Research articles for the 2020-02-23

A New Decomposition Ensemble Approach for Tourism Demand Forecasting: Evidence from Major Source Countries
Chengyuan Zhang,Fuxin Jiang,Shouyang Wang,Shaolong Sun

The Asian-pacific region is the major international tourism demand market in the world, and its tourism demand is deeply affected by various factors. Previous studies have shown that different market factors influence the tourism market demand at different timescales. Accordingly, the decomposition ensemble learning approach is proposed to analyze the impact of different market factors on market demand, and the potential advantages of the proposed method on forecasting tourism demand in the Asia-pacific region are further explored. This study carefully explores the multi-scale relationship between tourist destinations and the major source countries, by decomposing the corresponding monthly tourist arrivals with noise-assisted multivariate empirical mode decomposition. With the China and Malaysia as case studies, their respective empirical results show that decomposition ensemble approach significantly better than the benchmarks which include statistical model, machine learning and deep learning model, in terms of the level forecasting accuracy and directional forecasting accuracy.

Asymptotic Marginal Propensity to Consume
Qingyin Ma,Alexis Akira Toda

We prove that the consumption functions in income fluctuation problems are asymptotically linear if the marginal utility is regularly varying. We also analytically characterize the asymptotic marginal propensities to consume (MPCs) out of wealth and derive necessary and sufficient conditions under which they are 0, 1, or are somewhere in between. When the return process with time-varying volatility is calibrated from data, the asymptotic MPCs can be zero with moderate risk aversion. Our results potentially explain why the saving rates among the rich are positive and increasing in wealth.

CDS Channels of Influence on Discretionary Accruals
Cheng, Hao,Lim, Kian Guan
This paper finds that the initiation of trading in credit default swaps (CDS) improves earnings quality by reducing absolute abnormal earnings accruals through specific channels in CDS firms. CDS initiation brought about more private information discovery via financial analysts, cross-market speculators, and hedgers. New results indicate that the channels of reduction in discretionary accruals are through a firm's high accounts payable and low cash holdings related to negative accruals and trade credit exposures. The high discretionary accruals compel the firm to improve cash holdings, cash flows, and working capital when probability of default increases. In the longer run, this leads to higher EPS and improved firm value. Thus the generation of public information via CDS market reduces information asymmetry in the context of the trade credit market and enforces greater discipline in discretionary accounts reporting.

Corporate Board Reforms Around the World and Stock Price Crash Risk
Hu, Jinshuai,Li, Siqi,Taboada, Alvaro G.,Zhang, Feida
We examine the impact of corporate board reforms around the world on stock price crash risk. Using a sample of firms in 41 economies that passed major board reforms between 1990 and 2012, we find that board reforms are associated with a significant reduction in crash risk of about 13%. The effect of reforms on crash risk is stronger among firms with more severe ex ante agency problems. Our analysis further suggests that board reforms reduce crash risk by improving financial transparency and enhancing investment efficiency. In sum, our findings are consistent with the notion that board reforms improve board oversight and mitigate agency problems.

Do the Q-Factors Proxy for Surprises in Economic State Variables?
Oad Rajput, Suresh Kumar,Ilyas, Muhammad
In this paper, we investigate whether q-factors, ME, I/A, and ROE correlates the surprises in economic state variables that describe the changes in investment opportunities within the Intertemporal CAPM framework. The paper shows that ME, I/A, and ROE significantly correlate with the surprises in economic state variables. In particular, we find that ME correlates with the surprises in default spread, term spread, and treasury-bill yield; while I/A is related to the surprises in aggregate dividend yield. The profitability factor ROE correlates with surprises in term spread and default spread. These findings suggest that the q-factors are related to the surprises in economic state variables. We also show that for each portfolio formation, loadings on surprises in economic state variables resemble the loadings or a mirror image of loading on q-factors. These findings suggest that the q-factors may act as a proxy for the surprises in economic state variables that describe the changes in the investment opportunity set. The paper adds more insights to the ongoing debate on the theoretical justification of q-factors ME, I/A, and ROE.

