Research articles for the 2020-03-18

A Model-Based Fiscal Taylor Rule and a Toolkit to Assess the Fiscal Stance
Fournier, Jean-Marc,Lieberknecht, Philipp
This paper presents a model-based fiscal Taylor rule and a toolkit to assess the fiscal stance, defined as the change in the structural primary balance. This is built on the normative buffer-stock model of the government (Fournier, 2019) which includes key channels like hysteresis, cycle-dependent multipliers and a risk premium. A simple fiscal Taylor rule prescribes the fiscal stance as a function of past government debt, past output gap and the past structural primary balance. Applications suggest several advanced economies could have better managed their fiscal stance over the last 20 years. Simulations provide fiscal stance recommendations over the medium-term.

Auditors’ Responses to Asset Redeployability
Gul, Ferdinand A,Lai, Karen,Li, Tongxia,Pittman, Jeffrey
This study shows that auditors are more likely to charge higher audit fees, issue false-positive going concern opinions (i.e., Type I error), and resign from high asset redeployability (AR) firms. In supplemental tests, we use path analysis to show that the significant associations between AR and auditor responses can be explained by higher inherent risk (earnings management and abnormal asset sales) and audit business risk (misstatements and litigation risk). Collectively, our results suggest that auditors tend to react conservatively when firms are associated with high AR.

Bank Capital Structure and Tail Risk
Vissers, Suzanne
This paper presents a continuous-time bank capital structure model in which the bank's assets are subject to both diffusion and tail risk. The latter causes uninsured deposits to be risky, as the bank's assets can jump below the threshold at which it is optimal for depositors to run. The model shows that tail risk, rather than diffusion risk, is the main driver of the credit spread on deposits when the bank is unregulated and of the endogenous deposit insurance premium when the bank is regulated. Keeping total volatility constant, the model shows that an increase in tail risk leads to higher credit spreads and bankruptcy costs than an increase of diffusion risk. Furthermore, a bank with frequent but small asset jumps is safer than one with infrequent but large asset jumps.

Barbados' 2018-19 Sovereign Debt Restructuring-A Sea Change?
Anthony, Myrvin,Impavido, Gregorio,van Selm, Bert
This paper examines the causes, processes, and outcomes of Barbados' 2018-19 sovereign debt restructuring-its first ever. The restructuring was comprehensive, featuring several rarely used approaches, including the restructuring of treasury bills, and the use of a retrofitted collective action mechanism. The debt restructuring has helped to set Barbados' public debt on a clear downward trajectory. A sustained reform effort, maintaining high primary surpluses and ambitious structural reforms, will be needed to gradually reduce public debt from about 160 percent of GDP before the restructuring to the country's 60 percent debt-to-GDP target.

Behaving Optimally in Solar Renewable Energy Certificate Markets
Arvind Shrivats,Sebastian Jaimungal

SREC markets are a relatively novel market-based system to incentivize the production of energy from solar means. A regulator imposes a floor on the amount of energy each regulated firm must generate from solar power in a given period and provides them with certificates for each generated MWh. Firms offset these certificates against the floor and pay a penalty for any lacking certificates. Certificates are tradable assets, allowing firms to purchase/sell them freely. In this work, we formulate a stochastic control problem for generating and trading in SREC markets from a regulated firm's perspective. We account for generation and trading costs, the impact both have on SREC prices, provide a characterization of the optimal strategy, and develop a numerical algorithm to solve this control problem. Through numerical experiments, we explore how a firm who acts optimally behaves under various conditions. We find that an optimal firm's generation and trading behaviour can be separated into various regimes, based on the marginal benefit of obtaining an additional SREC, and validate our theoretical characterization of the optimal strategy. We also conduct parameter sensitivity experiments and conduct comparisons of the optimal strategy to other candidate strategies.

Boards of a Feather: Homophily in Foreign Director Appointments Around the World
Barrios, John Manuel,Bianchi, Pietro A.,Isidro, Helena,Nanda, Dhananjay
We examine whether similarities in legal, sociological, and cultural characteristics between countries (country-pair homophily) affect foreign director appointments. Our results from estimating a gravity model, which includes economic and geographic country characteristics, indicate that country-pair homophily is associated with foreign director appointments to corporate boards. Country-pair homophily plays a more significant role in the foreign director market than in other cross-border exchange, such as trade, migration, and foreign investment, consistent with homophily being more important in bilateral voluntary human exchange. We use the international IFRS adoption and the gender-quota adoption in Norway as regulatory interventions to assess the role of country-pair homophily in new foreign director appointments. We find that both events led firms to appoint directors from countries that were, prior to the regulation, less institutionally, socially and culturally similar, attesting to the importance of homophily in foreign director appointments. Overall, we identify an impediment to the effectiveness of foreign director appointments driving global governance practice convergence.

Comment on Peter L Swan’s ‘Investment, the Corporate Tax Rate, and the Pricing of Franking Credits’ (2019)
Pincus, Jonathan
The aim of Swan (2019) is ‘to show that the way Australia’s tax imputation scheme operates already achieves the goal of a zero, or close to zero, marginal tax rate on capital’. Swan found that franking credits are close to fully priced in the ASX market; inferred that the marginal investor in Australia borrows offshore to finance purchases of Australian equity and, on the margin, pays little or no Australian corporate tax; and that foreign portfolio investors can largely avoid the tax. Therefore, reductions in the company tax rate would barely stimulate investment: there is no or no material tax wedge between the supply and demand prices for funds.The comment explores difficulties with accepting Swan’s explication of the market equilibrium. Although offering no definitive explanation of Swan’s striking quantitative results, I suggest that they are consistent with the existence of a welfare-relevant tax wedge in the funds market.

