Research articles for the 2020-01-30

Automatic financial feature construction based on neural network
Jie Fang,Jianwu Lin,Yong Jiang,Shutao Xia

In automatic financial feature construction task, the state of the art technic leverages reverse polish expression to represent the features, then use genetic programming (GP) to conduct its evolution process. In this paper, we propose a new framework based on neural network, alpha discovery neural network (ADNN). In this work, we made several contributions. Firstly, in this task, we make full use of neural network's overwhelming advantage in feature extraction to construct highly informative features. Secondly, we use domain knowledge to design the object function, batch size, and sampling rules. Thirdly, we use pre-training to replace the GP's evolution process. According to neural network's universal approximation theorem, pre-training can conduct a more effective and explainable evolution process. Experiment shows that ADNN can remarkably produce more diversified and higher informative features than GP. Besides, ADNN can serve as a data augmentation algorithm. It further improves the the performance of financial features constructed by GP.

Beliefs and Behavioral Biases
Andersen, Steffen,Hanspal, Tobin,Martinez-Correa, Jimmy,Nielsen, Kasper Meisner
This study examines whether heterogeneous beliefs contribute to the incidence of the disposition effect. We show theoretically that optimistic investors are more likely to exhibit the disposition effect. We measure optimism using elicited beliefs from incentivized experiments and surveys and link these measures to investment decisions using administrative register data. We find that optimistic beliefs lead to both a higher allocation of wealth to risky assets and a higher incidence of the disposition effect. Individuals form optimistic beliefs from positive return experience consistent with reinforcement learning. We conclude that individuals’ beliefs help explain heterogeneity in behavioral biases in financial decisions.

CEO Turnover and Accounting Earnings: The Role of Earnings Persistence
Suk, Inho,, Seungwon,Kross, William
Although earnings persistence should have a nontrivial impact on CEO turnover decisions, prior studies have paid little attention to the role of earnings persistence in CEO turnover decisions. This study examines the effect of earnings persistence on the sensitivity (i.e., the negative relation) of CEO turnover to earnings performance. First, we find that the sensitivity of forced CEO turnovers to earnings performance is greater when earnings are more persistent. We also show that among numerous earnings attributes, earnings persistence is the most direct and dominant attribute in explaining CEO turnover-earnings sensitivity. Further, when the effect of earnings persistence on CEO compensation-earnings sensitivity is weak, the effect of earnings persistence on CEO turnover-earnings sensitivity is stronger, suggesting that the executive discipline system substitutes for the compensation system when earnings persistence is neglected by compensation policies. Overall, our findings suggest that earnings persistence plays a crucial role in CEO turnover decisions by elevating the board’s knowledge on the future performance implications of current earnings. Finally, the role of persistence is even more crucial when it is neglected by executive compensation policies.

Can the Balanced Scorecard Help in Designing Conference Calls? The Effect of Balanced Information Composition on the Cost of Capital
Firk, Sebastian,Hennig, Jan,Wolff, Michael
Most recent studies on conference calls focus on the costs for firms that can arise from the calls’ open nature. We study the benefits of conference calls and hypothesize that firms could use the balanced scorecard concept as a framework for presenting the information (i.e., balanced information composition) in conference calls to lower the cost of capital. Our results show a negative association between a more balanced information composition in conference calls and a firm’s cost of capital. Additional tests substantiate that the effect of such a balanced information composition on the cost of capital is driven by a reduction in information asymmetry. Overall, the findings suggest that firms can benefit from the balanced scorecard concept by using it as a framework for preparing their conference calls.

Capital Market Returns to New Product Development Success: Informational Effects on Product Market Advertising
Park, Kyung,Chintagunta, Pradeep K.,Suk, Inho
The authors seek to answer the question: if the capital market reacts with abnormal stock returns to new product development success events, do these returns influence subsequent marketing decisions? Drawing on informational market feedback and managerial learning theories, the authors posit that when firms are uncertain about how responsive the product market will be to their marketing activities, signals received from the capital market help them update their beliefs about the responsiveness. After decomposing the abnormal returns at the new drug approval event into components that can and cannot be predicted by the firm (i.e., predicted and unpredicted abnormal returns), the authors find that the post-approval advertising budget is larger when unpredicted abnormal approval returns are higher. Further, this tendency is more pronounced for detailing spending than for direct-to-consumer (DTC) advertising. Consistent with these higher budgets, the authors find that post-launch advertising effectiveness is better as unpredicted abnormal approval returns are higher, particularly for detailing (versus DTC). Overall, this study suggests that information flows from the capital market’s initial perceptions at new product introduction play an important role in subsequent marketing decisions in the product market.

Concavity, Stochastic Utility, and Risk Aversion
Jarrow, Robert,Li, Siguang
This paper studies the relation between concavity, stochastic or state dependent utility functions, and risk aversion. Using the common definition of risk aversion, but modified for state dependent preferences, we show that concavity does not imply risk aversion. Instead, it implies a weaker version of risk aversion, defined herein, and called risk aversion for independent gambles. Furthermore, to characterize the economic meaning of concavity, we define two new risk aversion notions, called uniform risk aversion and uniform risk aversion for independent gambles, respectively. We show that concavity is equivalent to uniform risk aversion for independent gambles, and that concavity plus some additional conditions are equivalent to uniform risk aversion.

