Research articles for the 2020-03-26

(Black)Rock the Vote: Index Funds and Opposition to Management
Farizo, Joseph
I propose a novel identification strategy to examine whether “passive” index funds participate in monitoring. Specifically, I examine how index funds vote their proxies on firms in its index that their family does not hold in its actively managed funds. For a given proxy proposal at a given point in time, I find that an index fund is more likely to oppose management on shares its family does not hold in its active funds than on shares its family does hold in its active funds. I further demonstrate that index fund governance has positive effects on the probability a proposal passes and on shareholder value.

A New Benchmark for Dynamic Mean-Variance Portfolio Allocations
Langlois, Hugues
We propose a new methodology to implement unconditionally optimal dynamic mean-variance portfolios. We model portfolio allocations using an auto-regressive process in which the shock to the portfolio allocation is the gradient of the investor's realized certainty equivalent with respect to the allocation. Our methodology accounts for transaction costs, short-selling and leverage constraints, and a large number of assets. In out-of-sample tests using equity portfolios, long-short factors, government bonds, and commodities, we find that its risk-adjusted performance, net of transaction costs, is on average more than double that of other benchmark allocations.

A Principal-Agent approach to study Capacity Remuneration Mechanisms
Clémence Alasseur,Heythem Farhat,Marcelo Saguan

We propose to study electricity capacity remuneration mechanism design through a Principal-Agent approach. The Principal represents the aggregation of electricity consumers (or a representative entity), subject to the physical risk of shortage, and the Agent represents the electricity capacity owners, who invest in capacity and produce electricity to satisfy consumers' demand, and are subject to financial risks. Following the methodology of Cvitanic et al. (2017), we propose an optimal contract, from consumers' perspective, which complements the revenue capacity owners achieved from the spot energy market, and incentivizes both parties to perform an optimal level of investments while sharing the physical and financial risks. Numerical results provide insights on the necessity of a capacity remuneration mechanism and also show how this is especially true when the level of uncertainties on demand or production side increases.

A new set of cluster driven composite development indicators
Anshul Verma,Orazio Angelini,Tiziana Di Matteo

Composite development indicators used in policy making often subjectively aggregate a restricted set of indicators. We show, using dimensionality reduction techniques, including Principal Component Analysis (PCA) and for the first time information filtering and hierarchical clustering, that these composite indicators miss key information on the relationship between different indicators. In particular, the grouping of indicators via topics is not reflected in the data at a global and local level. We overcome these issues by using the clustering of indicators to build a new set of cluster driven composite development indicators that are objective, data driven, comparable between countries, and retain interpretabilty. We discuss their consequences on informing policy makers about country development, comparing them with the top PageRank indicators as a benchmark. Finally, we demonstrate that our new set of composite development indicators outperforms the benchmark on a dataset reconstruction task.

Alpha Discovery Neural Network based on Prior Knowledge
Jie Fang,Zhikang Xia,Xiang Liu,Shutao Xia,Jianwu Lin,Yong Jiang

In financial automatic feature construction task, genetic programming (GP) is the state-of-the-art technique. It employs reverse polish expression to represent features and then simulate the evolution process. However, with the development of deep learning, more choices to design this algorithm are available. This paper proposes Alpha Discovery Neural Network (ADNN), equipped with different kinds of feature extractors to construct diversified financial technical factors based on prior knowledge. The experiment result shows that both fully-connected network and recurrent network are good at extracting information from financial time series, but convolution network structure can not effectively extract this information. ADNN effectively enrich the current factor pool because in all cases, ADNN can construct more informative and diversified features than GP. Moreover, features constructed by ADNN can always improve original strategy return, Sharpe ratio and max draw-down.

