Research articles for the 2020-06-19

A Fuzzy Bunching Estimator of Regulatory Costs
Alvero, Adrien,Xiao, Kairong
We propose a revealed preference approach to estimate the costs of financial regulation. We exploit the incentives for bunching created by regulatory thresholds and derive a fuzzy bunching estimator. Our approach does not require a sharp spike in the probability density function as existing bunching estimators do, making it particularly useful in settings with noisy data and small samples. We applying this methodology to estimate the regulatory costs of the Dodd-Frank Act on banks above the $10 billion and $50 billion asset threshold. We find that the magnitudes of regulatory costs revealed by banks' bunching behavior are much smaller than their self-reported estimates.

A Note on Regulatory Responses to Covid-19 Pandemic: Balancing Banks’ Solvency and Contribution to Recovery
Bitar, Mohammad,Tarazi, Amine
We see spikes in unemployment rates and turbulence in the securities markets during the COVID-19 pandemic. Governments are responding with aggressive monetary expansions and large-scale economic relief plans. We discuss the implications on banks and the economy of prudential regulatory intervention to soften the treatment of non-performing loans and ease bank capital buffers. We apply these easing measures on a sample of Globally Systemically Important Banks (G-SIBs) and show that these banks can play a constructive role in sustaining economic growth during the COVID-19 pandemic. However, softening the treatment of non-performing loans along with easing capital buffers should not undermine banks’ solvency in the recovery period. Banks should maintain usable buffer in the medium-term horizon to absorb future losses, as the effect of COVID-19 on the economy might take time to fully materialise.

Activos De Renta Fija (Fixed Income Assets)
Villar, Germán
Spanish Abstract: El presente paper desarrolla los tipos de activos de renta fija y sus respectivas características.English Abstract: This paper develops the types of fixed income assets and their respective characteristics.

Bank Complexity, Governance, and Risk
Correa, Ricardo,Goldberg, Linda S.
Bank holding companies (BHCs) can be complex organizations, conducting multiple lines of business through many distinct legal entities and across a range of geographies. While such complexity raises the costs of bank resolution when organizations fail, the effect of complexity on BHCs’ broader risk profiles is less well understood. Business, organizational, and geographic complexity can engender explicit trade-offs between the agency problems that increase risk and the diversification, liquidity management, and synergy improvements that reduce risk. The outcomes of such trade-offs may depend on bank governance arrangements. We test these conjectures using data on large U.S. BHCs for the 1996-2018 period. Organizational complexity and geographic scope tend to provide diversification gains and reduce idiosyncratic and liquidity risks while also increasing BHCs’ exposure to systematic and systemic risks. Regulatory changes focused on organizational complexity have significantly reduced this type of complexity, leading to a decrease in systemic risk and an increase in liquidity risk among BHCs. While bank governance structures have, in some cases, significantly affected the buildup of BHC complexity, better governance arrangements have not moderated the effects of complexity on risk outcomes.

COVID-19 Pandemic and Stock Market Contagion: A Wavelet-Copula GARCH Approach
Alqaralleh, Huthaifa,Canepa, Alessandra,Zanetti Chini, Emilio
In this study, we examine the influence of the COVID-19 pandemic on stock market contagion. Empirical analysis is conducted on six major stock markets using a wavelet-copula GARCH approach to account for both the time and the frequency aspects of stock market correlation. We find strong evidence of contagion in the stock markets under consideration during the COVID-19 pandemic.

Can Religion Explain Stock Price Crash Risk? A Global Perspective
Wang, Cong,Wang, Jimin
This study is motivated by the theoretical and empirical argument that assert an important association between religion and stock price crash risk (Kennedy and Lawton, 1998; Carter, McCullough and Carver, 2012; Jin and Myers, 2006; Callen and Fang, 2016; Li and Cai; 2018). We study the impact of religion, as informal institutions, on stock price crash risk around the world using a large cross-country panel data and attempt to establish causality by using physical instruments (2SLS). We find that firms located in countries with large percentage of religious population have lower stock price crash risk. These strong and robust results are supported by performing OLS and 2SLS estimators with fixed effect. In particular, this paper also shed light on the effects of major religious groups inducing Christianity, Judaism, Islam and Buddhism on stock price crash risk. Moreover, we find that decreasing effect of religion for managers bad-news-hoarding activities are enhanced in developing countries as well as risk seeking and high earnings management firms.

