Research articles for the 2020-04-15

A Large-Dimensional Test for Cross-Sectional Anomalies: Efficient Sorting Revisited
De Nard, Gianluca,Zhao, Zhao
Many researchers seek factors that predict the cross-section of stock returns. In finance, the key is to replicate anomalies by long-short portfolios based on their factor scores, with microcaps alleviated via New York Stock Exchange (NYSE) breakpoints and value-weighted returns. In econometrics, the key is to include a covariance matrix estimator of stock returns for the (mimicking) portfolio construction. This paper marries these two strands of literature in order to test the zoo of cross-sectional anomalies by injecting size controls, basically NYSE breakpoints and value-weighted returns, into efficient sorting. Thus, we propose to use a covariance matrix estimator for ultra-high dimensions (up to 5,000) taking into account large, small and microcap stocks. We demonstrate that using a nonlinear shrinkage estimator of the covariance matrix substantially enhances the power of tests for cross-sectional anomalies: On average, ‘Student’ t-statistics more than double.

A multivariate evolutionary generalised linear model framework with adaptive estimation for claims reserving
Benjamin Avanzi,Gregory Clive Taylor,Phuong Anh Vu,Bernard Wong

In this paper, we develop a multivariate evolutionary generalised linear model (GLM) framework for claims reserving, which allows for dynamic features of claims activity in conjunction with dependency across business lines to accurately assess claims reserves. We extend the traditional GLM reserving framework on two fronts: GLM fixed factors are allowed to evolve in a recursive manner, and dependence is incorporated in the specification of these factors using a common shock approach.

We consider factors that evolve across accident years in conjunction with factors that evolve across calendar years. This two-dimensional evolution of factors is unconventional as a traditional evolutionary model typically considers the evolution in one single time dimension. This creates challenges for the estimation process, which we tackle in this paper. We develop the formulation of a particle filtering algorithm with parameter learning procedure. This is an adaptive estimation approach which updates evolving factors of the framework recursively over time.

We implement and illustrate our model with a simulated data set, as well as a set of real data from a Canadian insurer.

Access to Internal Capital, Creditor Rights, and Corporate Borrowing: Does Group Affiliation Matter?
Thapa, Chandra,Rao, Sandeep,Farag, Hisham,Koirala, Santosh
We examine whether the effect of increased creditor rights on corporate borrowing depends on firm's access to internal capital. By exploiting a creditor protection reform in India, empirical outcomes strongly indicate that strengthening of creditor rights leads to increased corporate borrowing among firms that have constrained access to internal capital compared to business group affiliated firms, which have relatively easier access to internal capital. Further, the increased corporate borrowing by firms with constrained access to internal capital, in the post-reform period, is associated with a greater expansion of real investments, improved operational performance, and better market valuation. Taken together, these findings indicate that expanding creditor rights may aid in improving allocative efficiency.

An analytical study of participating policies with minimum guaranteed and surrender option
Maria B. Chiarolla,Tiziano De Angelis,Gabriele Stabile

We perform a detailed theoretical study of the value of a class of participating policies with four key features: $(i)$ the policyholder is guaranteed a minimum interest rate on the policy reserve; $(ii)$ the contract can be terminated by the holder at any time until maturity (surrender option); $(iii)$ at the maturity (or upon surrender) a bonus can be credited to the holder if the portfolio backing the policy outperforms the current policy reserve; $(iv)$ due to solvency requirements the contract ends if the value of the underlying portfolio of assets falls below the policy reserve. Our analysis is probabilistic and it relies on optimal stopping and free boundary theory. We find a peculiar structure of the optimal surrender strategy, which was undetected by previous (mostly numerical) studies on the same topic. For that we develop new methods in order to study the regularity of the corresponding optimal stopping boundaries.

Anatomy of a Sovereign Debt Crisis: Machine Learning, Real-time Macro Fundamentals, and CDS Spreads
Lucia, Alessi,Balduzzi, Pierluigi,Savona, Roberto
We use a machine-learning algorithm, the LASSO, to study the cross-sectional dependence of sovereign credit default swap (CDS) spreads on real-time, country-specific macro indicators during the different phases of the eurozone sovereign debt crisis. In contrast with the existing literature, we find that macro fundamentals played an important, albeit time-varying, role in explaining the cross-section of sovereign CDS spreads, with an average R2 of 98.5%. Moreover, we show how the cross-sectional regression coefficients help predict the VSTOXX volatility index, out of sample.

Asset Level Heterogeneity, Competition and Export Incentives: The Role of Credit Rationing
Marjit, Sugata,Ray, Moushakhi
Firm heterogeneity is mostly discussed in the literature from the viewpoint of productivity differential. In contrast this paper recognizes wealth heterogeneity as an important factor that results in firm heterogeneity. The issue of wealth heterogeneity and export incentive through credit market imperfection over the life cycle of a firm remains largely unaddressed in the literature. This paper studies the dynamics of wealth heterogeneity and export incentive of credit rationed firms through asset building. The theoretical and empirical results indicate that an increase in the initial level of competition implies greater export incentive. However, over the life cycle of a firm, the role of competition is impacted by the intensity of capital accumulation and the initial level of wealth. Greater local competition before the entry of firms in the export market hurts export incentive by limiting cash flows and asset build up. Thus low profits due to competition allows firms to look for export opportunities but lower cash flows hurt such incentives.

Asset Pricing with General Transaction Costs: Theory and Numerics
Lukas Gonon,Johannes Muhle-Karbe,Xiaofei Shi

We study risk-sharing equilibria with general convex costs on the agents' trading rates. For an infinite-horizon model with linear state dynamics and exogenous volatilities, we prove that the equilibrium returns mean-revert around their frictionless counterparts - the deviation has Ornstein-Uhlenbeck dynamics for quadratic costs whereas it follows a doubly-reflected Brownian motion if costs are proportional. More general models with arbitrary state dynamics and endogenous volatilities lead to multidimensional systems of nonlinear, fully-coupled forward-backward SDEs. These fall outside the scope of known wellposedness results, but can be solved numerically using the simulation-based deep-learning approach of Han, Jentzen and E (2018). In a calibration to time series of prices and trading volume, realistic liquidity premia are accompanied by a moderate increase in volatility. The effects of different cost specifications are rather similar, justifying the use of quadratic costs as a proxy for other less tractable specifications.

