Research articles for the 2019-11-06

A New Localization Model for Client Reluctance
Lee, Steven
Why do clients stop communicating with financial advisors? This paper seeks to answer this question by combining the Gantt Chart of project management with the Transtheoretical Model (TTM) of Changeâ€"a framework whereby advisors illicit client responses in an effort to reinforce positive behaviors and curb negative ones through the issuance of narrowly-focused tasks. This new client localization model identifies the client’s current position on the TTM spectrum and discusses the benefits for financial advisors to use this model in helping clients reach their financial goals.

A Rational Finance Explanation of the Stock Predictability Puzzle
Abootaleb Shirvani,Svetlozar T. Rachev,Frank J. Fabozzi

In this paper, we address one of the main puzzles in finance observed in the stock market by proponents of behavioral finance: the stock predictability puzzle. We offer a statistical model within the context of rational finance which can be used without relying on behavioral finance assumptions to model the predictability of stock returns. We incorporate the predictability of stock returns into the well-known Black-Scholes option pricing formula. Empirically, we analyze the option and spot trader's market predictability of stock prices by defining a forward-looking measure which we call "implied excess predictability". The empirical results indicate the effect of option trader's predictability of stock returns on the price of stock options is an increasing function of moneyness, while this effect is decreasing for spot traders. These empirical results indicate potential asymmetric predictability of stock prices by spot and option traders. We show in pricing options with the strike price significantly higher or lower than the stock price, the predictability of the underlying stock's return should be incorporated into the option pricing formula. In pricing options that have moneyness close to one, stock return predictability is not incorporated into the option pricing model because stock return predictability is the same for both types of traders. In other words, spot traders and option traders are equally informed about the future value of the stock market in this case. Comparing different volatility measures, we find that the difference between implied and realized variances or variance risk premium can potentially be used as a stock return predictor.

A Regulatory Sandbox for Robo Advice
Ringe, Wolf-Georg,Ruof, Christopher
Robo advice, the automated provision of financial advice without human intervention, holds the promise of cheap, convenient and fast investment services for consumers â€" freed from human error or bias. However, retail investors have limited capacity to assess the soundness of the advice, and are prone to make hasty, unverified investment decisions. Moreover, financial advice based on rough and broad classifications may fail to take into account the individual preferences and needs of the investor. On a more general scale, robo advice may be a source of new systemic risk.At this stage, the existing EU regulatory framework is of little help. Instead, this paper proposes a regulatory ‘sandbox’ â€" an experimentation space â€" as a step towards a regulatory environment where such new business models can thrive. A sandbox would allow market participants to test robo advice services in the real market, with real consumers, but under close scrutiny of the supervisor. The benefit of such an approach is that it fuels the development of new business practices and reduces the ‘time to market’ cycle of financial innovation while simultaneously safeguarding consumer protection. At the same time, a sandbox allows for mutual learning in a field concerning a little-known phenomenon, both for firms and for the regulator. This would help reducing the prevalent regulatory uncertainty for all market participants.In the particular EU legal framework with various layers of legal instruments, the implementation of such a sandbox is not straightforward. In this paper, we propose a ‘guided sandbox’, operated by the EU Member States, but with endorsement, support, and monitoring by EU institutions. This innovative approach would be somewhat unchartered territory for the EU, and thereby also contribute to the future development of EU financial market governance as a whole.

A Retrieved-Context Theory of Financial Decisions
Wachter, Jessica A.,Kahana, Michael J.
Studies of human memory indicate that features of an event evoke memories of prior associated contextual states, which in turn become associated with the current event's features. This mechanism allows the remote past to influence the present, even as agents gradually update their beliefs about their environment. We apply a version of retrieved context theory, drawn from the literature on human memory, to four problems in asset pricing and portfolio choice: over-persistence of beliefs, providence of financial crises, price momentum, and the impact of fear on asset allocation. These examples suggest a recasting of neoclassical rational expectations in terms of beliefs as governed by principles of human memory.

A Two-Step Mixed Pension System: How to Reinvent Social Security with the Help of Notional Accounts and Term Annuities
Domínguez-Fabián, Inmaculada,Devolder, Pierre,del Olmo García, Francisco,Herce, Jose A
The change in economic and sociodemographic reality, characterized by a continuous increase in longevity, the consequences of the economic crisis, and the lack of adequate adjustments of social security retirement pension systems everywhere, entails risks for workers and the social security systems themselves. Many reforms of public pension systems have been carried out in recent years, based on modifying system parameters and structural changes. Some reforms aim at increasing capitalization in the determination of the final pension through a life annuity to complement the public retirement pension as a second retirement income. Against the background of the change of agents’ behaviors throughout the life cycle and the presence of an adverse selection problem in the annuities market, we describe in this paper a two-step mixed pension system that tries to solve the pressure that increasing longevity is putting on pension schemes to provide adequate and sustainable pensions for all. In our two-step mixed system, when workers reach their ordinary retirement age they receive a term annuity generated by their previous capitalized savings to be replaced by a social security defined contribution pure life annuity when the so-called grand age is reached. The analysis is carried out from an individual perspective, through the internal rate of return that workers will receive after ordinary retirement in both schemes compared with the one they would get with the same contributions in the current situation. We also analyze some possible transition strategies to the new system.

