Research articles for the 2020-05-12

A Global Comparison of Corporate Value Adjustments to News of Cyber Attacks
Hogan, Karen M.
The growing threat of cyber breach as become one of the most feared risks corporations around the world are currently dealing with. The dynamic nature of cyber risk, along with evolving global regulations, necessitates that corporate management strategically address cyber risk to minimize effects on corporate value. This paper uses event study methodology to analyze global shareholder value effects of cyber breaches occurring between the periods 1990 to 2019. Cumulative Average Returns (CARs) are calculated by country, and in aggregate, from first notice date to periods of up to 90 days post announcement to compare short term and long term effects of cyber breaches on stock price. Similar to other smaller studies, results for this much larger data set show significant negative returns for US corporations in all sample windows. However, the changes in shareholder value are much smaller than were previously seen in other studies. Unlike its US counterparts, short term results for the five major non-US countries in this sample show no significant changes to price as a result of cyber breach announcements, even though the non-US firms also trade on US exchanges. Long term results for the aggregate non-US sample show significance only at the 0 to 30 day window. Long term results for some of the individual countries do support some various positive and negative event windows, but no common patterns are seen among countries. These results point to differences in how news of a cyber breach, by country, is perceived in the market. These results are interesting in that they also follow some of the patterns that insurance companies have seen in the reticent buying habits of global companies with respect to cyber insurance worldwide.

A Repo Model of Fire Sales with VWAP and LOB Pricing Mechanisms
Maxim Bichuch,Zachary Feinstein

We consider a network of banks that optimally choose a strategy of asset liquidations and borrowing in order to cover short term obligations. The borrowing is done in the form of collateralized repurchase agreements, the haircut level of which depends on the total liquidations of all the banks. Similarly the fire-sale price of the asset obtained by each of the banks depends on the amount of assets liquidated by the bank itself and by other banks. By nature of this setup, banks' behavior is considered as a Nash equilibrium. This paper provides two forms for market clearing to occur: through a common closing price and through an application of the limit order book. The main results of this work are providing sufficient conditions for existence and uniqueness of the clearing solutions (i.e., liquidations, borrowing, fire sale prices, and haircut levels).

Attributes and Implications of Mutual Fund Revenue Sharing and 'Defensive' 12b-1 Fees
Haslem, John A.
Revenue sharing rewards brokers for high and higher sales and/or asset holdings of fund shares, and further defrays current and higher broker costs of advertising and promotion, ongoing broker servicing of fund investor accounts, and educational support. It results in higher broker sales and increases fund assets under management (higher inflows) and profits; higher broker sales of fund shares increases sales concessions and distribution fees. Higher assets under management in turn increase trade size and broker commissions, trade execution, and profits. Revenue sharing usually brings direct payments from fund advisor “profits,” but may be bundled in fund management fees paid to advisors who write the checks. The use of management fees to pay revenue sharing increases fund fee size and fund outflows. Brokers rebate “fall-out benefits” from “excess” revenue sharing payments directly to fund advisors, which motivates higher revenue sharing payments and higher broker profits. Revenue sharing payments via management fees reduce current fund NAVs and shareholder returns. Most retail investors are unaware of the existence, nature, and costs of revenue sharing payments. Revenue sharing is agency conflicted with shareholder interests and returns.

Beta and Coskewness Pricing: Perspective from Probability Weighting
Shi, Yun,Cui, Xiangyu,Zhou, Xun Yu
The security market line is often flat or downward-sloping. We hypothesize that probability weighting plays a role and that one ought to differentiate between periods in which agents overweight extreme events and those in which they underweight them. Overweighting inflates the probability of extremely bad events and demands greater compensation for beta risk. Underweighting has the opposite effect. Overall, these two effects offset each other, resulting in a flat or slightly negative return--beta relationship. Similarly, overweighting the tails enhances the negative relationship between return and coskewness, whereas underweighting reduces it. We support our theory through an extensive empirical study.