Contract Disclosure, Earnings Management, and External Enforcement
Corona, Carlos,Kim, Tae Wook
We examine the effects of mandating compensation disclosure on executive incentive contracts, earnings management, and shareholders' and social welfare. We develop a moral hazard model with multiple principal-agent pairs facing an external inspector who allocates resources across firms to uncover and penalize earnings management. Contract disclosure confers principals with a first-mover advantage, allowing them to design the contract anticipating the inspector's reaction. However, it may also exacerbate a coordination problem among principals, as they do not consider externalities on other principals caused by the effects of their contract choices on the inspector's scrutiny allocation. We find that, if the internal enforcement intensity (e.g., internal control) is relatively weak, contract disclosure may make contracts more strongly contingent on reported earnings, worsen earnings manipulation, and nevertheless increase social welfare. However, disclosure improves shareholders' welfare only if the scrutiny resources available to the inspector are not strongly constrained.

Corporate Performance in Nigeria: The Effect of Oil Price and Exchange Rate Fluctuations
Omoregie, Osaretin Kayode,Olofin, Sodik
Discussions on the separate effect of oil price and exchange rate fluctuations on economic activity and corporate performance in Nigeria are inconclusive. This study investigates the simultaneous influence of oil price and exchange rate and the impact of the different exchange rate regimes adopted in Nigeria on corporate performance, using the structural vector autoregressive/historical decomposition framework. The literature in these areas is sparse. Result from this study suggests that oil price shocks have negative influence on corporate performance with a very short-term positive influence. Exchange rate shocks have positive impact on corporate performance with an instantaneous negative effect. Also, fixed exchange regimes are associated with a downturn in corporate performance, while flexible regimes are associated with improved corporate performance. This result support diversification and flexible exchange rate policies, while corporate managers should adopt risk-hedging strategies to cushion the adverse combined effect of oil price and exchange rate shocks.

Data-driven covariance estimators for high-dimensional minimum-variance portfolios
Sven Husmann,Antoniya Shivarova,Rick Steinert

The global minimum-variance portfolio is a typical choice for investors because of its simplicity and broad applicability. Although it requires only one input, namely the covariance matrix of asset returns, estimating the optimal solution remains a challenge. In the presence of high-dimensionality in the data, the sample covariance estimator becomes ill-conditioned and leads to suboptimal portfolios out-of-sample. To address this issue, we review recently proposed efficient estimation methods for the covariance matrix and extend the literature by suggesting a multi-fold cross-validation technique for selecting the necessary tuning parameters within each method. Conducting an extensive empirical analysis with four datasets based on the S&P 500, we show that the data-driven choice of specific tuning parameters with the proposed cross-validation improves the out-of-sample performance of the global minimum-variance portfolio. In addition, we identify estimators that are strongly influenced by the choice of the tuning parameter and detect a clear relationship between the selection criterion within the cross-validation and the evaluated performance measure.

Deep combinatorial optimisation for optimal stopping time problems and stochastic impulse control. Application to swing options pricing and fixed transaction costs options hedging
Thomas Deschatre,Joseph Mikael

A new method for stochastic control based on neural networks and using randomisation of discrete random variables is proposed and applied to optimal stopping time problems. Numerical tests are done on the pricing of American and swing options. An extension to impulse control problems is described and applied to options hedging under fixed transaction costs. The proposed algorithms seem to be competitive with the best existing algorithms both in terms of precision and in terms of computation time.

Did Trading Bots Resurrect the CAPM?
Park, Andreas,Wang, Jinhua
We document a significant, up to 10-fold increase in the intra-day correlation of firm-specific and market returns over the last decade. This surge in the intra-day correlation of returns coincided with the advent of electronic, automated trading in U.S. markets. Using changes to the S&P500 index, we establish evidence of a causal relationship. When firms are included in this major index, they enter the radar of high frequency arbitrageurs and market making algorithmic traders. These trading robots, who monitor prices in major securities closely and continuously, increase their quoting activities significantly and cause individual stocks’ returns to align more closely with the market.

Do Commissions Cause Investment Adviser Misconduct?
Patel, Tarun
Sales commissions may present a conflict of interest that allows investment advisers to obtain rents from uninformed clients. Alternatively, commissions might be a contracting solution to motivate information provision. To analyze the relation between commissions and adviser misconduct, I exploit quasi-exogenous changes in individual investment advisers' compensation arrangements caused by mergers between large registered investment advisory firms. The opportunity to earn sales commissions increases the probability that an adviser engages in misconduct, but competition is an important mediator. In regions with greater competition, sales commissions decrease misconduct claims. Increased misconduct from commissions is concentrated among low-experience advisers and male advisers. Damages paid out in claims involving commission-motivated advisers are $25,013 (36%) greater than other claims. The experimental design rules out latent firm and market explanations. Overall, I find that the connection between conflicts of interest and information provision depends on the competitive environment.

ESG Investing: How to Optimize Impact?
Landier, Augustin,Lovo, Stefano
This paper develops a general equilibrium model of a productive economy with negative externalities. Investors are not willing to accept lower returns than their best investment alternatives and entrepreneurs maximize profits. If capital markets are subject to a search friction, an ESG fund can raise assets and improve social welfare despite the selfishness of all agents. The presence of the ESG fund forces companies to partially internalize externalities. We derive the fund's optimal policy in terms of industry allocation and pollution limits imposed to portfolio companies. The fund prioritizes investments in companies where (i) the inefficiency induced by the externality is particularly acute and (ii) the capital search friction is strong. We also show that the ESG fund can take advantage of the supply-chain network: It can amplify its impact by imposing restrictions on the suppliers of the firms where it invests.

Earnings Management upon a Sovereign Downgrade
Lin, Yupeng,Zhang, Bohui,Zhang, Zilong
We examine the effect of sovereign credit rating downgrades on firms’ earnings management. Using the exogenous variation in credit ratings caused by sovereign rating downgrades from 61 countries, we show that firms reduce discretionary accruals after sovereign downgrades and are likely to experience a reversal of earnings subsequent to the accrual reduction. The reduction in discretionary accruals is more significant in countries with higher disclosure requirements. Interestingly, firms increase the impairments of intangible assets after sovereign downgrades. Our study provides new evidence that managers strategically employ big bath accounting in response to the negative shock on sovereign credit ratings.

