Research articles for the 2020-05-04

(Temporary?) Decoupling of Bad Subsidies as An Alternative to Support Mexican Fishers during the COVID-19 Pandemic
Martinez-Cruz, Adan L.
As of April 21, 2020, the Mexican Federal administration has committed a one-time transfer of MXP 7,200 (USD 374) to 193,200 fishers to support them during the COVID-19 pandemic. This amount affords a 4-member rural household’s basic basket of goods during a month and a half. Fishers, however, most likely will need support for a longer period. In this document, we suggest that a decoupling of bad fisheries subsidies represents an alternative to efficiently redirect public funds towards relief support. If, for instance, only fuel subsidies were going to be decoupled, the one-time transfer committed by Federal authorities can be increased to afford a basic basket of goods during two additional weeks. Alternatively, the decoupled subsidy can reach 79,178 additional fishers. We highlight that a decoupling policy addresses suggestions made by international institutions to face economic impacts from COVID-19 without deviating from Sustainable Development Goals. This recommendation is particularly relevant for developing economies as sustainability is a criterion when accessing loans from international institutions. While this document focuses on the Mexican case, its insights are relevant for developing countries that are searching for alternatives to support their populations in facing COVID-19.

A New Pricing Theory That Solves the St. Petersburg Paradox
Dahang Li

The St. Petersburg Paradox, an important topic in probability theory, has not been solved in the last 280 years. Since Nicolaus Bernoulli proposed the St. Petersburg Paradox in 1738, many people had tried to solve it and had proposed various explanations, but all were not satisfactory. In this paper we propose a new pricing theory with several rules, which incidentally resolves this paradox. The new pricing theory states that so-called fair (reasonable) pricing should be judged by the seller and the buyer independently. Reasonable pricing for the seller may not be appropriate for the buyer. The seller cares about costs, while the buyer is concerned about the realistic prospect of returns.The pricing theory we proposed can be applied to financial markets to solve the confusion that financial asset return with fat tails distribution will cause the option pricing formula to fail, thus making up the theoretical defects of quantitative financial pricing theory.

Adapting to Rising Sea Levels: How Short-Term Responses Complement Long-Term Investment
Guthrie, Graeme
This paper presents a parsimonious model of a coastal locality's adaptation to rising sea levels and uses the model to examine cost-minimizing policies involving two complementary approaches. One involves irreversible investment in sea walls and similar infrastructure. The other involves activities such as beach scraping that only provide temporary protection. Costs are minimized by delaying investment until the present value of the benefits from avoided inundation costs exceeds upfront investment costs by a margin that is economically significant. The premium, which can exceed 50% of investment costs, is higher when the sea level is rising more quickly. The ability to temporarily boost defenses is used aggressively: spending on temporary improvements immediately before investment is several times larger than its value immediately afterwards. Temporary improvements are made even when the marginal cost of increasing the effectiveness of defenses this way is significantly greater than the equivalent annual cost of permanently increasing effectiveness by investment.

Algorithmic market making for options
Bastien Baldacci,Philippe Bergault,Olivier Guéant

In this article, we tackle the problem of a market maker in charge of a book of options on a single liquid underlying asset. By using an approximation of the portfolio in terms of its vega, we show that the seemingly high-dimensional stochastic optimal control problem of an option market maker is in fact tractable. More precisely, when volatility is modeled using a classical stochastic volatility model -- e.g. the Heston model -- the problem faced by an option market maker is characterized by a low-dimensional functional equation that can be solved numerically using a Euler scheme along with interpolation techniques, even for large portfolios. In order to illustrate our findings, numerical examples are provided.

All You Need is Cash: Corporate Cash Holdings and Investment after a Crisis
Joseph, Andreas,Kneer, Christiane,van Horen, Neeltje
Cash is king as corporate revenues plummet during the COVID-19 lockdown. Evidence from the global financial crisis shows that firms with high pre-crisis cash holdings can invest during a crisis while their cash-poor rivals have to divest. This gives cash-rich firms a competitive advantage during the recovery period, resulting in a persistent and growing investment gap. The divergence in investment paths between cash-rich and cash-poor firms is particularly large for financially constrained firms and is absent during tranquil periods. Due to their ability to invest in a crisis, cash-rich firms can gain market share and accumulate more profits in the long-run. Cash balances at the onset of a downturn are therefore a key determinant as to whether firms emerge as winners or losers from a crisis.

Are CEOs Judged on Their Companies' Social Reputation?
Cai, Xiangshang,Gao, Ning,Garrett, Ian,Xu, Yan
How consequential is social reputation for a CEO's career? We find that the CEOs of those firms with greater strengths (controversies) on corporate social responsibilities (CSR) are more (less) likely to serve on external boards, and they hold more (fewer) outside directorships. CEOs lose board seats after the media expose their companies in negative environmental and social news. More nuanced analyses show that workplace diversity and supply-chain human rights are most consequential among the social and environmental dimensions of CSR. Our study demonstrates that CEOs are judged on their companies' social reputation in the director labor market. Our results also suggest that social reputation plays an important role in promoting CSR.

Arm's Length Banking and Firm Innovation: Evidence from Korea
Yim, Jeongdae
This study explores the effect of bank loans subdivided in arm’s length banking and relational banking on innovation of Korean listed firms. I find that bank loans from relational banking negatively affect firm innovation whereas those from arm’s length banking positively affect it. This finding implies that diverse opinions among banks may increase the probability of financing for innovation. This finding also remains robust in Tobit, Poisson, and negative binomial regressions, in using reconstructed sample by a propensity score matching, and in two-stage regressions using an instrumental variable. This finding also occurs both in high technology and non-high technology firms. However, I find no significant relationship between bank loans and innovation of Chaebol firms. This study provides managers or academic researchers with valuable implications for an appropriate bank-firm relationship for promoting firm innovation.

Banking Sector Resources In 2019
Zubov, Sergey
The provision of assets by the banking sector in 2019 remained rather squared. Given the fact that economic subjects kept confidence in the banking sector, the lending institutions went on a resource base binge by using traditional toolsâ€"taking household and corporate funds on deposits. However, growth rates declined somewhat compared to the previous year. Dynamics of the interest rates on retail deposits were mainly due to the inflation rate and the decisions on the monetary policy: after mid-year, a downward trend set up. Ruble appreciation and strengthening have contributed to the shrinkage of the currency liability entries in accounts which in its turn decreased exposure of the financial system against external shocks.

COVID-19 causes record decline in global CO2 emissions
Zhu Liu,Zhu Deng,Philippe Ciais,Ruixue Lei,Steven J. Davis,Sha Feng,Bo Zheng,Duo Cui,Xinyu Dou,Pan He,Biqing Zhu,Chenxi Lu,Piyu Ke,Taochun Sun,Yuan Wang,Xu Yue,Yilong Wang,Yadong Lei,Hao Zhou,Zhaonan Cai,Yuhui Wu,Runtao Guo,Tingxuan Han,Jinjun Xue,Olivier Boucher,Frederic Chevallier,Eulalie Boucher,Yimin Wei,Qiang Zhang,Dabo Guan,Peng Gong,Daniel M. Kammen,Kebin He,Hans Joachim Schellnhuber

The unprecedented cessation of human activities during the COVID-19 pandemic has affected global energy use and CO2 emissions from fossil fuel use and cement production. Here we show that the decrease in global fossil CO2 emissions during the first quarter of 2020 was of 5.8% (542 Mt CO2 with a 20% 1-{\sigma} uncertainty). Unlike other emerging estimates, ours show the temporal dynamics of emissions based on actual emissions data from power generation (for 29 countries) and industry (for 73 countries), on near real time activity data for road transportation (for 132 countries), aviation and maritime transportation, and on heating degree days for commercial and residential sectors emissions (for 206 countries). These dynamic estimates cover all of the human induced CO2 emissions from fossil fuel combustion and cement production. The largest share of COVID-related decreases in emissions are due to decreases in industry (157.9 Mt CO2, -7.1% compared to 2019), followed by road transportation (145.7 Mt CO2, -8.3%), power generation (131.6 Mt CO2, -3.8%), residential (47.8 Mt CO2, -3.6%), fishing and maritime transport (35.5Mt CO2, -13.3%) and aviation (33.4 Mt CO2, -8.0%). Regionally, decreases in emissions from China were the largest and earliest (-10.3%), followed by Europe (EU-27 & UK) (-4.3%) and the U.S. (-4.2%). Relative decreases of regional CO2 emissions are consistent with regional nitrogen oxides concentrations observed by satellites and ground-based networks. Despite the unprecedented decreases in CO2 emissions and comparable decreases in economic activities, we monitored decreases in the carbon intensity (Emission per unit of GDP) in China (3.5%), the U.S. (4.5%) and Europe (5.4%) over the first quarter, suggesting that carbon-intensive activities have been disproportionally impacted.

