Research articles for the 2020-05-13

A hybrid approach for risk assessment of loan guarantee network
Zhibin Niu,Dawei Cheng

Groups of Small and Medium Enterprises (SME) back each other and form guarantee network to obtain loan from banks. The risk over the networked enterprises may cause significant contagious damage. To dissolve such risks, we propose a hybrid feature representation, which is feeded into a gradient boosting model for credit risk assessment of guarantee network. Empirical study is performed on a ten-year guarantee loan record from commercial banks. We find that often hundreds or thousands of enterprises back each other and constitute a sparse complex network. We study the risk of various structures of loan guarantee network, and observe the high correlation between defaults with centrality, and with the communities of the network. In particular, our quantitative risk evaluation model shows promising prediction performance on real-world data, which can be useful to both regulators and stakeholders.

Adapted Wasserstein Distances and Stability in Mathematical Finance
Julio Backhoff-Veraguas,Daniel Bartl,Mathias Beiglböck,Manu Eder

Assume that an agent models a financial asset through a measure Q with the goal to price / hedge some derivative or optimize some expected utility. Even if the model Q is chosen in the most skilful and sophisticated way, she is left with the possibility that Q does not provide an "exact" description of reality. This leads us to the following question: will the hedge still be somewhat meaningful for models in the proximity of Q?

If we measure proximity with the usual Wasserstein distance (say), the answer is NO. Models which are similar w.r.t. Wasserstein distance may provide dramatically different information on which to base a hedging strategy.

Remarkably, this can be overcome by considering a suitable "adapted" version of the Wasserstein distance which takes the temporal structure of pricing models into account. This adapted Wasserstein distance is most closely related to the nested distance as pioneered by Pflug and Pichler \cite{Pf09,PfPi12,PfPi14}. It allows us to establish Lipschitz properties of hedging strategies for semimartingale models in discrete and continuous time. Notably, these abstract results are sharp already for Brownian motion and European call options.

Asset Prices and Pandemics
Detemple, Jerome
We examine the impact of pandemics propagation mechanisms on equilibrium prices, volatilities, risk premia, interest rate, wages and stock prices in an integrated epidemic-economy model with production. Two types of technologies are examined: a neo-classical technology and one capturing the notion of time-to-produce. Results show the interest rate displays cyclical behavior, wages tend to increase and stock prices can also cycle during an outbreak. The impact of a shelter-in-place policy with and without layoffs is examined. Equilibrium displays cycles under the welfare maximizing shelter-in-place policy.

Asymmetric Information, Reputation, and Welfare in Online Credit Markets
Xin, Yi
This paper studies the welfare impact of reputation/feedback systems in markets where both adverse selection and moral hazard are present. Using a transaction-level dataset from an online credit market, I estimate a dynamic model of borrowers and lenders, in which borrowers are subject to reputational incentives. I quantify the welfare loss from adverse selection and moral hazard separately and find that 78 percent of overall inefficiency is induced by moral hazard. When the reputation system is implemented, I find that 95 percent of total welfare loss from asymmetric information is eliminated. I also consider a policy intervention that protects borrowers from accidental loss of reputation. My results suggest that introducing a payment protection insurance into the market further improves total welfare.

Global Financial Crisis: Mere Dry Run for COVID-19?
Martín‐Oliver, Alfredo,Silaghi, Florina
This paper compares the stock and credit default swap market reactions to the COVID-10 announcement with the reaction to the Lehman bankruptcy, investigating the effects of both negative news and policy measures announcements by industry. We find that the CDS market reaction is not statistically different in the two outbreaks, implying a similar increase in average credit risk across firms. In stock markets, however, although the initial response is significantly larger for COVID, it is mitigated during the days after the shock, possibly because prices reflect a search for investment opportunities rather than credit risk.

How National Economies Will Recover after the Fall of Quarantine for COVID-19? (How the National Economy Works? Which Sectors Does Germany Support in Order to Achieve Prosperity after World War II?)
Banov, Bancho
Many economist wonder how and when national economies will recover after the fall of quarantine for COVID-19. Based on the article we can say that different types of economies (The types are described below in the article) will recover differently. The fastest will recover small, predominantly service-based (but small services) economies which have agricultural sector as well. On the other hand â€" big economies, which are heavily industrialised, will recover more slowly.

