Research articles for the 2019-10-31

6 Ways to Cut Costs and Grow Production (with a Capabilities-Driven Strategy)
Pettit, Justin
An application of Capabilities-Driven Strategy to upstream E&P. As the industry evolves, so too must E&P strategies, portfolios, organizational capabilities, and operating models â€" capabilities must be enhanced, workflows streamlined, and productivity optimized, through broad operating model redesign. Enterprise operating models require a stronger and more tailored set of key capabilities â€" some new â€" to accommodate our evolving business landscape and global resource base. Toward that end, we have identified the following list of six actions that will help you to cut costs and grow production, using a capabilities-driven strategy.

A Note on Gollier’s Model for a Collective Pension Scheme
Schumacher, J. M.
Gollier (2008) has proposed a model for the analysis of pension schemes that is helpful to focus attention on the impact of intergenerational risk sharing and on the role of the participation constraint. He uses the model to analyze the relative attractiveness of a collective scheme with respect to schemes that may be implemented by individuals for themselves. The analysis makes use of an assumption concerning the ownership rights of investment returns realized by generations that are between career start and retirement at the time of the transition from an individual to a collective system. This assumption is of a legal nature, and may be challenged. The present paper investigates the consequences of adopting an alternative assumption. Additionally, the effects are considered of changes in the specification of agents' preferences, aiming to express the specific nature of retirement income provision in the second pillar. The impact of the modifications turns out to be quite large. The Black-Scholes assumptions are used to model the economic environment, so that many results can be obtained in closed form.

Contagion: Can It Occur Without Trading Relations?
Basak, Gopal K.,Das, Pranab Kumar,Rohit, Allena
The paper explains origin of financial crisis in one country and its spread to other countries - contagion, in a multi country dynamic model of international capital inflow. The origin of crisis is rooted in this model in the common international loan market; thus crisis can occur even when the countries are not interconnected via bilateral or multilateral trade and commerce. The structure can explain various episodes of financial crisis in a common framework. A shift in the risk perception of loan repayment for a particular country is capable of generating a stronger contagion effect than a general shift in risk perception of the lenders. The model can usefully be employed to address the policy issues pertaining to capital inflow from the developed countries to developing countries.

Corporate Bond Price Reversals
Ivashchenko, Alexey
I demonstrate that investors trade U.S. corporate bonds not only for liquidity reasons but also on private information. Bond dealers let less-informed investors provide liquidity to informed traders and are not adversely selected. I obtain these results by contrasting corporate bond price reversals in bonds with different information asymmetry, trading volume, and dealers' capital commitment. I find strong price reversals that become less pronounced following high-trading-volume days. The effect is the strongest for bonds with high information asymmetry, and when dealers' end-of-day inventory does not change. The results suggest that information reveals itself in prices on high-volume days when dealers do not accept overnight inventory risk. The findings are in line with the predictions of a theoretical model in which investors trade both for liquidity reasons and on private news that arrive independently of changes in inventory. I further show that realized bid-ask spreads are not wide enough to negate reversal profits of high-asymmetry bonds. Such reversal portfolios earn 3% per year after trading cost adjustment. By connecting low market transparency with high non-fundamental price volatility, the paper also contributes to the ongoing policy debate.

Credit risk with asymmetric information and a switching default threshold
Imke Redeker,Ralf Wunderlich

We investigate the impact of available information on the estimation of the default probability within a generalized structural model for credit risk. The traditional structural model where default is triggered when the value of the firm's asset falls below a constant threshold is extended by relaxing the assumption of a constant default threshold. The default threshold at which the firm is liquidated is modeled as a random variable whose value is chosen by the management of the firm and dynamically adjusted to account for changes in the economy or the appointment of a new firm management. Investors on the market have no access to the value of the threshold and only anticipate the distribution of the threshold. We distinguish different information levels on the firm's assets and derive explicit formulas for the conditional default probability given these information levels. Numerical results indicate that the information level has a considerable impact on the estimation of the default probability and the associated credit yield spread.