An Overview of Research on Mergers and Acquisitions via Topic Modeling From 1935 Until 2018
Schmitz, Alexander
This article provides a comprehensive overview of academic research literature on Mergers and Acquisitions (M&A), organizing it along an objective and holistic structure of topics. It investigates what has been discussed on a very high level, outlines where specific topics have been mostly published, and analyzes when and to what extent topics have been researched. My findings are based on an extensive sample of 1352 M&A articles taken from twenty-three leading journals within the accounting, economics, finance, and management domain from 1935 until 2018. Employing topic modeling via Latent Dirichlet Allocation (LDA) with Gibbs sampling, I find that the entire body of M&A literature is based on fifty-seven topics. The top three most researched topics are on abnormal announcement returns, banks and the financial industry, and (post-acquisition) performance. Moreover, topics are mainly published within the finance domain. However, multiple domain-specific topics exist (e.g., tax effects within the accounting domain). By analyzing topics on five-year periods, I develop a framework that categorizes topics as hot (8 topics), average (34), or cold (15). I find that five average and four cold topics are currently inclining and can be considered high potentials for future hot topics. Overall, this analysis gives insight into the time line and extent of research on specific topics over the last decades. This article benefits scholars and practitioners alike as both can use the provided topic structure for their own orientation and guidance within the M&A research domain.

Brownian bridge with random length and pinning point for modelling of financial information
Mohammed Louriki

In this paper, we define and study the Brownian bridge with random length and pinning point. One of the main results of this work is that, unlike the deterministic case, the bridge fails to be Markovian for pinning points, the law of which is absolutely continuous with respect to the Lebesgue measure. As an application, we propose a new approach to gas storage valuation. We model the flow of information concerning the time at which the holders of a gas storage contract should inject or withdraw gas, by using a Brownian bridge starting from zero and conditioned to be equal to a constant x at the time of injection, and to a constant y at the time of withdrawal. This enables us to catch some empirical facts on the behavior of gas storage markets: when the Brownian bridge process is away from the boundaries x and y, the holders of the gas storage contract can be relatively sure that the best decision is to do nothing. However, when this process absorbs y, the holders of the contract should take the decision of withdrawing gas, otherwise, when the process absorbs x, they should take the decision of injecting gas.

Does Reducing Air Pollution Make Inventors More Innovative? Evidence from the NOx Budget Program
Luo, Yue,Chen, Yangyang,Lin, Ji-Chai
Using the NOx budget trading program (NBP) as a quasi-natural experiment, we examine whether a reduction in air pollution enhances inventor risk-taking, thus making inventors more innovative. We find that inventors located in NBP participating states produce more patents after the introduction of the NBP. These patents also receive more forward citations and have higher economic value. The effect of the NBP is larger for less experienced inventors and inventors living in high-pollution areas. Further, inventors located in NBP participating states engage more in experimental innovation and less in specialization innovation after the NBP, which confirms the risk-taking channel.

FX Vanilla Pricing and Smile Calibration
Garrivier, Alexandre
The first part of this document is dedicated to the pricing of undiscounted Vanilla Options: we compute the price and sensitivities of Calls and Puts, and highlight the different FX Delta conventions. The most important application of specific FX market conventions (and particularly Deltas conventions) is the FX smile construction. Indeed, the way the smile is described in forex market radically differs from other asset classes (equity, commodity...), requiring a specific procedure to recover the smile as a function of strike. In the second part of this document, we present two different approaches for the construction of one smile maturity slice. We apply both approaches to the calibration of UsdJpy 6 Months maturity smile and discuss the results.

Government Equity Investments in Coronavirus Rescues: Why, How, When?
Megginson, William L.,Fotak, Veljko
The coronavirus pandemic has led to a “great shutdown” whose ultimate impact on the US economy is hard to predict. What is already clear is that government intervention at an unprecedented scale is forthcoming. A rescue/stimulus package worth $2 trillion, or 10% of US GDP, is being approved at the time of writing. We argue that part of the intervention should take the form of preferred equity injections in both large and small firms. We discuss pros and cons of such an approach, the potential challenges, and our suggested solutions. While historical precedents help guide the policy response aimed at publicly traded firms, we call for a novel approach aimed at small businesses. With over 30 million small businesses in the country, novel public-private partnerships will be required for governments to incentivize private-sector actors to assist in identifying and valuing the right targets.