CEO Turnover Announcements and Information Frictions
John, Kose ,Liu, Y. Christine,Tian, Xu,Zhang, Haofei
This paper analyzes the market reaction to CEO turnover announcements in the presence of information frictions. We find that the market reaction to forced CEO turnover announcements is negatively related to the level of asymmetric information between a firm and its investors. No such relation exists for voluntary turnovers. We also find that in cases where information frictions are high, companies attempt to present forced turnover as voluntary and this behavior leads to a less negative market response. Overall, our results suggest that firms act strategically when disclosing information about CEO turnover to avoid a negative market reaction.

Causal Estimation of Stay-at-Home Orders on SARS-CoV-2 Transmission
M. Keith Chen,Yilin Zhuo,Malena de la Fuente,Ryne Rohla,Elisa F. Long

Accurately estimating the effectiveness of stay-at-home orders (SHOs) on reducing social contact and disease spread is crucial for mitigating pandemics. Leveraging individual-level location data for 10 million smartphones, we observe that by April 30th---when nine in ten Americans were under a SHO---daily movement had fallen 70% from pre-COVID levels. One-quarter of this decline is causally attributable to SHOs, with wide demographic differences in compliance, most notably by political affiliation. Likely Trump voters reduce movement by 9% following a local SHO, compared to a 21% reduction among their Clinton-voting neighbors, who face similar exposure risks and identical government orders. Linking social distancing behavior with an epidemic model, we estimate that reductions in movement have causally reduced SARS-CoV-2 transmission rates by 49%.

Credit Derivatives and Corporate Default Prediction
Ye, Xiaoxia,Yu, Fan,Zhao, Ran
There have been 91 defaults among U.S. CDS reference entities between 2002 and 2018. Within this sample, the five-year CDS spread significantly enhances the explanatory power of benchmark corporate default prediction models with equity market covariates and firm attributes, both in- and out-of-sample. This finding holds among financial and non-financial firms, and both within and without the great financial crisis. Moreover, the predictive power of the CDS spread is concentrated among entities with higher CDS market liquidity, while the illiquidity component of the CDS spread itself does not explain default. Lastly, neither the corporate bond yield spread nor CDS market indices explain default in the presence of firm-level CDS spreads. These results confirm the relevance of information contained in credit risk pricing to default prediction.

Customer's Perception of Data Theft at Canadian Banks
Kouame, Amoin,Tandja M., Djerry C.,Kammoun, Manel
This paper investigates how customers perceive the multiple data theft scandals occurring in Canadian Banks. To this end, we conducted a survey on 120 students from the University of Quebec at Outaouais. Two major points emerged from this survey: first, bank customers believe that their information is not sufficiently protected by the banks; second, customers want more protection from the bank through deposit insurance and from the government through new laws that would require banks to pay full damages to customers in the case of data theft.

Cyclical Systemic Risk and Downside Risks to Bank Profitability
Lang, Jan Hannes,Forletta, Marco
This paper studies the impact of cyclical systemic risk on future bank profitability for a large representative panel of EU banks between 2005 and 2017. Using linear local projections we show that high current levels of cyclical systemic risk predict large drops in the average bank-level return on assets (ROA) with a lead time of 3-5 years. Based on quantile local projections we further show that the negative impact of cyclical systemic risk on the left tail of the future bank-level ROA distribution is an order of magnitude larger than on the median. Given the tight link between negative profits and reductions in bank capital, our method can be used to quantify the level of “Bank capital-at-risk” for a given banking system, akin to the concept of “Growth-at-risk”. We illustrate how the method can inform the calibration of countercyclical macroprudential policy instruments.

Decomposing Tracking Error to Identify Mutual Fund Strategies
Buffa, Andrea M.,Javadekar, Apoorva
Decomposing mutual funds’ tracking error into its idiosyncratic and systematic components is informative about funds’ intention to implement picking and timing strategies. Accordingly, we define the fraction of a fund’s active return variance that is idiosyncratic as the fund’s degree of picking (dop), and document that pickers (high-dop funds) exhibit higher performance than timers (low-dop funds). We rule out that this outperformance is driven by different decreasing returns to scale across strategies, different levels of fund activeness, idiosyncratic risk, and fund styles. We also provide new evidence on the dynamics of fund strategies over business cycles and the fund life-cycle.

