Research articles for the 2020-05-20
SSRN
This paper investigates the incentives of a credit rating agency (CRA) to generate accurate ratings under an advertisement-based business model. We study a two-period endogenous reputation model in which the CRA can choose to provide private effort in evaluating financial products in each period. We show that the advertisement-based business model may provide sufficient incentives to improve the precision of signals when the CRA has an intermediate reputation. Furthermore, we identify conditions under which truthful reporting is incentive compatible.
SSRN
Structural factors that cause irrational investment in defined contribution savings plans are of great concern. Using a proprietary database of 401(k) plans we show that alphabeticity—the order that fund names appear when listed in alphabetical order—significantly biases participants' investment allocation decisions. While we show a larger impact as the number of funds in the plan increases, this bias is strong even when relatively few funds are available in the plan menu. Importantly, our findings suggest that a more strategic ordering of funds could result in favorable outcomes for participants.
SSRN
Answering a causal question with results extendable outside of a narrow sample is challenging. Regression discontinuity design (RDD) provides causal results with strong internal, but weak external, validity. We introduce a novel machine learning technique, causal forest, into the corporate finance literature because it has several benefits over RDD, including greater precision and extendibility of results. We revisit a well-known RDD setting in corporate finance, debt covenant violations. We show that this RDD framework recovers an overly-large treatment effect of default on investment because firms can manipulate the accounting ratios lenders use to define default thresholds. In contrast to previous literature that shows an economically significant decline in investment following a technical default, we find, on average, no change in investment. Intuitively, this result makes sense because firms that can manipulate their default status will only choose to default if there are no consequences to default. For these firms, which comprise the majority of our sample, the treatment effect of default on investment will be zero. We show that causal forest's ability to recover heterogeneous treatment effects is key to reconciling disparate findings in the debt covenant literature. Causal forest can be a broadly useful empirical technique for answering causal questions.
arXiv
There has been limited success applying the Nash Bargaining Solution (NBS) in assigning intellectual property damages due to the difficulty of applying it to the specific facts of the case. Because of this, parties are not taking advantage of Georgia-Pacific factor fifteen. The intent of this paper is to bring clarity to the NBS so it can be applied to the facts of a case. This paper normalizes the NBS and provides a methodology for determining the bargaining weight in Nash's solution. Several examples are shown demonstrating the use of this normalized form, and a nomograph is added for computational ease.
SSRN
Using NASDAQ trade and Reuters news data, I show that the response of aggressive non‐high‐frequency traders (nHFTs) to news is stronger than that of aggressive high‐frequency traders (HFTs). Classifying news into quantitative ("hard") and less quantitative ("softer") news, the trading response of aggressive nHFTs to softer news exceeds HFTs' response. Positive news elicits greater return and nHFT responses than negative news during the 2008 financial crisis period. As this phenomenon persists even after excluding the 2008 short‐sale ban, the results support the hypothesis of nHFTs exhibiting stronger asymmetric responses during crisis periods.
SSRN
We assess the ability of bank resolution frameworks to deal with systemic banking fragility. Using a novel and detailed database on bank resolution regimes in 22 member countries of the Financial Stability Board, we show that systemic risk, as measured by â?³CoVaR, increases more for banks in countries with more comprehensive bank resolution frameworks after negative system-wide shocks, such as Lehman Brothers' default, while it decreases more after positive system-wide shocks, such as Mario Draghi's "whatever it takes'' speech. These results suggest that more comprehensive bank resolution may exacerbate the effect of system-wide shocks and should not be solely relied on in cases of systemic distress.
SSRN
Employees in finance are known to earn higher wages and returns to talent than non-finance workers since the 1990s, suggesting that finance may have attracted talent at the expense of other industries. However, the allocation of talent is likely to respond to differences in career paths across industries, not in wages at a given date. We analyze the careers of 9,964 individuals from 1980 to 2017 based on their resumes, and find that they tend to remain in the same industry for most of their working lives, consistently with them choosing occupations based on comparisons of entire career paths. Comparing various aspects of careers - levels, slopes, PDV and risk of pay profiles - we document
arXiv
The recent advancements in computational power and machine learning algorithms have led to vast improvements in manifold areas of research. Especially in finance, the application of machine learning enables both researchers and practitioners to gain new insights into financial data and well-studied areas such as company classification. In our paper, we demonstrate that unsupervised machine learning algorithms can be used to visualize and classify company data in an economically meaningful and effective way. In particular, we implement the data-driven dimension reduction and visualization tool t-distributed stochastic neighbor embedding (t-SNE) in combination with spectral clustering. The resulting company groups can then be utilized by experts in the field for empirical analysis and optimal decision making. By providing an exemplary out-of-sample study within a portfolio optimization framework, we show that the application of t-SNE and spectral clustering improves the overall portfolio performance. Therefore, we introduce our approach to the financial community as a valuable technique in the context of data analysis and company classification.