Granular Data Offer New Opportunities for Stress Testing
Ullersma, Cees,van Lelyveld, Iman
Nowadays, more and more granular data is being collected. The 2008-2010 crisis has shown that authorities were missing crucial information for accurately identifying risks in the financial system. This realization has led to a significant increase in the depth and scope of information being reported across the system. At the same time, the cost of reporting has gone down due to further digitization.In this paper we will examine how increased granularity allows authorities to put the data to better use and we will focus in particular on stress testing. Stress testing involves postulating severe scenario’s that often have yet to materialize. More granular data combined flexibly from different sources allow for more accurate assessment of such adverse hypothetical states of the world. For instance, detailed information on inter-bank exposures allows for understanding bank to bank contagion much better.We will briefly discuss the developments in the last decade and discuss what possibilities arise. The new granular data sets allow us to implement stress tests on various levels of aggregations using the very same data sets. Then we will turn to prerequisites in terms of for instance meta data allowing to connect data sets and data governance specifying how to treat the data. Finally, we will discuss remaining challenges, ranging from data quality up to high performance IT infrastructure and a company culture that embraces data.

Implication of Working Capital Management on the Profitability: A Case Of ONGC LTD, India
Kandpal, Vinay,Kavidayal, P. C.
Financial Management basically deals with raising of financial resources and its proper allocation in order to maximize shareholders wealth. For a successful running of an organization fixed and current assets play a crucial role as organization generally invests in these options. A firm’s working capital consists of its investments in short-term assets like cash and bank balance, inventories, receivable and short term investments. Therefore, the working capital management mainly refers to the management of all these individual current assets. In this research paper an attempt has been made to study the components of working capital and the possible implications of working capital management policies on profitability of ONGC Limited. The paper also attempts to analyze the correlation between liquidity, profitability and return on investments of ONGC. The study is based on secondary data collected from annual reports of ONGC for the period 2000 to 2012. In this paper there is an application of correlation and regression analysis to identify the significant impact of Working capital management on the profitability. Working capital Management is essential as it might have a direct impact on profitability and liquidity.

Monetary Policy and Corporate Bond Returns
Guo, Haifeng,Kontonikas, Alexandros,Maio, Paulo F.
We investigate the impact of monetary policy shocks on excess corporate bonds returns. We obtain a significant negative response of bond returns to policy shocks, which is especially strong among low-grading bonds. The largest portion of this response is related to higher expected bond returns (discount-rate news), while the impact on expectations of future interest rates (interest-rate news) plays a secondary role. However, the interest-rate channel is dominant among high-grading bonds and Treasury bonds. By looking at the two components of bond premia news, we find that the dominant channel for high-rating (low-rating) bonds is term premia (credit premia) news.

OOPs! The Inherent Ambiguity of Out-of-Pocket Damages in Securities Fraud Class Actions
Booth, Richard A.
Most securities fraud class actions under SEC Rule 10b-5 involve revelation of negative information about the defendant company that should have been disclosed earlier â€" bad news that (allegedly) has been covered up by company agents. The standard remedy in such cases is out-of-pocket damages (OOPs). But this measure of harm is inherently ambiguous. Some courts interpret it as price inflation at the time of purchase. Others interpret it as the difference between the price paid and the price at which a stock settles after corrective disclosure. Although it might seem that these formulations are synonymous, the latter includes not only the difference in price that would have obtained if the truth had been known at the time of purchase but also any additional difference that might be caused by revelation of the truth. For example, the market may conclude that the company is likely to become the target of an SEC enforcement action or private securities litigation. Either way, the company is likely to suffer increased legal expenses. In addition, the company may suffer an increased cost of capital because the market perceives added risk that information about the company may be unreliable. These additional factors and possibly others â€" herein dubbed collateral damage â€" will be reflected in the decrease in price that occurs immediately upon corrective disclosure. But such collateral damage is harm suffered by the company that should be the subject of a derivative action â€" for the benefit of all stockholders â€" and not a direct (class) action. The clear implication is that OOPs should be measured as price inflation at the time of purchaseâ€" that is, price inflation narrowly defined net of any collateral damage. Indeed, because FRCP Rule 23 â€" which governs class actions â€" requires that a class action for damages be superior to any other means of resolving a dispute, Rule 23 itself requires that collateral damage be addressed in a derivative action simply because it can be so addressed. As demonstrated here, state corporation law is perfectly congruent with federal securities law such that a derivative action for collateral damage will lie whenever a meritorious claim can be stated under Rule 10b-5. Aside from simplifying the litigation process by providing for unitary corporate recovery, derivative actions avoid the circularity inherent in class actions while also addressing the problem of excessive deterrence by providing a perfectly tailored action against individual wrongdoers. Finally, because derivative actions quite clearly address corporate internal affairs, a corporation can assure that claims for collateral damage will be so addressed by adopting a bylaw to that effect.