Acceptability Indices of Performance for Bounded C\`adl\`ag Processes
Christos E. Kountzakis,Damiano Rossello

Indices of acceptability are well suited to frame the axiomatic features of many performance measures, associated to terminal random cash flows.We extend this notion to classes of c\`adl\`ag processes modelling cash flows over a fixed investment horizon.We provide a representation result for bounded paths. We suggest an acceptability index based both on the static Average Value-at-Risk functional and the running minimum of the paths, which eventually represents a RAROC-type model. Some numerical comparisons clarify the magnitude of performance evaluation for processes.

An Enhanced Mean-Variance Framework for Robo-Advising Applications
Strub, Moris,Li, Duan,Cui, Xiangyu
Any robo-advisor needs to decide on a framework to model the preferences of its investors over uncertain outcomes. As of today, most robo-advisors model their investors as mean-variance optimizers. While the mean-variance framework is intuitive and optimal investment strategies have been derived in various settings, it suffers from serious drawbacks due to its time-inconsistency and non-monotonicity. We propose an enhanced mean-variance framework for robo-advising applications which is based on the equivalence between the mean-variance objective and quadratic utility functions. By introducing a flexible weight on the decreasing part of the quadratic utility function, we can alleviate the issues of time-inconsistency and non-monotonicity while keeping the features leading to the popularity of the mean-variance framework. We show how the new framework can be calibrated by means of questionnaires and discuss the advantages of the novel framework in terms of the resulting terminal wealth distributions.

Behavioral Finance, Decumulation and the Regulatory Strategy for Robo-Advice
Baker, Tom,Dellaert, Benedict G. C.
This working paper surveys the decumulation services offered by investment robo-advisors as a case study with which to examine regulatory and market structure issues raised by automated financial advice. We provide a short introduction to decumulation, describing some of the uncertainties involved in identifying optimal decumulation strategies and sketching a few of the ‘rules of thumb’ that financial advisors have developed in this area in the face of this uncertainty. Next we describe behavioral effects that could inhibit consumers from following an optimal decumulation strategy, concluding that, left to their own devices, consumers are likely to make sub-optimal decumulation decisions. Then we describe some potentially useful automated decumulation services that are available on the market and present the results of a survey assessing whether those services are offered by investment robo-advisors. Finally, we discuss market structures that may inhibit financial advisors from implementing optimal decumulation strategies for their clients and explore whether there are regulatory strategies that could encourage financial advisors to provide better decumulation services. Two promising strategies are (1) adopting a record-keeping requirement for robo-advisors that is conceptually similar to the ‘black box’ requirement for commercial airlines, and (2) developing a set of robo-advice ‘do’s and don’ts’ and related input/output tests to confirm that these requirements are met.

Clustering Fosters Investment: Local Agglomeration and Household Portfolio Choice
Addoum, Jawad M.,Delikouras, Stefanos,Ke, Da,Korniotis, George M.
We investigate the impact of local agglomeration economies on household portfolio choice. Using detailed location and employment data from two U.S. household surveys, we document that individuals who work in locally agglomerated industries are more likely to invest in risky assets. This pattern cannot be explained by households sorting on latent factors, local employers' stock compensation and pension policies, or investors' local biases. Instead, the relation between local agglomeration and portfolio decisions is consistent with industry clusters enhancing human capital and in turn, raising workers' effective risk tolerance. Our findings highlight the role of geography in shaping household financial decisions.

Clusters of investors around Initial Public Offering
Margarita Baltakienė,Kęstutis Baltakys,Juho Kanniainen,Dino Pedreschi,Fabrizio Lillo

The complex networks approach has been gaining popularity in analysing investor behaviour and stock markets, but within this approach, initial public offerings (IPO) have barely been explored. We fill this gap in the literature by analysing investor clusters in the first two years after the IPO filing in the Helsinki Stock Exchange by using a statistically validated network method to infer investor links based on the co-occurrences of investors' trade timing for 69 IPO stocks. Our findings show that a rather large part of statistically similar network structures form in different securities and persist in time for mature and IPO companies. We also find evidence of institutional herding.

Collectivised Pension Investment with Exponential Kihlstrom--Mirman Preferences
John Armstrong,Cristin Buescu

In a collectivised pension fund, investors agree that any money remaining in the fund when they die can be shared among the survivors.

We give a numerical algorithm to compute the optimal investment-consumption strategy for an infinite collective of identical investors with exponential Kihlstrom--Mirman preferences, investing in the Black--Scholes market in continuous time but consuming in discrete time. Our algorithm can also be applied to an individual investor.

We derive an analytic formula for the optimal consumption in the special case of an individual who chooses not to invest in the financial markets. We prove that our problem formulation for a fund with an infinite number of members is a good approximation to a fund with a large, but finite number of members.