Comment Letter of Professors Max M. Schanzenbach and Robert H. Sitkoff on the Securities and Exchange Commission’s Request for Comment on the Names Rule for Mutual Finds in Light of ESG Investing and Other Market Developments
Schanzenbach, Max M.,Sitkoff, Robert H.
In March 2020, the Securities and Exchange Commission asked for public comment on the names rule (rule 35d-1) for mutual funds in light of developments since the rule's adoption in 2001. Among such developments, the request for comment identifies burgeoning investor interest in environmental, social, and governance (“ESG”) investing and the corresponding proliferation of funds that purport to make use of ESG factors. This response to the SEC’s request for comment has two purposes: First, we provide clarifying context for the ESG investing phenomenon and a summary of the current state of theoretical and empirical literature in financial economics on it. Second, we discuss how this context informs the critical relationship between ESG disclosure by a mutual fund, both in the fund’s name and in its prospectus, and the rules (e.g., state trust law or ERISA) that govern the extent to which a trustee or other fiduciary may use ESG factors in fiduciary investment.We organize this response in four parts: (1) we provide a clarifying taxonomy on the meaning of ESG investing and the methods for implementing it; (2) we discuss the inherent subjectivity in identifying and applying ESG factors; (3) we assess the current theory and evidence on whether ESG investing can improve risk-adjusted returns; and (4) we identify four interrelated questions of regulatory policy stemming from growing investor interest in ESG investing, situating the request for comment toward potential revision of the names rule within that four-part framework. This response is largely but not entirely based on “Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee,” 72 Stanford Law Review 381 (2020),

Dealing With the Reluctant Investor: Innovation and Governance in DC Pension Investment
Byrne, Alistair,Harrison, Debbie,Blake, David P.
Dealing with the reluctant investor examines the governance of defined contribution (DC) schemes with reference to investment choice and, in particular, the design of the default fund. We explain where and why the current system fails to support DC scheme members and what steps can be taken to address the problems. We examine the positive and negative features of current default models and draw attention to important innovations that have energized the DC investment world.

Do Individual Investors Bite Off More Than They Can Chew?
D'Hondt, Catherine,De Winne, Rudy,Merli, Maxime
Surveys worldwide indicate that return expectations of individual investors are often higher than actual market returns. This paper investigates the determinants of individual target returns and the capacity of investors to reach their expectations. Using trading records and matched survey data for 4,140 retail investors, we show that investor target returns are essentially driven by subjective individual characteristics like financial literacy and risk tolerance, as well as some socio-demographics (such as age and education). In addition, we find that investors with higher target returns and investors with the highest risk tolerance are less able to reach their targets. The gap to the target return decreases with age, education, portfolio size, portfolio risk, and portfolio return skewness. Women also appear better at setting more realistic targets.

Do Long-Short and Market Neutral Mutual Funds Sail on Even Keel?
Adams, John C.,Ahmed, Parvez,Nanda, Sudhir
Long-short and market neutral funds seek superior risk-adjusted returns while limiting their exposure to stock market risk. Over the 1999 to 2013 period the number of funds with these investment objectives increased by over 700 percent. Despite their growing popularity, we find that long-short and market neutral deliver lower risk-adjusted returns than U.S. Treasuries. Our investigation also reveals that the returns of both types of funds are positively and significantly correlated with the stock market. However, both fund types perform better in down markets. Finally, we report that market-neutral funds outperform long-short funds.

Does Bundling Induce Adverse Selection in Insurance?
Annan, Francis
Bundling credit with insurance contracts is a common approach to increasing insurance take-up, especially in low income-environments. I document that this approach can induce adverse selection in insurance; thus acting as an important source of inefficiency.

Does Competence of Central Bank Governors Influence Financial Stability?
Ozili, Peterson K
This study investigates whether the competence of central bank governors affect the stability of the financial system they are responsible for. Using publicly available information about central bank governors from 2000 to 2016 together with data on financial stability and the macro-economy, the findings reveal that central bank governors’ competence promotes financial stability, depending on how competence is measured. Specifically, the findings reveal that the financial system is more stable when the central bank governor is older and male. The financial system is also stable during the tenure of a central bank governor that has a combination of cognitive ability, social capital and technical competence in economics. The gender analyses reveal that the financial system is also stable during the tenure of a female central bank governor that has high social capital or high cognitive abilities while the financial system is relatively less stable during the tenure of a male central bank governor that has high social capital or high cognitive abilities. Comparing developed countries to developing and transition countries, the findings reveal that the financial system of developed countries is more stable during the tenure of a central bank governor that has high cognitive ability, social capital and technical competence in economics while the financial system of developing and transition countries is less stable during the tenure of a central bank governor that has high cognitive ability, social capital and technical competence in economics. Also, there is evidence that the financial system of developing and transition countries is more stable during the tenure of a central bank governor that has knowledge in disciplines other than economics. The findings are consistent with the view that certain characteristics of central bankers shape their beliefs, preferences and choice of policy, which in turn, are consequential for policy outcomes during their tenure.