Bank Liquidity Creation and Systemic Risk
Davydov, Denis,Vähämaa, Sami,Yasar, Sara
This paper examines the linkage between bank liquidity creation and systemic risk. Using quarterly data on U.S. bank holding companies from 2003 to 2016, we document that liquidity creation decreases systemic risk at the individual bank level after controlling for bank size, asset risk, and other bank-specific attributes. After decomposing systemic risk into bank-specific tail risk and systemic linkage, we find that the riskiness of individual banks is negatively linked to liquidity creation. Nevertheless, our results also demonstrate that liquidity creation strengthens the systemic linkage of individual banks to severe shocks in the financial system. Overall, our empirical findings demonstrate that the level of liquidity creation may have important implications for financial stability and macro-prudential supervision.

COVID-19 Pandemic, Oil Prices, Stock Market and Policy Uncertainty Nexus in the US Economy: Fresh Evidence from the Wavelet-Based Approach
Sharif, Arshian,Aloui, Chaker,Yarovaya, Larisa
In this paper, we analyze the connectedness between the recent spread of COVID-19, oil price volatility shock, the stock market and economic policy uncertainty in the US within a time-frequency framework. The coherence wavelet method and the wavelet-based Granger causality tests applied to US recent daily data unveil the unprecedented impact of COVID-19 and oil price shocks on the economic policy uncertainty and stock market volatility over the low frequency bands. The COVID-19 risk is perceived differently over the short and the long-run and may be firstly viewed as an economic crisis. Our study offers several urgent prominent implications and endorsements for policymakers and asset managers.

Central Bank Swaps Then and Now: Swaps and Dollar Liquidity in the 1960s
McCauley, Robert N.,Schenk, Catherine R.
This paper explores the record of central bank swaps to draw out four themes. First, this recent device of central bank cooperation had a sustained pre-history from 1962-1998, surviving the transition from fixed to floating exchange rates. Second, Federal Reserve swap facilities have generally formed a part of a wider network of central bank swap lines. Third, we take issue with the view of swaps as previously used only to manage exchange rates and only more recently to manage offshore funding liquidity and yields. In particular, we spotlight how in the 1960s the Federal Reserve, working in conjunction with the BIS and European central banks, repeatedly used swaps to manage eurodollar funding liquidity and Libor yields. BIS, Bank of England and Swiss National Bank archives show an intention to offset seasonal disturbances to funding liquidity in order to prevent eurodollar yield spikes. Fourth, this earlier cooperation underscores the Federal Reserve's use of swaps to prevent eurodollar shortages from interfering with the transmission of its domestic monetary policy. The US interest in the eurodollar market, and thus its self interest in central bank cooperation, is unlikely to end even when Libor is replaced as the benchmark for US floating-rate loans and mortgages.

Choice Between IEO and ICO: Speed vs. Liquidity vs. Risk
Miglo, Anton
This paper analyzes a financing problem for an innovative firm that is considering launching a web-based platform. Our model is the first one that analyzes an entrepreneur's choice between initial exchange offering (IEO) and initial coin offering (ICO). Compared to ICO, under IEO the firm is subject to screening by an exchange that reduces the risk of investment in tokens; also the firm gets access to a larger set of potential investors; finally tokens become listed on an exchange faster. We argue that IEO is a better option for the firm if: 1) the investment size is relatively large; 2) the extent of moral hazard problems faced by the firm is relatively large; 3) the degree of investors' impatience is relatively small. We aslo find a non-linear relationship between firm quality and its financing choice. Most of these predictions are new and have not been tested sofar.

Epidemic control via stochastic optimal control
Andrew Lesniewski

We study the problem of optimal control of the stochastic SIR model. Models of this type are used in mathematical epidemiology to capture the time evolution of highly infectious diseases such as COVID-19. Our approach relies on reformulating the Hamilton-Jacobi-Bellman equation as a stochastic minimum principle. This results in a system of forward backward stochastic differential equations, which is amenable to numerical solution via Monte Carlo simulations. We present a number of numerical solutions of the system under a variety of scenarios.

Exact Simulation of Variance Gamma related OU processes: Application to the Pricing of Energy Derivatives
Piergiacomo Sabino

In this study we define a three-step procedure to relate the self-decomposability of the stationary law of a generalized Ornstein-Uhlenbeck process to the law of the increments of such processes. Based on this procedure and the results of Qu et al. (2019), we derive the exact simulation, without numerical inversion, of the skeleton of a Variance Gamma, and of a symmetric Variance Gamma driven Ornstein-Uhlenbeck process. Extensive numerical experiments are reported to demonstrate the accuracy and efficiency of our algorithms. These results are instrumental to simulate the spot price dynamics in energy markets and to price Asian options and gas storages by Monte Carlo simulations in a framework similar to the one discussed in Cummins et al. (2017, 2018).

Extending Deep Reinforcement Learning Frameworks in Cryptocurrency Market Making
Jonathan Sadighian

There has been a recent surge in interest in the application of artificial intelligence to automated trading. Reinforcement learning has been applied to single- and multi-instrument use cases, such as market making or portfolio management. This paper proposes a new approach to framing cryptocurrency market making as a reinforcement learning challenge by introducing an event-based environment wherein an event is defined as a change in price greater or less than a given threshold, as opposed to by tick or time-based events (e.g., every minute, hour, day, etc.). Two policy-based agents are trained to learn a market making trading strategy using eight days of training data and evaluate their performance using 30 days of testing data. Limit order book data recorded from Bitmex exchange is used to validate this approach, which demonstrates improved profit and stability compared to a time-based approach for both agents when using a simple multi-layer perceptron neural network for function approximation and seven different reward functions.