Determinants of Bank Performance: ROE, ROA Profitability Measures Amongst Islamic and Conventional Banks in the GCC
Farah, Anas
We look at the profitability measures of the conventional and Islamic banking sectors in 5 GCC countries. We focus on the bank specific profitability determinants using panel regression models. In contrast to some of the results in the literature, we find no significant differences between the two sectors and hypothesis a possible local investor bias between the two sector potentially explaining the market differences.

Effects of Credit Restrictions in the Netherlands and Lessons for Macroprudential Policy
Galati, Gabriele,Kakes, Jan,Moessner, Richhild
Credit restrictions were used as a monetary policy instrument in the Netherlands from the 1960s to the early 1990s. We study the effects of credit restrictions being active on the balance sheet structure of banks and other financial institutions. We find that banks mainly responded to credit restrictions by making adjustments to the liability side of their balance sheets, particularly by increasing the proportion of long-term funding. Responses on the asset side were limited, while part of the banking sector even increased lending after the installment of a restriction. These results suggest that banks and financial institutions responded by switching to long-term funding to meet the restriction and shield their lending business. Arguably, the credit restrictions were therefore still effective in reaching their main goal, i.e. containing money growth.

Eurobonds (or Coronabonds) Would Not Be Costly for Northern Euro Area Countries
Weber, Matthias
Well-designed eurobonds would lower financing costs for many euro area countries while hardly or not increasing the costs for the others. These bonds should have an explicit guarantee from the ECB. These bonds could be used up to a limit of GDP (a low number of 10-25% of GDP would allow to observe market reactions before deciding whether to expand). Such bonds would increase the costs on regular German 10-year bonds by at most 10 to 30 basis points.

Extensions of Dupire Formula: Stochastic Interest Rates and Stochastic Local Volatility
Orcan Ogetbil

We derive generalizations of Dupire formula to the cases of general stochastic drift and/or stochastic local volatility. First, we handle a case in which the drift is given as difference of two stochastic short rates. Such a setting is natural in foreign exchange context where the short rates correspond to the short rates of the two currencies, equity single-currency context with stochastic dividend yield, or commodity context with stochastic convenience yield. We present the formula both in a call surface formulation as well as total implied variance formulation where the latter avoids calendar spread arbitrage by construction. We provide derivations for the case where both short rates are given as single factor processes and present the limits for a single stochastic rate or all deterministic short rates. The limits agree with published results. Then we derive a formulation that allows a more general stochastic drift and diffusion including one or more stochastic local volatility terms. In the general setting, our derivation allows the computation and calibration of the leverage function for stochastic local volatility models.

Financially Constrained Firms and Voluntary Non-Financial Disclosure: A Study of Initiation of Corporate Social Responsibility Reporting
Polack, Lisa-Ann
We examine effects of initiation of corporate social responsibility reporting (CSRR) concurrent with experiencing a negative event. In primary analyses, we examine whether these firms experience an increase in investor interest and a reduction in cost of capital, postdisclosure. In general, we find little evidence that these firms experience capital market benefits from CSRR initiation. However, these primary tests ignore the relative CSR performance scores of our sample firms. In additional analyses, we find a positive association between CSR performance scores and firm profitability. We also find a positive association between changes in CSR performance scores and institutional investor interest. Finally, we examine the effects of earnings announcements in relation to the timing of initial CSR disclosures on shareholder value and find that shareholders earn greater abnormal returns when CSR disclosures are released after or concurrent with earnings announcements.

How Do Households Respond to Job Loss? Lessons from Multiple High-Frequency Data Sets
Andersen, Asger Lau,Jensen, Amalie Sofie,Johannesen, Niels,Kreiner, Claus Thustrup,Leth‐Petersen, Søren,Sheridan, Adam
How do households respond to job loss, and which self-insurance channels are most important? By linking customer data from the largest bank in Denmark with information from government administrative registers, we quantify a broad range of responses to job loss in a unified empirical framework. Two response margins stand out: during the first 24 months after job loss, households reduce spending by 30% of the income loss while reduced saving in liquid assets accounts for 50%. Other response margins highlighted in the literature - spousal labor supply, private transfers, home equity extraction, mortgage refinancing, and consumer credit - are less important.

