Research articles for the 2019-10-25

Bank Competition and the Effects of Macroprudential Policy on Procyclicality of Lending
Kowalska, Iwona,Olszak, Małgorzata
Despite the extensive debate on the effects of bank competition on risk-taking and procyclicality, there is no evidence of its role in the effects of macroprudential policy on loans’ growth and on the sensitivity of lending to the business cycle. We contribute to the literature by investigating the impact of bank competition on the effects of individual macroprudential tools in a sample covering over 70,000 bank-level observations in 109 countries from 2004 to 2015. Our results are in line with the competition-fragility hypothesis and suggest that increased market power is associated with enhanced loans’ growth in countries in which macroprudential policy is effective in reducing credit growth and with decreased credit growth for instruments that are not effective in diminishing lending. We also find support for the view that increased market power in the banking sector helps to achieve reduced sensitivity of lending to the business cycle in countries that apply cyclical macroprudential instruments due to increased risk-taking in the banking sector. Moreover, we show that, for countries in which macroprudential policy is associated with reduced procyclicality of lending, some degree of market power is beneficial for bank lending, as it tames the excessive countercyclicality of credit.

Carry and Time-Series Momentum: A Match Made in Heaven
Molyboga, Marat,Qian, Junkai,He, Chaohua
This paper introduces a novel approach to combining time-series momentum and carry trade by conditioning trading signals of time-series momentum on the sign of the basis, a key input for carry trade. We find that this new technique applied to four major asset classes improves the Sharpe ratio of time-series momentum by approximately 0.17 net of fees. The improvement in performance is greater during recessions and, therefore, conditioning time-series momentum signals on the sign of the basis improves performance when it matters the most. Thus, the new approach has practical importance for investors and asset managers who attempt to improve their long-term performance without increasing downside risk during periods of market turbulence.

Deposit Insurance and Market Discipline
Quintero V, Juan Carlos
A standard feature in deposit insurance schemes that counterbalances moral hazard is limitedcoverage. It achieves this by reinforcing market discipline: depositors have greater incentives tomonitor banks’ risk-taking. In this paper I study market discipline and coverage levels by analyzingthe relationship of funding costs and deposit growth with banks’ leverage, non-performing loansand profitability. I use a database of Colombian banks’ balance sheets and take advantage ofa sudden, significant and exogenous increase in the coverage level that occurred in 2017. I findevidence of market discipline throughout the period of analysis and no indication of it diminishingwhen coverage levels changed. Furthermore, funding costs appear to be impacted by size-relatedvariables and there is no evidence of market discipline when analyzing only big banks. Too-big-to-fail perceptions seem to impact market discipline.

Discovering Fundamental Value
Dudley, Evan,Khan, Saad,Phelps, Luke,Riordan, Ryan
Using machine learning methods we identify the fundamental value and noise components of quarterly stock prices. We show that 28% of stock price variation is attributable to noise, and that 40% of noise is attributable to mutual fund trading. We find spikes in noise around the dot-com bubble, the 2008 financial crisis, and the European sovereign-debt crisis. Noise is higher for small firms and firms with high R&D expenditures. In an application of our methodology, we show that corporate managers do not have private information about future changes in fundamental value nor can they identify noise in prices.

Do Private Equity Managers Raise Funds on (Sur)real Returns? Evidence from Deal-Level Data
Hüther, Niklas
Recent studies on agency problems in private equity have fueled the suspicion that fund managers strategically manipulate performance estimates around fundraising times. While these studies rely on aggregated portfolio data, this paper offers the first empirical analysis of "window dressing'' in private equity based on quarterly reported deal-level performance. In contrast to previous findings of a smoking gun at the fund level, I do not find any evidence of inflated performance at the deal level. Observed interim peaks in valuation at the fund level result from lower returns on deals made under pressure to invest unspent capital closer to fundraising.