Financial Crises and Regulation: Past, Present and Future (Regulación Financiera Y Crisis: Ayer, Hoy Y Mañana)
Quintás-Seoane, Juan-Ramón
English Abstract: This article relates to the conference that Professor Quintás-Seoane gave on April 14, 2018, at the University of Santiago de Compostela (whose faculty he belonged to as Director of its Department of Economic Theory), on the occasion of the Anniversary Symposium celebrating "50 years of Economics in Galicia".The subject matter of the intervention, "Financial Regulation and Crisis", is analyzed in three sections: I The changing balance between Market and Public Interventions. II Post-crisis regulation. III Evaluation of the current situation.The first section recalls how the powerful productive capacity of capitalism is not only shaped by the forces of the free market, but also by the public intervention (regulations, direct government intervention, etc.), with the relative importance of each of them shifting over time in a pendular-like dynamic.The second section describes the various proposals for new financial regulation that arose as a reaction to the great crisis of 2008, classifying them into four main categories: A) Individual risk management B) Macroprudential regulation C) "Systemically important" banks D) Conflicts of interest.Finally, the third section evaluates the current situation, concluding that it’s an improvement over the one existing prior to the financial crisis, but it is still far from immunizing the system against major future disturbances. Three reasons underly this conclusion: - It seems likely that the scope and reach of the new regulations will end up being significantly less than what was originally intended.- It’s feasible that some gaps in the new regulations will eventually allow the very same factors that caused the previous crisis to once again introduce serious destabilizing influences. - Entirely new factors not envisioned by this regulation might end up triggering the next global crisis.The article ends with an analysis of the distinction between "more" and "better" regulation, reflecting on "regulatory fatigue". It then explores the merits of reconfiguring the current approach and philosophy to developing new regulations, by truly incorporating cost-benefit analysis and impact assessments and reinforcing the transparency of the process to the public.Only in this way, the article concludes, would the ultimate objective of creating a financial system that supports growth through the best combination of stability (imposed by the State) and the creative power of private initiative (channeled by the markets) be effectively served.Spanish Abstract: Este artículo se corresponde con la conferencia que el Profesor Quintás-Seoane pronunció el 14 de abril de 2018 en la Universidad de Santiago de Compostela (a cuyo claustro perteneció como Director de su Departamento de Teoría Económica), con motivo del Simposio-Aniversario celebrando los "50 años de Economía en Galicia".El tema objeto de la intervención, "Regulación Financiera y Crisis", se analiza a lo largo de tres secciones: I El cambiante equilibrio entre Mercado e Intervención Pública. II La regulación post-crisis. III Evaluación de la situación actual.En la primera sección se recuerda que la poderosa capacidad productiva del capitalismo no está solo configurada por las fuerzas del libre mercado, sino también por la intervención pública (regulaciones, intervención directa gubernamental, etc.), con la importancia relativa de cada una modificándose a lo largo del tiempo de acuerdo con una dinámica pendular.En la segunda sección se recogen las modificaciones propuestas de nueva regulación financiera que surgió como reacción frente a la gran crisis de 2008, encuadrándolas en cuatro grandes líneas: A) Gestión individual del riesgo B) La regulación macroprudencial C) Los bancos "sistémicamente importantes" D) Los conflictos de interés.Finalmente, en la tercera sección, se evalúa la situación actual, concluyendo que, aunque es mejor que la existente previamente a la gran crisis, está muy lejos de haber inmunizado al sistema frente a la repetición de grandes perturbaciones. Y esto es así por tres motivos principales, detallados en el texto: - Parece probable que el alcance de la nueva regulación será significativamente menor que el que se pretendía inicialmente. - En cualquier caso, quedarán algunas brechas por las que los factores causantes de crisis anteriores podrían introducir graves influencias desestabilizadoras. - Pero, además, en tercer lugar, es muy cierto que pueden ser nuevos factores los que detonen una nueva crisis global. El artículo finaliza con un análisis de la distinción entre "más" y "mejor" regulación, reflexionando sobre la "fatiga regulatoria" y la conveniencia de reconfigurar el sistema (y la filosofía) de producción de regulaciones, incorporando realmente el análisis costo-beneficio y la valoración de impactos, y reforzando la publicidad del proceso.Sólo así, concluye el artículo, se serviría eficazmente al objetivo último de crear un sistema financiero que dé soporte al crecimiento mediante la mejor combinación de estabilidad (impuesta por el Estado) y el poder creador de la iniciativa privada (canalizada por los mercados).

Global DSGE Models
Cao, Dan,Luo, Wenlan,Nie, Guangyu
In this paper, we introduce our GDSGE framework and MATLAB toolbox for solving dynamic stochastic general equilibrium models with a novel global solution method. The framework encompasses many well-known incomplete markets models with highly nonlinear dynamics such as models on financial crises, models with rare disasters (such as the current COVID-19 pandemic), with many financial assets and portfolio choices, and with occasionally binding constraints. The toolbox allows users to input a simple and intuitive model description script similar to Dynare, and returns a convenient MATLAB interface for accessing efficient computations implemented in C++. The toolbox is most effective in solving models featuring endogenous state variables with implicit law-of-motion such as wealth shares or consumption shares. It solves many recent important models more efficiently and accurately compared to their original solution algorithms.

