Research articles for the 2020-03-09

A Closed-Form Solution for Optimal Mean-Reverting Trading Strategies
Lipton, Alex,Lopez de Prado, Marcos
When prices reflect all available information, they oscillate around an equilibrium level. This oscillation is the result of the temporary market impact caused by waves of buyers and sellers. This price behavior can be approximated through an Ornstein-Uhlenbeck (OU) process.Market makers provide liquidity in an attempt to monetize this oscillation. They enter a long position when a security is priced below its estimated equilibrium level, and they enter a short position when a security is priced above its estimated equilibrium level. They hold that position until one of three outcomes occur: (1) they achieve the targeted profit; (2) they experience a maximum tolerated loss; (3) the position is held beyond a maximum tolerated horizon.All market makers are confronted with the problem of defining profit-taking and stop-out levels. More generally, all execution traders holding a particular position for a client must determine at what levels an order must be fulfilled. Those optimal levels can be determined by maximizing the trader's Sharpe ratio in the context of OU processes via Monte Carlo experiments. This paper develops an analytical framework and derives those optimal levels by using the method of heat potentials.

Antecedents of Audit Quality in MENA Countries: The Effect of Firm- and Country-Level Governance Quality
Sarhan, Ahmed,Ntim, Collins G.,Al‐Najjar, Basil
This paper investigates the effect of firm- and country-level governance quality on audit quality, as measured by (i) auditor choice and (ii) audit fees. Our findings are three-fold. First, our evidence suggests that board independence is positively related to engaging a Big 4 auditor, while family shareholdings show a negative association with hiring a Big 4 auditor. Second, board size, board independence and director shareholdings are positively related to audit fees, while government shareholdings and family shareholdings show a negative relationship with audit fees. Third, higher country-level governance quality is positively associated with hiring a Big 4 auditor and paying higher audit fees. Overall, we provide evidence that external audit quality in Middle Eastern and North African (MENA) countries is affected by firm- and country-level governance quality, which suggests that governance quality and external audit quality seem to be complements in protecting stakeholders interests through securing higher audit quality. Our results are robust to controlling for alternative measures and endogeneities.

Antitakeover Provisions and M&A Strategy: A Causal Analysis
Carline, Nicholas F.,Gogineni, Sridhar
The protection provided by antitakeover provisions (ATPs) can be used by managers to undertake acquisitions (M&A) that either reduce their personal risk but worsen shareholder wealth, or those that increase their personal risk but enhance shareholder wealth. We exploit sources of exogeneity at the level of an investing firm and find that managers strategically increase the extent of ATPs in preparation for M&A. This pre-emptive structural change is associated with firms of lower risk, and with firms whose managers are otherwise more likely to diversify the firm away from its primary business. We find that more ATPs cause more wealth creation during M&A. Our findings highlight the importance of controlling for endogenous sample selection and support the notion that takeover protection reduces managerial myopia and benefits shareholders when it comes to determining and shaping a firm's business strategy.

Atomic Swaptions: Cryptocurrency Derivatives
James A. Liu

The atomic swap protocol allows for the exchange of cryptocurrencies on different blockchains without the need to trust a third-party. However, market participants who desire to hold derivative assets such as options or futures would also benefit from trustless exchange. In this paper I propose the atomic swaption, which extends the atomic swap to allow for such exchanges. Crucially, atomic swaptions do not require the use of oracles. I also introduce the margin contract, which provides the ability to create leveraged and short positions. Lastly, I discuss how atomic swaptions may be routed on the Lightning Network.

Bank Supervision, the Great Depression, and the Creation of the New Deal
Conti-Brown, Peter,Vanatta, Sean
The banking crises of 1930-1933 created the Great Depression and with it the momentum that remade American politics with the election of Franklin Roosevelt in 1932. Pivotal to Roosevelt’s political success was the banking holiday of 1933, an event that restarted the financial system and became a keystone of 20th century political and financial history. In the conventional contemporaneous and historical narrative of these events the holiday represents the apotheosis of high politics and presidential power. Such accounts, however, say virtually nothing about what happened during the holiday itself. We reinterpret the banking crises of the 1930s â€" before and after Roosevelt’s election â€" through the lens of bank supervision, an institutional arrangement whereby government actors structure private markets in direct, visceral, haphazard, technocratic, political, disciplined, and arbitrary ways. This reinterpretation illustrates how the union of FDR’s inimitable political skills with the technocracy of bank supervision became key to the solving the banking crisis, jumpstarting the New Deal, and bringing the country back from the brink. Placing supervision at the center of this period of economic, political, and financial transition provides key insights into the exercise of government power, including the relationship between and among legitimacy, legality, politics, finance, and â€" perhaps especially â€" what it means for a government official to exercise discretion within a broad legislative mandate. This new approach, we argue, can provide an example of other reinterpretations of political history, from the New Deal and beyond, as an act of onsite government power, interacting with but defined only partially by law and politics.

Capital Outflow Waves in the Korean Economy during Financial Turmoil: Its Implications and Policy Suggestions
Suh, Jae-Hyun
Purpose â€" This paper investigates whether financial crises could be the indicators of capital outflow waves or vice versa in Korea. Korea has experienced two severe financial crises, which are the Asian Crisis and the global financial crisis. Although there were many variables associated with these two remarkable events, one notable variable was gross capital outflows, which had significantly increased around them. Motivated by existing literature which built theoretical frameworks explaining the relationship between capital flight and financial crises, we examine the empirical evidence for this relationship. Design/methodology â€" We use panel data from 61 countries including Korea from 1980 to 2009 to study the associations between capital flight and diverse financial crises such as banking, currency, debt, and inflation crises. To be specific, we use the complementary log-log model to see whether capital outflow waves are reliable indicators for domestic financial crises. Findings â€" The results show, first, that banking, currency, and inflation crises are associated with capital flight. Second, debt crises are also associated with capital flight, but the result is not robust to different specifications. And, third, the positive associations between capital flight and crises are mainly driven by banking flows rather than FDI and portfolio flows. Originality/value â€" This paper is one of a few studies that investigates domestic (not foreign) investors’ behavior during financial turmoil. Furthermore, theoretical studies which provide contradictory explanations on the movements of gross capital outflows during financial crises emphasizes the importance of empirical evidence in this paper.

