Research articles for the 2019-10-02

A Dimensionality-Robust Test in Multiple Predictive Regression
Xu, Ke-Li,Guo, Junjie
We consider inference of predictive regression with multiple predictors. Extant tests for predictability, including those constructed with robustness to unknown persistence and endogeneity of predictors, may perform unsatisfactorily and tend to discover spurious predictability as the number of predictors increases. We propose a battery of new instrumental-variables based tests which involve enforcement or partial enforcement of the null hypothesis in variance estimation and analyze their asymptotic properties. A test based on the parsimonious system approach is recommended. Empirical Monte Carlos demonstrate the remarkable finite-sample performance regardless of numerosity of predictors. Empirical application to equity premium predictability is also provided.

A Theory of Financial Media
Goldman, Eitan,Martel, Jordan,Schneemeier, Jan
Despite a growing empirical literature, which documents the economic importance of financial media, much of the existing theoretical work takes public financial news as a model primitive. In this paper, we develop a simple model in which financial media plays an economic role: many investors cannot observe the universe of all firm announcements and rely on a financial journalist to choose which announcements to report and which not to. The model explores implications for the behavior of the journalist, the manager, investors, and for stock prices. We find that the introduction of a journalist induces more informed trading by readers, but inadvertently incentivizes the manager to bias the firm's announcements. We argue that this bias arises in spite of the journalist, not because of her. Although the stock becomes mis-priced, readers are better off and prices are more informative. Finally, we find two endogenous biases: extreme financial news is more likely to be reported than mundane news and good news is more likely to be reported than bad news.

A nonparametric copula approach to conditional Value-at-Risk
Gery Geenens,Richard Dunn

Value-at-Risk and its conditional allegory, which takes into account the available information about the economic environment, form the centrepiece of the Basel framework for the evaluation of market risk in the banking sector. In this paper, a new nonparametric framework for estimating this conditional Value-at-Risk is presented. A nonparametric approach is particularly pertinent as the traditionally used parametric distributions have been shown to be insufficiently robust and flexible in most of the equity-return data sets observed in practice. The method extracts the quantile of the conditional distribution of interest, whose estimation is based on a novel estimator of the density of the copula describing the dynamic dependence observed in the series of returns. Real-world back-testing analyses demonstrate the potential of the approach, whose performance may be superior to its industry counterparts.

An Application of Risk Management on Airline Industry Via Financial Ratios and Artificial Intelligence
Baydar, Burcu,Dursun, Günay Deniz
The growing demand for airline transportation in recent years has increased the importance of airline passenger and cargo operations and aviation sector globally. Aviation sector is a sector that has unique properties like high fixed costs, cyclical demand, intense competition, and vulnerability to external shocks like terrorist attacks, disasters, global financial crises especially after deregulation in 1978. Air transport industry is responsible for connecting the global economy, providing a lot of jobs and making modern quality of life possible. Under high competition, it is crucial for airline companies to evaluate and analyze which core business areas are essential for them to prevent bankruptcy and to reach sustainable success. Initially developed in 1968 and evaluated by Altman in time, Altman’s Z score model remains a commonly used tool for evaluating the financial health. Altman Z” score has been well accepted, widely used models of predicting survivals and failures. This model is one of the most frequently used risk early warning models. As one of the biggest player of aviation sector, Turkish airline industry is affected by many different social, political, economic and legal factors on both national and international level as well as other airlines. It is very important to forecast the companies that may gone bankrupt and determine underlying causes. Therefore, this paper evaluates the Altman's Z” score model for predicting the bankruptcy risk of Turkish Airlines inc. which is the Turkey’s flag carrier via financial performance ratios taken from financial statements for the years between 2002 to 2016. Within the scope of the research, both the theoretical information and the applied method details are held. Also for next three years (2017-2019) Z” score values are predicted using artificial intelligence neural network algorithms.

Assessing the Effects of Imposing VAT on the Services Provided by the Banking Sector â€" the Case of Bulgaria
Angelov, Angel,Nenkova, Presiana
The treatment of banking services as VAT exempted is a dominant model and common practice among EU member countries mainly due to the technical difficulties of calculating value added and applying the general credit - invoice method of VAT taxation. Not charging VAT on banking sector results in overtaxation of business customers and undertaxation of final consumers, and creates serious distortions in the economy. With this study and empirical assessment made, we seek to address some of the problems that have not been solved so far and to contribute, at least to a certain degree, to the ongoing academic debate on whether financial services need and should stay VAT exempt. By using a modified mobile-ratio method the current paper explores and assesses economic effects of including banking sector in the range of VAT taxable supplies. To identify the potential gains and losses that could have been generated under a hypothetical case of applying VAT to banking services in Bulgaria we provide a quantitative estimate for the period 2008 through 2016 at two separate levels: (1) banking system, and (2) business consumers of banking services. Finally, we estimate the volume of revenue that could has been accumulated to the State budget during the period under review if banking services were subject to VAT.

