Research articles for the 2019-10-22

A Classification Framework for Stablecoin Designs
Amani Moin,Emin Gün Sirer,Kevin Sekniqi

Stablecoins promise to bridge fiat currencies with the world of cryptocurrencies. They provide a way for users to take advantage of the benefits of digital currencies, such as ability to transfer assets over the internet, provide assurance on minting schedules and scarcity, and enable new asset classes, while also partially mitigating their volatility risks. In this paper, we systematically discuss general design, decompose existing stablecoins into various component design elements, explore their strengths and drawbacks, and identify future directions.

A Novel Housing Price Misalignment Indicator for Germany
Hertrich, Markus
From 2014 until present, housing prices in Germany have been rising faster than consumer prices in all quarters except one, raising concerns about an excessive over-heating of the housing market. To assess the vulnerability of the German housing market to a future realignment of prices or even a housing bust, this paper develops a housing price misalignment indicator that is composed of seven indicators, which are commonly associated with the fundamental value of residential property. An empirical application to the most recent data suggests that the German housing market exhibits an overvaluation of approximately 11%, where interest rate risk and a relatively advanced stage of the housing cycle are identified as the main factors fueling these imbalances, while a rather solid debt-servicing capacity mitigates these imbalances since end-2009.

A hybrid stochastic differential reinsurance and investment game with bounded memory
Yanfei Bai,Zhongbao Zhou,Helu Xiao,Rui Gao,Feimin Zhong

This paper investigates a hybrid stochastic differential reinsurance and investment game between one reinsurer and two insurers, including a stochastic Stackelberg differential subgame and a non-zero-sum stochastic differential subgame. The reinsurer, as the leader of the Stackelberg game, can price reinsurance premium and invest its wealth in a financial market that contains a risk-free asset and a risky asset. The two insurers, as the followers of the Stackelberg game, can purchase proportional reinsurance from the reinsurer and invest in the same financial market. The competitive relationship between two insurers is modeled by the non-zero-sum game, and their decision making will consider the relative performance measured by the difference in their terminal wealth. We consider wealth processes with delay to characterize the bounded memory feature. This paper aims to find the equilibrium strategy for the reinsurer and insurers by maximizing the expected utility of the reinsurer's terminal wealth with delay and maximizing the expected utility of the combination of insurers' terminal wealth and the relative performance with delay. By using the idea of backward induction and the dynamic programming approach, we derive the equilibrium strategy and value functions explicitly. Then, we provide the corresponding verification theorem. Finally, some numerical examples and sensitivity analysis are presented to demonstrate the effects of model parameters on the equilibrium strategy. We find the delay factor discourages or stimulates investment depending on the length of delay. Moreover, competitive factors between two insurers make their optimal reinsurance-investment strategy interact, and reduce reinsurance demand and reinsurance premium price.

Adaptive-Aggressive Traders Don't Dominate
Daniel Snashall,Dave Cliff

For more than a decade Vytelingum's Adaptive-Aggressive (AA) algorithm has been recognized as the best-performing automated auction-market trading-agent strategy currently known in the AI/Agents literature; in this paper, we demonstrate that it is in fact routinely outperformed by another algorithm when exhaustively tested across a sufficiently wide range of market scenarios. The novel step taken here is to use large-scale compute facilities to brute-force exhaustively evaluate AA in a variety of market environments based on those used for testing it in the original publications. Our results show that even in these simple environments AA is consistently out-performed by IBM's GDX algorithm, first published in 2002. We summarize here results from more than one million market simulation experiments, orders of magnitude more testing than was reported in the original publications that first introduced AA. A 2019 ICAART paper by Cliff claimed that AA's failings were revealed by testing it in more realistic experiments, with conditions closer to those found in real financial markets, but here we demonstrate that even in the simple experiment conditions that were used in the original AA papers, exhaustive testing shows AA to be outperformed by GDX. We close this paper with a discussion of the methodological implications of our work: any results from previous papers where any one trading algorithm is claimed to be superior to others on the basis of only a few thousand trials are probably best treated with some suspicion now. The rise of cloud computing means that the compute-power necessary to subject trading algorithms to millions of trials over a wide range of conditions is readily available at reasonable cost: we should make use of this; exhaustive testing such as is shown here should be the norm in future evaluations and comparisons of new trading algorithms.

An Information-Based Theory of Financial Intermediation
Bethune, Zachary,Sultanum, Bruno,Trachter, Nicholas
We advance a theory of how private information and heterogeneous screening ability across market participants shapes trade in decentralized asset markets. We solve for the equilibrium market structure and show that the investors who intermediate trade the most and interact with the largest set of counterparties must have the highest screening ability. That is, the primary intermediaries are those with superior information–screening experts. We provide empirical support for the model’s predictions using transaction-level micro data and information disclosure requirements. Finally, we study the connection between screening ability and efficiency, and observe that a market where all investors are screening experts–and thus, a market with no private information–may be dominated in terms of welfare by a market with no screening experts.

