Research articles for the 2020-04-17
COMPTE RENDU DE LA RÉUNION DU G7 DES FONDS DE PENSIONS D’AOÛT 2019 Les objectifs de Développement Durable («ODD») sont désormais incontournables pour le secteur financier (Report on the G7 Pensions Meetings, August 2019: Sustainable Development Goals (‘SDGs’) Are Now Essential for the Financial Sector)
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French Abstract: Nicolas Firzli nous fait partager certains des travaux menés par le World Pensions Council (WPC) et résume ici une partie des interventions du G7 Pensions qui s'est tenu fin août dernier, en marge du Sommet du G7 de Biarritz. Il livre des pistes de réflexions précieuses pour nous en France et en Europe, notamment sur la bonne gouvernance des fonds de pensions ("The ESG-Driven Asset Owner of the Future") à l'heure de la montée en puissance des 'Sustainable Development Goals' (SDGs) de l'ONU et sur le financement des infrastructures dans les pays de l'OCDE ainsi que dans les nations émergentes de l'aire Asie-Pacifique, d'Afrique et d'Amérique Latine.English Abstract: The World Pensions Council (WPC), Africa Investor (Ai) and the Singapore Economic Forum (SEF) have held the G7 Pensionsâ„¢ Roundtable in Biarritz, 26 August 2019, in association with the CFA Society of New York Asset Owners Series (AOS)This high-level seminar co-chaired by Nicolas J. Firzli, WPC, brought together a select group of pension board members, trustees and policy makers from across G7 nations as well as Australia and South AfricaRE: ESG, SDG-Driven Investments and the Role of Asset Owners:Banks currently underwrite $7tn. and lend $3tn. every year. This money should flow in a way consistent with the SDGs, but, quite often, it's not the case when it comes to polluting (coal, shale gas, deep offshore oil) and unhealthy (tobacco, opioids...) industriesHere, the notion of "chain of ownership" is key. Who owns the capital of these [sometimes] complacent investment banks?Large asset owners such as e.g. Norges Bank in Europe [already] have it in their power to make a decisive impact on the world economy by engaging more forcefully with the banks in question [whose shares and bonds they own] re some of their current lending and underwriting practicesMore generally, influential asset owners such as public pension funds, SWFs and central banks will also need more reliable data to "shift the trillions" and accelerate the advent of "the SDG-Driven Firm of the Future"....Dr. Michael Urban, Economy & Society: Transformations and Justice Research Cluster, Oxford University, presented the preliminary findings of his ongoing research project re: ESG data and investment governance in the financial services sector â€" some of the notions advanced here are based on his research, others on papers published by the World Pensions Council RE: WOMEN EMPOWERMENT & GENDER EQUALITY "FROM BOARD-ROOMS TO PLANT-FLOORS"This high-level roundtable was led jointly by Valerie Easmon-George, Board Member (Trustee), Islington Council, Local Government Pensions Scheme (LGPS); Suzanne Bishopric, fmr. CIO, UN Joint Staff Pension Fund (JSPF), the New York-based supranational pension giant, and Chris Smith, Board Member (Trustee), Westminster City Council, LGPS & UNISON Br. Sec.The 2020 G7 Pensionsâ„¢ Roundtable will be held on June 12 2020, on the sidelines of the 46th G7 Summit.
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French Abstract: Nicolas Firzli nous fait partager certains des travaux menés par le World Pensions Council (WPC) et résume ici une partie des interventions du G7 Pensions qui s'est tenu fin août dernier, en marge du Sommet du G7 de Biarritz. Il livre des pistes de réflexions précieuses pour nous en France et en Europe, notamment sur la bonne gouvernance des fonds de pensions ("The ESG-Driven Asset Owner of the Future") à l'heure de la montée en puissance des 'Sustainable Development Goals' (SDGs) de l'ONU et sur le financement des infrastructures dans les pays de l'OCDE ainsi que dans les nations émergentes de l'aire Asie-Pacifique, d'Afrique et d'Amérique Latine.English Abstract: The World Pensions Council (WPC), Africa Investor (Ai) and the Singapore Economic Forum (SEF) have held the G7 Pensionsâ„¢ Roundtable in Biarritz, 26 August 2019, in association with the CFA Society of New York Asset Owners Series (AOS)This high-level seminar co-chaired by Nicolas J. Firzli, WPC, brought together a select group of pension board members, trustees and policy makers from across G7 nations as well as Australia and South AfricaRE: ESG, SDG-Driven Investments and the Role of Asset Owners:Banks currently underwrite $7tn. and lend $3tn. every year. This money should flow in a way consistent with the SDGs, but, quite often, it's not the case when it comes to polluting (coal, shale gas, deep offshore oil) and unhealthy (tobacco, opioids...) industriesHere, the notion of "chain of ownership" is key. Who owns the capital of these [sometimes] complacent investment banks?Large asset owners such as e.g. Norges Bank in Europe [already] have it in their power to make a decisive impact on the world economy by engaging more forcefully with the banks in question [whose shares and bonds they own] re some of their current lending and underwriting practicesMore generally, influential asset owners such as public pension funds, SWFs and central banks will also need more reliable data to "shift the trillions" and accelerate the advent of "the SDG-Driven Firm of the Future"....Dr. Michael Urban, Economy & Society: Transformations and Justice Research Cluster, Oxford University, presented the preliminary findings of his ongoing research project re: ESG data and investment governance in the financial services sector â€" some of the notions advanced here are based on his research, others on papers published by the World Pensions Council RE: WOMEN EMPOWERMENT & GENDER EQUALITY "FROM BOARD-ROOMS TO PLANT-FLOORS"This high-level roundtable was led jointly by Valerie Easmon-George, Board Member (Trustee), Islington Council, Local Government Pensions Scheme (LGPS); Suzanne Bishopric, fmr. CIO, UN Joint Staff Pension Fund (JSPF), the New York-based supranational pension giant, and Chris Smith, Board Member (Trustee), Westminster City Council, LGPS & UNISON Br. Sec.The 2020 G7 Pensionsâ„¢ Roundtable will be held on June 12 2020, on the sidelines of the 46th G7 Summit.
Climate Regulatory Risks and Corporate Bonds
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Examining how climate and other environmental regulatory risks affect bond risk and pricing, we find that bond credit ratings and yield spreads appear to be influenced by a firm's environmental performance along with its regulatory conditions. Firms with poor environmental profiles tend to have lower credit ratings and higher yield spreads, particularly when the firm is located in a state with more stringent environmental regulations. Using the Paris Agreement as a shock to expected climate regulation, we provide evidence of a causal relation between climate regulatory risks and the credit ratings and yield spreads of bonds with problematic environmental profiles.
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Examining how climate and other environmental regulatory risks affect bond risk and pricing, we find that bond credit ratings and yield spreads appear to be influenced by a firm's environmental performance along with its regulatory conditions. Firms with poor environmental profiles tend to have lower credit ratings and higher yield spreads, particularly when the firm is located in a state with more stringent environmental regulations. Using the Paris Agreement as a shock to expected climate regulation, we provide evidence of a causal relation between climate regulatory risks and the credit ratings and yield spreads of bonds with problematic environmental profiles.
Corporate Immunity to the COVID-19 Pandemic
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Using data on over 6,000 firms across 56 economies during the first quarter of 2020, we evaluate the connection between corporate characteristics and stock price reactions to COVID-19 cases. We find that the pandemic-induced drop in stock prices was milder among firms with (a) stronger pre-2020 finances (more cash, less debt, and larger profits), (b) less exposure to COVID-19 through global supply chains and customer locations, (c) more CSR activities, and (d) less entrenched executives. Furthermore, the stock prices of firms with greater hedge fund ownership performed worse, and those of firms with larger non-financial corporate ownership performed better. We believe ours is the first paper to assess international, cross-firm stock price reactions to COVID-19 as functions of these pre-shock corporate characteristics.
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Using data on over 6,000 firms across 56 economies during the first quarter of 2020, we evaluate the connection between corporate characteristics and stock price reactions to COVID-19 cases. We find that the pandemic-induced drop in stock prices was milder among firms with (a) stronger pre-2020 finances (more cash, less debt, and larger profits), (b) less exposure to COVID-19 through global supply chains and customer locations, (c) more CSR activities, and (d) less entrenched executives. Furthermore, the stock prices of firms with greater hedge fund ownership performed worse, and those of firms with larger non-financial corporate ownership performed better. We believe ours is the first paper to assess international, cross-firm stock price reactions to COVID-19 as functions of these pre-shock corporate characteristics.
Corporate Resilience and Response During COVID-19
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During a market collapse, it is strategically important for a company to be evaluated as resilient, thereby maintaining trust among investors. We study whether during the 2020 COVID-19-induced market crash, investors differentiated across companies based on a firm’s human capital, supply chain and operating crisis response. Using data derived from natural language processing measuring public sentiment around how companies have responded to the coronavirus crisis, we find that firms with more positive sentiment exhibit less institutional money outflows and negative returns than their competitors. This was especially true for companies with more salient responses.