Commemorating the 50‐Year Anniversary of Ball and Brown (1968): The Evolution of Capital Market Research over the Past 50 Years
Kothari, S.P.,Wasley, Charles E.
We commemorate the 50th anniversary of Ball and Brown by chronicling its impact on capital market research in accounting. We trace the evolution of various research paths that postâ€"Ball and Brown researchers took as they sought to build on the foundation laid by Ball and Brown to create a body of research on the usefulness, timeliness, and other properties of accounting numbers. We discuss how those paths often link back to the groundwork laid and questions originally posed in Ball and Brown.

Copula-based local dependence between energy, agriculture and metal commodity markets
Claudiu Albulescu,Aviral Tiwari,Qiang Ji

This paper studies the extreme dependencies between energy, agriculture and metal commodity markets, with a focus on local co-movements, allowing the identification of asymmetries and changing trend in the degree of co-movements. More precisely, starting from a non-parametric mixture copula, we use a novel copula-based local Kendall's tau approach to measure nonlinear local dependence in regions. In all pairs of commodity indexes, we find increased co-movements in extreme situations, a stronger dependence between energy and other commodity markets at lower tails, and a 'V-type' local dependence for the energy-metal pairs. The three-dimensional Kendall's tau plot for upper tails in quantiles shows asymmetric co-movements in the energy-metal pairs, which tend to become negative at peak returns. Therefore, we show that the energy market can offer diversification solutions for risk management in the case of extreme bull market events.

Coronavirus and Financial Volatility: 40 Days of Fasting and Fear
Albulescu, Claudiu
40 days after the start of the international monitoring of COVID-19, we search for the effect of official announcements regarding new cases of infection and death ratio on the financial markets volatility index (VIX). Whereas the new cases reported in China and outside China have a mixed effect on financial volatility, the death ratio positively influences VIX, that outside China triggering a more important impact. In addition, the higher the number of affected countries, the higher the financial volatility is.

Coronavirus and financial volatility: 40 days of fasting and fear
Claudiu Albulescu

40 days after the start of the international monitoring of COVID-19, we search for the effect of official announcements regarding new cases of infection and death ratio on the financial markets volatility index (VIX). Whereas the new cases reported in China and outside China have a mixed effect on financial volatility, the death ratio positively influences VIX, that outside China triggering a more important impact. In addition, the higher the number of affected countries, the higher the financial volatility is.

Debt Covenants and Corporate Governance
Chava, Sudheer,Fang, Shunlan,Kumar, Praveen,Prabhat, Saumya
We review the recent theoretical and empirical literature on debt covenants with a particular focus on how creditor governance after covenant violations can influence the borrower's corporate policies. From the theoretical literature, we identify the key trade-offs that help explain the observed heterogeneity in covenant types, inclusion, likelihood of violation, and post violation renegotiation flexibility. Empirically, we first review the literature that deals with ex ante evidence on covenant design and the various factors that influence covenant design; we next review the ex post evidence on the impact of technical covenant violations on the borrower. We then discuss limitations of the existing theoretical and empirical studies and conclude with some directions for future research in this burgeoning area.

Disclosure Regulation and Corporate Acquisitions
Bonetti, Pietro,Duro, Miguel,Ormazabal, Gaizka
This paper examines the effect of disclosure regulation on the takeover market. We study the implementation of a recent European regulation that imposes tighter disclosure requirements regarding the financial and ownership information on public firms. We find a substantial drop in the number of control acquisitions after the implementation of the regulation, a decrease that is concentrated in countries with more dynamic takeover markets. Consistent with the idea that the disclosure requirements increased acquisition costs, we also observe that, under the new disclosure regime, target (acquirer) stock returns around the acquisition announcement are higher (lower), and toeholds are substantially smaller. Overall, our evidence suggests that tighter disclosure requirements can impose significant acquisition costs on bidders and thus slow down takeover activity.

Do Credit Card Companies Screen for Behavioural Biases?
Ru, Hong,Schoar, Antoinette
Using granular data on the contract terms and design details of more than 1.3 million credit card offers, we document how card issuers shroud unappealing, back-loaded features of an offer (e.g., high default APRs, late or over-limit fees) via the position of the information, font size, or complexity of the language used. More heavily shrouded offers that rely on back-loaded fees are also more likely to be offered to less-educated consumers. In addition, we document a novel interaction between behavioral screening and adverse selection: Using changes in state-level unemployment insurance (UI) as positive shocks to consumer creditworthiness, we show that issuers rely more on shrouded and back-loaded fees when UI increases, especially for less-educated consumers. Card issuers weigh short-term rent maximization against increased credit risk when targeting consumers' behavioral biases.

Do Informational Cascades Happen with Non-myopic Agents?
Ilai Bistritz,Nasimeh Heydaribeni,Achilleas Anastasopoulos

We consider an environment where players need to decide whether to buy a certain product (or adopt a technology) or not. The product is either good or bad but its true value is not known to the players. Instead, each player has her own private information on its quality. Each player can observe the previous actions of other players and estimate the quality of the product. A classic result in the literature shows that in similar settings information cascades occur where learning stops for the whole network and players repeat the actions of their predecessors. In contrast to the existing literature on informational cascades, in this work, players get more than one opportunity to act. In each turn, a player is chosen uniformly at random and can decide to buy the product and leave the market or to wait. We provide a characterization of structured perfect Bayesian equilibria (sPBE) with forward-looking strategies through a fixed-point equation of dimensionality that grows only quadratically with the number of players. In particular, a sufficient state for players' strategies at each time instance is a pair of two integers, the first corresponding to the estimated quality of the good and the second indicating the number of players that cannot offer additional information about the good to the rest of the players. Based on this characterization we study informational cascades in two regimes. First, we show that for a discount factor strictly smaller than one, informational cascades happen with high probability as the number of players increases. Furthermore, only a small portion of the total information in the system is revealed before a cascade occurs. Secondly, and more surprisingly, we show that for a fixed number of players, as the discount factor approaches one, bad informational cascades are benign when the product is bad, and are completely eliminated when the discount factor equals one.