SSRN
Using transaction data from a large Fintech company, we document a decline of 40% to 50% in the spending of British households during the Covid-19 crisis. The fall is concentrated in services such as retail, restaurants and transportation. The initial rise in on-line shopping and groceries purchases has been subsequently reverted. Income reductions have become far more frequent, with a median decline around 30%. The share of borrowers facing financing issues has increased significantly for both secured and unsecured lending. Consumption and income inequality have surged, with the most economically vulnerable groups experiencing the largest percentage decline. Mortgagors and higher earners in London record the most sizable pound change.
arXiv
We discuss the pros of adopting government-issued digital currencies as well as a supranational digital iCurrency. One such pro is to get rid of paper money (and coinage), a ubiquitous medium for spreading germs, as highlighted by the recent coronavirus outbreak. We set forth three policy recommendations for adapting mobile devices as new digital wallets, regulatory oversight of sovereign digital currencies and user data protection, and a supranational digital iCurrency for facilitating international digital monetary linkages.
arXiv
The release of openly available, robust text generation algorithms has spurred much public attention and debate, due to algorithm's purported ability to generate human-like text across various domains. Yet, empirical evidence using incentivized tasks to assess human behavioral reactions to such algorithms is lacking. We conducted two experiments assessing behavioral reactions to the state-of-the-art Natural Language Generation algorithm GPT-2 (Ntotal = 830). Using the identical starting lines of human poems, GPT-2 produced samples of multiple algorithmically-generated poems. From these samples, either a random poem was chosen (Human-out-of-the-loop) or the best one was selected (Human-in-the-loop) and in turn matched with a human written poem. Taking part in a new incentivized version of the Turing Test, participants failed to reliably detect the algorithmically-generated poems in the human-in-the-loop treatment, yet succeeded in the Human-out-of-the-loop treatment. Further, the results reveal a general aversion towards algorithmic poetry, independent on whether participants were informed about the algorithmic origin of the poem (Transparency) or not (Opacity). We discuss what these results convey about the performance of NLG algorithms to produce human-like text and propose methodologies to study such learning algorithms in experimental settings.
SSRN
We examine the impact of the introduction of VIX exchange‐traded products (ETPs) on the information content and pricing efficiency of VIX futures. We document that trades in VIX futures have become less informative and that pricing errors exhibit more persistence after the introduction of VIX ETPs. In addition, we observe that the price process of the VIX futures has become noisier over time. These findings suggest that the introduction of the VIX ETPs had a prominent effect on the properties and dynamics of the VIX futures.
SSRN
This study examines environment, social, governance (ESG) consideration in rating reports published by credit rating agencies. 3,719 Moody's credit rating reports between 2004 and 2015 are examined and the ESG consideration is analyzed using a latent dirichlet allocation (LDA) approach. We further analyze the stock returns and credit default swap (CDS) spread changes to check whether ESG consideration has an effect on the capital market reactions. We find a small but present consideration of ESG in rating decisions. Within ESG, corporate governance plays the most important role. Moreover, the results reveal that ESG consideration is a significant determinant in the stock return and CDS spread around the rating announcement. We find that all ESG criteria are important for equity and debt investors.
RePEC
Mitigating climate change requires aligning real economy investments with climate objectives. This pilot study measures the climate consistency of investments in transport infrastructure and vehicles in Latvia between 2008 and 2018, estimated at EUR 1.5 billion per year on average. To do so, three complementary mitigation-related reference points are used. Applying the criteria defined by the European Union Taxonomy for Sustainable Activities results in 4.2% of investments assessed as making a substantial contribution to climate change mitigation. Comparing actual greenhouse gas trajectories for each transport mode to a 2°C scenario from the International Energy Agency's for the European Union and to projections from Latvia's 5th National Communication to the UNFCCC, indicates 32% climate-consistent and up to 9% climate-inconsistent investments. The majority of investments volumes could at this stage not be characterised due to limitations relating to the granularity or coverage of the reference points. Comparing current trends to 2030 and 2050 decarbonisation targets nevertheless highlights future investment and financing challenges, especially for road transport. The methodology piloted in this study can be replicated and scaled up across countries and sectors, using different or complementary reference points specifically aligned to the temperature goal of the Paris Agreement.
