Research articles for the 2019-12-05

A New Form of Banking -- Concept and Mathematical Model of Venture Banking
Brian P Hanley

This model contains concept, equations, and graphical results for venture banking. A system of 27 equations describes the behavior of the venture-bank and underwriter system allowing phase-space type graphs that show where profits and losses occur. These results confirm and expand those obtained from the original spreadsheet based model. An example investment in a castle at a loss is provided to clarify concept. This model requires that all investments are in enterprises that create new utility value. The assessed utility value created is the new money out of which the venture bank and underwriter are paid. The model presented chooses parameters that ensure that the venture-bank experiences losses before the underwriter does. Parameters are: DIN Premium, 0.05; Clawback lien fraction, 0.77; Clawback bonds and equity futures discount, 1.5 x (USA 12 month LIBOR); Range of clawback bonds sold, 0 to 100%; Range of equity futures sold 0 to 70%.

A Quantum algorithm for linear PDEs arising in Finance
Filipe Fontanela,Antoine Jacquier,Mugad Oumgari

We propose a hybrid quantum-classical algorithm, originated from quantum chemistry, to price European and Asian options in the Black-Scholes model. Our approach is based on the equivalence between the pricing partial differential equation and the Schrodinger equation in imaginary time. We devise a strategy to build a shallow quantum circuit approximation to this equation, only requiring few qubits. This constitutes a promising candidate for the application of Quantum Computing techniques (with large number of qubits affected by noise) in Quantitative Finance.

Active Fixed Income Illusions
Brooks, Jordan,Gould, Tony,Richardson, Scott A.
Over the past 20 years, active fixed income (FI) managers have tended to deliver returns in excess of their benchmarks. This has generated a popular notion that active investing in fixed income markets is ‘easy’. Our aim is to assess the veracity of that notion. Across a broad set of popular active FI categories, we find that passive exposures to traditional risk premia (especially exposure to credit risk) explain the majority of FI manager active returns. The resulting implication is that, contrary to popular belief, traditional discretionary active FI strategies offer little in the way of true alpha, and that traditional active FI strategies may significantly reduce the strategic diversification benefit of FI as an asset class.

Alpha Go Everywhere: Machine Learning and International Stock Returns
Choi, Darwin,Jiang, Wenxi,Zhang, Chao
We apply machine learning techniques and use stock characteristics to predict the cross-section of stock returns in 33 international markets. We conduct a stringent test to allay concerns about overfitting: the models are trained with past U.S. data and used to predict international stock returns. With fewer variables (based on past returns, size, volume, and accounting information) as inputs, we arrive at a conclusion similar to that in previous studies predicting U.S. stock returns with hundreds of stock characteristics and macroeconomic variables; complex methods outperform linear models in terms of both predicting returns and generating profits. We achieve even stronger results when the models are trained separately for each market, allowing for country-specific return-characteristic relationships. In most markets, we obtain out-of-sample R^2 and Sharpe ratios that are comparable to those in previous studies. Neural network models, which can handle complicated interactions among the predictors, produce the best results among various machine learning methods.

An Anatomy of Returns From Moving Average Trading Rules in the Russian Stock Market
Pätäri, Eero,Luukka, Pasi,Fedorova, Elena,Garanina, Tatiana
This paper examines the profitability of index trading strategies that are based on dual moving average crossover (DMAC) rules in the Russian stock market over the 2003â€"2012 period. It contributes to the existing technical analysis (TA) literature by comparing for the first time in emerging markets the relative performance of individual stocks’ trading portfolios to that of trading strategies for the MICEX index that consists of the same stocks (i.e., the most liquid stocks of the Moscow Exchange).The results show that the best trading strategies of the in-sample period can outperform their benchmark portfolios during the subsequent out-of-sample period, though the statistical significance of the outperformance is at its best weak. In addition, evidence of the benefits from using DMAC combinations that are much longer than those employed in previous TA literature is found. Moreover, the decomposition of the full-sample-period performance into separate bull- and bear-period performance shows that the outperformance of the best past index trading strategies over buy-and-hold strategy is mostly attributable to the fact that they managed to stay mostly out of the stock market during a huge crash caused by the global financial crisis.

An Unintended Consequence of Mortgage Financing Regulation - A Racial Disparity
Kau, James,Fang, Lu,Munneke, Henry J.
This study investigates whether mortgage financing regulation unintentionally leads to minorities paying a higher loan contract rate under a risk-based pricing system. We provide evidence that minority borrowers prepay less frequently than comparable non-minority borrowers and thus have lower termination risk. Racially neutral lending policies prohibit the lender from considering this reduced termination risk, resulting in a disparate impact from the overstatement of a minority borrower's and thus have lower termination risk. While we find little evidence of a rate differential among borrowers under the current regulatory structure, results show minorities pay a higher rate when the variation in termination risk is recognized.

Are there pricing spillovers within an ETF? Evidence from Emerging Market Corporate Bonds
Braun, Matías,Wagner, Rodrigo Andres
Using data from Emerging Market Corporate Bonds between 2012 and 2017, we find that the entry of a new bond into an ETF lowers the price of similar constituent bonds. Part of this effect is reversed after a few months, especially when the short-run ability to absorb this entry shock is more limited. The effect is also stronger for less liquid bonds. Overall, our findings support liquidity-related models of price pressure.