Bank's Liquidity Management and Financial Fragility
Deidda, Luca
We propose a novel theory of banks’ liquidity management and financial fragility. Banks hold liquidity and an illiquid productive asset, thereby engaging in maturity transformation, and insure their depositors against idiosyncratic and aggregate shocks. However, strategic complementarities in the depositors’ withdrawal decisions might trigger a self-fulfilling run, modelled as a “global game”. In equilibrium, if the liquidation of the productive asset is sufficiently costly and the depositors are sufficiently risk averse, banks manage their liquidity needs during runs following an endogenous pecking order: they first deplete liquidity, and then liquidate the productive asset. Thus, under these conditions banks subject to runs are first illiquid but solvent, and then become insolvent. Ex ante, if the probability of the idiosyncratic shock is sufficiently large, banks hoard liquidity, and narrow banking is not viable.

Bessel-like birth-death process
Vygintas Gontis,Aleksejus Kononovicius

We consider models of the population or opinion dynamics which result in the non-linear stochastic differential equations (SDEs) exhibiting the spurious long-range memory. In this context, the correspondence between the description of the birth-death processes as the continuous-time Markov chains and the continuous SDEs is of high importance for the alternatives of modeling. We propose and generalize the Bessel-like birth-death process having clear representation by the SDEs. The new process helps to integrate the alternatives of description and to derive the equations for the probability density function (PDF) of the burst and inter-burst duration of the proposed continuous time birth-death processes.

Capturing the power options smile by an additive two-factor model for overlapping futures prices
Marco Piccirilli,Maren Diane Schmeck,Tiziano Vargiolu

In this paper we introduce an additive two-factor model for electricity futures prices based on Normal Inverse Gaussian L\'evy processes, that fulfills a no-overlapping-arbitrage (NOA) condition. We compute European option prices by Fourier transform methods, introduce a specific calibration procedure that takes into account no-arbitrage constraints and fit the model to power option settlement prices of the European Energy Exchange (EEX). We show that our model is able to reproduce the different levels and shapes of the implied volatility (IV) profiles displayed by options with a variety of delivery periods.

Children’s Toy or Grown-Ups’ Gamble? LEGO Sets as an Alternative Investment
Shimkus, Nikita,Shanaev, Savva,Sharma, Satish,Ghimire, Binam
In this article, LEGO sets are studied as a potential alternative asset class. An exhaustive sample of 10,588 sets is utilised to generate inferences regarding long-term LEGO performance, its diversification benefits, and return determinants. Over 1966-2018, LEGO value-weighted index accounted for survivorship bias enjoys 1.20% inflation-adjusted return per annum, well below 5.54% for equities. However, the defensive properties of LEGO are considerable, as including 5-25% of LEGO in a diversified portfolio is beneficial in terms of Sharpe ratio and certainty equivalent metrics for investors with varying levels of risk aversion. LEGO secondary market is relatively internationalised, with investors from 95 countries engaging in 90,000 transactions over a 6-month period, comprising total trading volume of $7.5 million. Larger economies, countries with higher per capita incomes and less income inequality are shown to trade LEGO more actively. There is evidence of LEGO investors deriving non-pecuniary utility from holding sets that is separable from their risk-return profile. LEGO is not exposed to any of the Fama-French factors, however, set-specific size and value effects are also well-pronounced on the LEGO market, with smaller sets and sets with lower price-to-piece ratio exhibiting higher yields. Older sets are also enjoying higher returns, demonstrating a liquidity effect.

Do Investors Care About Corporate Externalities? Experimental Evidence
Bonnefon, Jean-Francois,Landier, Augustin,Sastry, Parinitha,Thesmar, David
We measure how shareholders value a firm's ethical actions via an experiment. Our findings are threefold. First, the "selfish investor hypothesis'' is strongly rejected. Participants are willing to pay $ .7 more for buying a share in a firm giving one more dollar per share to charities. Symmetrically, a firm that makes profits by exercising a negative externality of $1 on a charity is valued $.9 less than a similar company with no externality. The scaling of non-pecuniary preferences is linear: doubling the size of a social externality doubles its impact on willingness to pay. Second, the data show that whether investors are pivotal or not with regard to the ethical actions of the firm does not affect their willingness to pay. Third, when participants make investment decisions on behalf of a third party (delegation), their generosity level remains similar. Our results appear to be compatible with a utility model where non-pecuniary benefits are conditional on stock holding.