Confronting the Problem of Fraud on the Board
Friedlander, Joel Edan
Recent precedents make it difficult to challenge transactions approved by a board of directors and a stockholder majority. When should such cases be filed, proceed beyond the pleading stage, and prevail? My answer is that judicial intervention should remedy and deter tortious misconduct that corrupts board decision-making (i.e., misconduct that the Delaware Supreme Court has called “illicit manipulation of a board’s deliberative processes” or “fraud upon the board”). Commission of fraud on the board is an omnipresent temptation for self-interested controllers, activist stockholders, officers, financial advisors, and their legal counsel. Fraud can be used to put a company in play, steer a sale process toward a favored bidder, suppress the sale price to a controller, or make a favored bid look more attractive. I argue that confronting the problem of fraud on the board has three components. First, virtually all successful breach of fiduciary duty actions should be reinterpreted as occasions when courts determined that a board decision was corrupted by fraud or related tortious misconduct. Second, stockholders should be entitled to examine contemporaneously created books and records in order to detect fraud on the board. Third, when committed by a non-fiduciary, fraud on the board should be considered a free-standing tort, without the need to establish that duped directors breached their fiduciary duties. Recognizing a tort of fraud on the board would be consistent with tort principles and a sound stockholder litigation regime.

Consumer Persuasion and Remuneration of Advisors in Financial Markets
Weinert, Markus
Many consumers rely on professional advisors when purchasing financial products. We compare fee-based and commission-based remuneration systems for financial advisors from a total welfare perspective in a theoretical model, where advisors face transaction costs from persuading consumers of a recommended product and consumers have an initial prior belief about their best suitable product. We show, that total welfare is higher under a commission-based remuneration system in comparison to a fee-based remuneration system, if the magnitude of commission payments for different products are sufficiently close to each other.

Deep Learning for Stock Selection Based on High Frequency Price-Volume Data
Junming Yang,Yaoqi Li,Xuanyu Chen,Jiahang Cao,Kangkang Jiang

Training a practical and effective model for stock selection has been a greatly concerned problem in the field of artificial intelligence. Even though some of the models from previous works have achieved good performance in the U.S. market by using low-frequency data and features, training a suitable model with high-frequency stock data is still a problem worth exploring. Based on the high-frequency price data of the past several days, we construct two separate models-Convolution Neural Network and Long Short-Term Memory-which can predict the expected return rate of stocks on the current day, and select the stocks with the highest expected yield at the opening to maximize the total return. In our CNN model, we propose improvements on the CNNpred model presented by E. Hoseinzade and S. Haratizadeh in their paper which deals with low-frequency features. Such improvements enable our CNN model to exploit the convolution layer's ability to extract high-level factors and avoid excessive loss of original information at the same time. Our LSTM model utilizes Recurrent Neural Network'advantages in handling time series data. Despite considerable transaction fees due to the daily changes of our stock position, annualized net rate of return is 62.27% for our CNN model, and 50.31% for our LSTM model.

Fragmentation of Distributed Exchanges
Marius Zoican,Sorin Zoican

Distributed securities exchanges may become de facto fragmented if they span geographical regions with asymmetric computer infrastructure. First, we build an economic model of a decentralized exchange with two miner clusters, standing in for compact areas of economic activity (e.g., cities). "Local" miners in the area with relatively higher trading activity only join a decentralized exchange if they enjoy a large speed advantage over "long-distance" competitors. This is due to a transfer of economic value across miners, specifically from high- to low-activity clusters. Second, we estimate the speed advantage of "local" over "long-distance" miners in a series of Monte Carlo experiments over a two-cluster, unstructured peer-to-peer network simulated in C. We find that the speed advantage increases in the level of infrastructure asymmetry between clusters. Cross-region DEX blockchains are feasible as long as the asymmetry levels in trading activity and infrastructure availability across regions are positively correlated.

High-Speed Internet, Financial Technology and Banking in Africa
D'Andrea, Angelo,Limodio, Nicola
This paper provides empirical evidence on the effect of high-speed internet on financial technology and banking in Africa. Our test combines data on 551 banks and 28,171 firms with the staggered arrival of bre-optic submarine cables in Africa. High-speed internet promoted private-sector lending by banks, and credit and sales by firms. These results are consistent with an extensive adoption of financial technologies, like real-time gross settlement systems (RTGS), lowering transaction costs in African interbank markets. We find that liquidity management considerably changed for banks being weak interbank users prior to high-speed internet. In fact, such banks lowered their internal liquidity hoarding by 10%, increased interbank transactions by 40% and expanded lending by 37%. Analogously, firms in countries with weak pre-existing interbank markets presented stronger effects at the cable arrival. These results are consistent with high-speed internet promoting financial technology adoption, liquidity and credit.

How Does the Economy Shape the Financial Advisory Profession?
Law, Kelvin,Zuo, Luo
We examine whether economic conditions have a long-term impact on the composition of available financial advisors in the profession. We find that financial advisors who start their career in recessions are less likely to commit professional misconduct throughout their career, even compared with their colleagues working in the same firm, at the same location, and at the same point in time. We show that this relation between early economic conditions and advisor misconduct remains after controlling for differences in hiring firms, advisor job functions and quality, and opportunities to commit misconduct. Collectively, our evidence suggests a behavioral difference between recession and non-recession advisors and demonstrates that economic conditions partly shape the types of financial advisors who are ultimately available in the profession.