IPO Pricing: The Study of Efficient Pricing Mechanism, With Specific Reference to IPOs in India
Agrawal, Dr. Deepak,Phatak, Yogeshwari
The decision to go public through an Initial Public Offering (IPO) is one of the most critical decisions in the life cycle of a firm. Due to its presumed importance, it has become one of the most researched topics in the finance literature of the world, but very little work has been found done in our country. IPO goes under two type of pricing structure that is underpricing and overpricing. They both are simple market misvaluation between the offer price and first day listing price. When list price exceeds offer price tends to arise underpricing and when offer price exceeds list price overpricing exists. This current paper attempts to analyze the Indian IPO issue and their pricing mechanism. The study period was from 1st April’ 2000- 31st March’ 2009 and considered 379 IPOs. The average first day returns accounted to be 21.76% and the study reported the existence of underpricing in short period.

Initial Coin Offerings: What Rights Do Investors Have (If Any)?
Zhao, Xiaoju,Hou, Wenxuan,An, Jiafu,Liu, Xianda,Zhang, Yun
This introduction reviews the growing literature on initial coin offerings (ICOs), summaries the articles included this special issue and also provides original evidence of the investor protection on ICOs from 37 countries. We show that the anti-director rights and anti-self-dealing index are positively associated with the country-level raised fund of ICOs after controlling for economic and culture factors. The disclosure quality and investor rights as specified in the Whitepapers are generally poor and they are found to be important to raise more funds in ICOs. We argue that the lack of (self-) discipline poses a threat to investor protections. Around 60% Whitepaper do not disclose information on the use of proceeds or management team. Around 80% ICOs do not entitle investors the rights for dividend or vote. Our findings suggest the needs of regulating ICOs to protect investors.

National Culture and (Dis)trust in Banks: Cross-Country Evidence
Ahunov, Muzaffar Olimjonovich,Van Hove, Leo
We examine to what extent a specific aspect of national culture â€" uncertainty avoidance â€" can explain cross‐country variations in (dis)trust in banks. Relying on data from the World Values Survey, we find that trust in banks is lower in countries that score high for Hofstede's uncertainty avoidance index. Similarly, with Global Findex data, we find that financial exclusion due to a lack of trust in banks is high in high uncertainty avoidance cultures. These results highlight the need for a more culturally aware approach when designing consumer protection measures for the banking sector.

Non-parametric Estimation of Quadratic Hawkes Processes for Order Book Events
Antoine Fosset,Jean-Philippe Bouchaud,Michael Benzaquen

We propose an actionable calibration procedure for general Quadratic Hawkes models of order book events (market orders, limit orders, cancellations). One of the main features of such models is to encode not only the influence of past events on future events but also, crucially, the influence of past price changes on such events. We show that the empirically calibrated quadratic kernel is well described by a diagonal contribution (that captures past realised volatility), plus a rank-one "Zumbach" contribution (that captures the effect of past trends). We find that the Zumbach kernel is a power-law of time, as are all other feedback kernels. As in many previous studies, the rate of truly exogenous events is found to be a small fraction of the total event rate. These two features suggest that the system is close to a critical point -- in the sense that stronger feedback kernels would lead to instabilities.

Numerical Study of the Merton PIDE in Option Pricing
Cantarutti, Nicola
I present a complete numerical study of the implicit-explicit finite difference method used to solve partial integro-differential equations (PIDEs) arising in mathematical finance. The study considers the specific case of the Merton jump-diffusion model, which is used to compute prices of European call and put options. These PIDE prices are then compared with prices obtained by closed formula, Fourier inversion, and Monte Carlo methods.

On Intermediate Marginals in Martingale Optimal Transportation
Sester, Julian
We study the influence of information about call option prices on model-independent price bounds for exotic derivatives obtained through martingale transport. The considered call option prices and their associated marginal distributions do not correspond to some future maturity on which the payoff of the exotic derivative depends. In this case, we characterize marginals that indicate improved price bounds as well as those that exclude any improvement. Eventually we show in numerous examples that the consideration of additional price information on vanilla options may have a considerable impact on the resultant model-independent price bounds.

