Research articles for the 2020-01-08

A New Dynamic House-Price Index
Stanton, Richard,Strickland, Chris,Wallace, Nancy
Using a newly available panel data set containing property-specific, time-varying hedonic characteristics and sales prices, we develop a new dynamic house-price model that is suitable for out-of-sample forecasting applications such as mortgage valuation and bank stress-testing. The model is set up in a classical state-space framework and includes common factors that are univariate structural time series models scaled to form linear combinations specific to locations. Our common factors include trend, seasonal, and autoregressive components. The equations are linear and errors are Gaussian; however, the unbalanced nature of our panel data means that standard Kalman-filter smoothing algorithms are not suitable. Instead, we apply an alternative three-block Markov Chain Monte Carlo algorithm Strickland, Turner, Denham, and Mengersen (2009). We find significant in- and out-of-sample forecasting differences between our model and standard repeat-sales and hedonic regressions. We also test, and reject, two assumptions of repeat-sales estimators: a single common trend for all regions and a unit root in the index.

A New Value Strategy
Wang, Baolian
Motivated by recent studies on the relation between profitability and stock returns, we construct a new value measureâ€"the ratio of cash-based operating profitability to price (COP/P)â€"and find a zero-investment portfolio that buys the highest-COP/P stocks and shorts the lowest-COP/P stocks earns annualized returns of 11% on a value-weighted basis and 13% on an equal-weighted basis. The COP/P effect holds even for large-capitalization stocks, exists in different periods, is distinct from known return predictors, and cannot be explained by existing factor models. The COP/P measure subsumes existing value measures and the conservative-minus-aggressive investment factor of Fama and French (2015).

A Study of Efficiency of the Indian Stock Market
Hawaldar, Iqbal Thonse ,Mallikarjunappa, T.
In this study, we used event study methodology to examine stock price reactions to quarterly earnings announcement. The study is based on a sample of 146 companies listed on Bombay Stock Exchange and December 2000 quarterly earnings announcements are taken event. The abnormal performance is measured by using the market adjusted model, and market model. The results show that AAR and CAAR values are positive for majority of the days during the event window and the earnings announcement had a positive impact on the market. From Runs test statistics, it appears that AAR values are non-random. The Sign statistics for the mean adjusted model shows that the numbers of positive and negative AARs are different and not equal. The t-test results show that CAAR values are significant for most of the days for all the portfolios in the event window. The significant CAARs show that the investors can use buy and hold strategy to gain abnormal returns. Based on these evidences, we conclude that the Indian stock market is not efficient in the semi-strong form. The quarterly earnings announcement information can be used by the investors to earn abnormal returns in the Indian stock market.

Assessing Financial Education: Evidence from Boot Camp
Skimmyhorn, Bill
This study estimates the effects of Personal Financial Management Course attendance and enrollment assistance using a natural experiment in the U.S. Army. Course attendance reduces the probability of select credit account balances, average account balances, delinquencies, and adverse legal actions in the first year after the course, but it has no effects on accounts in the second year or credit scores in either year. The course and its bundled enrollment assistance increase retirement savings rates from 12% to 24%, with effects that persist through at least two years. The course has no significant effects on military labor market outcomes.

Bank Balance Sheet Risk Allocation
Júdice, Pedro,Zhu, Qiji Jim
We formulate the optimal balance sheet management problem as a linear program and study it using a duality approach. In addition to helping to determine the optimal balance sheet, the dual problem also provides us the market prices of interest rate risk and credit risk. Our methodology is used to determine premia on credit risk and interest rate risk for commercial banks, which in turn allows us to manage the risk allocation for a bank given a risk budget. Moreover, our approach will be of interest to regulators, who can use it to assess the market price of credit and interest rate risk at each point in the economic cycle. Finally, we apply this methodology to real data and show how it can be used to a real setting, using diversification constraints and a greedy algorithm that results in the optimal asset-liability allocation.

CESD Research Brief: Should We Expect a Change in the Rate of Azerbaijani Manat in Context of High Demand for US Dollar?
Research Group, CESD
Analysis of the current situation shows that the main factor behind increasing demand in foreign exchange markets is importation. Fiscal expansion and stable exchange rate have been promoting imports throughout the past two years.

Center of Volume Mass: Does Options Trading Predict Stock Returns?
Bernile, Gennaro (帅纳) ,Gao, Fei,Hu, Jianfeng
We examine whether the distribution of trades along the set of strike prices of option contracts on the same stock contains information about underlying price discovery. We show that option traders' demand for delta exposure drives the volume-weighted average strike-spot price ratio (VWKS). In turn, we find that VWKS predicts underlying returns and anticipates the flow of fundamental information about the stock. The return predictability is greater but not limited to stocks with higher information asymmetries and arbitrage costs, and becomes stronger ahead of value relevant news. Overall, options trading appears to play an important informational role for underlying markets.