Does Corporate Culture Add Value? Evidence from the Harvey Weinstein Scandal and the #MeToo Movement
Lins, Karl V.,Roth, Lukas,Servaes, Henri ,Tamayo, Ane
During the revelation of the Weinstein scandal and the emergence of the subsequent #MeToo movement, firms with a female-friendly corporate culture, as proxied by having more women among the firm’s five highest paid executives, earned excess returns of close to 1.5% per highly-paid female executive. These findings also hold when we relate the stock returns to corporate culture measured more broadly based on employee ratings. Our findings are stronger for industries with fewer women in executive positions. However, we find no evidence that having more women on the board is related to returns around these events. Overall, our results illustrate that having women in significant senior leadership positions can increase shareholder wealth.

Doing Well While Feeling Good
Mahmoud, Ola
Sustainable finance promotes the doing well while doing good paradigm, that is the idea of simultaneously achieving positive social impact and financial return. This paper posits that the decision to invest sustainably is, in part, driven by impurely altruistic motivations. A series of artefactual field experiments provides evidence that: (i) altruism is contextual and does not necessarily imply sustainable investing; (ii) the warm glow of giving is a primary driver for sustainable investing; (iii) doing well while doing good leads to greater happiness (the investor’s high); and (iv) these effects are largely intrinsic rather than extrinsic phenomena. Implications for market participants and policy makers are discussed.

Economically rational sample-size choice and irreproducibility
Oliver Braganza

Several systematic studies have suggested that a large fraction of published research is not reproducible. One probable reason for low reproducibility is insufficient sample size, resulting in low power and low positive predictive value. It has been suggested that insufficient sample-size choice is driven by a combination of scientific competition and 'positive publication bias'. Here we formalize this intuition in a simple model, in which scientists choose economically rational sample sizes, balancing the cost of experimentation with income from publication. Specifically, assuming that a scientist's income derives only from 'positive' findings (positive publication bias) and that individual samples cost a fixed amount, allows to leverage basic statistical formulas into an economic optimality prediction. We find that if effects have i) low base probability, ii) small effect size or iii) low grant income per publication, then the rational (economically optimal) sample size is small. Furthermore, for plausible distributions of these parameters we find a robust emergence of a bimodal distribution of obtained statistical power and low overall reproducibility rates, matching empirical findings. Overall, the model describes a simple mechanism explaining both the prevalence and the persistence of small sample sizes. It suggests economic rationality, or economic pressures, as a principal driver of irreproducibility.

Family Ownership and Antitrust Violations
Amore, Mario Daniele,Marzano, Riccardo
We study how family ownership shapes the firms’ likelihood of being involved in antitrust indictments. Using data from Italy, we show that family firms are significantly less likely than other firms to commit antitrust violations. To achieve identification, we exploit a law change that made it easier to transfer family control. Studying the mechanisms at play, we find that family firms are especially less likely to commit antitrust violations when they feature a more prominent size relative to the city where they are located, which magnifies reputational concerns. Next, we show that family firms involved in antitrust violations appoint more family members in top executive positions in the aftermath of the indictment. Moreover, these firms invest less and curb equity financing as compared to nonfamily firms. Collectively, our findings suggest that family control wards off reputational damages but, at the same time, it weakens the ability to expand in order to keep up with fiercer competition following the dismantlement of the anticompetitive practice.

Herding Behaviors in ASEAN Stock Markets
Yao, Jian,Tangjitprom, Nopphon
This paper aims to use comprehensive evidence to test the herding behaviors existing in 6 ASEAN stock markets, including Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Vietnam. The paper used a survivor-bias-free dataset of daily stock returns during the period January 1, 2009 to June 30, 2016 to measure the results. The empirical results from the 6 ASEAN stock markets showed that herding behavior has existed only in Vietnam, and Vietnam own significant herding behavior during different asymmetric market conditions. We also found evidence to show the significant role of U.S. return dispersions in the ASEAN stock market; however, the U.S. stock market cannot affect the herding formation of each ASEAN stock market.

