Research articles for the 2019-11-25

A singular stochastic control approach for optimal pairs trading with proportional transaction costs
Haipeng Xing

Optimal trading strategies for pairs trading have been studied by models that try to find either optimal shares of stocks by assuming no transaction costs or optimal timing of trading fixed numbers of shares of stocks with transaction costs. To find optimal strategies which determine optimally both trade times and number of shares in pairs trading process, we use a singular stochastic control approach to study an optimal pairs trading problem with proportional transaction costs. Assuming a cointegrated relationship for a pair of stock log-prices, we consider a portfolio optimization problem which involves dynamic trading strategies with proportional transaction costs. We show that the value function of the control problem is the unique viscosity solution of a nonlinear quasi-variational inequality, which is equivalent to a free boundary problem for the singular stochastic control value function. We then develop a discrete time dynamic programming algorithm to compute the transaction regions, and show the convergence of the discretization scheme. We illustrate our approach with numerical examples and discuss the impact of different parameters on transaction regions. We study the out-of-sample performance in an empirical study that consists of six pairs of U.S. stocks selected from different industry sectors, and demonstrate the efficiency of the optimal strategy.

Advances in Financial Machine Learning: Numerai's Tournament (Presentation Slides)
Lopez de Prado, Marcos
Machine learning (ML) is changing virtually every aspect of our lives. Today ML algorithms accomplish tasks that until recently only expert humans could perform. As it relates to finance, this is the most exciting time to adopt a disruptive technology that will transform how everyone invests for generations. In this course, we discuss scientifically sound ML tools that have been successfully applied to the management of large pools of funds.This material is part of Cornell University's ORIE 5256 graduate course at the School of Engineering.

Assessing Volatility Risk and Model Risk in Optimal Execution
Souza, Max O.,Thamsten, Yuri
We analyze the optimal liquidation problem considering stochastic volatility and model uncertainty. As a reference model, we take an extension of the classical continuous-time Almgren-Chriss model, assuming that the bid price of the traded asset has a volatility driven by a scalar Markov diffusion. In addition, we also assume that the agent is averse to model misspecification. Thus, the optimization also aims to pick the best model out of a suitable class of candidate models. We discuss the main qualitative changes in the optimal strategy obtained under these assumptions, and compare it with classical results. In order to better understand the optimal solutions, we consider two asymptotic expansions. These lead to closed-form approximations of the optimal liquidation strategy. The first expansion explores the case of an agent that is weakly ambiguous with respect to the reference model. The second one follows the Taylor series expansion method, allowing us to expand optimal solutions with respect to the state variable corresponding to the volatility driver process. We also carry out numerical experiments to illustrate the behavior of the optimal strategy, as well as the quality of the approximations obtained

Asymmetric Excitation and the US Bias in Portfolio Choice
Fan, Zhenzhen,Laeven, Roger J. A.,van den Goorbergh, Rob
We analyse a global equity return model driven by mutually exciting jump-diffusions with asymmetric excitation to account for the fact that crashes in the US get reflected quickly in other economies but much less the other way round. We solve in closed-form the associated portfolio optimization problem and find that the optimal portfolio is biased towards the US compared to classic models. By calibrating the model to historical returns on the US, Japanese, and European equity indices, we show that the over-exposure to the US equity predicted by our model is consistent with the cross-border equity portfolios observed in reality.