Bankers on the Board and CEO Turnover
Chang, Jen,Kang, Min Jung,Kim, Y. Han (Andy)
Governance literature finds that the independent directors from the lending banks (CBDs) bring both financial expertise and conflict of interest between shareholders and debtholder. We examine how the presence of CBDs affects the implicit incentive of CEO turnover. Using BoardEx and DealScan data, we hypothesize and find that CBDs make the CEO turnover more sensitive to both performance and risk. Post CEO turnover analysis reveals that firm performance improves and risk decreases in the presence of CBDs.

Buy in May and Sell on St. Leger Day? The Reversal Halloween Effect in QMJ
Li, Xuquan,Liu, Ruozhou,Zhang, Zili
Quality-minus-junk (QMJ) is a long-short factor that captures the time varying premium of high quality assets. The long side (Quality) is stocks with high quality and the short side (Junk) is stocks with low quality. In this paper, we find that both Quality and Junk have a significant Halloween effect: the portfolios have a relatively better performance during winter as compared with summer. In terms of the magnitude of Halloween effect, Junk is greater than Quality. As a result, the long-short QMJ factor exhibits a pattern of reversal Halloween effect and this result is robust under different study samples. In addition, we also find that the Halloween effect of the stock market (MKT) can be largely explained by its negative exposure on QMJ. After controlling for QMJ, the magnitude of Halloween effect for MKT diminishes more than 60%.

Closed Quantum Black-Scholes: Quantum Drift and the Heisenberg Equation of Motion
Will Hicks

In this article we model a financial derivative price as an observable on the market state function. We apply geometric techniques to integrating the Heisenberg Equation of Motion. We illustrate how the non-commutative nature of the model introduces quantum interference effects that can act as either a drag or a boost on the resulting return. The ultimate objective is to investigate the nature of quantum drift in the Accardi-Boukas quantum Black-Scholes framework which involves modelling the financial market as a quantum observable, and introduces randomness through the Hudson-Parthasarathy quantum stochastic calculus. In particular we aim to differentiate randomness that is introduced through external noise (quantum stochastic calculus) and randomness that is fundamental to a quantum system (Heisenberg Equation of Motion).

Collaborative Innovation Blocs â€" A Meso Perspective to Achieve Antifragility
Elert, Niklas,Henrekson, Magnus
We present the theory of the collaborative innovation bloc (CIB), an evolving system of innovation within which activity takes place over time. We show how the application of the CIB perspective can help make institutional and evolutionary economics more concrete, relevant, and persuasive, especially regarding policy prescriptions. Such policy actions should strive to improve the antifragility of CIBs and the economic system as a whole, thus enabling individual CIBs and the broader economic system to thrive when faced with macroeconomic shocks. With this in mind, we develop diagnostic tools to evaluate antifragility at the micro, meso, and macro levels before identifying a set of institutional areas where reform can be undertaken to improve antifragility.

Complexity of Global Banks and Their Foreign Operation in Hong Kong
Kwan, Simon H.,Ho, Kelvin,Tan, Edward
This paper studies the relation between the complexity of global banking organizations and their foreign banking operations (FBOs) in Hong Kong. Our empirical evidence indicates that the complexity of the parent company has significant effects on their Hong Kong branch’s business model, liquidity management, risk-taking, and profitability. The more complex the global banking organizations, the more likely their Hong Kong FBOs are to derive a larger share of revenues from fee-based activities, and incur a higher cost of production despite enjoying a funding cost advantage. Notwithstanding the FBOs in Hong Kong may serve as a funding hub for its parent company, FBOs of more complex global banks tend to hold more liquid assets. While our empirical evidence suggests that the complexity of global banks has significant effects on FBOs’ risk-taking and profitability, the relation depends on how complexity is measured. For example, both the BCBS complexity score and the measure of geographic complexity are significant in explaining FBO profitability, but they have different signs. Likewise, geographic complexity and scope complexity are often found to have significantly different effects on FBOs’ performance. Taken together, the concept of global bank complexity has multiple dimensions, where different facets could have qualitatively different effects on FBOs in Hong Kong.

Deep Learning in a Generalized HJM-type Framework Through Arbitrage-Free Regularization
Anastasis Kratsios,Cody B. Hyndman

We introduce a regularization approach to arbitrage-free factor-model selection. The considered model selection problem seeks to learn the closest arbitrage-free HJM-type model to any prespecified factor-model. An asymptotic solution to this, a priori computationally intractable, problem is represented as the limit of a 1-parameter family of optimizers to computationally tractable model selection tasks. Each of these simplified model-selection tasks seeks to learn the most similar model, to the prescribed factor-model, subject to a penalty detecting when the reference measure is a local martingale-measure for the entire underlying financial market. A simple expression for the penalty terms is obtained in the bond market withing the affine-term structure setting, and it is used to formulate a deep-learning approach to arbitrage-free affine term-structure modelling. Numerical implementations are also performed to evaluate the performance in the bond market.