Impact of Fee-Based Services on the Financial Performance of the Banks: An Empirical Study
Sarabhai, Shivangi
The banking industry forms an integral part of the entire economy. For long, the basic function of banks was to lend and receive funds and earn the difference in the form of interest. But after liberalization, the entry of several private and foreign banks led to intense competition and deregulation of interest. As a consequence, the profitability of banking sector declined considerably. To overcome this growing instability in profits, the banks shifted their focus from fund-based to fee-based activities that involve the receipt of revenue by providing services. Though private banks and foreign banks have extensively increased their share in fee income, public banks still operate majorly on the traditional sources of income generation. The purpose of this research is to identify the problems faced by banks in expanding their fee-based services and study the effect of increasing share of fee income on the financial performance of the banks. Using the regression analysis and paired t-test, the impact of fee income on the overall profitability is tested. It is observed that fee income has a positive impact on the profitability and financial performance of the banks. Using the trend forecasting, it is validated that increasing the share of fee income in public banks leads to increase in profitability. Moreover, a model is developed that indicates the problems faced by banks in diversifying their fee-based services, the measures to be undertaken and the anticipated outcomes therein.

Insider Profitability and Public Information: Evidence From the XBRL Mandate
Huang, Yuyun,Shan, Yuan George,Yang, Joey (Wenling)
Using XBRL as a quasi-natural experiment, we examine the extent to which insiders profit from publicly available information. We find that the XBRL adoption attenuates insider sale profits and has no effect on insider purchases. Further analyses reveal three channels through which the adoption of XBRL attenuates insider profits: faster information incorporation, less reporting opacity, and more financial disclosure. Our results are robust to a battery of additional tests including different insider types, varied investment horizons, the regression discontinuity design, the matched sample difference-in-difference, and the placebo tests.

Is 'Greenness' Priced in the Market? Evidence from Green Bond Issuance in China
Deng, Zhiyao,Tang, Dragon Yongjun,Zhang, Yupu
Green bonds are bonds with a defined use of proceeds towards mitigating and adapting to climate change and solving environmental problems. While its market has expanded rapidly in recent years and attracted great investment attention, whether investors can identify greenwashing behaviors remains a primary concern. This paper takes advantage of the unique feature of the Chinese green bond market that allows a proportion of the proceeds to be used for non-green purposes. We find that greener bonds (more proceeds are used for green projects) are sold at a premium. This pricing differential is primarily driven by bonds whose proceeds are 100% used for green projects. Our results also show that green bonds verified by a third-party have lower yield spreads, and the effect is stronger for more reputable third-parties. Overall, our results suggest that investors only reward fully green bonds, and they can differentiate greenwashing.

Is Firm-Level Clean or Dirty Innovation Valued More?
Dechezleprêtre, Antoine,Muckley, Cal B.,Neelakantan, Parvati
We examine how Tobin's Q is linked to 'clean' and 'dirty' innovation and innovation efficiency at the firm level. Clean innovation relates to patented technologies in areas such as renewable energy generation and electric cars, whereas dirty innovation relates to fossil- based energy generation and combustion engines. We use a global patent data set, covering over 15,000 firms across 12 countries. We find strong and robust evidence that the stock market recognizes the value of clean innovation and innovation efficiency and accords higher valuations to those firms that engage in successful clean research and development activities. The results are substantively invariant across innovation measurement, United States and European patents, model specifications, sub-samples of firms and estimators adopted.

Is the Federal Reserve Constitutional? An Originalist Argument for Independent Agencies
Chabot, Christine Kexel
The President’s inability to control the Federal Reserve’s monetary policy decisions raises significant constitutional concerns. The Federal Reserve’s Federal Open Market Committee executes critical statutory mandates when it buys or sells U.S. securities in order to expand or contract the money supply, and yet the Committee’s twelve voting members check one another instead of answering directly to the President. The President cannot remove Committee members who refuse to carry out his monetary policy directives. Seven of the Committee’s twelve voting members are Federal Reserve governors who enjoy for-cause protections from removal by the President. Congress delegated power to supervise and remove the remaining five voting members, who are presidents of regional Federal Reserve banks, to the governors rather than the President. Further, the President has no say in the appointment of regional bank presidents to the Committee. While the Committee’s independence and appointments process would likely pass muster under current precedent, a growing chorus of originalists have argued that the Constitution requires greater executive control and a more expansive application of Article II’s Appointments Clause requirements.This paper demonstrates that existing originalist accounts are incomplete. They do not account for the structural independence of an obscure agency known as the Sinking Fund Commission. This Commission was proposed by Alexander Hamilton, passed into law by the First Congress, and signed into law by President George Washington. One would expect all of these actors to have a clear grasp on the original public meaning of the Constitution, as well as a strong dedication to the structural commitments established therein. Their decisions to form a Sinking Fund Commission with multiple members to check one another â€" and to include the Vice President and Chief Justice as Commissioners who cannot be replaced or removed by the President â€" belie the notion that an independent agency structure violates the newly minted Constitution. The Sinking Fund Commission directed open market purchases of U.S. securities pursuant to a statutory mandate. It provides a direct historical analogue to the Federal Open Market Committee’s independent purchases of U.S. securities pursuant to a statutory mandate. This analysis shows that the structure of the Open Market Committee is not a novel invention of the twentieth century. Rather, the independence stemming from the Committee’s multi-headed structure and protections from removal has an impeccable originalist provenance which dates all the way back to Alexander Hamilton and First Congress.