Bidding in Smart Grid PDAs: Theory, Analysis and Strategy (Extended Version)
Susobhan Ghosh,Sujit Gujar,Praveen Paruchuri,Easwar Subramanian,Sanjay P. Bhat

Periodic Double Auctions (PDAs) are commonly used in the real world for trading, e.g. in stock markets to determine stock opening prices, and energy markets to trade energy in order to balance net demand in smart grids, involving trillions of dollars in the process. A bidder, participating in such PDAs, has to plan for bids in the current auction as well as for the future auctions, which highlights the necessity of good bidding strategies. In this paper, we perform an equilibrium analysis of single unit single-shot double auctions with a certain clearing price and payment rule, which we refer to as ACPR, and find it intractable to analyze as number of participating agents increase. We further derive the best response for a bidder with complete information in a single-shot double auction with ACPR. Leveraging the theory developed for single-shot double auction and taking the PowerTAC wholesale market PDA as our testbed, we proceed by modeling the PDA of PowerTAC as an MDP. We propose a novel bidding strategy, namely MDPLCPBS. We empirically show that MDPLCPBS follows the equilibrium strategy for double auctions that we previously analyze. In addition, we benchmark our strategy against the baseline and the state-of-the-art bidding strategies for the PowerTAC wholesale market PDAs, and show that MDPLCPBS outperforms most of them consistently.

Bond Funds and Credit Risk
Choi, Jaewon,Dasgupta, Amil,Oh, Ji Yeol Jimmy
We show that supply side effects arising from the bond holdings of open-end mutual funds affect corporate credit risk through a refinancing channel. In our framework, bond funds exposed to flow-performance relationships become excessively reluctant to refinance bonds of companies with poor cash flow prospects.This lowers refinancing prices, enhancing incentives for strategic default, thus engendering a positive association between bond funds’ presence and credit risk. Empirically, we find that firms with a large share of mutual fund holdings experience increases in CDS spreads, particularly for funds that are more sensitive to flows. We address potential endogeneity issues by using fund acquisitions as exogenous shocks to funds’ flow concerns.

Buying Manipulation around Seasoned Equity Offerings
Banerjee, Suman,Noe, Thomas H. ,Wang, Kai
We show that seasoned equity offerings (SEOs), in which secondary share-offering size greatly exceeds market share turnover, provide a unique opportunity for stock price manipulation by speculators holding restricted shares. The proposed new theory is consistent with several puzzling empirical findings, for example, the positive abnormal stock return between announcement and issuance and the long-term poorer returns of issuing firms after SEOs. The manipulation is characterized by a strong buying in the secondary market prior to the issuance, which drives up the market price and thereby the offering price of restricted shares, and a large amount of liquidation of restricted shares in the SEO. Our model predicts that favorable market reactions with speculator's manipulative intent after SEO announcement could occur, which naturally leads to a successful issuance and over-investment based long-term underperformance after SEO.

Changes in New Zealand’s Business Insolvency Rates after the Global Financial Crisis
Hall, Viv B.,McDermott, John
We examine the question of whether the rate of business insolvencies in New Zealand is related to overall macroeconomic conditions. In particular, our interest is in whether the rate of business insolvencies changed in the wake of the Global Financial Crisis (GFC). We find that there was a large increase in insolvencies in New Zealand following the onset of the GFC in 2008. We also find that the timing of the change did not occur uniformly over the country but occurred at different times in four key regional centres. Sharply rising relative costs were the most important macroeconomic factor influencing corporate insolvencies in New Zealand, Auckland, Waikato and Wellington, but have been immaterial in determining New Zealand’s total personal insolvencies. It is employment growth and house price inflation that have been significant in explaining total personal insolvencies.

Characterizing Cryptocurrency market with Levy's stable distributions
Shinji Kakinaka,Ken Umeno

The recent emergence of cryptocurrencies such as Bitcoin and Ethereum has posed possible alternatives to global payments as well as financial assets around the globe, making investors and financial regulators aware of the importance of modeling them correctly. The Levy's stable distribution is one of the attractive distributions that well describes the fat tails and scaling phenomena in economic systems. In this paper, we show that the behaviors of price fluctuations in emerging cryptocurrency markets can be characterized by a non-Gaussian Levy's stable distribution with $\alpha \simeq 1.4$ under certain conditions on time intervals ranging roughly from 30 minutes to 4 hours. Our arguments are developed under quantitative valuation defined as a distance function using the Parseval's relation in addition to the theoretical background of the General Central Limit Theorem (GCLT). We also discuss the fit with the Levy's stable distribution compared to the fit with other distributions by employing the method based on likelihood ratios. Our approach can be extended for further analysis of statistical properties and contribute to developing proper applications for financial modeling.