ESG and the Earnings Call: Communicating Sustainable Value Creation Quarter by Quarter
Eckerle, Kevin,Tomlinson, Brian,Whelan, Tensie
In this paper, we begin by discussing concerns that existing reporting practices, including those used on quarterly earnings calls, underweight ESG disclosures and amplify short-term pressures on corporate management. We survey the broad market trends that are encouraging greater focus on ESG and long-term strategy disclosures. Building on extensive interactions with market participants, including sell-side analysts, we set out practical recommendations and a framework for how issuers can embed disclosures on ESG and long-term strategy into the content of the quarterly earnings call. These recommendations can be readily ope-rationalized to meet the increased demand for ESG and long-term strategy information across the reporting ecosystem.

Effect of Debt Tax Benefits on Corporate Pension Funding and Risk-Taking
Omori, Kozo,Kitamura, Tomoki
Purpose: This study theoretically investigates the impacts of tax benefits on funding level and risk-taking of a corporate defined benefit (DB) pension plan.Design/methodology/approach: The present value of the future tax benefits is maximized while the stockholders determine the funding level and investment risk-taking in DB plans. As a feature of DB plans, this study considers pension benefits to be pre-determined. Further, the pension beneficiary has a priority over the sponsor company's creditors for the pension reserve fund. These are seldom considered in previous studies.Findings: It is desirable to decrease the funding level of DB plans to increase tax benefits. This is because the effect of tax exemption for the pension fund's investment income is eliminated by the change in the contribution arising from the investment's result. The optimal investment risk-taking depends on the funding level.Originality/value: The impact of tax benefits on decision-making for DB plans is significantly different from that stated by previous studies, that is, an increase in pension funds will reduce the corporate debt. To explain corporate behavior, this study's results â€" derived from the essential feature of DB plans, which could not have been included in previous studies â€" should be considered.

Ending Compulsory Annuitisation: Quantifying the Consequences
Blake, David P.,Cannon, E. S.,Tonks, Ian
This report ‘Ending compulsory annuitisation: Quantifying the consequences’ is intended to provide a quantitative assessment of the issues raised in our earlier report. ‘Ending compulsory annuitisation: What are the consequences?’ published in July 2010. We also provide policy recommendations in relation to the UK government's proposal to end compulsory annuitisation in UK pension schemes.

Ending Compulsory Annuitisation: What Are the Consequences?
Blake, David P.,Cannon, E. S.,Tonks, Ian
The purpose of this report is very specific: to stimulate debate about the proposal by the UK government to end the mandatory requirement to purchase annuities in pension schemes as formally announced in the Budget Statement on 22 June 2010.

Fair Value Accounting, Financial Stability and the Global Financial Crisis
Cayirli, Omer
When analysing the GFC and other crisis, it is important to identify the root cause(s), trigger(s) and amplifier(s). Crisis experience suggests that there is almost always a build-up period facilitated by one or more root causes. A set of root causes and amplifiers are needed for a market disruption as severe as GFC to come to existence. Without these, market disruption caused by trigger event is highly likely to be contained. GFC was a multifaceted disruption; it had various components which contributed to the build-up of the crisis and the resulting contagion. It was a reflection of structural flaws in the financial system, mainly in US. Often-quoted issues like excessive use of leverage, securitization, derivative markets and credit ratings are mostly a result of these structural flaws in the financial system. Problems relating to lack or lag of regulation and inadequate supervision also had a substantial role. FVA may have acted as an amplifier during the GFC. However, if any, its impact was limited. FVA has some serious flaws, like hypothetical market participant and her hypothetical assumptions, but it should be kept in mind that FVA standards are more of a strong guidance, not a straightforward recipe.

Fair Value in the Professional Valuation: Concepts and Models
Artemenkov, Andrey Igorevich
The paper addresses value measurement bases used in professional valuation. We, specifically, consider semantic and methodological features of equitable/fair value as a sui generis basis of Professional valuation. As used in the field of professional valuation, equitable/fair value is the logically necessary basis for estimating values-in-exchange for illiquid assets traded on the markets where the operations of “the law of one price” are very weak. Its logical relevance is demonstrated with the aid of a proposed tool based on Venn-diagrammatic approach (VDA). Then we analyse equitable/fair value estimating techniques resulting from V. Galasyuk’s and the transactional asset pricing approaches (TAPA). The contribution of the paper is in analysing the main aspects of existing equitable/fair value estimation theories in terms of where they fall in the normativist/positivist continuum of economic analysis. It is hoped this paper will help provide a new perspective enriching wider debates on fair value in the accounting measurements world.