Longevity-Linked Annuities: How to Preserve Value Creation Against Longevity Risk
Olivieri, Annamaria,Pitacco, Ermanno
The cost of longevity guarantees of traditional annuity products has increased in the recent scenario, characterized by declining mortality rates, in particular at unanticipated levels. Increasing the annuity loading rewarding the accepted longevity risk is not an option for annuity providers, given that individuals already consider annuities to be expensive. An alternative solution could be represented by participating structures, providing a link to some longevity experience. In particular, the benefit amount should be allowed to decrease, possibly maintaining a guaranteed minimum amount, in case of unanticipated longevity. This should be balanced by a reduction of the annuity loading or a participation to possible longevity profit.Linking the annuity benefit amount to the longevity experience determines two opposing effects on the business value: possible losses are reduced, but also possible profits. The trade-off is not obvious and requires appropriate assessment metrics. In this paper, we measure the business value of alternative linking designs. While we follow a traditional economic logic for defining the business value, namely the present value of future profits net of the cost of capital, we suggest how to identify the main components of the present value of future profits; further, we assess the capital size according to the riskiness retained by the provider, so to make sure that the business value can represent appropriately the risk-return trade-off for the provider. The time-profile of the business value is also considered.

Mispricing or the Risk Premium? An Explanation of the Positive R&D-Stock Return Relationship
Lee, Jangwook,Lee, Jiyoon
Two contrasting explanations are offered in the literature for the positive R&D-stock return relationship: limited investor attention to R&D spending that is expensed under generally accepted accounting principles or failure of conventional risk factors to completely capture the risk associated with R&D. Exploiting accounting treatments in Korea, in which R&D expenditures are capitalized under certain conditions, we show that both the expensed and capitalized portions of R&D are positively associated with returns. The positive R&D-return relationship weakens with the extent of progress toward completion of R\&D projects, consistent with Berk, Green, and Naik's (2004) risk-based theoretical prediction. The results suggest overall that the positive R&D-return relationship is attributable to compensation for bearing risk.

Monetary Policy Through the Stock Market: Central Bank Purchase of Equity Index Etfs
Chen, Zhuo,Ito, Keiichi,Yamada, Takeshi,Zhang, Bohui
As part of its unconventional monetary policy, since 2010 the Bank of Japan (BOJ) has purchased equity index exchange-traded funds (ETFs). The total purchased amount reached 3% of GDP and the bank has become among the largest shareholders in over 40% of listed companies. Because of the reduction in float shares and the non-informational nature of the BOJ purchases, liquidity and price informativeness of the underlying shares deteriorates, increasing friction in the share market. The number of shareholders, institutional ownership, and analyst coverage all decreased for firms in which the BOJ holds shares. These firms issue fewer shares. Although the BOJ’s ETF purchase might increase share prices, the increase in both illiquidity and downside risk limit the share price increases. Although the equity cost of capital decreases for firms with disproportionately large BOJ holdings, the cost of increased illiquidity might have wider effects for the all listed firms.

Moral Hazard in Insurance: Theory and Evidence from a Credit Reform in Ghana
Annan, Francis
Consumers in developing countries often buy insurance on credit. By allowing them to buy more coverage, it may lead to more claims. I evaluate this moral hazard effect by exploiting a regulatory reform in Ghana that outlawed the purchase of auto-insurance on credit. Consumers responded by switching from comprehensive to basic insurance. I show that if this change in contracts leads to a change in the distribution of claims, this implies the existence of moral hazard. Using administrative data on insurance contracts, I provide evidence and bounds on the effects of moral hazard. Results are likely driven by credit constraints.

Negative Interest Rates Policy and Banks' Risk-Taking: Empirical Evidence
Boungou, Whelsy
Using panel dataset of 9,421 banks from 59 countries over the period 2009-2018 and Differences-in-Differences framework, this paper aims to assess the effects of negative interest rates on banks' risk-taking. We find that banks' risk-taking has been lower in countries where negative rates have been implemented. This effect depends on the characteristics of a country's banking system, namely the level of capitalization and size.

