Research articles for the 2020-02-07

An Alternative Approach to Firms' Evaluation: Expert Systems and Fuzzy Logic
Magni, Carlo Alberto,Malagoli, Stefano,Mastroleo, Giovanni
Discounted Cash Flow techniques are the generally accepted methods for valuing firms. Such methods do not provide explicit acknowledgment of the value determinants and overlook their interrelations. This paper proposes a different method of firm valuation based on fuzzy logic and expert systems. It does represent a conceptual transposition of Discounted Cash Flow techniques but, unlike the latter, it takes explicit account of quantitative and qualitative variables and their mutual integration. Financial, strategic and business aspects are considered by focusing on twenty-nine value drivers that are combined together via if-then rules. The output of the system is a real number in the interval [0,1], which represents the value-creation power of the firm. To corroborate the model a sensitivity analysis is conducted. The system may be used for rating and ranking firms as well as for assessing the impact of managers' decisions on value creation and as a tool of corporate governance.

And the AR Goes to... Shock to Brand Capital: Evidence from the Oscars
Gerasimova, Nataliya,Maggi, Damiano
We identify the effect of changes in the brand capital on stock market performance. Using hand-collected data on the red carpet outfits during the Academy Awards ceremonies, we find that companies providing outfits to nominees experience a positive stock market performance with respect to a control group of comparables. This outperformance is unlikely to be attributable to differential risk, while Google search trends suggest the Academy Awards ceremonies have a positive impact on investor attention.

Attention and Housing Search: Evidence from Online Listings
Gargano, Antonio,Giacoletti, Marco,Jarnecic, Elvis
We study fluctuations in households' attention to the housing market and their effects on home sales. Exploiting a unique dataset that tracks user activity on a major property website, we show that buyers' attention positively responds to price growth in their postcode of residence. The increase in attention does not translate into higher effort allocated to inspecting individual listings, but in more extensive searches, covering a broader range of locations and property characteristics. These effects are mainly driven by homeowners, young households and residents of lower price postcodes in particular, consistent with higher price growth affecting users behavior through wealth effects or the easing of collateral constraints. Our results are stronger when postcode price growth is instrumented using a measure of local supply-elasticity. More extensive searches reduce segmentation on the demand side of the market, leading to higher prices and lower time on the market for homes listed for sale. This implies that fluctuations in households' attention have procyclical effects on house price growth and generate spillovers within metropolitan areas.

Avaliação de ativos de baixa volatilidade no mercado brasileiro: menor risco com maiores retornos (Low Volatility Asset Valuation in Brazilian Stock Market: Lower Risk With Higher Returns)
Boudjoukian França, Luciano
Portuguese Abstract: Este estudo avalia o comportamento de carteiras formadas por ativos do mercado acionário brasileiro ordenados em função de sua volatilidade para investigar a anomalia de baixa volatilidade.Entre janeiro de 2003 e junho 2017, o portfólio de baixa volatilidade apresentou um retorno anual 15,5% maior que o portfólio de maior volatilidade, com significância estatística tanto na geração de alfa como na melhora do Índice de Sharpe quando comparado com o universo de ativos do mercado. Tais resultados estão alinhados com as observações feitas por Blitz e Van Vliet (2007) nos mercados internacionais, que obtiveram 12% de alfa anual no período de 1986 a 2006.Ainda, através de um processo de duplo ordenamento, foi possível obter carteiras mais rentáveis e com menor risco do que quando ordenadas apenas por um fator de risco.English Abstract: This work evaluates the behavior of portfolios comprised of Brazilian stocks ordered by their volatility to investigate the low volatility anomaly. Between January 2003 and June 2017, the low volatility portfolio presented a 15.5% annual return above the high volatility portfolio, with statistical significance in alpha as in the Sharpe Index when compared to the assets universe. These results are aligned with the observations made by Blitz and Van Vliet (2007) in global markets, with an annual alfa spread of 12% over the period between 1986 and 2006.Also, through a double sorting process, it was possible to obtain portfolios with higher returns and lower risk than those ordered by a single risk factor.