How Persistent Low Expected Returns Alter Optimal Life Cycle Saving, Investment, and Retirement Behavior
Horneff, Vanya,Maurer, Raimond,Mitchell, Olivia S.
This Chapter explores how an environment of persistent low returns influences saving, investing, and retirement behaviors, as compared to what in the past had been thought of as more “normal” financial conditions. Our calibrated lifecycle dynamic model with realistic tax, minimum distribution, and Social Security benefit rules produces results that agree with observed saving, work, and claiming age behavior of U.S. households. In particular, our model generates a large peak at the earliest claiming age at 62, as in the data. Also in line with the evidence, our baseline results show a smaller second peak at the (system-defined) Full Retirement Age of 66. In the context of a zero-return environment, we show that workers will optimally devote more of their savings to non-retirement accounts and less to 401(k) accounts, since the relative appeal of investing in taxable versus tax-qualified retirement accounts is lower in a low return setting. Finally, we show that people claim Social Security benefits later in a low interest rate environment.

Investment Opportunity of Financial Technology
Pratama, Ahmad Aziz Putra
FinTech is a new term combining finance and technology. The term did not exist until the end of 2014. Although there is agreement over what finance is, there is no agreed upon definition of technology. It changes with time. American sociologist Read Bain wrote in 1937 that technology includes all tools, machines, utensils, weapons, instruments, housing, clothing, communicating devices, and transporting devices and the skills by which we produce and use them. Scientist Ursula Franklin [1992] gave a different definition in 1989 and referred to technology as a “practice, the way we do things around here.” Rather than referring to the objects that people produce and use, scientists and engineers usually prefer to define technology as applied science. Still, there are other views, such as French philosopher Bernard Stiegler’s (1988) definition of technology as “the pursuit of life by means other than life” and as “organized inorganic matter.”

Managing the Stress of Caregiving: A Guide for Consumers and Financial Advisors
Raskie, Sterling
The aging US population increases the need for caregiving for this expanding demographic. People with or without long-term care insurance will still need care from professional caregivers or family. Caregiving from family members, while having some rewards, may cause stress and depression that leads to overall poorer quality of life for caregivers. The paper starts with a focus on defining and observing caregiver stress, as well as its symptoms and effects. The paper transitions to a guide for consumers and financial advisors, giving recommendations and resources beneficial for assisting consumers in the caregiver role and in need of help.

Managing to Target: Dynamic Adjustments for Accumulation Strategies
Estrada, Javier
Planning for retirement, particularly during the accumulation period, largely consists of setting a target value for the retirement portfolio and implementing a policy aimed at hitting that target. Financial plans are inevitably based on expected returns, which are likely to be different from those an individual experiences during the accumulation period. Thus, when the portfolio deviates from the path outlined in the plan, the individual can choose between a static policy of sticking to his plan and simply hope to hit the target, or dynamic policies designed to keep the portfolio close to its path. This article evaluates three types of such dynamic policies, broadly referred to as ‘managing to target’ (M2T), that adjust the periodic contributions or the portfolio’s asset allocation. The results reported show that some of the dynamic policies outlined outperform a static policy, and adjusting contributions is far superior to adjusting the asset allocation.

Measuring Risk Preferences and Asset-Allocation Decisions: A Global Survey Analysis
Lo, Andrew W.,Remorov, Alexander,Ben Chaouch, Zied
We use a global survey of over 22,400 individual investors, 4,892 financial advisors, and 2,060 institutional investors between 2015 and 2017 to elicit their asset allocation behavior and risk preferences. We find substantially different behavior among these three groups of market participants. Most institutional investors exhibit highly contrarian reactions to past returns in their equity allocations. Financial advisors are also mostly contrarian; a few of them demonstrate passive behavior. However, individual investors tend to extrapolate past performance. We use a clustering algorithm to partition individuals into five distinct types: passive investors, risk avoiders, extrapolators, contrarians, and optimistic investors. Across demographic categories, older investors tend to be more passive and risk averse.

Micro-Prudential Regulation and Banks' Systemic Risk
de Haan, Jakob,Jin, Zhenghao,Chen, Zhou
This paper investigates how countries' micro-prudential regulatory regimes are related to banks' systemic risk. We use a bank-level systemic risk indicator that can be decomposed into a bank's individual risk and its systemic linkage. To proxy the strictness of a country's regulatory regime, we employ World Bank survey data.

Modelling bid-ask spread conditional distributions using hierarchical correlation reconstruction
Jarosław Duda,Robert Syrek,Henryk Gurgul

While we would like to predict exact values, available incomplete information is rarely sufficient - usually allowing only to predict conditional probability distributions. This article discusses hierarchical correlation reconstruction (HCR) methodology for such prediction on example of usually unavailable bid-ask spreads, predicted from more accessible data like closing price, volume, high/low price, returns. In HCR methodology we first normalize marginal distributions to nearly uniform like in copula theory. Then we model (joint) densities as linear combinations of orthonormal polynomials, getting its decomposition into (mixed) moments. Then here we model each moment (separately) of predicted variable as a linear combination of mixed moments of known variables using least squares linear regression - getting accurate description with interpretable coefficients describing linear relations between moments. Combining such predicted moments we get predicted density as a polynomial, for which we can e.g. calculate expected value, but also variance to evaluate uncertainty of such prediction, or we can use the entire distribution e.g. for more accurate further calculations or generating random values. There were performed 10-fold cross-validation log-likelihood tests for 22 DAX companies, leading to very accurate predictions, especially when using individual models for each company as there were found large differences between their behaviors. Additional advantage of the discussed methodology is being computationally inexpensive, finding and evaluation a model with hundreds of parameters and thousands of data points takes a second on a laptop.