An Introduction to Algorithmic Trading: Opportunities & Challenges within the Systematic Trading Industry
Burgess, Nicholas
In what follows we present systematic trading and discuss the benefits. We evaluate contemporary trends, the opportunities arising from machine learning and the operational cost challenges faced, leveraging on the history of the industry to demonstrate why maintaining a competitive edge is paramount to its continued success.

Are Professional Investors Prone to Behavioral Biases? Evidence from Mutual Fund Managers
Azimi, Mehran
I study the determinants of mutual fund managers’ expectations about the stock market and its implications for decision making and fund performance. Using a direct measure of managers’ market expectations extracted from mutual funds’ semi-annual reports, I find that fund managers extrapolate their funds’ past performance into their market outlook. In addition, their expectation about the market return is negatively related to whether they experienced the burst of the dot-com bubble. Funds with managers who have higher market expectation take more risk by increasing their equity holdings and the beta of their equity portfolios, but underperform subsequently. My results suggest that professional investors are also prone to behavioral biases, which is detrimental to mutual fund investors.

Bottom-Up Leading Macroeconomic Indicators: An Application to Non-Financial Corporate Defaults Using Machine Learning
Pike, Tyler,Sapriza, Horacio,Zimmermann, Tom
This paper constructs a leading macroeconomic indicator from microeconomic data using recent machine learning techniques. Using tree-based methods, we estimate probabilities of default for publicly traded non-financial firms in the United States. We then use the cross-section of out-of-sample predicted default probabilities to construct a leading indicator of non-financial corporate health. The index predicts real economic outcomes such as GDP growth and employment up to eight quarters ahead. Impulse responses validate the interpretation of the index as a measure of financial stress.

Can Machines Learn Capital Structure?
Amini, Shahram,Elmore, Ryan,Strauss, Jack
Yes, they can! Machine learning models that exploit big data can consistently predict corporate leverage better than classical methods over time and identify its determinants. Using a large sample of U.S. firms from 1972 to 2018, we apply random forests, gradient boosting machines, neural networks, and generalized additive models to predict corporate leverage and analyze its determinants. Results show that machine learning models that allow for nonlinearities and complex interactions boost the out-of-sample R-squared significantly and substantially over traditional linear methods such as OLS and LASSO. The superior predictive performance occurs every year of the out-of-sample period at the aggregate level as well as subsamples such as firms undergoing a major capital restructuring. Additionally, machine learning methods consistently identify the determinants of corporate leverage over time. Our best performing model, a random forest, selects market-to-book, industry median leverage, cash & equivalents, Z-Score, profitability, stock returns, and firm size as robust and reliable predictors of market leverage. These findings suggest that despite leverage climbing to record highs, firm fundamentals drive corporate leverage, since the determinants and predictability of corporate leverage have remained stable since 2000. Our work offers promise for applying machine learning models to the repertoire of capital structure studies seeking to predict corporate leverage with high precision; further, machine learning methods can change our perception of what variables are reliably important.

Consumption in the Great Recession: The Financial Distress Channel
Athreya, Kartik,Mather, Ryan,Mustre-del-Rio, Jose
During the Great Recession, the collapse of consumption across the U.S. varied greatly but systematically with house-price declines. We find that financial distress among U.S. households amplified the sensitivity of consumption to house-price shocks. We uncover two essential facts: (1) the decline in house prices led to an increase in household financial distress prior to the decline in income during the recession, and (2) at the zip-code level, the prevalence of financial distress prior to the recession was positively correlated with house-price declines at the onset of the recession. Using a rich-estimated-dynamic model to measure the financial distress channel, we find that these two facts amplify the aggregate drop in consumption by 7 percent and 45 percent respectively.

Consumption in the Great Recession: The Financial Distress Channel
Athreya, Kartik,Mather, Ryan,Mustre-del-Rio, Jose,Sánchez, Juan M.
During the Great Recession, the collapse of consumption across the US varied greatly but systematically with house-price declines. Our message is that household financial health matters for understanding this relationship. Two facts are essential for our finding: (1) the decline in house prices led to an increase in household financial distress (FD) prior to the decline in income during the recession, and (2) at the zip-code level, the prevalence of FD prior to the recession was positively correlated with house-price declines at the onset of the recession. We measure the power of the financial distress channel using a rich-estimated-dynamic model of FD. We find that these channels amplify the aggregate drop in consumption by 7% and 45%, respectively.

Differential Treatment in the Bond Market: Sovereign Risk and Mutual Fund Portfolios
Mallucci, Enrico
How does sovereign risk affect investors' behavior? We answer this question using a novel database that combines sovereign default probabilities for 27 developed and emerging markets with monthly data on the portfolios of individual bond mutual funds. We first show that changes in yields do not fully compensate investors for additional sovereign risk, so that bond funds reduce their exposure to a country's assets when its sovereign default risk increases. However, the magnitude of the response varies widely across countries. Fund managers aggressively reduce their exposure to high-debt countries and high-risk countries. By contrast, they are more lenient toward core developed markets. In this sense, these economies appear to receive preferential treatment. Second, we document what determines the destination of reallocation ows. When fund managers reduce their exposure to a country in response to its sovereign risk, they shift their assets to countries outside the immediate geographic region while at the same time avoiding countries with high debt-to-GDP ratios and markets to which they are already heavily exposed. These results are supportive of models of sovereign default that assign a nontrivial role to the preferences of international creditors.