Diamonds and Precious Metals for Reduction of Portfolio Tail Risk
Barbi, Massimiliano,Geman, Hélyette,Romagnoli, Silvia
We study the performance of diamonds compared to gold and other precious metals in mitigating the tail risk of a diversified equity market portfolio over the period June 2007 to October 2018. Our results display a diversification benefit of some diamond indices, which also improve the portfolio reward-to-risk ratio. To corroborate this evidence, we study the dependence structure and tail dependence of diamonds and a broad equity market portfolio and compare it to the dependence obtained with gold and other precious metals. Results from fitting a bivariate copula show that the average left tail dependence reaches its minimum when diamonds are used. We also show that using shares of diamond-mining companies does not provide the same benefits.

Disagreement about Innovations and Endogenous Growth
Heyerdahl-Larsen, Christian,Illeditsch, Philipp K.,Kung, Howard
We study an equilibrium model with disagreement about the likelihood of successful innovations. We show that disagreement stimulates aggregate economic growth and overcomes market failures that would otherwise occur in an equilibrium without disagreement. The higher growth with disagreement comes at the cost of a higher wealth and consumption inequality, as a few entrepreneurs will ex post be successful while most entrepreneurs will fail. Hence, our disagreement model provides a potential explanation for the “entrepreneurial puzzle” in which entrepreneurs choose to innovate despite taking on substantial idiosyncratic risk accompanied by low expected returns. We show that taxes on profits reduce growth because it deters entrepreneurs from innovating, leading to a “Laffer curve” as total tax revenue declines with high tax rates. A flat tax rate does not affect innovation and thus economic growth. A high enough flat tax rate leads to the first best for economic growth, assuming that the government would let all entrepreneurs pursue their way of innovating even though from its point of view many of these ways would seem irrational.

Do CEOs' Outside Directorships Affect the Performance of Their Own Firms?
Zhu, Pengcheng
The practice of CEOs serving on the board of other public firms has raised concerns from investors and proxy advisory firms about the potential harm to shareholders. Using the distance to appointing firms’ headquarters as an instrumental variable for outside directorship appointments, I find that holding just one outside directorship benefits CEOs' own firms through CEOs' learning experience, while holding multiple directorships results in a performance decline. These findings support investors' concerns that holding more than one outside directorship hurts CEOs' own firms but also point out the benefits of CEOs' outside board experience.

Do Private Equity Firms Reduce Product Commercialization?
Khoja, Moazzam
Private equity (PE) firms reduce product commercialization in their Leveraged Buyout (LBO) investments. This reduction is associated with a product focus in the product commercialization strategy of the LBO. Using a sample of LBOs against a control sample of firms that failed to close the LBO transaction and using trademarks as a measure of product commercialization, I find that PE firms reduce trademark filings, but they accompany it with the reduction in the number of product classes which is a sign of product focus. The effect is opposite when managerial incentives are not aligned. The level of deal leverage does not affect PE firms' product commercialization strategy; neither does PE firms' experience.

Factors Influencing CEO Compensation in US Telecommunication Industry
Garanina, Tatiana,Ladyzhenko, Yulia
The objective of this paper is to define the relationship between a set of factors and CEO compensation that will enable companies to imply better corporate governance practices in their management process. Developed econometric model is tested on the data of US telecom companies for the period 2004-2012. The study revealed that CEO compensation is strongly and positively related to revenue and earnings per share of the company, and unrelated to return on net assets and market value added. These results enable companies to use CEO compensation system as an effective mechanism to eliminate agency problem and, consequently, agency costs. The main directions for further research in this field are outlined.

Generative Synthesis of Insurance Datasets
Kevin Kuo

One of the impediments in advancing actuarial research and developing open source assets for insurance analytics is the lack of realistic publicly available datasets. In this work, we develop a workflow for synthesizing insurance datasets leveraging state-of-the-art neural network techniques. We evaluate the predictive modeling efficacy of datasets synthesized from publicly available data in the domains of general insurance pricing and life insurance shock lapse modeling. The trained synthesizers are able to capture representative characteristics of the real datasets. This workflow is implemented via an R interface to promote adoption by researchers and data owners.

Growing Up Under Mao and Deng: On the Ideological Determinants of Corporate Policies
Liang, Hao,Wang, Rong,Zhu, Haikun
Historically, economic activities have been organized around certain ideologies. We investigate the impact of politicians’ ideology on corporate policies by exploring a unique setting of ideological changeâ€"China from Mao to Deng around the 1978 economic reformâ€"in a regression discontinuity framework. We find that the age discontinuity of politicians around 18 years old in 1978, who had already joined the Chinese Communist Party (CCP) or joined soon thereafter and later became municipal paramount leaders, has had a lasting effect on contemporary firm- and city-level policies. In particular, firms in cities with mayors that joined the CCP under the ideological regime of Mao have made more social contributions, lowered within-firm pay inequality, and engaged in less internationalization than those under Deng’s regime. These effects are stronger in firms with political connections, in non-state-owned enterprises, and in regions that are more market-oriented and not “revolutionary bases.” We find further evidence that ideology-induced corporate policy biases have some impact on firm performance and valuation.