Detecting correlations and triangular arbitrage opportunities in the Forex by means of multifractal detrended cross-correlations analysis
Robert Gębarowski,Paweł Oświęcimka,Marcin Wątorek,Stanisław Drożdż

Multifractal detrended cross-correlation methodology is described and applied to Foreign exchange (Forex) market time series. Fluctuations of high frequency exchange rates of eight major world currencies over 2010-2018 period are used to study cross-correlations. The study is motivated by fundamental questions in complex systems' response to significant environmental changes and by potential applications in investment strategies, including detecting triangular arbitrage opportunities. Dominant multiscale cross-correlations between the exchange rates are found to typically occur at smaller fluctuation levels. However hierarchical organization of ties expressed in terms of dendrograms, with a novel application of the multiscale cross-correlation coefficient, are more pronounced at large fluctuations. The cross-correlations are quantified to be stronger on average between those exchange rate pairs that are bound within triangular relations. Some pairs from outside triangular relations are however identified to be exceptionally strongly correlated as compared to the average strength of triangular correlations.This in particular applies to those exchange rates that involve Australian and New Zealand dollars and reflects their economic relations. Significant events with impact on the Forex are shown to induce triangular arbitrage opportunities which at the same time reduce cross--correlations on the smallest time scales and act destructively on the multiscale organization of correlations. In 2010--2018 such instances took place in connection with the Swiss National Bank intervention and the weakening of British pound sterling accompanying the initiation of Brexit procedure. The methodology could be applicable to temporal and multiscale pattern detection in any time series.

Economics of Bankruptcy Exemption: Signaling Value of Collateral, Cost of Credit and Access to Credit
Arca, Pasqualina,Atzeni, Gianfranco Enrico,Deidda, Luca
We analyze the effect of a bankruptcy law according to which some of the borrower’s assets are exempt from liquidation in the event of default in the context of a competitive credit market characterized either by moral hazard (MH) or by adverse selection (AS). In particular, we study how the level of such exemption affects the role of collateral depending on the dominant source of asymmetric information. Under MH, conditional on the level of exemption, the cost of credit is higher for borrowers who are requested to post collateral. Moreover, conditional on posting collateral, the cost of credit does not change with the level of asset exemption. Differently, in the case of AS, the decision to post collateral results in a lower cost of credit, whenever the equilibrium is separating. Finally, under AS, a higher level of exemption is generally associated with a lower level of credit rationing. Similarly, credit rationing either stays unchanged or goes down with exemption in the case of MH. We exploit cross State variability in the level of asset exemption from liquidation â€" according to personal bankruptcy US State laws prior to 2005 federal reform â€" in order to identify the signaling role played by collateral in a sample of american small business taken from the SBFF data.

Exploring cities of Central and Eastern Europe within transnational company networks: the core-periphery effect
Natalia Zdanowska

After the Fall of the Berlin Wall, Central Eastern European cities (CEEc) integrated the globalized world, characterized by a core-periphery structure and hierarchical interactions between cities. This article gives evidence of the core-periphery effect on CEEc in 2013 in terms of differentiation of their urban functions after 1989. We investigate the position of all CEEc in transnational company networks in 2013. We examine the orientations of ownership links between firms, the spatial patterns of these networks and the specialization of firms in CEEc involved. The major contribution of this paper consists in giving proof of a core-periphery structure within Central Eastern Europe itself, but also of the diffusion of innovations theory as not only large cities, but also medium-sized and small ones are part of the multinational networks of firms. These findings provide significant insights for the targeting of specific regional policies of the European Union.