Filtering Response Directions
Elliott, Robert J.,Madan, Dilip B.,Wang, King
Equity market interactions with their the option markets are modeled using a two state hidden Markov model permitting transitioning between states when the asset market leads and when the option markets lead. Data on S&P 500 returns and returns on the VIX are employed to filter state probabilities and the transition probabilities between the states. The procedures are extended to other assets and their own asset specific VIX markets. Also included is the market for the VIX and options on the VIX as reflected in the VIX of the VIX. Filtered state and transition probabilities are reported on a variety of assets and their asset specific VIX levels.

Financial Inclusion and Bank Stability: Evidence from Europe
Danisman, Gamze Ozturk,Tarazi, Amine
The Great Recession of 2007-2009 piqued the interest of policymakers worldwide, prompting various initiatives to stabilize the financial system and advance financial inclusion. However, few studies have considered their interconnectedness or whether any synergies or trade-offs exist between them. This paper investigates how financial inclusion affects the stability of the European banking system. The findings indicate that advancements in financial inclusion through more account ownership and digital payments have a stabilizing effect on the banking industry. A deeper investigation shows that such a stabilizing impact is mainly driven by the targeting of disadvantaged adults who are young, undereducated, unemployed, and who live in rural areas. Hence, along with its known benefits to society as a whole, financial inclusion has the additional benefit of improving the stability of the financial system. Such findings call for policy configurations that are specifically designed to achieve financial inclusion for disadvantaged individuals.

Forensic Acculturation for Accountability in Local Governments: A Design Science Approach for School Leaders and Citizens
Kurpierz, John,Smith, Ken
Using Design Science methodology, this article describes a field-tested model of forensic accountants assisting average citizens in improving local governmental accountability and the provision of services via forensic acculturation. While most citizens lack the skills of forensic accountants, citizens have several traits that make them uniquely capable of detecting unhealthy financial behaviors. The field research uncovered systematic patterns of citizens being stymied in moving from the ‘being aware stage’ to the ‘making improvements’ or ‘holding accountable’ stages. We label the patterns of being stymied as 10 D’s (delay, deflect, distort, etc). We also discovered more successful individuals using behaviors we label the 3 P’s (Polite, Persistent & Professional) that are common traits among forensic experts. We provide case study evidence of the effects of citizen training and consultation processes, and refine a teaching tool ("3 P’s and 10 D’s") for use in further field tests.

Gender Equality in Mortgage Lending
Fang, Lu,Munneke, Henry J.
Using a sample of 30-year fixed-rate subprime mortgage loans, this article empirically examines whether gender inequality exists in the mortgage market, specifically whether a borrower’s gender affects the loan contract rate charged, beyond the impact of the borrower’s probability of default and prepayment. The results, based on a competing-risks loan hazard model, reveal that borrowers of different genders have different loan termination patterns. After controlling for the probability of a borrower defaulting or prepaying, female borrowers pay higher contract rates in the subprime mortgage market over the study period.

Gender and Executive Job Mobility: Evidence from Mergers and Acquisitions
Guo, Xiaohu,Gupta, Vishal K.,Mortal, Sandra,Nanda, Vikram K.
The increasing presence of women in executive positions has fostered interest in understanding how men and women fare in the managerial labor market. We examine gender differences in managerial job mobility by focusing on managers displaced (almost 90%) when their firms are acquired. Comparing labor market outcomes for similarly-ranked managers from the same target firm and within the same functional area, we find that career disruption results in a larger drop in rank for female managers, despite similar job search efforts. Gender differences are moderated for managers hired by firms with more women in upper echelon positions. Women with rich prior managerial experience and service on external boards also fare well. Our results point to a significant (implicit) ‘gender penalty’ for women in terms of managerial job mobility, but also indicate contexts in which the penalty may be alleviated, and even reversed.

How Do Savers Think About and Respond to Risk? Evidence From a Population Survey and Lessons for the Investment Industry
Blake, David P.,Haig, Alistair
We find that savers do not tend to think about risk in an integrated way, especially when it comes to long-term risk. Instead they appear to think in segmented boxes. This is very bad for long term planning, since it can lead to inconsistencies. To illustrate, it is possible for people facing a savings shortfall to also be reluctant to either save more or take more investment risk to increase the expected return on their savings. It is important therefore that savers recognize that they might be subject to inconsistencies and behavioral barriers when implementing their savings plans which means they might fail to achieve their savings goals. We propose ways to help savers deal with these issues. These also provide useful lessons for the investment industry, including both financial advisers and product providers.