Economic Uncertainty and Bank Risk: Evidence from Emerging Economies
Jeon, Bang Nam,Wu, Ji,Yao, Yao,Chen, Minghua
This paper examines the impact of economic uncertainty on the risk of banks in emerging markets. Using the data of approximately 1500 banks in 34 emerging economies during the period of 2000-2016, we find consistent evidence that bank risk increases with the level of uncertainty. Economic uncertainty mainly exerts its impact by affecting banks’ return and its volatility, and the effect of nominal uncertainty is seemingly more conspicuous relative to that of real uncertainty. We also find that the effect of uncertainty on bank risk is conditional on banks’ characteristics such as size and efficiency. Moreover, macroprudential policies can play a stabilizing force by mitigating bank risk as economic uncertainty surges.

Engineering Pass-Throughs in International Tax: The Case of Private Equity Funds
Kim, Young Ran (Christine)
Fund investment, or indirect investment, does not entail entity-level taxation domestically, so investors enjoy “tax neutrality” between direct and indirect investments made within a country. In contrast, when investments are made across borders, tax neutrality cannot be guaranteed because current international tax regimes are built upon bilateral tax treaties and lack pass-through tax rules for multinational fund investment schemes. This may put investors in a worse tax position than had they invested directly.In response, investors have created many strategies to reduce tax liabilities internationally when investing indirectly. Sometimes those strategies enable investors to pay even less taxes than they would with a tax-neutral benchmark. Recognizing that systematic pass-through taxation more likely would achieve tax neutrality goals, the OECD, through its limited rule-making power, developed several proposals for pass-through treatment. Unfortunately, none of them have been effective, either because of too narrow implementation or because they supply bilateral solutions to a multilateral problem.As an alternative, this Article proposes an innovative multilateral approach in which both the source country and the residence country may look-through certain fund vehicles in intermediary countries and will collect tax as if the investment was made directly from the residence country to the source country. This Article further develops the proposal by demonstrating its feasibility for private equity funds (PEFs). PEFs offer unique opportunities to reform international pass-through taxation because they tend to have only a handful of high-profile investors who rarely change during the fund’s lifetime. Although information about PEF investors notoriously has been less available to tax authorities, new public and private databases as well as a newly enhanced system for the exchange of tax information make such information now more accessible to governments. Tax authorities will be able to obtain information on the considerably small and manageable number of investors behind PEFs and implement pass-through taxation to realize robust tax neutrality goals.

Hidden Drivers of Violence Diffusion: Evidence from Illegal Oil Siphoning in Mexico
Lopez Cruz, Ivan,Torrens, Gustavo
This paper develops a model of spatial violence diffusion when criminal organizations specialized in one illegal activity (e.g., drug trafficking) are attacked by security forces and tests its theoretical implications using the wave of violence triggered by the Mexican War on Drugs. The model predicts that violence will spread to locations with strategic value for other illegal activities (e.g., oil siphoning). We find evidence supporting this prediction. We document that the Mexican War on Drugs induced drug trafficking organizations to begin stealing oil from the Mexican oil pipeline network and this portfolio reallocation of illegal activities affected the spatial diffusion of violence. We show that violence increased in locations in the oil pipeline network with no strategic value for drug trafficking. Also aligned with the theoretical predictions of the model, we find that violence increased more in isolated branches of the oil pipeline network, which are more complicated to protect by the authorities and where simultaneously opening several illegal taps produces a severe negative externality.

High-Frequency Trading, Endogenous Capital Commitment and Market Quality
Wang, Yenan
I study market quality implications of the competition between traditional market making and high-frequency trading. A long-run traditional market maker responds to the competition from high-frequency traders by reducing both the spread and the amount of capital committed in market making. While a lower spread is beneficial, less capital commitment deteriorates market quality. Specifically, the market's capacity to satisfy large demand is impaired. My model integrates price and quantity effects of high-frequency trading to better characterize its implications for market quality. I argue that focusing on spread alone is not always effective in measuring market quality. I further use this framework to analyze market quality implications of different high-frequency trading regulatory measures.