Coronavirus and Oil Price Crash
Albulescu, Claudiu
Coronavirus (COVID-19) creates fear and uncertainty, hitting the global economy and amplifying the financial markets volatility. The oil price reaction to COVID-19 was gradually accommodated until March 09, 2020, when, 49 days after the release of the first coronavirus monitoring report by the World Health Organization (WHO), Saudi Arabia floods the market with oil. As a result, international prices drop with more than 20% in one single day. Against this background, the purpose of this paper is to investigate the impact of COVID-19 numbers on crude oil prices, while controlling for the impact of financial volatility and the United States (US) economic policy uncertainty. Our ARDL estimation shows that the COVID-19 daily reported cases of new infections have a marginal negative impact on the crude oil prices in the long run. Nevertheless, by amplifying the financial markets volatility, COVID-19 also has an indirect effect on the recent dynamics of crude oil prices.

Current Trends in Insurance Fraud in Russia: Evidence from a Survey of Industry Experts
Timofeyev, Yuriy,Busalaeva, Tatiana
This study aims to explore the current trends in fraud prevention in the insurance industry in Russia. Survey responses from 20 experts and professionals of the leading insurance companies in Moscow were collected. More than a half of them are former police officers who work at security or investigation departments. Survey data analysis was employed. According to the experts’ opinion, existing gaps in the legislation and difficulties in cooperation with the police are the main sources of inefficiency of fraud prevention strategies utilised by the Russian insurance companies. The respondents agreed that both insurers and fraudsters actively use new technologies. Fraudulent claims in compulsory third party liability motor insurance remain the most common activity among Russian criminals, although they quickly expand to health and property insurance. Typically, an insurance fraudster is a 34-year old male with a college/university degree who cooperates with an insurance broker in 42 percent of cases. Based on this, a set of recommendations aimed at increasing the efficiency of insurance fraud prevention was produced.

Distributionally Robust Portfolio Optimization with STARR Performance Measure
Ji, Ran,Lejeune, Miguel,Fan, Zhengyang
We study the distributionally robust stable tail adjusted return ratio (DRSTARR) portfolio optimization problem, in which the objective is to maximize the STARR performance measure under data-driven Wasserstein ambiguity. We consider two types of partially informed uncertainties, named uncertain probabilities and continuum of realizations, associated with the returns of assets. We design a two-step solution framework to solve the proposed problems exactly and efficiently. First, we utilize conic duality theory to reformulate the semi-infinite programming constraint into a finite dimensional space. Second, we devise a decent-type bisection algorithm that solves the reformulated problem via a finite number of mixed-integer linear programming problems. We carry out a series of empirical tests to illustrate the scalability and effectiveness of the proposed reformulation and algorithmic framework, and to evaluate the performance of the DRSTARR-constructed portfolios. Our results show that the DRSTARR portfolios under the uncertain continuum of realizations setting display superior out-of-sample performance.

Dividend Policy and Corporate Investment under Information Shocks
Harakeh, Mostafa
This study exploits the mandatory adoption of International Financial Reporting Standards (IFRS) as an exogenous shock to the corporate information environment to examine how the constraining effect of dividend policy on corporate investment changes under lower levels of information asymmetry. To identify the treatment effect of the information shock, I employ a difference-in-differences research design using an international sample of 25 countries that spans the period 2000-2010. I first show that the information shock mitigates information asymmetry. Then, I find that the constraining effect of dividends on investments declines following the information shock, especially among firms with higher levels of information asymmetry ex-ante. Finally, I show that less constrained investments contribute to maximizing firm value. Overall, I show how reducing information asymmetry mitigates agency conflicts over dividend policy and thereby decreases the probability of forgoing valuable investments to pay dividends, which is found to maximize shareholders’ wealth.

Does Profitability Really Matter? Marginality, Volatility & $ Trillion Question
Muthusamy, Senthil Kumar
Firm Profitability - Does it really matter for shareholder return or ROE (return on equity)? Does this question sound oxymoron and antithetic? Not really. On the contrary, evidence has surfaced that Returns on equity - based on the shareholders' equity accounted in the balance sheet - is not really directly tied to firm's profitability because it is increasingly observed that more attention is given to short-term marginal gains of the stock rather than long-term value buildup for shareholders. And higher stock gains appear to be realized through trading on a short-term basis of frequent stock-buy & sell at the right time and speed. Notwithstanding what the conventional wisdom is, the disconnect between profitability and long-term ROE is becoming the hard truth in a modern stock market, while smart investors are achieving better returns through active trading.

Dual Agency Problems in Family Firms: Evidence from Director Elections
Ashraf, Rasha,Li, Huimin,Ryan, Harley E.
We use director elections to analyze outsider shareholder perspectives of agency problems in family firms. Compared to nonfamily firms, outsider shareholders in family firms provide weaker support for director slates proposed by the firms’ nominating committees. Outside shareholder support decreases when families receive private benefits of control, when family members serve in leadership roles, or when family members serve on board monitoring committees. We do not find similar results for other actively engaged concentrated owners. Our results provide new insights into outsider shareholders’ satisfaction with family control in publicly held firms and their perceptions of the family-outsider agency conflicts.

Environmental Policy and Audit Pricing
Rabarison, Monika K.,Siraj, Ibrahim,Wang, Bin
This paper examines the effect of environmental policy stringency on audit pricing. Exploiting the exogenous variation in environmental policies across 26 countries, we find that firms in countries with more stringent environmental policies incur lower audit fees. The inverse association is more pronounced in common law countries, in countries with a higher level of public enforcement of regulations, and in countries with more protection of investors. The lower audit fees are also more prominent for firms followed by more analysts and firms with larger institutional ownership. Furthermore, we find that firms in countries with strong regulations are better and more innovative at managing environmental risk, which implies that better environmental performance of the firms following stronger regulations could lower the business risks and thus, decrease audit fees. Overall, our findings suggest that compliant firms benefit from environmental policy stringency.