SSRN
Prompted by the shakeup of Covid-19 on financial markets, scholars have begun to explore the corporate traits that can make firms more resilient to a pandemic. In this paper, we test how the involvement of families in ownership and governance positions influences the financial performance of Italian listed firms during the spread of Covid-19. Our results indicate that firms with controlling family shareholders fared significantly better than other firms in the pandemic period. This effect is particularly pronounced among firms in which a family is both the controlling shareholder and holds the CEO position. Collectively, our results expand existing knowledge on the determinants of organizational resilience in the wake of adverse events.
SSRN
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.
arXiv
In this paper we show how to approximate the transition density of a CARMA(p, q) model driven by means of a time changed Brownian Motion based on the Gauss-Laguerre quadrature. We then provide an analytical formula for option prices when the log price follows a CARMA(p, q) model. We also propose an estimation procedure based on the approximated likelihood density.
SSRN
Tax avoidance schemes generate artificially complex cross-border financial structures inflating measured international investment stocks in tax havens. Using a standard gravity framework, we estimate that about 40\% of global assets (FDI, portfolio equity and debt) are 'abnormal' - unexplained - stocks. Abnormal stocks are increasing over time and concentrated in a limited number of jurisdictions. Six jurisdictions including three European countries are the largest contributors: Cayman, Bermuda, Luxembourg, Hong Kong, Ireland and the Netherlands. Interestingly, the Luxleaks in 2014 do not appear to have diverted cross-border investments away.
SSRN
We document significant heterogeneity in the relation between chief executive officer (CEO) equity incentives and firm value using quantile regression. We show that CEO delta is more effective in the presence of ample investment opportunities, while CEO vega is more beneficial for firms lacking investment opportunities. Further, Tobin's Q increases in CEO delta for more risk‐tolerant firms but increases in CEO vega for more risk‐averse firms. We also observe that higher monitoring intensity after the Sarbanes‐Oxley Act reduces CEO delta's role in compensation. Risk aversion alters the optimal incentive‐value relation, and the nature of this relation also depends on the level of Tobin's Q.
SSRN
We examine how firms use the network of overlapping directorships to determine chief executive officer (CEO) compensation. We contribute to related work by empirically exploring two competing hypotheses. In the first hypothesis, networks propagate relevant information used to establish good pay practices. In the second hypothesis, director networks are used opportunistically to benefit the CEO. The empirical findings are generally consistent with the first hypothesis. Yet, the importance of director networks is reduced when the CEO is entrenched and when management hires a compensation consultant. The latter finding is especially pronounced when director networks predict a reduction in CEO pay.
SSRN
The literature reports a tendency that future losses are discounted less than future gains, the so-called sign effect in intertemporal decision making. In this article, we study implications of the sign effect on risk taking: If future losses are discounted less than future gains, mixed lotteries involving both gains and losses should become less attractive when payments are delayed into the future. We refer to this phenomenon as Hyperopic Loss Aversion and provide experimental evidence for it: First, we provide a robust conceptual replication of the sign effect where we find non-positive discount rates for losses. Second, we confirm our hypothesis that mixed lotteries become less attractive over time. This effect can be attributed to Hyperopic Loss Aversion in our design, as a delay does not change the valuation of either pure gain and pure loss lotteries. Finally, we apply the notion of Hyperopic Loss Aversion to investment decisions and show that it offers a novel behavioral explanation for the equity premium puzzle. While our empirical analyses are entirely model-free, we also introduce a theoretical basis to analyze Hyperopic Loss Aversion. Our model, termed Discounted Prospect Theory, can be regarded as a natural extension of Prospect Theory to the intertemporal domain.
SSRN
Several papers study the real effects of zombie lending based on
SSRN
We show that the acquiring firm's idiosyncratic stock return volatility (sigma) is an important determinant of the selection and perceived valuation effects of earnouts in Mergers and Acquisitions (M&As). Earnout‐based M&As are more often announced by high‐sigma acquirers (nearly 40% of all earnout‐based M&As), yet the documented higher risk‐adjusted returns accrued to acquirers in earnout‐based M&As, relative to M&As settled in cash, stock or mixed payments (the earnout effect), appear in deals announced by low‐sigma acquirers (nearly 20% of all earnout‐based M&As). High‐sigma acquirers employing earnouts appear to break even, or even experience losses, relative to their counterparts employing single up‐front payments. These results are confirmed based on a quasi‐experimental design through which the earnout effect is measured in isolation. We argue that in M&As announced by high‐sigma acquirers, the earnout effect is potentially elusive due to the presence of an acquirer‐specific information revelation effect, resulting from the heightened extent of information asymmetry between (small) acquirers' managers and outside investors. On the contrary, the use of earnouts in M&As announced by low‐sigma (large) acquirers, whereby the acquirer‐specific information revelation effect is likely negligible, sends a strong signal for value creation that also prevents investors from inducing a size‐related discount.
