# Research articles for the 2020-03-12

A Behavioral Signaling Explanation for Stock Splits: Evidence from China
Cui, Chenyu,Li, Frank Weikai,Pang, Jiaren,Xie, Deren
SSRN
We propose a behavioral signaling explanation for the positive announcement effects of stock splits. There are two key behavioral ingredients in our model. First, (retail) investors have misconceptions about stock splits that make them view stock splits as good news. Second, investors are loss-averse and will be particularly disappointed if a splitting firmâ€™s ex-post performance falls short of expectation. In a separating equilibrium, only managers with favorable private information use stock splits to signal. Using a comprehensive sample of stock splits in China over the period of 1998 to 2017, we find supporting evidence: (1) stock splits elicit positive announcement returns and a higher split ratio is associated with a stronger market reaction; (2) splitting firms have better future operating performance and more favorable analyst forecasts; (3) when future performance is poor, splitting firms experience larger price declines than non-splitting firms; (4) the announcement returns of stock splits are smaller for firms with higher institutional ownership and firms with higher pre-split prices.

A Detailed take on Fat Tail
Thakur, Sandeep
SSRN
Understanding of fat tail and its importance was very less known when it comes to the economic field. This paper makes notes from other papers and describes what all are done in the field of fat-tail.

A Mean Field Game Approach to Equilibrium Pricing with Market Clearing Condition
Masaaki Fujii,Akihiko Takahashi
arXiv

In this work, we study an equilibrium-based continuous asset pricing problem which seeks to form a price process endogenously by requiring it to balance the flow of sales-and-purchase orders in the exchange market, where a large number of agents are interacting through the market price. Adopting a mean field game (MFG) approach, we find a special form of forward-backward stochastic differential equations of McKean-Vlasov type with common noise whose solution provides a good approximate of the market price. We show the convergence of the net order flow to zero in the large N-limit and get the order of convergence in N under some conditions. We also extend the model to a setup with multiple populations where the agents within each population share the same cost and coefficient functions but they can be different population by population.

Brain-Machine Interfaces and Ethics: A Transition from Wearables to Implantable
Montalbano, Lydia
SSRN
BMI is usually described as â€œa device that translates neuronal information into commands capable of controlling external software or hardware such as a computer or robotic arm.â€. This paper explored both existing and experimental innovations in this emerging field and highlighted some related ethical concerns. As a matter of fact, such powerfull technology may potentially undermine - as well as boost - our privacy and autonomy. I conclude that the potential threats can be substantially reduced by the Legislator if the right international regulations for the society are implemented and harmonized.

Closed-form approximations with respect to the mixing solution for option pricing under stochastic volatility
Kaustav Das,Nicolas Langrené
arXiv

We consider closed-form approximations for European put option prices within several stochastic volatility frameworks with time-dependent parameters. Our methodology involves writing the put option price as an expectation of a Black-Scholes formula and performing a second-order Taylor expansion around the mean of its argument. The difficulties then faced are simplifying a number of expectations induced by the Taylor expansion. Under the assumption of piecewise-constant parameters, we derive explicit pricing formulas and devise a fast calibration scheme. Furthermore, we perform a numerical error and sensitivity analysis to investigate the quality of our approximation and show that the errors are well within the acceptable range for application purposes. Lastly, we derive bounds on the remainder term generated by the Taylor expansion.

Covariance matrix filtering with bootstrapped hierarchies
Christian Bongiorno,Damien Challet
arXiv

Statistical inference of the dependence between objects often relies on covariance matrices. Unless the number of features (e.g. data points) is much larger than the number of objects, covariance matrix cleaning is necessary to reduce estimation noise. We propose a method that is robust yet flexible enough to account for fine details of the structure covariance matrix. Robustness comes from using a hierarchical ansatz and dependence averaging between clusters; flexibility comes from a bootstrap procedure. This method finds several possible hierarchical structures in DNA microarray gene expression data, and leads to lower realized risk in global minimum variance portfolios than current filtering methods when the number of data points is relatively small.

