Research articles for the 2019-12-08
A Practical Guide to Robust Portfolio Optimization
SSRN
Robust optimization considers uncertainty in inputs to address the shortcomings of mean-variance optimization. We investigate the mechanisms by which robust optimization achieves its goal and give practical guidance regarding its parametrization. We show that quadratic uncertainty sets are preferred to box uncertainty sets, that a diagonal uncertainty matrix with only variances should be used, and that the level of uncertainty can be chosen based on Sharpe ratios. We use examples with the proposed parametrization to show that robust optimization efficiently overcomes the weaknesses of mean-variance optimisation and can be applied in real investment problems like multi-asset portfolio management or robo-advising.
SSRN
Robust optimization considers uncertainty in inputs to address the shortcomings of mean-variance optimization. We investigate the mechanisms by which robust optimization achieves its goal and give practical guidance regarding its parametrization. We show that quadratic uncertainty sets are preferred to box uncertainty sets, that a diagonal uncertainty matrix with only variances should be used, and that the level of uncertainty can be chosen based on Sharpe ratios. We use examples with the proposed parametrization to show that robust optimization efficiently overcomes the weaknesses of mean-variance optimisation and can be applied in real investment problems like multi-asset portfolio management or robo-advising.
Analysis of the Risk-Sharing Principal-Agent problem through the Reverse-H{\"o}lder inequality
arXiv
arXiv
In this paper we provide an alternative framework to tackle the first-best Principal-Agent problem under CARA utilities. This framework leads to both a proof of existence and uniqueness of the solution to the Risk-Sharing problem under very general assumptions on the underlying contract space. Our analysis relies on an optimal decomposition of the expected utility of the Principal in terms of the reservation utility of the Agent and works both in a discrete time and continuous time setting. As a by-product this approach provides a novel way of characterizing the optimal contract in the CARA setting, which is as an alternative to the widely used Lagrangian method, and some analysis of the optimum.
Asymmetric Effects of Voluntary Disclosure on Stock Liquidity: Evidence from 8-K Filings
SSRN
This paper examines whether the change in stock liquidity subsequent to voluntary disclosure is different between good news and bad news. Using voluntary 8-K filings, we find that the increase in stock liquidity is more pronounced for firms with good news disclosure than for firms with bad news disclosure. In addition, such findings are stronger when a firm is less visible and when the short-selling costs are high, suggesting that these two factors play an important role in increasing stock liquidity. Overall, this paper provides evidence that the tone of voluntary 8-K news is an important determinant of stock liquidity.
SSRN
This paper examines whether the change in stock liquidity subsequent to voluntary disclosure is different between good news and bad news. Using voluntary 8-K filings, we find that the increase in stock liquidity is more pronounced for firms with good news disclosure than for firms with bad news disclosure. In addition, such findings are stronger when a firm is less visible and when the short-selling costs are high, suggesting that these two factors play an important role in increasing stock liquidity. Overall, this paper provides evidence that the tone of voluntary 8-K news is an important determinant of stock liquidity.
Asymmetric Pass-Through between Oil Prices and the Stock Prices of Clean Energy Firms: New Evidence from a Nonlinear Analysis
SSRN
There is an ongoing debate on how oil prices affect the stock prices of clean energy companies. We contribute to this debate by questioning the possibility of asymmetric linkages between oil prices, interest rates, and the stock prices of clean energy and technology firms. Using a recently developed approach (nonlinear auto-regressive distributed lag (NARDL) model), we document that ignoring the presence of nonlinearities leads to misleading results. The analyses reveal significant asymmetric effects among the variables of interest. Our findings suggest that the impacts of positive and negative changes in the oil prices, interest rates and technology stock prices on clean energy stock prices substantially vary in the short-and long-run. More specifically, our results point out that the increased investments in clean energy stocks appear to be due to speculative attacks along with an increase in oil prices in the short-run. But, in the long-run, the increased oil price has a negative impact on clean energy stock prices and this impact is asymmetric. Last but not least, the results also emphasize the importance of business cycle fluctuations for the clean energy stock performance in the long-run. The implications of this paper are noteworthy for energy economists, policymakers, and investors in the energy and financial markets.
