Research articles for the 2020-03-13

Banks' Net Interest Margins and Interest Rate Risk: Communicating Vessels?
Chaudron, Raymond,de Haan, Leo,Hoeberichts, Marco
This study investigates the effects of a flattening of the yield curve and decreasing interest rates on the net interest margin (NIM) of 41 Dutch banks during the period 2008Q1 to 2016Q2. Our contribution to the literature is that we distinguish explicitly between net interest income from pure maturity transformation and a residual part representing market power, compensation for risks and other markups. Our results show that the residual part increased when the yield curve flattened and interest rates fell, while total NIM remained constant. In other words, banks managed to keep net interest margins more or less constant by compensating for a loss in income from maturity transformation.

Benefits of Developing Rupee Derivatives in IFSC Opportunities, Benefits & Challenges (an Exploratory Study for IFSC, India)
Shah, Dipesh,Chugan, Pawan K.
Offshore markets in a non-convertible currency, usually referred to as non-deliverable forward (NDF) markets, enable trading of the non-convertible currency outside the influence of the domestic authorities. These contracts are settled in a convertible currency, usually US Dollars, as the non-convertible currency cannot be delivered offshore. Historically, NDF markets evolved for currencies with foreign exchange convertibility restrictions and controlled access for non-residents, beginning with countries in South America like Mexico and Brazil and thereafter moving on to emerging Asian economies, viz., Taiwan, South Korea, Indonesia, India, China, Philippines, etc. The sharp growth in the offshore trading volumes in the Rupee NDF market in recent years, even beyond the volumes in the onshore markets have raised concerns around the forces that are determining the value of the rupee and the ability of authorities to ensure currency stability. An attempt has been made in this paper to identify the challenges in trading in rupee derivatives which present good opportunities for India to develop this industry. For that, the paper first discusses the global scenario of currency derivatives which is followed by the rupee derivatives trading in India and rupee derivatives in volumes in other global markets. To draw some lessons from the Chinese experience it then covers in brief the Chinese currency trading experience. This is followed by details covering challenges and opportunities for developing rupee trading in International Financial Services Centre (IFSC) in India, as IFSC is like an offshore centre from regulation and tax perspective but is on Indian shore.

Carbon Premium around the World
Bolton, Patrick,Kacperczyk, Marcin T.
This paper explores how the carbon premium varies around the world. We estimate the stock return premium associated with carbon emissions at the firm level in a cross-section of over 14,400 firms in 77 countries. We find that there is a widespread carbon premiumâ€"higher stock returns for companies with higher carbon emissionsâ€"in all sectors over three continents, Asia, Europe, and North America. Stock returns are affected by both direct and indirect emissions through the supply chain. In addition, the carbon premium has been rising in recent years. We also find widespread divestment based on carbon emissions by institutional investors around the world, but institutional investors tend to focus their divestment on foreign companies.

Corporate Governance of Banks and Financial Institutions: Economic Theory, Supervisory Practice, Evidence and Policy
Hopt, Klaus J.
Banks are special, and so is the corporate governance of banks and other financial institutions as compared with the general corporate governance of non-banks. Empirical evidence, mostly gathered after the financial crisis, confirms this. Banks practicing good corporate governance in the traditional, shareholder-oriented style fared less well than banks having less shareholder-prone boards and less shareholder influence. The special governance of banks and other financial institutions is firmly embedded in bank supervisory law and regulation. Most recently there has been intense discussion on the purpose of (non-bank) corporations. Shareholder governance and stakeholder governance have been and still are the two different prevailing regimes in the United States and in Europe, particularly in Germany. Yet for banks this difference has given way to stakeholder and, more particularly, creditor or debtholder governance, certainly in bank supervision and regulation. The implications of this for research and reform are still uncertain and controversial. The regulatory core issues for the corporate governance of banks are manifold. A key problem is the composition and qualification of the (one tier or two tier) board. The legislative task is to enhance independent as well as qualified control. Yet the proposal of giving creditors a special seat in the board disregards the reality of labor codetermination. Giving bank supervisors a permanent seat in the board would create serious conflicts of interest since they would have to supervise themselves. There are many other important special issues of bank governance, for example the duties and liabilities of bank directors in particular as far as risk and compliance are concerned, but also the remuneration paid to bank directors and senior managers or key function holders. Claw-back provisions, either imposed by law or introduced by banks themselves, exist already in certain countries and are beneficial. Much depends on enforcement, an understudied topic.