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During a market collapse, it is strategically important for a company to be evaluated as resilient, thereby maintaining trust among investors. We study whether during the 2020 COVID-19-induced market crash, investors differentiated across companies based on a firm’s human capital, supply chain and operating crisis response. Using data derived from natural language processing measuring public sentiment around how companies have responded to the coronavirus crisis, we find that firms with more positive sentiment exhibit less institutional money outflows and negative returns than their competitors. This was especially true for companies with more salient responses.
Crude Oil Price Dynamics with Crash Risk Under Fundamental Shocks
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Our paper presents a crude oil price model in which the price is confined in a wide moving band. A price crash occurs when the price breaches the lower boundary where a smooth-pasting condition is imposed. Using an asymmetric mean-reverting fundamental (supply/demand) shock, the solution derived from the oil price equation for the model shows the oil price follows a mean-reverting square-root process, which is quasi-bounded at the boundary. The oil price dynamics generates left-skewed price distributions consistent with empirical observations. A weakened mean-reverting force for the price increases the probability leakage for the price across the boundary and the risk of a price crash. The empirical results show the oil price dynamics can be calibrated according to the model, where the mean reversion of the price dynamics is positively co-integrated with the oil production reaction to negative demand shocks, and with the risk reversals of the commodity currencies, the Canadian dollar and the Australian dollar in currency option markets. The results are consistent with an increased price crash risk with negative demand shocks and negative risk reversals. The forecasting performance of the oil price model is better than the futures-spread models and random walk models during the crash periods. While the price of oil was above the lower boundary for most of the time, the conditions for breaching the boundary were met in 2008 and 2014 when the price fell sharply.
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Our paper presents a crude oil price model in which the price is confined in a wide moving band. A price crash occurs when the price breaches the lower boundary where a smooth-pasting condition is imposed. Using an asymmetric mean-reverting fundamental (supply/demand) shock, the solution derived from the oil price equation for the model shows the oil price follows a mean-reverting square-root process, which is quasi-bounded at the boundary. The oil price dynamics generates left-skewed price distributions consistent with empirical observations. A weakened mean-reverting force for the price increases the probability leakage for the price across the boundary and the risk of a price crash. The empirical results show the oil price dynamics can be calibrated according to the model, where the mean reversion of the price dynamics is positively co-integrated with the oil production reaction to negative demand shocks, and with the risk reversals of the commodity currencies, the Canadian dollar and the Australian dollar in currency option markets. The results are consistent with an increased price crash risk with negative demand shocks and negative risk reversals. The forecasting performance of the oil price model is better than the futures-spread models and random walk models during the crash periods. While the price of oil was above the lower boundary for most of the time, the conditions for breaching the boundary were met in 2008 and 2014 when the price fell sharply.
Does Funding Source Matter for University R&D? The Effect of Government vs. Industry Grants
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Universities are an important source of new knowledge. U.S. universities have traditionally relied on federal government funding, but since 2000 the federal share has declined while the private industry share has increased. This paper offers the first causal comparison of federal and private university research funding, focusing on patenting and researcher career outcomes. We begin with unique data on grants from 22 universities, which include individual-level payments for everyone employed on all grants for each university-year. We combine this with patent and Census data, including national IRS W-2 histories. We instrument for an individual’s source of funding with government-wide R&D expenditure shocks within a narrow field of study. These funding supply changes yield a set of compliers who are pushed away from federal funding and into private funding. We find that a higher share of federal funding causes fewer but more general patents, much more high-tech entrepreneurship, a higher likelihood of remaining employed in academia, and a lower likelihood of joining an incumbent firm. Increasing the private share of funding has opposite effects for most outcomes. It appears that private funding leads to greater appropriation of intellectual property by incumbent firms.
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Universities are an important source of new knowledge. U.S. universities have traditionally relied on federal government funding, but since 2000 the federal share has declined while the private industry share has increased. This paper offers the first causal comparison of federal and private university research funding, focusing on patenting and researcher career outcomes. We begin with unique data on grants from 22 universities, which include individual-level payments for everyone employed on all grants for each university-year. We combine this with patent and Census data, including national IRS W-2 histories. We instrument for an individual’s source of funding with government-wide R&D expenditure shocks within a narrow field of study. These funding supply changes yield a set of compliers who are pushed away from federal funding and into private funding. We find that a higher share of federal funding causes fewer but more general patents, much more high-tech entrepreneurship, a higher likelihood of remaining employed in academia, and a lower likelihood of joining an incumbent firm. Increasing the private share of funding has opposite effects for most outcomes. It appears that private funding leads to greater appropriation of intellectual property by incumbent firms.
Does the ABDC Journal Classification Create Unequal Opportunities for Accounting and Finance Researchers?
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The Australian Business Deans Council (ABDC) journal classification list uses a methodology where a committee of experts puts a specific percentage of journals in each discipline in a certain category (A*, A, B, or C). We study whether this approach creates unequal opportunities in favor of some field and against others. We analyze a number of factors, such as the number of journals in each category, the number of papers published per year, the number of authors per paper, and the number of academics in each discipline. We find that there are clearly more opportunities for Management and Economics academics and less for Finance, Marketing, Econometrics, and especially Accounting researchers. This finding applies to both the highest two categories (A* and A) combined and to the highest category (A*) considered on itself. The difference in opportunities seems to have slightly gone down in the 2019 list compared to the 2016 list. We also suggest a methodology for a level-playing field list for a new top category (A**).
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The Australian Business Deans Council (ABDC) journal classification list uses a methodology where a committee of experts puts a specific percentage of journals in each discipline in a certain category (A*, A, B, or C). We study whether this approach creates unequal opportunities in favor of some field and against others. We analyze a number of factors, such as the number of journals in each category, the number of papers published per year, the number of authors per paper, and the number of academics in each discipline. We find that there are clearly more opportunities for Management and Economics academics and less for Finance, Marketing, Econometrics, and especially Accounting researchers. This finding applies to both the highest two categories (A* and A) combined and to the highest category (A*) considered on itself. The difference in opportunities seems to have slightly gone down in the 2019 list compared to the 2016 list. We also suggest a methodology for a level-playing field list for a new top category (A**).
Firm-Level Regulatory Beta
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Applying a simple asset pricing method to a novel administrative database, I introduce a new measure of "regulatory beta:" how firm-level stock returns comove with aggregate shocks to federal regulations. The monthly measure captures exposure to common shocks of any U.S. listed firm since 1981, varies intuitively over time and across sectors, and conveys important information about the firm's prospects. "Exposed'' firms sharply reduce investment and employment, indicative of response to adverse regulatory shocks. Consequently, a strategy that shorts "exposed'' firms and buys "insulated'' ones earns over 8% in risk-adjusted return per year. Cross-sectional tests suggest that regulatory shocks propagate by increasing legal uncertainty and exacerbating financial constraints.
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Applying a simple asset pricing method to a novel administrative database, I introduce a new measure of "regulatory beta:" how firm-level stock returns comove with aggregate shocks to federal regulations. The monthly measure captures exposure to common shocks of any U.S. listed firm since 1981, varies intuitively over time and across sectors, and conveys important information about the firm's prospects. "Exposed'' firms sharply reduce investment and employment, indicative of response to adverse regulatory shocks. Consequently, a strategy that shorts "exposed'' firms and buys "insulated'' ones earns over 8% in risk-adjusted return per year. Cross-sectional tests suggest that regulatory shocks propagate by increasing legal uncertainty and exacerbating financial constraints.
Forward Premium Puzzle and Heterogeneous Beliefs
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We propose a two-country model with heterogeneous beliefs to understand the forward premium puzzle. Facing a shock to the domestic money supply, the disagreement between domestic and foreign investors shifts the relative wealth of investors, which moves the exchange rate and interest rate differential in opposite directions. Calibrated to U.S. and U.K. data, our model reproduces the rejection of the uncovered interest rate parity. Using a monthly index of heterogeneous beliefs based on the Consensus Forecast in 15 major economies, the empirical evidence confirms that the dispersion of beliefs helps explain exchange rate movements and carry trade returns.
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We propose a two-country model with heterogeneous beliefs to understand the forward premium puzzle. Facing a shock to the domestic money supply, the disagreement between domestic and foreign investors shifts the relative wealth of investors, which moves the exchange rate and interest rate differential in opposite directions. Calibrated to U.S. and U.K. data, our model reproduces the rejection of the uncovered interest rate parity. Using a monthly index of heterogeneous beliefs based on the Consensus Forecast in 15 major economies, the empirical evidence confirms that the dispersion of beliefs helps explain exchange rate movements and carry trade returns.
