the price functions between adjacent timesteps. We introduce the least squares residual of the associated backward stochastic differential equation as the loss function. Our proposed framework yields prices and deltas on the entire spacetime, not only at a given point. The computational cost of the proposed approach is quadratic in dimension, which addresses the curse of dimensionality issue that state-of-the-art approaches suffer. Our numerical simulations demonstrate these contributions, and show that the proposed neural network framework outperforms state-of-the-art approaches in high dimensions.

SSRN

Previous literature disagrees on the impact of board independence on firm value. The disagreement generally stems from the endogenous nature of board appointments. I add new evidence to this discussion by using a sample of closed-end funds to document the value-enhancing effects of independent boards. Using cross-sectional, difference-in-difference, and instrumental variable techniques, I address these endogeneity concerns and find consistent evidence that board independence is associated with higher firm value.

SSRN

Well-educated and well-informed consumers on personal finance management are better able to make good decisions for their families by being in an efficient position to increase their economic well-being and the country they are in. Thus, financial education is important not only for individuals and their families, but for the entire community. In the classical economy, informed consumers provide "control and balance" that keep unscrupulous retailers out of the market. This fact in Albania leaves to be desired as, the consumer has a disadvantage of information and this means that education of the society is necessary. Despite this fact there is still no study on the knowledge that Albanians have about personal finance management, especially when the law on self-declaration of income came into force. A revolution for Albanians, in terms of financial management.

SSRN

In this paper, I develop a model in which risk-averse investors possess private information regarding both a stockâ€™s expected payoff and its risk. These investors trade in the stock and a derivative whose payoff is driven by the stockâ€™s risk. In equilibrium, the derivative is used to speculate on the stockâ€™s risk and to hedge against adverse fluctuations in the stockâ€™s risk. I analyze the derivative price and variance risk premium that arise in this equilibrium and their predictive power for stock returns. Finally, I examine the relationship between prices and trading volume in the stock and derivative.

SSRN

Governments often subsidize startups with the goal of spurring entrepreneurship. A common, but oft-misunderstood, policy tool is investor tax credits. Exploiting the staggered implementation of angel investor tax credits in 31 states from 1988 to 2018, we find that these programs increase angel investment along the extensive and intensive margins. However, additional investments flow to lower quality startups that are launched by less experienced entrepreneurs. Despite short-run propping up due to tax subsidies, angel-backed firms perform poorly in the long run. In aggregate, angel tax credit programs have no effect on the entry, exit, or job creation of nascent firms. Overall, the results suggest that investor tax credits are ineffective in boosting high-quality entrepreneurship and may distort the screening and monitoring incentives of early-stage investors.

SSRN

The changes in Interest rate risk in the banking book ( IRRBB ) of Basel capital frameworks Pillar 2, where the regulator prescribed a set of stress scenarios and shocks to a standardized interest rate risk measures on changes of Economic Value of Equity (EVE) and Net Income Interest (NII) force banks to model interest rate risks and develop hedging strategies to mitigate the sensitivity to interest rate shocks.In this work we define, model and compute both the NII and the EVE indicators. We study early renegotiation models, based either on an optimal exercise or a statistical model. Finally, we discuss hedging strategies for the NII and the EVE based on both variance and sensitivities minimization. The framework is flexible enough to take into account a wide variety of operational situations, including regulatory ones. To test it, we analyze numerically hedging strategies aiming to reduce the sensitivity of ALM risk measures. Notably, we show that the NII and the EVE are opposite measures: lowering the sensitivity of one of this measures increases the sensitivity of the other. However, anticipated refunds and renegociation effects might temper this conclusion.To reach these goals, we shift from a classical scenario-based definition of the NII and the EVE to a stochastic one, that is quite similar to a Front-Office portfolio analysis. However, there is a drawback in this approach: the targeted applications require not only to compute the EVE and the NII indicators, but also all their conditional futures prices and sensitivities' values. In an operational context, where the number of risk sources can be large, classical numerical methods face the so-called curse of dimensionality problem.To tackle this difficulty, we conduct our numerical experiments using a financial mathematics framework, embedding a partial differential equations (PDE's) solver, that overcomes the curse of dimensionality.

SSRN

How can macroeconomic tails risks originating from financial vulnerabilities be monitored systematically over time? This question lies at the heart of operationalising the macroprudential policy regimes that have developed around the world in response to the global financial crisis. Using quantile regressions applied to a panel dataset of 16 advanced economies, we examine how downside risk to growth over the medium term, GDP-at-Risk, is affected by a set of macroprudential indicators. We find that credit booms, property price booms and wide current account deficits each pose material downside risks to growth at horizons of three to five years. We find that such downside risks can be partially mitigated, however, by increasing the capitalisation of the banking system. We estimate that across our sample of countries, GDP-at-Risk, defined as the 5th quantile of the projected GDP growth distribution over three years, on average deteriorated by around 4.5 percentage points cumulatively in the run-up to the crisis. Our estimates suggest that an increase in bank capital equivalent to a countercyclical capital buffer rate of 2.5% (5%) would have been sufficient to mitigate up to 20% (40%) of this increase in medium-term macroeconomic tail risk.