Disclosure Obfuscation in Mutual Funds
deHaan, Ed,Song, Yang,Xie, Chloe,Zhu, Christina
Mutual funds hold 31% of the U.S. equity market and comprise 61% of retirement savings, yet retail investors consistently make poor choices when selecting funds. Theory suggests that investors’ difficulty in choosing between funds is partially due to mutual fund managers creating unnecessarily complex disclosures to keep investors uninformed and obfuscate poor performance. An empirical challenge in investigating this “disclosure obfuscation” theory is isolating manipulated complexity from complexity arising from inherent differences across funds. We address this concern by examining disclosure obfuscation among S&P 500 index funds, which have largely the same risks and gross returns but charge widely different fees. Using bespoke measures designed specifically for mutual funds, we find evidence consistent with funds attempting to obfuscate high fees with unnecessarily complex disclosures. Our study improves our understanding of the role of disclosure in the mutual fund market, and of why price dispersion persists among homogenous index funds. We also discuss insights for mutual fund regulation and the academic literature on corporate disclosures.

Does the Zero Lower Bound affect Euro Area Productivity? A Case Study
Moreira, Duarte
The main research question associated with this case study is to contribute modestly to the discussion of the relationship between Zero Lower Bound (ZLB) framework and Productivity of the Euro Area, Germany and the GIIPS. The relationship between ZLB and Unit Labor Costs is also analyzed.The series analyzed correspond to the period from the first quarter of 2000 to the third quarter of 2018. The purpose of choosing this period is to maximize the quality of the analysis by addressing multiple stages of the global business cycles.To put this analysis into practice, the Vector Error Correction Model (VECM) was applied and the Granger Causality was analyzed.It is possible to conclude that only in Portugal does the ZLB affect Productivity and that the ZLB affect unit labor costs in Portugal and Spain exclusively.

Economic Policy Uncertainty, Monetary Policy Uncertainty, and Bank Earnings Opacity
Jin, Justin Yiqiang,Kanagaretnam, Kiridaran (Giri),Liu, Yi,Lobo, Gerald J.
Using a sample of U.S. banks and indices for economic policy uncertainty and monetary policy uncertainty developed by Baker et al. (2016), we investigate whether these two sources of policy uncertainty affect bank earnings opacity. When economic and monetary policies are relatively uncertain, it is easier for bank managers to distort financial information, as unpredictable policy changes make assessing the existence and impact of hidden “adverse news” more difficult for external stakeholders such as investors and creditors. Policy uncertainty also increases the fluctuation in banks’ earnings and cash flows, thus providing additional incentives and opportunities for bank managers to engage in earnings management. Our results show that uncertainty in economic policy and monetary policy are positively related to earnings opacity, proxied by the magnitude of discretionary loan loss provisions and the likelihood of just meeting or beating the prior year’s earnings, and negatively related to the level of accounting conservatism (i.e., the timeliness of recognition of bad news relative to good news). Collectively, our results suggest that economic policy uncertainty and monetary policy uncertainty lead to greater earnings opacity. We also find that the impact of policy uncertainty on financial reporting distortion is less pronounced for stronger banks (i.e., banks with high capital ratios).