SSRN
We investigate the effects of an increase in tick size on order and trading flow across market fee models. Using the pilot firms in the U.S. Securities and Exchange Commission's Tick Size Pilot Program, we document that trade and order volume declines on maker‐taker fee models after the tick size implementation. We find that the inverted fee models (taker‐maker) experience an increase in both trade and order volume. Additionally, we find that a tick size adjustment has a substantial influence on market participation in maker‐taker fee models. We also find that measures of both hidden and algorithmic trading decline with an increasing tick size, which is strongly moderated by the differences in the maker‐taker and taker‐maker fee models.
SSRN
This paper extends the canonical, neoclassical investment‐based asset‐pricing model through the incorporation of intangible capital and the formulation of a joint productivity distribution with economic uncertainty shocks at the firm level. The distinctive evolutionary dynamics of intangible capital as opposed to that of physical capital mitigate the negative impact of temporary uncertainty shock on production and serve well to explain the value premium with modest assumptions. The value premium is unconditionally positive, but the realized value spread plummets to negative after major transient second‐moment shocks, for example, the Loma Prieta Earthquake and the 9/11 terrorist attack.
SSRN
We provide evidence on how corporate bond investors react to a change in yields, and how this behaviour differs in times of market‐wide stress. We also investigate 'reaching for yield' across investor types, as well as providing insights into the structure of the corporate bond market. Using proprietary sterling corporate bond transaction data, we show that insurance companies, hedge funds and asset managers are typically net buyers when corporate bond yields rise. Dealer banks clear the market by being net sellers. However, we find evidence for this behaviour reversing in times of stress for some investors. During the 2013 'taper tantrum', asset managers were net sellers of corporate bonds in response to a sharp rise in yields, potentially amplifying price changes. At the same time, dealer banks were net buyers. Finally, we provide evidence that insurers, hedge funds and asset managers tilt their portfolios towards higher risk bonds, consistent with 'reaching for yield' behaviour.
SSRN
The essence of EVAï¼Economic Value Addedï¼ is the "economic" profit generated by enterprise operation. In contrast to the "accounting" profit that people attach importance to, EVA concept reflects that the shareholder capital occupied by the enterprise also has a cost, so the cost of equity must be taken into account when measuring the performance of the enterprise. The formula of EVA calculation is written as NOPAT - (Total Assets - Current Liabilities) * WACC. A positive EVA implies the company is currently creating extra value for the shareholders and vice versa. The following content will discuss if EVA can be a good indicator of the quality of the investment and how EVA can be used in the stock selection. We will focus on the relationship between the EVA value and the stock return by testing the veracity of different literature resources and apply the regression test in the SAS tool.
SSRN
I report historical prices and estimate financial returns to investing in rare books. My sample consists of 25 fiction titles recommended by Clifton Fadiman in his 1960 Lifetime Reading Plan. Relying on prices realized at American and British auction houses between 1975 and 2018, I use hedonic regressions to estimate the average rate of return to each of the 25 titles. Jane Austenââ¬â¢s novel Pride and Prejudice tops the returns to all other titles. I then construct for the entire sample of rare books price indices based on various specifications with a view to identifying the most efficient way of computing rare book price indices for larger samples of books. Estimating the financial return to investing in rare books in general, I arrive for the boom period 1975-2007 at a real rate of return of about 4.6%, which exceeds similar estimates for investing in fine art. In a comparison with the returns in 1975-2007 of almost 9% from the US stock market, investing in rare books is justified only by substantial nonpecuniary returns.
arXiv
We investigate the problem of learning undirected graphical models under Laplacian structural constraints from the point of view of financial market data. We show that Laplacian constraints have meaningful physical interpretations related to the market index factor and to the conditional correlations between stocks. Those interpretations lead to a set of guidelines that users should be aware of when estimating graphs in financial markets. In addition, we propose algorithms to learn undirected graphs that account for stylized facts and tasks intrinsic to financial data such as non-stationarity and stock clustering.