Ethnic Groups' Access to State Power and Group Size
Hector Galindo-Silva

Many countries are ethnically diverse. However, despite the benefits of ethnic heterogeneity, ethnic-based political inequality and discrimination are pervasive. Why is this? This study suggests that part of the variation in ethnic-based political inequality depends on the relative size of ethnic groups within each country. Using group-level data for 569 ethnic groups in 175 countries from 1946 to 2017, I find evidence of an inverted-U-shaped relationship between an ethnic group's relative size and its access to power. This single-peaked relationship is robust to many alternative specifications, and a battery of robustness checks suggests that relative size influences access to power. Through a very simple model, I propose an explanation based on an initial high level of political inequality, and on the incentives that more powerful groups have to continue limiting other groups' access to power. This explanation incorporates essential elements of several existing theories on the relationship between group size and discrimination, and suggests a new empirical prediction: the single-peaked pattern should be weaker in countries where political institutions have historically been less open. This additional prediction is supported by the data.

Financial Knowledge and Personal Financial Literacy in Investment Priorities Among University Students.
Rashid, Abdul Aqil Abdul,Jantan, Mohd Sedek,Fairuz, Muhammad Adha Faiq Azam,Halim, Nurul Anis Abdul
Financial literacy covers basic knowledge on financial tools such as saving, budgeting, investing and risk management. This research aimed to examine the role of financial knowledge and financial literacy in investment priorities among university student. Total 23 questions were formed that covered three areas which were financial literacy, financial education and investment priorities. Total 238 respondent participated in this survey. It was found that financial literacy had significant positive effect (R Square = 0.677) on Investment Priorities. However, financial education had less significance to achieve minimal positive effect on Financial Literacy similarly with Financial Education and Investment Priorities.

Financial Stability Committees and the Countercyclical Capital Buffer
Edge, Rochelle M.,Liang, Nellie
Multi-agency financial stability committees (FSCs) have grown dramatically since the global financial crisis. However, most cannot direct actions or recommend to other agencies that they take actions, and most would influence policy actions only through convening and discussing risks. We evaluate whether the significant variation in FSCs and other financial regulatory structures across countries affect decisions to use the countercyclical capital buffer (CCyB). After controlling for credit growth and the severity of the financial crisis, we find that countries with stronger FSCs are more likely to use the CCyB, especially relative to countries where a bank regulator or the central bank has the authority to set the CCyB. While the experience with the CCyB is still limited, these results are consistent with some countries creating FSCs with strong governance to take actions, but most countries instead creating weak FSCs without mechanisms to promote actions, consistent more with a symbolic political delegation motive and raising questions about accountability for financial stability.

Global and Local Currency Effects on Euro Area Investment in Emerging Market Bonds
Adriaan Boermans, Martijn,Burger, John D.
We analyze how global and local factors affect portfolio allocation by euro area investors in emerging markets at the bond-level. First, cross-sectional analysis reveals a strong preference for home (Euro) currency bonds. Second, panel regressions, whether at the bond or aggregate flows level, consistently identify trade-weighted US dollar fluctuations as the most robust explanatory variable, in sharp contrast to other global factors, such as the VIX and Fed or ECB monetary policy, which have much less impact on reallocations to emerging market bonds. Our results are consistent with the notion that broad US dollar movements act as a barometer for global risk appetite, but with an important caveat: Throughout our analysis we find holdings in Euro-denominated bonds are less sensitive to global factors, which we interpret as further evidence of a home currency bias.

How Excess Global Saving and Investor Exuberance Brought a Secular Rise in U.S. Stocks
Scott, William
This short paper shows how excess global saving led to asset price inflation in U.S. stocks during 1981 to 2019. It compares stock PE ratios to corporate bond values to explain that investor exuberance for stocks enabled and enhanced the extent of the secular stock rise.

Identity and Choice Under Risk
D'Acunto, Francesco
Traditional gender norms have been blurring over the last years. Could this evolution have implications for economic decision-making? Identity theory posits that men who commit more to traditional male identity norms should take on more risk through a subjective-beliefs channel when their identity is salient, either because it is primed or threatened. I test these predictions using large-scale artefactual field experiments. Men whose identity is primed or threatened invest more in risky opportunities than control men and women. They become overconfident even in pure games of chance with no scope for skill, which is consistent with the subjective-beliefs channel identity theory postulates. The effects are stronger for men who commit more to male identity|older men and men in the Southern US. The recent blurring of traditional gender norms might thus imply a drop in aggregate risk taking over time, as men might reduce their willingness to take risks in disparate contexts.

Implementation of IFRS in Japan: An Analysis of Voluntary Adoption by Listed Firms
Giner, Begoña,Merello, Paloma,Nakamura, Miho,Pardo, Francisca
Since 2010 Japanese listed firms can voluntarily use international financial reporting standards for their consolidated financial statements. Using financial and non-financial data, we carry out a comprehensive research into the adopters’ determinants. We employ a multi-period logit model that considers every annual decision made along the period 2010-2019. We find that the having outside networks through subsidiaries and a strong internal corporate governance system are key factors. We also confirm a contagion effect. Finally, our results suggest that goodwill is also relevant, since only Japanese accounting standards require annual amortization.

Institutional Distance and Subsidiary Debt: The Spillover Effect of Home Country Institutional Quality
Du, Yan,Piljak, Vanja,Vulanovic, Milos
This study examines the spillover effects of home country institutional and cultural characteristics on the subsidiaries operating in France while they are in the process of making capital structure choices and debt maturity choices. We document that while subsidiaries financing choices are partially explained by standard determinants, at the same time, these choices are impacted by cultural distance factors such as economic, financial, and political distance. Namely, cultural distance is one of the essential determinants of the long-term debt proportion in the total amount of debt used for the financing of foreign subsidiaries in France.