On the Educational Curriculum in Finance and Technology
Karkkainen, Tatja,Panos, Georgios A.,Broby, Daniel,Bracciali, Andrea
Recent technological developments have enabled a wide array of new applications in financial markets, e.g. big data, cloud computing, artificial intelligence, blockchain, cryptocurrencies, peer-to-peer lending, crowdfunding, and robo-advising, inter alia. While traditionally comprising of computer programs and other technology used to support or enable banking and financial services, the new fintech sector is often seen as enabling transformation of the financial industry. A more moderate and critical view suggests that for the full transformative potential of fintech to be enabled, there is a need for an updated educational curriculum that balances knowledge and understanding of finance and technology. A curriculum that provides a skill portfolio in the two core components and complements them with applied knowledge can support the enabling forces which will render fintech as a true opportunity for the financial service industry and for society as a whole. We attempt a scholarship inquiry into the educational curriculum in finance and technology, aiming to inform this modern educational agenda. We review skills shortages, as identified by firms and experts, and examine the state-of-the art by some of the first educational programs in fintech.

Optimal Investment for a Retirement Plan with Deferred Annuities
Owadally, Iqbal,Jang, Chul,Clare, Andrew
We construct an optimal investment portfolio model with deferred annuities for an individual investor saving for retirement. The objective function consists of power utility in terms of secured retirement income from the deferred annuity purchases, as well as bequest from remaining wealth invested in equity, bond, and cash funds. The asset universe is governed by a vector autoregressive model incorporating the Nelson-Siegel term structure and equity returns. We use multi-stage stochastic programming to solve the optimization problem numerically. Our numerical results show that deferred annuity purchases are made continuously over the working lifetime of the investor, increasing particularly in the years before retirement. The investment strategy hedges price changes in deferred annuities, and bond holding and deferred annuity purchases increase when interest rates are high. Optimal investment and deferred annuity choices depend on realised and expected values of state variables. The optimal strategy is also compared with typical retirement plan strategies such as glide paths. Our results provide novel support for deferred annuities as a major source of retirement income.

Personalized Robo-Advising: Enhancing Investment through Client Interactions
Capponi, Agostino,Olafsson, Sveinn,Zariphopoulou, Thaleia
Automated investment managers, or robo-advisors, have emerged as an alternative to traditional financial advisors. Their viability crucially depends on timely communication of information from the clients they serve. We introduce and develop a novel human-machine interaction framework, in which the robo-advisor solves an adaptive mean-variance control problem, with the risk-return tradeoff dynamically updated based on the risk profile communicated by the client. Our model predicts that clients who value a personalized portfolio are more suitable for robo-advising. Clients who place higher emphasis on delegation and clients with a risk profile that changes frequently benefit less from robo-advising.

Reducing Legal Uncertainty and Regulatory Arbitrage for Robo-Advice
Maume, Philipp
Robo-advisers are online financial adviser services that use algorithms to create investment recommendations without human input. They deliver advice at low costs and they are growing in popularity. However, the nature of the interaction between client and machine raises many legal questions under the applicable EU regulation. This article argues that robo-advisers provide investment advice within the meaning of the Second Markets in Financial Instruments Directive (MiFiD2). They are subject to authorisation by the national regulator and ongoing conduct requirements. It might be tempting to introduce regulatory sandboxes to address the persisting legal uncertainties in practice, but such a regulatory change does not seem likely in the near future. Instead, regulatory arbitrage should be reduced by a uniform application of the MiFiD2 framework throughout the EU. Regulators and courts should also be aware that software replacing human advisers diverges from the basic idea of human interaction that forms the basis of contract law. Investment firms are able to use new technology in the services they provide. However, as this means introducing new risks for investors, the investment firm should be subject to a strict liability regime for failures of the respective technology (for example, the unavailability of the service).

Regulating Robo-Advisory
Maume, Philipp
Robo-advisors are internet-based advisory services that use algorithms to create investment recommendations with no human input, and they are growing in popularity. They deliver financial advice at a fraction of the cost of traditional financial advisors. However, the nature of the interaction between client and machine raises many legal questions and concerns. It is unclear how regulators should approach the phenomenon. Regulators in major jurisdictions have taken different approaches.

Reimagining Retirement: Longevity and Its Opportunities: An Interview with Joseph F. Coughlin, PhD
Consulting Submitter, Journal of Investment
As founder and director of the Massachusetts Institute of Technology (MIT) AgeLab, Joseph F. Coughlin, PhD, has spent the better part of the past twenty years researching how demographic change, technology, social trends, and consumer behavior drive innovations in business and government. In that capacity, he advised then-President George W. Bush’s White House Conference on Aging Advisory Committee, as well as nonprofits, governments, and corporations worldwide about how to improve the quality of life of older people and those who care for them. He has served on a variety of advisory boards for Fortune 500 companies and nonprofits worldwide. He was named one of “twelve pioneers inventing the future of retirement” by the Wall Street Journal, and one of the “100 most creative people in business” by Fast Company Magazine. He has authored more than 100 research publications and regularly contributes to Forbes, among other online and print publications. He is a frequent guest on television news programs and media outlets. He is the author of The Longevity Economy: Inside the World’s Fastest-Growing, Most Misunderstood Market, in which he explored what older people actually want, not what conventional wisdom suggests they need.In September 2018, Coughlin spoke with retirement Management Journal Editor-in-Chief Robert Powell about the ways we understand and misunderstand retirement and what it will take to effectively serve clients approaching and living in retirement.