Household Debt and Aging in Japan
Horioka, Charles Yuji,Niimi, Yoko
In this paper, we analyze the borrowing behavior of Japanese households in comparison to the other Group of Seven (G7) countries and also broken down by the age group of the household head. We find that pre-retirement households (households with a head in the 50-59 age group) in Japan do not have inordinate amounts of debt and that their financial health is satisfactory. However, we also find that households with a head in the 30-39 age group have shown a sharp increase in debt holdings in recent years, due partly to the fact that tax breaks for housing purchase, reforms in the housing loan market since the early 2000s, and expansionary monetary policy enabled Japanese households to purchase housing at a younger age than they could previously. We therefore need to monitor the borrowing behavior of this cohort over time as the Bank of Japan normalizes its monetary policy, especially since households have become more vulnerable to rising interest rates as the share of households who have chosen variable-rate housing loans has increased in recent years.

How Big of a Lemons Market is the Secondary Market for Private Equity Real Estate
Barker, David,Seah, Kiat Ying,Shilling, James D.
We find that shares of real estate limited partnerships sell at substantial discounts to net asset values (NAV) and these discounts are influenced by factors associated with agency costs and unrealized gains. Our study builds on previous work by Barber (1996) by examining a much longer time period (1994-2013), including additional control variables, and utilizing Tobit estimation instead of OLS, which we find superior. We find much larger effects of unrealized capital gains than Barber (1996). Factors that reduce fund managers' freedom to take actions that might reduce shareholder returns such as leverage and high dividend payments reduce discounts.

Intellectual Capital of a Board of Directors and its Elements: Introduction to the Concepts
Berezinets, Irina,Garanina, Tatiana,Ilina, Yulia
Purpose â€" The purpose of the study is to define the contribution of intellectual capital of the Board of Directors in generating intellectual capital of a company, to develop a definition of the intellectual capital of the Board of Directors, as well as two of its major elements: human capital (knowledge, skills, and experience of Board members, etc.), and social capital (relationships and networking opportunities of Board members), and to clarify the relationship between these elements and financial performance indicators of companies based on a literature review on the topic.Design â€" A literature review and analysis was applied as this study’s research design.Findings â€" The authors suggest that intellectual capital is generated not only by company staff, but also by governing bodies, particularly the Board of Directors, whose members are not always under contract with the company in the traditional sense. Members of the Board use their knowledge, experience, and networking opportunities to build intellectual capital for effective monitoring, advising, and providing the company with resources. In this sense, the Board of Directors serves as a source of intellectual capital for a company, being the main internal corporate governance mechanism that leads to value creation in a company, taking into consideration the interests of all stakeholders. Practical implications â€" The research indicates that the personal characteristics of Board members may influence the performance of a company. Therefore, companies should be recommended to carefully select candidates for nomination to the Board.Originality â€" This study contributes to further development of the concept of intellectual capital of the Board of Directors by bringing together the theory in the field and the empirical results of studies on the various elements of Board capital in a company’s value creation.

International Shock Transmission: Does Bank Organizational Structure Matter?
Gandhi, Priyank,Issa, George,Jarnecic, Elvis
The organization structure of global banks affects how they respond to liquidity shocks and matters for international shock transmission. Liquidity shocks to global banks induces a fire sales of securities by their international branches that rely on parent banks for funding, but not by their international subsidiaries that are independently capitalized and domestically funded. Domestic banks allocate funds to purchase securities sold in such fire sales, but in turn reduce credit supply, causing liquidity shocks to spill-over. Our study contributes to the debate regarding optimal regulation of global banks and externalities arising from securities trading by such banks.

Joint Extremes in Temperature and Mortality: A Bivariate POT Approach
Li, Han,Tang, Qihe
This paper contributes to insurance risk management by modeling extreme climate risk and extreme mortality risk in an integrated manner via extreme value theory (EVT). We conduct an empirical study using monthly temperature and death data in the U.S., and nd that the joint extremes in cold weather and old-age death counts exhibit the strongest level of dependence. Based on the estimated bivariate generalized Pareto distribution, we quantify the extremal dependence between death counts and temperature indexes. Methodologically, we employ the cutting edge multivariate peaks over threshold (POT) approach, which is readily applicable to a wide range of topics in extreme risk management.

Knight Meets Sharpe: Capital Asset Pricing under Ambiguity
Izhakian, Yehuda (Yud)
This paper extends the standard mean-variance preferences to mean-variance-ambiguity preferences by relaxing the assumption that probabilities are known, and instead assuming that probabilities are uncertain. The optimal portfolio is identified in general equilibrium, demonstrating that the two-fund separation theorem is preserved. Thereby, introducing ambiguity into the capital asset pricing model shows that the ambiguity premium corresponds to systematic ambiguity, which is distinguished from the systematic risk. With the closed-form measurable beta ambiguity, performance measures are generalized to account for ambiguity alongside risk. Use of this model can be extended to other applications including investment decisions and valuations.