Labor Costs and Corporate Investment in Italy
Garcia-Macia, Daniel
The recovery of private investment in Italy has lagged its euro area peers over the past decade. This paper examines the role of elevated labor costs in hindering the recovery. Specifically, labor costs rose faster than labor productivity prior to the global financial crisis and have remained high since, weighing on firms' profits, capital returns, and thus capacity to invest. Empirical analysis provides evidence for the impact of wages on investment at the sectoral and firm levels. Sectoral wage growth seems unrelated to sectoral productivity growth, but is negatively associated with investment. Firm-level data permit a better identification-by exploiting the interaction between sectoral wage growth (exogenous to the firm) and the lagged labor share of the firm. A 1 percent increase in real wages is estimated to cause a 1/3 percent fall in fixed capital. Profits absorb only 1/2 of the cost increase, pointing to the role of liquidity constraints. These results highlight the need for labor market reform to reinvigorate investment, and thus labor productivity and job creation.

Licensing the Insured: Providing Driver Licenses to Unauthorized Immigrants Has Not Impacted Auto Insurance in California
Lueders, Hans,Mumper, Micah
A key argument for providing unauthorized immigrants with driver licenses is that such policies will reduce the number of uninsured vehicles. The paper uses data on auto insurance take-up, claims, and premiums to test this argument in the context of California's Assembly Bill (AB) 60. Starting in January 2015, AB60 allowed unauthorized immigrants residing in California to apply for driver licenses. Exploiting cross-county variation in the estimated share of AB60 licenses, we find that even though more than one million licenses have been issued under the policy to date, it had no measurable effects on the rate of uninsured vehicles, uninsured motorists claims, or automobile insurance premiums. Our findings are supported by a power analysis and multiple robustness checks. We suggest that unauthorized immigrants may already have had access to cars and even auto insurance before AB60. In a highly car-dependent society, they had no choice but to drive even when it was illegal before 2015. As such, the effects of AB60 on the insurance market were negligible.

Liquidity in Credit Networks with Constrained Agents
Geoffrey Ramseyer,Ashish Goel,David Mazieres

In order to scale transaction rates for deployment across the global web, many cryptocurrencies have deployed so-called "Layer-2" networks of private payment channels. An idealized payment network behaves like a Credit Network, a model for transactions across a network of bilateral trust relationships. Credit Networks capture many aspects of traditional currencies as well as new virtual currencies and payment mechanisms. In the traditional credit network model, if an agent defaults, every other node that trusted it is vulnerable to loss. In a cryptocurrency context, trust is manufactured by capital deposits, and thus there arises a natural tradeoff between network liquidity (i.e. the fraction of transactions that succeed) and the cost of capital deposits.

In this paper, we introduce constraints that bound the total amount of loss that the rest of the network can suffer if an agent (or a set of agents) were to default - equivalently, how the network changes if agents can support limited solvency guarantees.

We show that these constraints preserve the analytical structure of a credit network. Furthermore, we show that aggregate borrowing constraints greatly simplify the network structure and in the payment network context achieve the optimal tradeoff between liquidity and amount of escrowed capital.

Low-volatility Anomaly and the Adaptive Multi-Factor Model
Robert A. Jarrow,Rinald Murataj,Martin T. Wells,Liao Zhu

The paper explains the low-volatility anomaly from a new perspective. We use the Adaptive Multi-Factor (AMF) model estimated by the Groupwise Interpretable Basis Selection (GIBS) algorithm to find the basis assets significantly related to each of the portfolios. The AMF results show that the two portfolios load on very different factors, which indicates that the volatility is not an independent measure of risk, but are related to the basis assets and risk factors in the related industries. It is the performance of the loaded factors that results in the low-volatility anomaly. The out-performance of the low-volatility portfolio may not because of its low-risk (which contradicts the risk-premium theory), but because of the out-performance of the risk factors the low-volatility portfolio is loaded on. Also, we compare the AMF model with the traditional Fama-French 5-factor (FF5) model in various aspects, which shows the superior performance of the AMF model over FF5 in many perspectives.

Mean-Semivariance Portfolio Optimization Using Minimum Average Partial
Rigamonti, Andrea,Lucivjanska, Katarina
Mean-semivariance and minimum semivariance portfolios are a preferable alternative to mean-variance and minimum variance portfolios whenever the asset returns are not symmetrically distributed. However, similarly to other portfolios based on downside risk measures, they typically perform poorly in practice because the estimates of the necessary inputs are less reliable than the estimates of the full covariance matrix. We address this problem by performing PCA using the Minimum Average Partial on the downside correlation matrix in order to reduce the dimension of the problem and, with it, the estimation errors. We apply our strategy to several datasets and show that it consistently outperforms various existing downside risk-based asset allocation rules, largely closing the gap in out-of-sample performance with the strategies based on the covariance matrix.

Minimum-Variance Hedging of Bitcoin Inverse Futures
Deng, Jun,Pan, Huifeng,Zhang, Shuyu,Zou, Bin
We formulate an optimal hedging problem of Bitcoin inverse futures under the minimumvariance framework. We obtain the optimal hedging strategy in closed forms for both short and long hedges, and compute hedging efficiency under the optimal strategy. Our empirical studies show that the optimal hedging strategy achieves superior effectiveness in reducing risk and beats the naıve hedge in all scenarios.