SSRN
There is an ongoing debate on how oil prices affect the stock prices of clean energy companies. We contribute to this debate by questioning the possibility of asymmetric linkages between oil prices, interest rates, and the stock prices of clean energy and technology firms. Using a recently developed approach (nonlinear auto-regressive distributed lag (NARDL) model), we document that ignoring the presence of nonlinearities leads to misleading results. The analyses reveal significant asymmetric effects among the variables of interest. Our findings suggest that the impacts of positive and negative changes in the oil prices, interest rates and technology stock prices on clean energy stock prices substantially vary in the short-and long-run. More specifically, our results point out that the increased investments in clean energy stocks appear to be due to speculative attacks along with an increase in oil prices in the short-run. But, in the long-run, the increased oil price has a negative impact on clean energy stock prices and this impact is asymmetric. Last but not least, the results also emphasize the importance of business cycle fluctuations for the clean energy stock performance in the long-run. The implications of this paper are noteworthy for energy economists, policymakers, and investors in the energy and financial markets.
BitMEX Funding Correlation with Bitcoin Exchange Rate
arXiv
arXiv
This paper examines the relationship between Inverse Perpetual Swap contracts, a Bitcoin derivative akin to futures and the margin funding interest rates levied on BitMEX. This paper proves the Heteroskedastic nature of funding rates and goes onto establish a causal relationship between the funding rates and the Bitcoin inverse Perpetual swap contracts based on Granger causality. The paper further dwells into developing a predictive model for funding rates using best-fitted GARCH models. Implications of the results are presented, and funding rates as a predictive tool for gauging the market trend is discussed.
CEO Pay Gap and Bank Risk-taking
SSRN
The large compensation received by bank executives is among the many factors blamed for the risk-taking that led to the 2008-2009 financial crisis. We test whether and how pay disparities between CEO and non-CEO executivesâ€"the so-called CEO pay gapâ€"influenced risk taking at publicly traded commercial banks in the U.S. between 1992 and 2014. Perhaps surprisingly, we find strong evidence that larger CEO pay gaps are associated with lower risk levels, improved financial performance, and greater information transparency. Our results imply that placing absolute limits on bank CEO pay would likely result in increased bank risk-taking.
SSRN
The large compensation received by bank executives is among the many factors blamed for the risk-taking that led to the 2008-2009 financial crisis. We test whether and how pay disparities between CEO and non-CEO executivesâ€"the so-called CEO pay gapâ€"influenced risk taking at publicly traded commercial banks in the U.S. between 1992 and 2014. Perhaps surprisingly, we find strong evidence that larger CEO pay gaps are associated with lower risk levels, improved financial performance, and greater information transparency. Our results imply that placing absolute limits on bank CEO pay would likely result in increased bank risk-taking.
Deposit Flow Seasonalities and the January Effect in Retail Deposit Rates
SSRN
Deposits flow out of the US banking system in January and February and flow in later in the year. In response to this outflow, banks increase rates on retail deposit products in January, including time, savings, and money market deposit accounts. Banks tend to offer highest deposit rates in January, after which the rates decline monotonically, reaching the minimum in December. The effect is more pronounced after the financial crisis, when banks relied less on nondeposit borrowings to replace outflowing liquidity. Consistent with the seasonal outflow of deposits, increased reliance on deposits, especially demand deposits, is associated with a stronger January effect in deposit rates at the bank level.
SSRN
Deposits flow out of the US banking system in January and February and flow in later in the year. In response to this outflow, banks increase rates on retail deposit products in January, including time, savings, and money market deposit accounts. Banks tend to offer highest deposit rates in January, after which the rates decline monotonically, reaching the minimum in December. The effect is more pronounced after the financial crisis, when banks relied less on nondeposit borrowings to replace outflowing liquidity. Consistent with the seasonal outflow of deposits, increased reliance on deposits, especially demand deposits, is associated with a stronger January effect in deposit rates at the bank level.