Growth and Inflation Implications of Systemic Risk in the Euro Area Banking Industry: Lessons from the Financial Crisis
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This study has two objectives. It first assesses the output and inflation effects of systemic risk-taking in the euro area banking sector using a factor-augmented vector autoregressive model that exploits a 519 time-series rich dataset, including coherent measures of systemic risk in all its forms and its time dimension. Then, it evaluates whether the systemic risk measures can be used as early warning signals of severe negative nominal growth outcomes using the Receiver Operating Characteristic approach. The main findings are that, overall, real GDP growth and inflation react negatively to a one-standard deviation shock to systemic risk measures of the euro area banking industry. Inflation depicts a more pronounced response than GDP. There is heterogeneity in the strength of the responses across diverse forms of systemic risk and their time dimension. Specifically, short-term systemic risk measures tend to portray stronger effects on output and inflation than their conditional forward counterparts. In particular, systemic risk in the form of banking sector vulnerability associated with interconnectedness and contagion plays a considerable role in depressing economic activity in the euro area. Finally, all but one systemic risk measure predict with high accuracy the extreme macro-financial instability in the euro area that followed Lehman Brothers’ collapse. The systemic risk measures are potentially good candidates to be included in a macroprudential-policy toolkit for calibrating instruments at thresholds that reflect policymakers’ risk preferences.
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This study has two objectives. It first assesses the output and inflation effects of systemic risk-taking in the euro area banking sector using a factor-augmented vector autoregressive model that exploits a 519 time-series rich dataset, including coherent measures of systemic risk in all its forms and its time dimension. Then, it evaluates whether the systemic risk measures can be used as early warning signals of severe negative nominal growth outcomes using the Receiver Operating Characteristic approach. The main findings are that, overall, real GDP growth and inflation react negatively to a one-standard deviation shock to systemic risk measures of the euro area banking industry. Inflation depicts a more pronounced response than GDP. There is heterogeneity in the strength of the responses across diverse forms of systemic risk and their time dimension. Specifically, short-term systemic risk measures tend to portray stronger effects on output and inflation than their conditional forward counterparts. In particular, systemic risk in the form of banking sector vulnerability associated with interconnectedness and contagion plays a considerable role in depressing economic activity in the euro area. Finally, all but one systemic risk measure predict with high accuracy the extreme macro-financial instability in the euro area that followed Lehman Brothers’ collapse. The systemic risk measures are potentially good candidates to be included in a macroprudential-policy toolkit for calibrating instruments at thresholds that reflect policymakers’ risk preferences.
International Bank Lending and Corporate Debt Structure
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Using a cross-country sample of bank-dependent public firms we study the international spillovers of a change in banking regulation on corporate borrowing. For identification we examine how US firms' liabilities vis-Ã -vis banks, non-bank lenders and bond markets evolve after an increase in capital requirements implemented by the European Banking Authority (EBA) in 2011. We find that US firms experience a reduction in credit lines but not in term loans from EU banks. In addition, US firms are able to compensate for the reduction in credit lines from EU banks by securing liquidity facilities from US non-bank financial institutions, without increasing borrowing from corporate bond markets. These results suggest that diversified domestic loan markets, with both banks and non-bank financial institutions providing loans to corporations, can help overcome cuts in cross-border bank funding.
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Using a cross-country sample of bank-dependent public firms we study the international spillovers of a change in banking regulation on corporate borrowing. For identification we examine how US firms' liabilities vis-Ã -vis banks, non-bank lenders and bond markets evolve after an increase in capital requirements implemented by the European Banking Authority (EBA) in 2011. We find that US firms experience a reduction in credit lines but not in term loans from EU banks. In addition, US firms are able to compensate for the reduction in credit lines from EU banks by securing liquidity facilities from US non-bank financial institutions, without increasing borrowing from corporate bond markets. These results suggest that diversified domestic loan markets, with both banks and non-bank financial institutions providing loans to corporations, can help overcome cuts in cross-border bank funding.
Investment Decisions and the Logic of Valuation. Linking Finance, Accounting, and Engineering
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This book presents a new approach to the valuation of capital asset investments and investment decision-making. Starting from simple premises and working logically through three basic elements (capital, income, and cash flow), it guides readers on an interdisciplinary journey through the subtleties of accounting and finance, explaining how to correctly measure a project’s economic profitability and efficiency, how to assess the impact of investment policy and financing policy on shareholder value creation, and how to design reliable, transparent, and logically consistent financial models.The book adopts an innovative pedagogical approach, based on a newly developed accounting-and-finance-engineering system, to help readers gain a deeper understanding of the accounting and financial magnitudes, learn about new analytical tools, and develop the necessary skills to practically implement them. This diverse approach to capital budgeting allows a sophisticated economic analysis in both absolute terms (values) and relative terms (rates of return), and is applicable to a wide range of economic entities, including real assets and financial assets, engineering designs and manufacturing schemes, corporate-financed and project-financed transactions, privately-owned projects and public investments, individual projects and firms. As such, this book is a valuable resource for a broad audience, including scholars and researchers, industry practitioners, executives, and managers, as well as students of corporate finance, managerial finance, engineering economics, financial management, management accounting, operations research, and financial mathematics. It features more than 180 guided examples, 50 charts and figures and over 160 explanatory tables that help readers grasp the new concepts and tools. Each chapter starts with an abstract and a list of the skills readers can expect to gain, and concludes with a list of key points summarizing the content.
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This book presents a new approach to the valuation of capital asset investments and investment decision-making. Starting from simple premises and working logically through three basic elements (capital, income, and cash flow), it guides readers on an interdisciplinary journey through the subtleties of accounting and finance, explaining how to correctly measure a project’s economic profitability and efficiency, how to assess the impact of investment policy and financing policy on shareholder value creation, and how to design reliable, transparent, and logically consistent financial models.The book adopts an innovative pedagogical approach, based on a newly developed accounting-and-finance-engineering system, to help readers gain a deeper understanding of the accounting and financial magnitudes, learn about new analytical tools, and develop the necessary skills to practically implement them. This diverse approach to capital budgeting allows a sophisticated economic analysis in both absolute terms (values) and relative terms (rates of return), and is applicable to a wide range of economic entities, including real assets and financial assets, engineering designs and manufacturing schemes, corporate-financed and project-financed transactions, privately-owned projects and public investments, individual projects and firms. As such, this book is a valuable resource for a broad audience, including scholars and researchers, industry practitioners, executives, and managers, as well as students of corporate finance, managerial finance, engineering economics, financial management, management accounting, operations research, and financial mathematics. It features more than 180 guided examples, 50 charts and figures and over 160 explanatory tables that help readers grasp the new concepts and tools. Each chapter starts with an abstract and a list of the skills readers can expect to gain, and concludes with a list of key points summarizing the content.
Long-Run Association Across Stock Markets in South-East Europe and Mean-Volatility Spillovers With Mature Markets
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This paper explores the inter-market linkages and the transmission of financial information among the capital markets of five South-Eastern European countries and their relationships with some of the mature markets. The Johansen co-integration framework pointed to the existence of one co-integrating vector, but the results could not be validated through standard tests. The VAR model that included the mature markets as well, revealed certain causal dependencies among the markets. Positive and significant ARCH and GARCH effects were found to exist on all of the markets, except in Slovenia and mean spillover effects from Germany into all of the younger markets were identified, as well as between some of the younger markets themselves. Volatility spillovers were also confirmed in almost the same instances. The implication for the investors is that they should closely monitor the trends in the leading markets as a source of valuable information for the composition of their portfolios. For the policymakers, the knowledge of the direction of the impacts is important for the purpose of predicting future exogenous shocks. An additional value of the paper is that these five markets, their mutual relationships and the linkages with mature markets are jointly analysed for the first time.
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This paper explores the inter-market linkages and the transmission of financial information among the capital markets of five South-Eastern European countries and their relationships with some of the mature markets. The Johansen co-integration framework pointed to the existence of one co-integrating vector, but the results could not be validated through standard tests. The VAR model that included the mature markets as well, revealed certain causal dependencies among the markets. Positive and significant ARCH and GARCH effects were found to exist on all of the markets, except in Slovenia and mean spillover effects from Germany into all of the younger markets were identified, as well as between some of the younger markets themselves. Volatility spillovers were also confirmed in almost the same instances. The implication for the investors is that they should closely monitor the trends in the leading markets as a source of valuable information for the composition of their portfolios. For the policymakers, the knowledge of the direction of the impacts is important for the purpose of predicting future exogenous shocks. An additional value of the paper is that these five markets, their mutual relationships and the linkages with mature markets are jointly analysed for the first time.