Home Sweet Host: Prudential and Monetary Policy Spillovers Through Global Banks
Avdjiev, Stefan,Hardy, Bryan,McGuire, Patrick,von Peter, Goetz
Prudential regulation of banks is multi-layered: policy changes by home-country authorities affect banks' global operations across many jurisdictions; changes by host-country authorities shape banks' operations in the host jurisdiction regardless of the nationality of the parent bank. Which layer matters most? Do these policies create cross-border spillovers? And how does monetary policy alter these spillovers? This paper examines the effect that changes in home- and hostcountry prudential measures have on cross-border credit, and how these interact with monetary policy. We use a novel approach to decompose growth in cross-border bank lending into separate home, host and common components, and then match each with the home or host policies that affect this component. Our results suggest that prudential policies can have spillover effects, which depend on the instrument used and on whether a bank's home or host country implemented them. Home policies tend to have larger spillovers on cross-border US dollar lending than host policies, primarily through substitution effects. We also find that a tightening of US monetary policy can compound the spillovers of certain prudential measures.

How Do Equity Analysts Impact Takeovers?
Fich, Eliezer M.,Liu, Tingting,Officer, Micah S.
Firms covered by more analysts are more likely to become takeover targets and more likely to enter deals in which their acquirers initiate private merger negotiations. Moreover, when equity analysts’ pre-acquisition price forecasts imply greater target undervaluation, target firms are more likely to initiate their own sale, takeover premiums are higher, those premiums tend to be revised upwards during private merger negotiations, and acquirer firms use less cash to structure the transaction. These results imply a material role for equity analysts during the M&A process: their coverage affects takeover probabilities while their price forecasts influence merger premiums and the merger consideration. Our findings support both investor recognition and information generation theories about the role of equity analysts in financial markets.

How do Banking Analysts behave around Unanticipated News? Evidence from Operational Risk Event Announcements
Gya, Hurvashee,Barakat, Ahmed,Amess, Kevin,Chernobai, Anna
We study earnings per share (EPS) forecast revision and accuracy of banking analysts around operational risk event announcements in U.S. banks from 1990 to 2016. We find that first announcements of operational risk events are more informative than their settlements announcements to banking analysts. Optimistic banking analysts revise their forecasts downwards more aggressively around operational risk disclosures, thereby improving forecast accuracy. We find consistent evidence linking competition among banking analysts with optimistic and inaccurate forecasts, suggesting that analysts seek to use inflated forecasts to curry favour and attract businesses to their brokerage house around the time of operational risk disclosures. Moreover, banking analysts have become less optimistic and more accurate in their reaction to operational risk disclosures during and following the global financial crisis with no effect of the Global Settlement of 2003. Overall, our results shed light on the determinants of optimism bias in banking analyst behaviour upon the arrival of unanticipated news.

Idiosyncratic and Systematic Shocks of COVID-19 Pandemic on Financial Markets
Naidenova, Iuliia,Parshakov, Petr,Shakina, Elena
This study is discovering the impact of idiosyncratic and systematic shocks of COVID-19 pandemic on financial markets. Under a condition when the application of a conventional event-study is limited due to a high frequency of negative news â€" we suggest brute-force search to identify those announcements which appear to be virtually impactful. Having chosen 22 countries with predominantly different initial conditions and anti-pandemic policies adopted we would expect high diversity of market reactions. However, our findings say that systematic shocks are consistently harmful. Idiosyncratic shocks are more important for the beginning of the deteriorating of the epidemiological situation in a particular country.

Implications of Negative Interest Rates for the Net Interest Margin and Lending of Euro Area Banks
Klein, Melanie
This paper explores the impact of low (but) positive and negative market interest rates on euro area banks' net interest margin (NIM) and its components, retail lending and retail deposit rates. Using two proprietary bank-level data sets, I find a positive impact of the level of the short-term rate on the NIM, which increases substantially at negative market rates. As low profitability could hamper the ability of banks to expand lending, I also investigate the impact of the NIM on new lending to the non-financial private sector. In general, the NIM is positively related to lending: When lending is less profitable, banks cut lending. However, at negative rates this effect vanishes. This finding suggests that banks adjusted their business practices when servicing new loans, thereby contributing to higher new lending in the euro area since 2014.

Indebted Demand
Mian, Atif,Straub, Ludwig,Sufi, Amir
We propose a theory of indebted demand, capturing the idea that large debt burdens by households and governments lower aggregate demand, and thus natural interest rates. At the core of the theory is the simple yet under-appreciated observation that borrowers and savers differ in their marginal propensities to save out of permanent income. Embedding this insight in a two-agent overlapping-generations model, we find that recent trends in income inequality and financial liberalization lead to indebted household demand, pushing down natural interest rates. Moreover, popular expansionary policies—such as accommodative monetary policy and deficit spending—generate a debt-financed short-run boom at the expense of indebted demand in the future. When demand is sufficiently indebted, the economy gets stuck in a debt-driven liquidity trap, or debt trap. Escaping a debt trap requires consideration of less standard macroeconomic policies, such as those focused on redistribution or those reducing the structural sources of high inequality.

Insolvency Regimes and Cross-Border Investment Decisions
Kliatskova, Tatsiana,Savatier, Loïc Baptiste
This paper investigates the effect of reforms of insolvency regulations on cross-border debt and equity investments at a sectoral level. Using disaggregated data from the Securities Holdings Statistics by Sector (SHSS) and OECD-indicators on the efficiency of insolvency regulations, we find that investors prefer to invest more in countries with more efficient insolvency frameworks. The effect, however, differs across sectors, with households and institutional investors being particularly sensitive. In addition, share-holders are mostly responsive to prevention and streamlining tools, while debt-holders respond more to availability of restructuring tools. Finally, we show that countries with developed financial markets and effective government are the ones that see the largest debt and equity inflows after reforms of insolvency regulations.

Institutional Consensus After Earnings Announcements: Information or Crowding?
Klein, Olga,Klein, Daniel
This paper examines information processing skills of institutional investors after earnings releases. If institutions can correctly process earnings signals, their trades should push the price towards the fundamental value. In contrast, if institutions mechanically trade in the news direction, their trading pressure should lead to price overreaction, consistent with predictions of Stein (2009). Overall, our findings reconcile the two opposing views by conditioning the effects of institutional trading on the precision of the earnings signal. We find that institutions are good at processing signals with greater precision, whereas their trades after weaker signals can have destabilizing effects on stock prices.