Long-run risk sensitive impulse control
Damian Jelito,Marcin Pitera,Łukasz Stettner

In this paper we consider long-run risk sensitive average cost impulse control applied to a continuous-time Feller-Markov process. Using the probabilistic approach, we show how to get a solution to a suitable continuous-time Bellman equation and link it with the impulse control problem. The optimal strategy for the underlying problem is constructed as a limit of dyadic impulse strategies by exploiting regularity properties of the linked risk sensitive optimal stopping value functions.

Model risk measures: A review and new proposals on risk forecasting
Müller, Fernanda,Righi, Marcelo
In financial decisions, model risk has been recognized as an important source of uncertainty. The revision of the Basel II suggests that financial institutions quantify and manage their model risk like other types of risk. Focusing on risk forecasting literature, we identify two main approaches to quantify model risk: the worst case and loss function. The first approach includes measures that are applied to a set of forecasts and have a similar structure to deviation measures. On the other hand, for the second approach, monetary risk measures are employed under a loss or error function, from some forecasting procedure. Moreover, based on the untapped features of model risk for both approaches we suggest new proposals, which include measures to quantify upside and downside model risk, and average costs associated with risk overestimation and underestimation. We also conduct an empirical assessment of model risk measures using Value at Risk (VaR) and Expected Shortfall (ES) forecasting. Results indicate that model risk estimates change according to measures, sample and functional (VaR and ES). We verify, using worst case measures, that model risk tends to increases in before crisis period and according to loss function measures model risk increases in the crisis period. We also conclude that a model with good performance to risk forecasting does not indicate this model has lower model risk. Furthermore, we highlight insights into future research directions regarding model risk subject.

Modeling and Prediction of Iran's Steel Consumption Based on Economic Activity Using Support Vector Machines
Hossein Kamalzadeh,Saeid Nassim Sobhan,Azam Boskabadi,Mohsen Hatami,Amin Gharehyakheh

The steel industry has great impacts on the economy and the environment of both developed and underdeveloped countries. The importance of this industry and these impacts have led many researchers to investigate the relationship between a country's steel consumption and its economic activity resulting in the so-called intensity of use model. This paper investigates the validity of the intensity of use model for the case of Iran's steel consumption and extends this hypothesis by using the indexes of economic activity to model the steel consumption. We use the proposed model to train support vector machines and predict the future values for Iran's steel consumption. The paper provides detailed correlation tests for the factors used in the model to check for their relationships with the steel consumption. The results indicate that Iran's steel consumption is strongly correlated with its economic activity following the same pattern as the economy has been in the last four decades.

Momentum Turning Points
Garg, Ashish,Goulding, Christian L.,Harvey, Campbell R.,Mazzoleni, Michele
Turning points are the Achilles' heel of time-series momentum portfolios. Slow signals fail to react quickly to changes in trend while fast signals are often false alarms. We examine theoretically and empirically how momentum portfolios of various intermediate speeds, formed by blending slow and fast strategies, cope with turning points. Our model predicts an optimal dynamic speed selection strategy. We apply this strategy across domestic and international equity markets and document efficient out-of-sample performance. We also propose a novel decomposition of momentum strategy alpha, highlighting the role of volatility timing.

Negative Jump Intensities in Financial Return Data
Madan, Dilip B.,Wang, King
Characteristic function recovery from option data is developed. Characteristic function logarithms χ(u) on division by iu are seen to be Fourier transform of Lévy tails. Lévy densities embedded in option prices are seen to be possibly negative. Cosine perturbations of the symmetric variance gamma are seen to deliver densities with formally negative jump intensities. More generally negative arrival rates arise when ratios of pure jump infinitely divisible characteristic functions are themselves characteristic functions. Ratios of bilateral gamma and CGMY models are developed and calibrated to short maturity option prices for some 60 underliers and a thousand days. We also observe that the denominator random variable is relatively symmetric.

On Ambiguity-Lovers in Finance Models
Makarov, Dmitry
Ruling out ambiguity-loving behavior has becoming a standard assumption in a growing finance literature with smooth ambiguity. This paper argues that neither a technical nor an empirical rationale justifies excluding ambiguity-lovers by assumption, which does not let the data speak for itself. Adopting a tractable “robust mean-variance” setting suggested by Maccheroni, Marinacci, and Ruffino (2013), we derive explicitly the necessary and sufficient condition for the smooth ambiguity utility function to be strictly concave and find that moderate ambiguity-loving is allowed. Second, we show that when, in line with evidence, individual investors have heterogeneous ambiguity attitudes and are ambiguity-averse on average, the corresponding representative investor may well be ambiguity-loving.

Optimal Risk Sharing with Time Inconsistency and Long-Run Risk
Tancheva, Zhaneta
I examine the role of time inconsistency, modeled by hyperbolic discounting, for the dynamics of asset prices and the wealth distribution between agents. Naive time-inconsistent investors with recursive preferences overconsume and have a lower effective elasticity of intertemporal substitution (EIS) than otherwise similar investors who are time-consistent. In both survival and overlapping-generations economies with i.i.d. consumption growth, I show that the suboptimal consumption and saving decisions of the naive time-inconsistent investors endogenously generate long-run risks in the consumption dynamics of the time-consistent agents. As a result, the presence of naive shortsighted investors increases the risk-free rate, volatility, and risk premium in the economy.