Can Long-Term Institutional Owners Improve Market Efficiency in Parsing Complex Legal Disputes?
Borochin, Paul,Wang, Xiaoqiong,Wei, Siqi
Long-horizon institutional investors can help mitigate information asymmetries around securities class action (SCA) lawsuits. We find that the machine readability of SCA complaint filings can predict the outcome and duration of class actions. Long-term institutional investor ownership leads to a more positive post-SCA announcement price reaction and increases the volatility ratio of prices as a measure of price informativeness. Furthermore, there is a significant interaction effect between long-term institutional ownership and SCA complexity on price informativeness consistent with a superior information processing ability about complex corporate events affecting portfolio firms.

Debtholder Monitoring Incentives and Bank Earnings Opacity
Danisewicz, Piotr,McGowan, Danny,Onali, Enrico,Schaeck, Klaus
We exploit exogenous legislative changes that alter the priority structure of different classes of debt to study how debtholder monitoring incentives affect bank earnings opacity. We present novel evidence that exposing nondepositors to greater losses in bankruptcy reduces bank earnings opacity, especially for banks with larger shares of nondeposit funding, listed banks, and independent banks. The reduction in earnings opacity is driven by a lower propensity to overstate earnings and becomes larger during crises, when the incentive to conceal capital shortfalls is stronger. Our findings highlight the importance of creditors’ monitoring incentives in improving the quality of information disclosure.

Deep Learning: Credit Default Prediction from User-Generated Text
Kriebel, Johannes,Stitz, Lennart
The digital transformation produces vast sources of unstructured data that are storable by and accessible to traditional banks and fintechs. Prior literature indicates that this unstructured information is valuable for decisions of accepting and pricing credit contracts. While processing this kind of information has been very difficult in the past, deep learning offers tools to process parts of these unstructured sources automatically and use it to predict credit defaults. We employ deep learning techniques to extract credit relevant information based on loan descriptions from Lending Club. Our results confirm that even short pieces of user-generated text can improve credit default predictions significantly. The additional information extracted by deep learning is robust towards controlling for credit scores, structured application information, and common theoretically suggested text characteristics.

Distorting Arrow-Debreu Securities: New Entropy Restrictions Implied by the Option Cross Section
Chabi-Yo, Fousseni,Liu, Yan
Replacing equity return (as in the equity risk premium) with returns on an arbitrary contingent claim, we obtain a new class of economic risk premiums to impose upon candidate models. These risk premiums reflect the distance between the physical and risk-neutral moments for asset returns, can be estimated in a model-free fashion from the option cross section, and provide sharp information in distinguishing alternative models. Confronting leading macro-finance models with our risk premiums, we uncover a wide dispersion in performance across candidate models. Our evidence points to the importance of incorporating persistent stochastic volatilities and/or higher moments in fundamentals to reconcile with the option data, as exemplified by Bansal and Yaron (2004) and Bekaert and Engstrom (2017).

