Research articles for the 2020-01-24

Asymmetric Volatility in Commodity Markets
Chen, Yu-Fu,Mu, Xiaoyi
The paper studies the return-volatility relationship in a range of commodities. We develop a commodity price model and show that the volatility of price changes can be positively or negatively related to demand shocks. An “inverse leverage effect” â€" the volatility is higher following positive price shocks â€" is found in more than half of the daily spot prices. The effect is weaker in 3-month futures market and monthly historical volatility measures. Only crude oil exhibits a “leverage effect” â€" a higher volatility follows a negative shock, and the reason is explored in the context of its special market structure.

Banken im Wandel der Digitalisierung: eine empirische Studie (Digitization in Retail Banks: An Empirical Study)
von Horn, Roland
German Abstract: Die vorliegende Studie basiert auf einer Umfrage mit mehr als 100 führenden deutschen und schweizer Banken sowie Unternehmensberatungen. Das heutige Geschäftsmodell der Universalbanken hat ausgedient. Neue Technologien, zunehmende Internetnutzung und das veränderte Kundenverhalten lassen den Bedarf nach neuen Geschäftsfelder entstehen. Die FinTechs sind der Treiber für die Finanzinnovationen. Die Universalbanken arbeiten in verschiedenen Kooperationsformen mit den FinTechs zusammen. Den Banken stehen Hemmnisse bei der Digitalisierung bevor. English Abstract: The purpose of this study is to evaluate the challenges of universal banks in a digital world. The study is based on a survey of more than 100 leading German and Swiss banks and management consultancies. The current business model of universal banks is outdated. New technologies, increasing internet use and changing customer behaviour are leading to new business fields. FinTechs are the driver of financial innovation. The universal banks cooperate with FinTechs in various forms. The banks are facing hurdles in digital transformation process.

Comment Letter In Opposition to the OCC's Proposed 'Valid-When-Made' Rule
Wilmarth, Arthur E.
This comment letter responds to a proposed rule issued by the Office of the Comptroller of the Currency (OCC), which would “codify” an alleged federal common-law “principle” known as “valid-when-made.” The proposed rule would amend two of the OCC’s regulations â€" 12 C.F.R. 7.4001 and 12 C.F.R. 160.110 â€" by providing that “interest on a loan that is permissible” for a national bank or a federal savings association, under 12 U.S.C. 85 or 12 U.S.C. 1463(g)(1), “shall not be affected by the sale, assignment, or other transfer of the loan.” 84 Fed. Reg. 64229, 64230-31 (Nov. 21, 2019). Thus, the OCC’s proposed rule seeks to expand the scope of federal preemption of state usury laws beyond national banks and federal thrifts to reach purchasers, assignees, and transferees of their loans. The comment letter maintains that, for the following three reasons, the proposed rule exceeds the OCC’s authority and is contrary to the public interest: (1) The proposed rule does not comply with the procedural and substantive requirements of 12 U.S.C. 25b, which governs rules and orders issued by the OCC that seek to preempt state consumer financial laws.(2) The proposed rule would unlawfully expand the preemptive scope of 12 U.S.C. 85 and 1463(g)(1) beyond the limits established by Congress, without congressional authorization and in contravention of applicable court decisions. (3) The proposed rule is contrary to the public interest because it would encourage predatory high-cost lending and other abusive practices that would inflict very serious injuries on consumers.The comment letter therefore contends that the OCC should withdraw the proposed rule, and the OCC should not issue any other rule or order that would attempt to expand the preemptive scope of 12 U.S.C. 85 and 1463(g) to reach purchasers, assignees, and transferees of loans made by national banks and federal thrifts.

Financial Restatements, Litigation, and Implied Cost of Equity
Bardos, Katsiaryna,Mishra, Dev R.
We reexamine the effect of financial restatements on the cost of equity vis-a-vis litigation risk. Specifically, we study the effect of litigation on post-restatement financing costs and whether market anticipates litigation before restatement announcement as evident from its effect on financing costs. While we find that the cost of equity increases subsequent to a financial restatement for all restating firms, the increase is substantially greater for firms facing litigation as a result of the restatement. We also find that investors do not adjust for the cost of equity prior to the announcement of a financial restatement for firms facing post-restatement litigation. Overall, our findings suggest that most of the increase in the cost of equity after restatement is concentrated in sued sub-sample and that the cost of equity is an important channel through, which litigation associated with financial restatement is priced. The economic effect of post-restatement litigation is approximately 259 basis points increase in the firm’s cost of equity.

Global Bank Liquidity (Presentation Slides)
Benink, H.A.
This presentation considers the role of liquidity requirements within the Basel Capital Adequacy framework. Problems of measuring liquidity for purposes of prudential regulation are discussed and an alternative approach to liquidity requirements is presented.