Calibrating Macroprudential Policies for the Canadian Mortgage Market
Brave, Scott A.,Kronick, Jeremy,Lopez, Jose A.
Macroprudential regulation has been on the rise since the 2007â€"09 global financial crisis. In Canada, the primary policy tools that have been employed in this regard are related to the residential housing market â€" namely, changes in mortgage loan-to-value ratios and loan maturity requirements. In this Commentary, we use an analytical model to forecast the probability of a state of low financial stability in the Canadian economy and recommend when policy action might be taken in light of its costs and benefits. We project a low probability of low financial stability in Canada that rises gradually through year-end 2020, but remains low. This might seem odd given recent events around COVID-19. However, there are two things for readers to keep in mind. First, COVID-19 is a black swan event occurring in the real economy, one that does not originate in financial markets, making it difficult for financial regulators and policymakers to anticipate and model in advance. This is critical, as the goal of our paper is to provide a modeling tool to do just that. Second, once we have entered a downturn, financial regulators will not tighten a policy to head off financial instability. They will, in fact, do the opposite, by loosening policy rules to try and stimulate the economy. Canada is an interesting case with respect to financial stability concerns and policies. Although the Canadian economy was able to stave off many of the negative effects of the last financial crisis, it continues to have growing levels of household debt. As a result, after loosening housing-related macroprudential policies in the lead-up to the crisis, policymakers have spent much of the past decade tightening these same policies. Despite work analyzing the effects of housing-related macroprudential policies, there has been very little focus on advising policymakers about when to implement them. Any such advice naturally begins with identifying occasions when financial stability concerns are prominent and likely to remain so, which we refer to as “low financial stability states.” The model identifies three such episodes in Canada between 1990 and the middle of 2019: the early 1990s recession, the mid-1990s government budget rebalancing and the 2008 financial crisis. The four Financial Stability Indicators (FSIs) in our model specifications are the house-priceto-rent ratio, the price-to-income ratio, the debt-servicing ratio and the household-credit-to-GDP ratio. We then use the model to forecast the probability of entering another such episode over a two-year policy horizon. The model provides an answer to the question of whether the probability of entering and staying in a low financial stability state is high enough to go ahead with the policy, given the cost of implementation. Our analysis suggests that, as of the second quarter of 2019, and abstracting from the black swan COVID-19 event, the probability of a lengthy period of low financial stability is low, extending to late 2020.

Can Religions Explain Cross Country Differences in Innovative Activities?
Wang, Jimin,Wang, Cong
Motivated by theoretical arguments (see e.g. Bénabou, Ticchi and Vindigni (2015) and Assouad and Parboteeah (2018)) that assert a negative impact of religion on innovation, this paper aims to provide empirical evidence between the two variables. In particular, we explore the impact of major religious groups (Christianity, Judaism, Islam and Buddhism) on various innovative activities globally. Using data for 113 countries (core sample) and territories from 1960 to 2018, this paper has found a significant direct effect of religion affiliations on R&D intensity. In particular, Christianity and Judaism reduce R&D intensity, while in general, Buddhism and Irreligion increase R&D intensity. The effect of Islam on R&D intensity is largely insignificant. The effects of sub-groups of Christianity, Judaism and Islam are also highly consistent with previous results, except for Catholics and Orthodox Judaism. Our results indicate that the direction of effect of religion groups stays relatively unchanged across countries with different levels of democracy, income and religion regulation.

Changing Vulnerability in Asia: Contagion and Systemic Risk
Dungey, Mardi H.,Kangogo, Moses,Volkov, Vladimir
This paper investigates the changing network of financial markets between Asian markets and those of the rest of the world during January 2003â€"December 2017 to capture both the direction and strength of the links between them. Because each market chooses whether to connect with emerging markets as a bridge to the wider network, there are advantages to having access to this bridge for protection during periods of financial stress. Both parties gain by overcoming the information asymmetry between emerging and global markets. We analyze networks for four key periods, capturing networks in financial markets before and after the Asian financial crisis and the global financial crisis. Increased connections during crisis periods are evident, as well as a general deepening of the global network. The evidence on Asian market developments suggests caution is needed on regulations proposing methods to create stable networks, because these may result in reduced opportunities for emerging markets.

Closed Form Optimal Exercise Boundary of the American Put Option
Kitapbayev, Yerkin
We present three models of stock price with time-dependent interest rate, dividend yield, and volatility, respectively, that allow for explicit forms of the optimal exercise boundary of the American put option. The optimal exercise boundary satisfies nonlinear integral equation of Volterra type. We choose time-dependent parameters of the model so that the integral equation for the exercise boundary can be solved in the closed form. We also define the contracts of put type with time-dependent strike price that support the explicit optimal exercise boundary. All these results can be used as approximations to the standard model with constant parameters, i.e., geometric Brownian motion process.

Closed-form Solutions for an Explicit Modern Ideal Tontine with Bequest Motive
John Dagpunar

In this paper I extend the work of Bernhardt and Donnelly (2019) dealing with modern explicit tontines, as a way of providing income under a specified bequest motive, from a defined contribution pension pot. A key feature of the present paper is that it relaxes the assumption of fixed proportions invested in tontine and bequest accounts. In making the bequest proportion an additional control function I obtain, hitherto unavailable, closed-form solutions for the fractional consumption rate, wealth, bequest amount, and bequest proportion under a constant relative risk averse utility. I show that the optimal bequest proportion is the product of the optimum fractional consumption rate and an exponentiated bequest parameter. Typical scenarios are explored using UK Office of National Statistics life tables, showing the behaviour of these characteristics under varying degrees of constant relative risk aversion.

Coherent CVA and FVA with Liability Side Pricing of Derivatives
Wujiang Lou

This article presents FVA and CVA of a bilateral derivative in a coherent manner, based on recent developments in fair value accounting and ISDA standards. We argue that a derivative liability, after primary risk factors being hedged, resembles in economics an issued variable funding note, and should be priced at the market rate of the issuer's debt. For the purpose of determining the fair value, the party on the liability side is economically neutral to make a deposit to the other party, which earns his current debt rate and effectively provides funding and hedging for the party holding the derivative asset. The newly derived partial differential equation for an option discounts the derivative's receivable part with counterparty's curve and payable part with own financing curve. The price difference from the counterparty risk free price, or total counterparty risk adjustment, is precisely defined by discounting the product of the risk free price and the credit spread at the local liability curve. Subsequently the adjustment can be broken into a default risk component -- CVA and a funding component -- FVA, consistent with a simple note's fair value treatment and in accordance with the usual understanding of a bond's credit spread consisting of a CDS spread and a basis. As for FVA, we define a cost -- credit funding adjustment (CFA) and a benefit -- debit funding adjustment (DFA), in parallel to CVA and DVA and attributed to counterparty's and own funding basis. This resolves a number of outstanding FVA debate issues, such as double counting, violation of the law of one price, misuse of cash flow discounting, and controversial hedging of own default risk. It also allows an integrated implementation strategy and reuse of existing CVA infrastructure.

Corporate Governance in China: A Survey
Jiang, Fuxiu,Kim, Kenneth
This paper surveys corporate governance in China, as described in a growing literature published in top journals. Unlike the classical vertical agency problems in Western countries, the dominant agency problem in China is the horizontal agency conflict between controlling and minority shareholders arising from concentrated ownership structure; thus one cannot automatically apply what is known about the U.S. to China. As these features are also prevalent in many other countries, insights from this survey can also be applied to countries far beyond China. We start by describing controlling shareholder and agency problems in China, and then discuss how law and institutions are particularly important for China, where controlling shareholders have great power. As state-owned enterprises have their own features, we separately discuss their corporate governance. We also briefly discuss corporate social responsibility in China. Finally, we provide an agenda for future research.