SSRN

Government interventions to support the financial institutions fall into two broad categories: direct interventions (which immediately increase the governmentâ€™s financing needs) and off-balance-sheet contingent guarantees (which have no immediate impact on debt but will add to government debt as and when a loss materializes). If financial sector losses are independent of sovereignâ€™s own risk, all else being equal, they must have the same effect on the sovereignâ€™s risk profile, even though they impact the government balance sheet differently. In this paper, we study the nature and effectiveness of a governmentâ€™s interventions on its own risk profile. Our findings suggest that direct assistance has a significantly large effect on sovereign risk, while the effect of contingent guarantees is statistically not significant, being significant only for the euro area founders. Controlling for government interventions, we also find that GDP, perceived government effectiveness, economic sentiment, size of the financial sector, and membership of the euro area reduce the sovereign risk, while asset concentration within the financial sector, unemployment and inflation have an adverse effect. Our findings support Bresciani and Cossaro (2016)â€™s claim that during the sovereign debt crisis, governments undertook complex financial operations to change the composition of their interventions towards contingent guarantees.

SSRN

We define and measure integration among a sample of 357 US banks over 25 years from 1993 to 2017 and show that the median US bankâ€™s integration has increased significantly post-2005. During the great recession and the Eurozone crisis, integration levels among US banks display a significant rise over and above their trend. We find that bank size is the most economically and statistically significant characteristic in explaining integration levels. Size and the equity ratio show positive association with bank integration while the net interest margin and combined tier 1 and tier 2 capital ratio influence bank integration negatively. For regulators, abnormally high in- tegration levels indicate warning signs of potential distress in the banking sector.

arXiv

Building on the line of work [DIRT15a], [DIRT15b], [NS17a], [DT17], [HLS18], [HS18] we continue the study of particle systems with singular interaction through hitting times. In contrast to the previous research, we (i) consider very general driving processes and interaction functions, (ii) allow for inhomogeneous connection structures, and (iii) analyze a game in which the particles determine their connections strategically. Hereby, we uncover two completely new phenomena. First, we characterize the "times of fragility" of such systems (e.g., the times when a macroscopic part of the population defaults or gets infected simultaneously, or when the neuron cells "synchronize") explicitly in terms of the dynamics of the driving processes, the current distribution of the particles' values, and the topology of the underlying network (represented by its Perron-Frobenius eigenvalue). Second, we use such systems to describe a dynamic credit-network game and show that, in equilibrium, the system regularizes: i.e., the times of fragility never occur, as the particles avoid them by adjusting their connections strategically. Two auxiliary mathematical results, useful in their own right, are uncovered during our investigation: a generalization of Schauder's fixed-point theorem for the Skorokhod space with the M1 topology, and the application of the max-plus algebra to the equilibrium version of the network flow problem.

SSRN

Subsequent to the stricter corporate governance listing standards adopted by the NYSE and NASDAQ in the early part of this century and the independence requirements of the Sarbanes Oxley Act of 2002 (SOX), the number of investment bankers (IB) serving on corporate boards has declined significantly. We document that the firms that lose the relationship with the investment bank after SOX become relatively more financially constrained soon after. The evidence is similar, albeit weaker, after departures of investment bankers at the advent of the financial crisis. We examine the mechanisms through which the constraints might be lowered, and observe that firms with IB directors face lower underwriting spreads when they issue equity and debt. Inconsistent with the hold-up problem associated with IB directors, the market reaction to seasoned equity offerings in firms with IB directors are less negative than comparable firms. The results point to costs associated with the increased attempts to improve board independence.

SSRN

Prior research concludes that stock price crash risk is primarily attributable to managersâ€™ withholding of bad news from investors. We extend this literature by investigating whether crash risk can also occur when managers disclose additional information via non-GAAP reporting, which downplays reported bad news by re-directing investorsâ€™ attention to other, more positive aspects of performance. We find that the likelihood of crash risk is higher when managers have reported non-GAAP earnings more frequently during the past year. We also find that managers appear to use non-GAAP reporting as a substitute for the more common reason for crash risk in prior researchâ€"withholding bad news. Moreover, we find that the association between non-GAAP disclosure and crash risk increases in periods when managers are likely more aggressive in their non-GAAP reporting. Finally, we use a regulatory shock as a quasi-natural experiment to mitigate endogeneity concerns.

SSRN

We investigate optimal dynamic capital structure policy in the presence of fixed issuance costs. For each level of issuance costs, including zero, we identify the global-optimal debt policy. Commitment to this optimal policy is credible if debtholders threaten to punish any deviation by forever pricing debt according to the no-commitment policy. However, commitment to debt repurchases is not credible once realistic equity issuance costs are accounted for, providing one explanation for why firms are unable to issue risk-free debt. When calibrated to realistic issuance costs, the no-commitment policy generates almost as much tax benefits to debt as does the optimal policy.