Does Ban on Futures Trading (De)stabilise Spot Volatility? Evidence from Indian Agriculture Commodity Market
Sobti, Neharika
Purpose: The purpose of this paper is to ascertain the possible consequences of ban on futures trading of agriculture commodities in India by examining three critical issues: first, the author explores whether price discovery dominance changes between futures and spot in the pre-ban and post-relaunch phase both in the long run and short run. Second, the author examines the impact of ban and relaunch of futures trading on its underlying spot volatility for five sample cases of agriculture commodities (Wheat, Sugar, Soya Refined Oil, Rubber and Chana) using both parametric and non-parametric tests. Third, the author revisits the destabilization hypothesis in the light of ban on futures trading by examining the impact of unexpected component of liquidity of futures on spot volatility.Design/methodology/approach: The author uses widely adopted methodology of co-integration to examine long-run relationship between spot and futures, while the short-run relationship is investigated using vector error correction model (VECM) and Granger causality to test price discovery in the pre-ban and post-relaunch phases. The second objective is explored using a combination of parametric and non-parametric tests such as Welch one-way ANOVA and Kruskalâ€"Wallis test, respectively, to gauge the impact of ban on futures trading on spot volatility along with post hoc tests to investigate pairwise comparison of spot volatility among three phases (pre-ban, ban and post-relaunch) using Dunn Test. In addition, extensive robustness test is undertaken by adopting augmented E-GARCH model to ascertain the impact of ban and relaunch of futures trading on spot volatility. The third objective is investigated using Granger causality test between spot volatility and unexpected component of liquidity of futures estimated using Hodrick and Prescott (HP) filter to re-visit the destabilization hypothesis.Findings: The author found extensive evidence for the dominance of futures market in the price discovery of agriculture commodities both in the pre-ban and post-relaunch phases in India. The ban on futures trading is found to have a destabilizing impact on spot volatility as evident from the findings of Wheat, Sugar and Rubber. In addition, it is observed that spot volatility was highest during the ban phase as compared to the pre-ban and post-relaunch phases for all four commodities barring Chana. The author found that destabilisation hypothesis holds true during the pre ban phase, while weakening of destabilization hypothesis is observed in the post-relaunch phase as unexpected futures liquidity has no role in driving the spot volatility.Originality/value: This study is a novel attempt to empirically examine the potential impact of ban and relaunch of futures trading of agriculture commodities on two key market quality dimensions â€" price discovery and spot volatility. In addition, destabilization hypothesis is revisited to investigate the impact of futures trading on spot volatility during the pre-ban and post-relaunch period.

Extremal Connectedness and Systemic Risk of Hedge Funds
Mhalla, Linda,Hambuckers, Julien,Lambert, Marie
In this paper, we study the connectedness between extreme losses of hedge funds, a crucial feature for systemic risk management. To do so, we exploit cross-sections of hedge funds monthly returns grouped by investment styles, and build a time-varying measure of tail dependence across styles. Relying on extreme value theory and regression techniques, we study the dynamics of the tail dependencies between fund styles conditional on factors reflecting the economic uncertainty and the stock market performance. The resulting tail dependence measures are used to construct a time-varying network between extreme losses of the various investment styles. We show that during a crisis period, while the extremal dependence between some pairs of investment styles remains stable, other pairs show a striking increase of their extremal connectedness. Our results highlight that a proactive regulatory framework should account for the dynamic nature of the tail dependence and its link with financial stress.

Factors and Risk Premia in Individual International Stock Returns
Chaieb, Ines,Langlois, Hugues,Scaillet , O.
We propose an estimation methodology tailored for large unbalanced panels of individual stock returns to study the factor structure and risk premia in international stock markets. We show that the local market is necessary to capture the factor structure in both developed and emerging markets. Neither the presence of multiple world risk factors, regional risk factors, systematic currency risk factors, nor a country-specific currency subsume the importance of the local market factor. Then, we show that multi-factor models generate pricing errors of similar economic magnitude across markets but that these pricing errors dramatically spike during crises.

Influences of Macroeconomic Variables on Stock Market in China: An Empirical Analysis
Huang, Peng,Chen, Shen,Wei, Wan,Elkassabgi, Ahmed
This paper investigates the influences of macroeconomic variables on the stock market in China. We use Granger causality tests, impulse response functions, and variance decompositions to examine how fundamental macroeconomic variables, such as output proxied by electricity generation, inflation, money supply, and short-term interest rate affect the Shanghai Stock Exchange Composite Index. Our estimation results indicate that variables that measure macroeconomic activity, such as output growth and inflation, have no statistically significant impact on stock returns. Moreover, the stock returns do not respond to changes of monetary policy variables such as money supply and short-term interbank offered rate. This implies that monetary policy does not exert significant influences on stock returns. In sum, the performance of the China stock market does not reflect macroeconomic fundamentals.