Direct and Indirect Effects based on Changes-in-Changes
Martin Huber,Mark Schelker,Anthony Strittmatter

We propose a novel approach for causal mediation analysis based on changes-in-changes assumptions restricting unobserved heterogeneity over time. This allows disentangling the causal effect of a binary treatment on a continuous outcome into an indirect effect operating through a binary intermediate variable (called mediator) and a direct effect running via other causal mechanisms. We identify average and quantile direct and indirect effects for various subgroups under the condition that the outcome is monotonic in the unobserved heterogeneity and that the distribution of the latter does not change over time conditional on the treatment and the mediator. We also provide a simulation study and an empirical application to the Jobs II programme.

Do Conventional Monetary Policy Instruments Matter in Unconventional Times?
Buchholz, Manuel,Schmidt, Kirsten,Tonzer, Lena
This paper investigates how declines in the deposit facility rate set by the ECB affect euro area banks' incentives to hold reserves at the central bank. We find that, in the face of lower deposit rates, banks with a more interest-sensitive business model are more likely to reduce reserve holdings and allocate freed-up liquidity to loans. The result is driven by wellcapitalized banks in the non-GIIPS countries of the euro area. This reveals that conventional monetary policy instruments have limited effects in restoring monetary policy transmission during times of crisis.

Do Excessively Volatile Forecasts Impact Investors?
Lundholm, Russell J.,Rogo, Rafael
There is a logical bound on the time-series variability of analyst forecasts; when variability exceeds this bound it must be caused by something besides statistically rational forecasting. We document occurrences of excessively volatile analyst forecasts and show that they influence investment performance. Comparing trading rules based on forecasts that are excessively volatile and those that are not, we find the returns to investing based on the former are significantly lower, with higher daily volatility, and a lower Sharpe ratio. We also show that returns to trading based on excessively volatile forecasts underperform the most when there is little news arriving and when the news that does arrive is relatively neutral. In this region, it is hardest to argue that analysts are unwittingly overreacting to news; instead, they appear to be intentionally making extreme forecasts to curry favor with management or to differentiate themselves from other analysts.

ETF Momentum
Li, Frank Weikai,Teo, Melvyn,Yang, Chloe (Chunliu)
We document economically large momentum profits when sorting ETFs on returns over the past two to four years. A value-weighted, long-short strategy based on ETF momentum delivers Carhart (1997) four-factor alphas of up to 1.20% per month. Neither cross-sectional stock momentum nor co-variation with macroeconomic and liquidity risks can explain ETF momentum. Instead, the post-holding period returns are most consonant with the behavioral story of delayed overreaction. While ETF momentum survives multiple adjustments for transaction costs, it may be difficult to arbitrage as the profits are volatile and concentrated in ETFs with high idiosyncratic volatility or that hold low-analyst-coverage stocks.

Effective Risk Oversight in a Changing World: Principles and Guidance for Board Risk Committees and Risk Functions in the UK Financial Services Sector (Response to the Risk Coalition Consultation)
Lyons, Sean
In June 2019 the Risk Coalition published a consultation document of their principles and guidance for board risk committees and risk functions in the UK financial services sector. This draft document entitled "Effective Risk Oversight in a Changing World" was open for public comment until 20th September 2019 and the Risk Coalition plans to issue the final version of the guidance in December 2019. The Risk Coalition aspires to improve risk governance and risk management in the UK financial services sector by providing clear and authoritative principle-based guidance. This guidance sets out to (a) develop a common understanding of the purpose and remit of board risk committees and risk functions, (b) raise expectations and promote good practice of risk oversight in UK financial services, and (c) provide a benchmark against which board risk committees and risk functions can be objectively assessed. This submission provides comments to address the risk oversight issue from two distinct perspectives: 1. General Observations This section addresses the following issues in the context of risk oversight: (a) the requirement for holistic risk oversight, and (b) delivering a holistic risk oversight framework 2. Response to Specific Questions This section provides feedback in relation to the specific consultation questions outlined by the Risk Coalition in the consultation document. Post-mortem investigations into the causes of ongoing corporate fiascos and financial scandals continue to identify both failures in corporate governance and poor risk management as major contributors. I welcome the initiative to provide clear and authoritative principles-based guidance in the area of risk governance, risk oversight, and risk management. Improved risk oversight can have a very important role to play in helping to better safeguard stakeholder interests going forward. The comments included in this submission are therefore intended to be a constructive attempt to contribute to the further improvement of the consultation document prior to being finalised.