Compact Finite Difference Scheme with Hermite Interpolation for Pricing American Put Options Based on Regime Switching Model
Chinonso Nwankwo,Weizhong Dai,Ruihua Liu

We consider a system of coupled free boundary problems for pricing American put options with regime-switching. To solve this system, we first fix the optimal exercise boundary for each regime resulting in multi-variable fixed domains. We further eliminate the first-order derivatives associated with the regime-switching model by taking derivatives to obtain a system of coupled partial differential equations which we called the asset-delta-gamma-speed option equations. The fourth-order compact finite difference scheme is then employed in each regime for solving the system of the equations. In particular, the performance of cubic and quintic Hermite and cubic spline interpolation is explored in estimating the coupled asset, delta, gamma and speed options in the set of equations. The numerical method is finally tested with several examples. Our results show that the scheme provides an accurate solution with the convergent rate of 3.7 which is very fast in computation as compared with other existing numerical methods.

Cross-Asset Skew
Baltas, Nick,Salinas, Gabriel
We find that realized skewness is a significant indicator of returns across a range of assets from different asset classes, namely commodities, government bonds, equity indices and currencies. Taking on skewness risk is broadly compensated within, but more substantially across asset classes. Portfolios in these four asset classes with long positions on most negatively (or least positively) skewed assets and short positions on least negatively (or most positively) skewed assets generate on average a Sharpe ratio of 0.35 between 1990 and 2017. We find little evidence of a common risk driver among these portfolios, to the extent that their combination benefits substantially from diversification, delivering a Sharpe ratio of 0.72. The patterns are not subsumed by other known factors that drive returns, such as value, momentum or carry factors and, consequently, mean-variance efficient multi-factor portfolios assign a positive weight to skewness. Our results remain robust to different measures of skewness and across sub-samples.

Cross-Sectional Modeling of Bank Deposits
Costa, Sofia,Faias, Marta,Júdice, Pedro,Mota, Pedro
Studying the dynamics of deposits is important for three reasons: first, it serves as an important component of liquidity stress testing; second, it is crucial to asset-liability management exercises and the allocation between liquid and illiquid assets; third, it is the support for a liquidity at risk (LaR) methodology. Current models are based on AR(1) processes that often underestimate liquidity risk. Thus a bank relying on those models may face failure in an event of crisis. We propose a novel approach for modeling deposits, using panel data and a momentum term. The model enables the simulation of a variety of deposit trajectories, including episodes of financial distress, showing much higher drawdowns and realistic liquidity at risk estimates, as well as density plots that present a wide range of possible values, corresponding to booms and financial crises.Therefore, this methodology is more suitable for liquidity management at banks, as well as for conducting liquidity stress tests.

Do Firms Inappropriately Capitalize Development Costs? Evidence From China
Ji, Kaiying,Xie, Deren,Zheng, Dengjin
An ongoing, unresolved heated debate in accounting practice relates to whether capitalization of development costs should be allowed. This study contributes to the debate by developing a new approach to examining the implementation of development costs capitalization in the second largest economy â€" China â€' and provides some evidence as to whether firms inappropriately capitalize development costs. We argue that capitalization of development costs should be positively associated with R&D outputs, and absence of such association indicates inappropriate implementation of capitalization. Using data from listed firms in China over the period 2007â€'2017, we find that capitalization of development costs is, in general, positively associated with R&D outputs, and such association is stronger for State-owned Enterprises and qualified High- and New-technology Enterprises. This association can be strengthened by more restrictive scrutiny; however, it can also be weakened when firms have higher agency costs and financial constraints. Furthermore, results suggest that capitalization of development costs is significantly and positively associated with current and future firm value, and the correlation is strengthening over time. This study finds that, in general, the capitalization of (higher) development costs does have positive association with higher R&D outputs, however, inappropriate implementation is possible under some settings. It sheds some light on the ongoing debate between IFRS and US GAAP surrounding expensing versus capitalizing development costs, and has implications for practitioners, auditors, and investors with potential risks involved in the implicit R&D accounting choice.

External Threats, Political Turnover and Fiscal Capacity
Hector Galindo-Silva

In most of the recent literature on state capacity, the significance of wars in state-building assumes that threats from foreign countries generate common interests among domestic groups, leading to larger investments in state capacity. However, many countries that have suffered external conflicts don't experience increased unity. Instead, they face factional politics that often lead to destructive civil wars. This paper develops a theory of the impact of interstate conflicts on fiscal capacity in which fighting an external threat is not always a common-interest public good, and in which interstate conflicts can lead to civil wars. The theory identifies conditions under which an increased risk of external conflict decreases the chance of civil war, which in turn results in a government with a longer political life and with more incentives to invest in fiscal capacity. These conditions depend on the cohesiveness of institutions, but in a non-trivial and novel way: a higher risk of an external conflict that results in lower political turnover, but that also makes a foreign invasion more likely, contributes to state-building only if institutions are sufficiently incohesive.