Chinese Import Competition and the Provisions for External Debt Financing in the US
Rahaman, Mohammad M.
How does international competition originating from low-wage countries affect domestic financing capacity of firms in high-wage countries? In this article, we use China’s entry into the World Trade Organization (WTO) as a quasi-natural experiment to investigate the effects of trade-induced competition originating from China on the price and design of bank-loan contracts for firms in US manufacturing industries. We find that the elevated level of Chinese import competition in the US, following China’s WTO entry, is associated with a reduction in the overall cost of bank financing for import-competing US manufacturing firms, evidenced by lower spread, higher amount, longer maturity, and less restrictive non-price contract terms such as collateral and covenants. We show that such reduction in the external financing premiums of import-competing firms is the result of trade-induced productivity gains within firms and a reallocation of financing between firms towards more capital-intensive and technologically advanced firms. These results suggest that engaging in international business activities with a low-wage country via trade openness is likely to ease the provisions of external debt financing for firms in high-wage countries.

Climate Disasters And Financial Fundamentals
Gregory, Richard Paul
I propose a rare disaster model of an economy where disasters are driven by CO2 levels that are determined by inputs of carbons from the firms of the economy. The probability and intensity of disaster are determined in part by the level of CO2 in the environment. In turn, disasters affect the budgets, the labor allocations and investment decisions of households; the production and investment decisions of firms; and, monetary policy. Prices are determined in equilibrium. From this model, Six propositions are developed relating carbon dioxide levels and climatic economic damages to the financial variables: the risk free rate, the price dividend ratio, and the risk premium.The six propositions are then tested empirically using a unique data set for the United States over the period from March 1958 to December 2018. The data is found to support the six propositions. In general, carbon use, as proxied by the carbon dioxide level, lowers the risk free rate and price dividend ratio, while raising the risk premium. Climatic economic damages raise the risk free rate, while lowering the price dividend ratio and risk premium. However, if the probability of climatic disaster rises sufficiently, these relationships can change. I then briefly discuss some implications of these results.

Collectivised Pension Investment
John Armstrong,Cristin Buescu

We study the optimal management of a collectivised pension fund, where all investors agree that the assets of deceased members are shared among the survivors. We find that for realistic parameters based on the UK pensions market, a collectivised fund achieves an approximately 20% better return than either an annuity or a personal investment fund.

We introduce models of investor preferences over a stream of pension payments in the presence of mortality, incorporating a new concept of adequacy. We find that for risk-averse individuals, pension adequacy plays an important role in determining the optimal fund management strategy.

A key issue in the design of collective funds is how to ensure the fund treats all investors fairly. This is a trivial problem in the case that all investors have identical preferences, wealth and mortality, but becomes challenging for heterogeneous funds. We give a strategy for the management of heterogeneous funds in complete markets and prove that it is asymptotically optimal in the absence of systematic longevity risk.

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.

Conditional inference on the asset with maximum Sharpe ratio
Steven E. Pav

We apply the procedure of Lee et al. to the problem of performing inference on the signal noise ratio of the asset which displays maximum sample Sharpe ratio over a set of possibly correlated assets. We find a multivariate analogue of the commonly used approximate standard error of the Sharpe ratio to use in this conditional estimation procedure. We also consider the simple Bonferroni correction for multiple hypothesis testing, fixing it for the case of positive common correlation among assets, and a chi-bar square test against one-sided alternatives.

Testing indicates the conditional inference procedure achieves nominal type I rate, and does not appear to suffer from non-normality of returns. The conditional estimation test has low power under the alternative where there is little spread in the signal noise ratios of the assets, and high power under the alternative where a single asset has high signal noise ratio.