Economic Policy Uncertainty and Firm Value: The Mediating Role of Intangible Assets and R&D
Borghesi, Richard,Chang, Kiyoung
We explore the mechanisms by which intangible assets and R&D intensity mediate the relationship between global economic policy uncertainty and firm value. We find that firms in high intangible-intensity industries and those engaging in R&D suffer the most from restrictive governance policies when economic instability is high. However, when the economic environment is volatile, these same firms benefit the most from prior investments in corporate social responsibility. Results add nuance to prior literature exploring the CSR and corporate governance strictly during the Great Recession and also shed light on optimal governance and CSR policies in times of global economic policy uncertainty.

Effects of a Long Mandatory Lockup Period on IPOs Underwriting
Bazan, Riccardo
Underwriting is the most common allocation mechanism for IPOs. Despite its diffusion, underwriting suffers from underpricing which is ultimately “money left on the table” that negatively influences the health of a company. For this reason, capital markets have identified some tools to reduce underpricing. The lockup period provision is one of them. Notwithstanding its widespread use during IPOs, lockups are neither regulated nor fixed by any financial authorities. This paper investigates the reasons why financial regulators should make the lockup clause a compulsory requirement for listing and should extend its length further than the current average.

Examining the Relationship among Brand Commitment, Brand Trust, and Brand Citizenship Behavior in the Service Industry (Análisis de la relación entre el compromiso de marca, la confianza en la marca y la ciudadanía corporativa de las marcas en la industria de servicios)
Handayani, Nurina Putri,Herwany, Aldrin
English Abstract: Brands are strategic prerequisites that help organizations to generate more value for customers and sustainable competitive advantage among competitors. Employee behavior is crucial for brand success because the service provided by employees is located in the interface between brand commitment and brand delivery. As a result, an increasing number of banks is encouraging their employees to be more competitive and improve the efficacy and stability of the banking sector. The main objective of this work is to investigate the relationships among brand commitment, brand trust, and brand citizenship behavior in private banks. The data were collected from 249 respondents from private banking companies in Indonesia. Structural equation modelling was used to test research hypotheses, and a highly reliable and valid model was developed. The findings indicate that brand commitment has a positive effect on brand citizenship behavior, while brand trust is not a predictor of brand citizenship behavior. Furthermore, there is a correlation between brand commitment and brand trust. These findings provide useful insight and suggestions for managers in the banking sector.Spanish Abstract: Una marca es un prerrequisito estratégico que ayuda a las organizaciones a generar más valor para sus clientes y una ventaja competitiva sostenible entre sus competidores. El comportamiento de los empleados es crucial para el éxito de la marca porque el servicio que prestan se encuentra en la interfaz entre el compromiso de la marca y el cumplimiento de la misma. Un número creciente de bancos ofrece la oportunidad de alentar a las empresas a ser más competitivas y mejorar la eficacia y la estabilidad de la banca. El objetivo principal de este artículo es estudiar las relaciones entre el compromiso de marca, la confianza en la marca y la ciudadanía corporativa de las marcas en bancos privados. Los datos fueron recolectados de 249 encuestados en compañías de banca privada en Indonesia. Se utilizó el modelado de ecuaciones estructurales para probar la hipótesis de investigación y se desarrolló un modelo con alta confiabilidad y validez. Los resultados indican que el compromiso de la marca tiene un efecto positivo en la ciudadanía corporativa de la marca, mientras que la confianza en la marca no es un predictor de dicha ciudadanía. Además, existe una correlación entre el compromiso de la marca y la confianza en la marca. Estos hallazgos proporcionan ideas y sugerencias útiles para la gestión corporativa en el sector bancario.

Formal versus Informal Mortgage Debt and Stock Market Participation
Yang, Jie,Fabozzi, Frank J.,Jiang, Danling,Xiao, Keli
We study whether formal mortgage loans obtained from licensed financial institutions and informal mortgage obtained from private lending have differing impacts on stock ownership. Using the China Household Finance Survey data, we show that the two have opposite effects on stock investing. Formal mortgage debt is positively, while informal mortgage debt is negatively, associated with a household’s likelihood and degree of stock market participation. Further tests based on instrumental variables suggest a causal impact of mortgage debt on stock investing, with the role of formal mortgage debt pronounced in urban areas and that of informal mortgage debt visible in rural areas.

How Safe are European Safe Bonds? An Analysis from the Perspective of Modern Portfolio Credit Risk Models
Rüdiger Frey,Kevin Kurt,Camilla Damian

Several proposals for the reform of the euro area advocate the creation of a market in synthetic securities backed by portfolios of sovereign bonds. Most debated are the so-called European Safe Bonds or ESBies proposed by (Brunnermeier et al. 2017). This paper provides a comprehensive quantitative analysis of such products. A key component of our contribution is a novel dynamic credit risk model which captures salient features of euro area sovereign CDS spreads and enables tractable modelling of default dependence amongst euro members. After successful calibration of our model to CDS spreads, we perform a thorough analysis of ESBies. We provide model-independent price bounds; we consider the expected loss as a function of model parameters and attachment points; we study the volatility of the credit spread of ESBies; and we discuss several approaches to assess the market risk of ESBies. Our analysis provides a fairly comprehensive picture of the risks associated with ESBies.