Macro Announcements and Volatilities of the Renminbi Onshore and Offshore Exchange Rates
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We examine how Chinese and US macro announcements affect the volatilities of Chinese renminbi (RMB) onshore (CNY) and offshore (CNH) exchange rates. We find that RMB exchange rates will generally become more stable if either China or US display better economic performance than expectation and otherwise more volatile if China or US fundamentals perform worse than expected. We also find the dominant role of Chinese macro news on the volatilities of both CNY and CNH from the perspective of average magnitudes. Decomposing the volatility into long-term trend and short-term cyclical components, we discover a closer connection of macro news effect with the long-run component of the volatility. Moreover, we focus on the isolated effects of negative and positive surprises, and uncover greater influence of Chinese announcements on CNY while greater response of CNH to US announcements. However, we find no evidence of asymmetric effects of positive versus negative surprises. Considering the event of China’s exchange rate reform in 2015, our results suggest a growing impact of Chinese macro announcements on RMB volatility determination.
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We examine how Chinese and US macro announcements affect the volatilities of Chinese renminbi (RMB) onshore (CNY) and offshore (CNH) exchange rates. We find that RMB exchange rates will generally become more stable if either China or US display better economic performance than expectation and otherwise more volatile if China or US fundamentals perform worse than expected. We also find the dominant role of Chinese macro news on the volatilities of both CNY and CNH from the perspective of average magnitudes. Decomposing the volatility into long-term trend and short-term cyclical components, we discover a closer connection of macro news effect with the long-run component of the volatility. Moreover, we focus on the isolated effects of negative and positive surprises, and uncover greater influence of Chinese announcements on CNY while greater response of CNH to US announcements. However, we find no evidence of asymmetric effects of positive versus negative surprises. Considering the event of China’s exchange rate reform in 2015, our results suggest a growing impact of Chinese macro announcements on RMB volatility determination.
Maximum Likelihood Estimation of Continuous-time Diffusion Models for Exchange Rates
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Five diffusion models are estimated using three different foreign exchange rates to find an appropriate model for each. Daily spot exchange rates expressed as the prices of 1 euro, 1 British pound and 100 Japanese yen in US dollars, respectively denoted by USD/EUR, USD/GBP, and USD/100JPY, are used. The maximum likelihood estimation method is implemented after deriving an approximate log-transition density function (log-TDF) of the diffusion processes because the true log-TDF is unknown. Of the five models, the most general model is the best fit for the USD/GBP, and USD/100JPY exchange rates, but it is not the case for the case of USD/EUR. Although we could not find any evidence of the mean-reverting property for the USD/EUR exchange rate, the USD/GBP, and USD/ 100JPY exchange rates show the mean-reversion behavior. Interestingly, the volatility function of the USD/EUR exchange rate is increasing in the exchange rate while the volatility functions of the USD/GBP and USD/100Yen exchange rates have a U-shape. Our results reveal that more care has to be taken when determining a diffusion model for the exchange rate. The results also imply that we may have to use a more general diffusion model than those proposed in the literature when developing economic theories for the behavior of the exchange rate and pricing foreign currency options or derivatives.
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Five diffusion models are estimated using three different foreign exchange rates to find an appropriate model for each. Daily spot exchange rates expressed as the prices of 1 euro, 1 British pound and 100 Japanese yen in US dollars, respectively denoted by USD/EUR, USD/GBP, and USD/100JPY, are used. The maximum likelihood estimation method is implemented after deriving an approximate log-transition density function (log-TDF) of the diffusion processes because the true log-TDF is unknown. Of the five models, the most general model is the best fit for the USD/GBP, and USD/100JPY exchange rates, but it is not the case for the case of USD/EUR. Although we could not find any evidence of the mean-reverting property for the USD/EUR exchange rate, the USD/GBP, and USD/ 100JPY exchange rates show the mean-reversion behavior. Interestingly, the volatility function of the USD/EUR exchange rate is increasing in the exchange rate while the volatility functions of the USD/GBP and USD/100Yen exchange rates have a U-shape. Our results reveal that more care has to be taken when determining a diffusion model for the exchange rate. The results also imply that we may have to use a more general diffusion model than those proposed in the literature when developing economic theories for the behavior of the exchange rate and pricing foreign currency options or derivatives.
On the Cyclical Properties of Hamilton’s Regression Filter
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Hamilton (2018) proposes a regression filter (Hamilton filter) as an alternative to the Hodrick-Prescott filter (HP filter). Using frequency domain analysis, among others, I show that the Hamilton filter improves on the HP filter, because it does not induce spurious cycles and it has a smaller end-of-sample bias. However, I find that this comes at a cost: in contrast to the HP filter, the Hamilton filter extracts frequencies with modifications. It alters variances and induces phase shifts. Furthermore, I show that the exact form of modifications depends on the underlying data generating process. I conclude the paper by discussing these differences in a broader context.
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Hamilton (2018) proposes a regression filter (Hamilton filter) as an alternative to the Hodrick-Prescott filter (HP filter). Using frequency domain analysis, among others, I show that the Hamilton filter improves on the HP filter, because it does not induce spurious cycles and it has a smaller end-of-sample bias. However, I find that this comes at a cost: in contrast to the HP filter, the Hamilton filter extracts frequencies with modifications. It alters variances and induces phase shifts. Furthermore, I show that the exact form of modifications depends on the underlying data generating process. I conclude the paper by discussing these differences in a broader context.
One-Year Premium Risk and Emergence Pattern of Ultimate Loss Based on Conditional Distribution
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We study the relation between one-year premium risk and ultimate premium risk. In practice, the one-year risk is sometimes related to the ultimate risk by using a so-called emergence pattern formula which postulates a linear relation between both risks. We define the true emergence pattern of the ultimate loss for the one-year premium risk based on a conditional distribution of the ultimate loss derived from a multivariate distribution of the claims development process. We investigate three models commonly used in claims reserving and prove that the true emergence pattern formulas are different from the linear emergence pattern formula used in practice. We show that the one-year risk, when measured by VaR, can be under and overestimated if the linear emergence pattern formula is applied. We present two modifications of the linear emergence pattern formula. These modifications allow us to go beyond the claims development models investigated in the first part and work with an arbitrary distribution of the ultimate loss.
SSRN
We study the relation between one-year premium risk and ultimate premium risk. In practice, the one-year risk is sometimes related to the ultimate risk by using a so-called emergence pattern formula which postulates a linear relation between both risks. We define the true emergence pattern of the ultimate loss for the one-year premium risk based on a conditional distribution of the ultimate loss derived from a multivariate distribution of the claims development process. We investigate three models commonly used in claims reserving and prove that the true emergence pattern formulas are different from the linear emergence pattern formula used in practice. We show that the one-year risk, when measured by VaR, can be under and overestimated if the linear emergence pattern formula is applied. We present two modifications of the linear emergence pattern formula. These modifications allow us to go beyond the claims development models investigated in the first part and work with an arbitrary distribution of the ultimate loss.
Participation After Sudden Access
SSRN
The German reunification experiment provided sudden access to previously unavailable financial products, supported by knowledgeable practitioners. This setting offers new perspectives on participation, inertia, and product diffusion. Controlling for characteristics, East Germans experienced a jump in securities participation to a level comparable to West Germans’ participation immediately following reunification, and to an even higher level for consumer debt, while exhibiting inertia in previously accessible products. They showed no signs of subsequent retreat. Lower financial resources are the most important characteristic explaining lower East German participation in all asset classes, while expectations and peer effects drive the higher East German debt participation.
SSRN
The German reunification experiment provided sudden access to previously unavailable financial products, supported by knowledgeable practitioners. This setting offers new perspectives on participation, inertia, and product diffusion. Controlling for characteristics, East Germans experienced a jump in securities participation to a level comparable to West Germans’ participation immediately following reunification, and to an even higher level for consumer debt, while exhibiting inertia in previously accessible products. They showed no signs of subsequent retreat. Lower financial resources are the most important characteristic explaining lower East German participation in all asset classes, while expectations and peer effects drive the higher East German debt participation.
Power and Statistical Significance in Securities Fraud Litigation
SSRN
Event studies, a half-century-old approach to measuring the effect of events on stock prices, are now ubiquitous in securities fraud litigation. In determining whether the event study demonstrates a price effect, expert witnesses typically base their conclusion on whether the results are statistically significant at the 95% confidence level, a threshold that is drawn from the academic literature. As a positive matter, this represents a disconnect with legal standards of proof. As a normative matter, it may reduce enforcement of fraud claims because litigation event studies typically involve quite low statistical power even for large-scale frauds.This paper, written for legal academics, judges, and policy makers, makes three contributions. First, it contributes to a nascent literature demonstrating that the standard event-study methodology can be problematic in securities litigation. In particular, the paper documents the tradeoff between power and confidence level and the ensuring impact on the likelihood that valid claims of fraud will erroneously be rejected. In so doing, the article highlights that the choice of confidence level is a policy judgment about the appropriate balance between the costs of litigation and the costs of securities fraud. Second, the article argues that the SEC has both the legal power and the institutional competence to develop litigation standards that balance these costs.Third, the article provides a novel and feasible framework through which the SEC can implement such litigation standards. The framework relies on an assessment of the defendant firm’s market capitalization and abnormal returns distribution to determine the maximum confidence level (minimum significance level) that is consistent with the minimum required power of detecting a fraud of the benchmark magnitude. The SEC is uniquely positioned to make this determination based on the information it possesses about the level of fraud in the capital markets and the role of private litigation in deterring fraud.