Does Governance Travel Across Industries? A Mutual Fund Episode
Chang, Yen-Cheng,Tseng, Kevin,Yen, Chia-Yi
SSRN
We examine whether better-managed mutual funds are at the same time good corporate monitors by exploiting small changes in market capitalizations of firms around the Russell 1000 and 2000 index cutoff. Tracking error concerns force active mutual funds to buy addition stocks moving into Russell 2000. Using a regression discontinuity design, we find that increases in ownership by better-managed mutual funds leads to better overall governance with more independent directors, fewer anti-takeover measures, and more equal voting rights. Firms' operating performance also improve. Our results provide evidence that management knowledge is transmittable across industries.

Efficient Cyber Risk: Security and Competition in Financial Markets
Brolley, Michael,Cimon, David,Riordan, Ryan
SSRN
In financial markets, clients entrust their capital and data to financial infrastructure providers who are vulnerable to breaches. We develop a model in which infrastructure providers compete to provide secure and efficient client services, in the presence of a cyber-attacker. In equilibrium, provider competition leads to both lower fees and security investment, but potentially greater vulnerability, in comparison to a monopolistic platform. We find that providers prefer to consolidate into a single platform, whereas clients prefer a fragmented infrastructure. The inefficiency of consolidated providers stems from under-investment in security when the market is small, and over-investment when the market is large. Policy makers should be wary of consolidation of critical financial infrastructure, as the impacts to security do not compensate clients for the increase in fees. Instead, minimum security investment requirements may improve security in competitive environments while yielding higher utility than the comparable monopoly platform.

Electoral systems and international trade policy
Serkan Kucuksenel,Osman Gulseven
arXiv

We develop a simple theoretic game a model to analyze the relationship between electoral sys tems and governments' choice in trade policies. We show that existence of international pressure or foreign lobby changes a government's final decision on trade policy, and trade policy in countries with proportional electoral system is more protectionist than in countries with majoritarian electoral system. Moreover, lobbies pay more to affect the trade policy outcomes in countries with proportional representation systems.

Equity Term Structures without Dividend Strips Data
Giglio, Stefano,Kelly, Bryan T.,Kozak, Serhiy
SSRN
We use a large cross-section of equity returns to estimate a rich affine model of equity prices, dividends, returns and their dynamics. Using the model, we price dividend strips of the aggregate market index, as well as any other well-diversified equity portfolio. We do not use any dividend strips data in the estimation of the model; however, model-implied equity yields generated by the model match closely the equity yields from the traded dividend forwards reported in the literature. Our model can therefore be used to extend the data on the term structure of discount rates in three dimensions: (i) over time, back to the 1970s; (ii) across maturities, since we are not limited by the maturities of actually traded dividend claims; and most importantly, (iii) across portfolios, since we generate a term structure for any portfolio of stocks (e.g., small or value stocks). The new term structure data generated by our model (e.g., separate term structures for value, growth, investment and other portfolios, observed over a span of 45 years that covers several recessions) represent new empirical moments that can be used to guide and evaluate asset pricing models.

Foreign Direct Investment and the Equity Home Bias Puzzle
Blank, Sven,Hoffmann, Mathias,Roth, Moritz A.
SSRN
The vast macroeconomic literature trying to explain the widely observed equity home bias disregards internationally active firms. In a DSGE model that features the endogenous choice of firms to become internationally active through either exports or foreign direct investment (FDI), we find that the optimal equity holdings of agents are biased towards domestic firms. Our finding indicates that international diversification is not as bad as empirical measures of the equity home bias suggest.

Good News, Bad News, No News: The Media and the Cross Section of Stock Returns
Naumer, Hans-JÃ¶rg,Yurtoglu, B. Burcin
SSRN
We examine the relationship between the tonality of news flow and the cross section of expected stock returns. We use a comprehensive definition of media coverage that includes both financial newspapers and mass media, represented by TV broadcasts. Using the total news flow with positive and negative tonality, we build a Media Tonality Indicator (MTI) with higher values reflecting a more positive tonality. Our sample consists of U.S. companies that were constituents of the S&P 500 index from January 2006 to October 2016. We use MTI to sort companies into portfolios and find an average monthly return spread in the order of 3% between the most positive and the most negative MTI-portfolio. This spread amplifies further when a companyâ€™s valuation, size or ESG scores are taken into account, disappears however when we use the MTI from the previous month to sort stocks. Foresighted investors can benefit from the tonality premium in overweighting stocks with high valuation, low market capitalization or a high ESG if they expect negative news and vice versa.