Investor Protection, Regulation and Bank Risk-Taking Behavior
Teixeira, João C. A.,Matos, Tiago F. A. ,da Costa, Gui L. P. ,Fortuna, Mario
This paper examines whether the influence of investor protection on banks’ risk is channeled through banking regulation, and vice-versa, using panel data from a sample of 567 European and US banks for the 2004â€"2015 period. As banking regulatory factors, we consider capital stringency, activity restrictions and private monitoring, whereas as investor protection factors, we consider the level of shareholder and creditor protection. We find that banking regulation moderates the positive direct influence of investor protection on banks’ risk, while investor protection reinforces the negative direct influence of banking regulation on risk. Moreover, we show that the negative effect of national regulations on banks’ risk is more pronounced during systemic crisis years. Finally, taking into account market competition, we argue that private monitoring only has a direct effect on banks’ risk, whereas the effects of capital stringency and activity restriction are channeled through market competition.

Meet Me in the Middle â€" Central Clearing and Netting Efficiency in the Credit Default Swap Market
Schoenemann, Gregor,Gehde-Trapp, Monika
We study the effect of central clearing on netting efficiency in the CDS market. We examine the development of position data and netting efficiency using aggregate data from the Depository Trust and Clearing Corporation (DTCC). Our main finding is that gross outstanding positions in cleared contracts increase, whereas net outstanding positions increase only at a marginally significant level. Hence, central clearing decreases netting efficiency to a considerable extent. Furthermore, we analyze different quintile portfolios of CDS contracts according to pre-clearing netting efficiency. We find that only those contracts that were most efficiently netted bilaterally, decrease in netting efficiency after the introduction of central clearing. The negative effect of central clearing on netting efficiency is more pronounced for the first contracts that have been made clearing eligible.

Multidimensional Effects of Central Clearing on CDS Market Liquidity and Their Economic Channels â€" A Regression Discontinuity Approach
Schoenemann, Gregor
In this study, I analyze the effect of central clearing on market liquidity in the CDS market. This study extends existing literature by using semi-parametric and non-parametric regression discontinuity designs (RDD) in order to isolate the effect of central clearing on measures of market tightness, market depth and market resiliency. I find evidence for a decrease in absolute bid-ask spreads with the beginning of central clearing and an increase in gross trading volume. Bid-ask spread resiliency decreases with the beginning of central clearing. These effect differ across contracts depending on their fundamental risk and liquidity risk. I show that counterparty risk and inventory costs may partly explain the effects of central clearing on CDS market liquidity. Especially the lower relevance of counterparty risk and lower regulatory capital charges seem to affect positively dealer competition and risk-taking capacity in the CDS market.

Numerical Solution for the Minimum Semivariance Portfolio Optimization Problem in R: The Semicov Package
Rigamonti, Andrea
Exact analytical solutions to the problem of computing a minimum semivariance portfolio cannot be obtained due to the endogeneity of the semicovariance matrix. However, when the number of assets is small, the weights for such a portfolio can be determined numerically. This paper presents the R package semicov, which provides a function that implements a numerical algorithm to minimize the semivariance of a portfolio with up to five assets. A function that estimates the approximation of the semicovariance matrix as in Estrada (2008) is also included in the package.

Optimal Demand for Index Insurance Under Basis Ambiguity
Yoichiro, Fujii,Osaki, Yusuke
This study examines how basis ambiguity influences the demand for index insurance. Ambiguity is introduced into the statistical relationship between the loss and the index because they are more difficult to guess than the occurrence of the loss and the index individually. Basis ambiguity lowers the demand for index insurance and increases the threshold to hold the index insurance. This is a possible explanation for the very low demand and participation in index insurance. Further, we consider how changes in ambiguity and ambiguity aversion influence the demand.

Persistence in the Market Risk Premium: Evidence Across Countries
Caporale, Guglielmo Maria,Gil-Alana, Luis A.,Martin-Valmayor, Miguel
This paper provides evidence on the degree of persistence of one of the key components of the CAPM, namely the market risk premium, as well as its volatility. The analysis applies fractional integration methods to data for the US, Germany and Japan, and for robustness purposes considers different time horizons (2, 5 and 10 years) and frequencies (monthly and weekly). The empirical findings in most cases imply that the market risk premium is a highly persistent variable which can be characterized as a random walk process, whilst its volatility is less persistent and exhibits stationary long-memory behaviour. There is also evidence that in the case of the US the degree of persistence has changed as a results of various events; this is confirmed by both endogenous break tests and the associated subsample estimates. Market participants should take this evidence into account when designing their investment strategies.

Pre-Election Drift in the Stock Market
Vojtko, Radovan,Cisár, Dominik
A particular event like elections are making lots of noise, but not only in our regular life where we should participate and so vote for our preferred candidate/party. This process also impacts financial markets. The uncertainty, which implies from the result of the elections, affects the volatility of the financial markets, which can easily double. In this paper, we were focused only on one specific market where we were seeking any pattern which could be profitable by assembling an investment strategy on it. Analyzing the stock market of the United States, where the elections occur on the exact day every even year, we found a specific pattern in the days before elections. This positive drift starts as soon as the fifth day before the election’s day and ends at the end of the election’s day with almost 2,5 % performance on average. An additional advantage of this pre-election pattern is its independence from the elections results even it is tied to elections. Last years showed us bigger market moves around elections due to increased uncertainty caused by political reasons which aren’t receding nowadays. Therefore, the period before elections could be more profitable regardless of the result of the elections.