Does Corporate Exposure to Weather Affect Bond Yield Spread?
Zhang, Lei,Zhu, Min
This paper studies the effect of corporate weather exposure on the cost of borrowing. We construct three firm-level measures of weather exposure â€" two obtained by regressing firm equity returns on abnormal cumulative precipitations in the firm’s headquarter state, and one by linguistically analyzing the firm’s annual reports. We show that exposure to weather risk substantially increases corporate bond yield spreads in both primary and secondary markets. The linkage from weather exposure to the cost of borrowing is explored. Tests reveal that weather risk has significant operational implications for firms, such as increased volatility of both cash flows and equity returns.

Dollar Borrowing, Firm-Characteristics, and Fx-Hedged Funding Opportunities
Gambacorta, Leonardo,Mayordomo, Sergio,Serena, José María
We explore the link between firms' dollar bond borrowing and their FX-hedged funding opportunities, as reflected in a positive corporate basis (the relative cost of local to synthetic currency borrowing). Consistent with previous research, we first document that firms substitute domestic for dollar borrowing when they have higher dollar revenues or long-term assets and when the corporate basis widens. Importantly, our novel firm-level dataset enables to show that when these funding opportunities appear, the currency substitution is stronger for very high-grade firms, as they can offer to investors close substitutes for safe dollar assets. However, firms with higher dollar revenues or long-term assets do not react to changes in the corporate basis. Altogether, the composition of dollar borrowers shifts when the basis widens, as very high-grade firms gain importance, relative to firms with operational needs.

Effect of segregation on inequality in kinetic models of wealth exchange
Lennart Fernandes,Jacques Tempere

Empirical distributions of wealth and income can be reproduced using simplified agent-based models of economic interactions, analogous to microscopic collisions of gas particles. Building upon these models of freely interacting agents, we explore the effect of a segregated economic network in which interactions are restricted to those between agents of similar wealth. Agents on a 2D lattice undergo kinetic exchanges with their nearest neighbours, while continuously switching places to minimize local wealth differences. A spatial concentration of wealth leads to a steady state with increased global inequality and a magnified distinction between local and global measures of combatting poverty. Individual saving propensity proves ineffective in the segregated economy, while redistributive taxation transcends the spatial inhomogeneity and greatly reduces inequality. Adding fluctuations to the segregation dynamics, we observe a sharp phase transition to lower inequality at a critical temperature, accompanied by a sudden change in the distribution of the wealthy elite.

Favoritism in Research Assistantship Selection in Turkish Academia
Osman Gulseven

This article analyzes the procedure for the initial employment of research assistants in Turkish universities to see if it complies with the rules and regulations. We manually collected 2409 applicant data from 53 Turkish universities to see if applicants are ranked according to the rules suggested by the Higher Education Council of Turkey. The rulebook states that applicants should be ranked according to a final score based on the weighted average of their GPA, graduate examination score, academic examination score, and foreign language skills score. Thus, the research assistant selection is supposed to be a fair process where each applicant is evaluated based on objective metrics. However, our analysis of data suggests that the final score of the applicants is almost entirely based on the highly subjective academic examination conducted by the hiring institution. Thus, the applicants GPA, standardized graduate examination score, standardized foreign language score are irrelevant in the selection process, making it a very unfair process based on favoritism.

Feverish Stock Price Reactions to the Novel Coronavirus
Ramelli, Stefano,Wagner, Alexander F.
This paper studies how markets adjust to the sudden and rapid emergence of previously neglected risks. It does so by analyzing the stock price effects of the 2019 novel Coronavirus (COVID-19) outbreak. In the last week of February 2020, many markets fell by 10% or more. The first week of March saw extreme levels of volatility worldwide. However, before these feverish whipsaw movements, we find that the market responded in a relatively orderly fashion by weighting the economic consequences of the evolving outbreak. Over the first two months of 2020, the health care industry did relatively well in China, the US, and several other countries. Transportation and Energy plummeted everywhere. Within industries, US stocks strongly exposed to the China supply chain and those with a strong export orientation towards China suffered. The time pattern in these effects is revealing: (1) A large part of the overall effect for the Chinese input exposure was realized in the first part of January (the "Incubation" phase), and part of the industry effects are already visible then. This is surprising because the first US earnings conference call that contained a discussion of "Coronavirus" took place on January 22; the fraction of companies discussing the virus steadily increased since then. Sophisticated investors following news out of China seem to have started pricing in the effects of the virus before managers or analysts started to pay attention. (2) Firms exporting to China heavily suffered only starting January 21 (though they may have suffered more and sooner if it had not been for the arguably good news contained in the "Phase 1" trade agreement between China and the US). (3) In the "Crash" week of February 24-28, firms with more exposure to China actually performed better. Substantial cross-sectional reversal took place, that is, the roles of winners and losers in the "Outbreak" phase (January 20 through February 17) tended to reverse in the "Crash" phase. These results suggest that behavioral, rather than fundamental factors such as Chinese supply chain considerations motivated investors to trade at that point. The Coronavirus represents a fearsome and novel risk. As such, it stirred feverish behavior by investors. Eerily, the contagion of the disease served as a metaphor for the contagion of information about its financial consequences. Yet, as we show, before the panic, reasonable economic expectations about sales and international trade underlay movements in the stock prices of individual firms.