Implications of Stochastic Transmission Rates for Managing COVID-19 Risks
Hong, Harrison G.,Wang, Neng,Yang, Jinqiang
We analyze an epidemic model of COVID-19 that highlights transmission-rate shocks due to unpredictable environmental factors. Pooling January-February case data, we estimate a single model for 16 high-risk countries. The reproduction number is 3.05 [90% CI of 1.12-6.52]. While our model produces sensible forecasts, our primary purpose is to tractably incorporate it into an asset pricing framework. As a result, we can relate firm-valuation damages from COVID-19 to epidemic data. Reproduction number is not a sufficient statistic for damages. Transmission volatility drives transition dynamics of infections and financial risks. Deterministic model forecasts differ from our model's conditional forecasts. Behavioral changes leading to reproduction numbers around 1.5 generate benefits comparable to a possible vaccine.

Implied volatility smile dynamics in the presence of jumps
Martin Magris,Perttu Barholm,Juho Kanniainen

The main purpose of this work is to examine the behavior of the implied volatility smiles around jumps, contributing to the literature with a high-frequency analysis of the smile dynamics based on intra-day option data. From our high-frequency SPX S\&P500 index option dataset, we utilize the first three principal components to characterize the implied volatility smile and analyze its dynamics by the distribution of the scores' means and variances and other statistics for the first hour of the day, in scenarios where jumps are detected and not. Our analyses clearly suggest that changes in the volatility smiles have abnormal properties around jumps compared with the absence of jumps, regardless of maturity and type of the option.

Inequality, a scourge of the XXI century
José Roberto Iglesias,Ben-Hur Francisco Cardoso,Sebastián Gonçalves

Social and economic inequality is a plague of the XXI Century. It is continuously widening, as the wealth of a relatively small group increases and, therefore, the rest of the world shares a shrinking fraction of resources. This situation has been predicted and denounced by economists and econophysicists. The latter ones have widely used models of market dynamics which consider that wealth distribution is the result of wealth exchanges among economic agents. A simple analogy relates the wealth in a society with the kinetic energy of the molecules in a gas, and the trade between agents to the energy exchange between the molecules during collisions. However, while in physical systems, thanks to the equipartition of energy, the gas eventually arrives at an equilibrium state, in many exchange models the economic system never equilibrates. Instead, it moves toward a "condensed" state, where one or a few agents concentrate all the wealth of the society and the rest of agents shares zero or a very small fraction of the total wealth. Here we discuss two ways of avoiding the "condensed" state. On one hand, we consider a regulatory policy that favors the poorest agent in the exchanges, thus increasing the probability that the wealth goes from the richest to the poorest agent. On the other hand, we study a tax system and its effects on wealth distribution. We compare the redistribution processes and conclude that complete control of the inequalities can be attained with simple regulations or interventions.

Inference on Achieved Signal Noise Ratio
Steven E. Pav

We describe a procedure to perform approximate inference on the achieved signal-noise ratio of the Markowitz Portfolio under Gaussian i.i.d. returns. The procedure relies on a statistic similar to the Sharpe Ratio Information Criterion. Testing indicates the procedure is somewhat conservative, but otherwise works well for reasonable values of sample and asset universe sizes.

Information Spillover through Private Lender Reports
de Jong, Abe,Kooijmans, Tim,Veld, Chris
This paper examines private information spillover from the lending market to markets for public securities. We find that information from private monthly reports to institutional lenders gradually spills over to the public equity market. We observe positive abnormal stock returns after firms provide favorable private reports. After unfavorable private reports, we find negative abnormal returns, as well as increased short interest. This private information leakage is striking and previously undocumented. We demonstrate how traders benefit from private information, as we show that they do not trade immediately upon receiving the private information. Instead, they time their trades to manage both the price impact and the risk of additional information arrival before the scheduled public release of their private information.