SSRN
In June 2001, Nevada changed its state corporate law by substantially reducing the legal liability of directors and officers for breaching fiduciary duties owed to the corporation. We examine the impact of the reduced litigation risk caused by this legislative change on Nevada-incorporated firmsâ loan contract terms and related borrower-lender agency conflicts. Using a difference-in-differences analysis, we find that this legislative change leads to less favorable loan contract terms for Nevada-incorporated firms: higher spread and more restrictive covenants. In addition, after the legislative change, Nevada-incorporated firms with severe borrower-lender agency conflicts take more risk, increase payout through stock repurchase, and reduce capital investment and equity issuance. Collectively, these results suggest that the reduced litigation risk exacerbates the borrower-lender agency conflicts.
SSRN
This paper investigates the cost of going public through initial public offerings (IPOs) for firms located in regions with significant fraud density. We find that companies in regions with a high proportion of nearby firms that have committed corporate misconduct have more pronounced underpricing, experience higher post‐IPO stock return volatility, and are more likely to withdraw their offerings. Overall, our results show that local corporate misconduct is associated with the pricing of IPOs, and the breach of trust is related to costly IPOs for newcomers.
SSRN
This study examines the relation between managerial ability and bond credit rating changes. We attempt to add to the credit rating agency literature by exploring the role managerial ability plays in the initial bond rating assignments and in rating changes. We predict firms with more‐able managers are more likely to have higher bond ratings and to be more able to have a positive influence on rating changes. We find a significant and positive relation between managerial ability and change in credit ratings, suggesting that more‐able managers can take effective actions to improve their credit ratings.
SSRN
This paper provides evidence that the managerial effect is a key determinant of firms' cost of capital, in the context of private debt contracting. Applying the novel empirical method developed by an earlier study to a large sample that tracks the job movement of top managers, we find that the managerial effect is a critical and significant factor that explains a large part of the variation in loan contract terms more accurately than firm fixed effects. Additional evidence shows that banks "follow" managers when they change jobs and offer loan contracts with preferential terms to their new firms.
SSRN
We propose a novel measure of bond market liquidity that does not depend on transaction data: the strength of the cross-sectional relationship between mutual fund cash holdings and fund flow volatility. Our measure captures how liquid funds perceive their portfolio holdings to be at a given point in time. The perceived liquidity of speculative grade and Rule 144A bonds is significantly lower than investment grade bonds in the cross section and deteriorated significantly following the 2008-9 financial crisis. Our measure can be applied in settings where either transaction data are not available or transactions are rare, including the markets for asset-backed securities, syndicated loans, and municipal bonds.
SSRN
Previous research shows that activist threats lead to corporate policy concessions. We find that the threat of proxy fights is responded to differently based on its credibility. Decomposing proxy fight threats, we find that only credible threats are associated with more leveraged, more innovative, and less acquisitive corporate policies. Management, however, does not respond to noncredible threats. Further, for materialized fights, the market reaction at announcement is also conditional on the credibility of the threats. Overall, not all activist threats are responded to equally by management or the market, and only credible threats achieve disciplinary effects and favorable valuation.
SSRN
Using a Delaware case law that recognized officers' distinct fiduciary duties for the first time in 2009, I examine the effect of officers' fiduciary duties (OFDs) on corporate acquisitions. I find that firms with entrenched officers prior to 2009 experienced increased announcement‐period abnormal stock returns, mainly because their acquisitions created more synergies and reduced officers' incentives to preserve control. These firms increased liability insurance premium expenditures, but reduced value‐decreasing acquisition frequencies. Furthermore, the effect of OFDs is more pronounced in firms where officers are not directors, have wealth risk, face less product market competition, are insulated from the market for corporate control, or are able to avoid board monitoring. Overall, OFDs are a critical corporate governance mechanism that works in tandem with other disciplinary mechanisms.
SSRN
The Basel III framework advises considering a reference indicator at the country level to guide the setting of the countercyclical capital buffer: the credit-to-GDP gap. In this paper, I provide empirical evidence suggesting that the credit-to-GDP gap is subject to spurious medium-term cycles, i.e. artificial boom-bust cycles with a maximum duration of around 40 years.
arXiv
This paper studies pairs trading using a nonlinear and non-Gaussian state-space model framework. We model the spread between the prices of two assets as an unobservable state variable and assume that it follows a mean-reverting process. This new model has two distinctive features: (1) The innovations to the spread is non-Gaussianity and heteroskedastic. (2) The mean reversion of the spread is nonlinear. We show how to use the filtered spread as the trading indicator to carry out statistical arbitrage. We also propose a new trading strategy and present a Monte Carlo based approach to select the optimal trading rule. As the first empirical application, we apply the new model and the new trading strategy to two examples: PEP vs KO and EWT vs EWH. The results show that the new approach can achieve a 21.86% annualized return for the PEP/KO pair and a 31.84% annualized return for the EWT/EWH pair. As the second empirical application, we consider all the possible pairs among the largest and the smallest five US banks listed on the NYSE. For these pairs, we compare the performance of the proposed approach with that of the existing popular approaches, both in-sample and out-of-sample. Interestingly, we find that our approach can significantly improve the return and the Sharpe ratio in almost all the cases considered.