Impediments for Banks in Case of Loan Adjustment: A Case Study
Rahman, Md. Ashabur
This paper examines the loan adjustment procedure and the efficiency of banks. Banks provide support to their local communities through credit facilities for all legitimate business in line with competitively determined interest rates. Although, making loans is the main economic function of banks. When the loans become uncollectible due to mismanagement, illegal manipulation of loans, misguided lending policies or an unexpected economic downturn, banks fall in trouble. At the time it needs to file law suit to adjust the loans. In an underdeveloped banking system, bank deposits have a positive and significant impact on bank loans, but the reverse relationship is not significant. However, litigation is the last way to recover bad loans.

Industry Dynamics and Capital Structure (Non)Commitment
Chen, Shiqi,Xu, Hui
We study the interaction between industry dynamics and equity holders’ inability to commit to future funding in a competitive equilibrium model. Equity holders are unable to commit to future debt level, but at the same time have to make entry, exit and production decisions in face of competition. The inability to commit significantly increases the cost of debt financing and hinders potential entries into the market. The resultant higher output price, nonetheless, alleviates the debt-equity conflict of the incumbents. More importantly, the leverage dynamics in conjunction with technology shock shapes the distribution of the firm universe, escalating the industry turnover and leverage. Our model also provides a micro-foundation for the highly positive skewed distribution of leverage ratio and empirically accounts for it. Overall, the model sheds new lights on real impacts of equity holders’ inability to commit to future debt level.

Lost Pensions, Lost Pensioners: Is a National Registry of Pension Plans the Answer?
Blake, David P.,Turner, John A.
In the United States and other countries, many retirees face great difficulties in tracing their former employers in order to apply for a pension to which they are entitled. At the same time, pension plans have trouble tracking down pensioners with whom they have lost contact. The problem of lost pensions and lost pensioners was also prevalent in the United Kingdom, but in 1991 the British government established a national registry of pension plans financed by a levy on all registered pension plans. The registry is cheap to run (equivalent to $0.20 per member per annum) and has helped thousands of people receive their pension entitlements. This solution should be considered in the US and other countries with similar problems.

Mortgage Pricing Implications of Prepayment: Separating Pecuniary and Non-pecuniary Prepayment
Fang, Lu
In the study of mortgage loan pricing, prepayment and default hazards are considered. While default results in loss of initial capital, prepayment is the more frequent termination event. This study makes a distinction between pecuniary and non-pecuniary prepayments in the mortgage pricing model. Pecuniary/non-pecuniary prepayments are distinguished from each other based on whether the market interest rate at prepayment is below/above the rate at origination, and thus whether mortgage lenders/investors can reinvest the proceeds at a lower/higher interest rate using the proceeds from a prepaid loan. Using a sample of 30-year fixed-rate mortgage loans for home purchase, this study finds that pecuniary and non-pecuniary prepayments are affected differently by certain overlapping factors and are driven by some unique factors. The results also show that combining these two types of prepayments into a single prepayment measure may yield inaccurate predictions of loan termination probabilities. The results from the mortgage pricing model indicate that pecuniary and non-pecuniary prepayment risks, together with default risk, contribute separately to the pricing of a loan.

Option-Implied Dependence and Correlation Risk Premium
Bondarenko, Oleg,Bernard, Carole
We propose a novel model-free approach to obtain the joint risk-neutral distribution among several assets that is consistent with all market prices of options on these assets and their weighted index. In an empirical application, we use options on the S&P 500 index and its nine industry sectors. The results of our analysis reveal that the option-implied dependence for the nine sectors is highly non-normal, asymmetric, and time-varying. The estimated joint distribution allows us to study two conditional correlations: when the market moves down or up. We find that the risk premium for the down correlation is strongly negative, while the opposite is true for the up correlation. These findings are consistent with the economic intuition that investors dislike the loss of diversification when markets fall, but they actually prefer high correlation when markets rally.