Have the Chinese National Oil Companies Paid Too Much in Overseas Asset Acquisition?
Mu, Xiaoyi
This paper provides both a quantitative and qualitative analysis of whether the Chinese oil companies have “overpaid” than international oil companies in overseas asset acquisitions. By controlling oil price and a number of asset- and deal-specific attributes that are known to affect the valuation of oil and gas projects, we find that while the Chinese companies did not overpay than international oil companies for the period of 2001-2008, there is statistically significant evidence that they overpaid during the 2009-2016 period (mainly 2009-2013). The counterfactual analysis indicates that the Chinese companies paid, on average, 64 percent more than what an international oil company would have paid for the same assets during the post-2008 period. Interviews with industry experts and qualitative analysis suggest that the overpayment mainly results from a series of mistakes due to lack of experience and rush for projects in a period of high oil prices rather than concerns about energy security or other political considerations. The results raise concerns over the efficiency and corporate governance of Chinese state-owned companies, pointing to the need for further reforms.

Higher Education: Does Debt Beat Savings?
Stackpole, David
This paper investigates the possible opportunity cost of using standard college savings plans against the advantages of using debt to pay for college. In addition, it presents a practical argument for using debt in place of college savings plans in certain instances.By doing so, investors may not only be able to mitigate the difficulty of saving, but also realize greater financial benefit in the long run.

Innovation, Exploration, and Survival: The Ripple Effects of Customer Fraud
Banerjee, Shantanu,Dasgupta, Sudipto,Shi, Rui
We investigate how suppliers adjust their innovation activities when a customer is revealed involved in corporate fraud. We find that suppliers reduce R&D expenses after financial misconduct of the customer become known and generate fewer patents in comparison to a control group of firms that are not affected in a similar manner. They engage in more (less) explorative (exploitative) innovation and move the direction of innovation away from that of the fraudulent customer. Interestingly, while the survival likelihood of the affected suppliers decreases in the next three years, over a ten-year period, their survival likelihood increases, relative to control firms. Suppliers who are successfully able to implement more explorative innovation increase their survival likelihood, while those that continue to do exploitative innovation are more likely to exit. These results are consistent with the view that adversity encourages risk-taking innovation (Manso, Balsmeier and Fleming (2019)), but also suggest that in the presence of major customers who benefit from dedicated investment, suppliers may not be diversifying their innovation optimally. Consistently, we find that the number of identifiable customers that the affected suppliers sell to increases relative to the control group after fraud revelation.

Lifting the Banking Veil: Credit Standards’ Harmonization Through Lending Transparency
Kang, Jung Koo,Loumioti, Maria,Wittenberg Moerman, Regina
We explore whether the transparency in banks’ lending activities enhances the harmonization of credit terms that a bank offers across its different geographic regions. We take advantage of a novel loan-level reporting initiative by the European Central Bank, which requires repo borrowing banks that pledge their asset-backed securities as collateral to disclose granular information on loan characteristics and performance. We find that loans originated under the transparency regime share more similar interest rate, loan-to-collateral-value ratio and maturity compared to same-purpose loans issued by the same bank in different regions. Underperforming regional branches and those with less easily accessible peer-branches experience greater convergence in their credit terms, suggesting that transparency facilitates learning across a bank’s different geographic regions. Additionally, banks that face stronger regulatory scrutiny are more likely to alleviate credit term disparities under the transparency regime. Overall, our findings suggest that transparency enhances the within-bank harmonization of lending practices.

Measuring Regulatory Complexity
Colliard, Jean-Edouard,Georg, Co-Pierre
Despite a heated debate on the perceived increasing complexity of financial regulation, there is no available measure of regulatory complexity other than the mere length of regulatory documents. To fill this gap, we propose to apply simple measures from the computer science literature by treating regulation like an algorithm - a fixed set of rules that determine how an input (e.g., a bank balance sheet) leads to an output (a regulatory decision). We apply our measures to the regulation of a bank in a theoretical model, to an algorithm computing capital requirements based on Basel I, and to actual regulatory texts. Our measures capture dimensions of complexity beyond the mere length of a regulation. In particular, shorter regulations are not necessarily less complex, as they can also use more "high-level" language and concepts. Finally, we propose an experimental protocol to validate measures of regulatory complexity.

Mr. Market’s Mind: Finance’s Hard Problem
Schotanus, Patrick
The market as a mind is the implicit premise in any discussion on whether the market is rational or not. Still, its implications, in terms of ontology and epistemology, are hardly understood. In particular, this paper defines the market’s version of the mind-body problem and labels it as finance’s “hard” problem. Its denial by modern finance causes this dominant paradigm to fail in dealing with reality in general and to produce incomplete investment knowledge in particular. Finally, as part of facing up to this problem, this paper offers a glimpse at a practical approach which may enrich investment research.