Financing Sustainable Hydropower Projects in Emerging Markets: An Introduction to Concepts and Terminology
Markannen, Sanna,Plummer Braeckman,
Hydropower is the largest single renewable electricity source globally. However, many 20th century hydropower projects were developed without sufficient regard for their adverse environmental and social impacts, resulting in diminished public acceptance of such projects. Although the construction of large dams remains a politically, environmentally and socially contentious issue, hydropower is likely to play a key role in helping countries across the world to achieve the Sustainable Development Goals (SDGs) and the Paris Agreement target of limiting global warming to below 2oC. In this new context, it will be increasingly important to understand how to develop socially and environmentally sustainable hydropower projects, and how to finance them. The challenge of improved energy access that is compatible with the Paris Agreement objectives and the SDGs will affect developing countries in particular. The purpose of this Working Paper is to introduce the key terms and concepts that are relevant to finance for sustainable large hydropower projects in Non-OECD countries/emerging markets. It is designed to address the needs of readers with little or no prior knowledge of either finance or hydropower, as well as those with limited experience in one of the two topics, but extensive background in the other (such as a hydropower specialist with an engineering background, but limited familiarity with financial concepts and terminology). The three main parts of the paper provide an overview of hydropower development process, hydropower finance, and risk and risk mitigation. Each of the three sections identifies the key actors and instruments, and defines their roles and purpose. The paper does not seek to engage in any detailed analysis of the various and often complex, value-laden questions surrounding hydropower. Instead, it aims to serve as a reference document to help readers better engage with the complex material on hydropower development and finance.

Growth Opportunities, Information Asymmetry, and Dividend Payout: Evidence from Mandatory IFRS Adoption
Chakraverty, Arkaja,Agarwal, Nishant
We study changes in firms’ dividend policies in response to an exogenous improvement in the information environment, enabled by IFRS adoption, between investors and firms. We document that the relationship between information asymmetry reduction and dividend payout policy is not monotonic but in fact depends upon a firm’s underlying growth opportunities. Following mandatory adoption of IFRS, firms with low growth opportunities exhibit a higher propensity to pay dividends. Conversely, those firms with high growth opportunities exhibit reduced propensity to pay dividends. These results are also consistent for dividend payout ratio. Together, they suggest that a firm’s growth rate plays a key role in determining the effect of an improved information environment on the firm’s dividend policies.

High Frequency Trading Strategy for the 30 Year Treasury Bond
Decrem, Peter,Stoikov, Sasha,Shen, Shuo,Yin, Jiaxin,Hua, Yikai,Li, Tengxiao,Fang, Zhengyi,Huang, Yunze,Basco, Colin
We construct new features based on order book data and separate them into three groups, e.g., time-insensitive features, time-sensitive features and cointegration features. For time-insensitive features, we applied serval transformation on imbalance in different levels, and some other features based on order book data. For time-sensitive features, we constructed features with historic information. Besides, we extracted information about deleting and adding order book to construct features on it. For cointegration, we applied linear regression, online regression and Kalman filter to both the treasury data and the corresponding futures data to construct cash and futures cointegration features separately. Then, we predicted the fair-price for each quote given each single feature and combination of features. At last, we designed two smart algorithms to trade 30 Year Treasury Bond given the predicted fair-price. We found that combination features from different groups can help to reduce transaction cost by 95% compared with one tick-size. We believe that the new features we constructed can extract more information from order book, and can be very effective for trading strategies.

In God We Trust: Religiosity, Religions, and Capital Structure Choice
Gill, Balbinder Singh
The empirical impact of religiosity on leverage is unclear. I provide causal evidence that this unclarity is due to lack of control for the concentration of religions with different views on the usage of corporate debt in previous studies. Utilizing a worldwide sample, I identify and verify the causal relationship using earthquake events that and its descriptive parameters as instruments for the endogenous religious variables. I find that the concentration of religions is able to completely reverse the positive impact of religiosity on leverage when the concentration of religions is greater than or equal to 50%.