Financial Reporting Readability: Managerial Choices Versus Firm Fundamentals
Hesarzadeh, Reza,Bazrafshan, Ameneh,RajabAlizadeh, Javad
An implicit premise of regulators and much empirical research is that financial reporting readability (readability) substantially reflects management choices. To investigate this issue, we decompose readability into its discretionary and innate components. To validate this decomposition, we examine whether these two components have different uncertainty effects. Our empirical findings show that readability is primarily the result of firm fundamentals rather than managerial choices. Furthermore, consistent with expectation, discretionary readability has a weaker uncertainty effect than innate readability. The findings are robust to a variety of additional tests. This study contributes to regulators to better assess readability and to empirical literature to construct more accurate tests.

Forecasting High-Risk Composite Camels Ratings
Gaul, Lewis,Uysal, Pinar
No abstract available.

Foreign Exchange Dealer Asset Pricing
Reitz, Stefan,Umlandt, Dennis
We show that excess returns to the carry trade can be interpreted as compensation for foreign exchange dealers' capital risk. Given that the top market makers in foreign exchange are at the heart of the market's information aggregation process we also suggest that it is their marginal value of wealth which prices foreign currencies. Consistent with this hypothesis the empirical results show that shocks to the equity capital ratios of the top three foreign exchange dealers have explanatory power for the cross-sectional variation in expected currency market returns, while those of the average dealer provide no substantial additional information.

Give Me Your Tired, Your Poor, Your High-Skilled Labor: H-1B Lottery Outcomes and Entrepreneurial Success
Dimmock, Stephen G.,Huang, Jiekun,Weisbenner, Scott J.
We study how access to high-skill labor affects the outcomes of start-up firms. We obtain exogenous variation in firms’ ability to access skilled labor by using win rates in H-1B visa lotteries. Relative to other firms that also applied for H-1B visas, firms with higher lottery win rates are more likely to receive additional venture capital funding and to have a successful exit via an IPO or acquisition. H-1B visa lottery winners also subsequently receive more patents and patent citations. Overall, our results show that access to high-skill labor is a critical determinant of success for start-up firms.

Global Spillovers of a China Hard Landing
Ahmed, Shaghil ,Correa, Ricardo,Dias, Daniel A.,Gornemann, Nils,Hoek, Jasper,Jain, Anil,Liu, Edith,Wong, Anna
China’s economy has become larger and more interconnected with the rest of the world, thus raising the possibility that acute financial stress in China may lead to global financial instability. This paper analyzes the potential spillovers of such an event to the rest of the world with three methodologies: a VAR, an event study, and a DSGE model. We find the sentiment channel to be the primary spillover channel to the United States, affecting global risk aversion and asset prices such as equity prices and the dollar, in addition to modest real effects through the trade channel. In comparison, the combined financial and real effects to other advanced and emerging market economies, especially net commodity exporters, would be more consequential due to their larger direct exposure to China and more limited scope of monetary policy to respond to shocks.

How Inheritance Law Affects Family Firm Performance: Evidence from a Natural Experiment
Gam, Yong Kyu,Kang, Min Jung,Park, Junho,Shin, Hojong
We argue that changes in the inheritance system affect the incentives toward sibling rivalry among descendants, thereby having a material impact on family firm performance. Using South Korea’s 1991 inheritance law reform that stipulates the equal distribution of a deceased person’s property to the descendants, we find that performance and operating growth rate in family firms show a significant enhancement compared to those of non-family firms. Moreover, the positive effects are greater for family firms that undertake a business succession with multiple sons and married daughters. Overall, our results suggest that changing to equal bequests of inheritance brings positive effect on firm value by providing better-aligned incentives to heirs in family firms. We conclude our paper by discussing implications of our findings for current generations in family firms.

Impact of Earnings Announcements on Share Prices: Switzerland
Al-Baidhani, Dr. Ahmed
The aim of this study is to evaluate the usefulness and relevance of earnings announcements, as the key determinant for share price changes. The main objective is to examine whether earnings response coefficient (ERC) behavior could explain more fully the share price changes, as to the reason why the stock price change is not equal to the amount of announced earnings. The study is conducted on Switzerland as a major developed economy for the period of 2001-2014. Two measures of abnormal returns are regressed against the size of the announced earnings. The first regression uses measures from individual events. The second regression uses a portfolio measure; that is, from portfolios that are made of all observations sorted by size of earnings into ten portfolios. The aim of the portfolio method was to control possible idiosyncratic-errors-in-variables problem using individual event measures. The results using individual-event measures resulted in reasonable ERC sizes with high R2 explanatory power, a little higher than those reported in prior studies on other countries. Importantly, the portfolio-based ERC of the country is somewhat close to the magnitude of the earnings which supports the famous value relevance theory in accounting. This finding is new to this literature.