Quote-Based Manipulation of Illiquid Benchmarks
Chau, Ching,Aspris, Angelo,Foley, Sean,Malloch, Hamish
We document a form of marking the close committed without transacting. Instead, manipulators utilize periods of order-book illiquidity to inflate the benchmark price. We find instances of closing price manipulation are associated with increases in end of day returns and, contrary to findings in the previous literature, observe no subsequent price reversals. Instead, we show these price effects continue in the manipulated direction over extended periods, with average excess returns of over 80\% in the six-months following the manipulation. Our results demonstrate that both regulators and exchanges need to be mindful of the pressures of external incentives on benchmark prices.

Real Exchange Rate Dynamics Beyond Business Cycles
Cao, Dan,Evans, Martin D.D.,Luo, Wenlan
We examine how medium-term movements in real exchange rates and GDP vary with international financial conditions. For this purpose, we study the international transmission of productivity shocks across a variety of IRBC models that incorporate different assumptions about the persistence of productivity shocks, the degree of international risk sharing and access to international asset markets. Using a new global solution method, we demonstrate that the transmission of productivity shocks depends critically on the proximity of a national economy to its international borrowing limit. We then show that this implication of the IRBC model is consistent with the behavior of the US-UK real exchange rate and GDP over the past 200 years. The model also produces a negative correlation between relative consumption growth and real depreciation rate consistent with more recent data, and hence offers a resolution of the Backus-Smith puzzle.

Recent Developments in the FinTech Industry
Chemmanur, Thomas J.,Imerman, Michael B.,Rajaiya, Harshit,Yu, Qianqian
In this article, we review some recent developments in the field of Financial Technology or “FinTech.” We begin with an overview of what FinTech is and why it has become an important growth industry in the financial services area and therefore an important research topic in finance. In the next section, we review some of the academic literature in the FinTech area. In the subsequent section, we characterize the financing of FinTech startups, especially by venture capital firms. In the following section, we characterize innovation by FinTech firms as well as by incumbent financial intermediaries. In the next section, we move on to discuss potential sources of value creation by FinTech start-up firms relative to existing incumbent firms: we conjecture that one source of value creation may arise from FinTech startups being able to provide a superior customer experience relative to incumbent firms in various areas of consumer finance. In the following section, we discuss the regulatory environment facing FinTech firms, in their banking as well as in their financial market activities. In the penultimate section, we analyze the buy-versus-build decision facing firms choosing to enter the FinTech sector, and discuss the trade-offs that may drive such decisions in practice. We conclude with some remarks about the future directions that may be taken by the FinTech industry.

Reserve Management and Sustainability: The Case for Green Bonds?
Fender, Ingo,McMorrow, Mike,Sahakyan, Vahe,Zulaica, Omar
Central banks' frameworks for managing foreign reserves have traditionally balanced a triad of objectives: liquidity, safety and return. Pursuing these objectives involves explicit trade-offs. More of an emphasis on returns, for instance, may require central banks to sacrifice some of the safety and liquidity of their overall holdings. Most recently, central banks have shown significant interest in incorporating environmental sustainability considerations into their policy frameworks, including their reserve management. This paper first explores whether sustainability considerations would support a tetrad of reserve management objectives, by drawing on the results of a recent BIS Survey on Reserve Management and Sustainability. It then illustrates how central banks might analyse (and weigh) all four objectives in allocating part of their foreign exchange reserves to green bonds using currently available market data.

Resolving the Excessive Trading Puzzle: An Integrated Approach Based on Surveys and Transactions
Liu, Hongqi,Peng, Cameron,Xiong, Wei A.,Xiong, Wei
The behavioral finance literature has provided over a dozen explanations for the so-called excessive trading puzzle â€" retail investors trade a lot even though more trading hurts their performance. It is difficult to use transaction data to differentiate these explanations as they share similar predictions by design. To confront this challenge, we design and administer a nation-wide survey among retail investors to elicit their responses to an exhaustive list of trading motives. By merging survey responses with account-level transaction data, we validate survey responses with actual trading behaviors and compare the power of survey-based and transaction-based measures of trading motives. A horse race among survey-based trading motives suggests that overconfidence in having information advantage and gambling preference quantitatively dominate other explanations. Moreover, other popular arguments such as neglect of trading cost do not contribute to excessive trading.

Retrospective Reserves and Bonus
Bruhn, Kenneth,Lollike, Alexander Sevel
Modern legislation has increased the amount of quantities that insurance companies should report in order to prove solvent as well as prudent. More of these quantities require not just simple bookkeeping but a mere projection of the future. In this paper, we provide a solid base for this crystal ball exercise as we derive differential equations for the retrospective reserves of a pension company, in a setting where the surplus and the dividends are modelled. The differential equations rely on dynamics of the stochastic reserve that are affine functions of the stochastic reserve themselves. The retrospective reserves are defined as conditional expected values, given limited information, leading to computational tractable differential equations for the reserves. We wrap up the theoretical part by suggestions for practical use in terms of considering validation of guarantees and discretionary benefits at future time points.

Risk Arbitrage and Hedging to Acceptability under Transaction Costs
Emmanuel Lepinette,Ilya Molchanov

The classical discrete time model of proportional transaction costs relies on the assumption that a feasible portfolio process has solvent increments at each step. We extend this setting in two directions, allowing for convex transaction costs and assuming that increments of the portfolio process belong to the sum of a solvency set and a family of multivariate acceptable positions, e.g. with respect to a dynamic risk measure. We describe the sets of superhedging prices, formulate several no (risk) arbitrage conditions and explore connections between them. In the special case when multivariate positions are converted into a single fixed asset, our framework turns into the no good deals setting. However, in general, the possibilities of assessing the risk with respect to any asset or a basket of the assets lead to a decrease of superhedging prices and the no arbitrage conditions become stronger. The mathematical technique relies on results for unbounded and possibly non-closed random sets in Euclidean space.