Currency Futures' Risk Premia and Risk Factors
Bernoth, Kerstin,Hagen, Jürgen von,de Vries, Casper
The use of futures exchange contracts instead of forwards completes the maturity spectrum of the correlation between the spot yield and the premium. We find that the forward premium puzzle (FFP) depends significantly on the maturity horizon of the futures contract and the choice of sampling period. The FFP appears to be a pre-crisis phenomenon and is only observed for maturities longer than about one month. When examining whether the observed excess returns of futures contracts represent a fair compensation for currency risk, we find that non-durable consumption risk and market risk can explain excess currency returns. But only in the pre-crisis period and when the maturity of the assets is longer than about three months.

Debt and Depth of Recessions
Park, Donghyun,Shin, Kwanho,Tian, Grace
This paper empirically investigates the relationship between the speed of buildup of private debt (household and corporate) and the depth of recessions. To do this, we differentiate between financial recessions and normal recessions on the basis of how quickly their private debt builds up. In addition to output recessions, we look at consumption and investment recessions. We find that financial recessions are deeper than normal recessions in advanced economiesâ€"and the differences become even more pronounced when emerging market economies are added to the sample. Our evidence suggests that a buildup in corporate debt is especially damaging for emerging markets during financial recessions. A higher ratio of debt to gross domestic productâ€"in other words, less fiscal spaceâ€"exacerbates recessions only beyond a certain threshold level, suggesting a nonlinear effect. We find that the buildup of corporate debtâ€"and not just household debtâ€"can worsen recessions, especially in emerging market economies.

Decentralized Finance: On Blockchain- and Smart Contract-based Financial Markets
Schär, Fabian
This paper explores the Decentralized Finance (DeFi) ecosystem. We examine how DeFi is emerging on top of the public Ethereum smart contract platform, compare it to the centralized architecture of traditional financial markets and highlight opportunities and potential risks of this ecosystem. We propose a multi-layered framework to analyze the implicit architecture and the various DeFi building blocks, including token standards, decentralized exchanges, decentralized debt markets, blockchain derivatives and on-chain asset management protocols. We conclude that DeFi still is a niche market with certain risks, but also has interesting properties in terms of efficiency, transparency, accessibility and interoperability. As such, it may potentially contribute to a more robust and transparent financial infrastructure.

Decision-Making, Sub-Additive Recursive "Matching" Noise And Biases In Risk-Weighted Stock/Bond Index Calculation Methods In Incomplete Markets With Partially Observable Multi-Attribute Preferences
Michael C. Nwogugu

While Indices, Index tracking funds and ETFs have grown in popularity during then last ten years, there are many structural problems inherent in Index calculation methodologies and the legal/economic structure of ETFs. These problems raise actionable issues of Suitability and fraud under US securities laws, because most Indices and ETFs are misleading, have substantial tracking errors and dont reflect what they are supposed to track. This article contributes to the existing literature by: a) introducing and characterizing the errors and Biases inherent in risk-adjusted index weighting methods and the associated adverse effects; b) showing how these biases/effects inherent in Index calculation methods reduce social welfare, and can form the basis for harmful arbitrage activities.

Derivatives Discounting Explained
Wujiang Lou

Derivative pricing is about cash flow discounting at the riskfree rate. This teaching has lost its meaning post the financial crisis, due to the addition of extra value adjustments (XVA), which also made derivatives pricing and valuation a very difficult task for investors. This article recovers a properly defined discount rate that corresponds to different collateral and margin schemes. A binomial tree model is developed, enabling end-users to price in counterparty default and funding risk. Coherent XVAs, if needed, naturally result from decomposing the discount rate, and can be computed on the same tree.

Disaster Insurance in Developing Asia: An Analysis of Market-Based Schemes
Surminski, Swenja,Panda, Architesh ,Lambert, Peter John
In recent years, insurance against natural disasters has gained recognition as an important tool for climate risk management that could, if carefully implemented, help increase the resilience of those insured. In response, insurance solutions are increasingly tested and applied in many countries that have no prior experience with insurance or no existing market. This paper analyzes the status, types, and patterns of market-based disaster insurance schemes across emerging and developing countries in Asia. We provide a snapshot of the current use of insurance based on data from Grantham Research Institute on Climate Change and the Environment’s Disaster Risk Transfer Scheme Database (2012â€"2018). Our analysis shows that although the use of insurance is expanding, there are many countries that still don’t have any kind of cover available. Where insurance mechanisms exist, they often rely on subsidies or bundling strategies. Although a mix of insurance schemes covering risks for governments (sovereign); or at meso (risk aggregators, cooperatives); and micro level currently operate to address a wide variety of climate and disaster risks, without demand-side support, many markets are likely to collapse or, at the very least, experience far lower penetration rates. We conclude with a discussion of the role of these insurance schemes in increasing resilience, which raises important questions for designing new and measuring and evaluating existing insurance schemes.

Distant Lending, Specialization, and Access to Credit
Di, Wenhua,Pattison, Nathaniel
Small business lending has historically been very local, but distances between small businesses and their lenders have steadily increased over the last forty years. This paper investigates a new lending strategy made possible by distant small business lending: industry specialization. Using data on all Small Business Administration 7(a) loans from 2001-2017, we document a substantial increase in remote, specialized small business lenders, i.e., lenders that originate many distant loans and concentrate these loans within a small number of industries. These lenders target low-risk industries and, consistent with expertise, experience better loan performance within these industries. We then examine whether this industry-specialized lending serves as a substitute or complement to traditional, geographically specialized lending. We exploit the staggered entry of a remote, specialized lender to estimate the impact of specialized lending on credit access. Entry significantly increases total lending, with no evidence of substitution away from other lenders. The results indicate that specialized lending can deepen credit markets by providing new loans to low-risk but underfinanced small businesses.

Do Local Social Norms Affect Investors’ Involvement in Social Activism? Revisiting the Case of US Institutional Investors
Cahan, Steven F.,Chen, Chen,Chen, Lily
Evidence provided by Dyck et al. (2019) suggests that, in contrast to European investors, local norms related to environmental and social (E&S) beliefs do not affect the willingness of US institutional investors to push for E&S improvements in US firms. We revisit this issue except, instead of measuring E&S social norms at the country level, we allow E&S social norms to vary between states. We find that the shareholdings of non-local US institutional investors from states with strong E&S social norms are positively related to E&S-related shareholder activism, indicating that local E&S social norms do matter for US institutional investors.

Does Closing a University because of the Corona Virus Constitute Negligence or a Breach of Fiduciary Duty?
McGee, Robert W.
This paper reviews the current Corona virus situation, then examines the legal definitions of negligence and fiduciary duty in an attempt to determine whether closing a university because of health concerns over the Corona virus might result in legal liability for the university’s board members and relevant university administrators.

Barth, Andreas,Mansouri, Sasan,Woebbeking, Fabian
It is relatively easy for us humans to detect that a question we asked has not been answered - we teach this skill to a computer. More specifically, we develop a measure that detects the rejection, avoidance or dodging of a question. Using a supervised machine learning framework on a large training set of 48,197 classified responses to questions, we identify 703 trigrams that signal whether or not the respondent tries to avoid answering. We show that this dictionary has economic relevance by applying it to a validation set of contemporaneous stock market reactions after earnings conference calls. Our findings suggest that obstructing the flow of information leads to significantly lower cumulative abnormal stock returns and higher implied volatility. Our metric is designed to be of general applicability for Q&A situations, and hence, can be applied outside the contextual domain of financial earnings conference calls.