SSRN
Event studies, a half-century-old approach to measuring the effect of events on stock prices, are now ubiquitous in securities fraud litigation. In determining whether the event study demonstrates a price effect, expert witnesses typically base their conclusion on whether the results are statistically significant at the 95% confidence level, a threshold that is drawn from the academic literature. As a positive matter, this represents a disconnect with legal standards of proof. As a normative matter, it may reduce enforcement of fraud claims because litigation event studies typically involve quite low statistical power even for large-scale frauds.This paper, written for legal academics, judges, and policy makers, makes three contributions. First, it contributes to a nascent literature demonstrating that the standard event-study methodology can be problematic in securities litigation. In particular, the paper documents the tradeoff between power and confidence level and the ensuring impact on the likelihood that valid claims of fraud will erroneously be rejected. In so doing, the article highlights that the choice of confidence level is a policy judgment about the appropriate balance between the costs of litigation and the costs of securities fraud. Second, the article argues that the SEC has both the legal power and the institutional competence to develop litigation standards that balance these costs.Third, the article provides a novel and feasible framework through which the SEC can implement such litigation standards. The framework relies on an assessment of the defendant firm’s market capitalization and abnormal returns distribution to determine the maximum confidence level (minimum significance level) that is consistent with the minimum required power of detecting a fraud of the benchmark magnitude. The SEC is uniquely positioned to make this determination based on the information it possesses about the level of fraud in the capital markets and the role of private litigation in deterring fraud.
Provocări pentru Finanţele Comportamentale în contextul COVID-19 (Some Challenges for the Behavioral Finance in the Context of COVID-19)
SSRN
Romanian Abstract: Recenta pandemie de coronavirus 2019-20 (COVID-19) a generat unele probleme, caracterizate printr-un grad înalt de incertitudine, care le face dificilă rezolvarea prin modele ale proceselor decizionale cu o raÅ£ionalitate deplină. ÃŽn domeniul finanÅ£elor, astfel de probleme sunt cele asociate cu politicile fiscale ÅŸi monetare, menite să combată recesiunea sau cu investiÅ£iile în prezenÅ£a turbulenÅ£elor de pe pieÅ£ele financiare. ÃŽn privinÈ›a politicilor fiscale ÅŸi monetare, guvernele ÅŸi băncile centrale ar putea fi tentate să utilizeze aceleaÅŸi strategii care au avut succes în atenuarea Marii Recesiuni din perioada 2007 â€" 2008, cu toate că actuala recesiune are cauze diferite. ÃŽn unele ţări dezvoltate au fost lansate pachete de stimulare prin care se aloca resurse financiare impresionante către ramurile economiei afectate de COVID-19. TotuÈ™i, la fel ca în cazul Marii Recesiuni, complexitatea circumstanÅ£elor face foarte dificilă o repartizare obiectivă a acestor resurse. Pentru Uniunea Europeană, o particularitate a soluÅ£iilor strategice la actuala criză derivă din faptul că multe dintre acestea sunt adoptate prin decizii de grup în care interesele participanÅ£ilor trebuie conciliate. ÃŽn multe ţări, căderea Produsului Intern Brut, majorarea deficitelor bugetare ÅŸi ratele actuale reduse ale dobânzilor ar putea impune alegerea dintre un ÅŸomaj ridicat ÅŸi o inflaÅ£ie accelerată. ÃŽn astfel de decizii, obiectivele guvernelor, de obicei sensibile la evoluÅ£ia ÅŸomajului, ar putea concura cu preocuparea băncilor centrale pentru stabilitatea preÅ£urilor. O inflaÅ£ie accelerată ar putea ÅŸoca populaÅ£iile din multe ţări dezvoltate care, în trecutul recent, s-au obiÅŸnuit cu o stabilitate monetară confortabilă. Ar putea, totodată, submina credibilitatea băncilor centrale, conducând la neîncredere în monedele naÅ£ionale. ÃŽn astfel de situaÅ£ii, aÅŸteptările asupra inflaÅ£iei nu vor mai fi o unealtă a politicilor monetare ci, dimpotrivă, un obstacol în calea obiectivelor acestora. Acestea ar putea, de asemenea, să sporească incertitudinea din unele decizii financiare, modificând comportamentele unor categorii variate de investitori, creditori sau debitori. ÃŽn primul trimestru al anului 2020, noutăţile despre propagarea COVID-19 sau despre măsurile în sprijinul economiilor au generat un număr neobiÅŸnuit de mare de ÅŸocuri negative sau pozitive pe pieÅ£ele de capital dezvoltate sau emergente. Astfel de turbulenÅ£e ar putea fi privite ca un simptom al reacÅ£iilor disproporÅ£ionate care apar adeseori în perioade de criză. Este posibil, cu toate că nu uÅŸor de demonstrat, ca preocuparea pentru propria sănătate să fi schimbat comportamentul unor investitori. Sporirea volatilităţii ar putea intimida mulÅ£i investitori cu aversiune faţă de risc, dar ar putea, de asemenea, atrage unii investitori ce obiÅŸnuiesc să îşi asume riscuri ridicate. ÃŽn unele ţări, monedele naÅ£ionale s-au depreciat È™i volatilitatea cursurilor valutare a crescut. AÅŸa cum s-a mai întâmplat în alte perioade turbulente, aurul a devenit un activ atrăgător pentru investitori. PotenÅ£ialele limite ale raÅ£ionalităţii induse de COVID-19 în decizii precum cele care privesc politicile fiscale ÅŸi monetare sau investiÅ£iile sunt, oarecum, noi pentru domeniul finanÅ£elor. Ele ar putea fi privite ÅŸi ca provocări pentru FinanÅ£ele Comportamentale care studiază cauzele iraÅ£ionalităţii din procesele decizionale financiare. Oricum, în aceste zile, când nu se poate estima cât va mai dura pandemia COVID-19 este, de asemenea, dificil de prezis dacă astfel de situaÅ£ii vor conduce la noi abordări în domeniul FinanÅ£elor Comportamentale. English Abstract: The recent coronavirus disease 2019 (COVID-19) generated some non-routine problems, characterized by a high degree of uncertainty which makes difficult the solving by the full rational decision making models. In the field of finance, such problems are those associated to the fiscal and monetary policies, that have to fight the recession or to investments in the presence of turbulences on the financial markets. Regarding the fiscal and monetary policies, governments and central banks could be tempted to use the same strategies that were successful in mitigating the effects of the Great Recession from 2007 â€" 2008, although the recent recession has different causes. In some developed countries there were launched stimulus packages, which allocated impressive financial resources to the economic branches affected by COVID-19. However, as in the case of Great Recession, the complexity of the circumstances made very hard an objective assignment of these resources. For the European Union, a particularity of the strategic solutions to the recent crisis is the fact that many of them are adopted by group decisions, where various interests of the participants have to be conciliated. In many countries, the fall of GDP, the rise of budget deficits and the present low interest rates could impose the choice between a high unemployment and an accelerating inflation. In such decisions, the objectives of governments, usually, very sensitive to the unemployment evolution, could compete with those of the central banks preoccupied by the prices stability. An accelerating inflation could shock the populations from many developed countries which, in the recent past, got used to a comfortable monetary stability. It could also undermine the central banks credibility, leading to distrust in the national currencies. In such situations, the inflation expectations would be no longer a tool for the monetary policies, but an obstacle for their objectives. They could also increase the uncertainty for some financial decisions, modifying the behaviors of various categories of investors, creditors of debtors. In the first quarter of 2020, the news about the COVID-19’s propagation and about the measures meant to help the economies provoked an unusual large number of negative and positive shocks on the developed and emerging capital markets. Such turbulences could be viewed as symptoms of overreactions which occur often in the times of crisis. It is possible, although not easy to prove, that the concern for their own health changed the behavior of some investors. The increased volatility could intimidate many risk-averse investors, but it could also attract some investors who use to take high risks. In some countries, the national currencies depreciated and the volatility of the exchange rates increased. As it happened before in other turbulent times, the gold became an attractive asset for investors. The potential boundaries of the rationality induced by COVID-19 in some decisions such as those regarding fiscal and monetary policies or investments are, somehow, new for the field of the finance. They could be viewed as challenges for the Behavioral Finance which studies the causes of irationality in the financial decision making. However, in the present days, when it is very hard to estimate for how long the COVID-19 pandemic will last, it is also very difficult to predict if such situation would lead to new approaches in the field of the Behavioral Finance.