Optimal Annuity Demand for General Expected Utility Agents
Bernard, Carole,De Gennaro Aquino, Luca,Levante, Lucia
We study the robustness of the results of Milevsky and Huang (2018) on the optimal demand for annuities to the choice of the utility function. To do so, we first propose a new way to span the set of all increasing concave utility functions by exploiting a one-to-one correspondence with the set of probability distribution functions. For example, this approach makes it possible to present a five-parameter family of concave utility functions that encompasses a number of standard concave utility functions, e.g., CRRA, CARA and HARA. Second, we develop a novel numerical method to handle the life-cycle model of Yaari (1965) and the annuity equivalent wealth problem for a general utility function. We show that the results of Milevsky and Huang (2018) on the optimal demand for annuities proved in the case of a CRRA and logarithmic utility maximizer hold more generally.

Optimal hydrogen supply chains: co-benefits for integrating renewable energy sources
Fabian Stöckl,Wolf-Peter Schill,Alexander Zerrahn

Green hydrogen can decarbonize transportation, but also help to integrate variable renewable energy sources if its production is sufficiently flexible in time. Using an open-source co-optimization model of the power sector and four supply chains for hydrogen at filling stations, we find a trade-off between energy efficiency and temporal flexibility: for lower shares of renewables and hydrogen, more energy-efficient decentralized electrolysis is optimal. For higher shares of renewables and/or hydrogen, more flexible centralized hydrogen supply chains gain importance as they allow disentangling hydrogen production from demand via storage. Liquid hydrogen emerges as particularly beneficial, followed by liquid organic hydrogen carriers and gaseous hydrogen. Centralized hydrogen supply chains can deliver substantial power sector co-benefits, mainly through reduced renewable surplus generation. Energy modelers and system planners should consider the flexibility characteristics of hydrogen supply chains in more detail when assessing the role of green hydrogen in future energy transition scenarios.

Rational Finance Approach to Behavioral Option Pricing
Jiexin Dai,Abootaleb Shirvani,Frank J. Fabozzi

When pricing options, there may be different views on the instantaneous mean return of the underlying price process. According to Black (1972), where there exist heterogeneous views on the instantaneous mean return, this will result in arbitrage opportunities. Behavioral finance proponents argue that such heterogenous views are likely to occur and this will not impact option pricing models proposed by rational dynamic asset pricing theory and will not give rise to volatility smiles. To rectify this, a leading advocate of behavioral finance has proposed a behavioral option pricing model. As there may be unexplored links between the behavioral and rational approaches to option pricing, in this paper we revisit Shefrin (2008) option pricing model as an example and suggest one approach to modify this behavioral finance option pricing formula to be consistent with rational dynamic asset pricing theory by introducing arbitrage transaction costs which offset the gains from arbitrage trades.

Semi-closed form prices of barrier options in the time-dependent CEV and CIR models
Peter Carr,Andrey Itkin,Dmitry Muravey

We continue a series of papers where prices of the barrier options written on the underlying, which dynamics follows some one factor stochastic model with time-dependent coefficients and the barrier, are obtained in semi-closed form, see (Carr and Itkin, 2020, Itkin and Muravey, 2020). This paper extends this methodology to the CIR model for zero-coupon bonds, and to the CEV model for stocks which are used as the corresponding underlying for the barrier options. We describe two approaches. One is generalization of the method of heat potentials for the heat equation to the Bessel process, so we call it the method of Bessel potentials. We also propose a general scheme how to construct the potential method for any linear differential operator with time-independent coefficients. The second one is the method of generalized integral transform, which is also extended to the Bessel process. In all cases, a semi-closed solution means that first, we need to solve numerically a linear Volterra equation of the second kind, and then the option price is represented as a one-dimensional integral. We demonstrate that computationally our method is more efficient than both the backward and forward finite difference methods while providing better accuracy and stability. Also, it is shown that both method don't duplicate but rather compliment each other, as one provides very accurate results at small maturities, and the other one - at high maturities.