Determinants of Mergers and Acquisitions: Evidence from the Insurance Industry
SSRN
This paper fills a gap in the existent literature on the determinants associated with the likelihood of being involved in mergers and acquisitions (M&As) by insurance firms. We investigate firm factors for both becoming a target or becoming an acquirer using a detailed database of the Spanish insurance industry over the period 2000-2012. The period encompasses the years of the global wave of M&As in the 2000s and the recent financial crisis. Results indicate that value-enhancing strategies have been the main motivations for M&As, since the increase of performance in terms of scale and allocative efficiency are principal reasons to be involved as acquirers and insurers are more likely to be targets if they are less profitable and have higher premium growth rates. We also find that insurer ownership type matters to be involved in M&As and this finding does not necessarily have to be explained by managerial entrenchment arguments. Results also show variations among different ownership types concerning the influence of the product diversification determinant on the probability to become acquirers.
SSRN
This paper fills a gap in the existent literature on the determinants associated with the likelihood of being involved in mergers and acquisitions (M&As) by insurance firms. We investigate firm factors for both becoming a target or becoming an acquirer using a detailed database of the Spanish insurance industry over the period 2000-2012. The period encompasses the years of the global wave of M&As in the 2000s and the recent financial crisis. Results indicate that value-enhancing strategies have been the main motivations for M&As, since the increase of performance in terms of scale and allocative efficiency are principal reasons to be involved as acquirers and insurers are more likely to be targets if they are less profitable and have higher premium growth rates. We also find that insurer ownership type matters to be involved in M&As and this finding does not necessarily have to be explained by managerial entrenchment arguments. Results also show variations among different ownership types concerning the influence of the product diversification determinant on the probability to become acquirers.
Gauging Market Responses to Monetary Policy Communication
SSRN
The modern model of central bank communication suggests that central bankers prefer to err on the side of saying too much rather than too little. The reason is that most central bankers believe that clear and concise communication of monetary policy helps achieve their goals. For the Federal Reserve, this means to achieve its goals of price stability, maximum employment, and stable long-term interest rates. This article examines the various dimensions of Fed communication with the public and financial markets and how Fed communication with the public has evolved over time. We use daily and intraday data to document how Fed communication affects key financial market variables. We find that Fed communication is associated with changes in prices of financial market instruments such as Treasury securities and equity prices. However, this effect varies by type of communication, by type of instrument, and by who is doing the speaking.
SSRN
The modern model of central bank communication suggests that central bankers prefer to err on the side of saying too much rather than too little. The reason is that most central bankers believe that clear and concise communication of monetary policy helps achieve their goals. For the Federal Reserve, this means to achieve its goals of price stability, maximum employment, and stable long-term interest rates. This article examines the various dimensions of Fed communication with the public and financial markets and how Fed communication with the public has evolved over time. We use daily and intraday data to document how Fed communication affects key financial market variables. We find that Fed communication is associated with changes in prices of financial market instruments such as Treasury securities and equity prices. However, this effect varies by type of communication, by type of instrument, and by who is doing the speaking.
Housing Bust, Bank Lending & Employment: Evidence from Multimarket Banks
SSRN
Using geographic variation in bank lending, I study how bank real estate losses affected the supply of credit and employment during the Great Recession. Banks exposed to distressed housing markets cut mortgage and small business lending relative to other banks in the same county. This lending contraction had real effects, as counties whose banks were exposed to adverse shocks in other markets suffered employment declines, especially in young firms. This finding is robust to instrumenting for bank exposure to housing shocks using shocks in distant markets, exposure based on historical lending, or exposure to markets with inelastic housing supply.
SSRN
Using geographic variation in bank lending, I study how bank real estate losses affected the supply of credit and employment during the Great Recession. Banks exposed to distressed housing markets cut mortgage and small business lending relative to other banks in the same county. This lending contraction had real effects, as counties whose banks were exposed to adverse shocks in other markets suffered employment declines, especially in young firms. This finding is robust to instrumenting for bank exposure to housing shocks using shocks in distant markets, exposure based on historical lending, or exposure to markets with inelastic housing supply.