How Do Banks Invest in Fintech? Empirical Evidences Around the World
Bellardini, Luca,Del Gaudio, Belinda Laura,Previtali, Daniele,Verdoliva, Vincenzo
This paper investigates how banks react to digital transformation outsourcing innovative activities. We provide evidence on the drivers of investment in FinTech firms (FCTs) made up by banks especially in terms of deal and investors characteristics. We also asses the grade of the investment discriminating for equity stake or acquisition. Using a unique sample of 1,198 rounds of worldwide investment in FTCs in which banks participated between 2008 and 2018, we find that the FTCs attract increasing amount when investor is a listed foreign located investment bank and it depend on previous amount already financed. The strategy of bank seems to be to invest in FTC which provide financial services, but this is no longer true in Emerging Market suggesting that bank seeks to cooperate investing in complementary activities.

Insider Trading and Gender
Eckbo, B. Espen,Ødegaard, Bernt Arne
We provide comprehensive, gender-based estimates of the performance of primary insiders' non-routine trades on the Oslo Stock Exchange. Regardless of gender, the time-series of insider holdings fail to indicate that insiders "buy low and sell high". However, there is evidence that the dramatic increase in the network of female directors following Norway's 2005 board gender-balancing law has increased the market reaction to female insider purchases. Moreover, female insider purchases spike following the market crash in 2008, both absolutely and relative to male insiders, which contradicts the conventional view that females are more risk averse than males.

Investment-Cash Flow Sensitivity and Financing Constraints: Study of Pakistani Business Group Firms
Mehmood, Yasir,Farid Hasnu, Syed Amjad
A large discrepancy exists on the use of the investmentâ€"cash flow sensitivity as a measure of financing constraints of firms. We examine this discrepancy by considering business group affiliated firms in Pakistan. The study includes 58 group affiliated firms and 32 non-group affiliated firms listed on the Karachi Stock Exchange during 2006-2010. Results of OLS and 2SLS shows a positive investment-cash flow sensitivity for business group affiliated firms and negative investment cash flow sensitivity for non-group affiliated firms. Additional tests accordingly express that investment-cash flow sensitivity of Pakistani group affiliated firms is significantly lower to non-group affiliated firms.

Katılım Bankacılığında Danışma Komiteleri: Faizsiz Bankacılık İlke ve Standartlarına Uyuma İlişkin Tebliğ (Tebliğ) Üzerine Bir İnceleme (Sharia Committees in Participation Banking: An Examination Upon Charter About Compliance With the Interest-Free Banking Principles and Standards (Charter))
Kartal, Mustafa Tevfik
Turkish Abstract: Türkiye’de katılım bankacılığı 2019 Ağustos ayı itibarıyla %5,9 sektör payına sahip bulunmaktadır. Katılım bankacılığının finansal piyasalar içinde düşük olan sektör payının artırılmasına yönelik faaliyetler sürdürülmektedir. Bu kapsamda, merkezi danışma kurulunun oluşturulmasının ardından katılım bankalarının bünyesindeki danışma kurullarına (yeni adıyla danışma komitelerine) yönelik olarak 14.09.2019 tarihinde Tebliğ yayınlanmıştır. Bu çalışmada, Tebliğ’in uluslararası standartlarla uyumu ve Tebliğ kapsamındaki hususlar incelenmiştir. Çalışma sonucunda, Tebliğ düzenlemelerindeki bazı hususların AAOIFI standartları ile uyumsuz olduğu belirlenmiştir. Söz konusu düzenlemelerin olumsuz etkilere neden olmaması ve uluslararası standartlarla uyumun sağlanması için bir gereklilik olarak ilave düzenleme yapılması önerilmektedir. Ayrıca, Tebliğ’in katılım bankacılığı üzerindeki etkileri Bankacılık Düzenleme ve Denetleme Kurumu (BDDK) tarafından yakından izlenmeli ve olumsuz etkilerin görülmesi halinde hızlı bir şekilde ilave tedbirler alınmalıdır. English Abstract: Participation banking has 5.9% market share in Turkey as of 2019 August. A variety of efforts has been done in order to increase market share of participation banking in financial markets. In this context, the charter regarding sharia boards (newly named as sharia committees) has been published on 09.14.2019 after establishment of central sharia board. In this study, Charter’s compliance with international standards and issues in the Charter are examined. As a result of the study, it is determined that some issues in the Charter are incompatible with the AAOIFI standards. It is recommended that as a requirement additional regulation should be issued in order not to cause negative effects and to provide compliance with the international standards. Also, effects of the Charter on participation banking should be followed up closely by Banking Regulation and Supervision Agency (BRSA) and additional measures should be taken immediately if negative effects are seen.