Denting the FRTB IMA computational challenge via Orthogonal Chebyshev Sliding Technique
Mariano Zeron-Medina Laris,Ignacio Ruiz

In this paper we introduce a new technique based on high-dimensional Chebyshev Tensors that we call \emph{Orthogonal Chebyshev Sliding Technique}. We implemented this technique inside the systems of a tier-one bank, and used it to approximate Front Office pricing functions in order to reduce the substantial computational burden associated with the capital calculation as specified by FRTB IMA. In all cases, the computational burden reductions obtained were of more than $90\%$, while keeping high degrees of accuracy, the latter obtained as a result of the mathematical properties enjoyed by Chebyshev Tensors.

Director Reputation, Settling-Up, and the Market for Boardroom Talent
Chen, Mark A.,Tran, Hai,Wu, Qinxi,Zhivotova, Evgenia
We examine how individual directors’ reputation affects their career outcomes in the labor market for boardroom talent. Using unique data on prestigious director awards, we find that individuals who experience positive reputational shocks tend to be rewarded with new board seats at firms that rank high in terms of size or public prestige. In addition, consistent with theories of career concerns and labor-market signaling, we find that these reputational effects are greater for younger directors and for non-overboarded directors. Overall, our findings provide new, clear-cut evidence of strong reputational rewards and ex post settling-up in the market for boardroom talent.

Does Corporate Diversification Provide Insurance Against Economic Disruptions?
Rahaman, Mohammad M.,Zhou, Simiao,Aivazian, Varouj
Can the product diversification strategy of a firm provide a natural hedge against adverse economic conditions? We use a quasi-natural experiment to show that diversification attenuates the detrimental impact of unanticipated economic disruptions and enables diversified firms to invest more efficiently than similar focused firms. We find that access to internal capital markets, segment cashflow coinsurance, and greater predictive accuracy are all channels that enhance the resiliency of conglomerates during economic disruptions. Our results suggest that firms’ product diversification is an important conduit for the propagation of systemic shocks.

Does a Wealth Tax Discriminate against Domestic Investors?
Bjerksund, Petter,Schjelderup, Guttorm
This paper studies the impact of a capital-income tax and a wealth tax on investor behavior in an efficient capital market under various assumptions regarding uncertainty and time horizons. We show that investors who face capital taxes have a lower discount rate, but that their willingness to pay for a company’s stock is not affected by these taxes. In a second step, we show that if a company owner increases her required rate of return from the company because of capital taxes, she will harm the company’s market value and thus her own wealth.

Euro Area Sovereign Debt: Restructuring Options
Arnold, Theresa,Gulati, G. Mitu,Panizza, Ugo
Countries with large debts stocks are vulnerable to the vagaries of the markets. Confidence crises can arise out of nowhere, constricting access to the markets. Hence, the question arises as to whether these countries should put in place mechanisms that will help them better prepare for the possibility of crisis. In effect, the choice is whether to buy insurance. The cost of buying such insurance is that the possibility that markets will see the sovereign’s proactive steps to protect against a crisis not as an indication of prudent governance but rather as an indicator that a crisis is imminent. In this article, we use the case of a Euro area country (Italy) with a large debt stock and a known vulnerability to confidence crises to set forth its options, as of 2019, to anticipate a possible future debt restructuring. It can: do nothing, do a little; or do something substantial.

Female Directors, Board Committees and Firm Performance: Time-Series Evidence from Turkey
Ararat, Melsa,Yurtoglu, B. Burcin
We study the relationship between female representation on boards and firm value and profitability in Turkey from 2011 to 2018, relying on hand-collected data covering the vast majority of listed firms. We build several proxies of female representation on boards and find no evidence that female directors predict firm value and profitability using broad measures that are typically required or mandated by regulators. However, we find that female directors predict higher firm value when they have a more active role in board governance through board committee memberships and when they are represented in these committees in relatively large numbers. Female directors, who are members of controlling families matter more than other types of female directors for firm value, and female independent directors are associated with higher profitability. We also study three potential channels through which female directors might influence firm outcomes and find that the presence of female directors on boards and board committees (i) facilitates the production of financial statements of higher quality; (ii) may lead to lesser incidence of violations of capital market laws and regulations, and (iii) reduces the hoarding of negative news and the related stock price crash risk.