How Does Firm Size Explain Cross-Country Differences in Ownership Concentration?
Moshirian, Fariborz,Thuy, Nguyen Thi,Yu, Jin,Zhang, Bohui
SSRN
Using a comprehensive international sample of 18,932 firms across 40 countries, we find that cross-country variations in ownership concentration are attributable to differences in firm sizes. Ownership concentration in large firms differs strikingly between countries. For example, large U.S. firms tend to have much more dispersed ownership structures than large non-U.S. firms. In contrast, the ownership concentration of small firms does not seem to vary across countries. Further analysis reveals that differences in ethical values and legal environments across countries can assist in explaining this cross-country variation in ownership across different firm size groups. Our results are robust to alternative blockholding proxies and firm size measures. Taken together, our findings not only provide novel and ethics-based explanations of corporate ownership structures around the world, but also potentially reconcile the presently conflicting views on whether U.S. ownership structures differ from those found elsewhere in the world.

Indemnity Payments in Agricultural Insurance: Risk Exposure of EU States
Osman Gulseven,Kasirga Yildirak
arXiv

This study estimates the risk contributions of individual European countries regarding the indemnity payments in agricultural insurance. We model the total risk exposure as an insurance portfolio where each country is unique in terms of its risk characteristics. The data has been collected from the recent surveys conducted by the European Commission and the World Bank. Farm Accountancy Data Network is used as well. 22 out of 26 member states are included in the study. The results suggest that the EuroMediterranean countries are the major risk contributors. These countries not only have the highest expected loss but also high volatility of indemnity payments. Nordic countries have the lowest indemnity payments and risk exposure.

Inf-convolution and optimal risk sharing with arbitrary sets of risk measures
Marcelo Brutti Righi
arXiv

The inf-convolution of risk measures is directly related to risk sharing and general equilibrium, and it has attracted considerable attention in mathematical finance and insurance problems. However, the theory is restricted to finite (or at most countable in rare cases) sets of risk measures. In this study, we extend the inf-convolution of risk measures in its convex-combination form to an arbitrary (not necessarily finite or even countable) set of alternatives. The intuitive principle of this approach is to regard a probability measure as a generalization of convex weights in the finite case. Subsequently, we extensively generalize known properties and results to this framework. Specifically, we investigate the preservation of properties, dual representations, optimal allocations, and self-convolution.

Investigating the influence Brexit had on Financial Markets, in particular the GBP/EUR exchange rate
Michael Filletti
arXiv

On 23rd June 2016, 51.9% of British voters voted to leave the European Union, triggering a process and events that have led to the United Kingdom leaving the EU, an event that has become known as 'Brexit'. In this piece of research, we investigate the effects of this entire process on the currency markets, specifically the GBP/EUR exchange rate. Financial markets are known to be sensitive to news articles and media, and the aim of this research is to evaluate the magnitude of impact of relevant events, as well as whether the impact was positive or negative for the GBP.

Lifting the Veil: How Do Underwriters Price Corporate Bond Offerings?
Wang, Liying
SSRN
Using newly available data on the initial bond yield, this study demonstrates that the pre-offering price formation of corporate bond (CB) offerings differs from that of equity IPOs. Specifically, CB underwriters set the initial yield to target the post-market trade yield, plus 20 bps, rather than the offering yield. Subsequently, the price update is smaller for riskier offerings, resulting in greater underpricing. Further evidence suggests that CB underwriters suffer greater pricing errors for riskier offerings, bookbuilding helps underwriters reduce pricing errors, and underwriters reward investors for their positive information production by offering greater underpricing, which provides support for bookbuilding theories.

Market Implementation of Multiple-Arrival Multiple-Deadline Differentiated Energy Services
Yanfang Mo,Wei Chen,Li Qiu,Pravin Varaiya
arXiv

An increasing concern in power systems is how to elicit flexibilities in demand, which leads to nontraditional electricity products for accommodating loads of different flexibility levels. We have proposed Multiple-Arrival Multiple-Deadline (MAMD) differentiated energy services for the flexible loads which require constant power for specified durations. Such loads are indifferent to the actual power delivery time as long as the duration requirements are satisfied between the specified arrival times and deadlines. The focus of this paper is the market implementation of such services. In a forward market, we establish the existence of an efficient competitive equilibrium to verify the economic feasibility, which implies that selfish market participants can attain the maximum social welfare in a distributed manner. We also show the strengths of the MAMD services by simulation.