Intellectual Capital Reporting: A User Perspective
Cuganesan, Suresh,Petty, Richard,Finch, Nigel
The field of intellectual capital (IC) has witnessed rapid growth in recent times, with a range of IC measurement and reporting models being developed by academics, consultants and practitioners. Despite widespread pronouncements that businesses report their IC, and increasingly regulatory requirements for organisations to do so, surveys of practice indicate limited IC reporting practice. In addition, there are limited empirically-validated insights in to the reasons for this apparent 'disconnect' between theory and practice, with important questions remaining unresolved: do users of corporate disclosure information find this adequate? Is there demand for IC reporting? If so, how is this best provided? Given these questions, this study examines the need of decision makers for IC information.

Labor Voice in Corporate Governance: Evidence from Opportunistic Insider Trading
Ng, Lilian K.,Pham, Man,Yu, Jing
This study examines the role of labor, an important corporate stakeholder, in corporate governance, particularly in how it disciplines opportunistic insider trading behavior. We find that firms with organized labor experience statistically significant declines in both opportunistic insider trading activity and profitability. This baseline evidence is robust to possible endogeneity concerns, alternative measures of insider trading activity, and conventional corporate governance measures. Labor voice is powerful in dampening insider opportunism through the employee welfare channel, labor unions' initiated shareholder proposals, and external mechanisms, including media and political support. The organized labor's role in improving corporate governance helps to enhance productivity and firm performance. Overall, insider trading in firms with organized labor is less predictive of future stock returns.

Measuring Risk Information
Smith, Kevin,So, Eric C.
We develop a measure of how information events impact investors’ perceptions of firms’ riskiness. We derive this measure from an option-pricing model where investors anticipate an announcement containing information on the mean and variance of firms’ future prices. We apply the measure to firms’ earnings announcements and show it has many desirable properties: it predicts firms’ return volatilities, risk-factor exposures, implied costs of capital, the timing of heightened volatility, and deterioration in fundamental performance, and outperforms textual-based proxies. Together, our study offers an approach for studying risk information conveyed by information events that is simple to implement and broadly applicable.

Portfolio Choice: Familiarity, Hedging, and Industry Bias
Che, Xin,Liebenberg, Andre P.,Lynch, Andrew A
Investors may under-diversify their portfolios by overweighting securities in which they perceive an informational advantage or by underweighting securities to hedge risks outside the portfolio. We investigate under-diversification in institutional portfolio construction by examining the under/overweighting of industries in U.S. Property-Liability (PL) insurers’ equity portfolios. We find that PL insurers underweight their own industry in their portfolios, as well as highly correlated industries. This underweighting is larger for PL insurers exposed to higher underwriting risk. While PL insurers have an informational advantage in investing in their peers, their underwriting risk drives them to underweight stocks in their industry.

Post-Earnings-Announcement Drift: Expected Growth Risk or Limits-to-Arbitrage?
Kim, Dongcheol,Lee, Deok-Hyeon,Min, Byoung-Kyu
To explain post-earnings-announcement drift (PEAD), we suggest expected growth risk, which is measured as covariance between stock returns and expected future real GDP growth rates. We find that both expected growth rates and expected growth risk increase with standardized unexpected earnings, and expected growth risk is significantly priced in the cross-section of returns. The model including expected growth risk alone explains PEAD satisfactorily. We also find that after adjustment for expected growth risk, the systematic relation of PEAD with the degree of limits-to-arbitrage disappears. This indicates that the empirical evidence supporting the mispricing hypothesis due to limits-to-arbitrage is a consequence of the failure in incorporating appropriate risk and the drift is a manifestation of expected growth risk.

Summer Vacation and Cross-Sectional Stock Returns
LI, Ya,Lam, FY Eric,Tang, Gordon Y. N.
The risk premium based on the cross sectional stock returns measured by a composite expected return signal displays closely similar winter vs. summer seasonal pattern as the market return does. We observe similar seasonal pattern for the signal component market value of equity, the book-to-market equity ratio, and total asset growth while less so for gross profitability. Our results are mostly consistent with the summer vacation argument of Bouman and Jacobsen (2002) and Jacobsen and Marquering (2008, 2009), which suggests that market wide risk aversion rises in summer and drops in winter due to seasonal variation in market participation. From the seasonality perspective, our findings support recent empirical asset pricing model of Fama and French (2014, 2015) that makes use of multiple factors based on the above signal components together with the market return simultaneously. We also provide further empirical seasonal regularity that an underlying pricing story to be developed would consider reconciling.

