Research articles for the 2020-07-08

A Natural Actor-Critic Algorithm with Downside Risk Constraints
Thomas Spooner,Rahul Savani

Existing work on risk-sensitive reinforcement learning - both for symmetric and downside risk measures - has typically used direct Monte-Carlo estimation of policy gradients. While this approach yields unbiased gradient estimates, it also suffers from high variance and decreased sample efficiency compared to temporal-difference methods. In this paper, we study prediction and control with aversion to downside risk which we gauge by the lower partial moment of the return. We introduce a new Bellman equation that upper bounds the lower partial moment, circumventing its non-linearity. We prove that this proxy for the lower partial moment is a contraction, and provide intuition into the stability of the algorithm by variance decomposition. This allows sample-efficient, on-line estimation of partial moments. For risk-sensitive control, we instantiate Reward Constrained Policy Optimization, a recent actor-critic method for finding constrained policies, with our proxy for the lower partial moment. We extend the method to use natural policy gradients and demonstrate the effectiveness of our approach on three benchmark problems for risk-sensitive reinforcement learning.

A Study on Retail Investors Asset Choices and its association with Demographic Parameters
Samudra, Aparna
The investment decisions of the investors are guided by both economic as well as demographic factors. The risk, return, liquidity etc. are not sufficient to explain the rationale behind the asset choices of the individual. This research explains the investment preferences of retail investors and also analyses the association of demographic factors like income and occupation with the asset choices of the retail investor of Nagpur city. To study the investment preference of 415 respondents Garrett Ranking test was applied and it was identified that Equity Shares is the most preferred investment followed by mutual funds. To study the association between income, occupation and investors asset choices Kruskal Wallis test was applied in the SPSS software and it was concluded that income and occupation are not strongly associated with the choices of the respondents.The results of the data analysis indicates that around 42% of the respondents are investing only upto 10% of their income which is in line with the National trend highlighted in the RBI report (Reserve Bank of India, 2019). When it comes to making allocation of money towards various assets, the Indian investors are shifting their preferences from traditional physical and financial assets towards new investment avenues such as mutual funds and equity shares (Karvy Private Wealth, 2019). The most preferred asset class for the respondents of the study is equity shares followed by mutual funds as per the Garrett Ranking. The asset allocation is done by the investors keeping in mind their investment objectives, the respondents of the study said that the prime three objectives of their investment includes wealth creation (Samudra & Burghate, 2012), regular income and tax planning. The assets prefered by the respondents are in sync with their investment objectives. The investor asset choices are also governed by factors such as age, gender, occupation and income etc. (Mittal, 2017) concluded that demographic parameters like education, occupation and family income have an impact on investment decisions. The researchers with the help of data analysis have established that there is an association between the asset choices of individuals and income for certain assets like equity shares, insurance, commodities, public provident funds and government bonds and also occupation has an association with preference for assets like mutual funds, equity share derivatives and public provident fund. The market regulators like SEBI, AMFI, broking houses and private wealth management firms keep conducting research in this area to improve the participation of individuals in capital markets, to guide them in achieving their financial goals and to develop new financial products and services to meet their financial objectives.

Accounting Comparability and the Value Relevance of Earnings and Book Value
Chen, Bingyi,Kurt, Ahmet C.,Wang, Guannan
The value relevance of financial statements is of great significance to investors and standard setters. The present research examines whether accounting comparability among industry peers enhances the value relevance of earnings and book value. This is an important question because both the Financial Accounting Standards Board and the Securities Exchange Commission seek greater comparability in financial reporting. However, there is limited empirical evidence on how comparability affects the value relevance of accounting information in the U.S. Our results show that accounting comparability increases the value relevance of earnings, but not book value. That is, when firms exhibit greater accounting comparability vis-à-vis industry peers, investors attach higher value to reported earnings. In terms of economic significance, the value relevance of earnings is 25.2 percent higher when accounting comparability is higher by one standard deviation. However, the incremental benefits of accounting comparability are attenuated when financial reporting opacity is high or when there exists an internal control material weakness over financial reporting. In contrast, comparability benefits are enhanced when an industry specialist auditor is employed. Our results are robust to using different model specifications.