Libra or Librae? Basket Based Stablecoins to Mitigate Foreign Exchange Volatility Spillovers
Giudici, Paolo,Pagnottoni, Paolo,Leach, Thomas
The paper aims to assess, from an empirical viewpoint, the advantages of a stablecoin whose value is derived from a basket of underlying currencies, against a stablecoin which is pegged to the value of one major currency, such as the dollar. To this aim, we first find the optimal weights of the currencies that can comprise our basket. We then employ volatility spillover decomposition methods to understand which foreign currency mostly drives the others. We then look at how the stability of either stablecoin is affected by currency shocks, by means of VAR models and impulse response functions. Our empirical findings show that our basket based stablecoin is less volatile than all single currencies. This results is fundamental for policy making, and especially for emerging markets with a high level of remittances: a librae (basket based stable coin) can preserve their value during turbolent times better than a libra (single currency based stable coin).

Long-Term Health Insurance: Theory Meets Evidence
Atal, Juan Pablo,Fang, Hanming,Karlsson, Martin,Ziebarth, Nicolas R.
To insure policyholders against contemporaneous health expenditure shocks and future reclassification risk, long-term health insurance constitutes an alternative to community-rated short-term contracts with an individual mandate. Relying on unique claims panel data from a large private insurer in Germany, we study a real-world long-term health insurance application with a life-cycle perspective. We show that German long-term health insurance (GLTHI) achieves substantial welfare gains compared to a series of risk-rated short-term contracts. Although, by its simple design, the premium setting of GLTHI contract departs significantly from the optimal dynamic contract, surprisingly we only find modest welfare differences between the two. Finally, we conduct counterfactual policy experiments to illustrate the welfare consequences of integrating GLTHI into a system with a “Medicare-like” public insurance that covers people above 65.

Mapping the evolving complexity of large hydropower project finance in low and lower-middle income countries
Plummer Braeckman, ,Markannen, Sanna,Souvannaseng, Pon
The structure and key actors involved in large hydropower project financing in low and lower-middle income countries (LICs and L-MICs) has changed considerably over the past 50 years. Exclusively publicly funded hydropower projects, typically financed by the host country government with support from multilateral development banks (MDBs), have become less common, while public-private-partnerships (PPPs) and new forms of bilateral finance arrangements have become more prevalent. However, purely privately financed projects with no public or MDB finance remain unusual in large hydropower projects in LICs and L-MICs. This paper traces the evolution and complexity of hydropower financing from the early 1970s to the present day, showing how the types and roles of various actors have changed over time and how new types of financing packages have surfaced to meet the growing need for large energy infrastructure projects in LICs and L-MICs. It focuses on the three most commonly used models of hydropower project financing in LICs and L-MICs: fully public finance, PPPs, and new bilateral finance. Examples from LICs and L-MICs are used to illustrate the ‘typical’ features of each financing models, as well as their strengths and limitations. Projects developed through PPPs often involve a complex mix of investors and lenders from both public and private sectors, as well as guarantees from MDBs and other risk mitigation measures. New forms of bilateral financing arrangements signal a return to ‘simpler’ financing models akin to the fully public projects in the pre-2000s, but typically involve a different type of contractual arrangements and sources of origin. Although ‘new’ bilateral finance is issued by many countries, including some OECD countries, the predominant position of China in this field has resulted in ‘new’ bilateral finance often being referred to as ‘Chinese finance’.

Optimal ESG Portfolios: An Example for the Dow Jones Index
Schmidt, Anatoly B.
Mean variance portfolio theory is expanded to accommodate investors’ preferences for the portfolio ESG value (PESGV). Namely, PESGV is added to the minimizing objective function so that portfolio weights are simultaneously optimized in terms of returns, risk (volatility), and PESGV. PESGV is assumed proportional to the sum of portfolio constituents’ weighted ESG scores and is controlled by the ESG strength parameter. A portfolio formed with 29 constituents of the Dow Jones Index in 2015 â€" 2019 is considered as an example. The MSCI ESG ratings are chosen for estimating PESGV. It is found that higher PESGVs yield more concentrated portfolios and lower Sharpe ratios. Partial correlations based portfolios are more diversified and have higher PESGVs than the Pearson’s correlations based portfolios.