How are Veterans Faring Financially? Updates and New Evidence from a National Survey
Mottola, Gary R.,Skimmyhorn, Bill
This research provides updated and new evidence on the financial well-being of military veterans. We leverage data from two waves of the FINRA Investor Education Foundation’s National Financial Capability Study (NFCS) to examine how veterans are faring over time, relative to comparable civilians, and among different demographic subgroups. Overall, veterans in 2018 are faring better than those in 2015 in a number of areas. They have less difficulty covering expenses and bills, lower likelihoods of experiencing an income drop, and higher likelihoods of having emergency funds and retirement plans in addition to an employer plan. Veterans in 2018 are, however, more likely to report problematic credit card behaviors. Relative to non-veterans, veterans continue to fare better in many areas. They report higher financial well-being, lower levels of financial anxiety, and a higher likelihood of having a will. They are also more likely to participate in the gig economy. Veterans who are female; who are younger; who are married, divorced or separated; or who have financial dependents are faring worse than their veteran peers. Further, black veterans are faring somewhat better than white veterans, while those identifying as an “Other” race/ethnicity are faring worse.

Industrial Policy and Asset Prices: Stock Market Reactions to Made In China 2025 Policy Announcements
Liu, Xia (Summer),Megginson, William L.,Xia, Junjie
Using event study methodology we examine investors’ initial and long-run assessments of the Made in China 2025 industrial policy, announced in May 2015. We track stock price evolutions through 2018 for 360 listed Chinese, US, Japanese, and European companies in the ten mostly high-tech industries targeted by the MC 2025 policy. Announcement period abnormal returns are significantly positive for treated Chinese and US companies, but generally insignificant for Japanese and EU treated firms. Chinese firms’ cumulative abnormal returns fall sharply (up to -49.6%) over May 2015 to October 2016, the month before Donald Trump’s election, and then decline much further (at least an additional -41.0%) through year-end 2018. US firms experience significantly positive CARs (up to 16.0%) during the post-announcement to pre-election period and even more (5.2% to 25.1%) after Trump’s election. Japanese firms have significantly negative CARs during the post-announcement to pre-election period, but all other group/period CARs are insignificant. Most Chinese treated-industry firms benefit during the first few post-announcement months, but then lose heavily from 2016 onwards. US treated-industry firms benefit in both the short and long-term, and US high-tech companies emerge as the biggest long-term MC 2025 financial winners, with CARs generally exceeding 30%. Economic policy uncertainty analysis verifies that our chosen event periods are indeed impactful. These results are not driven by post-announcement changes in R&D or capex spending, changing financial constraint levels or, for Chinese firms, by being located in a “key city”. Surprisingly, government subsidies decline significantly for all Chinese firms after 2015, most drastically for treated industries. Even from a non-financial perspective, such as gaining market share or promoting employment growth, the MC 2025 policy does not promote targeted industries.

Internal Control Quality and Litigation Risk -Evidence from China
Zhang, Hongming
This paper introduces internal control quality to study litigation risk which enrich the literature of how to reduce firms’ litigation risk. This paper use listed company data from 2000-2015 in China A-share market to research how firms’ internal control affect litigation risk, and which kind of influence on litigation risk caused by internal control. By using regression model and conducting endogenous test, this paper finds that the higher internal control quality, the lower litigation risk of firms by reducing the number of involving litigation and funds used in lawsuit. If companies with good internal control quality, they can avoid many risks caught by litigation risk. Especially for firms in growth and undeveloped market, internal control quality can play a more vital role in corporate governance.

Intra-Portfolio Systemic Contagion
Biggiero, Lucio
Traditional approaches to credit risk evaluation have looked at a portfolio’s obligors as separate elements. However, daily bank practice suggests that there can be contagion effects between obligors, a fact that through the current normative has been explicitly acknowledged by EU regulation authorities. The “group of connected clients” is the key-concept for this revolutionary change: EBA requires banks firstly to identify such groups according to a set of different criteria and then to treat each of them as a single risk unit. This normative challenges banks to adopt concepts and methods rather new with respect to its professional background and practice. Here, its conceptual and practical implications are discussed, and some of its main flaws are evidenced: its framework remains static instead of dynamic, local instead of systemic, threshold-based instead of continuous variations. Therefore, if on one side this normative introduces the revolutionary concept of the groups of connected clients among risk evaluation criteria, on the other side it remains still entrapped into the traditional view and leaves untouched the risk evaluation of “non-dominated” clients. Hence, it should be considered as a step towards a full new paradigm, which had to look at portfolios as inter-organizational networks, more or less subjected to “failure cascades” depending on its specific structures. To this aim, it is required to design a new rating system with which single obligor’s risk evaluation should be measured precisely and in relation with the position they cover within the whole portfolio.

Investor Relations and Corporate Communications (IRSC) and Cost of Debt and Equity Capital
Bhabra, Harjeet S,Kolahgar, Sam,Ravi, Rahul
In this study, we examine whether firms’ engagement in Investor Relations and Stakeholder Communication (IRSC) activities reduce the cost of information asymmetry at the time of external financing. We also analyze the intermediary role of financing source (debt vs equity) and the existing level of firm transparency. Measures of IRSC initiatives are frequency of press releases, frequency of events (conferences and meetings, including industry gatherings as well as investment bank seminars), ratio of question and answer portion to the length of events, the average length of answer per question asked during events, and the frequency of slides used in event presentations. Sample includes 1,190 firms listed on S&P1500 index (small, medium, and large-cap firms on NYSE, AMEX, and NASDAQ stock exchanges) from 1999 to 2018. Multiple regression analyses (with robust standard errors) show that press frequency and the portion of question and answer in events have a significant and positive relationship with the cost of financing and event frequency and the average length of answers have a negative association with the cost of financing. Multivariate multiple regression analyses (seemingly unrelated regression models) are used to control for simultaneous effects of debt and equity issue and show that these findings are more pronounced for firms of lower transparency who are going to issue equity compared to firms of higher transparency who are going to issue debt.