Accounting for Financial Stability: Bank Disclosure and Loss Recognition in the Financial Crisis
Bischof, Jannis,Laux, Christian,Leuz, Christian
This paper examines banks’ disclosures and loss recognition in the financial crisis and identifies several core issues for the link between accounting and financial stability. Our analysis suggests that, going into the financial crisis, banks’ disclosures about relevant risk exposures were relatively sparse. Such disclosures came later after major concerns about banks’ exposures had arisen in markets. Similarly, the recognition of loan losses was relatively slow and delayed relative to prevailing market expectations. Among the possible explanations for this evidence, our analysis suggests that banks’ reporting incentives played a key role, which has important implications for bank supervision and the new expected loss model for loan accounting. We also provide evidence that shielding regulatory capital from accounting losses through prudential filters can dampen banks’ incentives for corrective actions. Overall, our analysis reveals several important challenges if accounting and financial reporting are to contribute to financial stability.

An Analytical Study on Association of Demographic Factors With Risk Tolerance Level of Investors of Nagpur
Samudra, Aparna
Rational investor is risk averse, but the willingness to accept unfavourable changes in the returns of an asset differs from person to person. This willingness which is known as risk tolerance is influenced by many factors. The main purpose of this study is to understand and analyse the relation between demographic variables and risk taking capacity of individuals. The sample size for the study was 521 retail investors of Nagpur City in India. The statistical tools like Kruskal Wallis Test, Mc.Nemar Test and Chi-square were used to test the hypothesis. The data analysis indicated that demographic parameters like gender, education, monthly income, occupation and % of income invested have an association with the risk tolerance level. It was also observed that there is a difference between perception of investors regarding investment of earned income and investment of inherited money. Risk tolerance was found to be significantly related with level of education and income but not with age. Men were found to be more risk tolerant than women and similarly type of profession also had a significant relationship with risk tolerance of the investors.

An Investigation of U.S. Critical Audit Matter Disclosures
Burke, Jenna,Hoitash, Rani,Hoitash, Udi,Xiao, Xia
This study investigates the newly disclosed U.S. critical audit matters (CAMs) and fills two important gaps in the international literature on expanded audit reports. First, we extensively explore the determinants of CAM disclosures, and find that complexity, financial reporting issues, and the magnitude of accounts that require high degrees of judgment predict the quantity and subject of CAM disclosures. Unlike non-U.S. settings, we find that the majority of issuers disclose only one CAM, which is perplexing given the size and complexity of CAM adopters. Nevertheless, using textual similarity measures, we find that the language in CAM disclosures is not boilerplate as regulators and investors feared. Second, we examine whether CAMs are associated with changes to management’s disclosures. Uniquely, using textual analysis, we document significant changes in financial statement footnotes referenced by CAMs, suggesting that management, alone or in conjunction with their auditor, changes their disclosure in an apparent attempt to expand and clarify areas that may be scrutinized. In additional analysis, we comprehensively examine traditional outcomes from the expanded audit report literature and detect no market reaction or overall changes to audit quality or fees following the CAM disclosure requirement. Overall, our findings provide insights on the new CAM standard, especially for the PCAOB and auditors of smaller filers that are not yet required to comply with the regulation.

Anti-Selective Disclosure Regulation and Analyst Forecast Accuracy and Usefulness
Cowan, Arnold R.,Salotti, Valentina
We investigate regulations intended to stop managers from privately disclosing corporate information to analysts in a setting with enhanced potential to isolate regulatory effects: the European Union (EU) Market Abuse Directive (MAD), a common regulation implemented by member states with varying sanctions and enforcement resources. Following the implementation of MAD in a country, analyst forecasts become more accurate, with relatively little of the effect attributable to increased voluntary public disclosure by covered firms. The effect of MAD on analyst accuracy is stronger in countries with more stringent enforcement and sanction systems. Although the improvement in accuracy is associated with the implementation of MAD alone, stock prices do not respond more strongly to analyst forecast releases until after market-trading enforcement improves under subsequent EU legislation (MiFID).