Financial Risk and Performance of Small and Medium Enterprises in Nigeria
Offiong, Amenawo,Udoka, Chris O.,Bassey, James Godwin
Small and medium enterprises (SMEs) are imperative for the growth of a striving economy because they cater for a huge level of manpower and vast resources. Therefore, it is essential that their stability and performance should be ensured in order to pro- mote the economic growth of Nigeria. SMEs are pronged to unsecured financial risk, which can lead to the collapse of the enterprises. Various studies have been done on the small and medium enterprises’ contribution to the Nigerian economic growth, but only few have addressed how financial risks affect it. This study aims to investigate how financial risk affects SMEs` performance. In other to achieve this exploratory research design was used and data were sourced from Central Bank of Nigeria (CBN) statistical bulletin from 1986 to 2017. The study uses auto-regressive distributed lag (ARDL) techniques as the tool of analysis. It reveals a negative and insignificant relationship between financial risk and SMEs` performance in Nigeria in the long run. However, exchange rate risk, liquidity risk, interest rate risk and inflation risk have a significant, but negative impact on small and medium enterprises in the short run, as well as the long run. Financial risk adversely affects the performance of Nigerian SMEs and, there- fore, should be controlled to enhance their performance.

Forecasting Interest Rates Through Vasicek and CIR Models: A Partitioning Approach
Orlando, Giuseppe,Bufalo, Michele,Mininni, Rosa Maria
The aim of this paper is to propose a new methodology that allows forecasting, through Vasicek and CIR models, of future expected interest rates based on rolling windows from observed financial market data. The novelty, apart from the use of those models not for pricing but for forecasting the expected rates at a given maturity, consists in an appropriate partitioning of the data sample. This allows capturing all the statistically significant time changes in volatility of interest rates, thus giving an account of jumps in market dynamics. The performance of the new approach is carried out for different term structures and is tested for both models. It is shown how the proposed methodology overcomes both the usual challenges (e.g. simulating regime switching, volatility clustering, skewed tails, etc.) as well as the new ones added by the current market environment characterized by low to negative interest rates.

Funding Decision in Online Marketplace Lending
Ip, Chris K.C.,Lam, FY Eric
A recent HKMA survey shows that about half of the upcoming virtual banks in Hong Kong are keen on implementing digital marketplace platforms in their business. To gain some insights from overseas experience, this study analyzes more than 28 million recent loan listings on LendingClub, one of the world’s largest online marketplace lending platform. Using tree-based machine learning, we develop robust predictive representations of funding decision in this Fintech peer-to-peer lending platform. We find that a borrower's employment length is the main factor in the preference of lenders making funding decision. Requested amount and the existing leverage of a borrower are secondary in lenders' preference. The credit pricing charged on a funded listing fully depends on the loan grade assigned by LendingClub. Monetary policy seems to have little impact on funding decision in this platform.

Has Financial Reporting Quality Converged Under IFRS? International Differences in Conditional Conservatism
Jarva, Henry,Lodh, Suman,Nandy, Monomita,Ojala, Hannu
This paper examines whether financial reporting quality has converged under IFRS. Our sample includes firms that report under mandatory IFRS from 51 countries over the period 2005-2016. We hypothesize and find that financial reporting quality, as measured by conditional conservatism, is better in countries with better institutional quality. We are unable to find evidence that the reporting differences have diminished over time. Thus, our findings suggest that the implementation of IFRS remain predictably uneven. These findings have implications for investors, standard-setting bodies, and corporate governance.

Hierarchical Risk Parity: Accounting for Tail Dependencies in Multi-Asset Multi-Factor Allocations
Lohre, Harald,Rother, Carsten,Schäfer, Kilian Axel
We investigate portfolio diversification strategies based on hierarchical clustering. These hierarchical risk parity strategies use graph theory and unsupervised machine learning to build diversified portfolios by acknowledging the hierarchical structure of the investment universe. In this chapter, we consider two dissimilarity measures for clustering a multi-asset multi-factor universe. While the Pearson correlation coefficient is a popular choice, we are especially interested in a measure based on the lower tail dependence coefficient. Such innovation is expected to achieve better tail risk management in the context of allocating to skewed style factor strategies. Indeed, the corresponding hierarchical risk parity strategies seem to have been navigating the associated downside risk better, yet come at the cost of high turnover. A comparison based on block-bootstrapping evidences alternative risk parity strategies along economic factors to be on par in terms of downside risk with those based on statistical clusters.