January 2020 Bank Lending Survey in Spain
Menéndez Pujadas, Álvaro
According to the Bank Lending Survey, during 2019 Q4, credit standards tightened slightly for all categories of lending in Spain, whereas this only affected consumer credit and other lending to households in the euro area. In this segment, the general terms and conditions on new lending eased, both in Spain and in the euro area as a whole. Furthermore, in Spain, the terms and conditions on loans to households for house purchase tightened slightly. Demand for all types of credit in Spain decreased, whereas in the euro area as a whole loan applications from enterprises declined and those from households increased. According to the responding banks, regulatory and supervisory actions on capital, leverage and liquidity had a negligible impact on credit supply in Spain in the second half of 2019, whereas they prompted a slight tightening in the euro area. The NPL ratio contributed to a tightening of credit standards (in consumer credit in Spain and in the other two segments in the euro area). Lastly, as for the ECB’s TLTRO III (the third series of targeted longer-term refinancing operations), the banks’ participation in the September operation was limited and increased significantly in the December operation, as they were essentially attracted by the favourable conditions of this funding.

Jumping CAViAR
Götz, Pit
In this paper, Value-at-Risk (VaR) models that account for intraday-jumps are developed. The VaR is modeled directly as a quantile, the respective model-parameters are estimated by using quantile-regression. In order to analyze the dynamics of the impact of intraday-jumps on the forecasts, different models are developed and evaluated. It is assumed that the underlying time continuous log-price process follows a generic jump diffusion process. Based on this assumption a significant jump-size estimator is used and the jumps are included in the models. The evaluation of the models is done by fitting the model parameters on a high frequency dataset of DAX returns. As an evaluation frame, a data separation approach is used. The empirical results of the models out-of sample performances suggest that the inclusion of jumps does not necessarily improve the backtest results, compared to models without jumps. However, the new models perform better regarding the backtests rejection rate and are less prone to overfitting.

Kelly Betting with Quantum Payoff: a continuous variable approach
Salvatore Tirone,Maddalena Ghio,Giulia Livieri,Vittorio Giovannetti,Stefano Marmi

The main purpose of this study is to introduce a semi-classical model describing betting scenarios in which, at variance with conventional approaches, the payoff of the gambler is encoded into the internal degrees of freedom of a quantum memory element. In our scheme, we assume that the invested capital is explicitly associated with the free-energy (ergotropy) of a single mode of the electromagnetic radiation which, depending on the outcome of the betting, experiences attenuation or amplification processes which model losses and winning events. In particular, the evolution of the quantum memory results in a stochastic trajectory which we characterize within the theoretical setting of Bosonic Gaussian channels. As in the classical Kelly Criterion for optimal betting, we define the asymptotic doubling rate of the model and identify the optimal gambling strategy for fixed odds and probabilities of winning. The performance of the model are hence studied as a function of the input capital state under the assumption that the latter belongs to the set of Gaussian density matrices (i.e. displaced, squeezed thermal Gibbs states) revealing that the best option for the gambler is to devote all her/his initial resources into coherent state amplitude.

Market Making under a Weakly Consistent Limit Order Book Model
Baron Law,Frederi Viens

We develop a new market-making model, from the ground up, which is tailored towards high-frequency trading under a limit order book (LOB), based on the well-known classification of order types in market microstructure. Our flexible framework allows arbitrary order volume, price jump, and bid-ask spread distributions as well as the use of market orders. It also honors the consistency of price movements upon arrivals of different order types. For example, it is apparent that prices should never go down on buy market orders. In addition, it respects the price-time priority of LOB. In contrast to the approach of regular control on diffusion as in the classical Avellaneda and Stoikov [1] market-making framework, we exploit the techniques of optimal switching and impulse control on marked point processes, which have proven to be very effective in modeling the order-book features. The Hamilton-Jacobi-Bellman quasi-variational inequality (HJBQVI) associated with the control problem can be solved numerically via finite-difference method. We illustrate our optimal trading strategy with a full numerical analysis, calibrated to the order-book statistics of a popular Exchanged-Traded Fund (ETF). Our simulation shows that the profit of market-making can be severely overstated under LOBs with inconsistent price movements.

Mixture of Distribution Hypothesis: Analyzing Daily Liquidity Frictions and Information Flows
Le Fol, Gaëlle
The mixture of distribution hypothesis (MDH) model offers an appealing explanation for the positive relation between trading volume and volatility of returns. In this specification, the information flow constitutes the only mixing variable responsible for all changes. However, this single static latent mixing variable cannot account for the observed short-run dynamics of volume and volatility. In this paper, we propose a dynamic extension of the MDH that specifies the impact of information arrival on market characteristics in the context of liquidity frictions. We distinguish between short-term and long-term liquidity frictions. Our results highlight the economic value and statistical accuracy of our specification. First, based on some goodness of fit tests, we show that our dynamic two-latent factor model outperforms all competing specifications. Second, the information flow latent variable can be used to propose a new momentum strategy. We show that this signal improves once we allow for a second signal â€" the liquidity frictions latent variable â€" as the momentum strategies based on our model present better performance than those based on competing models.

Nonparametric Estimation of Large Covariance Matrices with Conditional Sparsity
Wang, Hanchao,Peng, Bin,Li, Degui,Leng, Chenlei
This paper studies estimation of covariance matrices with conditional sparse structure. We overcome the challenge of estimating dense matrices using a factor structure, the challenge of estimating large-dimensional matrices by postulating sparsity on the covariance of the random noises, and the challenge of estimating varying matrices by allowing factor loadings to smoothly change. A kernel-weighted estimation approach combined with generalised shrinkage is proposed. Under mild conditions, we derive uniform consistency for the developed estimation method and obtain convergence rates. Numerical studies including simulation and an empirical application are presented to examine the finite-sample performance of the developed methodology.