On the Physiology of Investment Biases: The Role of Cortisol and Testosterone
Nofsinger, John R.,Patterson, Fernando,Shank, Corey A.
The underlying physiological mechanisms of biases are not well understood. As such, we examine the impact of testosterone and cortisol levels on several commonplace investment biases using realistic trading simulations. Cortisol, the biological marker of stress, is positively related to the disposition effect and portfolio turnover, which is consistent with the relation between judgment errors and stress in social settings. Testosterone, the male hormone, is also positively related to portfolio turnover, which is consistent with androgen-driven behaviors. Overall, the results show that the endocrine system plays a significant role during financial decision-making, that has important consequences for the financial industry.

Online Appendix to 'Linking Policy to Outcomes: A Simple Framework for Debt Maturity Management'
Landoni, Mattia,Smith, Winthrop,Cameron, Christopher
We characterize the long-run stable maturity distribution induced by a fixed issuance policy, defined as the maturity mix of new issues, thereby providing a method to link issuance policies with their long-run consequences. We derive closed-form expressions for a new class of forward-looking stable metrics, including per-period refinancing need, debt service cost, and average maturity â€" an indicator of the supply of long-term bonds. We use these metrics to provide a normative analysis of the classical debt-management trade-off between refinancing risk and debt service cost. Our results indicate that the US Treasury could move closer to the “efficient frontier” by tilting its issuance towards notes.

Politics and Gender in the Executive Suite
Cohen, Alma,Hazan, Moshe,Weiss, David
We investigate whether CEOs’ political preferences are associated with the prevalence and compensation of women among non-CEO top executives at U.S. public companies. We find that “Democratic” CEOs are associated with more women in the executive suite. To explore causality, we use an event study approach to show that replacing a Republican with a Democratic CEO increases female representation. Additionally, we discuss how the lack of an association between CEO political preferences and gender diversity in the boardroom influences our interpretation of these results. Finally, gender gaps in the level and performance-sensitivity of compensation diminish, or disappear, under Democratic CEOs.

Susceptible-Infected-Recovered (SIR) Dynamics of COVID-19 and Economic Impact
Alexis Akira Toda

I estimate the Susceptible-Infected-Recovered (SIR) epidemic model for Coronavirus Disease 2019 (COVID-19). The transmission rate is heterogeneous across countries and far exceeds the recovery rate, which enables a fast spread. In the benchmark model, 28% of the population may be simultaneously infected at the peak, potentially overwhelming the healthcare system. The peak reduces to 6.2% under the optimal mitigation policy that controls the timing and intensity of social distancing. A stylized asset pricing model suggests that the stock price temporarily decreases by 50% in the benchmark case but shows a W-shaped, moderate but longer bear market under the optimal policy.

The CDS Market Reaction to Loan Renegotiation Announcements
Silaghi, Florina,Martín‐Oliver, Alfredo,Sewaid, Ahmed
This paper analyzes the credit market's reaction to loan renegotiation announcements through changes in credit default swap (CDS) spreads. Using a sample of public US firms during the period 2010-2017, we document a positive and significant CDS market reaction (decrease in CDS spreads). The strongest reactions are for material amendments such as line of credit amount or tranche amount. On the contrary, we find no significant stock market reaction. Moreover, we identify an anticipation effect of up to 30 days before the announcement date on the CDS market. Finally, we show that firm-specific CDS returns lead the idiosyncratic component of stock returns especially around the announcement date and for speculative-rated firms.