Loss aversion and the zero-earnings discontinuity
SSRN
Prior literature suggests that the zero-earnings discontinuity is caused by earnings management. This makes sense if investors are naÃve. We test for the possibility of investor naÃveté and find that they are aware of firms performing earnings management around zero reported earnings and that there is no obvious gain of reaching zero reported earnings. We extend a signaling model to include loss-averse investors and we find that earnings management is not only rational, but in equilibrium, it is not possible for investors to deduce the correct value of firms' earnings around the discontinuity. Our model could be applied to other reference points besides zero earnings, such as expected or last year's earnings
SSRN
Prior literature suggests that the zero-earnings discontinuity is caused by earnings management. This makes sense if investors are naÃve. We test for the possibility of investor naÃveté and find that they are aware of firms performing earnings management around zero reported earnings and that there is no obvious gain of reaching zero reported earnings. We extend a signaling model to include loss-averse investors and we find that earnings management is not only rational, but in equilibrium, it is not possible for investors to deduce the correct value of firms' earnings around the discontinuity. Our model could be applied to other reference points besides zero earnings, such as expected or last year's earnings
Modern Income-Share Agreements in Postsecondary Education: Features, Theory, Applications
SSRN
An income-share agreement (ISA) in postsecondary education is a contract in which students pledge to pay a certain percentage of their future incomes over a set period of time in exchange for funding educational program expenses in the present. Typically, participants begin to make payments once their incomes rise above a minimum threshold set by the terms of the ISA and will never pay more than a set cap (usually, a multiple of the original amount). Funding for ISAs can range from university sources to philanthropic funding and private investor capital. In this study, we describe the many varied and often complex incarnations of ISA contracts, as well as their many use cases in traditional college programs, nondegree/certificate programs, and workforce development settings. First, we discuss the current state of the nascent ISA marketplace, including how ISAs are structured and funded, how educational programs come to consider offering ISAs to students, and what factors they might weigh during the ISA design and implementation stages. Second, we discuss the benefits and disadvantages of each major aspect of an ISA (e.g., funding model, payment terms) to students, institutions, and  if applicable  investors. Finally, we discuss the theoretical underpinnings of ISAs and the main practical challenges that institutions offering ISAs, students choosing these contracts, and regulators face in both the short and the long term as ISAs promulgate.
SSRN
An income-share agreement (ISA) in postsecondary education is a contract in which students pledge to pay a certain percentage of their future incomes over a set period of time in exchange for funding educational program expenses in the present. Typically, participants begin to make payments once their incomes rise above a minimum threshold set by the terms of the ISA and will never pay more than a set cap (usually, a multiple of the original amount). Funding for ISAs can range from university sources to philanthropic funding and private investor capital. In this study, we describe the many varied and often complex incarnations of ISA contracts, as well as their many use cases in traditional college programs, nondegree/certificate programs, and workforce development settings. First, we discuss the current state of the nascent ISA marketplace, including how ISAs are structured and funded, how educational programs come to consider offering ISAs to students, and what factors they might weigh during the ISA design and implementation stages. Second, we discuss the benefits and disadvantages of each major aspect of an ISA (e.g., funding model, payment terms) to students, institutions, and  if applicable  investors. Finally, we discuss the theoretical underpinnings of ISAs and the main practical challenges that institutions offering ISAs, students choosing these contracts, and regulators face in both the short and the long term as ISAs promulgate.
Predatory Advertising, Financial Fraud, and Leverage
SSRN
We examine how an industry leader’s competitors respond when financial fraud by the leader is publicly revealed. We document evidence of predatory advertising and pricing. Close competitors of the leader step up advertisement spending relative to control firms. Although we do not directly observe product prices, we find that even though advertisement increases, competitors’ profit margins drop, consistent with predatory pricing. Evidence of predation is stronger when rival firms have larger market share, the fraud firm has higher leverage, and when the average leverage of rival firms is lower. The effects appear mainly in industries that produce customized products and where consumer switching costs are high. Increasing advertising expenditure appears to be a more potent predatory strategy in industries that experience new customer growth, whereas cutting prices appears more potent in industries with stagnant customer base. We present a switching cost model similar to Klemperer (1995) that generates implications broadly consistent with these observations.