Socio-Economic Impacts of COVID-19 on Household Consumption and Poverty
Amory Martin,Maryia Markhvida,Stéphane Hallegatte,Brian Walsh

The COVID-19 pandemic has caused a massive economic shock across the world due to business interruptions and shutdowns from social-distancing measures. To evaluate the socio-economic impact of COVID-19 on individuals, a micro-economic model is developed to estimate the direct impact of distancing on household income, savings, consumption, and poverty. The model assumes two periods: a crisis period during which some individuals experience a drop in income and can use their precautionary savings to maintain consumption; and a recovery period, when households save to replenish their depleted savings to pre-crisis level. The San Francisco Bay Area is used as a case study, and the impacts of a lockdown are quantified, accounting for the effects of unemployment insurance (UI) and the CARES Act federal stimulus. Assuming a shelter-in-place period of three months, the poverty rate would temporarily increase from 17.1% to 25.9% in the Bay Area in the absence of social protection, and the lowest income earners would suffer the most in relative terms. If fully implemented, the combination of UI and CARES could keep the increase in poverty close to zero, and reduce the average recovery time, for individuals who suffer an income loss, from 11.8 to 6.7 months. However, the severity of the economic impact is spatially heterogeneous, and certain communities are more affected than the average and could take more than a year to recover. Overall, this model is a first step in quantifying the household-level impacts of COVID-19 at a regional scale. This study can be extended to explore the impact of indirect macroeconomic effects, the role of uncertainty in households' decision-making and the potential effect of simultaneous exogenous shocks (e.g., natural disasters).

Some pricing tools for the Variance Gamma model
Jean-Philippe Aguilar

We establish several closed pricing formula for various path-independent payoffs, under an exponential L\'evy model driven by the Variance Gamma process. These formulas take the form of quickly convergent series and are obtained via tools from Mellin transform theory as well as from multidimensional complex analysis. Particular focus is made on the symmetric process, but extension to the asymmetric process is also provided. Speed of convergence and comparison with numerical methods (Fourier transform, quadrature approximations, Monte Carlo simulations) are also discussed; notable feature is the accelerated convergence of the series for short term options, which constitutes an interesting improvement of numerical Fourier inversion techniques.

Staggered Release Policies for COVID-19 Control: Costs and Benefits of Sequentially Relaxing Restrictions by Age
Henry Zhao,Zhilan Feng,Carlos Castillo-Chavez,Simon A. Levin

Strong social distancing restrictions have been crucial to controlling the COVID-19 outbreak thus far, and the next question is when and how to relax these restrictions. A sequential timing of relaxing restrictions across groups is explored in order to identify policies that simultaneously reduce health risks and economic stagnation relative to current policies. The goal will be to mitigate health risks, particularly among the most fragile sub-populations, while also managing the deleterious effect of restrictions on economic activity. The results of this paper show that a properly constructed sequential release of age-defined subgroups from strict social distancing protocols can lead to lower overall fatality rates than the simultaneous release of all individuals after a lockdown. The optimal release policy, in terms of minimizing overall death rate, must be sequential in nature, and it is important to properly time each step of the staggered release. This model allows for testing of various timing choices for staggered release policies, which can provide insights that may be helpful in the design, testing, and planning of disease management policies for the ongoing COVID-19 pandemic and future outbreaks.

Sustainable Finance and Stewardship: Unlocking Stewardship's Sustainability Potential
Katelouzou, Dionysia,Klettner, Alice Louise
This paper explores the role of investor stewardship against a background of broader efforts to improve the sustainability of financial markets. Stewardship codes, encouraging institutional investors to act as long-term, responsible shareholders, comprise an emerging aspect of contemporary corporate governance frameworks with important implications for sustainable finance. They have the potential to promote the incorporation of environmental, social and governance (ESG) factors into both financial and business decision-making. This paper examines the way in which 25 stewardship codes from across the world approach ESG integration and explores the possibilities for enhancing their impact on sustainability. It concludes that stewardship codes form an influential part of the overall network of regulatory instruments supporting sustainable finance. They help to secure transparency, accountability and a progressive interpretation of long-standing fiduciary duties that better balances the interests of all stakeholders.