Nonparametric sign prediction of high-dimensional correlation matrix coefficients
Christian Bongiorno,Damien Challet

We introduce a method to predict which correlation matrix coefficients are likely to change their signs in the future in the high-dimensional regime, i.e. when the number of features is larger than the number of samples per feature. The stability of correlation signs, two-by-two relationships, is found to depend on three-by-three relationships inspired by Heider social cohesion theory in this regime. We apply our method to US and Hong Kong equities historical data to illustrate how the structure of correlation matrices influences the stability of the sign of its coefficients.

On the difference between the volatility swap strike and the zero vanna implied volatility
Elisa Alos,Frido Rolloos,Kenichiro Shiraya

In this paper, Malliavin calculus is applied to arrive at exact formulas for the difference between the volatility swap strike and the zero vanna implied volatility for volatilities driven by fractional noise. To the best of our knowledge, our estimate is the rst to show the rigorous relationship between the zero vanna implied volatility and the volatility swap strike. In particular, we will see that the zero vanna implied volatility has a higher rate of convergence than the at-the-money (ATM) implied volatility for both zero and non-zero correlation and for all values of the Hurst parameter.

Order Splitting and Searching for a Counterparty
van Kervel, Vincent,Kwan, Amy,Westerholm, P. Joakim
Institutional investors have a strong incentive to find natural counterparties to trade larger amounts at lower costs. We show theoretically that order splitting may facilitate this search, as it gradually signals one's trading interest to the market and helps detect the presence of counterparties. Empirically, we confirm that investors can detect counterparties in real-time, in which case they adjust their strategy accordingly. A one-standard deviation increase in natural counterparty trading volume correlates with a 14.2% increase in order size and reduces the average implementation shortfall to close to zero.

Predicting Bond Return Predictability
Borup, Daniel,Eriksen, Jonas N.,Kjær, Mads Markvart,Thyrsgaard, Martin
We document predictable shifts in bond return predictability related to economic activity and uncertainty in the U.S. Treasury bond market using standard bond excess return predictors. Bond returns are predictable in high (low) economic activity (uncertainty) states, but not in others. We develop a new test for equal conditional predictive ability among two or more forecasting methods and show that relative performances are predictable and exploitable in a real-time forecasting setting. Using a novel forecast combination scheme with dynamic trimming based on predicted forecasting performance leads to strongly countercyclical out-of-sample risk premia estimates and substantial gains in predictive accuracy and economic value.

Pricing Asian Options with Stochastic Convenience Yield and Jumps
Ewald, Christian-Oliver,Wu, Yuexiang,Zhang, Aihua
We price Asian options on commodity futures contracts in the presence of stochastic convenience yield and interest rates as well as jumps in the commodity spot price. We obtain a closed-form solution for the geometric average case without the presence of jumps, both for continuous and discrete averaging. This analytic result enables us to apply suitable control variates to price an arithmetic average Asian option via Monte Carlo simulation. We observe a significant reduction in the size of confidence intervals in relation to plain Monte Carlo. Varying the parameters of the model, we obtain a good understanding as to how option prices change accordingly. We then consider a variation of the model through adding stochastic jumps to the commodity spot price dynamics. By conditioning on the jump times first and then averaging over the sequences of jump times, we show that our control variate still leads to a significant variance reduction, even though a closed form solution for a geometric average Asian option in the presence of jumps is unavailable.

Private Money Production without Banks
Gorton, Gary B.
I test the Dang, Gorton, and Holmström (2018) (DGH) theory that the optimal design of private money is debt backed by debt. I do this in the context of English inland bills of exchange (where all parties to the bill were in England), which were used as a medium of exchange during the Industrial Revolution in the north of England in the eighteenth and first half of the nineteenth centuries. These bills circulated via indorsements, committing each indorser’s personal wealth to back the bill. A sample of bills from the period 1762- 1850 is studied to determine how frequently they changed hands (liquidity/velocity) and to determine how their credibility was established. Some bills were backed by banks and others by the joint liability of indorsers only. I test the DGH theory by asking: Were bankbacked bills more liquid than the joint liability-backed bills?

Raising Capital Under Demand Uncertainty
Terovitis, Spyros
Does security-based crowdfunding create economic value, and how? Which economic participants would find this method of financing attractive? What is the optimal capital-raising process in security-based crowdfunding platforms? To answer these questions, we study the capital-raising problem of an entrepreneur of an innovative product, when future demand is uncertain and market participants have access to costly and imperfect information. Under the optimal contract, investors take their backing decisions sequentially and financing goes through only if enough investors back the project. We show that if the ability of economic participants to commit is limited, raising capital via a security-based crowdfunding platform can alleviate under-financing of creditworthy projects.

Restructuring and Privatisation of the Bulgarian Banking Sector
Kondova, Galia
This article is a brief review of developments in the banking sector in Bulgaria as well as an analysis of the political and macroeconomic factors that have influenced this process. It begins with a historical overview of the different stages in the evolution of the Bulgarian financial sector. Greatest attention is placed on banking sector reforms after the abandonment of the 'monobank' system. In particular, the bank consolidation process, the 'bad debt' problem, and the 1996 banking crisis that occurred during the transition period are discussed in detail. These developments are properly linked to the relevant macroeconomic factors and legal framework as well. Furthermore, the recently achieved stability in the banking sector is justly ascribed to the introduction of the currency board in 1997. The stabilizing effects of the currency board are highlighted. Finally, a brief overview is included of both the political and economic stabilization in Bulgaria up until the end of 1999 and it provides the necessary background for understanding the achieved progress in bank privatization over the last two years. In fact, at the end of 1999 approximately half of the total bank assets were in private hands.