How Costly to Sell a Company? A Structural Analysis of Takeover Auctions
Kim, Dong-Hyuk,Zheng, Ying
To explain why sellers in takeover auctions limit bidders entry, we structurally measure economic costs incurred by the seller for inviting an additional bidder. Our auction model allows bidders to discount their synergy values when rivals obtain the target companys confidential information, which induces the information cost. We identify the model primitives with unobserved heterogeneity, as confidential information is latent. From a sample of U.S. M&As, we find that the unobserved heterogeneity is critical, bidders lower values by 11.9% for each rival, and the information (operation) cost amounts to 1.3% (4.1%) of the equilibrium deal value for a representative target.

Impact of Electricity Consumption, Financial Development, Trade Openness on CO2 Emissions: Evidence from Nigeria
Tawiah, Vincent
This paper has explored the role of electricity consumption financial development and trade openness on the CO2 emissions. The study utilizes annual data from 1972 to 2014 and employs various robust econometric techniques. Our analysis reveals that there is no long-term relationship financial development, trade openness and CO2 emission. However, the short-run analysis indicates significant relationship among the variables. The results also reveal that the bidirectional relationship between electricity consumption and CO2 emissions, and a unidirectional causality from financial development to CO2 emissions. Our results imply that policies that will promote renewable energy consumption and financial development can be pursued concurrently.

Implementing a Systematic Long-only Momentum Strategy: Evidence From India
Raju, Rajan,Chandrasekaran, Abhijit
We show that a monthly-rebalanced, long-only portfolio of top-decile stocks selected from the NIFTY100 using `off-the-shelf' momentum criteria significantly outperforms the NIFTY100 Index - both in terms of absolute returns (by 10.70% pa) and risk adjusted returns, with a mean turnover of 32.10% per month. We show that momentum persists in the near term but dissipates over time. We demonstrate that our long-only approach has a significant tilt to the momentum factor. We also show that time in the market rather than timing the market is important for momentum investing. The strategy has higher volatility and the occasional momentum crash. The strategy's out performance survives real-world implementation given the rise of discount brokers in India. In the absence of cheap ETFs to get exposure to momentum, the systematic long-only strategy from the most liquid part of the market using `off-the-shelf' criteria provides a practical, executable investment methodology that exposes an investor to momentum in the Indian market.

Indian Stock Market Reaction to the Quarterly Earnings Information
Hawaldar, Iqbal Thonse ,Mallikarjunappa, T.
This paper examines stock market reaction to the earnings announcements by taking December 2001 quarter earnings announcement as an event. The study is based on 152 companies having minimum 20 percent foreign holdings. The companies are divided into, good news, bad news and overall portfolios. We have used event study methodology, t test, Runs test, sign test, raw returns and log returns. The behaviour of AARs and CAARs are examined for 30 days before and 31 days after the announcement of quarterly earnings. The results of the study revealed that Indian stock market reaction to the quarterly earnings announcements is slow and stock market is not semi strong form of efficient. The quarterly earnings announcement information can be used by the investors to earn abnormal profits in the Indian stock market.

Indoor Positioning Using WCL Based on RSSI
Sharma, Parul,Suthar, Dr. Anilkumar
This paper presents the use of RSSI (Received Signal Strength Indicator) in terms of Wi-Fi Signals for calculating the current position of the user. For Outdoor Navigation satellite signals are the best option but those are not sufficient for Indoor Positioning. There has been associate degree upward trend within the demand of indoor positioning systems victimization Bluetooth low energy (BLE), Wi-Fi and visual light weight communication. There are numerous centroid algorithms used to calculate the current position but the one which we are using over here is Weighted Centroid Localization (WCL) algorithm using RSSI values. This WCL is simulated and the results are calculated in terms of error rate.

Informational Efficiency and Price Reaction Within In-Play Prediction Markets
Angelini, Giovanni,De Angelis, Luca,Singleton, Carl
We propose a practical framework to detect mispricing, test informational efficiency and evaluate the behavioural biases within high-frequency prediction markets, especially in how prices react to news. We show this using betting exchange data for association football, exploiting the moment when the first goal is scored in a match as major news that breaks cleanly. There is mispricing in these markets and inefficiency, explained by reverse favourite-longshot bias. This is systematically absorbed or amplified after a goal, depending on the match conditions. We find that prices respond correctly when news is expected but overreact when it is a surprise.