Does Competition Enhance Double Bottom Line Performance in Microfinance Institutions?
Hossain, Shahadat,Galbreath, Jeremy,Hasan, Mostafa Monzur,Randoy, Trond
This paper investigates how competition affects the double-bottom-line performance of microfinance institutions (MFIs). While classical economic theory highlights that competition enhances efficiency and benefits both customers and firms, we argue that this is unlikely to apply to institutions operating in socially oriented industries, such as microfinance. Using a cross-country dataset of 4,576 MFI-year observations (1,139 unique MFIs) operating in 59 countries over a 10-year period (2005â€"2014), we find that competition has an adverse effect on MFIs’ economic sustainability and that competition undermines their breadth of outreach but enhances their depth of outreach. These results are robust to alternative specifications of competition and to the use of a two-stage least squares (2SLS) analysis to alleviate the endogeneity concern. The findings from our analysis have important implications when considering the regulation of MFI competition, especially in the light of the recent turmoil of MFI markets in some developing countries.

Efficient Minimum Distance Estimation of Pareto Exponent from Top Income Shares
Alexis Akira Toda,Yulong Wang

We propose an efficient estimation method for the income Pareto exponent when only certain top income shares are observable. Our estimator is based on the asymptotic theory of weighted sums of order statistics and the efficient minimum distance estimator. Simulations show that our estimator has excellent finite sample properties. We apply our estimation method to U.S. top income share data and find that the Pareto exponent has been stable at around 1.5 since 1985, suggesting that the rise in inequality during the last three decades is mainly driven by redistribution between the rich and poor, not among the rich.

Failure to Share Natural Disaster Risk
Tomunen, Tuomas
I test whether asset prices reflect the preferences of financial intermediaries in a setting that is well suited to tackling concerns about omitted risk factors. I analyze catastrophe bonds whose cash flows are linked to the occurrence of natural disasters and find that 71% of the variation in their expected returns can be explained by a theoretically-motivated measure of financial intermediaries' marginal rate of substitution. Assuming that natural disasters are independent of aggregate wealth, this pricing result is inconsistent with any explanation based on macroeconomic risk factors. However, the result is consistent with intermediary asset pricing models suggesting that financial intermediaries are marginal investors in capital markets. I also show that the premium on natural disaster risk has decreased significantly in recent years and has become less responsive to the occurrence of disasters, suggesting that intermediaries' access to outside capital has improved over time.

Financial Innovations and the Curse of Safety
Siddiqi, Hammad,Anwar, Sajid
We show that financial innovations, by letting firms benefit from safe cash flows in new ways, potentially cause a misallocation of resources at the firm level with low net present value (NPV) projects (with larger amounts of safe cash flows) getting preference over high NPV projects. Even negative NPV projects may be accepted. Such financial innovations benefit large firms (with large cash flows) more than small firms; hence, they widen the value-gap between leader and follower firms. These results indicate that productivity slowdown and the rise of superstar firms are not independent phenomena, rather they share the same underlying cause: Financial innovations letting firms benefit from safe cash flows. We show that misallocation towards low NPV projects gets worse as interest rates approach zero. The value-gap between large and small firms also increases as interest rates approach zero. These results cast doubt on the effectiveness of monetary policy in a low interest rate environment.

Network VAR Models to Measure Financial Contagion
Ahelegbey, Daniel Felix,Giudici, Paolo,Hashem, Shatha Qamhieh
Financial contagion among countries can arise from different channels, the most important of which are financial markets and bank lending. The paper aims to build an econometric network approach to understand the extent to which contagion spillovers (from one country to another) arise from financial markets, from bank lending, or from both. To achieve this aim we consider a model specification strategy which combines Vector Autoregressive models with network models. The paper contributes to the contagion literature with a model that can consider bank exposures and financial market prices, jointly and not only separately. From an empirical viewpoint, our results show that both bilateral exposures and market prices act as contagion channels in the transmission of shocks arising from a country to international financial markets. While the impact of the former is more stable in time, the latter is more volatile and reacts to a wider variety of events.