Computation of bonus in multi-state life insurance
Jamaal Ahmad,Kristian Buchardt,Christian Furrer

We consider computation of market values of bonus payments in multi-state with-profit life insurance. The bonus scheme consists of additional benefits bought according to a dividend strategy that depends on the past realization of financial risk, the current individual insurance risk, the number of additional benefits currently held, and so-called portfolio-wide means describing the shape of the insurance business. We formulate numerical procedures that efficiently combine simulation of financial risk with more analytical methods for the outstanding insurance risk. Special attention is given to the case where the number of additional benefits bought only depends on the financial risk.

Corporate Valuation Techniques & Applications: A Case Study
Islam, Md Saiful
The primary concern of financial analysis is the operating performance of a firm when they consider investing in a firm. Due to recent several corporate bankruptcies, the financial analysts and Finance Managers are using different valuation methods in order to achieve more accurate results out of their analysis before deciding upon further investments (Beneda 2003). Sofat et al. (2011), in their book Strategic Financial Management, described the valuation of a firm as a combination of theory, judgments, and experience. Bradford Cronell (cited in Sofat 2011:275) expressed the same view about the corporate valuation “Valuing a company is neither an art nor a science but an odd combination of both. There is enough science that appraisers are not left to rely solely on experience, but there is enough art that without experience and judgments, failure is assured.”Business valuation is done for a different reason i.e. acquisition & disposal, stock market floatation, share disposal or purchase in unlisted companies, internal trading of employees’ shares or options, assessment of an owner’s tax liabilities, and establishing collateral for a loan (anon 2008). In this case study, we will explore different corporate valuation techniques and identify the strengths and weaknesses of those techniques. Furthermore, we will perform the valuations on a publicly listed company to determine whether this company is a worthwhile investment. As the Free Cash Flow (FCF) basis valuation produces a most accurate assessment of economic worth (anon 2008), we will perform this valuation first and later we will carry out the Dividend basis and Earnings basis valuation in order to determine whether our selected company is worth to be invested in.

Data Security and Merger Waves
Sun, Yuan,Wei, Lai,Xie, Wensi
We examine whether data security affects the merger waves in the era of big data. Exploiting the staggered adoption of laws that require mandatory disclosure of data breaches across states, we find a significant increase in the number and values of acquisitions of a state’s data-intensive companies after the state enacted the laws. The effects are stronger among industries that are more competitive and technology intensive. Acquirers offer a higher premium for data-intensive targets in states that have adopted the laws. These results suggest that the data breach laws facilitate M&A deals by mitigating targets’ data lemon problem.

Determinants of Working Capital of Indian MSMEs
Shroff, Sumita J
The Indian Micro, Small, and Medium Enterprises are the forerunners in the Indian growth story with a contribution of 29 percent to Indian GDP, 45 percent contribution to exports, and employment generation of 11.10 crores. Further, every business entity needs working capital to facilitate the smooth functioning of its business, revenue generation, and efficient asset utilization. In this context, the current study examined the determinants of working capital of the Indian Micro, Small, and Medium Enterprises over a period of 13 years from 2006-07 to 2018-19. Taking firm size, tangibility, leverage, profitability, sales growth, as determining variables, the results of stepwise regression analysis revealed that firm size and leverage are significant determinants of working capital for firms in Indian MSMEs in the chemical industry.

Distracted Analysts: Evidence from Climatic Disasters
Han, Yuqi,Mao, Connie X.,Tan, Hongping,Zhang, Chi
We study the causal effect of climatic disasters on information production in capital market. We find that analysts who are hit by a disaster have higher earnings forecast errors within three months after the disaster and are more likely to reiterate their previous forecasts. Stock prices respond less strongly to earnings revisions by distracted analysts. Analysts affected by disasters strategically allocate their scarce attention to firms of greater importance or salience. The distraction effect of disasters is smaller among analysts who had experienced natural disasters in the recent past, and larger in disaster-struck firms where demand for analyst attention rises.