Ensemble Forecasting for Intraday Electricity Prices: Simulating Trajectories
Michał Narajewski,Florian Ziel

Recent studies concerning the point electricity price forecasting have shown evidence that the hourly German Intraday Continuous Market is weak-form efficient. Therefore, we take a novel, advanced approach to the problem. A probabilistic forecasting of the hourly intraday electricity prices is performed by simulating trajectories in every trading window to receive a realistic ensemble to allow for more efficient intraday trading and redispatch. A generalized additive model is fitted to the price differences with the assumption that they follow a mixture of the Dirac and the Student's t-distributions. Moreover, the mixing term is estimated using a high-dimensional logistic regression with lasso penalty. We model the expected value and volatility of the series using i.a. autoregressive and no-trade effects or load, wind and solar generation forecasts and accounting for the non-linearities in e.g. time to maturity. Both the in-sample characteristics and forecasting performance are analysed using a rolling window forecasting study. Multiple versions of the model are compared to several benchmark models. The study aims to forecast the price distribution in the German Intraday Continuous Market in the last 3 hours of trading, but the approach allows for application to other continuous markets. The results prove superiority of the mixture model over the benchmarks gaining the most from the modelling of the volatility.

Equilibrium Theory in Continuous Time
Bjork, Tomas
This paper contains my (still incomplete) lecture notes on equilibrium theory in continuous time. It is intended for PhD students with a reasonably solid background in stochastic calculus.

Equity Cross-Listings in the U.S. and the Price of Debt
Ball, Ryan T.,Hail, Luzi,Vasvari, Florin P.
Using a large panel from 46 countries over 20 years, we find that non-U.S. firms issue corporate bonds more frequently and at lower offering yields following an equity cross-listing on a U.S. exchange. Firms issue more bonds through public offerings instead of private placements and in foreign markets rather than at home, in both cases at significantly lower yields. Moreover, the debt-related benefits are concentrated among firms domiciled in countries with less private benefits of control, efficient debt enforcement, and developed bond markets, suggesting that equity cross-listings cannot completely offset the impact of weak home country institutions. The results support the notion that the monitoring, transparency, and visibility benefits brought about by equity cross-listings on U.S. exchanges are valuable to bond investors.

Exponential-growth prediction bias and compliance with safety measures in the times of COVID-19
Ritwik Banerjee,Joydeep Bhattacharya,Priyama Majumdar

We conduct a unique, Amazon MTurk-based global experiment to investigate the importance of an exponential-growth prediction bias (EGPB) in understanding why the COVID-19 outbreak has exploded. The scientific basis for our inquiry is the well-established fact that disease spread, especially in the initial stages, follows an exponential function meaning few positive cases can explode into a widespread pandemic if the disease is sufficiently transmittable. We define prediction bias as the systematic error arising from faulty prediction of the number of cases x-weeks hence when presented with y-weeks of prior, actual data on the same. Our design permits us to identify the root of this under-prediction as an EGPB arising from the general tendency to underestimate the speed at which exponential processes unfold. Our data reveals that the "degree of convexity" reflected in the predicted path of the disease is significantly and substantially lower than the actual path. The bias is significantly higher for respondents from countries at a later stage relative to those at an early stage of disease progression. We find that individuals who exhibit EGPB are also more likely to reveal markedly reduced compliance with the WHO-recommended safety measures, find general violations of safety protocols less alarming, and show greater faith in their government's actions. A simple behavioral nudge which shows prior data in terms of raw numbers, as opposed to a graph, causally reduces EGPB. Clear communication of risk via raw numbers could increase accuracy of risk perception, in turn facilitating compliance with suggested protective behaviors.

Extending the Black-Scholes Option Pricing Theory to Account for an Option Market Maker's Funding Costs
Wujiang Lou

An option market maker incurs funding costs when carrying and hedging inventory. To hedge a net long delta inventory, for example, she pays a fee to borrow stock from the securities lending market. Because of haircuts, she posts additional cash margin to the lender which needs to be financed at her unsecured debt rate. This paper incorporates funding asymmetry (borrowed cash and invested cash earning different interest rates) and realistic stock financing cost into the classic option pricing theory. It is shown that an option position can be dynamically replicated and self financed in the presence of these funding costs. Noting that the funding amounts and costs are different for long and short positions, we extend Black-Scholes partial differential equations (PDE) per position side. The PDE's nonlinear funding cost terms create a free funding boundary and would result in the bid price for a long position on an option lower than the ask price for a short position. An iterative Crank-Nicholson finite difference method is developed to compute European and American vanilla option prices. Numerical results show that reasonable funding cost parameters can easily produce same magnitude of bid/ask spread of less liquid, longer term options as observed in the market place. Portfolio level pricing examples show the netting effect of hedges, which could moderate impact of funding costs.

Financial Education Affects Financial Knowledge and Downstream Behaviors
Kaiser, Tim ,Lusardi, Annamaria,Urban, Carly,Menkhoff, Lukas
We study the rapidly growing literature on the causal effects of financial education programs in a meta-analysis of 76 randomized experiments with a total sample size of over 160,000 individuals. The evidence shows that financial education programs have, on average, positive causal treatment effects on financial knowledge and downstream financial behaviors. Treatment effects are economically meaningful in size, similar to those realized by educational interventions in other domains and are at least three times as large as the average effect documented in earlier work. These results are robust to the method used, restricting the sample to papers published in top economics journals, including only studies with adequate power, and accounting for publication selection bias in the literature. We conclude with a discussion of the cost-effectiveness of financial education interventions.

Fund Names vs. Family Names: Implications for Mutual Fund Flows
El Ghoul, Sadok,Karoui, Aymen
An emerging literature has shown that investors are sensitive to mutual fund names. Using a sample of US equity funds over the period 1993-2017, we provide evidence that funds with a name closer to the family’s name attract more flows and display a stronger performance-flow relationship. We also find that retail investors, in comparison to institutional investors, are more affected by this name bias. Our results are in line with the literature on social biases and costly searches and show that seemingly innocuous differences in fund attributes â€" such as fund names â€" translate into significant differences in investor decisions.

Gap Risk KVA and Repo Pricing: An Economic Capital Approach in the Black-Scholes-Merton Framework
Wujiang Lou

Although not a formal pricing consideration, gap risk or hedging errors are the norm of derivatives businesses. Starting with the gap risk during a margin period of risk of a repurchase agreement (repo), this article extends the Black-Scholes-Merton option pricing framework by introducing a reserve capital approach to the hedging error's irreducible variability. An extended partial differential equation is derived with two new terms for expected gap loss and economic capital charge, leading to the gap risk economic value adjustment and capital valuation adjustment (KVA) respectively. Practical repo pricing formulae is obtained showing that the break-even repo rate decomposes into cost of fund and economic capital charge in KVA. At zero haircut, a one-year term repo on main equities could command a capital charge as large as 50 basis points for a 'BBB' rated borrower.

Haircutting Non-cash Collateral
Wujiang Lou

Haircutting non-cash collateral has become a key element of the post-crisis reform of the shadow banking system and OTC derivatives markets. This article develops a parametric haircut model by expanding haircut definitions beyond the traditional value-at-risk measure and employing a double-exponential jump-diffusion model for collateral market risk. Haircuts are solved to target credit risk measurements, including probability of default, expected loss or unexpected loss criteria. Comparing to data-driven approach typically run on proxy data series, the model enables sensitivity analysis and stress test, captures market liquidity risk, allows idiosyncratic risk adjustments, and incorporates relevant market information. Computational results for main equities, securitization, and corporate bonds show potential for uses in collateral agreements, e.g. CSAs, and for regulatory capital calculations.

Herding Behavior in Corporate Bond and Equity Markets: A Comparative Approach
Radi, Sherrihan,Pappas, Vasileios,Alexandridis, Antonis
This study investigates and compares herding in US corporate bond and equity markets between January 2008 and December 2018. Our initial unconditional tests detect significant herding in speculative grade (high yield) corporate bonds only. However, once we condition on market liquidity and volatility, we find significant asymmetric herding behavior in both markets and their credit rating portfolios (investment grade, high yield and non-rated). The results suggest that investors are inclined to collectively herd towards the market consensus during high market liquidity and low volatility days. Interestingly, the herding effects are more pronounced in corporate bonds in comparison to equities. The findings are robust through the Subprime mortgage crisis and post crisis periods, and hold even after conditioning for both liquidity and volatility market states, simultaneously. Our further tests also provide new empirical evidence of the existence of herding spillovers from US corporate bonds to US equities, where the spillover effect seem to be one sided and time-period specific (during the crisis).