Quantifying Systemic Risk Using Bayesian Networks
Sourabh, Sumit,Hofer, Markus,Kandhai, Drona
We develop a novel framework using Bayesian networks to capture distress dependence in the context of counterparty credit risk. This allows us to calibrate the probability of distress of an entity conditional on the distress of a different entity. We apply our methodology to wrong-way risk model proposed by Turlakov and stress scenario testing. Our results show that stress propagation in an interconnected financial system can have a significant impact on counterparty credit exposures.

Rational choice hypothesis as X-point of utility function and norm function
Takeshi Kato,Yasuyuki Kudo,Junichi Miyakoshi,Jun Otsuka,Hayato Saigo,Kaori Karasawa,Hiroyuki Yamaguchi,Yasuo Deguchi

Towards the realization of a sustainable, fair and inclusive society, we propose a novel decision-making model that incorporates social norms in a rational choice model from the standpoints of deontology and utilitarianism, and make a hypothesis that interprets choice of action as the X-point for individual utility function increasing with actions and social norm function decreasing with actions. This hypothesis is based on humans balancing the value of utility and the value of norms psychologically in choosing actions. Using the hypothesis and approximation, we were able to isolate and infer utility function and norm function from real-world measurement data of actions on environmental conditions, and elucidate the interaction between the both functions to lead actions from current to target. As examples of collective data that aggregate decision-making of individuals, we looked at the changes in power usage before and after the Great East Japan Earthquake and the correlation between national GDP and CO2 emission in different countries. The first example is interpreted that the benefits for power (i.e., utility of power usage) is stronger than the power usage restrictions imposed by norms after the earthquake, contrary to our expectation. The second example is interpreted that the reduction of CO2 emission in each country is not related to utility derived from GDP but to norms related to CO2 emission. Going forward, we will apply this new X-point model to actual social practices involving normative problems, and design the approaches for the diagnosis, prognosis, and intervention of social systems (individual action, inter-individual interaction, and institution) by IT systems.

Regional inequality simulations based on asset exchange models
Takeshi Kato,Yasuyuki Kudo,Hiroyuki Mizuno,Yoshinori Hiroi

To gain insights into the regional inequality problem, we proposed new regional asset exchange models based on existing kinetic income-exchange models in economic physics by setting spatial exchange range and adding bias to asset fraction probability in equivalent exchanges. Simulations of asset distribution and Gini coefficients showed that suppressing regional inequality requires, first, increasing the intra-regional economic circulation rate, and, second, narrowing down the exchange range (inter-regional economic zone). Avoiding overconcentration of assets due to repeated exchanges, however, requires, thirdly, adding local support bias (distribution norm). A comprehensive solution incorporating these three measures enabled shifting the asset distribution from overconcentration to exponential distribution, eventually approaching the normal distribution and further reducing the Gini coefficient. Going forward, we will further expand the models by setting production capacity based on assets, path dependency on two-dimensional space, and bias according to disparity, and verify measures to reduce regional inequality in actual communities.

Responsible Institutional Investing Around the World
Gibson , Rajna,Glossner, Simon,Krueger, Philipp,Matos, Pedro,Steffen, Tom
We explore a novel survey on responsible investing by institutional investors around the world and match it to archival data on equity portfolio holdings. We document that institutions that commit to responsible investing exhibit different environmental, social and governance (ESG) portfolio-level scores but this is not the case for US-domiciled institutions. We also examine if different ESG implementation strategies (e.g., screening, integration, engagement) affect portfolio-level ESG scores but find limited evidence. Finally, we find that responsible investing does not enhance portfolio returns but acts more as a risk mitigation tool.

Sector connectedness in the Chinese stock markets
Ying-Ying Shen,Zhi-Qiang Jiang,Jun-Chao Ma,Gang-Jin Wang,Wei-Xing Zhou