Risk Management with Tail Quasi-Linear Means
Nicole Bäuerle,Tomer Shushi

We generalize Quasi-Linear Means by restricting to the tail of the risk distribution and show that this can be a useful quantity in risk management since it comprises in its general form the Value at Risk, the Tail Value at Risk and the Entropic Risk Measure in a unified way. We then investigate the fundamental properties of the proposed measure and show its unique features and implications in the risk measurement process. Furthermore, we derive formulas for truncated elliptical models of losses and provide formulas for selected members of such models.

Robust Optimal Investment and Reinsurance Problems with Learning
Nicole Bäuerle,Gregor Leimcke

In this paper we consider an optimal investment and reinsurance problem with partially unknown model parameters which are allowed to be learned. The model includes multiple business lines and dependence between them. The aim is to maximize the expected exponential utility of terminal wealth which is shown to imply a robust approach. We can solve this problem using a generalized HJB equation where derivatives are replaced by generalized Clarke gradients. The optimal investment strategy can be determined explicitly and the optimal reinsurance strategy is given in terms of the solution of an equation. Since this equation is hard to solve, we derive bounds for the optimal reinsurance strategy via comparison arguments.

Security Design with Endogenous Implementation Choice
Terovitis, Spyros
Motivated by security-based Crowdfunding, we study a model of project financing, where a cashless entrepreneur: i) has private information about her project; ii) might be associated with a negative-NPV project, and; iii) has limited liability. We find that the optimal security is debt accompanied by a clause that effectively, provides the entrepreneur with the option of not implementing the project when it is socially wasteful. We show that relaxing the implicit assumption that the entrepreneur is obliged to implement the project after raising capital: i) prevents market breakdown; ii) leads to more efficient allocations of resources, and; iii) strengthens the entrepreneur's incentive to exert productivity-increasing effort.

Sins of the Father: The Effect of a Parent Firm's Accounting Misconduct on Current and Former Subsidiaries
Utke, Steven,Xu, Jingyu
We exploit a unique setting to examine how managerial and economic connections affect the current and former subsidiaries (“subsidiaries”) of a parent firm undergoing a restatement and bankruptcy. The demise of Enron and the varying nature of ties between Enron and its four publicly traded subsidiaries allow us to examine if capital market reactions for each of the subsidiaries surrounding Enron’s failure vary with the nature of their connections to Enron. We observe no significant differences in contemporaneous market reaction regardless of the nature and strength of connections between Enron and the subsidiaries, providing two main insights. First, over the year following the Enron events, those subsidiaries with ownership or accounting ties but with weak economic ties performed in-line with the industry, consistent with the lack of a differential market reaction across these sets of firms. This result contrasts with recent studies finding evidence of manager fixed effects affecting accounting choices. Second, we find that Enron’s most economically connected subsidiary (predictably) went bankrupt shortly after Enron, suggesting a market under-reaction at the time of the Enron events. Additional analysis provides some limited evidence that low institutional ownership or slow analyst forecast updating partly explains this under-reaction. Our study adds to the literature on restatements, management reputation effects, peer information transfer, and the market’s ability to react to specific fundamental information.

Swiss Cantonal Banks: A DEA Efficiency and Productivity Analysis
Bandyopadhyay, Trishit,Bobst, David,Hummel, Tobias,Kondova, Galia
This paper applies a data envelopment analysis (DEA) to study the efficiency and productivity changes in the Swiss cantonal bank sector in the period 2006-2014. The efficiency analysis is conducted by applying the production input-oriented DEA variable returns to scale model in a three-stage procedure. The productivity is studied by estimating a DEA-based Malmquist Productivity Index (MPI) that provides evidence of increasing productivity growth on average for the sector in the studied period. The main source of productivity growth as per the components of the Banker, Charnes and Cooper (BCC) MPI model is related to a frontier-shift (technological innovation) rather than to improvements in the technical efficiency. The decreasing average DEA scores in the post-global financial crisis period of 2008-2014 further support this finding. In the second stage of the efficiency analysis, the environmental factors influencing the productivity growth are analysed by conducting a general method of moments (GMM) regression. The results provide evidence of a positive and statistically significant relationship between the stock of residential buildings per canton and technical efficiency. In the third stage, the environmental variables from the second-stage regression are included within the constraints of the first-stage DEA model as proposed by Ray. The third-stage DEA scores support the evidence of slightly decreasing average post-global crisis technical efficiency. The overall average technical efficiency in the Swiss cantonal banking sector, however, remains at a relatively high level in the studied period.

The Impact of Oil and Gold Prices Shock on Tehran Stock Exchange: A Copula Approach
Amir T. Payandeh Najafabadi,Marjan Qazvini,Reza Ofoghi

There are several researches that deal with the behavior of SEs and their relationships with different economical factors. These range from papers dealing with this subject through econometrical procedures to statistical methods known as copula. This article considers the impact of oil and gold price on Tehran Stock Exchange market (TSE). Oil and gold are two factors that are essential for the economy of Iran and their price are determined in the global market. The model used in this study is ARIMA-Copula. We used data from January 1998 to January 2011 as training data to find the appropriate model. The cross validation of model is measured by data from January 2011 to June 2011. We conclude that: (i) there is no significant direct relationship between gold price and the TSE index, but the TSE is indirectly influenced by gold price through other factors such as oil; and (ii) the TSE is not independent of the volatility in oil price and Clayton copula can describe such dependence structure between TSE and the oil price. Based on the property of Clayton copula, which has lower tail dependency, as the oil price drops, stock index falls. This means that decrease in oil price has an adverse effect on Iranian economy.