Infrastructure Disparities in Northern Malaysia
Mukaramah Harun

This study examines the disparities of infrastructure in four states in Northern Peninsular Malaysia. This study used a primer data which is collected by using a face to face interview with a structure questionnaire on head of household at Kedah, Perlis, Penang and Perak. The list of respondents is provided by the Department of Statistics of Malaysia (DOS). The Department of Statistics of Malaysia (DOS) uses the population observation in 2010 to determine the respondents is provided by the Department of Statistics of Malaysia (DOS).

Interdependencies in the Euro Area Derivatives Clearing Network: A Multi-Layer Network Approach
Rosati, Simonetta,Vacirca, Francesco
The global nature of derivatives markets, and the presence of large key financial institutions trading in several markets across the globe, call for taking a “macro” view on the interconnections arising in the clearing network. Based on the analysis of derivatives transactions data reported under the EMIR Regulation we reconstruct the network of relationships in the centrally-cleared derivatives market and analyse its topology providing insight into its structural features. The centrally-cleared derivatives network is modelled in the form of a multiplex network where each layer is represented by a derivatives asset class market. In turn, each node represents a single counterparty in that market. On the basis of different centrality measures applied to the collapsed aggregate and to the multiplex network, the critical participants of the euro area centrally-cleared derivatives market are identified and their level of interconnectedness analysed. This paper provides insight on how the collected data pursuant to the EMIR regulation can be used to shed light on the complex network of interrelations underlying the financial markets. It provides indications on structural features of the euro area centrally-cleared derivatives market and discusses policy relevant implications and future applications.

Measuring the Procyclicality of Impairment Accounting Regimes: A Comparison between IFRS 9 and Us Gaap
Buesa, Alejandro,Población García, Francisco Javier,Tarancón, Javier
The purpose of this paper is to compare the cyclical behavior of various credit impairment accounting regimes, namely IAS 39, IFRS 9 and US GAAP. We model the impact of credit impairments on the Profit and Loss (P&L) account under all three regimes. Our results suggest that although IFRS 9 is less procyclical than the previous regulation (IAS 39), it is more procyclical than US GAAP because it merely requests to provision the expected loss of one year under Stage 1 (initial category). Instead, since US GAAP prescribes that lifetime expected losses are fully provisioned at inception, the amount of new loans originated is negatively correlated with realized losses. This leads to relatively higher (lower) provisions during the upswing (downswing) phase of the financial cycle. Nevertheless, the lower procyclicality of US GAAP seems to come at cost of a large increase in provisions.

Microfoundations of Discounting
Alexander T. I. Adamou,Yonatan Berman,Diomides P. Mavroyiannis,Ole B. Peters

An important question in economics is how people choose between different payments in the future. The classical normative model predicts that a decision maker discounts a later payment relative to an earlier one by an exponential function of the time between them. Descriptive models use non-exponential functions to fit observed behavioral phenomena, such as preference reversal. Here we propose a model of discounting, consistent with standard axioms of choice, in which decision makers maximize the growth rate of their wealth. Four specifications of the model produce four forms of discounting -- no discounting, exponential, hyperbolic, and a hybrid of exponential and hyperbolic -- two of which predict preference reversal. Our model requires no assumption of behavioral bias or payment risk.

Mining the Automotive Industry: A Network Analysis of Corporate Positioning and Technological Trends
Niklas Stoehr,Fabian Braesemann,Michael Frommelt,Shi Zhou

The digital transformation is driving revolutionary innovations and new market entrants threaten established sectors of the economy such as the automotive industry. Following the need for monitoring shifting industries, we present a network-centred analysis of car manufacturer web pages. Solely exploiting publicly-available information, we construct large networks from web pages and hyperlinks. The network properties disclose the internal corporate positioning of the three largest automotive manufacturers, Toyota, Volkswagen and Hyundai with respect to innovative trends and their international outlook. We tag web pages concerned with topics like e-mobility and environment or autonomous driving, and investigate their relevance in the network. Sentiment analysis on individual web pages uncovers a relationship between page linking and use of positive language, particularly with respect to innovative trends. Web pages of the same country domain form clusters of different size in the network that reveal strong correlations with sales market orientation. Our approach maintains the web content's hierarchical structure imposed by the web page networks. It, thus, presents a method to reveal hierarchical structures of unstructured text content obtained from web scraping. It is highly transparent, reproducible and data driven, and could be used to gain complementary insights into innovative strategies of firms and competitive landscapes, which would not be detectable by the analysis of web content alone.

Moral Hazard with Excess Returns
Blonski, Matthias,Lilienfeld-Toal, Ulf von
We consider a public firm characterized by a moral hazard problem. A distinguished player is a CEO or activist shareholder who (i) is unrestricted to trade shares and (ii) has discretion to increase the value of this firm by exerting costly effort. Von Lilienfeld-Toal and Ru ̈nzi (2014) investigate and confirm the empirical relevance of both these properties. This article shows that a distinguished player cannot be ”priced in” correctly. In particular, such a firm is traded at a discount below its equilibrium value in a market equilibrium. Buyers can systematically earn excess returns on their investment. This prediction is indeed consistent with substantial positive abnormal returns for distinguished player firms within the S&P500 and S&P1500 sample reported in von Lilienfeld-Toal and Runzi (2014).