Macroprudential Regulation and Leakage to the Shadow Banking Sector
Mazelis, Falk
Macroprudential policies are often aimed at the commercial banking sector, while a host of other non-bank financial institutions, or shadow banks, may not fall under their jurisdiction. We study the effects of tightening commercial bank regulation on the shadow banking sector. We develop a DSGE model that differentiates between regulated, monopolistic competitive commercial banks and a shadow banking system that relies on funding in a perfectly competitive market for investments. After estimating the model using euro area data from 1999 â€" 2014 including information on shadow banks, we find that tighter capital requirements on commercial banks increase shadow bank lending, which may have adverse financial stability effects. Coordinating macroprudential tightening with monetary easing can limit this leakage mechanism, while still bringing about the desired reduction in aggregate lending. In a counterfactual analysis, we compare how macroprudential policy implemented before the crisis would have dampened the business and lending cycles.

Mitigating Disaster Risks to Sustain Growth
Hong, Harrison G.,Wang, Neng,Yang, Jinqiang
We provide the planner's solution to a model where households learn from exogenous natural disaster arrivals about arrival rates and spend to mitigate future damages. Mitigation cannot be decentralized due to positive externalities from curtailing aggregate risks. First-best can be implemented by capital taxes and mitigation subsidies. Willingness-to-pay, toward public health for pandemics or environmental protection for climate disasters, depends on mitigation efficacy. Efficacy can be inferred from damage functions that depend on prior arrivals which determine preparedness. Regulatory risks arise since disaster leads to pessimistic arrival-rate beliefs and taxes or mandates to fund mitigation, which reduce consumption, investment and stock-market value.

Modulated Information Flows in Financial Markets
Edward Hoyle,Andrea Macrina,Levent A. Mengütürk

We model continuous-time information flows generated by a number of information sources that switch on and off at random times. By modulating a multi-dimensional L\'evy random bridge over a random point field, our framework relates the discovery of relevant new information sources to jumps in conditional expectation martingales. In the canonical Brownian random bridge case, we show that the underlying measure-valued process follows jump-diffusion dynamics, where the jumps are governed by information switches. The dynamic representation gives rise to a set of stochastically-linked Brownian motions on random time intervals that capture evolving information states, as well as to a state-dependent stochastic volatility evolution with jumps. The nature of information flows usually exhibits complex behaviour, however, we maintain analytic tractability by introducing what we term the effective and complementary information processes, which dynamically incorporate active and inactive information, respectively. As an application, we price a financial vanilla option, which we prove is expressed by a weighted sum of option values based on the possible state configurations at expiry. This result may be viewed as an information-based analogue of Merton's option price, but where jump-diffusion arises endogenously. The proposed information flows also lend themselves to the quantification of asymmetric informational advantage among competitive agents, a feature we analyse by notions of information geometry.

Multivariate non-Gaussian models for financial applications
Michele Leonardo Bianchi,Asmerilda Hitaj,Gian Luca Tassinari

In this paper we consider several continuous-time multivariate non-Gaussian models applied to finance and proposed in the literature in the last years. We study the models focusing on the parsimony of the number of parameters, the properties of the dependence structure, and the computational tractability. For each model we analyze the main features, we provide the characteristic function, the marginal moments up to order four, the covariances and the correlations. Thus, we describe how to calibrate them on the time-series of log-returns with a view toward practical applications and possible numerical issues. To empirically compare these models, we conduct an analysis on a five-dimensional series of stock index log-returns.

Online Appendix for 'Currency Factors'
Aloosh, Arash,Bekaert, Geert
This online appendix provides additional tables and data information mostly in the order it is referred to in the paper.The full-text paper can be found at:

Optimal Judicial Decision Making in Corporate Bankruptcy Cases
Mallick, Indrajit
The fundamental question in any corporate bankruptcy case is whether the bankrupt firm should be liquidated or continued (and how). This paper provides a generic model as to how this question can be addressed by the bankruptcy judge who does not know at the outset whether the management of the firm is of efficient type (continuation value exceeds liquidation value) or of inefficient type (liquidation value exceeds continuation value). A screening mechanism is proposed such that efficiency is preserved in bankruptcy decision making. A first best result in contract theory is obtained and applicability in actual corporate bankruptcy decision makings discussed.

Quadratic Hedging for Sequential Claims with Random Weights in Discrete Time
Jun Deng,Bin Zou

We study a quadratic hedging problem for a sequence of contingent claims with random weights in discrete time. We obtain the explicit optimal hedging strategy in a recursive representation, without imposing the nondegeneracy condition on the model and square integrability on hedging strategies. We relate the results to hedging under random horizon and fair pricing in the quadratic sense.