The Pricing of European Non-Performing Real Estate Loan Portfolios: Evidence on Stock Market Evaluation of Complex Asset Sales
Manz, Florian,Müller, Birgit,Schiereck, Dirk
Recent empirical evidence raises doubt about the ability of financial market participants to generate information efficient valuations for capital market instruments whose cash flows are related to residual claims and dependent on real estate income. We contribute to this literature with the examination of value implications of non-performing loan (NPL) divestitures in the banking industry during the period 2012 to 2018. In a first step, we provide descriptive statistics of the European NPL market, which lacks transparency and publicly available basic information on portfolio size and components. We then analyze wealth effects of distressed loan sale announcements for a uniquely large transaction database with 317 NPL deals, which is largely driven by real estate collateral. Our results show positive stock market reactions for vendor banks following NPL divestitures that tend to be driven by real estate collateral and a size effect.

The Role of Pension Business Benefits in Institutional Block Ownership and Corporate Governance
Huang, Jing,Matsunaga, Steven,Wang, Zhi Jay
We investigate whether potential pension contracting benefits lead institutions that provide pension services to acquire ownership blocks in firms and the implications of such blockholdings on the firms’ corporate governance. We use the 2006 Pension Protection Act, which expanded pension participation in certain states, as a quasi-exogenous shock and find an increase in block ownership by pension-providing institutions in firms with substantial operations in affected states. Further, we find that the acquisition of a large block increases the likelihood that the institution will provide future pension services to the firm. With regard to corporate governance, we find that the acquisition of large pension blockholdings is associated with higher CEO pay and lower CEO turnover following poor financial performance. However, contrary to the prediction of the private benefits hypothesis, we do not find consistent evidence that large pension blockholdings are associated with declining firm profitability, suggesting that pension institutions are incentivized to exert monitoring to preserve the investment value of their blockholdings. Overall, our evidence is consistent with pension service institutions acquiring ownership blocks to obtain pension contracts, but our evidence does not support the prediction that they use their influence to compromise shareholder value.

UK Vice Chancellor Compensation: Do They Get What They Deserve?
Lucey, Brian M.,Urquhart, Andrew,Zhang, Hanxiong
The compensation received by UK Vice Chancellors (VCs) has been on an upward trend in re- cent years and attracted a lot of negative media attention. In this paper, we examine whether VC compensation is excessive. Using a panel dataset covering the academic years 2007/2008 to 2016/2017, we develop a model to predict expected VC compensation to determine whether VCs are over- or undercompensated. Our model finds that VCs are not overcompensated regarding their base salary, but some are overcompensated in terms of their benefits and pension contributions. However, there is very little difference in terms of characteristics of over- and undercompensated VCs, indicating that on average, UK VCs receive the compensation they deserve. For robustness purposes, we employ a variety of alternative model specifications and subsamples which all support our findings.

What's My Share? Information Acquisition by Loan Syndicate Participants
Chi, Sabrina,Jin, Hengda,Owens, Edward,Ton, Karen
Participant lenders in syndicated loans generally rely on the lead arranger for borrower screening and monitoring because the lead arranger is primarily responsible for interactions with the borrower. This gives rise to both moral hazard and adverse selection concerns. We investigate whether participant lenders independently acquire borrower accounting reports to help mitigate these information frictions. We find that participant lenders’ SEC EDGAR searches of borrower filings are positively associated with their shares of the syndicated loan, consistent with mitigation of intra-syndicate information asymmetry. This association is weaker when the lead arranger has a better reputation, when participant lenders have a prior lending relationship with the borrower, and when the borrower’s information environment is richer, suggesting information frictions are less acute in such cases. This novel direct evidence enhances our understanding of the role of accounting information in facilitating deal formation in syndicated loan markets.

What’s in a Name? A Cautionary Tale of Profitability Anomalies and Limits to Arbitrage
DeLisle, Jared,Yuksel, H. Zafer,Zaynutdinova, Gulnara R.
Recent literature investigating profitability anomalies defines profitability in various ways (i.e. gross, operating, and cash-based). We show that limits to arbitrage are associated with returns of gross and cash-based operating profitability anomalies, suggesting mispricing. In contrast, returns from the operating profitability strategy have no relation with barriers to arbitrage and exhibit no evidence of mispricing. Additionally, we show that the differential effects of limited arbitrage-related mispricing of gross and cash-based operating profitability anomalies are attributable to their respective correlations with SG&A expense and accruals anomalies. Interestingly, we find SG&A return predictability, like that of accruals, is related to limits to arbitrage. These findings suggest that investors and researchers should proceed with caution when searching for return predictability by redefining profitability measures.

Whos Ditching the Bus?
Simon J. Berrebi,Kari E. Watkins

This paper uses stop-level passenger count data in four cities to understand the nation-wide bus ridership decline between 2012 and 2018. The local characteristics associated with ridership change are evaluated in Portland, Miami, Minneapolis/St-Paul, and Atlanta. Poisson models explain ridership as a cross-section and the change thereof as a panel. While controlling for change in frequency, jobs, and population, the correlation with local socio-demographic characteristics are investigated using data from the American Community Survey. The effect of changing neighborhood demographics on bus ridership are modeled using Longitudinal Employer-Household Dynamics data. At a point in time, neighborhoods with high proportions of non-white, carless, and most significantly, high-school-educated residents are the most likely to have high ridership. Over time, white neighborhoods are losing the most ridership across all four cities. Places with high concentrations of residents with college education and without access to a car also lose ridership at a faster rate in two of the cities. The sign and significance of these results remain consistent even when controlling for intra-urban migration. Although bus ridership is declining across neighborhood characteristics, these results suggest that the underlying cause must be primarily affecting the travel behavior of white bus riders. Shifts in neighborhood socio-demographics, however, were found to be modest and unlikely to be causing the nation-wide ridership crisis. Only in Miami is the proportion of white residents near the most frequent parts of the bus network increasing. There, demographic shifts may be contributing to the overall decline in bus ridership.