Information Leakage Prior to SEC Form Filingsâ€"Evidence from TAQ Millisecond Data
Ho, Steven Wei,Zhang, Mingrui
We investigate the stock price movements prior to the publication of publicly-listed firms' SEC form filings. By analyzing the time-stamps of all SEC form filings as well as the stock prices in the 30 minute interval pre- and post-publication, utilizing the TAQ millisecond data, we find strong evidence of information leakage in the 30-minute intervals around Edgar acceptance timestamp of corporate SEC filings, in that if the stocks are ranked into 5 portfolios based on the price run-up prior to filing release, for all form types, the events with the highest run-up would also have the highest price increase post filing release. Also, depending on the type of the SEC filing, for filings that could contain both positive and negative information, for example, form 8K 10K and 10Q (as opposed to 13D or 13G which generally can only be good new for stock price), the events with the most run-down prior to the release would also have the most price decrease post filing release. The results are not driven by momentum, and they remain even after the SEC’s server fix in March, 2015, as Bolandnazar et al (2015) have documented information leakage in the several-minutes range due to a technical issue related to SEC’s dissemination through FTP and PDS services, which is also a different time-horizon than the 30 minute range we are focusing on. To the best of our knowledge, this phenomenon has not been previously documented in the literature using high frequency intra-day data.

Inversion of Convex Ordering: Local Volatility Does Not Maximize the Price of VIX Futures
Acciaio, B.,Guyon, Julien
It has often been stated that, within the class of continuous stochastic volatility models calibrated to vanillas, the price of a VIX future is maximized by the Dupire local volatility model. In this article we prove that this statement is incorrect: we build a continuous stochastic volatility model in which a VIX future is strictly more expensive than in its associated local volatility model. More generally, in this model, strictly convex payoffs on a squared VIX are strictly cheaper than in the associated local volatility model. This corresponds to an inversion of convex ordering between local and stochastic variances, when moving from instantaneous variances to squared VIX, as convex payoffs on instantaneous variances are always cheaper in the local volatility model. We thus prove that this inversion of convex ordering, which is observed in the SPX market for short VIX maturities, can be produced by a continuous stochastic volatility model. We also prove that the model can be extended so that, as suggested by market data, the convex ordering is preserved for long maturities.

Macro to the Rescue? An Analysis of Macroprudential Instruments to Regulate Housing Credit
Falter, Alexander
This paper builds a macro model with a financial sector and a housing market to understand the transmission and effects of macroprudential instruments addressing mortgage credit. The model compares the introduction of a loan-to-value ratio (LTV), a countercyclical capital buffer (CCyB)-style rule and sectoral constraints similar to sectoral risk weights. The results show that instruments work largely as intended and are to different extents suitable to dampen credit booms. Moreover, there is a trade-off between effectiveness, i.e. the extent to which instruments are able to dampen credit booms, and efficiency, i.e. the extent to which instruments might exhibit unintended consequences for the financial sector or real economy. General shocks, where housing credit increases as a side effect of larger movements, might warrant the use of the CCyB or also sectoral risk weights to correct for sector specific developments. Simple sectoral shocks can be dealt with or responded to first with sectoral risk weights. The LTV is much more effective than sectoral risk weights in confining credit growth, but shows less efficiency due to strong substitution effects.

Mesoscale impact of trader psychology on stock markets: a multi-agent AI approach
J. Lussange,S. Palminteri,S. Bourgeois-Gironde,B. Gutkin

Recent advances in the fields of machine learning and neurofinance have yielded new exciting research perspectives in practical inference of behavioural economy in financial markets and microstructure study. We here present the latest results from a recently published stock market simulator built around a multi-agent system architecture, in which each agent is an autonomous investor trading stocks by reinforcement learning (RL) via a centralised double-auction limit order book. The RL framework allows for the implementation of specific behavioural and cognitive traits known to trader psychology, and thus to study the impact of these traits on the whole stock market at the mesoscale. More precisely, we narrowed our agent design to three such psychological biases known to have a direct correspondence with RL theory, namely delay discounting, greed, and fear. We compared ensuing simulated data to real stock market data over the past decade or so, and find that market stability benefits from larger populations of agents prone to delay discounting and most astonishingly, to greed.

Order patterns, their variation and change points in financial time series and Brownian motion
Christoph Bandt

Order patterns and permutation entropy have become useful tools for studying biomedical, geophysical or climate time series. Here we study day-to-day market data, and Brownian motion which is a good model for their order patterns. A crucial point is that for small lags (1 up to 6 days), pattern frequencies in financial data remain essentially constant. The two most important order parameters of a time series are turning rate and up-down balance. For change points in EEG brain data, turning rate is excellent while for financial data, up-down balance seems the best. The fit of Brownian motion with respect to these parameters is tested, providing a new version of a forgotten test by Bienaym'e.

Preguntas Y Respuestas Sobre Valoración (Questions and Answers on Valuation)
Fernandez, Pablo
Spanish Abstract: Este documento contiene preguntas sobre valoración de empresas que me han formulado en los últimos años alumnos, antiguos alumnos y otras personas (jueces, árbitros, clientes,…). Se han recopilado para ayudar al lector a recordar, aclarar, reforzar, matizar y, en su caso, discutir, conceptos útiles en valoración. La mayoría de las preguntas tienen una respuesta clara, pero otras son matizables.Las preguntas se agrupan en 6 apartados: flujos, endeudamiento, tasas de descuento, valoración, transacciones e intangibles. A todas las preguntas les sigue una respuesta breve.English Abstract: This document has 205 questions from students, alumnae and other persons (judges, lawyers, clients, etc.). They are useful to clarify some useful concepts in valuation. Most of the questions have a clear answer. The document also has short answers to all questions.