Market Timing on the Johannesburg Stock Exchange
Bowler, Matthew
SSRN
Whether there are significant relationships between independent variables with future returns, of differing horizons, between 1960 and 2010 and finds, using correlation analysis, several significant relationships. These significant relationships are then included in multifactor forecast models, which are estimated using ordinary least squares regression. The findings from these estimations indicate that there is some, albeit small, portion of the market that is predictable by historic variables. Applying these forecasts to three trading strategies, this study finds that returns in excess of 6% above that of the JSE ALSI are possible.However, there are several look-ahead biases that impact on this initial result. As the beta coefficients and the specification of the model (based on relational strength between variables) are determined based on the full sample of observations, it is possible that limiting the data such that it reflects only the information available to an investor at each point in time could lead to both differing coefficients and different specifications.However, even when employing a dynamically updating model to eliminate these biases, there is still evidence of market predictability that can be profitably exploited, with an optimal combination of regression type, trading strategy and return horizon generating slightly less than 3% in excess of the JSE ALSI. Even incorporating transaction costs of 150 basis points of transaction value, it is found that it is possible to generate returns of 0.5% in excess of those of the JSE ALSI.

Multidimensional Analysis of Monthly Stock Market Returns
Osman Gulseven
arXiv

This study examines the monthly returns in Turkish and American stock market indices to investigate whether these markets experience abnormal returns during some months of the calendar year. The data used in this research includes 212 observations between January 1996 and August 2014. I apply statistical summary analysis, decomposition technique, dummy variable estimation, and binary logistic regression to check for the monthly market anomalies. The multidimensional methods used in this article suggest weak evidence against the efficient market hypothesis on monthly returns. While some months tend to show abnormal returns, there is no absolute unanimity in the applied approaches. Nevertheless, there is a strikingly negative May effect on the Turkish stocks following a positive return in April. Stocks tend to be bullish in December in both markets, yet we do not observe anya significant January effect is not observed.

Multiple Buffer CoCos and Their Impact on Financial Stability
Neamtu, Ioana
SSRN
In this paper we develop a theoretical model to investigate the effect on a bank's financial stability of having multiple contingent convertible bonds buffers (CoCos) on the same bank balance sheet, using cash-in-the-market pricing and global games methodologies. Contingent convertible bonds are meant to act as a bail-in mechanism for banks, where CoCo debt converts into equity when a bank needs it the most. We find that having CoCo buffers which trigger at different capitalisation levels can be detrimental for the CoCo bail-in capacity. Market-based triggers lead to premature conversion and fire-sales of equity. In contrast with existing literature, we show that book-based trigger CoCos yield an optimal outcome, as long as they incorporate expected credit losses.

Numerical smoothing and hierarchical approximations for efficient option pricing and density estimation
Christian Bayer,Chiheb Ben Hammouda,Raul Tempone
arXiv

When approximating the expectation of a functional of a certain stochastic process, the efficiency and performance of deterministic quadrature methods, and hierarchical variance reduction methods such as multilevel Monte Carlo (MLMC), is highly deteriorated in different ways by the low regularity of the integrand with respect to the input parameters. To overcome this issue, a smoothing procedure is needed to uncover the available regularity and improve the performance of the aforementioned methods. In this work, we consider cases where we cannot perform an analytic smoothing. Thus, we introduce a novel numerical smoothing technique based on root-finding combined with a one dimensional integration with respect to a single well-chosen variable. We prove that under appropriate conditions, the resulting function of the remaining variables is highly smooth, potentially allowing a higher efficiency of adaptive sparse grids quadrature (ASGQ), in particular when combined with hierarchical representations to treat the high dimensionality effectively. Our study is motivated by option pricing problems and our main focus is on dynamics where a discretization of the asset price is needed. Our analysis and numerical experiments illustrate the advantage of combining numerical smoothing with ASGQ compared to the Monte Carlo method. Furthermore, we demonstrate how numerical smoothing significantly reduces the kurtosis at the deep levels of MLMC, and also improves the strong convergence rate. Given a pre-selected tolerance, $\text{TOL}$, this results in an improvement of the complexity from $\mathcal{O}\left(\text{TOL}^{-2.5}\right)$ in the standard case to $\mathcal{O}\left(\text{TOL}^{-2} \log(\text{TOL})^2\right)$. Finally, we show how our numerical smoothing enables MLMC to estimate density functions, which standard MLMC (without smoothing) fails to achieve.