Modeling of the Greek road transportation network using complex network analysis
Dimitrios Tsiotas

This article studies the interregional Greek road network (GRN) by applying complex network analysis (CNA) and an empirical approach. The study aims to extract the socioeconomic information immanent to the GRN's topology and to interpret the way in which this road network serves and promotes the regional development. The analysis shows that the topology of the GRN is submitted to spatial constraints, having lattice-like characteristics. Also, the GRN's structure is described by a gravity pattern, where places of higher population enjoy greater functionality, and its interpretation in regional terms illustrates the elementary pattern expressed by regional development through road construction. The study also reveals some interesting contradictions between the metropolitan and non-metropolitan (excluding Attica and Thessaloniki) comparison. Overall, the article highlights the effectiveness of using complex network analysis in the modeling of spatial networks and in particular of transportation systems and promotes the use of the network paradigm in the spatial and regional research.

Monetary Policy Transmission in Emerging Markets and Developing Economies
Brandao-Marques, Luis,Gelos, Gaston,Harjes, Thomas,Sahay, Ratna,Xue, Yi
Central banks in emerging and developing economies (EMDEs) have been modernizing their monetary policy frameworks, often moving toward inflation targeting (IT). However, questions regarding the strength of monetary policy transmission from interest rates to inflation and output have often stalled progress. We conduct a novel empirical analysis using Jord�'s (2005) approach for 40 EMDEs to shed a light on monetary transmission in these countries. We find that interest rate hikes reduce output growth and inflation, once we explicitly account for the behavior of the exchange rate. Having a modern monetary policy framework-adopting IT and independent and transparent central banks-matters more for monetary transmission than financial development.

NISE Estimation of an Economic Model of Crime
Eric Blankmeyer

An economic model of crime is used to explore the consistent estimation of a simultaneous linear equation without recourse to instrumental variables. A maximum-likelihood procedure (NISE) is introduced, and its results are compared to ordinary least squares and two-stage least squares. The paper is motivated by previous research on the crime model and by the well-known practical problem that valid instruments are frequently unavailable.

Nash Equilibria in Optimal Reinsurance Bargaining
Michail Anthropelos,Tim J. Boonen

We introduce a strategic behavior in reinsurance bilateral transactions, where agents choose the risk preferences they will appear to have in the transaction. Within a wide class of risk measures, we identify agents' strategic choices to a range of risk aversion coefficients. It is shown that at the strictly beneficial Nash equilibria, agents appear homogeneous with respect to their risk preferences. While the game does not cause any loss of total welfare gain, its allocation between agents is heavily affected by the agents' strategic behavior. This allocation is reflected in the reinsurance premium, while the insurance indemnity remains the same in all strictly beneficial Nash equilibria. Furthermore, the effect of agents' bargaining power vanishes through the game procedure and the agent who gets more welfare gain is the one who has an advantage in choosing the common risk aversion at the equilibrium.

Network Models to Improve Robot Advisory Portfolio Asset Allocation
Giudici, Paolo,Polinesi, Gloria,Spelta, Alessandro
Robot advisory services are rapidly expanding, responding to a growing interest people have in directly managing their savings. Robot advisors may reduce costs and improve the quality of the service, making user involvement more transparent. However, they may underestimate market risks, especially when highly correlated assets are being considered, leading to a mismatch between investors' expected and actual risk. The aim of the paper is to enhance robot advisory portfolio allocation, taking users' preference into account. In particular, we demonstrate how Random Matrix Theory and Network models can be combined to construct investment portfolios that provide lower risks with respect to standard Markovitz portfolios. To demonstrate the advantages of this approach we employ the observed returns of a large set of ETFs, which is representative of the financial products at the ground of the activity of robot advisors.

New Kids on the Block: The Effect of Generation X Directors on Corporate Performance
He, Zhaozhao,Miletkov, Mihail K.,Staneva, Viktoriya
Generation X directors are slowly replacing Baby Boomers on U.S. corporate boards and will eventually dominate corporate boardrooms in the U.S. and around the world. We provide the first robust evidence of a significantly positive effect of Generation X directors on corporate performance. The positive effect is not driven by other director attributes such as age, sex, ethnicity, or professional expertise, and is robust to endogeneity checks using instrumental variables. Part of the improvement in firm performance can be attributed to the commitment of Generation X directors to corporate social responsibility and to the inclusion of women on corporate boards.

Observable Implications of the Conditional CAPM
de Oliveira Souza, Thiago
Tests of the conditional CAPM are often based on the joint (internally inconsistent) hypothesis that the stock portfolio used in the tests is the theoretical, mean-variance efficient, market portfolio. I derive a new test based exclusively on the theory in the conditional CAPM. According to this test, the conditional CAPM explains asset pricing anomalies, such as the unconditional alphas and betas of momentum, value, and size portfolios. In contrast, the unconditional CAPM theory is rejected by portfolios with negative unconditional betas and positive unconditional alphas, under the same assumptions. Hence, relaxing this joint assumption does not render the CAPM untestable.

Obtaining Implied Volatilities From the New York Money Market: 1890 to 1934
Cantillo, Miguel
This paper obtains monthly implied volatilities of the New York securities market from 1890 to 1934 from interest rate differentials. The implied volatilities did predict the 1929 crash but no other financial crisis. The historical implied volatilities are similar to their modern (2008-2019) counterparts. I find that before 1924, implied volatilities were autoregressive and seasonal, and that after 1924 these series behave in a non-stationary manner, echoing results by Mankiw, Miron and Weil (1987) for interest rates. The paper uses a Heckman method to correct for censored six month interest rate data due to anti usury laws from that period.