On a robust risk measurement approach for capital determination errors minimization
Marcelo Brutti Righi,Fernanda Maria Müller,Marlon Ruoso Moresco

We propose a robust risk measurement approach that minimizes the expectation of overestimation plus underestimation costs. We consider uncertainty by taking the supremum over a collection of probability measures, relating our approach to dual sets in the representation of coherent risk measures. We provide results that guarantee the existence of a solution and explore the properties of minimizer and minimum as risk and deviation measures, respectively. Empirical illustration is carried out to demonstrate the use of our approach in capital determination.

On the Concavity of Expected Shortfall
Mikhail Tselishchev

It is well known that Expected Shortfall (also called Average Value-at-Risk) is a convex risk measure, i. e. Expected Shortfall of a convex linear combination of arbitrary risk positions is not greater than a convex linear combination with the same weights of Expected Shortfalls of the same risk positions. In this short paper we prove that Expected Shortfall is a concave risk measure with respect to probability distributions, i. e. Expected Shortfall of a finite mixture of arbitrary risk positions is not lower than the linear combination of Expected Shortfalls of the same risk positions (with the same weights as in the mixture).

Optimal Execution Strategy Under Price and Volume Uncertainty
Julien Vaes,Raphael Hauser

In the seminal paper on optimal execution of portfolio transactions, Almgren and Chriss (2001) define the optimal trading strategy to liquidate a fixed volume of a single security under price uncertainty. Yet there exist situations, such as in the power market, in which the volume to be traded can only be estimated and becomes more accurate when approaching a specified delivery time. In this paper, we develop a model that accounts for volume uncertainty and we show that a risk-averse trader has benefit in delaying their trades. More precisely, we argue that the optimal strategy is a trade-off between early and late trades in order to balance risk associated with both price and volume. By incorporating a risk term related to the volume to trade, the static optimal strategies suggested by our model avoid the explosion in the algorithmic complexity usually associated with dynamic programming solutions, all the while yielding competitive performance.

Product Demand Sensitivity and the Corporate Diversification Discount
Hassan, M. Kabir,Maroney, Neal,Siraj, Ibrahim
We consider the consumer responsiveness to the changes in the macroeconomic environment, i.e., product demand sensitivity, as a systematic industry characteristic to study how industrial diversification adds value. We argue that diversified firms, with the advantages of the internal capital market and imperfectly correlated cash flows of the segments, would perform better than focused firms when demand sensitivity of a product increases. Moreover, such premium predominantly exists during the recessionary periods, even though it disappears in the presence of low coinsurance and inefficient use of the internal capital market. Our empirical evidence reveals a significant diversification premium associated with the increase in sensitivity. Our results are robust to alternative measures of sensitivity and performance metrics, different empirical model specifications, and to the concern of plausible biased estimations associated with the sample of diversified and focused firms.

Productivity propagation with networks transformation
Satoshi Nakano,Kazuhiko Nishimura

We model sectoral production by cascading binary compounding processes. The sequence of processes is discovered in a self-similar hierarchical structure stylized in the economy-wide networks of production. Nested substitution elasticities and Hicks-neutral productivity growth are measured such that the general equilibrium feedbacks between all sectoral unit cost functions replicate the transformation of networks observed as a set of two temporally distant input-output coefficient matrices. We examine this system of unit cost functions to determine how idiosyncratic sectoral productivity shocks propagate into aggregate macroeconomic fluctuations in light of potential network transformation. Additionally, we study how sectoral productivity increments propagate into the dynamic general equilibrium, thereby allowing network transformation and ultimately producing social benefits.

Proxyeconomics, the inevitable corruption of proxy-based competition
Oliver Braganza

When society maintains a competitive system to promote an abstract goal, competition by necessity relies on imperfect proxy measures. For instance profit is used to measure value to consumers, patient volumes to measure hospital performance, or the Journal Impact Factor to measure scientific value. Here we note that \textit{any proxy measure in a competitive societal system becomes a target for the competitors, promoting corruption of the measure}, suggesting a general applicability of what is best known as Campbell's or Goodhart's Law. Indeed, prominent voices have argued that the scientific reproducibility crisis or inaction to the threat of global warming represent instances of such competition induced corruption. Moreover, competing individuals often report that competitive pressures limit their ability to act according to the societal goal, suggesting lock-in. However, despite the profound implications, we lack a coherent theory of such a process. Here we propose such a theory, formalized as an agent based model, integrating insights from complex systems theory, contest theory, behavioral economics and cultural evolution theory. The model reproduces empirically observed patterns at multiple levels. It further suggests that any system is likely to converge towards an equilibrium level of corruption determined by i) the information captured in the proxy and ii) the strength of an intrinsic incentive towards the societal goal. Overall, the theory offers mechanistic insight to subjects as diverse as the scientific reproducibility crisis and the threat of global warming.