SSRN
Romanian Abstract: Recenta pandemie de coronavirus 2019-20 (COVID-19) a generat unele probleme, caracterizate printr-un grad înalt de incertitudine, care le face dificilă rezolvarea prin modele ale proceselor decizionale cu o raÅ£ionalitate deplină. ÃŽn domeniul finanÅ£elor, astfel de probleme sunt cele asociate cu politicile fiscale ÅŸi monetare, menite să combată recesiunea sau cu investiÅ£iile în prezenÅ£a turbulenÅ£elor de pe pieÅ£ele financiare. ÃŽn privinÈ›a politicilor fiscale ÅŸi monetare, guvernele ÅŸi băncile centrale ar putea fi tentate să utilizeze aceleaÅŸi strategii care au avut succes în atenuarea Marii Recesiuni din perioada 2007 â€" 2008, cu toate că actuala recesiune are cauze diferite. ÃŽn unele ţări dezvoltate au fost lansate pachete de stimulare prin care se aloca resurse financiare impresionante către ramurile economiei afectate de COVID-19. TotuÈ™i, la fel ca în cazul Marii Recesiuni, complexitatea circumstanÅ£elor face foarte dificilă o repartizare obiectivă a acestor resurse. Pentru Uniunea Europeană, o particularitate a soluÅ£iilor strategice la actuala criză derivă din faptul că multe dintre acestea sunt adoptate prin decizii de grup în care interesele participanÅ£ilor trebuie conciliate. ÃŽn multe ţări, căderea Produsului Intern Brut, majorarea deficitelor bugetare ÅŸi ratele actuale reduse ale dobânzilor ar putea impune alegerea dintre un ÅŸomaj ridicat ÅŸi o inflaÅ£ie accelerată. ÃŽn astfel de decizii, obiectivele guvernelor, de obicei sensibile la evoluÅ£ia ÅŸomajului, ar putea concura cu preocuparea băncilor centrale pentru stabilitatea preÅ£urilor. O inflaÅ£ie accelerată ar putea ÅŸoca populaÅ£iile din multe ţări dezvoltate care, în trecutul recent, s-au obiÅŸnuit cu o stabilitate monetară confortabilă. Ar putea, totodată, submina credibilitatea băncilor centrale, conducând la neîncredere în monedele naÅ£ionale. ÃŽn astfel de situaÅ£ii, aÅŸteptările asupra inflaÅ£iei nu vor mai fi o unealtă a politicilor monetare ci, dimpotrivă, un obstacol în calea obiectivelor acestora. Acestea ar putea, de asemenea, să sporească incertitudinea din unele decizii financiare, modificând comportamentele unor categorii variate de investitori, creditori sau debitori. ÃŽn primul trimestru al anului 2020, noutăţile despre propagarea COVID-19 sau despre măsurile în sprijinul economiilor au generat un număr neobiÅŸnuit de mare de ÅŸocuri negative sau pozitive pe pieÅ£ele de capital dezvoltate sau emergente. Astfel de turbulenÅ£e ar putea fi privite ca un simptom al reacÅ£iilor disproporÅ£ionate care apar adeseori în perioade de criză. Este posibil, cu toate că nu uÅŸor de demonstrat, ca preocuparea pentru propria sănătate să fi schimbat comportamentul unor investitori. Sporirea volatilităţii ar putea intimida mulÅ£i investitori cu aversiune faţă de risc, dar ar putea, de asemenea, atrage unii investitori ce obiÅŸnuiesc să îşi asume riscuri ridicate. ÃŽn unele ţări, monedele naÅ£ionale s-au depreciat È™i volatilitatea cursurilor valutare a crescut. AÅŸa cum s-a mai întâmplat în alte perioade turbulente, aurul a devenit un activ atrăgător pentru investitori. PotenÅ£ialele limite ale raÅ£ionalităţii induse de COVID-19 în decizii precum cele care privesc politicile fiscale ÅŸi monetare sau investiÅ£iile sunt, oarecum, noi pentru domeniul finanÅ£elor. Ele ar putea fi privite ÅŸi ca provocări pentru FinanÅ£ele Comportamentale care studiază cauzele iraÅ£ionalităţii din procesele decizionale financiare. Oricum, în aceste zile, când nu se poate estima cât va mai dura pandemia COVID-19 este, de asemenea, dificil de prezis dacă astfel de situaÅ£ii vor conduce la noi abordări în domeniul FinanÅ£elor Comportamentale. English Abstract: The recent coronavirus disease 2019 (COVID-19) generated some non-routine problems, characterized by a high degree of uncertainty which makes difficult the solving by the full rational decision making models. In the field of finance, such problems are those associated to the fiscal and monetary policies, that have to fight the recession or to investments in the presence of turbulences on the financial markets. Regarding the fiscal and monetary policies, governments and central banks could be tempted to use the same strategies that were successful in mitigating the effects of the Great Recession from 2007 â€" 2008, although the recent recession has different causes. In some developed countries there were launched stimulus packages, which allocated impressive financial resources to the economic branches affected by COVID-19. However, as in the case of Great Recession, the complexity of the circumstances made very hard an objective assignment of these resources. For the European Union, a particularity of the strategic solutions to the recent crisis is the fact that many of them are adopted by group decisions, where various interests of the participants have to be conciliated. In many countries, the fall of GDP, the rise of budget deficits and the present low interest rates could impose the choice between a high unemployment and an accelerating inflation. In such decisions, the objectives of governments, usually, very sensitive to the unemployment evolution, could compete with those of the central banks preoccupied by the prices stability. An accelerating inflation could shock the populations from many developed countries which, in the recent past, got used to a comfortable monetary stability. It could also undermine the central banks credibility, leading to distrust in the national currencies. In such situations, the inflation expectations would be no longer a tool for the monetary policies, but an obstacle for their objectives. They could also increase the uncertainty for some financial decisions, modifying the behaviors of various categories of investors, creditors of debtors. In the first quarter of 2020, the news about the COVID-19’s propagation and about the measures meant to help the economies provoked an unusual large number of negative and positive shocks on the developed and emerging capital markets. Such turbulences could be viewed as symptoms of overreactions which occur often in the times of crisis. It is possible, although not easy to prove, that the concern for their own health changed the behavior of some investors. The increased volatility could intimidate many risk-averse investors, but it could also attract some investors who use to take high risks. In some countries, the national currencies depreciated and the volatility of the exchange rates increased. As it happened before in other turbulent times, the gold became an attractive asset for investors. The potential boundaries of the rationality induced by COVID-19 in some decisions such as those regarding fiscal and monetary policies or investments are, somehow, new for the field of the finance. They could be viewed as challenges for the Behavioral Finance which studies the causes of irationality in the financial decision making. However, in the present days, when it is very hard to estimate for how long the COVID-19 pandemic will last, it is also very difficult to predict if such situation would lead to new approaches in the field of the Behavioral Finance.
Risk Disclosure Noncompliance
SSRN
We examine companies’ risk disclosure compliance with IFRS risk disclosure rules for the first fiscal year following the year 2007. For a sample of 383 firms from 20 European countries we find that average risk disclosure compliance is 62 percent only. Countries’ enforcement strength is generally positively associated with risk disclosure compliance, and even more effective in the presence of outsiders’ monitoring. We highlight that cross-country differences in enforcement must be properly accounted for to ensure consistent risk disclosure compliance.
SSRN
We examine companies’ risk disclosure compliance with IFRS risk disclosure rules for the first fiscal year following the year 2007. For a sample of 383 firms from 20 European countries we find that average risk disclosure compliance is 62 percent only. Countries’ enforcement strength is generally positively associated with risk disclosure compliance, and even more effective in the presence of outsiders’ monitoring. We highlight that cross-country differences in enforcement must be properly accounted for to ensure consistent risk disclosure compliance.
Social Security Contributions and Corporate Financing Decisions: Evidence from China’s Social Insurance Law
SSRN
This paper investigates whether social security contributions affect corporate financing decisions. Treating the 2011 Social Insurance Law in China as a quasi-natural experiment, our difference-in-differences framework utilizes two-dimension variations: initial social security contribution rates across firms (i.e., high relative to low) and year (i.e., before and after 2011). We find that more social security contributions lead to decreased capital structure, particularly for firms with greater labor intensity and financial constraints as well as those located in areas with greater fiscal pressure. Further, consistent with the financial distress hypothesis, firm’s operating leverage and profitability volatility increase, and the supply of trade credit decreases. Moreover, we exclude several alternative explanations, including firms’ other motivations and creditors’ strategic behavior. Our findings demonstrate that firms tend to choose conservative financing policies to partially mitigate the likelihood of financial distress caused by increasing social security contributions.