On the Corporate Governance (CG) of Model Validation (Mv): A Micro-CG Illustration of ROEg, Put-Call Parity (Pcp), and Yule-Simpson Paradox (Ysp) As Archetypal Models of Financial Risk Evaluation and Valuation Subject to Mv
Wurts, Henry
This paper builds on Wurts (2018a,b) in a variety of ways. It (1) introduces a Return-on-Equity variable g (ROEg) equation as an additional archetypal model, as an opinion-based analytical model, (2) introduces two additional bright-line tests (BLT) (to address Yule-Simpson Paradox (YSP) and ROEg as archetypes for empirical and opinion-based models, respectively, to complement the BLT for the Put-Call Parity (PCP) as an archetypal analytical model), (3) adds additional attention-direction tools (e.g., the Five Demonstrations (5D) and the Defining and Simplifying Story and Model (DSSM) frame, both to help resolve the broad validation issue) and a host of named analogies that can be applied more broadly to help identify biased persuasion within the rhetoric of models, (4) elaborates more on (4a) corporate governance (CG) issues regarding model validation (MV), (4b) requirements for theories of model validation (TMV), (4c) the archetypal CGMV story, and (4d) the NEP-WED frame. Specifically, (5) a DSSM frame is introduced to provide language to help understand how a model can fail in perhaps an abstract sense; namely, because it cannot answer the question of interest (QOI) provided by the Defining Story of the issue of concern (IOC), with perhaps (6) a cascade of deterioration with respect to the power of an argument as (6a) the Simplifying Story the model is intended to address has lost too much information (i.e., become too “degree negative”), (6b) leading to a Simplifying Model that cannot really answer the QOI (i.e., the Minimal Model Story is insufficient to even answer the IOC presented by the Simplifying Story), (6c) sometimes leading questionable modelers to add information that did not exist (i.e., hence, “degree positive”) in either the Defining or Simplifying Story, creating an accompanying Maximal Model Story laden with unsupportable “degree positive” assumptions that influence conclusions beyond sensible inference. Together, (7) the 5D and DSSM tools provide frames to both (7a) proactively identify inference concerns to avoid having a model blow-up a company and (7b) reactively identify, as forensic analysis, specifically how a model blew-up a company. Together, they address two directions of a common question: what question does the model actually answer, regardless of what advocates claim it can answer and is answering? Key conclusions are justified: (1) the ROEg model helps illustrate how accounting reporting measurements may be inadequate for measuring economic risks of corporate interest, (2) the PCP model helps identify that arbitrage forces may not be strong enough to justify the use of arbitrage-free pricing models in a corporate finance context, and (3) the YSP model illustrates that regression equation coefficient estimates are often inadequate as isolated performance measures of factor sensitivities. And yet, such conclusions can be generalized toward more-complex models.

Passive Funds Actively Affect Prices: Evidence from the Largest ETF Markets
Todorov, Karamfil
This paper studies the size and source of exchange-traded funds’ (ETFs) price impact in the most ETF-dominated asset classes: volatility (VIX) and commodities. I show that the introduction of ETFs increased futures prices and decreased realized returns. To identify ETF-induced price distortions, I propose a model-independent approach to replicate the value of a VIX futures contract. This allows me to isolate a non-fundamental component in VIX futures prices, of 18.5% per year, that is strongly related to the rebalancing of ETFs. To understand the source of that component, I decompose trading demand from ETFs into three main parts: leverage rebalancing, calendar rebalancing, and flow rebalancing. Leverage rebalancing has the largest effects. It amplifies price changes and introduces unhedgeable risks for ETF counterparties. Surprisingly, providing liquidity to leveraged ETFs turns out to be a bet on variance, even in a market with a zero net share of ETFs. Trading against leveragerebalancing delivers large abnormal returns and Sharpe ratios above two across markets.

Real Effects of Public Country-by-Country Reporting and the Firm Structure of European Banks
Eberhartinger, Eva,Speitmann, Raffael,Sureth-Sloane, Caren
European regulation mandates public country-by-country reporting for banks and is expected to increase reputational costs in case of tax haven activities. We test whether the availability of additional public information on the locations of banks' subsidiaries reduces their tax haven presence. In a preliminary difference-in-difference analysis we find that indeed, tax haven presence in “Dot-Havens” has declined significantly after the introduction of mandatory public country-by-country reporting for European banks, as compared to the insurance industry which is not subject to this regulation.

Systemic Risk in Networks with a Central Node
Amini, Hamed,Filipović, Damir,Minca, Andreea
We examine the effects on a financial network of clearing all contracts though a central node (CN) thereby transforming the original network into a star-shaped one. The CN is capitalized with external equity and a guaranty fund. We introduce a structural systemic risk measure that captures the shortfall of end users. We show that it is possible to simultaneously improve the expected surplus of the banks and the CN as well as decrease the shortfall of end users. We determine the CN's equity and guaranty fund policies as a Nash bargaining solution. We illustrate our findings on simulated Credit Default Swap networks compatible with aggregate market data.