Financial Liberalization and Export Promotion: Evidence From Nigeria (1987 â€" 2018)
Adekunle, Oludayo,Adodo, Feyisayo Loveth
Financial liberalization policy is expected to enhance credit allocation to important sector in the economy. With previous studies mainly focusing on the effect of financial liberalization on economic growth in Nigeria, this study explored the effect of financial liberalization on export promotion in Nigeria from 1987 - 2018. The study used secondary data obtained from Central Bank of Nigeria Statistical Bulletin (2018). Techniques such as Augmented Dickey â€" Fuller (ADF), Philip Perron, Bound Co-integration Test, Autoregressive Distributed Lag and Pairwise Granger Causality were employed. It was found from the unit result that lending rate was stationary at level form while loan on export, savings rate, gross domestic product, exchange rate and trade openness were integrated at first difference. Also, long run relationship was established among the variables. The ARDL result showed that loan on export, gross domestic product and trade openness significantly enhanced total export while savings rate and exchange rate negatively influenced total export in Nigeria. Furthermore, the Pairwise causality test revealed that loan to export, gross domestic product and exchange rate granger caused total export. The study concluded that financial liberalization has the potential of enhancing exportation in Nigeria through the provision of adequate credit to export based firms. It was recommended that, adequate credit should be given to export based industries at low rate of at least 12%, also, savings rate should be push upward to a threshold of at least 10% to increase savings and resources mobilization of financial and finally, exchange rate should be stabilized through adoption of effective policies.

Financial Liberalization and the Development of Microcredit
Deidda, Luca
We analyze the debt origination process in which a lender offers prospective borrowers a microcredit product alongside a traditional bank loan, and the impact anti-usury mandates can cause within this credit market. This is a paper about the prospects of financial liberalization following a more flexible determination of anti-usury rates and, with it, the development of a formal microcredit market. In the presence of asymmetric information, a lender assesses a borrower's credit worthiness via a screening process, which its effectiveness is negatively affected by the opaqueness of the borrower's financial information. For this economy, an equilibrium is possible where all opaque borrowers, regardless of their true riskiness, are rationed from credit where usury rates are exogenously set too low by regulatory authorities. Were the anti-usury mandate was relaxed, these borrowers would have the option of financing through microcredit.

Going Abroad, Friends on Board: Cross-Border Venture Capital and Syndication
Qiu, Zhiyi,Chen, Rong,Yang, Ye
Cross-border venture capitals (CBVCs) are increasingly prevailing in recent decades, especially in emerging markets like China. With foreignness growing, it turns from liability into advantage in the context of CBVCs. We investigate the VC firm’s syndication when faced with foreignness caused by culture differences. We find an inverse U-shape relationship between foreignness and syndication, with the firm’s reputation as moderator. Apart from syndication, foreign firms establish a local subsidiary when faced with foreignness.

How China Could Become a Net Exporter of Oil & Gas: Lessons Learned from International Tight Oil Development
Pettit, Justin
Even with very aggressive growth assumptions for renewables, the role for oil and gas will grow, both in absolute terms and as a share of China’s total energy mix. And yet China’s domestic production of oil and gas continues to fall short and China’s need for expensive, foreign imports will only get worse. Meanwhile, the United States â€" once the world’s largest importer of oil â€" has become the world’s largest oil producer, with only one-half as many drilling rigs as China. The implications for China are profound. China has an enormous resource base â€" if China could apply the lessons learned from international development of tight oil and gas, and replicate the US success, it would reap tremendous benefits in terms of energy security, international trade, energy costs, and domestic industrial and economic development.