Should the CEO Pay Ratio Be Regulated?
Anginer, Deniz,Liu, Jinjing,Schipani, Cindy A.,Seyhun, H. Nejat
Starting from January 2017, all publicly listed firms in the United States are required to disclose a pay ratio of annual CEO compensation to the median employee compensation (Pay Ratio). Opponents of this legislation have argued that this additional Pay Ratio disclosure would simply add to the costs of compliance without providing any new information to the market over and above the existing CEO Pay Slice variable, known as the ratio of CEO’s pay to top five executives’ compensation. Using hand-collected data, this paper finds that both variables are related to CEO power, but the Pay Ratio variable provides new and additional information over and above the Pay Slice variable. Furthermore, the Pay Ratio variable is more informative about the agency costs excessive CEO power imposes on shareholders. The cost of capital increases significantly as Pay Ratio increases and Pay Ratio dominates and eliminates the explanatory power of Pay Slice. Our empirical finding suggests that to understand the costs imposed on shareholders by excessive CEO power, we also need to pay attention to the Pay Ratio variable.

Social Exclusion, Ambiguity and (IR)rationality
Brown, Donald,Krauss, Annette
This working paper extends the methodology of non-smooth affective portfolio theory (APT) for eliciting (IR)rational preferences of investors endowed with continuous quasilinear utility functions, where assets are portfolios of risky and ambiguous state-contingent claims. The elicitation is a solution of the affective Afriat inequalities. Solving the smooth affective Afriat inequalities is Np-hard. The proposed extension is a methodology for the elicitation of (IR)rational preferences of individuals endowed with random continuous quasilinear utility functions defined over finite subsets of discrete social goods as a refutable model of social exclusion in the incomplete markets for social goods. The methods of elicitation are generalized estimating equations (GEE) and alternating logistic regression (ALR).

Stability of Equilibrium Asset Pricing Models: A Necessary and Sufficient Condition
Jaroslav Borovicka,John Stachurski

We obtain an exact necessary and sufficient condition for the existence and uniqueness of equilibrium asset prices in infinite horizon, discrete-time, arbitrage free environments. Through several applications we show how the condition sharpens and improves on previous results. We connect the condition, and hence the problem of existence and uniqueness of asset prices, with the recent literature on stochastic discount factor decompositions. Finally, we discuss computation of the test value associated with our condition, providing a Monte Carlo method that is naturally parallelizable.

Stationarity of the detrended time series of S&P500
Karina Arias-Calluari,Morteza. N. Najafi,Michael S. Harré,Fernando Alonso-Marroquin

Our study presents the analysis of stock market data of S&P500 before and after been detrended. The analysis is based on two types of returns, simple return and log-return respectively. Both of them are non-stationary time series. This means that their statistical distribution change over time. Consequently a detrended process is made to neutralize the non-stationary effects. The detrended process is obtained by decomposing the financial time series into a deterministic trend and random fluctuations. We present an alternative method on detrending time series based on the classical moving average (MA) models, where Kurtosis is used to determine the windows size. Then, the dentrending fluctuation analysis (DFA) is use to show that the detrended part is stationary. This is done by considering the autocorrelation of detrended price return and the power spectrum analysis of detrended price.

The Competitive Threat from TechFins and BigTech in Financial Services
King, Michael R.
The Chinese TechFins Ant Financial and Tencent's WePay are harnessing technology to redefine financial services and increase financial inclusion. TechFins purport to use technology to create a world where customers have access to financial services just like tap water â€" you open the tap and water just flows out. From being a minority view several years ago, the new consensus among bank insiders and industry commentators is that TechFins, not FinTechs, represent a greater threat over the next decade to financial incumbents. The other threat comes from a diverse collection of North American technology companies known collectively as “BigTech”. The main competitive strength of BigTech companies such as Amazon, Apple, Facebook and Google comes from massive datasets on customer transactions and behaviour in their platform ecosystems. This forthcoming chapter reviews the history and strategies of two companies that have moved farthest into financial services â€" Ant Financial and Amazon. It examines their key competitive strengths to gauge the threat they pose to financial incumbents over the coming decade.