Uncovering the risk transmitting path within economic sectors in China is crucial for understanding the stability of the Chinese economic system, especially under the current situation of the China-US trade conflicts. In this paper, we try to uncover the risk spreading channels by means of volatility spillovers within the Chinese sectors using stock market data. By applying the generalized variance decomposition framework based on the VAR model and the rolling window approach, a set of connectedness matrices is obtained to reveal the overall and dynamic spillovers within sectors. It is found that 17 sectors (mechanical equipment, electrical equipment, utilities, and so on) are risk transmitters and 11 sectors (national defence, bank, non-bank finance, and so on) are risk takers during the whole period. During the periods with the extreme risk events (the global financial crisis, the Chinese interbank liquidity crisis, the Chinese stock market plunge, and the China-US trade war), we observe that the connectedness measures significantly increase and the financial sectors play a buffer role in stabilizing the economic system. The robust tests suggest that our results are not sensitive to the changes of model parameters. Our results not only uncover the spillover effects within the Chinese sectors, but also highlight the deep understanding of the risk contagion patterns in the Chinese stock markets.

Stability of the indirect utility process
Oleksii Mostovyi

We investigate the dynamic stability of the indirect utility process associated with a (possibly suboptimal) trading strategy under perturbations of the market. Establishing the reverse conjugacy characterizations first, we prove continuity and first-order convergence of the indirect-utility process under simultaneous perturbations of the finite variation and martingale parts of the return of the risky asset.

Stochastic Dynamic Utilities and Inter-Temporal Preferences
Marco Maggis,Andrea Maran

We propose an axiomatic approach which economically underpins the representation of dynamic preferences in terms of a stochastic utility function, sensitive to the information available to the decision maker. Our construction is iterative and based on inter-temporal preference relations, whose characterization is inpired by the original intuition given by Debreu's State Dependent Utilities (1960).

Sustainability and fairness simulations based on decision-making model of utility function and norm function
Takeshi Kato,Yasuyuki Kudo,Junichi Miyakoshi,Jun Otsuka,Hayato Saigo,Kaori Karasawa,Hiroyuki Yamaguchi,Yoshinori Hiroi,Yasuo Deguchi

We introduce a decision-making model based on value functions that include individualistic utility function and socio-constructivistic norm function, and propose a norm-fostering process that recursively updates norm function through mutual recognition between the self and others. As an example, we will look at the resource-sharing problem typical of economic activities and assume the distribution of individual actions to define the (1) norm function fostered through mutual comparison of value/action ratio based on the equity theory (progressive tax-like), (2) norm function proportional to resource utilization (proportional tax-like) and (3) fixed norm function independent of resource utilization (fixed tax-like). And, by carrying out numerical simulation, we will show that the progressive tax-like norm function (i) does not increase disparity for the distribution of the actions, unlike the other norm functions, and (ii) has high resource productivity and low Gini coefficient, i.e., the progressive tax-like norm function has the highest sustainability and fairness.

Terrorism Risk Insurance Act: Time to Renew . . . or Rethink?
Thomas, Jeffrey E.
This paper summarizes the U.S. program for terrorism insurance, outlines its advantages and disadvantages, and describes the current proposals for extension of the program. The program, generally referred to as a “Federal Backstop,” functions in some ways that are similar to reinsurance, but it does not require participants to pay premiums ex ante. Instead uses an ex post recoupment mechanism to recover some or all of the Federal payments made under the program. This approach has the advantage of reducing the cost and increasing the availability of terrorism insurance. Some have criticized the program for its interference in market mechanisms, but the program facilitated the development of the market underneath the backstop. The program does not cover NBCR risk, and some types of insurance are excluded. In addition, the program does not preempt state price regulation or the mandated use of the standard fire insurance policy, which provides coverage for ensuing fires after terrorism events. These weaknesses are not addressed by current proposed legislation to extend the program for seven years without any changes. The strong, bipartisan support for the proposed legislation suggests that it is likely to pass.

The Role of Pension Business Benefits in Institutional Block Ownership and Corporate Governance
Huang, Jing,Matsunaga, Steven R.,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.

Volatility has to be rough
Masaaki Fukasawa

First, we give an asymptotic expansion of short-dated at-the-money implied volatility that refines the preceding works and proves in particular that non-rough volatility models are inconsistent to a power law of volatility skew. Second, we show that given a power law of volatility skew in an option market, a continuous price dynamics of the underlying asset with non-rough volatility admits an arbitrage opportunity. The volatility therefore has to be rough in a viable market of the underlying asset of which the volatility skew obeys a power law.