Investment Funds Under Stress
Gourdel, Régis,Maqui Lopez, Eduardo,Sydow, Matthias
This paper presents a model for stress testing investment funds, based on a broad worldwide sample of primary open-end equity and bond funds. First, we employ a Bayesian technique to project the impact of macro-financial scenarios on country-level portfolio flows worldwide that are constructed from fund-level asset holdings. Second, from these projected country-level flows, we model the scenarios’ repercussions on individual funds along a three year horizon. Importantly, we further decompose portfolio flows, disentangling the specific contributions of transactions, valuation and foreign exchange effects. Overall, our results indicate that the impact of a global adverse macro-financial scenario leads to a median depletion in assets under management (AUM) of 24% and 5%, for euro area-domiciled equity and bond funds respectively, largely driven by valuation effects. Scenario and results both present similarities to the global financial crisis. We use historical information on fund liquidations to estimate a threshold for a drop in AUM that signals a high likelihood of a forthcoming liquidation. Based on this, we estimate that 5.8% and 0.5% of euro area-domiciled equity and bond funds respectively could go into liquidation. Such empirical thresholds can be useful for the implementation of prudential policy tools, such as redemption gates.

Is US Tight Oil a 'Ponzi Scheme'?
Pettit, Justin
As US oil and gas share prices languish, there is some nagging concern about the financial health of the industry. Despite turning the world’s largest importer of crude oil into a global exporter, questions linger about profitability and financial leverage â€" some skeptics have gone so far as to ask if the industry is a “Ponzi Scheme.” Moreover, as oil and gas prices continue their lower-for-longer (but volatile) trajectory, and investors clamor for ever-more cash â€" in the form of dividends and share repurchases â€" operators struggle to balance competing demands on cash. We analyzed 35 publicly-traded, US and Canadian tight/shale oil and gas specialists over the six years since global oil prices collapsed and found the industry to be largely profitable (i.e., aggregate Net Income of $5 per oil-equivalent-barrel produced), despite relatively low oil and gas prices. Moreover, with aggregate operating cash flow of $19 per oil-equivalent-barrel (boe) produced the industry has matured sufficiently to self-finance its own growth. In fact, despite heavy investment in both production-growth and reserves-growth, total financial leverage is modest (1.6x EBITDA) and one-third of operators’ credit ratings are investment grade. And in a separate comparative analysis with conventional Independents, we found that US tight oil operators have demonstrated superior profitability, growth and reinvestment, and financial leverage. Across the North American onshore E&P industry, technology-led, operational continuous improvement is driving dramatic, sustainable gains in well-productivity and cost per boe.

Kernel Based Estimation of Spectral Risk Measures
Suparna Biswas,Rituparna Sen

Spectral risk measures (SRMs) belongs to the family of coherent risk measures. A natural estimator for the class of spectral risk measures (SRMs) has the form of $L$-statistics. In the literature, various authors have studied and derived the asymptotic properties of the estimator of SRM using the empirical distribution function. But no such estimator of SRM is studied considering distribution function estimator other than empirical cdf. We propose a kernel based estimator of SRM. We try to investigate the large sample properties of general $L$-statistics based on i.i.d cases and apply them to our kernel based estimator of SRM. We prove that the estimator is strongly consistent and the estimator is asymptotically normal. We compare the finite sample performance of the kernel based estimator with that of empirical estimator of SRM using Monte Carlo simulation, where appropriate choice of smoothing parameter and the user's coefficient of risk aversion plays an important role. Based on our simulation study we have estimated the exponential SRM of four future index-that is Nikkei 225, Dax, FTSE 100 and Hang Seng using our proposed kernel based estimator.

Markov Chain Approximation of One-Dimensional Sticky Diffusions
Christian Meier,Lingfei Li,Gongqiu Zhang

We develop continuous time Markov chain (CTMC) approximation of one-dimensional diffusions with a lower sticky boundary. Approximate solutions to the action of the Feynman-Kac operator associated with a sticky diffusion and first passage probabilities are obtained using matrix exponentials. We show how to compute matrix exponentials efficiently and prove that a carefully designed scheme achieves second order convergence. We also propose a scheme based on CTMC approximation for the simulation of sticky diffusions, for which the Euler scheme may completely fail. The efficiency of our method and its advantages over alternative approaches are illustrated in the context of bond pricing in a sticky short rate model for low interest environment.