SSRN
We examine how an industry leader’s competitors respond when financial fraud by the leader is publicly revealed. We document evidence of predatory advertising and pricing. Close competitors of the leader step up advertisement spending relative to control firms. Although we do not directly observe product prices, we find that even though advertisement increases, competitors’ profit margins drop, consistent with predatory pricing. Evidence of predation is stronger when rival firms have larger market share, the fraud firm has higher leverage, and when the average leverage of rival firms is lower. The effects appear mainly in industries that produce customized products and where consumer switching costs are high. Increasing advertising expenditure appears to be a more potent predatory strategy in industries that experience new customer growth, whereas cutting prices appears more potent in industries with stagnant customer base. We present a switching cost model similar to Klemperer (1995) that generates implications broadly consistent with these observations.
Pricing Defaulted Italian Mortgages
SSRN
Our paper forecasts expected recovery rates of defaulted Italian mortgage loans backed by either residential or commercial real estate. Compared to our findings, rating agencies such as Moody’s paint a rosier picture with higher recovery rates. As a consequence non-performing mortgage loans held by Italian banks might be overvalued.
SSRN
Our paper forecasts expected recovery rates of defaulted Italian mortgage loans backed by either residential or commercial real estate. Compared to our findings, rating agencies such as Moody’s paint a rosier picture with higher recovery rates. As a consequence non-performing mortgage loans held by Italian banks might be overvalued.
Risk Profile and Mutual Fund Scheme Selection of Investors
SSRN
Investors in general may have different risk tolerance levels. Hence, mutual funds in particular offer various schemes ranging from very low to very high risk. Depending upon the objective of investment, investor can choose mutual fund scheme which suits to his risk profile for Risk tolerance level. However, there is always a possibility of mismatch between the risk profile of investor and the mutual fund schemes selected by him. This mismatch can defeat the whole purpose of making investment in mutual funds for the investors. The present study attempts to investigate if mutual fund schemes selections show their suitability to various risk profiles of mutual fund investors. Based on a sample of 200 respondents, the study has found that there is a significant Association between risk tolerance level and risk level of mutual funds scheme selected by investors. However, there have also been instances of mismatch of risk profile and mutual fund schemes selection reported in the study.
SSRN
Investors in general may have different risk tolerance levels. Hence, mutual funds in particular offer various schemes ranging from very low to very high risk. Depending upon the objective of investment, investor can choose mutual fund scheme which suits to his risk profile for Risk tolerance level. However, there is always a possibility of mismatch between the risk profile of investor and the mutual fund schemes selected by him. This mismatch can defeat the whole purpose of making investment in mutual funds for the investors. The present study attempts to investigate if mutual fund schemes selections show their suitability to various risk profiles of mutual fund investors. Based on a sample of 200 respondents, the study has found that there is a significant Association between risk tolerance level and risk level of mutual funds scheme selected by investors. However, there have also been instances of mismatch of risk profile and mutual fund schemes selection reported in the study.
The Choice of When to Buy and When To Sell
arXiv
arXiv
A consumer who wants to consume a good at a particular period may nevertheless attempt to buy it earlier if he is concerned that the good will otherwise be sold. We analyze the behavior of consumers in equilibrium and the price a profit-maximizing firm would charge. We show that a firm profits by not selling early. If, however, the firm is obligated to also offer the good early, then the firm may maximize profits by setting a price which induces consumers to all arrive early, or all arrive late, depending on the good's value to the customer.
The international effects of central bank information shocks
arXiv
arXiv
We explore the international transmission of monetary policy and central bank information shocks by the Federal Reserve and the European Central Bank. Identification of these shocks is achieved by using a combination of high-frequency market surprises around announcement dates of policy decisions and sign restrictions. We propose a high-dimensional macroeconometric framework for modeling aggregate quantities alongside country-specific variables to study international shock propagation and spillover effects. Our results are in line with the established literature focusing on individual economies, and moreover suggest substantial international spillover effects in both directions for monetary policy and central bank information shocks. In addition, we detect heterogeneities in the transmission of ECB policy actions to individual member states.