Instabilities in Multi-Asset and Multi-Agent Market Impact Games
Cordoni, Francesco,Lillo, Fabrizio
We consider the general problem of a set of agents trading a portfolio of assets in the presence of transient price impact and additional quadratic transaction costs and we study, with analytical and numerical methods, the resulting Nash equilibria. Extending significantly the framework of Schied and Zhang (2018), who considered two agents and one asset, we focus our attention on the conditions on the value of transaction cost making the trading profile of the agents, and as a consequence the price trajectory, wildly oscillating and the market unstable. We find that the presence of more assets, the heterogeneity of trading skills (e.g. speed or cost), and a large number of agents make the market more prone to large oscillations and instability. When the number of assets is fixed, a more complex structure of the cross-impact matrix, i.e. the existence of multiple factors for liquidity, makes the market less stable compared to the case when a single liquidity factor exists.

Issues In Disintermediation In The Real Estate Brokerage Sector
Michael C. Nwogugu

This article introduces new models of disintermediation of the real estate broker by the buyer or the seller. The decision to retain a real estate broker is critical in the property purchase/sale process. The existing literature does not contain analysis of: 1) information asymmetry, 2) the conditions under which it will be optimal to disintermediate the broker, 3) social capital and reputation, 4) the impact of different types of real estate brokerage contracts. The article shows that dis-intermediation of the real estate broker by the seller or buyer may be optimal in certain conditions.

Liability-side Pricing of Swaps and Coherent CVA and FVA by Regression/Simulation
Wujiang Lou

An uncollateralized swap hedged back-to-back by a CCP swap is used to introduce FVA. The open IR01 of FVA, however, is a sure sign of risk not being fully hedged, a theoretical no-arbitrage pricing concern, and a bait to lure market risk capital, a practical business concern. By dynamically trading the CCP swap, with the liability-side counterparty provides counterparty exposure hedge and swap funding, we find that the uncollateralized swap can be fully replicated, leaving out no IR01 leakage. The fair value of the swap is obtained by applying to swap's net cash flows a discount rate switching to counterparty's bond curve if the swap is a local asset or one's own curve if a liability, and the total valuation adjustment is the present value of cost of funding the risk-free price discounted at the same switching rate. FVA is redefined as a liquidity or funding basis component of total valuation adjustment, coherent with CVA, the default risk component. A Longstaff-Schwartz style least-square regression and simulation is introduced to compute the recursive fair value and adjustments. A separately developed finite difference scheme is used to test and find regression necessary to decouple the discount rate switch. Preliminary results show the impact of counterparty risk to swap hedge ratios, swap bid/ask spreads, and valuation adjustments, and considerable errors of calculating CVA by discounting cash flow or potential future exposure.

Litigating Crashes? Insights from Security Class Actions
Ni, Xiaoran
Investors tend to litigate large stock price declines, i.e., file “stock-drop lawsuits”. Enterprising plaintiffs’ attorneys seek to take advantage of the stock market declines that have accompanied the COVID-19 outbreak in early 2020 by filing class action lawsuits. However, it is less clear whether the ex-ante threat of security class actions can deter stock price crashes. To address this question, we exploit the 1999 ruling of the Ninth Circuit Court of Appeals that discourages security class actions as a quasi-exogenous shock, and find that reducing the threat of security class actions leads to a significant increase in stock price crash risk. This effect is more pronounced for firms faced with higher litigation risk, with worse earnings quality and weaker monitoring from auditors, and is partially driven by decreased timeliness of bad-news disclosure. Our overall findings highlight the importance of security class actions in constraining bad-news hoarding and maintaining market stability.

MVA Transfer Pricing
Wujiang Lou

This article prices OTC derivatives with either an exogenously determined initial margin profile or endogenously approximated initial margin. In the former case, margin valuation adjustment (MVA) is defined as the liability-side discounted expected margin profile, while in the latter, an extended partial differential equation is derived and solved for an all-in fair value, decomposable into coherent CVA, FVA and MVA. For uncollateralized customer trades, MVA can be transferred to the customer via an extension of the liability-side pricing theory. For BCBS-IOSCO covered OTC derivatives, a market maker has to charge financial counterparties a bid-ask spread to transfer its funding cost. An IM multiplier is applied to calibrate to external IM models to allow portfolio incremental pricing. In particular, a link to ISDA SIMM for equity, commodity and fx risks is established through the PDE with its vega and curvature IM components captured fully. Numerical examples are given for swaps and equity portfolios and offer a plausible attribution of recent CME-LCH basis spread widening to elevated MVA accompanying dealers' hedging of customer flows.

Macroprudential Policy in Asian Economies
Kim, Soyoung
This paper analyzes the conduct and effects of macroprudential policy in 11 Asian economies. Of these, India, the People’s Republic of China, and the Republic of Korea frequently used loan-to-value ratios and required reserve ratios even before the global financial crisis. India and the People’s Republic of China are the most frequent users of macroprudential policy tools. Since 2000, tightening actions have been more frequent than loosening in the 11 economies. Most took tightening actions more frequently after the global financial crisis than before it. In most of these economies, macroprudential policy tends to be tightened when credit expands. The main empirical results from the analysis, which uses panel vector autoregression models, are that contractionary macroprudential policy has significant negative effects on credit and output; and that these effects are qualitatively similar to those of monetary policy. This suggests that policy authorities may experience potential policy conflicts when credit conditions are excessive and the economy is in recession.

Monetary Policy, Financial Regulation and Financial Stability: A Comparison between the Fed and the ECB
Schnabl, Gunther,Sonnenberg, Nils
The paper analyses in light of Austrian and Keynesian economic theory the impact of conventional and unconventional monetary policies as therapies for financial crises. It compares the financial market stabilization measures of the Federal Reserve System and the European System of Central Banks in response to the US subprime crisis and the European financial and debt crisis. It is shown that the Federal Reserve System’s crisis measures were more directed towards stabilizing the banking system, whereas the European Central Bank had a stronger focus on the stabilization of the debt affordability of euro area crisis countries. In both cases, household credit growth remained under control despite renewed monetary expansion, while new imbalances emerged in the corporate sector. In the euro area, loose monetary policy had a destabilizing impact on the financial sector.

Network Structure and Naive Sequential Learning
Krishna Dasaratha,Kevin He

We study a sequential-learning model featuring a network of naive agents with Gaussian information structures. Agents apply a heuristic rule to aggregate predecessors' actions. They weigh these actions according the strengths of their social connections to different predecessors. We show this rule arises endogenously when agents wrongly believe others act solely on private information and thus neglect redundancies among observations. We provide a simple linear formula expressing agents' actions in terms of network paths and use this formula to characterize the set of networks where naive agents eventually learn correctly. This characterization implies that, on all networks where later agents observe more than one neighbor, there exist disproportionately influential early agents who can cause herding on incorrect actions. Going beyond existing social-learning results, we compute the probability of such mislearning exactly. This allows us to compare likelihoods of incorrect herding, and hence expected welfare losses, across network structures. The probability of mislearning increases when link densities are higher and when networks are more integrated. In partially segregated networks, divergent early signals can lead to persistent disagreement between groups.

Neural Networks and Value at Risk
Alexander Arimond,Damian Borth,Andreas Hoepner,Michael Klawunn,Stefan Weisheit

Utilizing a generative regime switching framework, we perform Monte-Carlo simulations of asset returns for Value at Risk threshold estimation. Using equity markets and long term bonds as test assets in the global, US, Euro area and UK setting over an up to 1,250 weeks sample horizon ending in August 2018, we investigate neural networks along three design steps relating (i) to the initialization of the neural network, (ii) its incentive function according to which it has been trained and (iii) the amount of data we feed. First, we compare neural networks with random seeding with networks that are initialized via estimations from the best-established model (i.e. the Hidden Markov). We find latter to outperform in terms of the frequency of VaR breaches (i.e. the realized return falling short of the estimated VaR threshold). Second, we balance the incentive structure of the loss function of our networks by adding a second objective to the training instructions so that the neural networks optimize for accuracy while also aiming to stay in empirically realistic regime distributions (i.e. bull vs. bear market frequencies). In particular this design feature enables the balanced incentive recurrent neural network (RNN) to outperform the single incentive RNN as well as any other neural network or established approach by statistically and economically significant levels. Third, we half our training data set of 2,000 days. We find our networks when fed with substantially less data (i.e. 1,000 days) to perform significantly worse which highlights a crucial weakness of neural networks in their dependence on very large data sets ...