Financial ratios and stock returns reappraised through a topological data analysis lens
Pawel Dlotko,Wanling Qiu,Simon Rudkin

Firm financials are well established as return predictors, being the inspiration for a large set of anomalies in the asset pricing literature. Employing topological data analysis we revisit the question of association between seven of the most commonly studied financial ratios and stock returns. Specifically the TDA Ball Mapper algorithm is applied to visualise the point cloud of financial ratios as an abstract two-dimensional graph readily allowing for identification of interdependencies between factors. These relationships are seldom monotonic, opportunities for investors to profitably exploit this knowledge provided by TDA abound. Clear potential offered by the tools of TDA to shed new light on asset pricing models is demonstrated. Scope for benefit is limited only by the availability of information to the analyst.

Neural Networks for Option Pricing and Hedging: A Literature Review
Ruf, Johannes,Wang, Weiguan
Neural networks have been used as a nonparametric method for option pricing and hedging since the early 1990s. Far over a hundred papers have been published on this topic. This note intends to provide a comprehensive review. Papers are compared in terms of input features, output variables, benchmark models, performance measures, data partition methods, and underlying assets. Furthermore, related work and regularisation techniques are discussed.

New Funds, Familiar Fears: Are Exchange Traded Funds Making Markets Less Stable? Part II â€" Interaction Risks
Clements, Ryan
Exchange Traded Funds (ETFs) â€" tradeable investments that provide a return linked to an underlying index or basket of assets â€" are likely the most successful financial product since the 2008 crisis. Over the last decade they’ve experienced remarkable growth. Yet these products may also be making the financial system less stable and, like Wall Street innovations of the past, connecting banks and main street with dangerous implications. This final article - of a two-part study on ETF risks - posits that these products may be introducing two “interaction risks” into financial markets due to a complex operating and trading ecosystem. First, ETFs could create information cascades, facilitate investor herding, and financial contagion. Second, ETFs could be distorting the informational efficiency of underlying asset and securities prices, and disincentivizing active price discovery, in a way that masks market risk.This article builds on its predecessor, which showed how ETFs could create a fragile “illusion” of liquidity, since financial intermediaries, in a crisis, often act unpredictably and pursue discretionary incentives. The combined study compliments prior work on financial market systemic risk by analogizing ETF interaction risks to prior crises â€" particularly 2008. Given the comparisons, the ETF market’s continuing growth and interest by retail investors, institutions, and pensions, regulatory and academic attention should be increased to ensure risks are both understood and appropriately mitigated. This article introduces several areas where heightened focus is warranted.

Omega and Sharpe ratio
Eric Benhamou,Beatrice Guez,Nicolas Paris1

Omega ratio, defined as the probability-weighted ratio of gains over losses at a given level of expected return, has been advocated as a better performance indicator compared to Sharpe and Sortino ratio as it depends on the full return distribution and hence encapsulates all information about risk and return. We compute Omega ratio for the normal distribution and show that under some distribution symmetry assumptions, the Omega ratio is oversold as it does not provide any additional information compared to Sharpe ratio. Indeed, for returns that have elliptic distributions, we prove that the optimal portfolio according to Omega ratio is the same as the optimal portfolio according to Sharpe ratio. As elliptic distributions are a weak form of symmetric distributions that generalized Gaussian distributions and encompass many fat tail distributions, this reduces tremendously the potential interest for the Omega ratio.