Shapley-Lorenz Decompositions in eXplainable Artificial Intelligence
Giudici, Paolo,Raffinetti, Emanuela
Explainability of artificial intelligence models has become a crucial issue, especially in the most regulated fields, such as health and finance. In this paper, we provide a global explainable AI model which is based on Lorenz decompositions, thus extending previous contributions based on variance decompositions. This allows the resulting Shapley Lorenz decomposition to be more generally applicable, and provides a unifying variable importance criteria that combines predictive accuracy with explainability, using a normalised and easy to interpret metric. The proposed decomposition is illustrated within the context of a real financial problem: the prediction of bitcoin prices.

Should the Modern Corporation Maximize Shareholder Value?
Bhagat, Sanjai,Hubbard, R. Glenn
The modern corporation should maximize shareholder value. To strengthen the prospects for success of long-term shareholder value maximization, we suggest steps to align shareholder wealth maximization with stakeholder interests: First, antitrust public policies should be vigorously enforced to maintain and enhance competition in product markets and labor markets. Second, management and board compensation should be reformed to focus on creating and sustaining long-term shareholder value. Third, the Business Roundtable and other organizations should reconsider their policy of applying direct and indirect pressure on corporations to focus on non-shareholder priorities. Because public corporations are more susceptible to such pressure, it could be an impetus to companies to go private or not go public. Recent evidence suggests fewer public companies leads to more concentrated product markets, with the increased likelihood of diminished competition in these product and labor markets. Finally, and more importantly, for many of society’s more serious problems, corporations do not represent the appropriate level of action. Climate change, for example, poses significant challenges for societies and businesses. But significant changes to combat climate change require public policy changes in the United States and abroad. Turning more to corporations because the political process seems broken won’t do.

Tax-Efficient Portfolio Transition: A Tax-Aware Relaxed-Constraint Approach to Switching Equity Managers
Sosner, Nathan,Krasner, Stanley
For a taxable investor with a highly appreciated equity portfolio, replacing the portfolio manager is likely to trigger substantial tax liabilities. We focus on transitioning an appreciated equity portfolio to an actively managed strategy. We compare transition from an appreciated portfolio to a traditional long-only tax-agnostic equity strategy with transition to equity strategies utilizing more advanced portfolio management techniques such as tax-aware rebalancing and relaxed-constraint portfolio construction. We find that transition to a tax-aware relaxed-constraint strategy results in both high implementation efficiency and tax efficiency both during and after the transition. As a result, a tax-aware relaxed-constraint post-transition strategy significantly outperforms a traditional tax-agnostic long-only strategy in its ability to preserve and grow the investors after-tax wealth over the long term. We also discuss risks and limitations of the tax-aware relaxed-constraint approach.

The Determinants of IPO Withdrawals: Evidence From SPACs
Dimic, Nebojsa,Lawrence, Edward R.,Vulanovic, Milos
This study examines the determinants of IPO withdrawal using a unique sample of Specified Purpose Acquisition Companies (SPACs) in the period 2003-2019. Our results show that both prospectuses' characteristics and market characteristics determine choices of withdrawal. The likelihood of withdrawals is in direct relation with the level of volatility on the day of IPO/withdrawal and if the acquisition target is in the private equity domain. SPACs are less likely to withdraw their IPO if they have a clear focus of acquisition, have a larger number of underwriters in the syndicate, and if their legal counsel is specialized in the SPAC market. We also document that the speed of IPO for SPACs is directly related to the level of the market, size of IPO, and if the CEO was previously manager of other public companies. On the other side, IPO takes longer if two lead underwriters underwrite SPAC.

Tweeting on Monetary Policy and Market Sentiments:The Central Bank Surprise Index
Masciandaro, Donato,Romelli, Davide,Rubera, Gaia
This paper explores the relationship between central bank communication and market sentiment,and proposes a new measure. Market sentiment is proxied using a Twitter-based metric: theCentral Bank Surprise Index. The empirical study covers three cases: the Federal Reserve, theEuropean Central Bank and the Bank of England.