SSRN
We document that fund managers are more likely to allocate assets to firms managed by executives and directors with whom they share a similar political partisan affiliation. We find that this bias is not associated with improved fund performance. Funds with more partisan bias suffer from higher levels of idiosyncratic volatility than those with less bias. Partisan bias is more evident when fund managers are less experienced, in more informationally opaque firms, and when the U.S. president comes from fund managersâ own party. These findings suggest that political partisan bias among fund managers may be due to in-group favoritism.
SSRN
This paper examines the driven factor for asset investment under the defined benefit pension plan, especially in the underfunded case, there are two mechanisms of motivation support these driven factors, one is risk management and the other one is risk-shifting. This paper finds that if the corporate has inadequate cash inflows or assets, or plenty of cash outflows or obligation, or has an optimistic view about future financial health, these corporates would not likely exchange capital gain to the extra investment risk, these corporations would invest more on conservative assets. This finding shares the same idea with risk management, the corporate would like to bear certain risk, if the corporate facing financial pressure in the current period, they would not likely transfer this kind of pressure to the investment risk, rather than control a certain amount of risk by giving up accordingly investment gain.
SSRN
We analyse minute-level multi-dimensional information flows within and between bitcoin spot and derivatives. We show that perpetual swaps and futures traded on the unregulated exchanges Huobi, OKEx and BitMEX are much the strongest instruments for bitcoin price discovery and we examine potential determinants of their leadership strength. Prices on the regulated CME bitcoin futures and the US-based spot exchanges react to, rather than lead, price movements on the unregulated exchanges and they may do so relatively slowly. In a multi-dimensional setting including the main price leaders within futures, perpetuals and spot markets, the CME futures have a very minor effect on price discovery, even less than the spot exchanges Bitfinex, Bitstamp and Coinbase. Our findings highlight the persistent problems stemming from inconsistent regulation in bitcoin spot and derivatives markets, including insufficient price stability and lack of resistance to manipulative trading. We conclude that the SEC are correct to maintain such issues as their main concern for bitcoin ETF applications.
arXiv
In this paper, we address the question of the optimal Delta and Vega hedging of a book of exotic options when there are execution costs associated with the trading of vanilla options. In a framework where exotic options are priced using a market model (e.g. a local volatility model recalibrated continuously to vanilla option prices) and vanilla options prices are driven by a stochastic volatility model, we show that, using simple approximations, the optimal dynamic Delta and Vega hedging strategies can be computed easily using variational techniques.
arXiv
A recursive free cash flow model (FCFF) is proposed to determine the corporate value of a company in an efficient market in which new market and company-specific information is modelled by additive white noise. The stochastic equations of the FCFF model are solved explicitly to obtain the average corporate value and valuation risk. It is pointed out that valuation risk can be reduced significantly by implementing a conventional two-step Kalman filter in the recursive FCFF model, thus improving its predictive power. Systematic errors of the Kalman filter, caused by intermediate changes in risk and hence in the weighted average cost of capital (WACC), are detected by measuring the residuals. By including an additional adjustment step in the conventional Kalman filtering algorithm, it is shown that systematic errors can be eliminated by recursively adjusting the WACC. The performance of the three-step adaptive Kalman filter is tested by Monte Carlo simulation which demonstrates the reliability and robustness against systematic errors. It is also proved that the conventional and adaptive Kalman filtering algorithms can be implemented into other valuation models such as the economic value added model (EVA) and free cash flow to equity model (FCFE).
SSRN
At year-end 2019, high rates of the retail lending market were registered. This growth demonstrated increased accessibility of loans to households amid moderate inflation and stable financial state of households. Excessive banking sectorâs liquidity was an additional trigger for this growth. Meanwhile, the excessive level of the debt burden can lead to losses in the banking sector, pose risks for the real sector of the economy, provoke adverse social consequences.