The Choice Channel of Financial Innovation
Iachan, Felipe,Nenov, Plamen,Simsek, Alp
Financial innovation in recent decades has expanded portfolio choice. We investigate how greater choice affects investors' savings and asset returns. We establish a choice channel by which greater portfolio choice increases investors' savings --- by enabling them to earn the aggregate risk premium or to take speculative positions. In equilibrium, portfolio customization (access to risky assets beyond the market portfolio) reduces the risk-free rate. Participation (access to the market portfolio) reduces the risk premium but typically increases the risk-free rate. Empirically, stock market participants in the U.S. save more than nonparticipants, and have increasingly dispersed portfolio returns, consistent with the choice channel.

The Impact of Credit Risk on Equity Options
Maglione, Federico
The aim of this work is to understand and measure to what extent equity options price credit risk. With a novel structural model, the the price of an option is shown to depends on the probability of the option expiring in-the-money, conditional on the firm’s survival. The novelty of this approach stems from the works of Geske (1977) and Geske (1979) where equity is seen as a compound call option written on the firm’s assets. A new measure of impact of credit risk on options is also introduced, and it is shown that put options, contrary to calls, are sensitive to changes in the default risk in the underlying company. In addition, this measure is able to forecast future changes of the negative skew of long-term maturity options written on the equity of the same company. Finally, I show that the implied volatilities estimated á la Black-Scholes tend to average out the effect of credit risk over the moneyness space, leading to potential biases when applied for risk management purposes.

The Limits of Antitrust in the 21st Century
Lambert, Thomas A.
In recent months, commentators and policymakers have called for expanded antitrust enforcement to address a number of novel harms. As Judge Frank Easterbrook famously observed in 1984, however, antitrust is an inherently limited enterprise, and improvident antitrust enforcement can create greater harm than benefit. To optimize antitrust’s effectiveness, Easterbrook proposed a set of screening mechanisms that would constrain the law’s reach. This Article examines Easterbrook’s prescriptions in light of recent economic learning and market developments. It concludes that Easterbrook’s overarching prescriptionâ€"that antitrust policies should be calibrated to minimize the sum of error and decision costsâ€"remains fundamentally sound. However, his assertion that false convictions are systematically worse than false acquittals is questionable, and several of his specific screening mechanisms appear unwarranted. As courts and enforcers respond to calls for a bigger and bolder antitrust, they should embrace a revised version of Easterbrook’s approach and supplement it with four additional screening mechanisms. They should intervene only (1) to address consumer harm (2) stemming from behavior that extends market power, where (3) the harm is unlikely to be addressed in a less distortive manner by another body of law or by private ordering, and (4) the intervention does not require extensive knowledge by central planners or confer a great deal of discretionary authority on government officials.

The Liquidationist ‘Genie’ Within the Eurozone’s Banking Union
Cabral, Ricardo
The Banking Union increased bank capital requirements and tightened crisis response policy instruments, favoring bank resolutions or liquidations, while hindering bank bailouts. The ECB has gained new powers as the Eurozone's main supervisory authority and as the leading 'resolution or liquidation' authority. The new framework has led to the multiplication of triggers for the application of resolution or liquidation measures. As a result, the Banking Union has had significant fiscal costs and large redistributive effects. Further, it has weakened financial stability and the 'irreversibility of the euro'.

The Roles of Capital Market Investors and Auditors in the Shared Auditor Spillover Effect
Cao, Viet Nga,Pham, Anh
This paper studies the interaction among key stakeholders (investors, managers, and auditors) in the corporate behavioral spillover through shared auditors. Upon the release of U.S. Securities and Exchange Commission comment letters on issues relating to the recognition of revenue, gains, and losses in 10-K filings, both recipients and other clients of the same auditor experience negative cumulative abnormal returns (CARs) and a higher future degree of accounting conservatism. In both comment letter recipients and non-recipients with a shared auditor, the magnitude of CARs on their stocks is positively associated with the future degree of accounting conservatism. Surprisingly, CARs on the stock of comment letter recipients predict the future degree of accounting conservatism in non-recipients with a shared auditor over and beyond CARs on the stocks of the latter. Managerâ€"shareholder incentive alignment does not affect the association between a firm’s CAR and its future degree of accounting conservatism. The results suggest the dominance of the informational intermediary role of auditors over the monitoring role of capital market investors in the shared auditor spillover effect.