Financial Crises and Innovation
Hardy, Bryan,Sever, Can
Financial crises are accompanied by permanent drops in economic growth and output. Technological progress and innovation are important drivers of economic growth. This paper studies how financial crises affect innovative activities. Using cross-country panel data on patenting at the industry-level, we identify a financial channel whereby disruptions in financial markets impact patenting activity. Specifically, we find that patenting decreases more following banking crises for industries that are more dependent on external finance. This financial channel is not at play during currency crises, sovereign debt crises, or recessions more generally, suggesting that disruption in banking activity matters for investment in innovative activities. The effect on patenting is economically large and long-lasting, resulting in less patenting, in terms of both total quantity and quality, for 10 years or longer after a banking crisis. The average patent quality, however, does not appear to decline. We show the results are not likely to be driven by reverse causality or omitted variables. These findings provide a link between banking crises and the observed patterns of lower long-term growth. Liquidity support in the aftermath of banking crises appears to help reduce the effects through the financial channel over the short term.

Foreign Banks, Liquidity Shocks, and Credit Stability
Belton, Daniel,Gambacorta, Leonardo,Kokas, Sotirios
We empirically assess the responses of banks in the United States to a regulatory change that influenced the distribution of funding in the banking system. Following the 2011 FDIC change in the assessment base, insured banks found wholesale funding more costly, while uninsured branches of foreign banks enjoyed cheaper access to wholesale liquidity. We use quarterly bank balance sheet data and a rich data set of syndicated loans with borrower and lender characteristics to show that uninsured foreign banks, which faced a relatively positive shock, engaged in liquidity hoarding. Hence, they accumulated more reserves but extended fewer total syndicated loans and became more passive in the syndicated loan deals in which they participated. These results contribute to the discussion on the role of foreign banks in credit creation, especially in a country like the United States where foreign banks also have a crucial role in managing USD money market operations at the group level.

Global Imbalances and Policy Wars at the Zero Lower Bound
Caballero, Ricardo J.,Farhi, Emmanuel,Gourinchas, Pierre-Olivier
This paper explores the consequences of extremely low real interest rates in a world with integrated but heterogenous capital markets and nominal rigidities. We establish four main results: (i) Liquidity traps spread to the rest of the world through the current account, which we illustrate with a new Metzler diagram in quantities; (ii) Beggar-thy-neighbor currency and trade wars provide stimulus to the undertaking country at the expense of other countries; (iii) (Safe) public debt issuances and increases in government spending anywhere are expansionary everywhere; (iv) At the ZLB, net issuers of safe assets experience a disproportionate share of the global stagnation.

Interest Rates Benchmark Reform and Options Markets
Piterbarg, Vladimir
We examine the impact of interest rates benchmark reform and upcoming Libor transition on options markets. We address various modelling challenges the transition brings. We specifically focus on the impact of the clearing houses' discounting switch on swaptions, and the consequences of Libor transition on Libor-in-arrears swaps, caps, and range accruals as typical representatives of a very wide range of Libor derivatives.

Malliavin-Mancino estimators implemented with non-uniform fast Fourier transforms
Patrick Chang,Etienne Pienaar,Tim Gebbie

We implement and test kernel averaging Non-Uniform Fast-Fourier Transform (NUFFT) methods to enhance the performance of correlation and covariance estimation on asynchronously sampled event-data using the Malliavin-Mancino Fourier estimator. The methods are benchmarked for Dirichlet and Fej\'{e}r Fourier basis kernels. We consider test cases formed from Geometric Brownian motions to replicate synchronous and asynchronous data for benchmarking purposes. We consider three standard averaging kernels to convolve the event-data for synchronisation via over-sampling for use with the Fast Fourier Transform (FFT): the Gaussian kernel, the Kaiser-Bessel kernel, and the exponential of semi-circle kernel. First, this allows us to demonstrate the performance of the estimator with different combinations of basis kernels and averaging kernels. Second, we investigate and compare the impact of the averaging scales explicit in each averaging kernel and its relationship between the time-scale averaging implicit in the Malliavin-Mancino estimator. Third, we demonstrate the relationship between time-scale averaging based on the number of Fourier coefficients used in the estimator to a theoretical model of the Epps effect. We briefly demonstrate the methods on Trade-and-Quote (TAQ) data from the Johannesburg Stock Exchange to make an initial visualisation of the correlation dynamics for various time-scales under market microstructure.

Mis-allocation Within Firms: Internal Finance and International Trade
Doerr, Sebastian,Marin, Dalia,Suverato, Davide,Verdier, Thierry
We develop a novel theory of mis-allocation within firms (rather than between firms) due to managers’ empire building. We introduce an in- ternal capital market into a two-factor model of multi-segment firms. We show that more open markets impose discipline on competition for capital within firms, which explains why exporters exhibit a lower conglomerate discount than non-exporters (a fact that we establish). Testing our model with data on US companies, we establish that import competition reduces mis-allocation within firms. A one standard deviation increase in Chinese imports lowers the conglomerate discount by 32% and over-reporting of costs by up to 15%.

Model independent WWR for regulatory CVA and for accounting CVA and FVA
Chris Kenyon,Mourad Berrahoui,Benjamin Poncet

Wrong way risk (WWR) is a consideration for regulatory capital for credit valuation adjustment (CVA). WWR is also of interest for pricing and accounting and in these cases must include funding as well as exposure and default in CVA and FVA calculation. Here we introduce a model independent approach to WWR for regulatory CVA and also for accounting CVA and FVA. This model independent approach is extremely simple: we just re-write the CVA and FVA integral expressions in terms of their components and then calibrate these components. This provides transparency between component calibration and CVA/FVA effect because there is no model interpretation in between. Including funding in WWR means that there are now two WWR terms rather than the usual one. Using a regulatory inspired calibration from MAR50 we investigate WWR effects for vanilla interest rate swaps and show that the WWR effects for FVA are significantly more material than for CVA. This model independent approach can also be used to compare any WWR model by simply calibrating to it for a portfolio and counterparty, to demonstrate the effects of the model under investigation in terms of components of CVA/FVA calculations.