SSRN
This paper investigates whether social security contributions affect corporate financing decisions. Treating the 2011 Social Insurance Law in China as a quasi-natural experiment, our difference-in-differences framework utilizes two-dimension variations: initial social security contribution rates across firms (i.e., high relative to low) and year (i.e., before and after 2011). We find that more social security contributions lead to decreased capital structure, particularly for firms with greater labor intensity and financial constraints as well as those located in areas with greater fiscal pressure. Further, consistent with the financial distress hypothesis, firm’s operating leverage and profitability volatility increase, and the supply of trade credit decreases. Moreover, we exclude several alternative explanations, including firms’ other motivations and creditors’ strategic behavior. Our findings demonstrate that firms tend to choose conservative financing policies to partially mitigate the likelihood of financial distress caused by increasing social security contributions.
The Equity Premium Puzzle Solution: Incentives to Under-Report Inflation
SSRN
The biggest and most well-known unsolved problem in academic finance is famously referred to as the Equity Premium Puzzle. It refers to the unexplained phenomenon that for over 100 years the average return on a well-diversified portfolio of equities has far outperformed that of risk-free, short-term US treasuries. Although there have been countless proposed solutions, all have failed as these attempts implicitly assume perfectly-correct inflation statistics. Examining these assumptions, we discover that not only are the inflation numbers materially flawed, but more so, there are significant incentives for government entities to under-report inflation. With this, we find that to explain the Equity Premium Puzzle, inflation would only need to be under-reported by about 2-6% per year: an exceedingly likely scenario given the significance of these incentives.
SSRN
The biggest and most well-known unsolved problem in academic finance is famously referred to as the Equity Premium Puzzle. It refers to the unexplained phenomenon that for over 100 years the average return on a well-diversified portfolio of equities has far outperformed that of risk-free, short-term US treasuries. Although there have been countless proposed solutions, all have failed as these attempts implicitly assume perfectly-correct inflation statistics. Examining these assumptions, we discover that not only are the inflation numbers materially flawed, but more so, there are significant incentives for government entities to under-report inflation. With this, we find that to explain the Equity Premium Puzzle, inflation would only need to be under-reported by about 2-6% per year: an exceedingly likely scenario given the significance of these incentives.
The Financing of Small and Medium-Sized Enterprises: an analysis of the financing Gap in Brazil
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While small and medium-sized enterprises (SMEs) are important for economic growth and employment, they face numerous obstacles in accessing external finance. In this article, we review recent developments in the availability of financing for SMEs in Brazil, focusing on the greater use of equity and debt for SMEs. In assessing the barriers to external financing, we focus on the role of bank characteristics, market structure and variations of interest rate spreads across banks and time. Moreover, as banks retreat from SME financing, we examine the potential for SMEs to seek new sources of financing from private equity and venture capital funds. We examine the changes in the availability of bank loans between 2014 and 2016. By considering demand, we estimate the SME loan gap based on Central Bank and publicly available data. Our results show that the loan gap in Brazil is substantial. Finally, we show that the gap grew from 54.29% in 2014 to 87.5% in 2016.
SSRN
While small and medium-sized enterprises (SMEs) are important for economic growth and employment, they face numerous obstacles in accessing external finance. In this article, we review recent developments in the availability of financing for SMEs in Brazil, focusing on the greater use of equity and debt for SMEs. In assessing the barriers to external financing, we focus on the role of bank characteristics, market structure and variations of interest rate spreads across banks and time. Moreover, as banks retreat from SME financing, we examine the potential for SMEs to seek new sources of financing from private equity and venture capital funds. We examine the changes in the availability of bank loans between 2014 and 2016. By considering demand, we estimate the SME loan gap based on Central Bank and publicly available data. Our results show that the loan gap in Brazil is substantial. Finally, we show that the gap grew from 54.29% in 2014 to 87.5% in 2016.
The Pricing Strategies of Unsecured Consumer Loans
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This paper analyzes lenders' pricing strategies in the business-to-customer (B2C) unsecured loan market by using a proprietary dataset of approximately 3 million unsecured consumer loans from a B2C online retailer in China. We find that lenders' decisions to invite customers are based on customers' credit rating and age and that lenders increase credit limits and charge higher interest rates for solicited riskier borrowers than for unsolicited riskier borrowers. This phenomenon was exacerbated after the passage of the China Banking Regulatory Commission (CBRC) Act. We develop a model of revolving credit contract design. The model's predictions are consistent with our empirical findings.
SSRN
This paper analyzes lenders' pricing strategies in the business-to-customer (B2C) unsecured loan market by using a proprietary dataset of approximately 3 million unsecured consumer loans from a B2C online retailer in China. We find that lenders' decisions to invite customers are based on customers' credit rating and age and that lenders increase credit limits and charge higher interest rates for solicited riskier borrowers than for unsolicited riskier borrowers. This phenomenon was exacerbated after the passage of the China Banking Regulatory Commission (CBRC) Act. We develop a model of revolving credit contract design. The model's predictions are consistent with our empirical findings.
The Role of Corporate Cultural Similarity in Corporate Acquisitions: Does Cultural Similarity Affect Managerial Learning?
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This study examines whether the corporate cultural similarity between a target and an acquiring firm influences the acquiring managers’ decision to abandon a corporate acquisition attempt conditional on the acquiring firm's stock price reaction at the announcement of the deal. We find that higher cultural similarity decreases the propensity of acquiring managers to listen to the stock market. We use the inclusion in the annual list of the 100 Best Corporate Citizens as an exogenous shock to establish a causal link. We interpret the findings to imply that acquiring managers are subject to a confirmatory bias that leads them to give an overly optimistic valuation to target firms that share similar corporate culture. Therefore, cultural similarity between a target and an acquiring firm could have detrimental effects on the acquiring firm.
SSRN
This study examines whether the corporate cultural similarity between a target and an acquiring firm influences the acquiring managers’ decision to abandon a corporate acquisition attempt conditional on the acquiring firm's stock price reaction at the announcement of the deal. We find that higher cultural similarity decreases the propensity of acquiring managers to listen to the stock market. We use the inclusion in the annual list of the 100 Best Corporate Citizens as an exogenous shock to establish a causal link. We interpret the findings to imply that acquiring managers are subject to a confirmatory bias that leads them to give an overly optimistic valuation to target firms that share similar corporate culture. Therefore, cultural similarity between a target and an acquiring firm could have detrimental effects on the acquiring firm.
The Scientific Value of Finance After the Crisis
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Understanding how market participants naturally respond to and cope with crises that cast doubt on the trustworthiness of accepted knowledge is important for the crisis-prone field of finance. I use citations of scholarly articles in practitioner-oriented journals around the 2007-2009 financial crisis to diagnose the effects of the shock to trust in academic finance and to investigate how institutional scholarship affects subsequent product market behavior. Rather than limiting use of research, citations to finance scholarly works did not change among academics and practitioners in the wake of the crisis. Citations of non-finance scholarly papers increased significantly among academics but not practitioners. Academic and practitioner authors reduced reliance on unpublished, non-scholarly sources. These findings are revealed against previously undocumented inert behaviors towards science â€" academics are permanently and positively predisposed to citing scholarly works, whether finance-related or not, while practitioners generally shun scholarly literatures while relying heavily on non-scholarly works. Combining practitioner-oriented scholarship data at the institutional level with patenting records, I show that an increase in practitioner journal publishing is positively related to leading institutions’ patenting activities in the post crisis period. Thus, institutional scholarship appears to aid in coping and recovering from the crisis.
SSRN
Understanding how market participants naturally respond to and cope with crises that cast doubt on the trustworthiness of accepted knowledge is important for the crisis-prone field of finance. I use citations of scholarly articles in practitioner-oriented journals around the 2007-2009 financial crisis to diagnose the effects of the shock to trust in academic finance and to investigate how institutional scholarship affects subsequent product market behavior. Rather than limiting use of research, citations to finance scholarly works did not change among academics and practitioners in the wake of the crisis. Citations of non-finance scholarly papers increased significantly among academics but not practitioners. Academic and practitioner authors reduced reliance on unpublished, non-scholarly sources. These findings are revealed against previously undocumented inert behaviors towards science â€" academics are permanently and positively predisposed to citing scholarly works, whether finance-related or not, while practitioners generally shun scholarly literatures while relying heavily on non-scholarly works. Combining practitioner-oriented scholarship data at the institutional level with patenting records, I show that an increase in practitioner journal publishing is positively related to leading institutions’ patenting activities in the post crisis period. Thus, institutional scholarship appears to aid in coping and recovering from the crisis.