Multilevel evolutionary developmental optimization (MEDO): A theoretical framework for understanding preferences and selection dynamics
Adam Safron

What is motivation and how does it work? Where do goals come from and how do they vary within and between species and individuals? Why do we prefer some things over others? MEDO is a theoretical framework for understanding these questions in abstract terms, as well as for generating and evaluating specific hypotheses that seek to explain goal-oriented behavior. MEDO views preferences as selective processes influencing the likelihood of particular outcomes, which are more or less consistent with the dynamics underlying those influences. With respect to biological organisms, these patterns must compete and cooperate in shaping system evolution. To the extent that shaping processes are themselves altered by experience, this enables feedback relationships where histories of reward and punishment can impact future motivation. In this way, various biases can undergo either amplification or attenuation, potentially resulting in enduring preferences and orientations. MEDO is unique in that it specifically models all shaping dynamics in terms of natural selection operating on multiple levels--genetic, neural, and cultural--and even considers aspects of development to themselves be evolutionary processes. Thus, MEDO reflects a kind of generalized Darwinism, in that it assumes that natural selection provides a common principle for understanding the emergence of complexity within all dynamical systems in which replication, variation, and selection occur. However, MEDO combines this evolutionary perspective with economic decision theory, which describes both the preferences underlying individual choices, as well as the preferences underlying choices made by engineers in designing optimized systems. In this way, MEDO uses economic decision theory to explain goal-oriented behaviors as well as the interacting evolutionary optimization processes from which they emerge.

Objective Function of a Non-Price-Taking Firm with Heterogeneous Shareholders
Moskalev, Alexandr
I derive the objective function of a firm with heterogeneous shareholders. In contrast to Fisher separation theorem, I drop the price-taking assumption. Therefore, shareholders have no unanimous preferences for profit maximization. I allow shareholders to act strategically by omitting the conditional sincerity assumption and by accounting for possible correlation in their votes. I derive the exact form of the objective function and provide the equilibrium existence conditions. The resulting objective function can be approximated by a weighed sum of shareholders portfolios' profit. Shareholder groups with positive within group correlation carry greater weight.

Optimized Portfolio Using a Forward-Looking Expected Tail Loss
Sanford, Anthony
In this paper, I construct an optimal portfolio by minimizing the expected tail loss (ETL) derived from the forward-looking natural distribution of the Recovery Theorem (RT). The RT is one of the first successful attempts at deriving an unparameterized natural distribution of future asset returns. This distribution can be used as the criterion function in an expected tail loss (ETL) portfolio optimization problem. I find that the portfolio constructed using the RT outperforms both the equally-weighted portfolio and a portfolio constructed using historical ETL. The portfolio constructed using the RT has the smallest historical tail loss, smallest maximum drawdown, highest Sortino Ratio, and highest Sharpe Ratio.

Option-based Equity Risk Premiums
Alan L. Lewis

We construct the term structure of the (forward-looking, US market) equity risk premium from SPX option chains. The method is "model-light". Risk-neutral probability densities are estimated by fitting $N$-component Gaussian mixture models to option quotes, where $N$ is a small integer (here 4 or 5). These densities are transformed to their real-world equivalents by exponential tilting with a single parameter: the Coefficient of Relative Risk Aversion $\kappa$. From history, I estimate $\kappa = 3 \pm 0.5$. From the inferred real-world densities, the equity risk premium is readily calculated. Three term structures serve as examples.

Power Laws without Gibrat's Law
John Stachurski

This paper shows that the power law property of the firm size distribution is a robust prediction of the standard entry-exit model of firm dynamics. Only one variation is required: the usual restriction that firm productivity lies below an ad hoc upper bound is dropped. We prove that, after this small modification, the Pareto tail of the distribution is predicted under a wide and empirically plausible class of specifications for firm-level productivity growth. We also provide necessary and sufficient conditions under which the entry-exit model exhibits a unique stationary recursive equilibrium in the setting where firm size is unbounded.