Price Reversals and Price Continuations Following Large Price Movements
Dyl, Edward Alexander,Yuksel, H. Zafer,Zaynutdinova, Gulnara R.
We concurrently examine price reversals and price continuations that follow extreme one-day price changes in the period 1986â€"2015. Consistent with the overreaction and underreaction hypotheses, we find that investors overreact to non-information-based price movements and underreact to public announcements containing firm-specific information. We also find that, consistent with the liquidity hypothesis, smaller firms and firms with lower institutional ownership are more likely to experience price reversals relative to price continuations. The magnitudes of reversals and continuations are also greater for smaller firms and firms with lower institutional ownership. Liquidity improvement following the post-decimalization period led to the reduction in the magnitudes of both, price reversals and continuations. These findings have implications for future debate about underlying reasons of observed price movements and the impact of decimalization on financial markets.

Relative Net Utility and the Saint Petersburg Paradox
Daniel Muller,Tshilidzi Marwala

The famous St Petersburg Paradox shows that the theory of expected value does not capture the real-world economics of decision-making problem. Over the years, many economic theories were developed to resolve the paradox and explain the subjective utility of the expected outcomes and risk aversion. In this paper, we use the concept of the net utility to resolve the St Petersburg paradox. The reason why the principle of absolute instead of net utility does not work is because it is a first order approximation of some unknown utility function. Because the net utility concept is able to explain both behavioral economics and the St Petersburg paradox it is deemed a universal approach to handling utility. Finally, this paper explored how artificial intelligent (AI) agent will make choices and observed that if AI agent uses the nominal utility approach it will see infinite reward while if it uses the net utility approach it will see the limited reward that human beings see.

Risk Weighting, Private Lending and Macroeconomic Dynamics
Donadelli, Michael,Jüppner, Marcus,Prosperi, Lorenzo
According to current regulation, European banks can apply zero risk weights to sovereign exposures in their balance sheet, irrespective of the assigned rating. We show that a zero risk weighting of sovereign bonds has implications by distorting banks' asset allocation decisions. Due to the lower regulatory cost of sovereign bonds, banks invest more in those bonds at the expense of lending to the real sector. To quantify the effect of this distortion, we build a standard RBC model featuring financial intermediation and a government sector calibrated to the euro area economy. Financial regulation is introduced via a penalty function that punishes banks if they deviate from the target capital ratio. We study the zero risk weight policy during normal times when there is no sovereign default risk and find that a policy introducing positive risk weights on government bonds has both long-run effects and stabilising properties with respect to the business cycle. This policy makes the steady state lending spread on loans to firms decline, stimulating investment and output. Also, it stabilises the lending spread, leading to a lower volatility of investment and output.

Scarred Consumption
Malmendier, Ulrike,Shen, Leslie Sheng
We show that prior lifetime experiences can "scar" consumers. Consumers who have lived through times of high unemployment exhibit persistent pessimism about their future financial situation and spend significantly less, controlling for the standard life-cycle consumption factors, even though their actual future income is uncorrelated with past experiences. Due to their experience-induced frugality, scarred consumers build up more wealth. We use a stochastic lifecycle model to show that the negative relationship between past experiences and consumption cannot be generated by financial constraints, income scarring, and unemployment scarring, but is consistent with experience-based learning.

Shareholder Activism and Firms' Voluntary Disclosure of Climate Change Risks
Flammer, Caroline,Toffel, Michael W.,Viswanathan, Kala
This paper examines whether â€" in the absence of mandated disclosure requirements â€" shareholder activism can elicit greater disclosure of firms' exposure to climate change risks. We find that environmental shareholder activism increases the voluntary disclosure of climate change risks, especially if initiated by investors who are more powerful (institutional investors) or whose request has more legitimacy (long-term institutional investors). We also find that companies that voluntarily disclose climate change risks following environmental shareholder activism achieve a higher valuation, suggesting that investors value transparency with respect to climate change risks.

Statistical Governance and FDI in Emerging Economies
von Kalckreuth, Ulf
The importance of institutional settings for economic development outcomes is broadly acknowledged nowadays. This paper investigates the role of official statistics in alleviating financing constraints in emerging and developing economies, with a particular focus on Sub-Saharan Africa. Official statistics has a major dual role: it directly adds to the information set of investors regarding the general state of the economy and it is a key commitment and signalling device as to future good governance. Empirically, the paper investigates, for a sample of 98 emerging and developing countries, the relationship between the adoption of the IMF General Data Dissemination Standard (GDDS) for statistical data production and the net incurrence of foreign direct investment liabilities. Direct investment is considerably higher under GDDS. Controlling also for time and country effects, using fixed effects and quantile panel regression, the relationship ceases to be uniformly positive. Heterogeneity matters: There is a large and significant difference between poorer and richer countries, as well as between countries in Sub-Saharan Africa and elsewhere. Given the information asymmetry problems in poor developing countries, this is not unexpected. Furthermore, it becomes evident that the relationship between the adoption of GDDS and net incurrence of FDI liabilities is negative for richer countries and outside Sub-Saharan Africa. For richer countries, the relevant alternative might have been the more demanding SDDS, turning the adoption of GDDS into an unfavourable signal. Quantile regression is carried out using the quantile panel estimator of Canay (2011).