Optimal hedging under fast-varying stochastic volatility
Josselin Garnier,Knut Solna

In a market with a rough or Markovian mean-reverting stochastic volatility there is no perfect hedge. Here it is shown how various delta-type hedging strategies perform and can be evaluated in such markets in the case of European options. A precise characterization of the hedging cost, the replication cost caused by the volatility fluctuations, is presented in an asymptotic regime of rapid mean reversion for the volatility fluctuations. The optimal dynamic asset based hedging strategy in the considered regime is identified as the so-called `practitioners' delta hedging scheme. It is moreover shown that the performances of the delta-type hedging schemes are essentially independent of the regularity of the volatility paths in the considered regime and that the hedging costs are related to a vega risk martingale whose magnitude is proportional to a new market risk parameter. It is also shown via numerical simulations that the proposed hedging schemes which derive from option price approximations in the regime of rapid mean reversion, are robust: the `practitioners' delta hedging scheme that is identified as being optimal by our asymptotic analysis when the mean reversion time is small seems to be optimal with arbitrary mean reversion times.

Options on infectious diseases
Andrew Lesniewski,Nicholas Lesniewski

We present a parsimonious stochastic model for valuation of options on the fraction of infected individuals during an epidemic. The underlying stochastic dynamical system is a stochastic differential version of the SIR model of mathematical epidemiology.

Pricing with Variance Gamma Information
Lane P. Hughston,Leandro Sánchez-Betancourt

In the information-based pricing framework of Brody, Hughston and Macrina, the market filtration $\{ \mathcal F_t\}_{t\geq 0}$ is generated by an information process $\{ \xi_t\}_{t\geq0}$ defined in such a way that at some fixed time $T$ an $\mathcal F_T$-measurable random variable $X_T$ is "revealed". A cash flow $H_T$ is taken to depend on the market factor $X_T$, and one considers the valuation of a financial asset that delivers $H_T$ at $T$. The value $S_t$ of the asset at any time $t\in[0,T)$ is the discounted conditional expectation of $H_T$ with respect to $\mathcal F_t$, where the expectation is under the risk neutral measure and the interest rate is constant. Then $S_{T^-} = H_T$, and $S_t = 0$ for $t\geq T$. In the general situation one has a countable number of cash flows, and each cash flow can depend on a vector of market factors, each associated with an information process. In the present work, we construct a new class of models for the market filtration based on the variance-gamma process. The information process is obtained by subordinating a particular type of Brownian random bridge with a gamma process. The filtration is taken to be generated by the information process together with the gamma bridge associated with the gamma subordinator. We show that the resulting extended information process has the Markov property and hence can be used to price a variety of different financial assets, several examples of which are discussed in detail.

Scoring Functions for Multivariate Distributions and Level Sets
Xiaochun Meng,James W. Taylor,Souhaib Ben Taieb,Siran Li

Interest in predicting multivariate probability distributions is growing due to the increasing availability of rich datasets and computational developments. Scoring functions enable the comparison of forecast accuracy, and can potentially be used for estimation. A scoring function for multivariate distributions that has gained some popularity is the energy score. This is a generalization of the continuous ranked probability score (CRPS), which is widely used for univariate distributions. A little-known, alternative generalization is the multivariate CRPS (MCRPS). We propose a theoretical framework for scoring functions for multivariate distributions, which encompasses the energy score and MCRPS, as well as the quadratic score, which has also received little attention. We demonstrate how this framework can be used to generate new scores. For univariate distributions, it is well-established that the CRPS can be expressed as the integral over a quantile score. We show that, in a similar way, scoring functions for multivariate distributions can be "disintegrated" to obtain scoring functions for level sets. Using this, we present scoring functions for different types of level set, including those for densities and cumulative distributions. To compute the scoring functions, we propose a simple numerical algorithm. We illustrate our proposals using simulated and stock returns data.

Social Infrastructure Finance and Institutional Investors
Inderst, Georg
Social infrastructure has endured a long period of neglect in most developed and emerging countries, with chronic underinvestment exposed by the coronavirus crisis 2020. Private sector investment in social infrastructure has widely fallen back over the last decade - this in contrast to economic infrastructure. One of the outcomes of the last global (financial) crisis 2007/08 was a slow revival of economic infrastructure policies, and a growing involvement of institutional investors.This is the first, more systematic account of social infrastructure investment from an international perspective, leading to several key conclusions. The public sector will remain the dominant funding and financing source. Nonetheless, much more private capital could flow with more clarity on social assets and projects, given their very diverse specific characteristics. There are various investment strategies that can realistically be improved and expanded. Sustainability, impact and SDG investing open a new door for asset owners.

Sovereign Debt Guarantees and Default: Lessons from the UK and Ireland, 1920-1938
Foley-Fisher, Nathan,McLaughlin, Eoin
We study the daily yields on Irish land bonds listed on the Dublin Stock Exchange during the years 1920â€"1938. We exploit Irish events during the period and structural differences in land bonds to tease out a measure of investors׳ credibility in a UK sovereign guarantee. Using Ireland׳s default on intergovernmental payments in 1932, we find a premium of about 43 basis points associated with uncertainty about the UK government guarantee. We discuss the economic and political forces behind the Irish and UK governments׳ decisions pertaining to the default. Our finding has implications for modern-day proposals to issue jointly-guaranteed sovereign debt.

Stressing of Migration Matrices for IFRS 9 and ICAAP Calculations
Witzany, Jiri
Rating transition matrices have become a workhorse of the IFRS 9 expected credit loss and ICAAP stress test modelling. The standard method to stress a through-the-cycle transition matrix is based on a single factor Gaussian model with a correlation parameter that is usually estimated on the level of a product pool. The goal of the paper is to generalize the model allowing for more general distributional assumptions and to test empirically the sensitivity of the results with respect to these assumptions and different possible approaches to the correlation parameter estimation. We are not aware of any such empirical study in the literature. The results show that this dependence is very strong with the standard approach underestimating the results, as we argue, of a more precise calculation many times. Therefore, there is a significant model risk that needs to be taken into account in ICAAP/IFRS 9 implementation and dealt with in further research.