The Disappearing IPO Puzzle: New Insights from Proprietary U.S. Census Data on Private Firms
Chemmanur, Thomas J.,He, Jie,Ren, Xiao,Shu, Tao
The U.S. equity markets have experienced a remarkable decline in IPOs since 2000, both in terms of smaller IPO volume and entrepreneurial firms’ greater tendency to exit through acquisitions rather than IPOs. Using proprietary U.S. Census data on private firms, we conduct a comprehensive analysis of the above two notable trends and provide several new insights. First, we find that the dramatic reduction in U.S. IPOs is not due to a weaker economy that is unable to produce enough “exit-eligible” private firms: in fact, the average total factor productivity (TFP) of private firms is slightly higher post-2000 compared to pre-2000. Second, we do not find evidence supporting the conventional wisdom that the disappearing IPO puzzle is mainly driven by the decline in IPO propensity among small private firms. Third, we do not find a significant change in the characteristics of private firms exiting through acquisitions from pre- to post-2000. Fourth, the decline in IPO propensity persists even after we account for the changing characteristics of private firms over time. Fifth, we show that the difference in TFP between IPO firms and acquired firms (and between IPO firms and firms remaining private) went up considerably post-2000 compared to pre-2000. Finally, venture-capital-backed (VC-backed) IPO firms have significantly lower post-exit long-term TFP than matched VC-backed private firms in the post-2000 era relative to the pre-2000 era, while this pattern is absent among IPO and matched private firms without VC backing. Overall, our results strongly support the explanations based on standalone public firms’ greater sensitivity to product market competition and entrepreneurial firms’ access to more abundant private equity financing in the post-2000 era. We find mixed evidence regarding the explanations based on the smaller net financial benefits of being standalone public firms or the increased need for confidentiality after 2000.

The Expected Return on Risky Assets: International Long-run Evidence
Kuvshinov, Dmitry,Zimmermann, Kaspar
This paper studies long-run trends in the expected return on risky wealth and its relationship with the safe rate. We combine new data and time-varying return predictability regressions to estimate expected returns on two major risky asset classes â€" equity and housing â€" across 17 countries and 145 years. We show that the expected risky return has been in steady long-run decline, falling by more than one-third between 1870 and 2015. Much of this decline is driven by a fall in the risk premium â€" from 6% in 1870 to 3% in 1990 â€" which can in turn be traced back to secular declines in the price of risk and macro-financial volatility. We further show that movements in expected returns are largely unrelated to safe rates, and hence safe rates and risk premia are strongly negatively correlated. This suggests that relative supply and demand factors â€" such as safe asset shortages and investor risk appetite â€" play a key role in determining the prices of risky and safe assets in the economy.

The Millennial Boom, the Baby Bust, and the Housing Market
Marijn A. Bolhuis,Judd N. L. Cramer

As baby boomers have begun to downsize and retire, their preferences now overlap with millennials' predilection for urban amenities and smaller living spaces. This confluence in tastes between the two largest age segments of the U.S. population has meaningfully changed the evolution of home prices in the United States. Utilizing a Bartik shift-share instrument for demography-driven demand shocks, we show that from 2000 to 2018 (i) the price growth of four- and five-bedroom houses has lagged the prices of one- and two-bedroom homes, (ii) within local labor markets, the relative home prices in baby boomer-rich zip codes have declined compared with millennial-rich neighborhoods, and (iii) the zip codes with the largest relative share of smaller homes have grown fastest. These patterns have become more pronounced during the latest economic cycle. We show that the effects are concentrated in areas where housing supply is most inelastic. If this pattern in the housing market persists or expands, the approximately 16.5 trillion in real estate wealth held by households headed by those aged 55 or older will be significantly affected. We find little evidence that these upcoming changes have been incorporated into current prices.

The Social Value of Debt in the Market for Corporate Control
Burkart, Mike,Lee, Samuel,Petri, Henrik
The free-rider problem in takeovers is in essence a (coordination) failure to “negotiate” mutually beneficial terms. Means for bidders to unilaterally seize gains could solve this issue but target shareholders prefer to limit such means. We show that takeover debt can bridge this divide in that debt constraints can serve as Pareto-improving “sharing rules.” In this theory (i) leveraged buyouts are privately and socially optimal and (ii) competing bidders raise more debt, amplifying gains to target shareholders and in takeover efficiency. At its best, leveraging bids neutralizes the free-rider problem â€" to mutual benefit.