Retirement Security, Finance Science, SeLFIES and The Flex MMM Plan
Muralidhar, Arun
Prof. Merton’s attempts to improve retirement security over the last 40 years, when viewed through his preferred lens of using “finance science” to address societal challenges, results in the creation of SeLFIES (Standard-of-Living indexed, Forward-starting, Income-only Securities) to improve retirement outcomes. SeLFIES have been proposed in countries as diverse as Australia, Chile, Colombia, France, India, Japan, Portugal, Spain, South Africa, South Korea, Turkey, and the United States â€" all interested in funding infrastructure and improving retirement security. Merton (1984) introduced the idea of government-issued consumption-linked bonds as a way to allow a fully funded public pension fund to offer consumption-indexed annuities. Later, Merton (2007) would address the challenges of defined contribution (DC) plans and argue that the welfare of individuals should be expressed in units of retirement income, and not wealth. A key insight is that the traditional “risk-free” asset in Modern Portfolio Theory (MPT) was risky from a retirement income perspective. Muralidhar, Ohashi and Shin (2014), in developing the Relative Asset Pricing Model (RAPM), leveraged the Merton (2007) idea that in retirement planning (or in any goals-based portfolio), investors care about (the utility of) funded status, defined as wealth divided by stochastic liabilities, and not expected utility of wealth. In RAPM, an additional variable â€" the relative risk-free asset or the asset that replicates the stochastic goal â€" is critical to asset allocation and asset pricing (and CAPM is just a special case of RAPM; namely CAPM assumes a deterministic goal). Currently in DC plans, the goal replicating portfolio (an annuity) is illiquid, costly and complex and Modigliani (1986) highlights the “annuity puzzle”. Muralidhar (2015) and Muralidhar, Ohashi and Shin (2015) recommend the creation of a new bond that replicates the desired cash flow profile in DC plans â€" a bond (called BFFS) that pays a fixed currency coupon, in real-terms, that starts paying once an individual retires for a period equal to the life expectancy of the country. Merton and Muralidhar (2017b) recommend linking these bonds to per-capita consumption (leveraging Merton 1984) thereby creating SeLFIES and show why SeLFIES are a good deal for governments too. BFFS/SeLFIES help complete financial markets and this idea is easily extended to other goals. The paper concludes by demonstrating how finance science can be used to design effective DC pension plans for uncovered workers.

Richard Thaler, PhD Founding Father of Behavioral Economics
Consulting Submitter, Journal of Investment
Richard Thaler is considered one of the founding fathers of behavioral economics, the nexus of economics and psychologyâ€"specifically how people and organizations make decisions that have negative consequences and how they frequently repeat these mistakes. Years of observing human behavior have convinced Thaler that efficient-market-based economic theories are inadequate because they fail to account for the fact that investors do not always act rationally or logically. In the best-selling book Nudge, Thaler and co-author Cass Sunstein explored how people make choices and what processes and structures might lead to better choices. In Nudge, Thaler and Sunstein advocate strategies that do not force anyone to do anything, yet effectively promote good choices.

Robo-advising: Learning Investor's Risk Preferences via Portfolio Choices
Humoud Alsabah,Agostino Capponi,Octavio Ruiz Lacedelli,Matt Stern

We introduce a reinforcement learning framework for retail robo-advising. The robo-advisor does not know the investor's risk preference, but learns it over time by observing her portfolio choices in different market environments. We develop an exploration-exploitation algorithm which trades off costly solicitations of portfolio choices by the investor with autonomous trading decisions based on stale estimates of investor's risk aversion. We show that the algorithm's value function converges to the optimal value function of an omniscient robo-advisor over a number of periods that is polynomial in the state and action space. By correcting for the investor's mistakes, the robo-advisor may outperform a stand-alone investor, regardless of the investor's opportunity cost for making portfolio decisions.

Robo-advising: Learning Investor's Risk Preferences via Portfolio Choices
Alsabah, Humoud,Capponi, Agostino,Ruiz Lacedelli, Octavio,Stern, Matt
We introduce a reinforcement learning framework for retail robo-advising. The robo-advisor does not know the investor’s risk preference, but learns it over time by observing her portfolio choices in different market environments. We develop an exploration-exploitation algorithm which trades off costly solicitations of portfolio choices by the investor with autonomous trading decisions based on stale estimates of investor’s risk aversion. We show that the algorithm’s value function converges to the optimal value function of an omniscient robo-advisor over a number of periods that is polynomial in the state and action space. By correcting for the investor’s mistakes, the robo-advisor may outperform a stand-alone investor, regardless of the investor’s opportunity cost for making portfolio decisions.