Risk Contagion of Covid-19 on Japanese Stock Market: A Network Approach
Kanno, Masayasu
Coronavirus (COVID-19) is one of the most severe pandemics throughout human history. From perspective of finance, a research question is proposed to assess the contagion effect of COVID-19 on financial markets. First, this study proposes a susceptible-infected-recovered-death (SIRD) model of COVID-19 and analyzes the infection spread in Japan. Second, it analyzes the impact of COVID-19 on Japanese stock market through correlation and network analyses of Tokyo Stock Exchange Sector indexes. Finally, in terms of finance, this study finds that the analyses of the interconnectedness between an infection network such as the COVID-19 and financial networks can serve as pandemic risk management in finance.

SeLFIES Can Help Brazil Create a SUPER Supplementary Pension
Muralidhar, Arun,Merton, Robert C.,Vitorino, Alexandre
Brazilian policy makers and researchers have discussed the introduction of a complementary pension system to complement the Regime Geral de Previdência Social (RGPS), specially for those that want a retirement income above the RGPS ceiling. This article first recommends that the complementary system must be SUPER (Simple, Universal, Portable, Efficient with low cost and Robust Regulatation). It then proposes the adoption of a financial innovation called SeLFIES (Standard-of-Living, Forward-starting, Income-only Securities), as the default investment option for a modern capitalization regime. Brazil presents an interesting opportunity to be the first country to adopt and implement SeLFIES given the initial conditions, especially the innovations introduced in the market for government bonds. This financial innovation would help the Brazilian government address two challenges simultaneously: improve retirement security (by including even the most financially illiterate people and those in the informal sector in retirement plans) and boost infrastructure financing.

Smoke on the Market: Inattentive Investors and the War in Ukraine
Kochnev, Artem
This paper confronts predictions of rational choice, gain-loss, and inattention theories in the context of financial markets during war in Ukraine. Using various measures of conflict intensity as an explanatory variable, the paper finds that the Ukrainian stock market a) did not use all available information, b) reacted non-linearly in parameters with where regime 1 being characterized by a negative reaction and regime 2 characterized by ignorance. The paper also finds heterogeneous effects with respect to geographical location of the enterprises: a negative effect for enterprises with located in close proximity to the conflict events and a positive effect for the ones located elsewhere.The author argues that the first finding is only compatible with the inattention framework, and suggests that the second one is driven by the portfolio re-balancing effect.

Speaking With One Voice: Shareholder Collaboration on Activism
Pi, Shaoting
Governing a firm via "voice" is effective only when sufficient shares speak with one voice. However, a lead activist of a shareholder campaign typically only owns a small fraction of the target firm's shares. Thus, to make governing a firm via "voice" possible and effective, an activist with small stakes confront two challenges. One is how to motivate other active shareholders to collaborate on intervention when the costs of intervention are too high relative to her small stakes, and the other one is how to win support from passive shareholders who have a conflicting preference. We present a game-theoretic model to study how an activist with small stakes overcomes these two challenges to force a value-enhancing change on a firm. We show that the activist can function as a fictional large shareholder through communicating and collaborating with other active shareholders. In particular, by leaking information to some active shareholders before the shareholder campaign, the activist can negotiate a collaboration contract with them. The contract enables the activist and the active shareholders to act in concert and share intervention costs. However, the activist's coalition with active shareholders also has a cost: it may cause passive shareholders to oppose the activist. Consequently, in equilibria, the activist has to limit the collaboration with active shareholders for enlisting the support of passive shareholders. The interplay between the collaboration with active shareholders and the support of passive shareholders endogenously determines the optimal size of the activist's coalition.

Stabilizing Congestion in Decentralized Record-Keepers
Assimakis Kattis,Fabian Trottner

We argue that recent developments in proof-of-work consensus mechanisms can be used in accordance with advancements in formal verification techniques to build a distributed payment protocol that addresses important economic drawbacks from cost efficiency, scalability and adaptablity common to current decentralized record-keeping systems. We enable the protocol to autonomously adjust system throughput according to a feasibly computable statistic - system difficulty. We then provide a formal economic analysis of a decentralized market place for record-keeping that is consistent with our protocol design and show that, when block rewards are zero, the system admits stable, self-regulating levels of transaction fees and wait-times across varying levels of demand. We also provide an analysis of the various technological requirements needed to instantiate such a system in a commercially viable setting, and identify relevant research directions.