Much Ado About Nothing? New Evidence on the Effects of Payday Lending on Military Members
Skimmyhorn, Bill,Carter, Susan
We evaluate the effect that payday loan access has on credit and labor market outcomes of individuals in the U.S. Army. Using the conditional random assignment of service members to different locations, we employ three identification strategies: cross-sectional variation in state policies, within-term variation in payday lending access, and a difference in- difference analysis using the national Military Lending Act. We find few adverse effects of payday loan access on service members when using any of these methods, even when we examine dozens of subsamples that explore potential differential treatment effects.

Mutual Fund Flows and Fund's Strategic Behavior When Investors Are Inattentive
Javadekar, Apoorva
The paper builds on a simple yet novel idea that the way investors react to the recent mutual fund performance depends largely upon the long-term historical performance of that fund. In particular, I find that investors react more actively to the fund's recent performance in case of the funds with good performance history. I show that these effects are strongest for funds which are likely to attract attentive investors such as funds having more visibility or funds with high entry loads. Next, I show that investors who are less responsive to the fund performance are also less responsive to the changes in fund fees which suggests that investor inattention rather than any other rational decision making process that explains the sluggish capital flows. I build a model which shows how the concentration of attentive investors within fund rise with the historical performance which feeds into more reactive capital flows. I provide evidence that mutual funds are aware of the varying degree of investor responsiveness and they adjust their pricing and portfolio risk to maximize the revenue.

Nonparametric Hedging of Volatility Swaps with Variance Swaps in Stochastic Volatility Models
Frido Rolloos

In this paper the zero vanna implied volatility approximation for the price of freshly minted volatility swaps is generalised to seasoned volatility swaps. We also derive how volatility swaps can be hedged using only variance swaps without making use of a specific stochastic volatility model. As dynamically trading variance swaps is in general cheaper and operationally less cumbersome compared to dynamically rebalancing a continuous strip of options, our result makes the hedging of volatility swaps both practically feasible and robust. Within the class of stochastic volatility models our pricing and hedging results are model-independent and can be implemented at almost no computational cost.

Optimal Insurance for Prudent Risk Averters and Risk Lovers
André, Eric,Le Courtois, Olivier,Su, Xiaoshan
This paper examines the structure of optimal insurance contracts for a broad class of insureds that includes both risk averters and risk lovers and by assuming that the insureds are prudent. We specify the difference in optimal contract form between risk averters and risk lovers. Treating these decision-makers as a unique group, we show that the optimal insurance form is dual limited stop-loss insurance with an upper limit, which implies that including risk lovers in the group of decision-makers changes the contract in the small loss part. We also consider the situation of contracts with a concave payoff, where the optimal contract form becomes limited change-loss insurance or limited dual change-loss insurance depending on the coefficient of variation of the retained loss. Finally, we derive the form of optimal contracts in the presence of a background risk.

Peer Effects in Stock Market Participation: Evidence from Immigration
Girshina, Anastasia,Mathä, Thomas Y.,Ziegelmeyer, Michael
This paper studies how peers’ financial behaviour affects individuals’ own investment choices. To identify the peer effect, we exploit the unique composition of the Luxembourg population and use the differences in stock market participation across various immigrant groups to study how they affect stock market participation of natives. We solve the reflection problem by instrumenting immigrants’ stock market participation with lagged participation rates in their countries of birth. We separate the peer effect from the contextual and correlated effects by controlling for neighbourhood and individual characteristics. We find that stock market participation of immigrant peers has sizeable effects on that of natives. We also provide evidence that social learning is one of the channels through which the peer effect is transmitted. However, social learning alone does not account for the entire effect and we conclude that social utility might also play an important role in peer effects transmission.

Pursuing More Sustainable Energy Consumption by Analyzing Sectoral Direct and Indirect Energy Use in Malaysia: An Input-Output Analysis
Mukaramah Harun

Malaysia is experiencing ever increasing domestic energy consumption. This study is an attempt at analyzing the changes in sectoral energy intensities in Malaysia for the period 1995 to 2011. The study quantifies the sectoral total, direct, and indirect energy intensities to track the sectors that are responsible for the increasing energy consumption. The energy input-output model which is a frontier method for examining resource embodiments in goods and services on a sectoral scale that is popular among scholars has been applied in this study.