Neural Networks with Asymptotics Control
Antonov, Alexandre,Konikov, Michael,Piterbarg, Vladimir
Artificial Neural Networks (ANNs) have recently been proposed as accurate and fast approximators in various derivatives pricing applications. ANNs typically excel in fitting functions they approximate at the input parameters they are trained on, and often are quite good in interpolating between them. However, for standard ANNs, their extrapolation behavior â€" an important aspect for financial applications â€" cannot be controlled due to complex functional forms typically involved. We overcome this significant limitation and develop a new type of neural networks that incorporate large-value asymptotics, when known, allowing explicit control over extrapolation.This new type of asymptotics-controlled ANNs is based on two novel technical constructs, a multi-dimensional spline interpolator with prescribed asymptotic behavior, and a custom ANN layer that guarantees zero asymptotics in chosen directions. Asymptotics control brings a number of important benefits to ANN applications in finance such as well-controlled behavior under stress scenarios, graceful handling of regime switching, and improved interpretability.

On Fintech and Financial Inclusion
Philippon, Thomas
The cost of financial intermediation has declined in recent years thanks to technology and increased competition in some parts of the finance industry. I document this fact and I analyze two features of new financial technologies that have stirred controversy: returns to scale and the use of big data and machine learning. I argue that the nature of fixed versus variable costs in robo-advising is likely to democratize access to financial services. Big data is likely to reduce the impact of negative prejudice in the credit market but it could reduce the effectiveness of existing policies aimed at protecting minorities.

On solutions of a partial integro-differential equation in Bessel potential spaces with applications in option pricing models
Jose Cruz,Daniel Sevcovic

In this paper we focus on qualitative properties of solutions to a nonlocal nonlinear partial integro-differential equation (PIDE). Using the theory of abstract semilinear parabolic equations we prove existence and uniqueness of a solution in the scale of Bessel potential spaces. Our aim is to generalize known existence results for a wide class of L\'evy measures including with a strong singular kernel.

As an application we consider a class of PIDEs arising in the financial mathematics. The classical linear Black-Scholes model relies on several restrictive assumptions such as liquidity and completeness of the market. Relaxing the complete market hypothesis and assuming a Levy stochastic process dynamics for the underlying stock price process we obtain a model for pricing options by means of a PIDE. We investigate a model for pricing call and put options on underlying assets following a Levy stochastic process with jumps. We prove existence and uniqueness of solutions to the penalized PIDE representing approximation of the linear complementarity problem arising in pricing American style of options under Levy stochastic processes. We also present numerical results and comparison of option prices for various Levy stochastic processes modelling underlying asset dynamics.

Online Reputation and Debt Capacity
Derrien, François,Garel, Alexandre,Petit-Romec, Arthur,Weisskopf, Jean-Philippe
This paper explores the effects of online customer ratings on debt capacity. Using a large sample of Parisian restaurants, we find a positive and economically significant relation between customer ratings and bank debt. We use the locally exogenous variation in customer ratings resulting from the rounding of scores in regression discontinuity tests to establish causality. Customer ratings affect financial policy through a reduction in cash flow risk and higher resilience to demand shocks. Restaurants with good ratings use their extra debt capacity to invest in tangible assets. Finally, favorable online ratings relax credit constraints mostly for moderately constrained restaurants.

Operational and Cyber Risks in the Financial Sector
Aldasoro, Iñaki,Gambacorta, Leonardo,Giudici, Paolo,Leach, Thomas
We use a unique cross-country dataset at the loss event level to document the evolution and characteristics of banks' operational risk. After a spike following the great financial crisis, operational losses have declined in recent years. The spike is largely accounted for by losses due to improper business practices in large banks that occurred in the run-up to the crisis but were recognised only later. Operational value-at-risk can vary substantially - from 6% to 12% of total gross income - depending on the method used. It takes, on average, more than a year for operational losses to be discovered and recognised in the books. However, there is significant heterogeneity across regions and event types. For instance, improper business practices and internal fraud events take longer to be discovered. Operational losses are not independent of macroeconomic conditions and regulatory characteristics. In particular, we show that credit booms and periods of excessively accommodative monetary policy are followed by larger operational losses. Better supervision, on the other hand, is associated with lower operational losses. We provide an estimate of losses due to cyber events, a subset of operational loss events. Cyber losses are a small fraction of total operational losses, but can account for a significant share of total operational value-at-risk.

Option Pricing with Greed and Fear Factor: The Rational Finance Approach
Svetlozar Rachev,Frank J. Fabozzi,Boryana Racheva-Iotova,Abootaleb Shirvani

We explain the main concepts of Prospect Theory and Cumulative Prospect Theory within the framework of rational dynamic asset pricing theory. We derive option pricing formulas when asset returns are altered with a generalized Prospect Theory value function or a modified Prelec weighting probability function and introduce new parametric classes for Prospect Theory value functions and weighting probability functions consistent with rational dynamic pricing Theory. We study the behavioral finance notion of greed and fear from the point of view of rational dynamic asset pricing theory and derive the corresponding option pricing formulas in the case of asset returns that follow continuous diffusion or discrete binomial trees.