Stock market under the global pandemic of COVID-19: Evidence from Tunisia
Ben Ayed, Wassim,Medini, Fatma,Lamouchi, Rim Ammar
The purpose of this study is to investigate the impact of COVID-19 on stock returns performance of all companies listed on the Tunis Stock Exchange. More specifically, we analyse the impact of (1) the daily growth of confirmed cases (2) the daily growth of Death tolls and (3) the daily growth of recovered cases on Stock market outcomes. We use the Swamyâ€"Arora method for panel data analysis during the period from January 20, to April 20, 2020. This is the first study that focuses on analyzing the behaviour of stock market returns and its determinants in Tunisia during stress periods. Our findings show that: First, DCG has a positive impact on stock returns, while DDG increases the performance of stock returns. However, DReC has a positive relationship but not significant. Second, the results highlight that Firm capitalization, and the daily return of Brent Crude oil have a positive impact on Stock returns, while the FX has a negative impact. Third, these results support the efforts of national authorities in setting up early preventive measures in order to protect citizens and economy from the pandemic. By conducting a sectorial analysis, we also find that the consumer cyclical sector has suffered the hardships of COVID-19. However, the stocks return of service sector shows the best performance. These results will be useful for policy authorities seeking to clarify the linkages between economic and medical effects of the novel coronavirus (COVID-19).

The Effect of TlTRO-II on Bank Lending
Laine, Olli-Matti
This study estimates the effect of the European Central Bank’s second series of targeted longer-term refinancing operations (TLTRO-II) on bank lending using bank level data from multiple countries and instrumental variable estimation. Effects on corporate loans and loans for consumption are analysed separately. The cumulative effect of TLTRO-II on participating banks’ stock of corporate loans is estimated to be about 20 per cent. The effect on lending for consumption is found close to zero. The positive effects on corporate loans are found to be driven by crisis countries indicating that the effectiveness of monetary policy depends on the economic conditions. Additionally, the effect on government bond purchases is found negative. This result is very different from the earlier results regarding non-targeted liquidity operations.

There's an App for That: Goal-Setting and Saving in the FinTech Era
Gargano, Antonio,Rossi, Alberto G.
We study the effects of goal-setting on saving behavior, exploiting the exogenous introduction of goal-setting features for saving in a FinTech app. We establish that setting goals increases individuals' saving rate, and show that the effect is causal using two distinct identification strategies that control for individuals' endogenous decision to adopt goal-setting. Our results vary along several dimensions. Individuals save more for goals with shorter horizon and larger amounts. They also save more when they use another feature of the app that allows them to divide their overall saving into small amounts (5 Euros) throughout the month. The nature of the goal, on the other hand, does not matter. Only one third of the goals are achieved before the deadline, with general goals having higher probability to be achieved than specific ones. Taken together, our findings indicate that goal-setting has a positive effect on saving, but there is considerable scope to increase its effectiveness by helping individuals set well-calibrated goals, possibly using robo-advising tools.

U.S. Monetary Policy and the Predictability of Global Economic Synchronization Patterns
Balcilar, Mehmet,Demirer, Riza
This paper proposes output gap dispersion as a measure of economic synchronization patterns across the world economies. Utilizing a novel, multivariate quantile causality testing methodology and data from a set of 45 advanced and emerging nations, we present evidence of significant causal effects of U.S. monetary policy measures over synchronization patterns across the advanced and emerging economy business cycles, even after controlling for various risk and uncertainty proxies. While U.S. monetary policy actions cause significant interdependence in business cycles across advanced economies, we find that the Fed’s policy decisions also contribute to uncertainty in industrial output patterns. U.S. monetary policy actions are also found to have significant causal effects on the dispersion of emerging market output gaps at low quantiles, suggesting that policy actions by the U.S. Fed drive synchronized economic activity across emerging nations. The findings have significant implications, particularly for policy makers in emerging economies, when it comes to the coordination of their domestic as well as regional monetary policies in response to monetary policy shocks from the U.S.