Performance of Moving Average Trading Rules in a Volatile Stock Market: The Russian Evidence
Luukka, Pasi,Pätäri, Eero,Fedorova, Elena,Garanina, Tatiana
This paper examines the profitability of dual moving average crossover (DMAC) trading strategies in the Russian stock market over the 2003â€"2012 period. It contributes to the existing technical analysis (TA) literature by testing, for the first time, the applicability of ordered weighted moving averages (OWMA) as an alternative calculation basis for determining DMACs. In addition, this paper provides the first comprehensive performance comparison of DMAC trading rules in the stock market that is known as one of the most volatile markets in the world. The results show that the best trading strategies of the in-sample period can also outperform their benchmark portfolio during the subsequent out-of-sample period. Moreover, the out-performance of the best DMAC strategies is mostly attributable to their superior performance during bearish periods and, particularly, during stock market crashes.

Political Environment and Financial Crises
Nguyen, Thanh Cong,Castro, Vítor,Wood, Justine A
This paper assesses the role of the political environment in the timing of financial crises over a sample of 85 countries during the period 1975-2017. We consider systemic banking, currency, and sovereign debt crises in addition to twin and triple crises. Using a fixed effects logit model, this study shows that banking and currency crises are more likely to occur within one year after elections. There is also evidence that the probability of currency crises increases when right-wing parties are in office. Moreover, time in office of incumbent chief executives reduces the likelihood of any type of financial crises. The incidence of twin and triple crises is lower when majority governments are in office. This study contributes to the literature by calling attention to the importance of some political factors for different types of financial crises.

R&D or R vs. D? Firm Innovation Strategy and Equity Ownership
Driver, James,Kolasinski, Adam C.,Stanfield, Jared R.
We analyze a unique dataset that separately reports research and development expenditures for a large panel of public and private firms. Definitions of “research” and “development” in this dataset, respectively, correspond to definitions of knowledge “exploration” and “exploitation” in the innovation theory literature. We can thus test theories of how equity ownership status relates to innovation strategy. We find that public firms have greater research intensity than private firms, inconsistent with theories asserting private ownership is more conducive to exploration. We also find public firms invest more intensely in innovation of all sorts. These results suggest relaxed financing constraints enjoyed by public firms, as well as their diversified shareholder bases, make them more conducive to investing in all types of innovation. Reconciling several seemingly conflicting results in prior research, we find private-equity-owned firms, though not less innovative overall than other private firms, skew their innovation strategies toward development and away from research.

Revisiting the Epps effect using volume time averaging: An exercise in R
Patrick Chang,Roger Bukuru,Tim Gebbie

We revisit and demonstrate the Epps effect using two well-known non-parametric covariance estimators; the Malliavin and Mancino (MM), and Hayashi and Yoshida (HY) estimators. We show the existence of the Epps effect in the top 10 stocks from the Johannesburg Stock Exchange (JSE) by various methods of aggregating Trade and Quote (TAQ) data. Concretely, we compare calendar time sampling with two volume time sampling methods: asset intrinsic volume time averaging, and volume time averaging synchronised in volume time across assets relative to the least and most liquid asset clocks. We reaffirm the argument made in much of the literature that the MM estimator is more representative of trade time reality because it does not over-estimate short-term correlations in an asynchronous event driven world. We confirm well know market phenomenology with the aim of providing some standardised R based simulation tools.

Role of Financial Market in Economic Growth of India
Jarwal, Devendra
In financial market, the securities in trade is money which could be raised through various instruments, under well governed rules and regulations, carefully administered and adhered to by different institutions or market operators. It is true that the rate of economic growth of any nation is inextricably linked to the sophistication of its financial market and specifically its capital market efficiency. Considering importance of role of financial market in economic growth of any nation, this study is an attempt to describe the role of financial market in economic growth of India. Various market regulators and SEBI’s report has been used to complete this study.

Scale Economies in the Money Market
Li, Su,Musto, David K.
Money-market issuers reward scale when they borrow from prime money funds. The scale they reward isn’t the scale of the transaction or of the fund, but rather the scale of the fund complex. For a one-month loan the magnitude is a basis point per fourfold increase in complex size. Larger complexes also enjoy an advantage when exiting holdings: they are both more likely to part with a holding and more likely to exchange it with the issuer for new paper with longer maturity. Our results demonstrate both economies of scale, which can concentrate the industry, and also the importance of relationships in money-market transactions.

Selection into Informative Consumer Credit Markets
Liskovich, Inessa,Shaton, Maya
Recent technological innovation in credit markets has made it easier for households to access information about their cost of credit. We exploit a quasi-natural experiment in an online consumer credit market to identify which households take advantage of informative markets. In the setting studied, a lending platform switched from offering personalized loan prices to pricing by broad credit grades. We find that individuals with fewer years of experience in credit markets immediately and disproportionately exit the market, especially among riskier borrowers. We conclude that less experienced borrowers sort into markets that offer personalized information. Additional analysis confirms that their behavior is consistent with learning from personalized offers. Our results highlight the role of the growing fintech sector in allowing inexperienced households to learn about their costs of credit.