Scaling in Income Inequalities and its Dynamical Origin
Zoltan Neda,Istvan Gere,Tamas S. Biro,Geza Toth,Noemi Derzsy

Individual level and exhaustive income data for Romania (Cluj county) is analysed for several consecutive years. The income distributions collapse on a master-curve when a properly normalised income is considered. The Beta Prime distribution is appropriate to fit the collapsed data. A dynamical model based on a master equation with growth and reset terms is successful in explaining the observed distribution in a self-consistent manner, i.e. the growth and reset rates are evaluated from the same individual level data. Income distribution derived for other countries are following similar trends. The collapse on the master-curve is not perfect however, suggesting that for a more realistic modelling specific socio-economic characteristics have to be taken also into account.

SeLFIES for Portugal - An Innovative Pan European Retirement Solution
Merton, Robert C.,Muralidhar, Arun,Ferreira, Rui Seybert P
With a rapidly aging population, Portugal faces some serious pension challenges including a Social Security system which is under pressure, and pension benefits gradually approaching levels that will require individuals to supplement Social Security with private savings. In addition, Portugal has a low rate of financial literacy and hence transferring the responsibility of retirement planning to the general population runs a major risk of many individuals retiring poor. While some attempts have been made to create private pension plans, they have not had the level of acceptance as has been the case in some of the Anglo-Saxon countries. This paper argues that the government of Portugal could issue a new form of Sovereign Contingent Debt Instrument (SCDI) that can address the growing retirement challenge and achieve other goals as well. SeLFIES (Standard-of-Living indexed, Forward-starting Income-only Securities) are a new type of bond that greatly simplify retirement planning to the level of basic financial literacy and can not only address retirement security, but also improve the government’s debt financing and funding for infrastructure. Finally, since Portugal is part of the EU, the demand for these new bond instruments could be Euro-wide thereby providing both a Pan European solution and additional benefits to the Portuguese government in reducing its overall financing cost.

Singular Perturbation Expansion for Utility Maximization with Order-$\epsilon$ Quadratic Transaction Costs
Andrew Papanicolaou,Shiva Chandra

We present an expansion for portfolio optimization in the presence of small, instantaneous, quadratic transaction costs. Specifically, the magnitude of transaction costs has a coefficient that is of the order $\epsilon$ small, which leads to the optimization problem having an asymptotically-singular Hamilton-Jacobi-Bellman equation whose solution can be expanded in powers of $\sqrt\epsilon$. In this paper we derive explicit formulae for the first two terms of this expansion. Analysis and simulation are provided to show the behavior of this approximating solution.

Stopping the Clock On Retirement: Target Wealth Stopping Time Problems
Shearer, James W,Stein, Harvey J.
Retirement planning attempts to build sufficient funds to retire at a fixed, predefined horizon. In that the only guaranteed way to hit a target wealth at a fixed horizon is by appropriate risk free investments, these strategies either have a large risk of falling short of the goal or require excessive savings.In this paper, we investigate what we consider to be a more useful approach. Instead of optimizing wealth at a fixed future time, we optimize on the stopping time at which one has sufficient wealth. This builds on an approach to retirement suggested by Bode in "Retirement Investing: A New Approach", 2001.

Suppliers’ Listing Status and Trade Credit Provision
Abdulla, Yomna,Dang, Viet Anh,Khurshed, Arif
We show that public suppliers extend more trade credit than their private counterparts. The impact of stock market listing on accounts receivable is more pronounced among firms that are financially more constrained or more reliant on external finance. Moreover, firms significantly increase their trade credit provision following equity issuances in stock exchanges. These results are consistent with the argument that stock market listing status improves firms’ access to external sources of financing, especially equity capital, thus enhancing their ability to offer more trade credit to customers.

The Fourier Transform Method for Volatility Functional Inference by Asynchronous Observations
Richard Y. Chen

We study the volatility functional inference by Fourier transforms. This spectral framework is advantageous in that it harnesses the power of harmonic analysis to handle missing data and asynchronous observations without any artificial time alignment nor data imputation. Under conditions, this spectral approach is consistent and we provide limit distributions using irregular and asynchronous observations. When observations are synchronous, the Fourier transform method for volatility functionals attains both the optimal convergence rate and the efficient bound in the sense of Le Cam and H\'ajek. Another finding is asynchronicity or missing data as a form of noise produces "interference" in the spectrum estimation and impacts on the convergence rate of volatility functional estimators. This new methodology extends previous applications of volatility functionals, including principal component analysis, generalized method of moments, continuous-time linear regression models et cetera, to high-frequency datasets of which asynchronicity is a prevailing feature.

The Human Side of Decision Making: Thinking Things Through with Daniel Kahneman, PhD
Consulting Submitter, Journal of Investment
Daniel Kahneman is widely considered the most influential psychologist in the world today. He is best known in the financial realm for pioneering work that helped to lay the foundation for behavioral economics, which studies the psychology of judgment and economic decision making and its impact on the financial markets. Together with his long-time collaborator Amos Tversky, Dr. Kahneman explored the ways in which human judgment systematically departs from the basic principles of decision theory when evaluating economic risk, consequently creating the concept of prospect theory. Their findings challenged fundamental economic assumptions and expanded the boundaries of research by introducing psychologically realistic models into economic theory. In 2002, Dr. Kahneman’s work was recognized with the Nobel Memorial Prize in Economic Sciences for his integration of insights from psychological research into economic science.