The Value of Employee Satisfaction in Disastrous Times: Evidence from COVID-19
Shan, Chenyu,Tang, Dragon Yongjun
The novel coronavirus (“COVID-19”) has severely affected the workplace, corporate activities, and share prices. Using a crowdsourced dataset from a FinTech company, we find that firms with higher employee satisfaction are more resilient to negative market-wide shocks during the COVID-19 outbreak. While many publicly listed companies in China suffered a record loss in stock value on February 3, 2020, the first trading day after the lockdown of Wuhan and other cities, firms with more satisfied employees experienced smaller stock price drops. This finding is robust to alternative measures and econometric methods. The role of employee satisfaction in withstanding the public health shock is more pronounced for firms that have more intangible assets or are in the knowledge-based industries. Overall, our findings suggest that employee morale is beneficial for shareholders during disastrous times.

To What Extent Are Non Performing Assets Affecting the Profitability of Co-Operative Banks in Maharashtra?
Khan, Furquan Mohammad,Das, Rituparna
An important role is played by the cooperative institutions, comprised of Urban Co-operative Banks (UCBs) and rural cooperative credit societies in the delivery of the banking needs to small and medium income groups who are unable to get the banking facilities from the commercial banks. For flourishing economy a strong banking sector is important. An increase in NPA put a significant impact on the profitability of the bank because banks compensate these losses from its profit. As per the Financial Stability Report June 2018, 'the stress in the banking sector continues as gross non-performing advances (GNPA) ratio rises further'. The rural sector of India has the largest contribution to the GDP of the country and the contribution of the rural population are considerably high. The cooperative banks are more active in the rural areas of India. Increasing NPA in the Co-operative banks has an adverse effect on the rural economy. The problem of NPAs are affecting the banks as well as the whole economy. This study deals with understanding the extent to which NPAs are affecting the profitability of Co-operative banks in Maharashtra.

Trademarks as Value Signals: Evidence from US IPOs
Drivas, Kyriakos,Gounopoulos, Dimitrios,Konstantios, Dimitris,Tsiritakis, Emmanuel D.
We examine the impact of trademarks (TMs) on the initial public offering (IPO) valuation process of firms, their future performance, and capital market resilience. We find that TMs play an ambivalent role in under-pricing, depending on their quality. The existence of TMs tends to increase under-pricing, while a high-quality trademark portfolio has the opposite effect. For firms in the service sector, where intangible assets dominate, TMs exhibit a greater influence on under-pricing. Results are robust to a battery of tests, including propensity score matching and instrumental variable analysis. After the IPO, we find that firms with TM activity prior to their listing on average perform better than expected as evidenced by i) their abnormal returns following the IPO and ii) a lower hazard of being de-listed from organized exchanges. Our results call for increased disclosure of TM activity by firms to reduce under-pricing and therefore 'money left on the table’.

Tweeting in the Dark: Corporate Tweeting and Information Diffusion
Wolfskeil, Isabella
Is there a link between corporate information dissemination on social media and valuations? Are social media reshaping the diffusion of corporate information? After constructing a novel and comprehensive data-set of over 7 million tweets posted by S&P 1500 firms, I adopt text analysis methods and find that firms with negative earnings surprises have higher announcement returns if they tweet about earnings news. This result is concentrated among firms with higher retail investor ownership and larger social media networks. I also find evidence that firm-initiated tweets increase investors' fundamental information acquisition and the speed of information diffusion to investors. The findings are consistent with firms managing investors expectations and utilizing social media to expedite the diffusion of corporate information, encouraging more efficient market reactions.

Volatility Spillover Effects From Global and National Variables to Sovereign CDS Spreads: Evidence From Turkey
Cihangir, Çiğdem Kurt
In this study global and national variables that affect the sovereign Credit Default Swaps (CDS) spreads for Turkey are examined. The study utilities monthly time-series data, spanning from August of 2009 to September 2018. Empirical analysis is done in two steps: In the first step, the causality relationships between related variables are investigated by the Granger causality test. In the second step, the effect of symmetric and asymmetric spillover effects on sovereign CDS spread is determined. The findings show that both national and global shocks are relevant for Turkey’ sovereign CDS spreads volatility, but national variables tend to have a greater impact. Furthermore, there exist mean asymmetric effects for external fragility, domestic interest rate and the VIX variables. It is tested that sovereign CDS spreads react more sharply to domestic interest rates and VIX bad news than a positive shock of equal size. Generally, both uncertainties in global conditions and the relatively high need for external borrowing of Turkey necessitates a multi-faceted policy-making and management process.