Portfolio Similarity and Asset Liquidation in the Insurance Industry
Girardi, Giulio,Hanley , Kathleen Weiss,Nikolova, Stanislava (Stas),Pelizzon, Loriana,Getmansky Sherman, Mila
We examine whether the concern of academics and regulators about the potential for insurers to sell similar assets due to the overlap in their holdings is justified. We measure this overlap using cosine similarity and find that insurers with more similar portfolios have larger subsequent common sales. We show that faced with a shock to their assets or liabilities, affected insurers with greater portfolio similarity have larger common sales that impact prices. Our measure can be used by regulators to predict the common selling of any institution that reports security or asset class holdings regardless of their public company status making it a useful ex-ante predictor of divestment behavior in times of market stress.

Private Equity, Consumers, and Competition: Evidence from the Nursing Home Industry
Gandhi, Ashvin,Song, YoungJun,Upadrashta, Prabhava
This paper studies the impact of private equity (PE) acquisitions on quality of care in U.S. nursing homes. To do this, we examine 77 PE deals covering 1451 nursing homes between 1993 and 2017. We find significant heterogeneity in the effect of PE ownership according to levels of local market concentration. In highly competitive markets, PE owners increase staffing by $72,501 worth of care annually, while in less competitive markets they reduce staffing by an average of $18,604. These results suggest that PE owners are more sensitive to competitive incentives than non-PE owners. Policymakers concerned about the potential adverse effects of PE ownership on consumer stakeholders should therefore pay careful attention to whether acquisitions occur in concentrated markets. We further show that PE-owned nursing homes respond more strongly to policies intended to spur competition. We study the introduction of the Five-Star Quality Rating System, a policy that increased the salience of staffing for consumers. Following its introduction, PE-owned facilities increased their staffing by an average of $77,063 worth of care more than their non-PE counterparts. Moreover, PE managers more aggressively shift their staffing composition towards registered nurses (RNs) in response to the rating system's emphasis on RN staffing. Taken together, the effect of market concentration and pro-competition policies are substantial. PE owners in highly competitive markets under the five-star system raise staffing expenditure by 3.6% of the mean, or enough to raise RN staffing by 18% of the mean. In contrast, acquisitions in less competitive markets prior to the five-star system lowered staffing expenditure by 4.3% of the mean, cost-equivalent to reducing RN staffing by 21% of the mean.

Pyrrhic Victory? The Unintended Consequences of the UK Pensions Act 2004
Harrison, Debbie,Byrne, Alistair,Rhodes, Bill,Blake, David P.
The UK Pensions Act 2004 has turned the defined benefit pension promise into a pension guarantee and has established the Pension Protection Fund (PPF) in order to secure this guarantee where a company becomes insolvent and the scheme is underfunded. The Act has greatly upset corporate pension sponsors, not only because it has fundamentally altered the voluntary arrangements that these companies provide for their own workforce, but also because it forces financially strong companies to subsidies financially weak companies via the PPF levy. Importantly, it appears that this cross-subsidy relates to jobs as well as pensions.In addition to these observations, we found that the Act will have a number of serious unintended consequences. One consequence is that, as a result of conflicts of interest, company directors increasingly will cease to be members of the trustee board and that as a result of this disconnection between scheme and sponsor, many trustee boards will become rudderless. There is no help from the Act in redressing this situation, but participants in our research suggested a range of sound governance principles that could be used to address how this two-way information vacuum may be filled in future.A further very significant consequence is that the Act will accelerate the demise of defined benefit pension provision in the UK private sector and its replacement with defined contribution schemes in which workers bear all the risks.

Recent Developments in Financing and Bank Lending to the Non-Financial Private Sector 2019 H2
Alves, Pana,Arrizabalaga, Fabián,Delgado, Javier,Ferrer, Alejandro
In the final stretch of 2019, the funds raised by households and non-financial corporations grew at very moderate rates, somewhat below those recorded in the first half of the year. This occurred against a setting of weak demand for funds, in which credit standards for bank loans had tightened slightly, although the cost of credit declined again, in keeping with the more accommodative monetary policy stance. Deposit institutions’ loan portfolios continued to contract, albeit at a more moderate pace, while their average quality improved, with further reductions in the NPL ratio and in foreclosed assets.

Returning to the Core: Rediscovering a Role for Real Estate in Defined Contribution Pension Schemes
Harrison, Debbie,Blake, David P.,Key, Tony
The objective of the research was to analyse and evaluate the role of real estate in the UK’s defined contribution (DC) pensions market in relation to auto-enrollment â€" the new system of pension scheme provision for private sector employees in the UK, which is being phased in by all employers between October 2012 and 2018. The most important feature of auto-enrollment schemes is the ‘default fund’, which is the multi-asset investment strategy designed for the majority of members who do not wish to make investment decisions.The research presents what the authors believe is the first comprehensive independent academic study of its kind that investigates the role of real estate in the new world of auto-enrollment. From our research, it was apparent that although there is clear evidence that real estate is being incorporated as a core (significant separate) asset class in default funds, to fully harness the role real estate can play, DC and real estate professionals need to build a better mutual understanding of their respective markets and objectives.