Do Court Delays Distort Capital Formation?
Koutroumpis, Pantelis,Ravasan, Farshad
Weak enforcement of financial contracts often distorts the incentive to invest and delays efforts to catch up with the technology frontier. We study how longer bankruptcy trials affect the cost, structure and allocation of corporate capital across different regions in Italy. We take advantage of an exogenous change in local court efficiency caused by the reorganization of judicial districts under the legislative reform of 2012. Using an instrumental variable strategy, we find that the change in length of bankruptcy proceedings had a strong impact on firm-level outcomes. Our estimates show that the interquantile reduction in the length of bankruptcy trials lowers the marginal cost of capital by 11.5% and increases the firm’s capital stock and capital intensity of production by 9.7% to 11.5%. Significantly, our results show that poor enforcement of financial contract lead firms to under-allocate capital in their intangible assets. Moreover the effects are stronger in sectors that depend more on external finance and firms with high leverage.

Does Savings Affect Participation in the Gig Economy? Evidence from a Tax Refund Field Experiment
Bufe, Sam,Roll, Stephen,Kondratjeva, Olga,Hardy, Bradley,Grinstein-Weiss, Michal
This paper investigates how saving the federal tax refund affects gig economy participation forlow-income online tax filers in the six months following tax filing. Using longitudinal surveyand administrative data, we leverage random assignment in a unique refund savings experimentas an instrument for refund savings. We find significant heterogeneity in estimated effects thatare consistent with life cycle models on consumption and savings. Specifically, refund savingsreduced the likelihood of low-income students working in the gig economy, but increased thelikelihood of more economically vulnerable households working in the gig economy.

Evidence of Crowding on Russell 3000 Reconstitution Events
Micheli, Alessandro,Neuman, Eyal
We develop a methodology which replicates in great accuracy the FTSE Russell indexes reconstitutions, including the quarterly rebalancings due to new initial public offerings (IPOs). While using only data available in the CRSP US Stock database for our index reconstruction, we demonstrate the accuracy of this methodology by comparing it to the original Russell US indexes for the time period between 1989 to 2019. A python package that generates the replicated indexes is also provided. As an application, we use our index reconstruction protocol to compute the permanent and temporary price impact on the Russell 3000 annual additions and deletions, and on the quarterly additions of new IPOs . We find that the index portfolios following the Russell 3000 index and rebalanced on an annual basis are overall more crowded than those following the index on a quarterly basis. This phenomenon implies that transaction costs of indexing strategies could be significantly reduced by buying new IPOs additions in proximity to quarterly rebalance dates.

Explicit option valuation in the exponential NIG model
Jean-Philippe Aguilar

We provide closed-form pricing formulas for a wide variety of path-independent options, in the exponential L\'evy model driven by the Normal inverse Gaussian process. The results are obtained in both the symmetric and asymmetric model, and take the form of simple and quickly convergent series, under some condition involving the log-forward moneyness and the maturity of instruments. Proofs are based on a factorized representation in the Mellin space for the price of an arbitrary path-independent payoff, and on tools from complex analysis. The validity of the results is assessed thanks to several comparisons with standard numerical methods (Fourier-related inversion, Monte-Carlo simulations) for realistic sets of parameters. Precise bounds for the convergence speed and the truncation error are also provided.

Finance, Governance and Inclusive Education in Sub-Saharan Africa
Asongu, Simplice,Odhiambo, Nicholas
This research assesses the importance of credit access in modulating governance for gender inclusive education in 42 countries in Sub-Saharan Africa with data spanning the period 2004-2014. The Generalized Method of Moments is employed as empirical strategy. The following findings are established. First, credit access modulates government effectiveness and the rule of law to induce positive net effects on inclusive “primary and secondary education”. Second, credit access also moderates political stability and the rule of law for overall net positive effects on inclusive secondary education. Third, credit access complements government effectiveness to engender an overall positive impact on inclusive tertiary education. Policy implications are discussed with emphasis on Sustainable Development Goals.