Risk Management for Sovereign Debt Financing with Sustainability Conditions
Zenios, Stavros A.,Consiglio, Andrea,Athanasopoulou, Marialena,Moshammer, Edmund,Gavilan, Angel,Erce, Aitor
We develop a model of debt sustainability analysis with optimal financing decisions in the presence of macroeconomic, financial and fiscal uncertainty. We define a coherent measure of refinancing risk, and trade off the risks of debt stock and flow dynamics, subject to debt sustainability constraints and endogenous risk and term premia. We optimize both static and dynamic financing strategies, compare them with several simple rules and consol financing to demonstrate economically significant effects of optimal financing, and show that the stock-flow tradeoff can be critical for sustainability. We quantify the minimum refinancing risk and the maximum rate of debt reduction that a sovereign can achieve given its economic fundamentals, and extend the model to identify optimal timing for debt flow adjustments that allow the sovereign to go beyond these limits. We put the model to the data on three real-world cases: a representative euro zone crisis country, a low-debt country (Netherlands) and a high-debt country (Italy). These applications illustrate the use of the model in informing diverse policy decisions on sustainable public finance. The model is part of the European Stability Mechanism toolkit to assess debt sustainability and repayment capacity of member states in the context of financial assistance.

Sector Rotation through the Business Cycle: A Machine Learning Regime Approach
Sauer, Maximilian
Sector returns should theoretically differ during business cycle regimes. The notion of cyclical and defensive sectors is clearly established among practitioners and academics alike. On the other hand, the persistence, now- and forecastability of business cycles has been documented by a vast amount of literature. This study tests whether both strands can be merged to construct an investable sector rotation strategy based on the analysis of macroeconomic data. I find that both relationships hold: If one has forward looking information about GDP, outperformance from sector rotation is possible. Furthermore, one can nowcast the current position in the business cycle with some accuracy. While nowcasting accuracy is too small to translate into constant outperformance, the value of the examined methodology lies in the timely identifi cation of major economic crises and provides economically superior performance by signifi cantly reducing drawdowns during such.

Sentimental Recovery
Pazarbasi, Altan,Schneider, Paul,Vilkov, Grigory
We extract subjective risk-neutral and physical distributions from option quotes on S&P 500 and VIX futures according to agents’ sentiment. Without assumptions on preferences or underlying processes, we only impose a good-deal bound on the distributions to recover the bivariate distribution of the S&P 500 and VIX. We devise optimal Sharpe ratio trading strategies in S&P500 and VIX futures markets that are subjective to the agents, and implement them at the observed quotes. The bivariate distributions define important investment opportunities that would not be available considering the two markets separately. Dispersion of beliefs regarding both market and volatility dynamics is related to, and predicts macroeconomic indicators.

Spatial polarisation within foreign trade and transnational firms' networks. The Case of Central and Eastern Europe
Natalia Zdanowska

After the fall of the Berlin Wall, Central and Eastern Europe were subject to strong polarisation processes. This article proposes examines two neglected aspects regarding the transition period: a comparative static assessment of foreign trade since 1967 until 2012 and a city-centred analysis of transnational companies in 2013. Results show a growing economic differentiation between the North-West and South-East as well as a division between large metropolises and other cities. These findings may complement the targeting of specific regional strategies such as those conceived within the Cohesion policy of the European Union.

The Impact of Underpricing of the Default Risk on Investment: Evidence from Real Estate Investment Trusts (REITs)
Nguyen, Linh,Steininger, Bertram I.
This study examines the impact of under-priced default risk on investment in the real estate investment trust (REIT) sector, where firms’ investment is highly sensitive to changes in credit market conditions. The findings reveal that REITs exploiting under-priced default risk have a higher level of investment than their peers because the former can access low-cost capital. Moreover, exploiting the under-priced default risk is specific to not only REITs but also to the whole real estate investment sector. In contrast, under-priced default risk has an insignificant impact on investment of non-real estate firms because non-recourse loans are unpopular in these firms.