Shadow Insurance? Money Market Fund Investors and Bank Sponsorship
Unal, Haluk ,Jacewitz, Stefan
In this paper, we argue that bank-sponsored prime institutional money market funds (PI-MMFs) are different from non-bank-sponsored PI-MMFs. This difference can arise because the sponsoring bank holding companies (BHCs) can extend shadow insurance to ailing affiliated MMFs. We hypothesize that PI-MMFs price this shadow insurance through higher expense ratios. Indeed, after September 2008 when industry risk increased, expense ratios were seven basis points higher than those of non-BHC-sponsored MMFs. This increase is of similar size to the average deposit insurance premium charged by the FDIC in 2008. We also show, despite higher expense ratios, the redemptions in BHC sponsored MMFs were lower in contrast to expectations of prior literature.

Sorbojoneen Samajik Bank: An Innovated Model of Interest-free Banking
Zahid, Jawad R
Money is a legal construct evolved as a means of transaction. It is not a tradable commodity. Nevertheless, banks create money at no cost and make profit by borrowing money at low and lending at high interest; then grow the money exponentially by compounding the interest. This is a permanent arbitrage profit making process for banks transferring wealth from the poor to the rich. In turn, it creates inequity in society. It also causes periodic financial market crises when production growth in economy cannot keep pace with the exponential growth of banks’ money creation. On the other hand, borrowing-lending is a social philanthropic practice and bank is a service organization. If, banks stop charging interest on debts, instead, earn revenue from intermediation fees and other service charges, â€" Walla! We have a promise of a whole new world.

Spatial Heterogeneity in the Borrowers' Mortgage Termination Decision â€" a Nonparametric Approach
Fang, Lu,Munneke, Henry J.
This paper attempts to address the issue of borrower heterogeneity when modelling a borrower’s mortgage loan termination behaviors (default and prepayment) by applying a nonparametric spatial model to a traditional competing-risks loan hazard model. In this spatial competing-risks hazard model, all of the parameters are allowed but not forced to vary across space. Using a sample of 30-year fixed-rate subprime mortgage loans for home purchase, this study finds a substantial level of spatial variation in a borrower’s responsiveness to interest rate change and housing equity change in exercising the default or prepayment option. Further analysis indicates that the observed spatial variation is associated with different levels of resistance to negative shocks, financial literacy, and financial constraints.

The Mist of Corporate Innovation
Gao, Xuechen,Luo, Jinbo
This study investigates the impact of air pollution on corporate innovation. Using the satellite generated Particulate Matter 2.5 concentration data in 390 cities in China over the period of 2000-2015, we find that severe air pollution (haze pollution) in a region may deteriorate the innovative performance of companies in the same region. Our results are robust to different air pollution and innovation measures. We employ an instrument variable approach to alleviate potential endogeneity concerns. In addition, we identify two possible mechanisms, reduced funds availability and loss of innovative talents, to explain the negative impact of air pollution on innovation.

The Performance of Hedge Fund Performance Fees
Ben-David, Itzhak,Birru, Justin,Rossi, Andrea
We study the long-run outcomes associated with hedge funds' compensation structure. Over a 22-year period, the aggregate effective incentive fee rate is 2.5 times the average contractual rate (i.e., around 50% instead of 20%). Overall, investors collected 36 cents for every dollar earned on their invested capital (over a risk-free hurdle rate and before adjusting for any risk). In the cross-section of funds, there is a substantial disconnect between lifetime performance and incentive fees earned. These poor outcomes stem from the asymmetry of the performance contract, investors' return-chasing behavior, and underwater fund closures.

To Trend or to Revert - A Portfolio Perspective on Time Series Momentum
Thiruvengadasamy, Balaji
Time series momentum or trend following strategies have grown in popularity among institutional investors, with over $300 billion assets under management in managed futures strategies. A portfolio approach on recent return history of 60 liquid futures across different asset classes shows that evidence for both time series momentum and its opposite, reversal, is weak. While recent literature highlights evidence for reversal over long time horizons, this study shows reversal is significant even in short time horizons and that there is no clear pattern across asset classes.