Perceptions of Coronavirus Mortality and Contagiousness Weaken Economic Sentiment
Thiemo Fetzer,Lukas Hensel,Johannes Hermle,Christopher Roth

We provide the first analysis on how fear of the novel coronavirus affects current economic sentiment. First, we collect a global dataset on internet searches indicative of economic anxieties, which serve as a leading indicator of subsequent aggregate demand contractions. We find that the arrival of coronavirus in a country leads to a substantial increase in such internet searches of up to 58 percent. Second, to understand how information about the coronavirus drives economic anxieties, we conduct a survey experiment in a representative sample of the US population. We find that participants vastly overestimate mortality from and contagiousness of the virus. Providing participants with information regarding these statistics substantially lowers participants' expectations about the severity of the crisis and participants' worries regarding the aggregate economy and their personal economic situation. These results suggest that factual public education about the virus will help to contain spreading economic anxiety and improve economic sentiment.

Quantum Implementation of Risk Analysis-relevant Copulas
Janusz Milek

Modern quantitative risk management relies on an adequate modeling of the tail dependence and a possibly accurate quantification of risk measures, like Value at Risk (VaR), at high confidence levels like 1 in 100 or even 1 in 2000. Quantum computing makes such a quantification quadratically more efficient than the Monte Carlo method; see (Woerner and Egger, 2018) and, for a broader perspective, (Or\'us et al., 2018). An important element of the risk analysis toolbox is copula, see (Jouanin et al., 2004) regarding financial applications. However, to the best knowledge of the author, no quantum computing implementation for sampling from a risk modeling-relevant copula in explicit form has been published so far. Our focus here is implementation of simple yet powerful copula models, capable of a satisfactory capturing the joint tail behaviour of the modelled risk factors. This paper deals with a few simple copula families, including Multivariate B11 (MB11) copula family, presented in (Milek, 2014). We will show that this copula family is suitable for the risk aggregation as it is exceptionally able to reproduce tail dependence structures; see (Embrechts et al., 2016) for a relevant benchmark as well as necessary and sufficient conditions regarding the ultimate feasible bivariate tail dependence structures. It turns out that such a discretized copula can be expressed using simple constructs present in the quantum computing: binary fraction expansion format, comonotone/independent random variables, controlled gates, and convex combinations, and is therefore suitable for a quantum computer implementation. This paper presents design behind the quantum implementation circuits, numerical and symbolic simulation results, and experimental validation on IBM quantum computer. The paper proposes also a generic method for quantum implementation of any discretized copula.

Shorting Costs and Profitability of Longâ€"Short Strategies
Kim, Dongcheol,Lee, Byeung Joo
We examine how profitability of longâ€"short arbitrage strategies based on anomalies is affected after adjustment for two shorting costs: implicit cost due to unavailability of stocks in the short-leg to sell short and loan fee actually paid to stock lenders. The combined shorting cost amounts to almost 40 percent of gross longâ€"short arbitrage raw returns over the sample period from January 2006 to December 2017. After adjustment for these shorting costs, longâ€"short arbitrage profits are thus reduced by almost 40 percent. Even after adjustment for risk, the proportion of shorting costs is also substantial. If other trade-related transaction costs are considered, longâ€"short arbitrage profits would be reduced further. Our results provide explicit evidence that casts doubt on the profitability of long-short arbitrage strategies based on anomalies.

SkillCheck: An Incentive-based Certification System using Blockchains
Jay Gupta,Swaprava Nath

Skill verification is a central problem in workforce hiring. Companies and academia often face the difficulty of ascertaining the skills of an applicant since the certifications of the skills claimed by a candidate are generally not immediately verifiable and costly to test. Blockchains have been proposed in the literature for skill verification and tamper-proof information storage in a decentralized manner. However, most of these approaches deal with storing the certificates issued by traditional universities on the blockchain. Among the few techniques that consider the certification procedure itself, questions like (a) scalability with limited staff, (b) uniformity of grades over multiple evaluators, or (c) honest effort extraction from the evaluators are usually not addressed. We propose a blockchain-based platform named SkillCheck, which considers the questions above, and ensure several desirable properties. The platform incentivizes effort in grading via payments with tokens which it generates from the payments of the users of the platform, e.g., the recruiters and test-takers. We provide a detailed description of the design of the platform along with the provable properties of the algorithm.

Stewardship and Shareholder Engagement in Germany
Ringe, Wolf-Georg
Corporate stewardship holds great promise for the improvement of shareholder engagement and the encouragement of more responsible and long-term oriented value creation. Many countries have now adopted a best practice code for the stewardship role of institutional investors and asset managers, but Germany has so far refused to follow that trend. This paper explores the reasons for this reluctance, as well as whether the adoption of a Stewardship Code would still make sense in the regulatory framework of Germany today.Despite the increased presence of shareholder engagement (and even activism), several reasons may be put forward for why lawmakers have refused to adopt a stewardship code. This paper argues that the main political reason for this reluctance lies in the limited geographical reach of such a code, which would primarily apply to the (limited) domestic fund industry and would be unable to prescribe any meaningful principles to foreign-based asset managers. Still, I argue that the adoption of a code in the German context may make sense, for example to define expectations and to clarify the obligations of investee companies. Most importantly, it would benefit domestic investors that are typically ‘home biased’ and thereby frequently disproportionately invested in domestic funds.

Tax- and expense-modified risk-minimization for insurance payment processes
Kristian Buchardt,Christian Furrer,Thomas Møller

We study the problem of determining risk-minimizing investment strategies for insurance payment processes in the presence of taxes and expenses. We consider the situation where taxes and expenses are paid continuously and symmetrically and introduce the concept of tax- and expense-modified risk-minimization. Risk-minimizing strategies in the presence of taxes and expenses are derived and linked to Galtchouk-Kunita-Watanabe decompositions associated with modified versions of the original payment processes. Furthermore, we show equivalence to an alternative approach involving an artificial market consisting of after-tax and after-expense assets, and we establish a type of consistency with classic risk-minimization. Finally, a case study involving classic multi-state life insurance payments in combination with a bond market exemplifies the results.