Shareholder Empowerment and Board of Directors Effectiveness
Drymiotes, George,Lin, Haijin
We develop a model to examine implications of empowering shareholders to replace directors. We find that shareholder empowerment functions as a double‐edged sword. On the one hand, it can weaken ineffective boards' incentive to hold on to their position. On the other hand, it can induce both effective and ineffective boards to behave strategically to avoid a potential dismissal. As a result, empowerment does not necessarily increase firm value; in some cases, empowerment exacerbates the agency problem it is intended to address. Giving shareholders the power to set board compensation (have a “say on pay”) can mitigate these problems. However, even when empowerment benefits (harms) the shareholders, firm value may decrease (increase). Finally, we discuss empirical and policy implications of the main findings.

Shareholder Liability and Bank Failure
Aldunate, Felipe,Jenter, Dirk,Korteweg, Arthur G.,Koudijs, Peter
Does additional shareholder liability reduce bank failure? We compare the performance of around 4,400 state-regulated banks of similar size in neighboring U.S. states with different liability regimes during the Great Depression. We find that additional shareholder liability reduced bank failure by 30%. Results are robust to a diff-in-diff analysis incorporating National banks (which faced the same regulations in every state), and are not driven by other differences in state regulation, FED membership, or differential selection into state and nationally regulated banks. Our results suggest that exposing shareholders to more downside risk reduces bank risk taking.

Short Selling Risk and Hedge Fund Performance
Ma, Matthew
Hedge funds, on average, outperform other actively managed funds. However, hedge fund managers often use trading strategies that are not used by other managed portfolios, and thus they bear unique risks. In particular, many hedge funds use short selling. I construct an option-based measure of short selling risk as the return spread between the decile of stocks with low option-implied short selling fees and the decile of those with high fees. I find that hedge funds that are significantly exposed to short selling risk outperform low-exposure funds by 0.45% per month on a risk-adjusted basis. However, there is no such relation for mutual funds that invest primarily on the long side. The results highlight that a significant proportion of abnormal performance of hedge funds is compensation for the risk they take on their short positions.

Stylized Facts and Agent-Based Modeling
Simon Cramer,Torsten Trimborn

The existence of stylized facts in financial data has been documented in many studies. In the past decade the modeling of financial markets by agent-based computational economic market models has become a frequently used modeling approach. The main purpose of these models is to replicate stylized facts and to identify sufficient conditions for their creations. In this paper we introduce the most prominent examples of stylized facts and especially present stylized facts of financial data. Furthermore, we given an introduction to agent-based modeling. Here, we not only provide an overview of this topic but introduce the idea of universal building blocks for agent-based economic market models.

Testing Disagreement Models
Chang, Yen-Cheng,Ljungqvist, Alexander,Hsiao, Pei-Jie,Tseng, Kevin
We provide well-identified evidence for the role of investor disagreement in asset prices. Our natural experiment exploits the staggered implementation of EDGAR, which induces a decrease in investor disagreement with no accompanying changes in company fundamentals, disclosure quality, or earnings management. The decrease in disagreement leads to lower stock price crash risk. The effect is more significant for stocks with binding short-sale constraints and high investor optimism. The decrease in investor disagreement also leads to higher subsequent returns. Our results provide evidence consistent with models of investor disagreement.

The Effect of IFRS 9 on the Timeliness of Loan Loss Recognition
Kim, Jeong-Bon,Ng, Jeffrey,Wang, Chong
Effective from January 1, 2018, IFRS 9 drastically changed banks’ accounting for the impairment of financial assets by replacing the incurred credit loss (ICL) model with the expected credit loss (ECL) model, which enhances the timeliness of accounting for credit losses. Using a sample of international banks from 33 countries, we examine the impact of this shift to the ECL model on loan loss recognition timeliness (LLRT). Using a difference-in-differences empirical specification, our results reveal that this shift increases LLRT. Consistent with the ECL model allowing a larger amount of expected loan losses to be recognized earlier, we find that the positive effect on LLRT is more pronounced for riskier banks and banks that recorded lower loan losses prior to the shift. Finally, consistent with the enforcement of IFRS being important to its effectiveness, we find a larger positive effect on LLRT for countries with stronger IFRS enforcement. Overall, our results offer early insight into a revolutionary shift in accounting for credit losses.

The Faith in Peril: Do Financial Analysts Overestimate Political Connections?
Yuting, Huang,Zhang, Fan
We examine the superiority of political connections in the Chinese capital market through the lens of analysts' forecast optimism. We find that politically firms receive more optimistic earnings forecasts than their unconnected counterparties in the presence of stock crashes. Further analysis shows that the central inspection, considered as a threat to the connection, widely weakens such overestimation effect. Moreover, this bias is proven to be driven by the attribution bias and thus the overconfidence into the political connections. Busier or less competent analysts are more likely to overestimate the political connections. Their overoptimistic forecast is associated with more net inflows of main funds by block traders into the connected firms, which, however, do not translate into the improvement of corporate fundamentals in the post-crash period. Collectively, these pieces of evidence suggest that analysts have subjectively overestimated the effect of political connections and might bring in a misallocation of financial liquidity.