Time-Varying Relative Risk Aversion: Mechanisms and Evidence
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This paper explores theoretically and empirically the issue of time-varying relative risk aversion (TVRRA). We analytically solve a parsimonious life-cycle portfolio choice model with the preferences given by Greenwood, Hercowitz and Huffman (1988, GHH). Our analytical solution identifies four partial equilibrium effects of TVRRA generated by GHH preferences on risky shares through two channels, and two general equilibrium effects whose signs hinge on the value of a key structural parameter. Our mean and quantile regression results about how wealth affects portfolio choices are robust and provide strong evidence of TVRRA using micro-data. Thus, we show successfully that TVRRA generated by GHH preferences provides a plausible underlying mechanism in understanding TVRRA in the micro-data. Furthermore, we conclude that such a mechanism alone is not enough in explaining how risky shares respond to labor income and labor income risks in the micro-data.
SSRN
This paper explores theoretically and empirically the issue of time-varying relative risk aversion (TVRRA). We analytically solve a parsimonious life-cycle portfolio choice model with the preferences given by Greenwood, Hercowitz and Huffman (1988, GHH). Our analytical solution identifies four partial equilibrium effects of TVRRA generated by GHH preferences on risky shares through two channels, and two general equilibrium effects whose signs hinge on the value of a key structural parameter. Our mean and quantile regression results about how wealth affects portfolio choices are robust and provide strong evidence of TVRRA using micro-data. Thus, we show successfully that TVRRA generated by GHH preferences provides a plausible underlying mechanism in understanding TVRRA in the micro-data. Furthermore, we conclude that such a mechanism alone is not enough in explaining how risky shares respond to labor income and labor income risks in the micro-data.
Trading Bond Value
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In out-of-sample trading tests, combined trading strategies based on the bond value model is able to raise the Sharpe ratio to 0.85, from the 0.78 achieved by a passive benchmark of 10-year government bonds equally weighted across 12 developed countries (US, Japan, Germany, UK, France, Italy, Canada, Switzerland, Sweden, Norway, Australia, and New Zealand). The paper also shows the bond value model to be robust against data revisions in the US. The paper includes tests of the trading model on both an absolute value and relative value basis. On an absolute value basis by itself the model raises the Share ratio 0.05 to 0.83. Also, using the model equilibrium yield as a counter signal to future changes in market yield allows one to achieve a Sharpe ratio of 0.84 on a 12-country average. The paper refers to this as “Model Mean Reversion.†Using both approaches on a 50/50 basis brings the Sharpe to 0.85. The paper also explores the use of a momentum factor by itself and in combination with the value models and finds no benefit. The paper provides evidence of the bond value model’s robustness for estimating equilibrium yields across major economies and also introduces a novel and potentially beneficial trading strategy in Model Mean Reversion.
SSRN
In out-of-sample trading tests, combined trading strategies based on the bond value model is able to raise the Sharpe ratio to 0.85, from the 0.78 achieved by a passive benchmark of 10-year government bonds equally weighted across 12 developed countries (US, Japan, Germany, UK, France, Italy, Canada, Switzerland, Sweden, Norway, Australia, and New Zealand). The paper also shows the bond value model to be robust against data revisions in the US. The paper includes tests of the trading model on both an absolute value and relative value basis. On an absolute value basis by itself the model raises the Share ratio 0.05 to 0.83. Also, using the model equilibrium yield as a counter signal to future changes in market yield allows one to achieve a Sharpe ratio of 0.84 on a 12-country average. The paper refers to this as “Model Mean Reversion.†Using both approaches on a 50/50 basis brings the Sharpe to 0.85. The paper also explores the use of a momentum factor by itself and in combination with the value models and finds no benefit. The paper provides evidence of the bond value model’s robustness for estimating equilibrium yields across major economies and also introduces a novel and potentially beneficial trading strategy in Model Mean Reversion.
Undervaluation and Non-Financial Disclosure: Evidence from Voluntary CSR News Releases
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In this paper, we examine whether stock market imperfection plays a role in a firm’s decision to disclose non-financial information and if yes, what are the underlying channels. To address our questions, we web-scraped corporate social responsibility (CSR) news for a sample of publicly traded non-financial US firms from CSRwire and explored the exogeneous variation in stock valuation driven by institutional price pressure. Our empirical results show that firms facing stock market undervaluation are more likely to release CSR news and the effect is concentrated in firms with low CSR commitment and low stock price informativeness. Lastly, we find evidence that stock market reacts positively to CSR news released by undervalued firms, and more so for undervalued firms with high information asymmetry.
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In this paper, we examine whether stock market imperfection plays a role in a firm’s decision to disclose non-financial information and if yes, what are the underlying channels. To address our questions, we web-scraped corporate social responsibility (CSR) news for a sample of publicly traded non-financial US firms from CSRwire and explored the exogeneous variation in stock valuation driven by institutional price pressure. Our empirical results show that firms facing stock market undervaluation are more likely to release CSR news and the effect is concentrated in firms with low CSR commitment and low stock price informativeness. Lastly, we find evidence that stock market reacts positively to CSR news released by undervalued firms, and more so for undervalued firms with high information asymmetry.
Volatility Spillovers and Capital Buffers Among the G-Sibs
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We assess the dynamics of volatility spillovers among global systemically important banks (G-SIBs). We measure spillovers using vector-autoregressive models of range volatility of the equity prices of G-SIBs, together with machine learning methods. We then compare the size of these spillovers with the degree of systemic importance measured by the Basel Committee on Banking Supervision's G-SIB bucket designations. We find a high positive correlation between the two. We also find that higher bank capital reduces volatility spillovers, especially for banks in higher G-SIB buckets. Our results suggest that requiring banks that are designated as being more systemically important globally to hold additional capital is likely to reduce volatility spillovers from them to other large banks.
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We assess the dynamics of volatility spillovers among global systemically important banks (G-SIBs). We measure spillovers using vector-autoregressive models of range volatility of the equity prices of G-SIBs, together with machine learning methods. We then compare the size of these spillovers with the degree of systemic importance measured by the Basel Committee on Banking Supervision's G-SIB bucket designations. We find a high positive correlation between the two. We also find that higher bank capital reduces volatility spillovers, especially for banks in higher G-SIB buckets. Our results suggest that requiring banks that are designated as being more systemically important globally to hold additional capital is likely to reduce volatility spillovers from them to other large banks.
When Japanese Stock Market Meets COVID-19: Impact of Ownership, Trading, ESG, and Liquidity Channels
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This paper aims to identify the factors affecting Japanese stock returns in the first quarter of 2020 during the coronavirus (COVID-19) outbreak. The sample is divided into three phases of the virus propagation and stock market returns. The findings are as follows. First, we focus on the ownership structure with the following results: foreign ownership is negatively associated with abnormal returns, whereas ownership related with traditional business groups is positively associated with abnormal returns. Furthermore, we find a severe decline in the stock price of index-included firms. Second, China FDI companies suffer low returns, especially after the Chinese government announces a lockdown policy in several areas. Third, ESG intensity is not associated or is negatively associated with abnormal stock returns. Fourth, we find that low liquidity firms, low cash-holding firms, and high financial leverage firms are associated with low stock returns.
SSRN
This paper aims to identify the factors affecting Japanese stock returns in the first quarter of 2020 during the coronavirus (COVID-19) outbreak. The sample is divided into three phases of the virus propagation and stock market returns. The findings are as follows. First, we focus on the ownership structure with the following results: foreign ownership is negatively associated with abnormal returns, whereas ownership related with traditional business groups is positively associated with abnormal returns. Furthermore, we find a severe decline in the stock price of index-included firms. Second, China FDI companies suffer low returns, especially after the Chinese government announces a lockdown policy in several areas. Third, ESG intensity is not associated or is negatively associated with abnormal stock returns. Fourth, we find that low liquidity firms, low cash-holding firms, and high financial leverage firms are associated with low stock returns.
When a Master Dies: Speculation and Asset Float
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The death of an artist constitutes a negative supply shock to his future produc- tion; in finance terms, this supply shock reduces the artist’s float. Intuition may thus suggest that this supply shock reduces the future auction volume of the artist. However, if collectors have fluctuating heterogeneous beliefs, since they cannot sell short, prices overweigh optimists’ beliefs and have a speculative component. If collectors have limited capacity to bear risk, an increase in float may decrease sub- sequent turnover and prices (Hong et al., 2006). Symmetrically, a negative supply shock leads to an augmentation of prices and turnover. We find strong support for this prediction in the data on art auctions that we examine.
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The death of an artist constitutes a negative supply shock to his future produc- tion; in finance terms, this supply shock reduces the artist’s float. Intuition may thus suggest that this supply shock reduces the future auction volume of the artist. However, if collectors have fluctuating heterogeneous beliefs, since they cannot sell short, prices overweigh optimists’ beliefs and have a speculative component. If collectors have limited capacity to bear risk, an increase in float may decrease sub- sequent turnover and prices (Hong et al., 2006). Symmetrically, a negative supply shock leads to an augmentation of prices and turnover. We find strong support for this prediction in the data on art auctions that we examine.