Testing Market Timing Using Daily Mutual Fund Returns
Ding, Jing,Jiang, Lei,Liu, Xiaohui,Peng, Liang
We propose nonparametric methods to test the significance of market timing in mutual funds using daily fund returns with heavy tail and volatility persistence. Compared to the traditional parametric estimation of the timing coefficient in the Treynor-Mazuy and Henriksson-Merton models, our measures generate dramatically different inferences. Examining the characteristics for the portfolios of funds with positive and perverse timing, we find that they hold different types of stocks. We also test the association between market timing and stock picking skill; we find evidence of a tradeoff between the two when we exclude funds with zero timing skill.

The Effect of Financial Performance and Corporate Governance to Stock Price in Non-Bank Financial Industry
Karamoy, Herman,Tulung, Joy Elly
Indonesia’s financial sector is highly dominated by the banking industry than the non-bank. It controlled almost 74% of Indonesia’s financial assets in 2014. After post-crisis restructuration, the banking sector has become stronger, with a higher capital adequacy ratio and profitability. While, the non-bank financial industry is expected to solve the problems in the Indonesian economy, as well as becoming one of the long-term economic instruments. The purpose of this study is to test and analyse the effect of financial performance and the implementation of corporate governance on the non-bank financial industry stock prices on the Indonesia Stock Exchange in 2012-1016. The research population includes the non-bank financial industry listed in IDX, as many as 37 companies. This study found the probability, managerial ownership, institutional ownership and the composition of the independent commissioner partially and simultaneously does not significantly influence the stock price of the non-bank financial industry.

The Effect of Uncertainty Perception in Linguistic Features on Corporate Investment and Liquidity: Evidence From European Micro and Small Enterprises
Song, Bing
This study aims to investigate the effect of uncertainty perception and concept about the future time on owner-managers’ investment decisions and liquidity of 1,883 European micro and small enterprises’ (MSEs) for their first years of existence. I construct a novel measurement of individuals’ uncertainty perception â€" the inflectional morphology used for the future tense in languages â€" that is based on MSEs’ location and owner-managers’ nationality. The results suggest that the novel measurement of uncertainty perception in this study has a positive effect on MSEs’ tangibility and negative relations with account receivable (debtors) ratio, cash ratio, and liquidity. The results introduce a new explanation and evidence for the impact of MSEs’ owner-managers’ characteristics on corporate investment decisions. The findings provide MSEs’ owner-managers, entrepreneurs and regulators with suggestions. The findings are robust to the inclusion of several owner-managers’ characteristics, corporate-specific variables, macroeconomic factors, and Hofstede’s cultural dimensions.

The Effects of Trade War Risk on U.S. Financial Markets
Chen, Yong,Fang, Jing,Liu, Dingming
This paper investigates the effects of trade war risk on various U.S. financial variables using a structural vector autoregression model identified by a heteroscedasticity-based approach. The empirical results indicate that increases in trade war risk cause declines in equity prices, Treasury yields and inflation expectations, a widening of BAA corporate spreads, a fall in the dollar against the yen, and rises in gold prices and stock market volatility. More importantly, we find that concerns about risks from the trade war may be overblown. Trade war risk shocks did not account for as large of a portion of the variances in the financial variables as expected over the sample period we consider, whose contribution was short-lived, quickly settling down to even smaller unconditional shares. Additional studies employing stock prices in the S&P 500 index to explore potential transmission channels show that firms with high input or output exposures to China’s market suffer significantly more from trade war risk.

The Failures of Peer-to-Peer Lending Platform Finance and Politics
He, Qing,Li, Xiaoyang
We investigate the influence of financial and political factors on Peer-to-Peer (P2P) platform failures in the online lending market in China. Using a competing risk model for platform survival, we show that large, listed platforms and platforms with better information disclosure are less likely to go bankruptcy or run off with investors’ money. More importantly, falling platforms are much less likely to go bankruptcy or run off in advance of important political events, but more likely to go bankruptcy after these events. These effects are more pronounced, among platforms that are more politically connected, and platforms operating in provinces where local officials have a close central-local political ties, and when there is a better local financial condition. Our study highlights the role of political incentives on government regulatory intervention of platform failures.

The Influence of Top Management Team (Tmt) Characteristics Toward Indonesian Banks Performance During the Digital Era (2014â€"2018)
Mojambo, Gabriel,Tulung, Joy Elly,Saerang, Regina Trifena
Despite the abundant opportunities in the Indonesian bank industry, the digital era began to challenge banks to fully embrace the use of technology (information) to prolong competitive advantage. An organization becomes a reflection of its top managers. In facing such challenges, Top Management Team (TMT) members' initiative to overcome the current status quo, will be reflected in the company under their management. For this reason, an effective TMT structure is mandatory during the digital era to digitalize banking firms. This research investigates the relationship between top management team characteristics and Indonesian banks' financial performance during the digital era. For top management team characteristics, this research includes functional background, gender diversity, average age, level of education, IT Expertise, and experience in years. While to measure the performance of Indonesian banks' financial performance the paper includes return on asset (ROA), capital adequacy ratio (CAR), and non-performing loan (NPL). The results show that gender diversity has positive significant influences on NPL, average age have positive significant influences on ROA, CAR, NPL, and IT expertise have positive significant influences on CAR.

The commuting phenomenon as a complex network: The case of Greece
Dimitrios Tsiotas,Konstantinos Raptopoulos

This article studies the Greek interregional commuting network (GRN) by using measures and methods of complex network analysis and empirical techniques. The study aims to detect structural characteristics of the commuting phenomenon, which are configured by the functionality of the land transport infrastructures, and to interpret how this network serves and promotes the regional development. In the empirical analysis, a multiple linear regression model for the number of commuters is constructed, which is based on the conceptual framework of the term network, in effort to promote the interdisciplinary dialogue. The analysis highlights the effect of the spatial constraints on the network's structure, provides information on the major road transport infrastructure projects that constructed recently and influenced the country capacity, and outlines a gravity pattern describing the commuting phenomenon, which expresses that cities of high population attract large volumes of commuting activity within their boundaries, a fact that contributes to the reduction of their outgoing commuting and consequently to the increase of their inbound productivity. Overall, this paper highlights the effectiveness of complex network analysis in the modeling of spatial and particularly of transportation network and promotes the use of the network paradigm in the spatial and regional research.