Leverage and Risk-Weighted Capital in Banking Regulation
Masera, Rainer
This paper offers a critical survey of the swings in banking regulation, notably with reference to leverage and risk weighted ratios. At the outset the distinction is made between economic and regulatory capital and between private vs social costs/benefits of equity finance for banking firms. The inherent limitations of the transformation process of assets into a combined size-risk metric are brought to the fore, as well as the relative ease of circumventing the rules. The complexity of regulatory risk weighting creates significant (fixed) compliance costs. Unless appropriate tiering is adopted, a competitive distortion is created in favour of large banking institutions. These shortcomings were especially evident in the Basel II standard. With reference to the Basel III/IV framework it is argued that the two regulatory ratios (leverage and risk weighted capital) can be complementary, but require close and constant supervision, rather than the quest of an optimal (steady state) ex-ante calibration, which may prove time inconsistent. Emphasis should be placed on corporate governance and on the effective interaction between supervisory activity and internal controls. This is usefully complemented by stress-testing techniques which are less model dependent. Finally, potential drawbacks inherent in the latest regulatory change in the U.S. (community banks have now the option of abandoning tiered risk weighted requirements and adopting exclusively a leverage constraint, higher than 9%) are indicated.

Mind the Gap: A Discussion Paper on Financial Literacy and Financial Behaviour: Is There Any Gender Gap?
Sholevar, Maryam,Harris, Laurence
Since the 2008 global crisis, financial literacy has come into the spotlight, but the available definitions are of theoretical nature addressing major issues appeared in specific economies, as presented here through an in-depth analysis of the literature. While the common focus has been on the United States, the economic infrastructure of Europe is very diverse. Despite the global epidemic of the crisis, its pattern was not globally the same. Utilising the current definitions without considering their validity has caused a misconception for inspecting emerging problems. Therefore, a new definition of financial literacy is proposed, which can be universally applied to various types of economies. The approach is to find the appropriate perspective for tailoring the framework of financial literacy for specific environments. Applying this definition to typical cases revealed that some of the key problems discussed in the literature are not indeed the critical issues, while major problems are usually neglected. The best example is the case of the gender gap where we might need to find new solutions as most of the previous studies have been based on inappropriate (or at least less practical) premises.

On the Equivalence of Private and Public Money
Brunnermeier, Markus K.,Niepelt, Dirk
When does a swap between private and public money leave the equilibrium allocation and price system unchanged? To answer this question, the paper sets up a generic model of money and liquidity which identifies sources of seignorage rents and liquidity bubbles. We derive sufficient conditions for equivalence and apply them in the context of the â€Å"Chicago Plan�, cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). Our results imply that CBDC coupled with central bank pass-through funding need not imply a credit crunch nor undermine financial stability.

Paying for Beta: Embedded Leverage and Asset Management Fees
Hitzemann, Steffen,Sokolinski, Stanislav,Tai, Mingzhu
This article studies the effects of leverage constraints on asset management fees. We present a new model in which constrained investors delegate capital to asset managers. In the equilibrium, risk-seeking investors choose high beta managers who charge high fees for providing embedded leverage. Our empirical results in the sample of the U.S. equity mutual funds are consistent with the model's three novel predictions: 1) fees increase in market beta, but only when beta is larger than one, 2) this relation is stronger when leverage constraints tighten, and 3) fund net alpha declines in beta faster than its gross alpha. Our study suggests that willingness to pay for embedded leverage helps explain net-of-fees underperformance of actively managed funds.