Oil economy phase plot: a physical analogy
Luciano Celi,Claudio Della Volpe,Luca Pardi,Stefano Siboni

A phase plot of the oil economy is built using the literature data of world oil production, price, and EROEI (Energy Returned on Energy Invested). An analogy between the oil economy and the Benard convection is proposed; some methods of interpretation and forecast of the system behavior are also shown based on "phase portrait" using as main variables the price, production and EROEI values. A scenery is proposed on this basis.

On The Choice Between A Sale-Leaseback And Debt
Michael C. Nwogugu

This article introduces decision models for commercial real estate leasing. The concepts and models developed in the article can also be applied to equipment leasing and other types of leasing.

On track for retirement?
Matthew Olckers

Over sixty percent of employees at a large South African financial services company select the minimum rate of 7.5 percent for their monthly retirement contributions, far below the recommended rate of 15 percent. I use a field experiment to investigate whether providing employees with a retirement calculator, which shows projections of retirement income, leads to increases in contributions. The average treatment effect is positive but very small and not statistically different from zero.

Optimal Stress Tests and Liquidation Cost
Gu, Jiadong
We study stress tests as Bayesian persuasion within the fundamental bank run framework. This paper shows that the optimal disclosure policy depends on the liquidation cost of the long-term asset. In particular, when the liquidation cost is high, the optimal stress test partially discloses information about banks' asset: it reduces the likelihood of a full bank run. When the liquidation cost is low, the optimal stress test fully discloses information: it increases the likelihood of enjoying the high expected asset return. The central trade-off in the design of a stress test is between the bank run cost and the high expected asset return. The theory suggests a joint design of the stress test and other policies that affect asset market liquidity.

Pension Overhang and Corporate Investment
Alanis, Emmanuel,Chava, Sudheer,Simasek, Peter
We exploit an exogenous, universal increase in discount rates mandated by the Moving Ahead for Progress Act (MAP-21) to identify the impact of pension overhang on investment. We find that firms with large unfunded pension liabilities increase investment by 13% after the MAP-21 induced decrease in pension liabilities. The effects are more pronounced for ex- ante financially constrained firms, yet pension-related cash flows have a minimal impact on investment. Credit ratings of affected firms improve while CEOs with more pay-for- performance and longer horizon increase investment to a greater extent after MAP-21. Our results highlight the role of pension overhang on investment.

Price Discovery for Options
Malamud, Semyon,Tseng, Michael,Zhang, Yuan
We consider a market where traders have asymmetric information regarding the distribution of asset return and study price discovery of derivatives. The informed trader has private information regarding arbitrary higher moments of asset return, such as volatility or skewness, and exploits her private information by trading a complete menu of options. The equilibrium trading strategies of the informed agent in our model reflect those used by traders in the market when trying to exploit higher order moment information, such as the volatility straddle.

Quantitative Easing and the Price-Liquidity Trade-Off
Ferdinandusse, M.,Freier, Maximilian,Ristiniemi, Annukka
We consider the effects of quantitative easing on liquidity and prices of bonds in a search-and matching model. The model explicitly distinguishes between demand and supply effects of central bank asset purchases. Both are shown to lead to a decline in yields, while they have opposite effects on market liquidity. This results in a price-liquidity trade-off. Initially, liquidity improves in reaction to central bank demand. As the central bank buys and holds bonds, supply becomes scarcer and other buyers are crowded out. As a result, liquidity can fall below initial levels. The magnitude of the effects depend on the presence of preferred habitat investors. In markets with a higher share of these investors, bonds are scarcer and central bank asset purchases lower yields more. With a lower share of preferred habitat investors and a relatively illiquid market, central bank demand has a stronger positive effect on liquidity. We are the first to construct an index from bond holding data to measure the prevalence of preferred habitat investors in each euro area country. Subsequently, we calibrate the model to the euro area and show how yields and liquidity are affected by the European Central Banks asset purchase programme.

Regret Theory And Asset Pricing Anomalies In Incomplete Markets With Dynamic Un-Aggregated Preferences
Michael Nwogugu

Although the CML (Capital Market Line), the Intertemporal-CAPM, the CAPM/SML (Security Market Line) and the Intertemporal Arbitrage Pricing Theory (IAPT) are widely used in portfolio management, valuation and capital markets financing; these theories are inaccurate and can adversely affect risk management and portfolio management processes. This article introduces several empirically testable financial theories that provide insights, and can be calibrated to real data and used to solve problems, and contributes to the literature by: i) explaining the conditions under which ICAPM/CAPM, IAPT and CML may be accurate, and why such conditions are not feasible; and explaining why the existence of incomplete markets and dynamic un-aggregated markets render CML, IAPT and ICAPM inaccurate; ii) explaining why the Consumption-Savings-InvestmentProduction framework is insufficient for asset pricing and analysis of changes in risk and asset values; and introducing a unified approach to asset pricing that simultaneously considers six factors, and the conditions under which this approach will work; iii) explaining why leisure, taxes and housing are equally as important as consumption and investment in asset pricing; iv) introducing the Marginal Rate of Intertemporal Joint Substitution (MRIJS) among Consumption, Taxes, Investment, Leisure, Intangibles and Housing - this model incorporates Regret Theory and captures features of reality that dont fit well into standard asset pricing models, and this framework can support specific or very general finance theories and or very complicated models; v) showing why the Elasticity of Intertemporal Substitution (EIS) is inaccurate and is insufficient for asset pricing and analysis of investor preferences.

Repo Haircuts and Economic Capital
Wujiang Lou

This article develops a haircut model by treating repos as debt investments and seeks haircuts to control counterparty contingent exposure to asset price gap risk. It corroborates well with empirically stylized facts, explains tri-party and bilateral repo haircut differences, recasts haircut increases during the financial crisis, and sets a limit on access liquidity dealers can extract while acting as funding intermediaries between money market funds and hedge funds. Once a haircut is set, repo's residual risk becomes a pricing challenge, as is neither hedgeable nor diversifiable. We propose a capital pricing approach of computing repo economic capital and charging the borrower a cost of capital. Capital charge is shown to be countercyclical and a key element of repo pricing and used in explaining the repo pricing puzzle and maturity compression phenomenon.

Saving Macroeconomics from the Grand Trap of Liquidity
Ahn, Y.
Money is neither a product nor an asset but the medium of exchange or “liquidity” as some call it. The money stock (M) can by no means affect the economy when separated from its velocity (V). Unfortunately, however, macroeconomists attach excessive meaning to “money” even though there is no way to estimate its velocity. As a consequence, there are some erroneous money-related ideas, among others, the quantity equation, the liquidity preference, and the liquidity trap. The common root cause for those errors is taking velocity as constant and paying attention to money by itself.This essay starts from an analysis of lay people’s activities and shows why these three popular ideas are misconceived. On the one hand, we human beings take part in creating products (C) and (new) assets (I) and earn incomes. On the other hand, we buy products for present utility and assets for future utility. Along the way, we trade exiting assets to smooth and maximize our lifetime utility. All through our life, what is critical to us and to the economy is not money per se but a system (“credit line”) which gets the power of purchasing available to us on time. As a matter of fact, money has historically been nothing other than certain ways of credit certification.

Some Issues In Securitization And Disintermediation
Michael C. Nwogugu

Securitization has become prevalent in many countries, and has substantial impact on government monetary policy and fiscal policy which have not yet been adequately analyzed in the existing literature. This article develops optimal conditions for efficient securitization, identifies constraints on securitization, and analyzes the interactions of capital-reserve requirements and securitization. This article introduces new decision models and theories of asset-securitization.

Survival of Firms during Economic Crisis
Bosio, Erica,Djankov, Simeon,Jolevski, Filip,Ramalho, Rita
We estimate the survival time of nearly 7,000 firms in a dozen of high-income and middle-income countries in a scenario of extreme economic distress, using the World Bank’s Enterprises Surveys. Under the assumption that firms have no incoming revenues and cover only fixed costs, the median survival time across industries ranges within 8 to 19 weeks, while on average firms have liquidity to survive between 12 and 38 weeks. Schumpeter’s (1934) theory of creative destruction is not corroborated in the data. A potential exit is not predicated on the size of firms, their age or their productivity.