On unbiased simulations of stochastic bridges conditioned on extrema
Andrew Schaug,Harish Chandra

Stochastic bridges are commonly used to impute missing data with a lower sampling rate to generate data with a higher sampling rate, while preserving key properties of the dynamics involved in an unbiased way. While the generation of Brownian bridges and Ornstein-Uhlenbeck bridges is well understood, unbiased generation of such stochastic bridges subject to a given extremum has been less explored in the literature. After a review of known results, we compare two algorithms for generating Brownian bridges constrained to a given extremum, one of which generalises to other diffusions. We further apply this to generate unbiased Ornstein-Uhlenbeck bridges and unconstrained processes, both constrained to a given extremum, along with more tractable numerical approximations of these algorithms. Finally, we consider the case of drift, and applications to geometric Brownian motions.

Passive Debt Ownership and Corporate Financial Policy
Gibbons, Brian
A recent dramatic rise in the assets managed by passive corporate debt funds has profound implications for firm financing and payout policy. I use fund-specific flows to isolate exogenous increases in firm-level passive debt ownership at a firm. Firms respond to higher levels of passive debt ownership by increasing leverage, consistent with a recapitalization. More passive debt ownership does not lead to risk-shifting, but rather an increase in direct payouts to shareholders. I show that passive debtholders facilitate these effects by reducing aggregate ex-ante and ex-post monitoring. The presence of a bank monitor mitigates the relationship between passive debt ownership and increased payout.

Regulatory Arbitrage in the Use of Insurance in the New Standardized Approach for Operational Risk Capital
Migueis, Marco
Basel’s new standardized approach (SA) for operational risk capital may allow for regulatory arbitrage through the use of insurance. Under the SA, banks will have incentive to insure recurring losses, which can meaningfully reduce capital requirements even as it does not meaningfully decrease tail operational loss exposure. Several alternatives to deal with this regulatory arbitrage strategy are discussed.

Risk-dependent centrality in economic and financial networks
Paolo Bartesaghi,Michele Benzi,Gian Paolo Clemente,Rosanna Grassi,Ernesto Estrada

Node centrality is one of the most important and widely used concepts in the study of complex networks. Here, we extend the paradigm of node centrality in financial and economic networks to consider the changes of node "importance" produced not only by the variation of the topology of the system but also as a consequence of the external levels of risk to which the network as a whole is submitted. Starting from the "Susceptible-Infected" (SI) model of epidemics and its relation to the communicability functions of networks we develop a series of risk-dependent centralities for nodes in (financial and economic) networks. We analyze here some of the most important mathematical properties of these risk-dependent centrality measures. In particular, we study the newly observed phenomenon of ranking interlacement, by means of which two entities may interlace their ranking positions in terms of risk in the network as a consequence of the change in the external conditions only, i.e., without any change in the topology. We test the risk-dependent centralities by studying two real-world systems: the network generated by collecting assets of the S\&P 100 and the corporate board network of the US top companies, according to Forbes in 1999. We found that a high position in the ranking of the analyzed financial companies according to their risk-dependent centrality corresponds to companies more sensitive to the external market variations during the periods of crisis.

Should We Use Closing Prices? Institutional Price Pressure at the Close
Bogousslavsky, Vincent,Muravyev, Dmitriy
The closing price is the most important stock price of the day, but is it better than alternatives? Closing prices are determined in a special call auction. This single trade accounts for 7.3% of daily stock volume in 2018 and is strongly associated with ETF ownership and institutional rebalancing. Strikingly, this huge volume contributes nothing to price discovery. Closing prices frequently and significantly deviate from closing quote midpoints, but these deviations fully revert overnight. These deviations are economically significant and make a difference for two applications that we consider: ETF mispricing, and put-call parity violations and their ability to predict next-day stock returns. Our results raise concerns about an overwhelming reliance on closing prices and highlight the costs of indexing.