Toward Understanding FinTech and its Industry
Knewtson, Heather,Rosenbaum, Zachary
We define the term FinTech, differentiating it from financial technology, and use the definition to develop an industry framework. FinTech is a technological innovation that promises a financial market a product or service characterized by sophisticated technology relative to existing technology in that market. The existing FinTech literature is mapped into the FinTech Space, reflecting research on Agile Technologies, the Value of Agile Technologies, FinTech Asset Standards, FinTech Assets, FinTech Services and FinTech Policy and Regulation. These research areas surround FinTech firms and its industry. The Tech Paradigm proposed to clarify the type of technology needed to qualify as a FinTech firm. We use the definition to identify FinTech firms, and provide a structure for its industry, classifying each type of firm by FinTech characteristics.

Trading Activity in Commodity Futures and Options Markets
Zhang, Tianyang
Little is known about trading activity in commodity options market. We study the information content of commodity futures and options trading volume. Time-series tests indicate that futures contracts in a portfolio with the lowest option-to-futures volume ratio (O/F) outperform those in a portfolio with the highest ratio by 0.3% per week. Cross-sectional tests show that O/F has higher predictive power for futures returns than such traditional risk factors as the carry, momentum, and liquidity factors. O/F has longer predictive horizon for post-announcement returns than the information contained in the monthly World Agricultural Supply and Demand Estimates (WASDE) reports. The analysis of the weekly Commitments of Traders (COT) reports indicates that commercials (hedgers) provide liquidity to non-commercials (speculators) in short term in commodity options market.

Transforming Paradigms: A Global AI in Financial Services Survey
Ryll, Lukas,Barton, Mary Emma,Zhang, Bryan Zheng,McWaters, R. Jesse,Schizas, Emmanuel,Hao, Rui,Bear, Keith,Preziuso, Massimo,Seger, Elizabeth,Wardrop, Robert,Rau, P. Raghavendra,Debata, Pradeep,Rowan, Philip,Adams, Nicola,Gray, Mia,Yerolemou, Nikos
This report presents the findings of a global survey on AI in Financial Services jointly conducted by the Cambridge Centre for Alternative Finance (CCAF) at the University of Cambridge Judge Business School and the World Economic Forum in Q2-Q3 2019. Representing one of the largest global empirical studies on AI in Financial Services, a total of 151 respondents from 33 countries participated in the survey, including both FinTechs (54% of the sample) and incumbent financial institutions (46% of the sample). The study was supported by EY and Invesco. The study’s objective was to analyse and understand the current state of AI adoption in Financial Services, as well as its subsequent implications. This was done through the comparative analysis of empirical data collected via a web-based questionnaire.This research provides a comprehensive picture of how AI is currently being applied in Financial Services by both FinTechs and Incumbents; driving different business models; underpinning new products and services; and playing a strategic role in digital transformation. The findings also reveal how financial service providers across the globe are meeting the challenges of AI adoption with its emerging risks and regulatory implications, as well as the impact of AI on the competitive landscape and employment levels.The overarching findings of the study suggest that AI is expected to transform a number of different paradigms within the Financial Services industry. These anticipated changes include how data is utilised to generate more actionable insights; business model innovation (e.g., selling AI as a service); changes to the competitive environment with the entrance of ‘Big Tech’ and consolidation; various impacts on jobs and regulation; impacts on risks and biases; and the further development and adoption of game-changing technologies.

Transportation networks and their significance to economic development
Dimitrios Tsiotas,Martha Geraki,Spyros Niavis

This article attempts to highlight the importance that transportation has in the economic development of Greece and in particular the importance of the transportation infrastructure and transportation networks, which suggest a fixed structured capital covering the total of the country. For this purpose, longitudinal and cross-sectoral statistical data are examined over a set of fundamental macroeconomic measures and metrics. Furthermore, the study attempts to highlight the structural and functional aspects composing the concept of transportation networks and to highlight the necessity of their joint consideration on the relevant research. The transportation networks that are examined in this paper are the Greek road (GRN), rail (GRAN), maritime (GMN) and air transport network (GAN), which are studied both in terms of their geometry and technical characteristics, as well as of their historical, traffic and political framework. For the empirical assessment of the transportation networks importance in Greece an econometric model is constructed, expressing the welfare level of the Greek regions as a multivariate function of their transportation infrastructure and of their socioeconomic environment. The further purpose of the article is to highlight, macroscopically, all the aspects related the study of transportation infrastructure and networks.

Trust and Saving in Financial Institutions
Galiani, Sebastian,Gertler, Paul J.,Navajas Ahumada, Camila
We examine the role of trust in financial institutions as a necessary condition for the wider use of formal financial services by the poor. We randomly assigned beneficiaries of a conditional cash transfer program in 130 villages in Peru to attend a 3.5 hour training session designed to build their trust in financial institutions. Using household survey data combined with high-frequency administrative data, we find that the intervention: (a) significantly increased the level of trust in the financial system, but had no effect on knowledge of the banking system or financial literacy; and (b) resulted in the treatment group saving 13 Peruvian Soles more than he control group over a ten month period and (c) had no effect of the use of bank accounts for transactions. The increase in savings is close to double the savings of the treatment over the 10 month period prior to the intervention, 7 times the savings of the control group over the same period, and a 1.6 percentage point increase in the savings rate out of the cash transfer depostis.