Tail Granger causalities and where to find them: extreme risk spillovers vs. spurious linkages
Piero Mazzarisi,Silvia Zaoli,Carlo Campajola,Fabrizio Lillo

Identifying risk spillovers in financial markets is of great importance for assessing systemic risk and portfolio management. Granger causality in tail (or in risk) tests whether past extreme events of a time series help predicting future extreme events of another time series. The topology and connectedness of networks built with Granger causality in tail can be used to measure systemic risk and to identify risk transmitters. Here we introduce a novel test of Granger causality in tail which adopts the likelihood ratio statistic and is based on the multivariate generalization of a discrete autoregressive process for binary time series describing the sequence of extreme events of the underlying price dynamics. The proposed test has very good size and power in finite samples, especially for large sample size, allows inferring the correct time scale at which the causal interaction takes place, and it is flexible enough for multivariate extension when more than two time series are considered in order to decrease false detections as spurious effect of neglected variables. An extensive simulation study shows the performances of the proposed method with a large variety of data generating processes and it introduces also the comparison with the test of Granger causality in tail by [Hong et al., 2009]. We report both advantages and drawbacks of the different approaches, pointing out some crucial aspects related to the false detections of Granger causality for tail events. An empirical application to high frequency data of a portfolio of US stocks highlights the merits of our novel approach.

The Declining Trade Credit Ratio Puzzle
D'Mello, Ranjan,Gruskin, Mark,Toscano, Francesca
Despite the importance of trade credit as a source of financing there is a significant and persistent decline in this form of short-term borrowing and lending over the 1979 to 2018 interval. We find that the median firm’s accounts receivable ratio decreased by 52 percent while accounts payable ratio fell by 47 percent. The decline in firms’ trade credit over time is systematic as it is present in most industries and sub-samples of firms classified on different characteristics. Further, firms’ trade credit ratios are significantly less than predicted ratios based on firm-specific characteristics and industry factors and this deficiency is becoming larger, that is, more negative, over the sample period. The pattern in trade credit ratios persists after controlling for changes in macro factors implying that the declining trade credit ratio represents a puzzle.

The Fair Basis: Funding and capital in the reduced form framework
Wujiang Lou

A negative basis trade enters a long bond position and buys protection on the issuer of the bond through credit default swap (CDS), aiming at arbitrage profit due to the bond-CDS basis. To classic reduced form model theorists, the existence of the basis is an abnormality or merely liquidity noise. Such a view, however, fails to explain large basis trading losses incurred during the financial crisis. Employing a bond continuously hedged by CDS under a dynamic spread model with bond repo financing, we find that there is unhedged and unhedgeable residual jump to default risk that can't be diversified because of credit correlation. An economic capital approach has to apply and a charge on the use of capital follows. Together with the hedge funding cost, it allows us to better understand the basis's economics and to predict its fair level.

The First Outside Director
Larcker, David F.,Tayan, Brian
Little is known about the process by which pre-IPO companies select independent, outside board membersâ€"directors unaffiliated with the company or its investors. Private companies are not required to disclose their selection criteria or process, and are not required to satisfy the regulatory requirements for board members set out by public listing exchanges. In this Closer Look, we look at when, why, and how private companies add their first independent, outside director to the board.We ask: • Why do pre-IPO companies rely on very different criteria and processes to recruit outside directors than public companies do?• What does this teach us about governance quality?• How important are industry knowledge and managerial experience to board oversight?• How important are independence and monitoring? • Does a tradeoff exist between engagement and fit on the one hand and independence on the other?

The Illusory Promise of Stakeholder Governance (Presentation Slides)
Bebchuk, Lucian A.,Tallarita, Roberto
The presentation slides in this document provide an overview of our study, The Illusory Promise of Stakeholder Governance, which will be published by the Cornell Law Review in December 2020. The document is based on presentations slides we prepared for March 2020 presentations at Columbia Law School and Harvard Law School.Corporate purpose is now the focus of a fundamental and heated debate, with rapidly growing support for the proposition that corporations should move from shareholder value maximization to “stakeholder governance” and “stakeholder capitalism.” Our study critically examines the increasingly influential “stakeholderism” view, according to which corporate leaders should give weight not only to the interests of shareholders but also to those of all other corporate constituencies (including employees, customers, suppliers, and the environment). We conduct a conceptual, economic, and empirical analysis of stakeholderism and its expected consequences. We conclude that this view should be rejected, including by those who care deeply about the welfare of stakeholders. Stakeholderism, we demonstrate, would not benefit stakeholders as its supporters claim. To examine the expected consequences of stakeholderism, we analyze the incentives of corporate leaders, empirically investigate whether they have in the past used their discretion to protect stakeholders, and examine whether recent commitments to adopt stakeholderism can be expected to bring about a meaningful change. Our analysis concludes that acceptance of stakeholderism should not be expected to make stakeholders better off. Furthermore, we show that embracing stakeholderism could well impose substantial costs on shareholders, stakeholders, and society at large. Stakeholderism would increase the insulation of corporate leaders from shareholders, reduce their accountability, and hurt economic performance. In addition, by raising illusory hopes that corporate leaders would on their own provide substantial protection to stakeholders, stakeholderism would impede or delay reforms that could bring meaningful protection to stakeholders. Stakeholderism would therefore be contrary to the interests of the stakeholders it purports to serve and should be opposed by those who take stakeholder interests seriously.

The Impact of Expected Pensions on Consumption: Evidence from China
Zheng, Wei,Lyu, Youji,Jia, Ruo,Hanewald, Katja
We study how pension participation and expected pension benefits affect the consumption of working-age adults based on a nationally representative dataset from the China Health and Retirement Longitudinal Study during the period 2011â€"2015. We find that working-age adults covered by the Employees’ Basic Pension, a compulsory public pension scheme for employees in the formal sector, have a consumption rate (total consumption to permanent income) that is 29.9 percentage points higher than those who do not participate in any public pension scheme. However, the Residents’ Basic Pension, a low-benefit voluntary public pension scheme for other residents, only promotes the consumption of working-age adults with a low income. Focusing on pension participants, we find that if working-age adults’ expected replacement rate (expected pension benefits at retirement to permanent income) increases by one percentage point, their consumption rate will increase by three percentage points. Working-age adults who are older, poorer, or live in a rural area increase their consumption more in response to the expected replacement rate. Nondurable consumption is more responsive to the expected replacement rate than durable consumption. Overall, our findings suggest that pension expectations are critical to the consumption decisions of working-age adults and can, therefore, affect total consumption.

The Information in Trade Financing
Barardehi, Yashar H.,Da, Zhi,Warachka, Mitch
We identify informed trading by conditioning on how trades are financed. Fund managers with a positive short-lived private signal appear to self finance informed purchases of a stock by selling, on the same day, an equivalent dollar amount of stock in the same industry. These balanced intra-industry pair trades are motivated by relative valuation as well as the need to maintain specific industry allocations and hedge industry exposure. The informed trades we identify, which constitute less than 1% of all trades, produce up to 78 bps of abnormal returns over the subsequent five days, amounting to at least $38.9 million in total trading profit per year. Consistent with positive short-lived private signals, informed buy trades precede positive price jumps and high earnings announcement returns. Informed trades also involve relatively large dollar-denominated transactions that are uncorrelated across fund managers. Consistent with self financing, fund managers with tighter cash constraints execute informed trades more frequently, although informed trades are too infrequent to generate a persistent alpha.

The Long Run Earnings Effects of a Credit Market Disruption
Adamopoulou, Effrosyni,de Philippis, Marta,Sette, Enrico,Viviano, Eliana
This paper studies the long term consequences on workers' labour earnings of the credit crunch induced by the 2007-2008 financial crisis. We study the evolution of both employment and wages in a large sample of Italian workers followed for nine years after the start of the crisis. We rely on a unique matched bank-employer-employee administrative dataset to construct a firm-specific shock to credit supply, which identifies firms that, because of the collapse of the interbank market during the financial crisis, were unexpectedly aected by credit restrictions. We find that workers who were employed before the crisis in firms more exposed to the credit crunch experience persistent and sizable earnings losses, mainly due to a permanent drop in days worked. These effects are heterogeneous across workers, with high-type workers being more affected in the long run. Moreover, firms operating in areas with favorable labor market conditions react to the credit shock by hoarding high-type workers and displacing low-type ones. Under unfavorable labor market conditions instead, firms select to displace also high-type (and therefore more expensive) workers, even though wages do react to the slack. All in all, our results document persistent eects on the earnings distribution.