Student Loan Supply, Parental Saving & Portfolio Allocation
Jerphanion, Emiel
I show that an expansion of student loan supply affects parents' saving decisions and portfolio allocation. By exploiting policy-induced variation on expected student aid, I find a 2.2 pp increase in the parental saving rate, from 4.9% to 6.1%. The mechanism that drives this result is the positive effect of student aid on students’ college enrollment. Consistent with this interpretation, I find a disproportionate increase in college enrollment for children of families affected by the reform. The positive saving response is largest among lower- and middle-income families and for parents with strong saving preferences. A placebo test validates that the effect is absent in families without children. Moreover, I show that affected parents shift the allocation of saving flows towards riskier assets.

Temperature Shocks and Industry Earnings News
Addoum, Jawad M.,Ng, David T.,Ortiz-Bobea, Ariel
Climate scientists project a rise in both average temperatures and the frequency of temperature extremes. We study how extreme temperatures affect companies' earnings across different industries and whether sell-side analysts understand these relationships. We combine granular daily data on temperatures across the continental U.S. with locations of public companies' establishments and build a panel of quarterly firm-level temperature exposures. Extreme temperatures significantly impact earnings in over 40% of industries, with bi-directional effects that harm some industries while others benefit. Analysts and investors do not immediately react to observable intra-quarter temperature shocks, but earnings forecasts account for temperature effects by quarter-end in many, though not all, industries.

The Comprehensive Wealth of Older Immigrants and Natives
Love, David A.,Schmidt, Lucie
This article compares the retirement preparations of immigrant and native-born Americans aged 51 or older. The authors estimate the present value of future income streams in calculating measures of comprehensive wealth and an annualized equivalent. In addition to some significant differences in median annualized wealth between immigrants and natives, the authors find that the most recent waves of immigrants are more financially vulnerable in retirement than earlier immigration cohorts were at similar ages. With a decomposition analysis, the authors estimate how much of the immigrant-native wealth gap is attributable to differences in observable characteristics and how much is attributable to differences in returns to those characteristics.

The Effect of Share Capital on Company Performance
Dudycz, Tadeusz
This article examines the impact of share capital on companies’ performance as well as the effect of accounting information on companies’ market performance and the impact of pre-IPO information on the predictive power of companies' performance after an initial public offering (IPO). The research was conducted on a sample of IPO companies debuting on the Warsaw Stock Exchange in the period 1998â€"2013. It shows that a large percentage of share capital in equity reduces capital flexibility but can also be a signal to improve companies' market performance. It also shows that after an IPO, the market's information efficiency diminishes, which means, among other things, that pre-IPO accounting information has a negligible impact on the companies’ market performance after the IPO.

The Volcker Rule and the Hedge Fund Liquidity Circle
Bowe, Michael,Kolokolova, Olga,Yu, Lijie
This paper finds that the implementation of the Volcker Rule (section 619 of the 2010 Dodd-Frank Act) profoundly impacts overall equity market liquidity, the funding liquidity of hedge funds, and their liquidity provision to the market. Analysis of a sample of 8,686 hedge funds reveals that subsequent to the Volcker Rule, funding flows to hedge funds decline, and their flow-performance sensitivity increases. Hedge funds also reduce their exposure to market liquidity and realign their market-making activities to the most liquid segment of stocks. The impact appears more pronounced for those funds with business connections to systemically important US banks, weak past performance, and adopting non-directional investment strategies.

The route to chaos in routing games: When is Price of Anarchy too optimistic?
Thiparat Chotibut,Fryderyk Falniowski,Michał Misiurewicz,Georgios Piliouras

Routing games are amongst the most studied classes of games. Their two most well-known properties are that learning dynamics converge to equilibria and that all equilibria are approximately optimal. In this work, we perform a stress test for these classic results by studying the ubiquitous dynamics, Multiplicative Weights Update, in different classes of congestion games, uncovering intricate non-equilibrium phenomena. As the system demand increases, the learning dynamics go through period-doubling bifurcations, leading to instabilities, chaos and large inefficiencies even in the simplest case of non-atomic routing games with two paths of linear cost where the Price of Anarchy is equal to one.