SME: Apparently Small but of Great Derivative Value! Literature Review of Tourism SMEs to Create Employment and Access to Finance
Nure, Gazmend,Bazini, Evelina,Madani, Filloreta
Contributions from various tourism SMEs to improve socio-economic development in developed countries include employment creation, improved living standards and increased family income. Despite this, you have great deals on the direct link between job creation, but there is also some controversy over who creates jobs and how they do it. Various documents say that Tourism SMEs play an important role in training young people, covering the labour deficit and generating benefits to the efficiency of the economy, innovation and overall growth. Therefore, this study will help us build the evidence needed to create Tourism SME policies and understand the core operational values of SMEs that maximize results in terms of achieving basic objectives such as job creation, increasing employee productivity and what are the financial challenges facing tourism SMEs. Policy initiatives to encourage the financial sector to be more proactive in securing tourism financing SMEs can also be envisaged, including taking steps to improve the knowledge and understanding of the tourism sector.

Safe Asset Migration
Ross, Chase P.
Post-crisis reforms changed the location of safe asset production. I propose a pair of tests to identify who issues safe assets and which safe asset issuers opportunistically time issuance when the price of safe assets is high. The Federal Home Loan Bank (FHLB) system is a newly crucial safe asset producer. FHLB debt issuance is an important determinant of the price of safe assets, and FHLB debt issuance responds to day-to-day fluctuations in the demand for safe assets â€" measured via the convenience yield. FHLBs issue more after an unexpected increase in the convenience yield and an unexpectedly large FHLB issue decreases the convenience yield. The FHLBs' ability to produce safe assets depends on their implicit government backing, a potential source of concern for future policymakers.

Sparse Information and Market Efficiency: Policy Interventions in the Housing Market
Gargano, Antonio,Giacoletti, Marco
We use two policy interventions in local housing markets to study the effects of improved information standards on market efficiency. Information on comparable sales plays a key role in driving buyers' valuations, but, even when available, is sparse, diluted among a multiplicity of irrelevant transactions. During the period of booming house prices preceding the interventions, sellers in house auctions appear to post distorted listing prices to take advantage of buyers' uncertainty on valuations, which is determined by sparse information on comparables. The new policies impose that sellers set listing prices consistent with sales prices of comparable properties, and, in a specific instance, that sellers directly provide comparables sales prices to prospective buyers. The interventions improve the information content of auction listings, reducing the gap between listing and sales prices. Moreover, directly providing information on comparables to buyers has an effect on sales prices, reducing the value that sellers can extract from auctions. Our results highlight how regulators may use information standards to intervene in the housing market.

Supply and demand shocks in the COVID-19 pandemic: An industry and occupation perspective
R. Maria del Rio-Chanona,Penny Mealy,Anton Pichler,Francois Lafond,Doyne Farmer

We provide quantitative predictions of first order supply and demand shocks for the U.S. economy associated with the COVID-19 pandemic at the level of individual occupations and industries. To analyze the supply shock, we classify industries as essential or non-essential and construct a Remote Labor Index, which measures the ability of different occupations to work from home. Demand shocks are based on a study of the likely effect of a severe influenza epidemic developed by the US Congressional Budget Office. Compared to the pre-COVID period, these shocks would threaten around 22% of the US economy's GDP, jeopardise 24% of jobs and reduce total wage income by 17%. At the industry level, sectors such as transport are likely to have output constrained by demand shocks, while sectors relating to manufacturing, mining and services are more likely to be constrained by supply shocks. Entertainment, restaurants and tourism face large supply and demand shocks. At the occupation level, we show that high-wage occupations are relatively immune from adverse supply and demand-side shocks, while low-wage occupations are much more vulnerable. We should emphasize that our results are only first-order shocks -- we expect them to be substantially amplified by feedback effects in the production network.

The Frequency of One-Day Abnormal Returns and Price Fluctuations in the Forex
Caporale, Guglielmo Maria,Plastun, Oleksiy,Oliinyk, Viktor
This paper analyses the explanatory power of the frequency of abnormal returns in the FOREX for the EURUSD, GBRUSD, USDJPY, EURJPY, GBPCHF, AUDUSD and USDCAD exchange rates over the period 1994-2019. Abnormal returns are detected using a dynamic trigger approach; then the following hypotheses are tested: their frequency is a significant driver of price movements (H1); it does not exhibit seasonal patterns (H2); it is stable over time (H3). For our purposes a variety of statistical methods (both parametric and non-parametric) are applied including ADF tests, Granger causality tests, correlation analysis, (multiple) regression analysis, Probit and Logit regression models. No evidence is found of either seasonal patterns or instability. However, there appears to be a strong positive (negative) relationship between returns in the FOREX and the frequency of positive (negative) abnormal returns. On the whole, the results suggest that the latter is an important driver of price dynamics in the FOREX, is informative about crises and can be the basis of profitable trading strategies, which is inconsistent with market efficiency.

The Impact of Regulation in the Cryptocurrency Market: An Event Study Assessing Assets’ Returns Reaction
Chokor, Ahmad,Alfieri, Elise
While the empirical evidence is still scant, we attempt in this paper to examine the impact of regulation on the cryptocurrency market. Do cryptocurrency traders perceive regulation in a beneficial or a costly way? Using an event study methodology for daily data covering the period 2015-2019, we assess how regulatory news and events have affected returns in the cryptocurrency market. The results suggest that events that increase the probability of a regulation adoption are associated with a negative abnormal return for concerned cryptocurrencies. We isolate events that consider cryptocurrencies under securities law and find that the reaction is amplified and that there is a negative and more significant relationship. Moreover, we assess whether specific cryptocurrency characteristics and in particular their liqudity explain cross-sectional variations in cryptocurrencies’ return reactions. We find that the magnitude of the returns’ reaction was not the same across all the cryptocurrencies samples. Furthermore, we examine the performance of cryptocurrencies on the long-term using the Sharpe ratio, CAPM, Fama-Frenceh 3-factors model, and Carhart model. After measuring a positive and significant performance in the pre-event period, we find a non-significant performance in the post-event period.