Sabrina: Modeling and Visualization of Economy Data with Incremental Domain Knowledge
Alessio Arleo,Christos Tsigkanos,Chao Jia,Roger A. Leite,Ilir Murturi,Manfred Klaffenboeck,Schahram Dustdar,Michael Wimmer,Silvia Miksch,Johannes Sorger

Investment planning requires knowledge of the financial landscape on a large scale, both in terms of geo-spatial and industry sector distribution. There is plenty of data available, but it is scattered across heterogeneous sources (newspapers, open data, etc.), which makes it difficult for financial analysts to understand the big picture. In this paper, we present Sabrina, a financial data analysis and visualization approach that incorporates a pipeline for the generation of firm-to-firm financial transaction networks. The pipeline is capable of fusing the ground truth on individual firms in a region with (incremental) domain knowledge on general macroscopic aspects of the economy. Sabrina unites these heterogeneous data sources within a uniform visual interface that enables the visual analysis process. In a user study with three domain experts, we illustrate the usefulness of Sabrina, which eases their analysis process.

The Cross-section of Return and Risk Relationship: New Evidences from Portfolio Diversification Strategies
Pugalia, Saharsh,Chandra, Abhijeet
In recent decades, low-risk stocks provide higher returns than riskier stocks. This contradicts a well-established market theory of higher risk-higher return. The distorted relationship between risk and return over the last few years has been attributed to factors such as the risk aversion tendency among investors and the steadily growing practices of index investing by fund managers. Motivated by the emerging theory of upended risk-return relationship, we argue that the positive risk-return relationship hypothesis is true to a certain level of risk, however, beyond that threshold, the relationship between risk and return breaks down and they behave independently. We argue that for lower and moderate levels of risk, the returns are positively correlated and compensate for the incremental risk undertaken by investors, however, when the risks tend to be substantially higher, the return behaves independently irrespective of changing risk levels. Such a situation provides investors and risk managers to observe riskiness in the market very closely to formulate their investment choices. Investors would refrain from taking risky positions when the market seems to be very volatile as this might necessarily provide returns commensurate with the higher risks.

The Informativeness of Estimation Moments
Bo Honore,Thomas Jorgensen,Aureo de Paula

This paper introduces measures for how each moment contributes to the precision of parameter estimates in GMM settings. For example, one of the measures asks what would happen to the variance of the parameter estimates if a particular moment was dropped from the estimation. The measures are all easy to compute. We illustrate the usefulness of the measures through two simple examples as well as an application to a model of joint retirement planning of couples. We estimate the model using the UK-BHPS, and we find evidence of complementarities in leisure. Our sensitivity measures illustrate that the estimate of the complementarity is primarily informed by the distribution of differences in planned retirement dates. The estimated econometric model can be interpreted as a bivariate ordered choice model that allows for simultaneity. This makes the model potentially useful in other applications.

The Performance of Diverse Teams: Evidence from U.S. Mutual Funds
Evans, Richard B.,Prado, Melissa Porras,Rizzo, Antonino Emanuele,Zambrana, Rafael
We use the U.S. mutual fund industry to study the relation between team diversity and performance. Focusing on diversity concerning political ideology, we find that diverse portfolio manager teams outperform homogeneous teams and have a higher active share, and tracking error. These results are robust to controlling for manager and family fixed effects, as well as other dimensions of diversity, manager political connections, and incentives. We also find that political polarization has a strong limiting effect of diversity on performance, consistent with a reversal of the benefits of diversified perspectives when external forces negatively affect team trust and cooperation. In assessing possible mechanisms for the observed out-performance, we find evidence consistent both with improved decision-making due to the increased variety of perspectives, as well as increased monitoring by heterogeneous team members. Lastly, in exploring why diverse teams are not more prevalent in the industry, we find that entrenched managers prefer homogeneous teams and that local labor markets are constrained in their supply of ideologically diverse managers.

Tournament Incentives and Reserve Management
Nart, Ahmet,Lai, Gene C.,Ho, Chia-Ling
This paper examines the relation between tournament incentives and reserve management. We find a positive relation between internal tournament incentives and reserve errors, implying that a larger pay gap as a tournament prize induces vice presidents (VPs) to overestimate loss reserves. In other words, a higher tournament prize is associated with conservative loss reserve management. Unlike the literature, we do not find a positive relation between tournament incentive and profits (risk taking behavior). Taken together, the evidence indicates that VPs focus on strong financial health of the firm instead of its profitability. In addition, we find the impact of internal tournament incentives on the reserve error is more pronounced for larger, financially weak and more geographically focused firms, and is mitigated for the firms with higher percentage of claim loss reserve over total liability and paying relatively higher tax rates. Our results also suggest that SOX mitigates the conservative reserve behavior. Finally, we also find that as board independence enhances, VPs induced by promotion-based tournaments become more likely to have conservative reserve behavior.