The CMMV Pricing Model in Practice
Bernard De Meyer,Moussa Dabo

Mainstream financial econometrics methods are based on models well tuned to replicate price dynamics, but with little to no economic justification. In particular, the randomness in these models is assumed to result from a combination of exogenous factors. In this paper, we present a model originating from game theory, whose corresponding price dynamics are a direct consequence of the information asymmetry between private and institutional investors. This model, namely the CMMV pricing model, is therefore rooted in market microstructure. The pricing methods derived from it also appear to fit very well historical price data. Indeed, as evidenced in the last section of the paper, the CMMV model does a very good job predicting option prices from readily available data. It also enables to recover the dynamic of the volatility surface.

The Effects of the Eurosystem's App on Euro Area Bank Lending: Letting Different Data Speak
Blaes, Barno,Kraaz, Björn,Offermanns, Christian
We study the implications of the Eurosystem's expanded Asset Purchase Programme (APP) for the bank lending business of euro area banks with euro area non-financial corporations (NFCs) using microeconometric matching techniques. Based on confidential bank-level data on quantitative balance sheet items and interest rates as well as on qualitative survey responses to the Eurosystem's Bank Lending Survey, we identify the exposure of banks to the APP and corresponding effects on loan growth. We find that the APP was effective in stimulating the lending activity with NFCs for a subset of relatively sound banks. At the same time, our results show that there is a non-negligible number of banks with less healthy balance sheets which could not transfer the APP stimulus into more lending. Instead, such banks appear to have used the APP stimulus for consolidating their balance sheets, thereby also reducing their lending business with NFCs. This confirms the importance of accounting for the large degree of heterogeneity in the euro area banking sector in analyses of the effectiveness of monetary policy measures.

The Premium Reduction of European, American, and Perpetual Log Return Options
Taylor, Stephen Michael,Vecer, Jan
Traditional plain vanilla options can be regarded as options on a simple return. These options have convex payoffs and as a consequence of Jensen’s inequality, their prices are increasing are increasing as a function of maturity in the absence of interest rate. This makes long dated call options as excessively expensive in relationship to the fraction of the insured portfolio. We show that replacing a simple return payoff with the log return call option payoff leads to substantial savings while providing the same protection type. The call options on log return have a favorable price for very long maturities in the scale of decades, making them attractive for long term investment funds, such as pension funds.

The Real Effects of Bank Distress: Evidence from Bank Bailouts in Germany
Bersch, Johannes,Degryse, Hans,Kick, Thomas,Stein, Ingrid
How does bank distress impact their customers' probability of default and trade credit availability? We address this question by looking at a unique sample of German firms from 2000 to 2011. We follow their firm-bank relationships through times of distress and crisis, featuring the different transmission of bank distress shocks into already weakened firm balance sheets. We find that a distressed bank bailout, which is subject to restructuring and deleveraging conditions, leads to a bank-induced increase of firms' probabilities of default. Moreover, bailouts tend to reduce trade credit availability and ultimately firms' sales. We further find that the direction and magnitude of the effects depends on firm quality and the relationship orientation of banks.

The Value of Insider Information for Super--Replication with Quadratic Transaction Costs
Yan Dolinsky,Jonathan Zouari

We study super--replication of European contingent claims in an illiquid market with insider information. Illiquidity is captured by quadratic transaction costs and insider information is modeled by an investor who can peek into the future. Our main result describes the scaling limit of the super--replication prices when the number of trading periods increases to infinity. Moreover, the scaling limit gives us the asymptotic value of being an insider.

The equivalence of two tax processes
Dalal Al Ghanim,Ronnie Loeffen,Alex Watson

We introduce two models of taxation, the latent and natural tax processes, which have both been used to represent loss-carry-forward taxation on the capital of an insurance company. In the natural tax process, the tax rate is a function of the current level of capital, whereas in the latent tax process, the tax rate is a function of the capital that would have resulted if no tax had been paid. Whereas up to now these two types of tax processes have been treated separately, we show that, in fact, they are essentially equivalent. This allows a unified treatment, translating results from one model to the other. Significantly, we solve the question of existence and uniqueness for the natural tax process, which is defined via an integral equation. Our results clarify the existing literature on processes with tax.

Tractable Rare Disaster Probability and Options-Pricing
Barro, Robert J.,Liao, Gordon
We derive an option-pricing formula from recursive preference and estimate rare disaster probability. The new options-pricing formula applies to far-out-of-the money put options on the stock market when disaster risk dominates, the size distribution of disasters follows a power law, and the economy has a representative agent with Epstein-Zin utility. The formula conforms with options data on the S&P 500 index from 1983-2018 and for analogous indices for other countries. The disaster probability, inferred from monthly fixed effects, is highly correlated across countries, peaks during the 2008-2009 financial crisis, and forecasts equity index returns and growth vulnerabilities in the economy.