Nurturing Infrastructure Investments in Emerging Markets and Africa: Notes from Washington, Beijing and Riyadh
Firzli, M. Nicolas J.
SSRN
The investment choices of large asset owners such as pension funds, sovereign wealth funds and endowments, are, to a large extent â€˜guidedâ€™ and pre-determined by the systematic use of old- fashioned indices or benchmarks designed by a small set of Anglo- American â€˜index providersâ€™ â€" most notably MSCI, formerly known as Morgan Stanley Capital International (MSCI). These companies and the rather conformist investment consultants promoting their indexes tend to be unwittingly biased in favor of liquid assets in rich, developed countries e.g. the archetypal MSCI All Country World Index (ACWI) clearly encourages asset owners to allocate 55% percent (or more) of their overall (equity) assets to the United States and 8% to Japan â€" whereas these two ageing nations only represent 15% and 4% of the world economy respectively (in real terms i.e. based on purchasing-power-parity or PPP).These unfair, deeply ingrained biases have de facto forced Northern Hemisphere asset owners to over-allocate capital to the US, Germany, Japan etc., thus sucking-up much needed financial resources from the rest of the world and hurting the long-term economic interests of Asia, Africa and Latin America. The paper also explores the geo-economic and financial implications of the US-China rivalry from the perspective of long-term asset owners and the G20 Saudi Arabia Presidency in relation to the increasingly 'Asianized World Economy.'The accelerating 'Sino-American Race' could benefit pivot-nations like Kenya, Egypt, Morocco, Ivory Coast, Senegal, Angola, Madagascar in Africa, and Estonia, Romania, Cyprus, Israel, Saudi Arabia, Vietnam, Cambodia, Malaysia in the Eurasia Pacific area â€" which will be courted like never before by Washington, Brussels and Beijing â€" thus eventually adding massive public funding and risk insurance resources to the rising private capital flows coming from sophisticated asset owners based in Canada, Scandinavia, Holland, Australia and Singapore (â€œPension Superpowersâ€).

Planetary Health and the Global Financial System
Chenet, Hugues
SSRN
â€¢ The financial system is not structurally well equipped to address long-term global public goods issues like planetary health. Relying on the financial system to solve planetary health is therefore challenging.â€¢ Planetary health finance should shift current global investment flows towards economic activities compatible with planetary health; it is also important to cease financing those activities that create environmental and health problems.â€¢ Public finance has a strong role to play in planetary health to support innovation and crowd-in private actors.â€¢ The volume of available financial capital appears to be large enough to be substantially mobilised for planetary health.â€¢ Nature conservation finance is a promising approach to target concrete impact on the ground, but it may be difficult to scale to global level.â€¢ There is a need to channel capital towards planetary health and manage the related risks to the financial system, but the traditional mechanics of risk pricing cannot work in this case because markets cannot manage the fundamental uncertainty and long time horizons at stake.â€¢ A precautionary approach to the financial risks associated with planetary health is needed, as is the application of a new approach to supervision and regulation of the financial system.â€¢ Mobilizing finance for planetary health is likely to require deeper regulation of the financial system, although measures taken will strongly depend on each countryâ€™s current approach to financial regulation.

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

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.

Stochastic Dominance in Mutual Fund Returns
Jiang, Lei,Wen, Quan,Wu, Ke,Yin, Mengfan
SSRN
We find that a large portion of U.S. equity mutual funds almost second-order stochastically dominates the market portfolio. Consistent with the canonical definition of second-order stochastic dominance, both fund investors and managers reveal their preference for funds with a higher degree of almost second-order stochastic dominance through higher inflows and higher manager ownership. Funds with a higher degree of stochastic dominance over the market portfolio significantly outperform their peers, after controlling for common performance predictors and the Sharpe ratio. Inference based on stochastic dominance is more consistent with the Manipulation-Proof Performance Measure (MPPM) than with the Sharpe ratio.