The Coordination Role of Stress Tests in Bank Risk‐Taking
Corona, Carlos,Nan, Lin,Zhang, Gaoqing
We examine whether stress tests distort banks' risk‐taking decisions. We study a model in which a regulator may choose to rescue banks in the event of concurrent bank failures. Our analysis reveals a novel coordination role of stress tests. Disclosure of stress‐test results informs banks of the failure likelihood of other banks, which can reduce welfare by facilitating banks' coordination in risk‐taking. However, conducting stress tests also enables the regulator to more effectively intervene banks, coordinating them preemptively into taking lower risks. We find that, if the regulator has a strong incentive to bail out, stress tests improve welfare, whereas if the regulator's incentive to bail out is weak, stress tests impair welfare.

The Dog that Did Not Bark: Limited Price Efficiency and Strategic Nondisclosure
Zhou, Frank,Zhou, Yuqing
Theory posits that investors can rationally infer the implications of strategic nondisclosure for firm value, pressuring managers to disclose information voluntarily. This study documents that the lack of an earnings guidance predicts an abnormal return of -41 basis points around the subsequent quarterly earnings announcement, suggesting that investors do not fully incorporate the implications of nonguidance. Further analyses demonstrate that limitations in price efficiency, driven by investors' limited attention and short‐selling constraints, explain the mispricing of nonguidance and are associated with less guidance issuance. Our results collectively highlight limited price efficiency as another friction when studying managers' strategic disclosure decisions.

The Impact of Corporate’s Size on Their Common Stock’s Return: Evidence from EGX
Wagdi, Osama,Tarek, Yasmeen,Medhat , Ahmed,Mahdy, Amr,Waleed, Batool,Ashraf, Omar
The current research investigates the impact of the corporate's size of their common stock return in Egyptian exchange (EGX); the population of the study is Egyptians corporation that has been issued common stock and listed on the Egyptian Stock Exchange during the year 2019, finally, the study found an impact of corporate's size on their return; and it explain a 41% from the change on common stock's return in EGX. The study recommends that investors and portfolio managers consider the corporate's size as one of the determinants of investment weights for common stock; it's has impact of performance's portfolio, according to two dimensions are risk and return.

The Moderating Effect of Internal Control on Performance of Cross-Border M&A under the Uncertainty of Economic Policy: Evidence from China
Huang, Xiao-Lin,Chen, Guanting,Lee, Eun-Hye
Purpose â€" The purpose of this paper is to investigate the relationship between internal control, economic policy uncertainty, and performance of cross-border merger and acquisition (M&A) based on the panel data of Chinese listed firms. The authors expected that internal control has a positive moderating effect on the performance of cross-border M&A and that it mainly occurs during periods when economic policies are relatively stable. In addition, the authors tried to find out the mechanism of internal control affecting cross-border M&A and the corporate performance. Design/methodology â€" The authors tested the hypotheses by a multivariate regression model based on the panel data of Chinese listed firms from 2009 to 2017. The dependent variable is the change value of business performance (DROA_1,2,3) and the explanatory variables are cross-border M&A (MA), China’s uncertainty of economic policy (EPU), and internal control level (IC) respectively. Findings â€" The authors find that internal control has a positive moderating effect on the relationship between cross-border M&A and corporate performance. Further, the authors find that the moderating effect is more significant in state-owned enterprises and that it mainly occurs during periods when economic policies are relatively stable. Originality/value â€" This paper is the leading study that tries to analyze empirically the relationship between internal control, economic policy uncertainty, and performance of cross-border M&A. It provides a new avenue through which internal control might reasonably mitigate the risks of crossborder M&A and correspondingly improve the performance of cross-border M&A. It also confirms the moderating effect of internal control on the performance of cross-border M&A under the uncertainty of economic policy.

The Politics of M&A Antitrust
Mehta, Mihir,Srinivasan, Suraj,Zhao, Wanli
Antitrust regulators play a critical role in protecting market competition. We examine whether the political process affects antitrust reviews of merger transactions. We find that acquirers and targets located in the political districts of powerful U.S. congressional members who serve on committees with antitrust regulatory oversight receive relatively favorable antitrust review outcomes. To establish causality, we use plausibly exogenous shocks to firmâ€"politician links and a falsification test. Additional findings suggest congressional members’ incentives to influence antitrust reviews are affected by three channels: special interests, voter and constituent interests, and ideology. In aggregate, our findings suggest that the political process adversely interferes with the ability of antitrust regulators to provide independent recommendations about anticompetitive mergers.

The Relative Value of the $\delta-$Symmetric Strangle under the Black Scholes Model
Ben Boukai

In this article we propose and calculate, under the Black Scholes option pricing model, a measure of the relative value of a delta- Symmetric Strangle. The proposed measure accounts for the price of the strangle, relative to the (present value of the) spread between the two strikes, all expressed, after a natural re-parameterization, in terms of delta and a volatility parameter. We show the startling main result that under the standard BS option pricing model, this measure of relative value is a function of delta only and is independent of the time to expiry, the price of the underlying security or the prevailing volatility used in the pricing model. In fact, the simple and intuitively appealing expression for this measure allows us to study the strangle's exit strategy and the corresponding optimal choices for values of delta.