Viability and Arbitrage under Knightian Uncertainty
Matteo Burzoni,Frank Riedel,H. Mete Soner

We reconsider the microeconomic foundations of financial economics. Motivated by the importance of Knightian Uncertainty in markets, we present a model that does not carry any probabilistic structure ex ante, yet is based on a common order. We derive the fundamental equivalence of economic viability of asset prices and absence of arbitrage. We also obtain a modified version of the Fundamental Theorem of Asset Pricing using the notion of sublinear pricing measures. Different versions of the Efficient Market Hypothesis are related to the assumptions one is willing to impose on the common order.

Volatility and the Cross-Section of Real Estate Equity Returns during COVID-19
Milcheva, Stanimira
This paper uses the global systemic shock associated with the outbreak of the novel coronavirus Covid-19 to assess the risk-return relationship in the cross-section of real estate equities internatioanlly. Real estate is among the industries hardest hit as countries around the world lock down their economies. I construct a global Covid-19 risk factor to capture the risk exposure of individual stocks to the pandemic. I report that the average firm sensitivity to the Covid-19 risk factor increases from close to zero prior to the pandemic to 0.6 during the pandemic with large variations across countries and property sectors. Fama MacBeth regressions reveal evidence for a low-risk effect which is not explained by behavioral biases but rather by financial constraints. Consistent with the existing research on the effects of Covid-19 on stock markets, the findings in this paper suggest that investors perceive the shock caused by the pandemic to be amplified by financial channels. Finally, countries with previous experience to similar pandemics are associated with significantly higher returns and alphas.

When Credit Rating Agencies Avoid Downgrading: The Effects of Performance-Sensitive Debt
Herpfer, Christoph,Maturana, Gonzalo
Credit rating inflation in securitized products was a major contributor to the Financial Crisis. The major credit rating agencies (CRAs) subsequently settled with the U.S. government for yielding to conflicts of interest, and they renewed their commitment to credit rating quality. We study the $900 billion performance-sensitive debt market, in which interest rates are a dynamic function of credit ratings. Using detailed data on loan pricing schedules, we show that credit rating inflation is prevalent in this market, and credit rating inflation remained unchanged after the settlements. In the presence of competing CRAs, rating inflation is stronger for a CRA when its rating is decisive in determining interest rates. Our results are not driven by firms hiding negative information from CRAs, and they are not driven by CRAs catering to investors at the border of the investment grade classification. Moreover, the potential for credit inflation is priced at origination, indicating that borrowers and lenders are aware of the CRAs' conflicts of interest.

Which bills are lobbied? Predicting and interpreting lobbying activity in the US
Ivan Slobozhan,Peter Ormosi,Rajesh Sharma

Using lobbying data from, we offer several experiments applying machine learning techniques to predict if a piece of legislation (US bill) has been subjected to lobbying activities or not. We also investigate the influence of the intensity of the lobbying activity on how discernible a lobbied bill is from one that was not subject to lobbying. We compare the performance of a number of different models (logistic regression, random forest, CNN and LSTM) and text embedding representations (BOW, TF-IDF, GloVe, Law2Vec). We report results of above 0.85% ROC AUC scores, and 78% accuracy. Model performance significantly improves (95% ROC AUC, and 88% accuracy) when bills with higher lobbying intensity are looked at. We also propose a method that could be used for unlabelled data. Through this we show that there is a considerably large number of previously unlabelled US bills where our predictions suggest that some lobbying activity took place. We believe our method could potentially contribute to the enforcement of the US Lobbying Disclosure Act (LDA) by indicating the bills that were likely to have been affected by lobbying but were not filed as such.

Why Fixed Costs Matter for Proof-of-Work Based Cryptocurrencies
Garratt, Rodney,van Oordt, Maarten R.C.
This paper assesses how the cost structure of cryptocurrency mining affects the response of miners to exchange rate fluctuations and the immutability of cryptocurrency ledgers that rely on proof-of-work. The results suggest that the amount of mining power supplied to currencies that rely on application-specific integrated circuits (ASICs), such as Bitcoin, responds less to adverse exchange rate shocks than other currencies, a fact that may be instrumental to avoiding double-spending attacks. The results may change if mining equipment used for a particular cryptocurrency can be transferred over to another. For smaller currencies with low exchange rate correlation, transferability can eliminate the protection that fixed costs provide. Our results have important implications for what type of cryptocurrencies could be more successful in the long-run.