Platform Mispricing and Lender Learning in Peer-to-Peer Lending
Liu, Xinyuan,Wei, Zaiyan,Xiao, Mo
We document how online lenders exploit a flawed, new pricing mechanism in a peer-to-peer lending platform: Switching from auctions to a posted-price mechanism in December 2010, Prosper assigned loan listings with different estimated loss rates into seven distinctive rating grades and adopted a single price for all listings with the same rating grade. We show that lenders adjusted their investment portfolios towards listings at the low end of the risk spectrum of each Prosper rating grade. We find heterogeneity in the speed of adjustment by lender experience, investment size, and diversification strategies. It took about 16â€"17 months for an average lender to take full advantage of the “cherry-picking” opportunity under the single-price regime, which is roughly when Prosper switched to a more flexible pricing mechanism.

Politics of Exclusion through Language in the Presidential Speeches of Donald Trump
Abbasi, Ameer Ali
The current research is an attempt to define and discuss the mechanisms of power as used by Trump in his presidential speeches that he has made during the year, 2017, in accordance with Foucault’s Theory of Power/Knowledge. However, a number of research articles have been published on the speeches of Trump, but no one has analysed the mechanisms of power in his speeches as discussed by Foucault. So the present research fills up the gap by analysing Trump’s speeches using Foucault’s Power and Knowledge Theory. The researcher aims to answer the problem of mechanisms of power such as politics of exclusion in the concerned speeches, the way Trump employs to create discourse and knowledge. In order to discuss and analyse the speeches, the study embraces the qualitative method that enables to answer the question related to power mechanisms. The discussion and analysis consists of the mechanisms such as American nationalism, Islam and politics of exclusion, and paranoia. Besides, he also makes use of purposive, explanatory and descriptive designs of research to collect and analyse data using the above given theory. Thus, the study explores Trump's mechanisms of exclusionary politics as used in his presidential speeches.

Portfolio Weighting Methods: Naïve vs. Scientific Diversification
Mendes, António Marques,Santos, Dinis
In our study we found that picking the right weighting method at times doubles portfolio returns. But, paradoxically, we found no significant differences between returns achieved through naïve and scientific weighting methods. Nevertheless, we dismissed the hypothesis that portfolio weightings are irrelevant, since we found a set of variables explaining their relative performance. Our conclusion is that passive investors will gain from sticking to weighting methods based on the marginal efficiency of equity or capitalization rather than the widely advocated mean-variance method. However, active investors can gain from portfolio re-balancing based on one or multiple weighting methods.

Stock Comovement and Financial Flexibility
Kumar, Anil,Sacchetto, Stefano,Vergara-Alert, Carles
We develop a dynamic model of corporate investment and financing, in which shocks to the value of collateralizable corporate real estate assets generate variation in firms' debt capacity. We show that the degree of similarity among firms' financial flexibility forecasts cross-sectional variation in return correlation. We test the implications of the model and find that the correlation among stocks in the top-percentile portfolio according to the similarity of financial flexibility is 1.5% higher than the correlation among stocks in the median portfolio. This link is stronger for firms with more investment opportunities, for older firms, and during periods of increasing real estate prices. Our results are robust to multivariate analyses that control for exposure to systematic return factors and several dimensions of similarity across firms.

The Collateralizability Premium
Ai, Hengjie,Li, Jun E.,Li, Kai,Schlag, Christian
A common prediction of macroeconomic models of credit market frictions is that the tightness of financial constraints is countercyclical. As a result, theory implies a negative collateralizability premium; that is, capital that can be used as collateral to relax financial constraints provides insurance against aggregate shocks and commands a lower risk compensation compared with non-collateralizable assets. We show that a longshort portfolio constructed using a novel measure of asset collateralizability generates an average excess return of around 8% per year. We develop a general equilibrium model with heterogeneous firms and financial constraints to quantitatively account for the collateralizability premium.