The Portfolio Size Effect and Lifecycle Asset Allocation Funds: A Different Perspective
Pfau, Wade D.
Basu and Drew (in the JPM Spring 2009 issue) argue that lifecycle asset allocation strategies are counterproductive to the retirement savings goals of typical individual investors. Because of the portfolio size effect, most portfolio growth will occur in the years just before retirement when lifecycle funds have already switched to a more conservative asset allocation. In this article, we use the same methodology as Basu and Drew, but we do not share their conclusion that the portfolio size effect soundly overturns the justification for the lifecycle asset allocation strategy. While strategies that maintain a large allocation to stocks do provide many attractive features, we aim to demonstrate that a case for supporting a lifecycle strategy can still be made with modest assumptions for risk aversion and diminishing utility from wealth. Our differing conclusion results from four factors: (1) we compare the interactions between different strategies; (2) we consider a more realistic example for the lifecycle asset allocation strategy; (3) we examine the results for 17 countries; and (4) we provide an expected utility framework to compare different strategies. We find that with a very reasonable degree of risk aversion, investors have reason to prefer the lifecycle strategy in spite of the portfolio size effect.

The Return Expectations of Institutional Investors
Andonov, Aleksandar,Rauh, Joshua D.
Analysis of newly-required disclosures on the expected returns of public pension funds across asset classes reveals that institutional investors rely on past performance in setting return expectations. These extrapolative expectations occur across all risky asset classes, operate through the expected risk premium, and affect target asset allocations. Pension funds with higher unfunded liabilities assume higher returns through higher inflation, but this relation is distinct from the extrapolative effect of past returns. Pension funds are more likely to extrapolate performance when working with certain investment consultants, and when their executives have personally experienced a longer history of performance with the fund.

The Role of Boutique Financial Advisors in Mergers and Acquisitions
Loyeung, Anna
This study examines the choice of boutique financial advisors in mergers and acquisitions, and the consequences of this choice on deal outcomes and post-acquisition performance. Boutique advisors often specialize in a particular industry and focus exclusively on providing advice in mergers and acquisitions. The results suggest that boutique financial advisors are preferred when the deal is considered complex and when information asymmetry is high. The study finds that the benefits of hiring a boutique advisor flow to both the acquirers and the target firms. Acquiring firms benefit in terms of improved post-merger performance, while target firms benefit in terms of higher completion of value-enhancing deals and positive cumulative abnormal returns. Overall, these results provide support for the growing popularity of boutique financial advisors in the Australian market.

The Voice of Risk: Wall Street CEOS Vocal Masculinity and Financial Crisis in 2008
Kang, Min Jung,Kim, Y. Han (Andy)
Masculinity driven culture of Wall Street has been criticized as one of the worst culprits that caused the global financial crisis in 2008. Using digital voice pitch analysis of male Wall Street CEO interviews on CNBC during 2008~2009, we find that the CEOs with lower voice pitch (1) managed riskier firms; (2) received high equity compensation; (3) were more likely to be fired after financial crisis; (4) were replaced by higher voice pitched CEOs; and (5) repaid the TARP money faster, which enabled them to exercise option compensations back again.

Valuation, Personal Taxes, and Dividend Policy under Passive Debt Management
Dierkes, Stefan,Sümpelmann, Johannes
We derive consistent valuation models in accordance with the flow to equity and adjusted present value approaches, which allow accounting for the firm’s dividend policy and passive debt management in light of differentiated personal taxes at the equity investor level. Specifi-cally, we establish appropriate adjustment formulas for the relationship between the firm’s unlevered and levered cost of equity, which are the basis for the unlevering and relevering of beta factors. Furthermore, using simulations, we show that dividend policy has a significantly positive effect on equity market value.

Variations in Investment Advice Provision: A Study of Financial Advisors of Millionaire Investors
Baeckstrom, Ylva,Marsh, Ian W.,Silvester, Jo
We analyse portfolio recommendations and judgements about the investment knowledge and control of fictitious but plausible millionaire clients made by a panel of professional investment advisors. Using the vignette methodology in which we describe millionaire investors in pen portraits, we exactly control the information set given to each advisor about the would-be clients. Investor characteristics contribute to the portfolio recommendations in ways broadly in line with expectations. However advisor characteristics are at least as important. Experienced advisors and those with wealthier clients recommend higher risk portfolios, as do the very youngest category of advisors. Unmeasured advisor variables drive both judgements made about clients and the recommendations made. Female clients are judged to be less knowledgeable and less in control than equivalent male investors yet both genders receive the same investment advice. We conclude that millionaire investors receive very different investment advice depending on who their advisor is. These findings have relevance to the wealth management industry and financial market regulators who monitor advisor activities.

Will the Financial Fragility of Retirees Increase?
Sass, Steven A.
Retirees have long been considered financially fragile. The notion that they are ill-equipped to absorb financial shocks is captured in the traditional trope that they live on fixed incomes. Going forward, retirees will get much less income from fixed Social Security and employer pensions, and much more from savings in 401(k) plans and individual retirement accounts (IRAs). These savings give retirees greater flexibility to respond to shocks. But tapping into their nest eggs comes at the cost of having fewer resources to cover ongoing expenses. The increased dependence on financial assets also introduces new sources of riskâ€"that households accumulate too little over their working years or draw down their savings too quickly in retirement, and their finances increasingly are exposed to financial market downturns. To the extent these changes increase the financial fragility of retirees, they create new challenges that must be addressed.