The Social-Psychological Perspective on Executive Compensation: Evidence From a Two-Tier Board System
Schwering, Anja,Sommer, Friedrich,Uepping, Florian,Winkelmann, Sandra
This paper investigates whether and how three social-psychological factors âˆ' reciprocity, similarity and role experience âˆ' affect CEO compensation packages with respect to the levels of total and fixed compensation and the variable proportion of the compensation package. We use evidence from Germany as it is considered a prototype of a two-tier board system. Given the primary roles of the CEO and the chairman of the supervisory board, we especially highlight social-psychological aspects of the above-mentioned relationship and emphasize the mechanisms in the process leading to the final compensation package. Using a hand-collected dataset we find that reciprocity in particular can lead to a compensation package that is more favorable for the CEO. Results on similarity are ambivalent to the extent that similarity is not a universal construct. It is rather that the effects of similarity on CEO compensation âˆ' both positive and negative âˆ' depend on the dimension of similarity. Finally, the chairman’s role experience also plays an important role in shaping CEO compensation. More specifically, role experience leads to increased variable compensation. Hence, it is worth noting that higher compensation does not seem to be granted unconditionally, although this could be concluded from theory and prior literature. When higher levels of compensation are paid, the increase often stems from an increase in the proportion of variable compensation.

The hyperbolic geometry of financial networks
Martin Keller-Ressel,Stephanie Nargang

Based on data from the European banking stress tests of 2014, 2016 and the transparency exercise of 2018 we demonstrate for the first time that the latent geometry of financial networks can be well-represented by geometry of negative curvature, i.e., by hyperbolic geometry. This allows us to connect the network structure to the popularity-vs-similarity model of Papdopoulos et al., which is based on the Poincar\'e disc model of hyperbolic geometry. We show that the latent dimensions of `popularity' and `similarity' in this model are strongly associated to systemic importance and to geographic subdivisions of the banking system. In a longitudinal analysis over the time span from 2014 to 2018 we find that the systemic importance of individual banks has remained rather stable, while the peripheral community structure exhibits more (but still moderate) variability.

Understanding the Exposure at Default Risk of Commercial Real Estate Construction and Land Development Loans
Luo, Shan,Murphy, Anthony
We study and model the determinants of exposure at default (EAD) for large U.S. construction and land development loans from 2010 to 2017. EAD is an important component of credit risk, and commercial real estate (CRE) construction loans are more risky than income producing loans. This is the first study modeling the EAD of construction loans. The underlying EAD data come from a large, confidential supervisory dataset used in the U.S. Federal Reserve’s annual Comprehensive Capital Assessment Review (CCAR) stress tests. EAD reflects the relative bargaining ability and information sets of banks and obligors. We construct OLS and Tobit regression models, as well as several other machine-learning models, of EAD conversion measures, using a four-quarter horizon. The popular LEQ and CCF conversion measure is unstable, so we focus on EADF and AUF measures. Property type, the lagged utilization rate and loan size are important drivers of EAD. Changing local and national economic conditions also matter, so EAD is sensitive to macro-economic conditions. Even though default and EAD risk are negatively correlated, a conservative assumption is that all undrawn construction commitments will be fully drawn in default.

Why the Italian Banking System that ‘Cruised Over’ the Global Financial Crisis, Found Itself Roiled by the Sovereign Debt Crisis: Reviewing and Highlighting the Key Issues
Jameaba, Muyanja-Ssenyonga
The Italian banking sector, except for some few albeit systemically important institutions, to a large extent rode the tide of the global financial crisis (2007-2008) relatively unscathed. The feat owed as much to resilient banks with adequate capital and liquidity, capacity to augment capital without BI support, that is part is attributable to the existence strong regulatory regime that covered most aspects of bank operations, including management and auditing board appointment, investment, transactions with connected parties, governance at both solo and group level, a comprehensive offsite and onsite supervisory regime, and the existence of a strong if not generous deposit insurance system, complemented by the existence and enforcement of a strong multi-stakeholder macroprudential regime that fostered financial stability. Nonetheless, as the financial crisis intensified and begun to roil not on domestic and European financial markets as contagion spread the United States, support from the Italian government through Bank Italia and Ministry of Finance and economy, coupled with the injection of capital from ECB was also an important factor in the equation that not only prevented the spread of contagion throughout the entire banking and financial system, but created the foundation on which a healthier and more sound, transparent, less leveraged, high risk asset weighted capital buffered banking system is emerging. State intervention, however, inevitably exacerbated rising sovereign indebtedness that since 2011 has become the new daunting if not intricate problem for the Italian banking system and economy. This is the more so , given the pivotal role that Italian government bonds contributed to stymying the Italian banking sector from even deeper contraction by strengthening bank balance sheets through injection of new capital, an overhang of illiquid toxic assets and managing toxic liabilities since 2008. Regulatory framework has in the aftermath of financial crisis been enhanced to plug some of the fissures the crisis exposed including protection of minority shareholders, by among other requirements things requiring enhanced governance, appointment of independent directors, giving more say on representatives of minority shareholders through for example the appointment of independent directors; strengthening BI authority to manage troubled banks by enhancing its authority to influence the appointment bank management boards, bank senior officials, and external auditors; enforcing integrity and governance and transparency of banks; minimizing and preventing fraud though transactions involving connected parties; and strengthen deposit insurance regime. However, protection for supervisors from litigation that arises and is consequence of the conduct of their duties, remains a weak point that needs strengthening. The same applies to the opportunity that remains open for bank shareholders to source funds to contribute to bank equity by borrowing which undermines efforts to bolster prudential banking principles, upholding fitness and propriety of bank investors, and reducing undue influence and intervention from vested interests, all of which are aimed at strengthening bank soundness and resilience. Other remaining obstacles that future bank stability in Italy is likely to face include, the still relatively low risk weighted bank capital, lingering NPLs, high concentration of bank ownership among a few banking groups, which also control other subsectors of the financial sector such as insurance services; limited transparency of foundations that control banking groups and sole banks through complex cross ownership schemes; the role of political intervention (requiring court decisions) on issues that should be in the remit of supervisory agencies. On that list other issues that are equally important , while by no means exhaustive one, run the gamut to range from the ex post funding approach for activities of deposit insurance agencies such as repaying compensation to third party depositors which makes the insurance system vulnerable to shortage of funds in the event of a banking crisis. That reduces the ability and capacity of deposit insurance to perform their vital function of mitigating depositor trust in the banking system during times of financial uncertainty and economic turbulence; high indebtedness of municipal and regional governments, which ironically contributed to the success of Italian banking in averting near collapse akin to a pyrrhic victory that occurred in other EU member countries such as Ireland, Greece, Iceland, Portugal, and Spain, hence a legacy of global financial crisis that in part contributes to the high net debt of the general government; sluggish total investment, anemic economic growth that is not high enough to reduce unemployment that hovers above 10 percent, and high cost of doing business. The cacophony of the above problems, will undoubtedly be compounded by the repercussions of the fallout of the COVID-19 on not exponential growth of government expenditure on health care provision, economic stimulus package to rejuvenate and prevent deeper economic contraction across the board from transportation, financial services, tourism and entertainment, manufacturing, and trade and commerce. There is little doubt that EU will have to lend a hand in some way, if the impact that COVID-19 has had on Italy (and Spain) as the worst hit EMU economies, is not to send shock waves throughout EU, thereby providing fodder for anti-EU skeptics to start where ‘Brexters’ stopped-whipping up nationalism-populism to a new dangerous level that unless handled with dexterity and extreme caution, may pose serious threat of not only undermining but most worryingly sound a death knell, to the most successful social, economic, political and cultural integration project to date- the European Union.