The Impact of Unconventional Monetary Policies on Retail Lending and Deposit Rates in the Euro Area
Hofmann, Boris,Illes, Anamaria,Lombardi, Marco J.,Mizen, Paul
This paper investigates the overall effect of the European Central Bank's (ECB's) unconventional monetary policies (UMPs) implemented since 2008 on euro area bank retail lending and deposit rates offered to households and non-financial corporations. To do so, we use an analytical approach that combines the estimation of the cumulative effects of UMP on key money and capital market rates via daily event study analysis with monthly retail rate pass-through estimation. In counterfactual simulations, we quantify the full effect of the ECB's UMPs implemented since 2008 on retail lending and deposit rates and systematically explore differences in their effects over time and across euro area countries. Our results show that the ECB's UMPs - particularly the measures launched since 2012 - significantly lowered retail lending and deposit rates in Germany, France, Spain and in particular in Italy. The impact on banks' intermediation margins through retail lending-deposit rate spreads turns out to be not clear-cut, with significant compressions prevailing only in Germany and Italy.

The Saving Glut of the Rich and the Rise in Household Debt
Mian, Atif,Sufi, Amir
Rising income inequality since the 1980s in the United States has generated a substantial increase in saving by the top of the income distribution, which we call the saving glut of the rich. The saving glut of the rich has been as large as the global saving glut, and it has not been associated with an increase in investment. Instead, the saving glut of the rich has been linked to the substantial dissaving and large accumulation of debt by the non-rich. Analysis using variation across states shows that the rise in top income shares can explain almost all of the accumulation of household debt held as a financial asset by the household sector. Since the Great Recession, the saving glut of the rich has been financing government deficits to a greater degree.

Trades by Insiders and the Informativeness of Earnings Announcements
Crego, Julio A.,Gider, Jasmin
Investors learn from trades by insiders about the next earnings announcement. By exploiting the discontinuity in the term structure of option prices on the announcement date, we show that this learning is nontrivial: the trades carry information about both the first and second moments of earnings. On the one hand, buys decrease earnings informativeness, on the other hand, sales increase it. Conversely, signals by analysts and 13D filers, who are also informed, unequivocally decrease earnings informativeness. The difference between insiders and other informed agents resides on their natural underdiversification, which incentivizes them to trade on the second moment.

Tullock Contest: A Model of Proof-of-Work Mining in Cryptocurrencies
Soria, Jorge
This paper presents an N-player Tullock contest where players purchases shares in a lottery at a fixed common cost. Once all players have purchased their shares, a common value reward is raffled off. The model has some similarities to all-pay auctions, however the assignment mechanism differs. This difference ensures that, unlike all-pay auctions, the N-player Tullock contest has an unique pure strategy Nash equilibrium. This article presents also a new kind of Tullock contest that integrates the main mechanism behind proof-of-work mining of cryptocurrencies such as Bitcoin. The application of the model is expanded to analyze some topics of proof-of-work protocols, such as concentration of hashing power, double-spending attacks and environmental externalities.

Unintended Consequences of Demand-side Housing Policies: Evidence from Capital Reallocation
Qian, Wenlan,Tu, Hong,Wu, Jing,Xu, Weibiao
We empirically investigate how households reallocate their funds in response to an austere housing-market cooling interventionâ€"the Housing Purchase Restriction (HPR) policy in Chinaâ€"that depresses housing demand. Based on a proprietary dataset on individual stock accounts from a large stock brokerage firm, we find a significant increase in new stock accounts opening and capital inflow to the stock market by the affected households immediately after the HPR implementation, which absorbs 54% of the capital that would have flowed into the housing market. The affected investors more likely steer capital toward investment in the listed real estate developers, a pattern that is prevalent across investor demographics and particularly strong in HPR cities with a higher pre-policy house price growth. The capital reallocation results in a significant trading loss for affected investors. We also find listed real estate developers, even the capital-constrained and more HPR-exposed firms, do not reduce corporate investment and employment despite the negative demand outlook.

What Does Financial Heterogeneity Say About the Transmission of Monetary Policy?
Vats, Nishant
I study the role of heterogeneity of financial frictions in determining the effect of monetary policy shocks on firm investment. Using staggered enactment of anti-recharacterization legislation across different states in the US as a source of exogenous variation in creditor rights, I find that the investment of unconstrained firms is more sensitive to monetary policy shocks relative to the constrained firms. A one standard deviation expansionary monetary policy shock results in a 0.02 standard deviation higher investment growth among unconstrained firms relative to constrained firms. This effect is most prominent among firms operating in industries with extensive use of special purpose vehicles and greater engagement in secured asset-based borrowing. However, constrained firms are more responsive to monetary policy shocks relative to unconstrained firms during periods of economic downturns and low-interest rate regimes. Lastly, I provide some suggestive evidence that my results are not driven by the Fed information effect, and the effects dominate during periods of high wage and contractual rigidity.

When Does Information Disclosure Help Innovation? Evidence from Blue Sky Laws
Akkoyun, Cagri,Ersahin, Nuri
Using historical firm-level patent and accounting data, we analyze how information disclosure affects firm innovation. To establish a causal link, we use the enactment of blue sky laws, the first form of investor protection laws, across some U.S. states at the beginning of the 20th century, when there was no federal regulation. These laws required firms to disclose information before selling their securities and increased penalties in case of financial fraud. Using archival records, we document that young innovative firms (startups) had a large share of intangible assets and relied heavily on equity financing (venture capital). In a difference-in-differences setting, we show that following the enactment of these laws, innovative firms that previously had limited access to external finance raised more funds and increased their innovation activity. Our results suggest that disclosure requirements help innovation when the information environment is weak to begin with.