The Impact of BRICS Formation on Portfolio Diversification: Empirical Evidence from Pre- and Post-Formation Eras
Al-Mohamad, Somar,Khaki, Audil,Bakry, Walid,Jreisat, Ammar,Vo, Xuan Vinh
This paper aims at contributing to the international portfolio investment decisions among the emerging BRICS countries where individual and institutional investors seek diversification benefits and to help in advocating policy changes and implementation as a response to the changing dynamics in these countries pre- and post-BRICS formation. Therefore, the context of this paper is aimed towards examining the short term causalities and long term integration among the BRICS stock market pre- and post-BRICS formation. The research applies the Augmented Dicker-Fuller (ADF) and Philips-Perron tests (PP) tests to analyze stationarity among the selected variables. The pre- and post-BRICS formation long-term linear relationship is investigated using Johansen and Juselius cointegration test while the Granger Causality is applied to assess the direction of the causality between the stock market indices. The study also extends the investigation by employing the impulse response function and variance decomposition to evaluate the reaction of each of the BRICS market to a shock from other BRICS stock markets. Weekly stock market indices of BRICS countries were used covering the period from January 2003 to December 2018. One key finding is that the degree of financial integration among the BRICS stock markets has moderately strengthened in the post-BRICS formation period compared to the pre-BRICS formation period. Another significant finding is that the Chinese stock market are mostly independent from other BRICS markets in the two aforementioned sub-periods, implying diversification benefits for the international investors both in the short and the long run. Further, the results also reveal a unidirectional causal relationship from the Russian stock market to its BRICS counterparts in both periods. Finally, the overall results show an increased responsiveness of stock markets in BRICS countries to shocks in each other after the formation of the bloc as compared to pre- formation period.

The Man(ager) Who Knew Too Much
Banerjee, Snehal,Davis, Jesse,Gondhi, Naveen
There is widespread evidence that better informed individuals exhibit the “curse of knowledge.” We study how this bias affects communication choices and investment decisions within a firm. A principal chooses the optimal level of investment in a risky project, conditional on the information she receives from a better informed, but “cursed,” manager. The curse of knowledge leads the manager to overestimate the informativeness of his communication. This misperception amplifies the information loss from strategic communication when the manager and principal’s incentives are misaligned. However, this same distortion in the manager’s perception leads him to over-invest in acquiring private information. We characterize the overall impact on firm value and on the choice of whether to delegate the investment decision to the manager.

The Real Effects of Environmental Activist Investing
Naaraayanan, S Lakshmi,Sachdeva, Kunal,Sharma, Varun
Using a socially-motivated activist campaign by a large pension fund, we measure the real effects of activist investing on pollution and the environment. Targeted firms reduced their total toxic chemical releases, production-related emissions, cancer-causing pollution, environmental accidents, and legal risks. These effects do not come at the expense of lower financial performance or returns. We rule out natural alternative hypotheses while also presenting evidence supporting the external validity of socially motivated activism. These findings suggest that shareholders can delegate their pro-social preferences onto firms to maximize their total value between their financial and non-pecuniary benefits.

Time Distance and Mutual Fund Holding Horizon: Evidence from a Quasi-Natural Experiment Setting of High-Speed Railway Opening
Liu, Qiliang,Tian, li,Wang, Junbo
Using a quasi-natural experiment setting of high-speed railway opening, we examine whether mutual fund holding horizon changes after the time distance between mutual funds and listed companies is shortened following the opening of high-speed railway. With the DID (difference-in-difference) method, we find that the holdings of mutual fund in remote listed companies increase following high-speed railway opening of remote cities in which these listed companies are located. We also find that this effect is mainly reflected in the high-speed railway transportation optimal interval (i.e. physical distance between 240 and 1800 kilometers), and this effect is stronger for companies with lower analyst coverage. We further find that the opening of high-speed railway facilitates the site visits of mutual funds to remote listed companies, which will eventually increase mutual fund holdings and extend mutual fund holding horizon.

Under- and Over-Reaction in Yield Curve Expectations
Wang, Chen
I study how professional forecasts of interest rates across maturities respond to new information. I confirm and provide additional evidence for a pattern noted by Bordalo et al. (2019b): forecasts for short-term rates underreact to new information while forecasts for long-term rates overreact. I propose a new explanation based on “autocorrelation averaging,” whereby, due to limited cognitive processing capacity, forecasters’ estimate of the autocorrelation of a given process is biased toward the average autocorrelation of all the processes they observe. Consistent with this view, I show that forecasters over -estimate the autocorrelation of the less persistent term premium component of interest rates and under -estimate the autocorrelation of the more persistent short rate component. A calibrated model quantitatively matches the documented pattern of misreaction. Finally, I explore the pattern’s implication for asset prices. I show that an overreaction-motivated predictor, the realized forecast error for the 10-year Treasury yield, robustly predicts excess bond returns

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.