SSRN
This paper aims to differentiate between optimistic splits and overoptimistic/opportunistic splits. Although markets do not distinguish between these two groups at the split announcement time, optimistic (overoptimistic/opportunistic) splits precede positive (negative) long‐term buy‐and‐hold abnormal returns. Using the calendar month portfolio approach, we show that the zero‐investment, ex ante identifiable, and fully implementable trading strategy proposed in this paper can generate economically and statistically significant positive abnormal returns. Our findings indicate that pre‐split earnings management and how it relates to managers' incentives, is an omitted variable in the studies of post‐split long‐term abnormal returns.
SSRN
We show that many stylized empirical patterns for mutual fund flows are driven by investor sentiment. Specifically, when sentiment is high, investors exhibit a stronger tendency of chasing past fund performance; fund flows are less sensitive to fund expenses; and investors are attracted more to funds with sheer visibility. Moreover, the well‐documented positive relation between fund flows and future fund performance is significant only during high sentiment periods and is mainly driven by expected component of fund flows. Finally, we show that mutual fund investors exhibit a significantly negative timing ability at the individual fund level when sentiment is high.
arXiv
This paper describes a general approach for stochastic modeling of assets returns and liability cash-flows of a typical pensions insurer. On the asset side, we model the investment returns on equities and various classes of fixed-income instruments including short- and long-maturity fixed-rate bonds as well as index-linked and corporate bonds. On the liability side, the risks are driven by future mortality developments as well as price and wage inflation. All the risk factors are modeled as a multivariate stochastic process that captures the dynamics and the dependencies across different risk factors. The model is easy to interpret and to calibrate to both historical data and to forecasts or expert views concerning the future. The simple structure of the model allows for efficient computations. The construction of a million scenarios takes only a few minutes on a personal computer. The approach is illustrated with an asset-liability analysis of a defined benefit pension fund.
SSRN
Regulation needs effective supervision; but regulated entities may deviate with unobserved actions. For identification, we analyze banks, exploiting ECB's asset-quality-review (AQR) and supervisory security and credit registers. After AQR announcement, reviewed banks reduce riskier securities and credit (also overall securities and credit supply), with largest impact on riskiest securities (not on riskiest credit), and immediate negative spillovers on asset prices and firm-level credit supply. Exposed (unregulated) nonbanks buy the shed risk. AQR drives the results, not the end-of-year. After AQR compliance, reviewed banks reload riskier securities, but not riskier credit, with medium-term negative firm-level real effects (costs of supervision/safe-assets increase).
SSRN
We analyze equity diversification of all retail investors in a country (Denmark). We find that underdiversification is pervasive. We calculate the nationwide aggregate loss due to underdiversification and express it in absolute and expected‐return terms. The aggregate loss is large. We find that investors with low education, low income, and low wealth are more likely to underdiversify. Despite better diversification, the larger fraction of the aggregate loss nevertheless adheres to the top of the income/wealth distribution. Finally, our results indicate that underdiversification arises because investors have limited information about the benefits of diversification.
SSRN
We expand the traditional specification of the tax gain from leverage by accounting for the choice between issuing debt and utilizing internal retained earnings equity. Standard analyses focus solely on the choice between debt and external equity. This results in the traditional tax gain from leverage, which equals the corporate tax benefit from debt minus the partially offsetting personal tax disadvantage. Expanding the debt analysis to include internal equity introduces a third tax component to the gain from leverage: a supplemental personal tax disadvantage. This supplemental disadvantage reflects the personal tax cost of distributing internally-generated equity to investors and using replacement debt. It reduces the overall or comprehensive tax gain from leverage and frequently converts it into a tax loss. Therefore, using debt often is costlier than generally assumed. We provide conceptual support for the comprehensive tax gain, plus some initial empirical support.
SSRN
The recent debate about the falling labor share has brought the attention to the income shares' trends, but less attention has been devoted to their variability. In this paper, we analyze how their fluctuations can be insured between workers and capitalists, and the corresponding implications for financial markets. We study a neoclassical growth model with aggregate shocks that affect income shares and financial frictions that prevent firms from fully insuring idiosyncratic risk. We examine theoretically how aggregate risk sharing is distorted by the combination of idiosyncratic risk and moving shares. Accumulation of safe assets by firms and risky assets by households emerges naturally as a tool to insure income shares' risk. We calibrate the model to the U.S. economy and show that low rates, rising capital shares, and accumulation of safe assets by firms and risky assets by households can be rationalized by persistent shocks to the labor share.