The Performance of Exchange-Traded Funds
Blitz, David,Vidojevic, Milan
Exchange-traded funds (ETFs) are commonly regarded as an efficient, low-cost alternative to actively managed mutual funds, yet their perceived superiority is largely anecdotal. We evaluate the performance of a comprehensive, survivorship bias-free sample of US equity ETFs following the same approach that has been commonly used to evaluate the performance of actively managed mutual funds. We find that ETFs have collectively lagged the market by an amount that appears similar to the widely documented underperformance of active mutual funds. We perform textual and regression-based analysis to identify factor ETFs and show that most of these have also failed to beat the market. We conclude that, from a pure performance perspective, the allure of ETFs finds little support in the data.

The Technological Revolution in Financial Services: Introduction
King, Michael R.,Nesbitt, Richard
The financial industry is being transformed by a combination of structural forces: heightened regulation, technological disruption, and changing demographics. These forces are lowering barriers to entry and increasing competition from within and outside the industry. A diversity of new entrants are challenging the incumbent banks, assets managers, insurance provides and other industry stakeholders (collectively “incumbents””). The new entrants range from entrepreneurial financial technology (FinTech) start-ups to large, non-financial technology-based companies (TechFins and BigTech). The goal of this edited volume is to provide insights on the evolution and future landscape of banking and financial services over the coming decades. This book exposes financial practitioners, policymakers, and students to the views and insights of industry leaders, regulators and academic researchers who provide a roadmap on how this industry will evolve. This book is divided into three main sections. The first section examines the structural forces and technologies transforming financial services and how these catalysts are changing customer expectations and the competitive landscape. The second section examines the business models and value proposition of new entrants and how incumbents are adapting their strategies and business models to respond to these challenges. The third section focuses on what actions senior financial leaders need to take to be successful in this new digital era.

Trading via Image Classification
Naftali Cohen,Tucker Balch,Manuela Veloso

The art of systematic financial trading evolved with an array of approaches, ranging from simple strategies to complex algorithms all relying, primary, on aspects of time-series analysis. Recently, after visiting the trading floor of a leading financial institution, we noticed that traders always execute their trade orders while observing images of financial time-series on their screens. In this work, we built upon the success in image recognition and examine the value in transforming the traditional time-series analysis to that of image classification. We create a large sample of financial time-series images encoded as candlestick (Box and Whisker) charts and label the samples following three algebraically-defined binary trade strategies. Using the images, we train over a dozen machine-learning classification models and find that the algorithms are very efficient in recovering the complicated, multiscale label-generating rules when the data is represented visually. We suggest that the transformation of continuous numeric time-series classification problem to a vision problem is useful for recovering signals typical of technical analysis.

Unintended Benefits of Employment Protection Laws: Households Increased Risk-taking Behavior
Jo, Chanik
US households increase the share of stocks in financial wealth by 8.1 to 8.9% when a state-level employment protection law is adopted. Stock market participation accounting for indirect investment also increases two years after the adoption. These effects are stronger for households with a higher layoff risk. The exact opposite risk-taking behaviors are observed when the law is reversed. After a reversal, households significantly reduce both the share of stocks and stock market participation with a stronger effect for households with a higher layoff risk. I also find that discharged households at the time of the adoption reduce their stock holding and participation after the adoption, consistent with the increased labor income risk for discharged households because the employment protection laws decrease firms' employment. Overall, findings in this paper suggest that employment protection laws effectively reduce households' labor income risk, especially for households with a higher risk, associated with younger and lower income, and induce them to take more financial risk, which is an indirect social benefit of the employment protection law.

Universal Ownership in the Anthropocene
Quigley, Ellen
This paper reviews the existing literature on Universal Ownership Theory and expands on it to encompass a theoretical and practical framework for Universal Owners in the Anthropocene era. This extension of the theory is necessary because of the scale and urgency of the climate crisis, on one hand, and the expansion of the category of funds considered to be Universal Owners on the other â€" through the rise of fiduciary capitalism and the increase in institutional ownership, and through the increasing prevalence of passive investing.This paper incorporates several novel elements into Universal Ownership Theory: an Existential Risk lens, which highlights the portfolio risk of civilisational collapse; a theoretical framework that reflects advances in behavioural science; a practical investment framework based on the tenets of Positive Investment, including asset class-specific recommendations with a focus on capital allocation, the primary-to-secondary market transition, and “ungameable” metrics; and the proposition of a “duty of expansion” for Universal Owners to extend participation to communities and regions of the world currently underrepresented among the body of large institutional investors.