Variability in Risk-Weighted Assets: What Does the Market Think?
Santos, Edson Bastos e,Esho, Neil,Farag, Marc,Zuin, Christopher
The global financial crisis highlighted a number of weaknesses in the regulatory framework, including concerns about excessive variability in banks' risk-weighted assets (RWAs) stemming from their use of internal models. The Basel III reforms that were finalised in 2017 by the Basel Committee on Banking Supervision seek to reduce this excessive RWA variability. This paper develops a novel approach to measuring RWA variability - the variability ratio - by comparing a market-implied measure of RWAs with banks' reported regulatory RWAs. Using a panel data set comprising a large sample of internationally-active banks over the period 2001 to 16, we find that there was a wide degree of RWA variability among banks, and that market-implied RWA estimates were persistently higher than regulatory RWAs. We then assess the determinants of this variability, and find a strong and statistically-significant association between our measure of RWA variability and (i) the share of opaque assets held by banks (eg derivatives); (ii) the degree to which a bank is capital constrained; and (iii) jurisdiction-specific factors. These results suggest that market participants may be applying an 'opaqueness' premium for banks that hold highly-complex instruments, and that the incentive for banks to game their internal models is particularly acute for capital-constrained banks. The results also point to the importance of jurisdiction-specific factors in explaining RWA variability. In addition, we find that RWA variability directly affects banks' own profitability through higher funding costs. Finally, we find that the 2017 Basel III reforms - most notably the output floor - help to reduce excessive RWA variability.

Water in the Wine? Monetary Policy and the Impact of Non-bank Financial Intermediaries
Kronick, Jeremy,Wu, Yan Wendy
Canada was lauded for surviving the 2007-08 global financial crisis relatively unscathed. In part, this was due to the success of our financial services sector. This resilience, especially in contrast to the US banking sector, is partly explained by the smaller size of the non-bank financial intermediation (NBFI) sector in Canada â€" more popularly known as “shadow banking.” But signs of robust growth in Canada’s NBFI sector after the crisis suggest this resilience might be under threat. The assets of those institutions engaged in non-bank financial intermediation have continued to grow in Canada since the global financial crisis, and now account for a larger share of total financial assets than prior to the crisis. A more important NBFI sector has multiple effects on the financial system and on the economy. On the one hand, intermediaries in the sector, or NBFIs, provide alternatives for both depositors and borrowers that improve the functioning of the economy by increasing competition. On the other hand, they also might increase vulnerabilities, since they are often not as closely regulated, and deposit insurance does not cover their liabilities. We find that, as NBFI deposit growth increases in importance, it can dilute the effectiveness of monetary policy. This drag might be the result of depositors shifting between NBFIs and traditional banks, an effect that is exacerbated as the NBFI sector grows. We also find that contractionary monetary policy causes an increase in business credit growth for NBFIs and a fall in chartered bank business loan growth. Although the overall effect on business credit growth is the desired decrease, the increase in NBFI business loans both decreases monetary policy effectiveness and results in a riskier composition. Lastly, we find the insignificant effect on overall mortgage credit growth following a contractionary monetary policy shock appears to be driven by a shift of credit from traditional banks to NBFIs, and could be a concern from a financial stability perspective. Overall, these results highlight the importance of a growing NBFI sector for monetary policy and financial stability. Our findings suggest that both the traditional monetary policy tool of the overnight rate and tightening mortgage underwriting standards through macroprudential policy might have the unintended side effect of increasing financial instability. One way to reduce this potential side effect is to limit the migration of loans between traditional banks and NBFIs by tightening regulation of NBFIs to level the playing field between the two types of financial institutions. At a minimum, the systemically important NBFIs should face capital requirements and underwriting standards similar to those imposed on traditional banks. We hope these results help the Bank of Canada as it continues to evaluate and model the evolution of monetary policy transmission in the Canadian economy. To that end, NBFIs should be front and centre when the four coordinating bodies that provide systemic financial services oversight next meet.

Weighted Comonotonic Risk Sharing Under Heterogeneous Beliefs
Liu, Haiyan
We study a weighted co-monotonic risk sharing problem among multiple agents with distortion risk measures under heterogeneous beliefs. The explicit forms of optimal allocations are obtained, which are Pareto-optimal. A necessary and sufficient condition is given to ensure the uniqueness of the optimal allocation, and sufficient conditions are given to obtain an optimal allocation of the form of excess-of-loss or full insurance. The optimal allocation may satisfy individual rationality depending on the choice of the weight. When the distortion risk measure is Value-at-Risk or Tail-Value-at-Risk, an optimal allocation is generally of the excess-of-loss form. The numerical examples suggest that a risk is more likely to be shared among agents with heterogeneous beliefs, and the introduction of the weight enables us to prioritize some agents as part of a group sharing a risk.

With Regard to Local Contents Rule (Non-tariff Barriers to Trade): After Announcing the Shanghai-Hong Kong Stock Connect, is the Chinese Capital Market Suitable for Korean Investors?
Kim, Yoonmin,Jo, Gab-Je
Purpose â€" As the U.S.-China trade war has become considerably worse, the Chinese government is considering applying non-tariff barriers to trade, especially local contents rule. The main purpose of this research is to check whether it is suitable for Korean investors to invest in the current Chinese capital market. Design/methodology â€" In order to check the stability of the recent Chinese capital market, we investigated the behavior of foreign equity investment (including Korean equity investment) in the Chinese capital market after China announced the Shanghai-Hong Kong Stock Connect (SH-HK Connect). In this paper, we researched whether international portfolio investment would or would not contribute to an increase the volatility of an emerging market’s stock market (Chinese capital market) when foreign investors make investment decisions based on the objective of short-term gains by rushing into countries whose markets are booming and fleeing from countries whose markets are falling. Findings â€" The empirical results indicate that foreign investors show strong, negative feedback trading behavior with regard to the stock index of the Shanghai Stock Exchange (SSE), and when the performance of foreign investors in the Chinese stock market was fairly good. Also, we found evidence that the behavior of foreign investors significantly decreased volatility in SSE stock returns. Consequently, the SH-HK Connect brought on a win-win effect for both the Chinese capital market and foreign investors. Originality/value â€" It appeared that the Chinese capital market was very suitable for Korean investors after the China’s declaration of the SH-HK Connect. However, the win-win effect was brought on by the Chinese government’s aggressive capital control but the capital controls could possibly cause financial turmoil in the Chinese capital market. Therefore, Chinese reform in industrial structure and the financial sector should keep pace with suitable capital control policies.