The Color of Hedge Fund Activism
Chu, Yongqiang,Huang, Bo,Zhang, Chengsi
We examine the effect of hedge fund activism on mortgage lending. We find that banks targeted by hedge fund activism discriminate less against African American borrowers by approving more mortgage applications from African Americans. We also find that target banks charge lower interests on loans to African Americans. We show that these changes are not driven by changes in risk or risk preferences.

The Impact of Governance on Economic Growth: An Empirical Assessment in Sub-Saharan Africa
Adzima, Kokou,Baita, Kossi
In recent decades, issues of good governance and its impact on the well-being of populations have been at the heart of debates among researchers and international organizations. This article examines the impact of governance on economic growth in Sub-Saharan Africa. The panel data estimated shows that governance has a positive and significant impact on economic growth in Sub-Saharan Africa at the 1% threshold. An improvement of one unit of this composite governance indicator would lead to an increase in the economic growth of 19.43% on average. Effective governance and the rule of law are important determinants of economic growth. However, a country that improves these two indicators would encourage an increase in its economic growth. A better quality of institutions would reduce poverty through economic growth.

The New City Regulators: Platform and Public Values in Smart and Sharing Cities
Ranchordas, Sofia,Goanta, Catalina
Cities are increasingly influenced by novel and cosmopolitan values advanced by transnational technology providers and digital platforms, which differ from the traditional public values protected by national and local laws and policies. This article contrasts the public values created by digital platforms in cities with the democratic and social national values that the platform society is leaving behind. It innovates by showing how co-regulation can balance public values with platform values. In this article, we argue that despite the value-creation benefits produced by the digital platforms under analysis, public authorities should be aware of the risks of technocratic discourses and potential conflicts between platform and local values. In this context, we suggest a normative framework which enhances the need for a new kind of knowledge-service creation in the form of local public-interest technology. Moreover, our framework proposes a negotiated contractual system that seeks to balance platform values with public values in an attempt to address the digital enforcement problem driven by the functional sovereignty role of platforms.

The Regulation of Financial Markets and the European Social Model
Hinojosa Martínez, Luis Miguel
This work starts from the assumption that the technical regulation of markets is not objective because any economic rule derives from a prior political approach and responds to a social model. Subsequently, it examines the way in which financial regulation is produced at the international level and enquires into the degree to which fairness and maximization of social welfare are taken (or not) into account in such a process. In particular, this study analyzes how European financial norms and decisions are made and special attention is paid to the mechanisms of democratic control established in the EU in order to evaluate if this normative output reflects the distributional preferences of the citizenry. Three paradigmatic examples of European financial reform (the recovery and resolution of banks, the financial transaction tax and the limits on the remuneration of financial executives) are reviewed to evaluate whether the distributional effects of these new legislation suffice to talk of a social market economy that is coherent with the core elements of the European social model.

The Risk Weighted Ownership Index: An Ex-Ante Measure of Banks’ Risk and Performance
Bellardini, Luca,Murro, Pierluigi,Previtali, Daniele
Attributing ratings to the top-20 owners, we construct a Risk-Weighted Ownership index (RWO) to measure the profitability and risk-taking behaviour of the ownership structure at banks. Collecting data from 19 European countries plus the UK over the 2008-2017 period, preliminary results show strong evidence that RWO measures are significant in explaining bank performance and risk, at both an accounting and a market-based level. Overall, these results suggest that not only markets and regulators should look at bank’s owners: instead, it is far more relevant to assess the contribution carried by top-owners to bank risk, both individually and collectively.

William T Ziemba's Contributions to Portfolio Theory and Practice
Ziemba, William T.
This paper reviews contributions to portfolio theory and practice by William T. Ziemba and his colleagues. The paper covers static and dynamic portfolio and capital growth theory along with real applications to asset and asset-liability management and various types of trading and prediction and risk control models for a variety of asset classes. There is reference to and synopsis of many journal articles, academic and practical research and books. The effects of parameter errors on optimal portfolio choice is reviewed along with exit strategies from bubble like financial markets. Mispriced options, risk and pure arbitrage, political effects and stock market anomalies are used along with optimization in various applications.