Understanding the dual formulation for the hedging of path-dependent options with price impact
Bruno Bouchard,Xiaolu Tan

We consider a general path-dependent version of the hedging problem with price impact of Bouchard et al. (2019), in which a dual formulation for the super-hedging price is obtained by means of PDE arguments, in a Markovian setting and under strong regularity conditions. Using only probabilistic arguments, we prove, in a path-dependent setting and under weak regularity conditions, that any solution to this dual problem actually allows one to construct explicitly a perfect hedging portfolio. From a pure probabilistic point of view, our approach also allows one to exhibit solutions to a specific class of second order forward backward stochastic differential equations, in the sense of Cheridito et al. (2007). Existence of a solution to the dual optimal control problem is also addressed in particular settings. As a by-product of our arguments, we prove a version of It{\^o}'s Lemma for path-dependent functionals that are only C^{0,1} in the sense of Dupire.

Using Unconventional Wisdom to Re-Assess and Rebuild the BRICS
Guillotin, Bertrand
In 2015, Goldman Sachs closed its BRIC (Brazil, Russia, India, China) fund after years of losses and plummeting assets. Emerging markets had, once again, turned into submerging markets. Their dependence on “developed” markets and established institutions had failed them in a post-Global Financial Crisis (GFC) era, anchored in protectionism, risks, volatility, and uncertainty. The once commonly-accepted wisdom that called for US housing prices to always increase was part of the problem and contagion. Rebuilding the BRICS (S for South Africa) using conventional wisdom would probably not work. A new approach is necessary, especially since the last key contributions to show the inadequacy of a conventional wisdom-based strategy in emerging markets are more than ten years old. To help fill this gap, this paper proposes a holistic analytical framework for strategists to re-assess risks and opportunities in the BRICS. We illustrate how five basic assumptions can be proven wrong and lead to the creation of unconventional wisdom that can help derive some strategic insights. We find that rebuilding the BRICS for them to be more resilient is possible, if not vital, for the health of the global economy.

Ways to Reduce Cost of Living: A Case Study among Low Income Household in Kubang Pasu, Kedah, Malaysia
Mukaramah Harun

This study was conducted to examine and understand the spending behavior of low income households (B40), namely households with income of RM3800 and below. The study focused on the area Kubang Pasu District, Kedah.

What is the Value of an Innovation? Theory and Evidence on the Stock Market's Reaction to Innovation Announcements
Chemmanur, Thomas J.,Li, Dongmei,Tseng, Kevin,Wang, Yu (Yvonne)
We analyze, theoretically and empirically, the effect of investor attention on the stock market reaction to innovation announcements and suggest how market-based measures of the economic value of patents can be enhanced. We develop a dynamic model with limited investor attention to show that, following the immediate market reaction to innovation announcements, there will also be a stock return drift: the magnitude of the announcement effect will be increasing while that of the post-announcement drift will be decreasing in investor attention. We test our model predictions using two different datasets: a matched sample of pharmaceutical industry patent grant and subsequent FDA drug approval announcements; and a general USPTO sample of patent grant announcements. We use the media coverage of innovation announcements as a proxy for the investor attention paid to them. Consistent with model predictions, we find the following. First, in our matched patent grant and drug approval analysis, the announcement effects of patent grant announcements are smaller than those of FDA drug approval announcements; the subsequent stock return drifts, however, are larger for patent grant announcements. Second, the announcement effect of patent grant announcements is increasing in investor attention while the subsequent stock return drift is decreasing in investor attention. Third, the stock-return drift following patent grant announcements has predictive power for the economic value of patents, over and above the information contained in the announcement effect. Finally, we show that a long-short trading strategy based on investor attention is profitable over the one-month period after patent grant announcements.

Winners and Losers from Sovereign Debt Inflows: Evidence from the Stock Market
Broner, Fernando,Martin, Alberto,Pandolfi, Lorenzo,Williams, Tomas
This paper analyzes the effects on firms of sovereign debt inflows in emerging countries. To deal with the endogeneity between capital inflows and economic activity, we focus on capital inflows driven by countries’ inclusions into well-known local currency sovereign debt market indexes. These events convey little information about the future economic prospects of countries but induce large capital flows from institutional investors tracking the indexes. We show that inclusion-driven flows significantly reduce government bond yields and appreciate the domestic currency. In turn, these flows have heterogenous impact on firms’ stock market returns. Government related firms, financial firms and firms with larger financial constraints experience positive abnormal returns following the announcement of these events. Instead, companies operating in export-intensive sectors have negative abnormal returns. Our findings shed novel light on the channels through which capital inflows to sovereign debt markets affect firms in the economy.