The Effect of Political Risk on Shareholder Value and the Mitigating Role of Corporate Social Responsibility (CSR)
Chatjuthamard, Pattanaporn,Jiraporn, Pornsit,Singh, ,Sarajoti, Pattarake
We investigate the effect of political risk on shareholder value, using an event study and a novel measure of firm-level political risk recently developed by Hassan et al. (2019). We exploit the guilty plea of Jack Abramoff, a well-known lobbyist, on January 3, 2006, as an exogenous shock that made lobbying less effective and less useful in the future, depriving firms of an important tool to reduce political exposure. Our results show that the market reactions are significantly more negative for firms with more political exposure. Additional analysis corroborates the results, including propensity score matching, instrumental-variable analysis, and Oster’s (2019) method for testing coefficient stability. Finally, we find that the adverse effect of political risk on shareholder value is substantially mitigated for firms with strong social responsibility, consistent with the risk mitigation hypothesis.

The Importance of Staying Positive: The Impact of Emotions on Attitude to Risk
Brooks, Chris,Sangiorgi, Ivan,Saraeva, Anastasiya,Hillenbrand, Carola,Money, Kevin
In this paper we examine the impact of emotions towards financial investments and emotions towards life in general on attitudes to financial risk using questionnaire data from 970 UK-based retail investors. We show that risk tolerance monotonically increases with positive emotions towards investments and life, and decreases with negative emotions. We incorporate a broader range of relevant emotions than in comparable existing studies and we show, perhaps surprisingly, that positive emotions have a stronger impact on risk tolerance than negative emotions. We find that emotions towards investments have a considerably greater explanatory power for the cross-section of risk aversion than gender, age, income, investment experience and investment knowledge. Our research sheds light on the different impacts that integral and incidental emotions have on retail investor financial decision-making. We suggest several implications for regulators and financial advisors, and we emphasise the importance for financial educators to support investors in developing emotional resilience.

The Macroprudential Role of Stock Markets
Chousakos, Kyriakos,Gorton, Gary B.,Ordoñez, Guillermo
A financial crisis is an event of sudden information acquisition about the collateral backing short-term debt in credit markets. When investors see a financial crisis coming, however, they react by more intensively acquiring information about firms in stock markets, revealing those that are weaker, which as a consequence end up cut off from credit. This cleansing effect of stock markets’ information on credit markets’ composition discourage information acquisition about the collateral of the firms remaining in credit markets, slowing down credit growth and potentially preventing a crisis. Production of information in stock markets, then, acts as a macro-prudential tool in the economy.

The Mystery of Operating Leverage
Dudycz, Tadeusz
Operating leverage is one of the more popular parameters used in management practice and scientific research. However, its definition and measurement method are not coherent and are presented imprecisely in both textbooks and scientific publications. This results in a great deal of freedom among authors in the selection of measures for estimating operating leverage and the interpretation of the results, which has a negative impact on functionality for synthesis and theory building. Although some authors made such reservations clear as early as the 1980s, the situation has not changed. The article critically analyses the operational leverage measures used in recent publications and proposes to organize and refine the concept of operational leverage as leverage to increase value added and profit at a given output level using a trade-off mechanism between variable and fixed costs. The measure of this leverage is the share of fixed costs in total costs measured at the break-even point.

The Pollution Premium
Hsu, Po-Hsuan,Li, Kai,Tsou, Chi-Yang
This paper studies the asset pricing implications of industrial pollution. A long-short portfolio constructed from firms with high versus low toxic emission intensity within industry generates an average return of 4.42% per annum, which remains significant after controlling for risk factors. We examine several possible explanations for this pollution premium, which include policy uncertainty with respect to environmental regulations, relatedness to existing systematic risks, investors' preference for social responsibility, market sentiment, political connection, and corporate governance. Our empirical evidence suggests that the pollution premium is attributable to environmental policy uncertainty, which constitutes a systematic risk in a general equilibrium model.

The Stock-Bond Correlation
Czasonis, Megan,Kritzman, Mark,Turkington, David
Investors rely on the stock-bond correlation for a variety of tasks, such as forming optimal portfolios, designing hedging strategies, and assessing risk. Most investors estimate the stock-bond correlation simply by extrapolating the historical correlation of monthly returns and assume that this correlation best characterizes the correlation of future, annual or multi-year returns, but this approach is decidedly unreliable. The authors introduce four innovations for generating a reliable prediction of the stock-bond correlation. First, they show how to represent the correlation of single period cumulative stock and bond returns in a way that captures how the returns drift during the period. Second, they identify fundamental predictors of the stock-bond correlation. Third, they model the stock-bond correlation as a function of the path of some fundamental predictors rather than single observations. And fourth, they censor their sample to include only relevant observations, in which relevance has a precise mathematical definition.