Starting with this simple class, we show that every system has a carrying capacity, above which it becomes unstable. If the equilibrium flow is a symmetric $50-50\%$ split, the system exhibits one period-doubling bifurcation. A single periodic attractor of period two replaces the attracting fixed point. Although the Price of Anarchy is equal to one, in the large population limit the time-average social cost for all but a zero measure set of initial conditions converges to its worst possible value. For asymmetric equilibrium flows, increasing the demand eventually forces the system into Li-Yorke chaos with positive topological entropy and periodic orbits of all possible periods. Remarkably, in all non-equilibrating regimes, the time-average flows on the paths converge exactly to the equilibrium flows, a property akin to no-regret learning in zero-sum games. These results are robust. We extend them to routing games with arbitrarily many strategies, polynomial cost functions, non-atomic as well as atomic routing games and heteregenous users. Our results are also applicable to any sequence of shrinking learning rates, e.g., $1/\sqrt{T}$, by allowing for a dynamically increasing population size.

Vol-of-vol expansion for (rough) stochastic volatility models
Ozan Akdogan

We introduce an asymptotic small noise expansion, a so called vol-of-vol expansion, for potentially infinite dimensional and rough stochastic volatility models. Thereby we extend the scope of existing results for finite dimensional models and validate claims for infinite dimensional models. Furthermore we provide new, explicit (in the sense of non-recursive) representations of the so-called push-down Malliavin weights that utilizes a precise understanding of the terms of this expansion.

When Does Portfolio Compression Reduce Systemic Risk?
Veraart, Luitgard A. M.
We analyse the consequences of portfolio compression on systemic risk. Portfolio compression is a post-trading netting mechanism that reduces gross positions while keeping net positions unchanged and it is part of the financial legislation in the US (Dodd-Frank Act) and in Europe (European Market Infrastructure Regulation). We derive necessary structural conditions for portfolio compression to be harmful and discuss policy implications. In particular, we show that the potential danger of portfolio compression comes from defaults of firms that conduct portfolio compression. If no such defaults occur, then portfolio compression weakly reduces systemic risk.

Why Austerity? The Mass Politics of a Contested Policy
Bansak, Kirk,Bechtel, Michael M.,Margalit, Yotam
The merits of austerity as a response to economic crisis are widely contested. Critics contend that public spending cuts and tax hikes inflict more pain and are less effective than the alternative of fiscal stimulus. Nonetheless, governments routinely adopt austerity in response to sharp economic downturns. We explore this puzzle by focusing on public opinion as a key component of understanding governments' choices. Using original survey data from five European countries, our analysis demonstrates that austerity is in fact the preferred response among most voters. We then test potential explanations for this seemingly surprising preference using experiments. The results suggest that voters' ideology and reliance on partisan signals are an important part of the answer. Moreover, support for austerity is highly contingent on the specific features of the policy. We devise a novel approach to predict support for historical austerity programs and find that public approval of austerity likely reflects governments' strategic crafting of policy packages.

Why so many significant phase III results in clinical trials?
Jérôme Adda,Christian Decker,Marco Ottaviani

Planning and execution of clinical research and publication of results should conform to the highest ethical standards, given that human lives are at stake. However, economic incentives can generate conflicts of interest for investigators, who may be inclined to withhold unfavorable results or even tamper with the data. Analyzing p-values reported to the registry with two different methodologies, we find suspicious patterns only for results from trials conducted by smaller industry sponsors, with presumably less reputation at stake. First, a density discontinuity test reveals an upward jump at the classical threshold for statistical significance for phase III results by small industry sponsors, suggesting some selective reporting. Second, we find an excess mass of significant results in phase III compared to phase II. However, once we link trials across phases, we can explain almost completely this excess mass for large industry sponsors by accounting for the incentives to selectively continue from phase II to phase III. In contrast, for trials sponsored by small pharmaceutical companies, selective continuation of trials economizing on research costs only explains less than one third of the increase in the share of significant results from phase II to phase III.