SSRN

In the Bitcoin futures markets, the dominating contracts are inverse contracts. Unlike standard futures, Bitcoin inverse futures have a non-linear payoff structure, are settled in Bitcoin instead of the fiat currency, and require Bitcoins to be deposited into the margin account during trading.We characterize the unique high-order risk factors, asymmetry effect and (de)leverage effect of Bitcoin inverse futures, and obtain optimal hedging strategies in closed forms for both short and long hedges under the minimum-variance framework. We use the market data of Bitcoin spot and futures to conduct empirical studies. Our findings show that the optimal hedging strategies of Bitcoin inverse futures achieve superior hedging performance across exchanges.

SSRN

This study explores the performance if seven state-of-the-art risk-based portfolio optimization strategies. Analyzing the inverse volatility (IV), minimum variance (MV), l2-norm constrained minimum variance (NMV), l2-norm constrained maximum decorrelation (NMC), maximum diversification (MD) and risk parity (RP) portfolio, we find that most strategies systematically outperform the equally weighted (EW) benchmark portfolio, both on an absolute and risk-adjusted basis. Further tail- and extreme risk analysis, portfolio diversification statistics as well as bull and bear market comparison reveal that these strategies provide significant downside risk reduction. The results are robust for different estimation windows, rebalancing periods and covariance estimation methodologies. Finally, our empirical results indicate that the maximum decorrelation portfolio is the worst strategy in terms of risk reduction, while the long-only minimum variance portfolio is the best performing portfolio.

SSRN

We study the role of trading, and in particular market making, for the provision of stock-based incentives to managers. Market making provides liquidity as it allows trading on private information about the value of the firm. But in a liquid market the stock price does not react much to the order flow, including the order flow of informed traders. Market making therefore makes it more difficult to detect shirking and to provide stock-based incentives. Our model provides novel comparative statics, e.g., the manager may receive more stock-based pay when traders' information becomes worse, clarifies the role of public information such as accounting numbers as an additional performance measure, and shows that economic efficiency can be independent of stock-market efficiency because the optimal incentive contract adjusts to market conditions.

SSRN

A maker fee is the fee charged to submitters of limit orders that execute. This could increase the cost of supplying liquidity and be reflected in bid-ask spreads and prices more generally. We analyze the introduction of maker fees on Coinbase Pro, a leading cryptocurrency exchange. We perform a difference-in-differences analysis using data from Bitfinex, another leading cryptocurrency exchange, as a control sample. Our study is different from previous papers in that:(1) it analyzes cryptocurrency rather than equity markets, (2) uses both low-frequency (daily) and high-frequency (minute-by-minute) data and, (3) studies how the introduction of a maker fee affects liquidity beyond the best quotes. We find that, upon the introduction of the maker fee, quoted spreads increases while depth and trading activity decrease. Liquidity beyond the best quotes also decreases.

SSRN

This paper produces an edited version of an interview conducted by Professor Eric Beinhocker, Executive Director, INET Oxford, with Professor Sanjit Dhami of the University of Leicester, author of the Foundations of Behavioral Economic Analysis (Dhami 2016), on 9th May 2019 at the University of Oxford. The questions posed by Professor Beinhocker covered a wide interdisciplinary terrain that ranged from important contributions in behavioral economics and the way forward; inertia in the economics profession to accept the new interdisciplinary research; the scientific method; the interplay of culture, behavior and institutions; the role of norms; and a critique of complexity and agent based models. We are publishing this interview as a working paper to foster debate and reflection among economists and other social scientists regarding some of the â€œbig-pictureâ€ questions in the behavioral sciences, and to highlight the powerful role that behavioral economics can play in illuminating a deeper understanding of the economy and other social systems.

SSRN

We introduce a simple, exact and closed-form formula for pricing the arithmetic Asian options. The pricing formula is as simple as the classical Black-Scholes formula. In doing so, we show the distribution of the continuous average of log-normal variables.

SSRN

We propose a measure of system-wide connectedness that refines the popular generalized spillover index, based on generalized forecast error variance decompositions, of Diebold and Yilmaz (2012, 2104). Our measure relies on joint conditional forecasts to decompose variance, as opposed to the popular method's reliance on single-variable conditioning sets, and has a more natural interpretation as a measure of aggregate spillovers. We show in an application to US industry sector stock returns that the difference between the two measures can be substantial.

SSRN

Google searches for stock tickers and company-specific Wikipedia page views may provide reasonable proxies for latent investor attention that are easily accessible for both researchers and practitioners. We draw upon Shannon transfer entropy, a model-free measure that detects any statistical dependence between time series and allows us to infer the dominant direction of the information transfer, to investigate if these different online search queries provide equivalent proxies for online investor attention. Our results show that this is not the case when considering information-theoretical arguments. Moreover, some of the detected bi-directional information transfer is nonlinear.