The Urgency to Borrow in the Interbank Market
Brunetti, Celso,Harris, Jeffrey H.,Mankad, Shawn
We study the motivations of traders in the interbank market around the 2007-09 subprime crisis. We develop a new methodology that measures the funding liquidity needs of banks and reveals the underlying urgency to trading. We find that the dispersion of beliefs and urgency to borrow lead sovereign CDS spreads and react to non-standard central bank interventions introduced during the crisis. Our results map the linkages between the interbank market and sovereigns and shed light on the channels that give rise to the sovereign-bank nexus.

The fundamental theorem of asset pricing for self-financing portfolios
Eckhard Platen,Stefan Tappe

Consider a financial market with nonnegative semimartingales which does not need to have a num\'{e}raire. We are interested in the absence of arbitrage in the sense that no self-financing portfolio gives rise to arbitrage opportunities, where we are allowed to add a savings account to the market. We will prove that in this sense the market is free of arbitrage if and only if there exists an equivalent local martingale deflator which is a multiplicative special semimartingale. In this case, the additional savings account relates to the finite variation part of the multiplicative decomposition of the deflator. By focusing on self-financing portfolios, this result clarifies links between previous results in the literature and makes the respective concepts more realistic.

The socio-economic determinants of the coronavirus disease (COVID-19) pandemic
Viktor Stojkoski,Zoran Utkovski,Petar Jolakoski,Dragan Tevdovski,Ljupco Kocarev

The magnitude of the coronavirus disease (COVID-19) pandemic has an enormous impact on the social life and the economic activities in almost every country in the world. Besides the biological and epidemiological factors, a multitude of social and economic criteria also govern the extent of the coronavirus disease spread in the population. Consequently, there is an active debate regarding the critical socio-economic determinants that contribute to the resulting pandemic. In this paper, we contribute towards the resolution of the debate by leveraging Bayesian model averaging techniques and country level data to investigate the potential of 29 determinants, describing a diverse set of socio-economic characteristics, in explaining the coronavirus pandemic outcome. We show that the true empirical model behind the coronavirus outcome is constituted only of few determinants, but the extent to which each determinant is able to provide a credible explanation varies between countries due to their heterogeneous socio-economic characteristics. To understand the relationship between the potential determinants in the specification of the true model, we develop the coronavirus determinants Jointness space. In this space, two determinants are connected with each other if they are able to jointly explain the coronavirus outcome. As constructed, the obtained map acts as a bridge between theoretical investigations and empirical observations, and offers an alternate view for the joint importance of the socio-economic determinants when used for developing policies aimed at preventing future epidemic crises.

US Partisan Conflict and Cryptocurrency Market
Yen, Kuang-Chieh,Cheng, Hui-Pei
This paper investigates whether partisan conflict can predict the cryptocurrency return and volatility. First, we find that the change rate of the partisan conflict can predict positively (negatively) the cryptocurrency return (volatility), Bitcoin in particular. Moreover, the findings still hold when controlling the effect of Chinese economic policy uncertainty (EPU), which is considered a significant predictor for the return and volatility of the Bitcoin. Overall, our results provide evidence to support that the Bitcoin could be a hedged asset against the risk from the U.S. partisan conflict.

Value-at-Risk substitute for non-ruin capital is fallacious and redundant
Vsevolod Malinovskii

This seemed impossible to use a theoretically adequate but too sophisticated risk measure called non-ruin capital, whence its widespread (including regulatory documents) replacement with an inadequate, but simple risk measure called Value-at-Risk. Conflicting with the idea by Albert Einstein that "everything should be made as simple as possible, but not simpler", this led to fallacious, and even deceitful (but generally accepted) standards and recommendations. Arguing from the standpoint of mathematical theory of risk, we aim to break this impasse.