The Cost of Misaligned Tax Incentives: Evidence from Tax-Motivated Special Dividends
Krupa, Trent,Utke, Steven
SSRN
Prior research finds that firms pay special dividends before dividend tax increases. We examine the real effects of this decision, finding that firms incur costs to pay these tax-motivated special dividends. Specifically, firms reduce investment and repurchases to pay tax-motivated special dividends. Further, the source of funding varies with the tax-incentives of shareholders. When the dividend is likely influenced by (tax-insensitive) institutional investors for the benefit of shareholders other than insiders, firms reduce repurchases and capital expenditures. Conversely, misaligned tax incentives between insiders and outside shareholders are associated with a reduction in R&D, consistent with managerial myopia which erodes shareholder value. Tests using total factor productivity support these conclusions. These findings add to our understanding of tax-based agency issues influencing real corporate decisions.

The Effect of the Global Financial Crisis on the Profitability of Islamic Banks in UAE
SSRN
This paper empirically analyzes the profitability of the four Islamic banks operating in the UAE during the financial period between 2004 and 2009 using three profitability indicators, return on total income, return on assets and return on equity. The researcher uses a variety of techniques, equality of means, coefficient of variation and Anova analysis to assess the effect of the financial crisis on the performance of the four specified banks. The findings show that although the financial crisis began in the 3rd quarter of 2007, its impact on the profitability of Islamic banks was most profound in 2008 and 2009 where there was a notable decline in all analyzed financial indicators. Moreover, the three indicators held a higher variability rate during the crisis years spanning 2008 to 2009 in stark contrast with the pre-crisis rates of the period spanning 2004 to 2007. Anova analysis across the four banks show significant differences between the mean of most indicators, suggesting varying performance under the adverse conditions present during the recession.

The New Public Management: Administrative Reform in Iran
Siami-Namini, Sima
SSRN
New Public Management (NPM) has become one of the dominant paradigms for public management across the world. This paper proceeds by defining NPM and giving an insight on the context within which it emerged. The paper goes on to explore essential characteristics of NPM. Thereafter, it recommends administrative reforms that need to be adopted to strengthen public administration (PA) in Iran as a case study and the challenges in implementing them. It concludes with a summary of key issues and suggestions posed in the discussion.

The Shareholder Response to Corporate Tax Planning Advice Regulation
Donohoe, Michael P.,Gale, Brian,Mayberry, Michael
SSRN
We examine the shareholder response to heightened regulation of corporate tax planning advice through the covered opinions rules under U.S. Treasury Department Circular No. 230. These rules imposed extensive due diligence obligations and drafting requirements on tax professionals for a broad range of written tax advice. Despite overwhelming criticism from tax professionals, stock returns reveal a positive shareholder response to the promulgation of the rules, equating to a \$12.33 billion increase in aggregate shareholder value. Consistent with shareholders believing that the benefits of the rules â€" deterrence of excessively risky tax planning and increased monitoring â€" would offset the burdens, we find that the shareholder response was more positive for firms with higher tax risk, weaker monitoring, and higher tax risk coupled with weaker monitoring. Overall, these findings provide new evidence that shareholders perceive regulations aiming to curtail risky tax planning differently depending on whether they target tax professionals or taxpayers.

Top-up Design and Health Care Expenditure: Evidence from Cardiac Stents
Jin, Ginger Zhe,Lien, Hsienâ€Ming,Tao, Xuezhen
SSRN
Taiwanâ€™s National Health Insurance (NHI) has adopted a top-up design for cardiac stents since 2007: the NHI covers the full cost of baseline treatment (bare-metal stents); but if a patient prefers more expensive treatments (drug-eluting stents), she must pay for the incremental cost out of pocket. Such a â€œtop-upâ€ coverage has been advocated as a good model to provide essential care for the mass population and keep the cost of health care under control. To further reduce health spending, the NHI cut the reimbursement rate of bare-metal stents (to hospitals) by 26% in January 2009. We study how hospitals responded to this price change and how such response affects the actual payment from the NHI and patients. Based on individual patient records and hospital-reported stent prices (2007-2010), we find no evidence of hospitals raising the price of drug-eluting stents. However, on average hospitals increase the number of stents per admission by 0.14 in 2009, and most of the increases are for bare metal stents. As a result, the rate cut induces about 18% more BMS usage and providers recoup up to 30% of the revenue loss in 2009 after the NHI rate cut. This suggests that the rate cut is still effective in reducing NHI expenditure on cardiac stents, despite hospital moral hazard.