The Use of Fuzzy Logic and Expert Systems for Rating and Pricing Firms: A New Perspective on Valuation
Malagoli, Stefano,Magni, Carlo Alberto,Mastroleo, Giovanni
This paper presents an expert system aimed at evaluating firms and business units. It makes us of fuzzy logic and integrates financial, strategic, managerial aspects, processing both quantitative and qualitative information. Twenty-nine value drivers are explicitly taken into account and combined together via if-then rules to produce an output. The output is a real number in the interval [0,1], representing the value-creation power of the firm. The system may be used for rating, ranking and pricing firms as well as for assessing the impact of managers' decisions on value creation and as a tool of corporate governance.

Time Spreads in China SSE 50 Options
Slivka, Ronald T.,Wang, Ruichen
Using day-end pricing data from a comprehensive data base not readily available outside of China, an algorithm to trade near-the-money call option time spreads on China’s SSE 50 ETF was developed and tested. Analysis of in-sample data, suggested profitable trading rules that, when applied to limited out-of-sample data, failed to produce superior similar results. A likely explanation for this outcome is offered. Further testing is planned. To our knowledge, there are no known related studies of SSE 50 option time spreads so this work provides a helpful addition to the growing knowledge about the developing China derivatives market. Opportunities for further research are described.

Uncertainty > Risk: Lessons for Legal Thought from the Insurance Runoff Market
Baker, Tom
Insurance ideas inform legal thought: from tort law, to health law and financial services regulation, to theories of distributive justice. Within that thought, insurance is conceived as an ideal type in which insurers distribute determinable risks through contracts that fix the parties’ obligations in advance. This ideal type has normative appeal, among other reasons because it explains how tort law might achieve in practice the objectives of tort theory. This ideal type also supports a restrictive vision of liability-based regulation that opposes expansions and supports cutbacks, on the grounds that uncertainty poses an existential threat to insurance markets. Prior work has criticized this restrictive vision on normative grounds. This article criticizes that vision on empirical grounds. The article describes an emerging secondary insurance market â€" the insurance runoff market â€" that transfers liabilities under insurance policies issued many years in the past. Starting with legacy asbestos and hazardous waste liabilities, the runoff market now extends to other insurance contracts that have not worked out well for the insurers that issued them, including workers compensation, savings-linked life insurance, pension and annuity guarantees, and long term care insurance. Runoff specialists reprice these legacy liabilities with hindsight, consolidate them and develop relevant expertise, and take calculated risks that encourage capital to enter the runoff market. That market transforms the uncertainties of the past into today’s tradeable risks, bringing into the open a dynamic that pervades all insurance markets. The promises that are made in all insurance policies get bundled and reconceptualized into sets of liabilities that are valued and revalued, further combined and redefined over time. Through the lens of the runoff market we can see many ways that insurance organizations manage uncertainty, revealing the resilience in insurance markets and the flexibility and innovation that produce that resilience. The runoff market teaches that we should give much less weight to arguments that liability reform will undermine insurance markets. Insurance already involves so much uncertainty, and insurers have so many ways to manage it, that the most likely result will always be that they will continue to muddle through.

Wall Street and Vine: Hollywood's View of Business
Ribstein, Larry E.
American films have long presented a negative view of business. This article is the first comprehensive and in-depth analysis of filmmakers' attitude toward business. It shows that it is not business that filmmakers dislike, but rather the control of firms by profit-maximizing capitalists. The article argues that this dislike stems from filmmakers' resentment of capitalists' constraints on their artistic vision. Filmmakers' portrayal of business is significant because films have persuasive power that tips the political balance toward business regulation.