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The scientific consensus is clear. The earthâs climate is changing, and mankind must take collective bold action. While the pace of decarbonization is being debated as a political question, it is already impacting business decisions and needs to also be addressed by regulators. From a decarbonization perspective, most challenging is what happens inside the home: addressing natural gas used for heating, cooking, clothes drying and hot water. Eliminating natural gas usage for these activities will require societal change at a massive scale, with significant economic and regulatory implications.As states move toward full decarbonization, the natural gas distribution system will need to become a central focus. Pipes put into the ground today have a lifespan of up to 80 years â" far past the point where the scientific community has indicated we will need to be fully transitioned away from all fossil fuel use. Compounding this problem from a financial and regulatory perspective, natural gas distribution systems are monopoly regulated utilities, with their costs paid for by captive ratepayers. The transition raises three interrelated questions, one political and two regulatory: 1) what policies are necessary to electrify household uses; 2) how regulators should shut down the natural gas distribution system; and 3) how should regulators compensate regulated monopoly utilities for the assets that have become stranded in the transition? The answer to the first question will have a direct impact on the other two.To address these questions, this article starts with a discussion of why cities have focused on buildings, followed by a description of the natural gas distribution system, including a quantification of value. The paper discusses options which exist for regulators as they plan to shut off, and subsequently decommission, natural gas infrastructure. Assuming some assets will become stranded, this paper reviews learnings from other stranded asset challenges, potential regulatory treatments, and what regulators could do to lessen future challenges as they are approving projects now. How to both incent and pay for the transition of all residential uses away from natural gas will be the most difficult challenge of decarbonization.
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Securitized loans have lower lead bank shares, but larger shares held by non‐CLO (collateralized loan obligation) institutional investors than nonsecuritized loans. The result can largely be explained by their degree of information asymmetry and credit risk. We find that lead banks increase their holdings after a nonsecuritized loan becomes securitized, but they do not reduce financial exposure to securitized facilities during the boom of the CLO market. Furthermore, we find that securitized loans do not perform differently from similar nonsecuritized loans. We conclude that differences in syndicate structure are likely shaped by participants' investment preference rather than a manifestation of adverse selection.
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We study the welfare effects of the transition of online debt crowdfunding from the older "peer-to-peer" model to the "marketplace" model, where the crowdfunding platform sells diversified loan portfolios to investor. We develop an equilibrium model of debt crowdfunding capturing platform design (peer-to-peer or marketplace) and lender preferences over loan and portfolio product characteristics, and we estimate it on a novel database on credit at a large online platform based in China. Moving from the peer-to-peer to the marketplace model raises lender surplus, platform profits, and credit provision. At the same time, reducing lender exposure to liquidity risk can be beneficial. A counterfactual scenario where the platform resembles a bank by bearing liquidity risk has similar welfare properties as the marketplace model when liquidity is high, but results in larger lender surplus and credit provision, and only moderately lower platform profits, when liquidity is low.
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We show that more cash allows innovative firms facing financing constraints to undertake more research and development projects and that this phenomenon has been more pronounced since 1980. In contrast to the secular increase in the level of cash holdings, average excess cash has not increased appreciably. We analyze excess cash disposition and document a strong relation between excess cash and research and development spending. Finally, our results suggest that increased difficulty in valuing research and development might be a source of financing frictions. These findings imply that "seemingly excess cash" has played an increasingly important role in mitigating underinvestment in innovation.
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Equity option markets exhibit intense trading activity. We use the variability of option implied volatility spread as a proxy for the impounding of new information, and changes in the interpretation of existing information, into option prices. Over the 2006 â" 2016 period, we find that the predictive power of option implied volatility spread for future stock returns is significantly greater when implied volatility spread has been more variable in the past. Our results are statistically and economically significant and robust in both univariate and multivariate settings.
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We study performance persistence across a global sample of equity mutual funds from 27 countries. In contrast to the existing U.S.‐based evidence, we find that net performance persistence is present in the majority of fund industries, suggesting that fund manager skill is commonplace rather than a rarity. Consistent with the intuition that more competition in the mutual fund industry makes remaining a winner fund less likely but keeping a loser fund at the bottom of the performance ranks more probable, we show that competitiveness explains the cross‐sectional variation in performance persistence.
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I ask why the same large shareholders have different investment horizons. Using data for 1998–2013, I examine four fundamental firm policies for their potential influence on blockholders' investments with different time horizons. The panel ordinary least squares, difference‐in‐difference (using the Sarbanes‐Oxley Act), logistic, and dynamic generalized method of moments regression analyses reveal that blockholders adopt a short‐term horizon in smaller firms with a less independent board, high leverage, and high dividends while the same blockholders keep their investments longer in firms with a more independent board and low dividends. Under various economic conditions, different firm characteristics gain importance in blockholders' decision on short‐term versus long‐term investments.