Uncertainty Shocks and Financial Crisis Indicators
Hristov, Nikolay,Roth, Markus
The current paper broadens the understanding for the role of uncertainty in the context of a macroeconomic environment. It focuses on the implications of uncertainty shocks on indicators that tend to precede financial crises. In an empirical analysis we show for a set of four euro area countries that negative uncertainty shocks, while accompanied by favorable effects to economic activity, are followed by unfavorable reactions of financial crisis indicators. We conclude that uncertainty indicators contain some useful information on the potential buildup of vulnerabilities in the financial system.

Variance Risk Premium Components and International Stock Return Predictability
Londono, Juan,Xu, Nancy R.
No abstract available.

What Drives Inventory Accumulation? News on Rates of Return and Marginal Costs
Gortz, Christoph,Gunn, Christopher,Lubik, Thomas
We study the effects of news shocks on inventory accumulation in a structural VAR framework. We establish that inventories react strongly and positively to news about future increases in total factor productivity. Theory suggests that the transmission channel of news shocks to inventories works through movements in marginal costs, through movements in sales, or through interest rates. We provide evidence that changes in external and internal rates of return are central to the transmission for such news shocks. We do not find evidence of a strong substitution effect that shifts production from the present into the future.

Why Did Belgium Pay Leopold's Bonds?
Oosterlinck, Kim,Blocher, Joseph,Gulati, G. Mitu
A body of empirical research in finance has attempted to assess whether stocks associated with sinful behavior (companies selling alcohol, tobacco, gambling activities, etc.) suffer from a market penalty. This question has been less studied in the sovereign bond market, but there is some research such finding similar penalties for some of the dodgier debts of sinful regimes such as the 1906 Tsarist bond issue and the 2017 Venezuelan Hunger Bond sale. In this article, we examine the presence of the sin penalty for the debts of one of the most odious of regimes ever: that of King Leopold II of the Congo Free State whose cruelty resulted in one of the first global human rights movements and his removal from power. The question is we ask is whether, once information as to the genocidal behavior of Leopold’s minions became widespread in the early 1900s, the market imposed a penalty on Leopold’s borrowings. We find no evidence of any market penalty on the debt that funded Leopold’s misdeed; even though there had been widespread condemnation of his behavior at the time. We ask: Why not?

反思中国的é‡'融æŠ'制与隐性担保 (Rethink the Financial Repression and Implicit Guarantee in China)
An, Ping
Chinese Abstract: 本文构建了一个é"¶è¡Œè‡ªç"±ç«žäº‰ï¼Œå±…æ°'受到“高储è"„率æŠ'制”,国有企业受到“经营波动æŠ'制”的模型,可以解释å½"前中国许多é‡'融æŠ'制现象å'Œé‡'融市场均衡。基于模型本文提出,å½"前中国“é‡'融æŠ'制”现象的根源不在于é‡'融部门,而在于居æ°'å'Œå›½æœ‰ä¼ä¸šå—到æŠ'制。在这种环境下,隐性担保并非影å"é‡'融稳定的核心风险:一方面,中国é‡'融市场中的隐性担保,不是市场非理性行为ç»"果,而是一个客观制度环境。所有市场参与者都在此环境下做出优化决策,从而隐性担保因素已在资产定价过程中被包含,不存在定价偏误。另一方面,居æ°'å'Œå›½æœ‰ä¼ä¸šé¢ä¸´çš„æŠ'制有助于ç¼"解隐性担保的潜在风险。而ä¸"数值模拟显示,提高é"¶è¡Œé—´å¸‚场流动性,同时适å½"降低国有企业æŠ'制,可以在不æ‰"破隐性担保的情况下提升中国é‡'融市场效率。如果强制æ‰"破隐性担保,反而会产ç"Ÿå‰§çƒˆçš„市场动荡å'Œæœ‰æ‚–社会公平的æ"¶å…¥åˆ†é…æ•ˆåº"。English Abstract: I construct a model where the banks compete freely, while the household faces “high saving repression”, the state owned enterprise (SOE) faces “operation fluctuate repression”. The model can explain nearly all financial repression phenomena and financial market equilibria in China after the 2008 global financial crisis. By the model, I propose that the root of “financial repression phenomena” in China, not comes from the financial sector, but comes from the household and SOE sectors. Against this background, the implicit guarantee is not the main risk of the financial instability. On one hand, the implicit guarantee is an exogenous institutional environment rather than an endogenous irrational outcome of the market, hence it was already contained in the asset prices; on the other hand, the repressions of the household and SOE alleviate the risk of the implicit guarantee. Furthermore, the simulation shows that, improve the liquidity in the inter-bank market and moderately relax the SOE repression can raise efficiency of the financial market without break the implicit guarantee. If the regulator compels the bank to break the implicit guarantee will cause the financial market turmoil and the redistribution effect that violates social fairness.