Turning Pension Plans into Pension Planes: What Investment Strategy Designers of Defined Contribution Pension Plans can Learn from Commercial Aircraft Designers
Blake, David P.,Cairns, Andrew J. G.,Dowd, Kevin
Many, if not most, individuals cannot be regarded as ‘intelligent consumers’ when it comes to understanding and assessing different investment strategies for their defined contribution pension plans. This gives very little incentive to plan providers to improve the design of their pension plans. As a consequence, pension plans and their investment strategies are still currently in a very primitive stage of their development. In particular, there is very little integration between the accumulation and decumulation stages. It is possible to produce well-designed DC plans but these need to be designed from back to front (that is, from desired outputs to required inputs) with the goal of delivering an adequate targeted pension with a high degree of probability. We use the analogy of designing a commercial aircraft to explain how this might be done. We also investigate the possible role of regulators in acting as surrogate ‘intelligent consumers’ on behalf of plan members.

UK Pension Fund Management: How is Asset Allocation Influenced by the Valuation of Liabilities?
Blake, David P.
A single valuation basis (using market values) now dominates the valuation of pension scheme assets and has replaced the previously dominant actuarial and accounting bases.The same cannot be said for pension scheme liabilities. There are three different valuation bases for liabilities currently in use: a statutory basis (specified in the 1986 Finance Act), an actuarial basis (the Minimum Funding Requirement, specified in the 1995 Pensions Act) and an accounting basis (specified in Financial Reporting Standard 17). Since each of these uses different underlying assumptions, the three bases are not consistent with each other and produce substantially different measures of pension scheme liabilities. None of these measures corresponds to an economic valuation. Moves should be made to develop a single valuation basis for pension liabilities.A key difference relates to the discount rate used to calculate the present value of future pension payments. The Accounting Standards Board’s new FRS17 and the recent MFR Review conducted by the Faculty and Institute of Actuaries have both proposed a bond-based discount rate. Anecdotal evidence suggests that this is pushing pension fund asset allocations towards bonds in an attempt to reduce the short-term volatility mismatch between assets and liabilities. Moves should be made to ensure that the valuation basis for pension liabilities does not distort pension fund asset allocations.As a consequence, asset allocations are being pulled away from the asset classes most suitable for the long-term asset allocation of pension funds, namely equities and property. This raises the long-term cost to the sponsor of delivering defined benefit pensions, further encouraging the switch to defined contribution schemes.Various insurance-based mechanisms have recently been proposed in the event of scheme insolvency, namely a central discontinuance fund and mutual or commercial insurance. Experience from the US suggests that moral hazard risks are such that commercial insurance might provide the best chance of reflecting accurately the insolvency risk associated with a scheme’s particular funding stance should the MFR be replaced.

Understanding Momentum and Reversals
Kelly, Bryan T.,Moskowitz, Tobias J.,Pruitt, Seth
Stock momentum, long-term reversal, and other past return characteristics that predict future returns also predict future realized betas, suggesting these characteristics capture time-varying risk compensation. We formalize this argument with a conditional factor pricing model. Using instrumented principal components analysis, we estimate latent factors with time-varying factor loadings that depend on observable firm characteristics. We show that factor loadings vary significantly over time, even at short horizons over which the momentum phenomenon operates (one year), and that this variation captures reliable conditional risk premia missed by other factor models commonly used in the literature. Our estimates of conditional risk exposure can explain a sizeable fraction of momentum and long-term reversal returns and can be used to generate even stronger return predictions.

Valoración y Análisis de Activos de Renta Fija (Fixed Income Assets: Valuation)
Villar, Germán
Spanish abstract: El presente paper desarrolla las características básicas de la valoración y análisis de los activos de renta fija.English abstract: This paper develops the basic characteristics of the valuation and analysis of fixed income assets.

VfM: Assessing Value for Money in Defined Contribution Default Funds
Harrison, Debbie,Blake, David P.,Dowd, Kevin
In this report, we ask whether the cost of pension scheme membership in the UK (we use the total expense ratio or TER) offers value for money to the ‘average’ member, by which we mean the 90-97% of employees who will be automatically enrolled into the default fund. The key features of a pension scheme’s VfM are the design and cost of the default asset allocation strategy, plus scheme costs, such as administration, marketing and communication. In most cases, the stated cost of asset management is not the biggest component of the TER. However, it is not always clear what other component costs cover and whether these should be paid for by the member. In some cases, the member charge increases when a member leaves the scheme or transfers their pot to another scheme. Good governance requires VfM to be maximized, while recognizing that ‘cheapest’ does not always mean ‘best’ and that the quality of services such as administration is as important as their cost. Good governance also requires the regular assessment of how the scheme is delivering VfM.