Financial Sector Transparency and Net Interest Margins: Should the Private or Public Sector lead Financial Sector Transparency?
Kusi, Baah,AGBLOYOR, ELIKPLIMI,Gyeke-Dako, Agyapomaa,Asongu, Simplice
This study examines the effect of private and public sector led financial sector transparency on bank interest margins across eighty-six economies. Using a two-step dynamic system generalized method of moments, least square dummy variables, fixed effects and bootstrap quantile panel models between 2005 and 2016, the findings of the two-step GMM are reported as follows. First, results reveal that financial sector transparency whether led by private or public sector reduces interest margins. Second, while no statistical evidence was found on which of the two (private or public sector led transparency) is more effective in dealing with bank interest margins, public sector-led financial transparency is found to be more consistent in reducing bank interest margins across many more economies. Third, the study shows that the effect of financial sector transparency is visible at lower and middle levels of bank interest margins implying that economies with lower and moderately high bank interest margin level can benefit more from policies targeted at improving transparency in the financial sector. These findings imply that the sampled countries must enact policies and laws that deepen and expand financial sector transparency in order to potentially reduce bank interest margins for the good of banking market participants and society at large.

Heterogeneous Risk Behaviour of Bank Holding Companies after the Doddâ€"Frank Act
Clark, Ephraim,Degl'Innocenti, Marta,Radic, Nemanja,Zhou, Si
We investigate the risk-taking behaviour of Bank Holding Companies (BHCs) that are subject to the Doddâ€"Frank Act (DFA). Specifically, we employ a difference-in-differences method to assess the effectiveness of the DFA in reducing the riskiness of complex banks and their contribution to systemic risk. Consistent with the Risk Monitoring Hypothesis, our results suggest that the DFA generally reduced the market risk and Distance to Default of complex BHCs and increased their stability. Furthermore, our findings show that the DFA also caused a significant reduction in the BHC contribution to systemic risk, measured both as Expected Capital Shortfall and the Systemic Expected Shortfall. In addition, we identified various economic transmission channels to explain how the DFA has affected the individual risk of complex BHCs. Our findings are robust to a battery of additional analyses and tests.

Impact Investing 2.0: Building the Impact Economy
Martin, Maximilian
This course focuses on “impact investing 2.0” and was taught at the University of St. Gallen in 2016. Excluding illiquid assets and cash, the World Wealth Report 2016 calculated that globally, 31% of high net worth investment portfolios are based on the concept of social gain. Over the past several years, the level of discussion taking place by government, investors, philanthropists, and nonprofits around the topic of impact investment â€" the practice of investing with the intention to generate measurable social and environmental impact alongside a financial return â€" has kept hitting new high watermarks.Is it also another silver bullet for addressing skyrocketing deficits, uncertain financial markets, and staggering need just around the corner? Not yet, and it will not be unless the industry manages to successfully address its limiting constraints. For instance, J.P. Morgan predicted in 2010 that the market has the potential over the next 10 years for invested capital of USD 400bnâ€" USD 1tn and profit of USD 183bnâ€"USD 667bn. However, contrast this with the fact that there were over USD 600tn in financial assets globally in 2010, and that there will be an estimated USD 900tn in financial assets in 2020. Many consider J.P. Morgan’s estimates about the potential market size ambitious. Even if they are correct, impact investing might grow to only 0.1 percent of all financial assets by the end of the decade. This means it seemingly has all the promise of a drop in the bucket.Yet, if impact investment does its homework, and asserts itself as an investment style rather than an asset class, the ramifications of this industry for the overall competitiveness, prosperity and sustainability of the world’s market economies could very well exceed the significance implied by the estimates.This course discusses an industry on the cusp. It looks at the fundamentals driving the magnitude of supply and demand. It looks at how all actors involved â€" from foundations to angel investors to financial services institutions to name a few â€" can contribute to and benefit from the growing impact investing industry.The course’s key goals are: to understand the fundamental context for impact investing; to grasp impact investing requirements; to develop an ability to spot impact investing opportunities; and to work as a team to develop a final paper on a relevant aspect of impact investing.

Institutional Investment Horizon and Hedge Fund Activism
Togan Egrican, Asli
I examine how institutional investment horizon affects hedge fund activism. I find that hedge fund activism is higher in firms that long-term institutional investors invest. Furthermore, hedge fund campaigns and success rates differ with investment horizon of institutions. Firms with investors that have long-term investment horizons are more likely to receive demands on corporate governance improvements. These firms also experience significant improvement in firm performance post shareholder activism. Firms that are targeted by hedge funds and have institutional investors with shorter-term investment horizons, on the other hand, are more likely to be delisted. Also, there is no significant performance improvement in these firms post activism. Overall, the results suggest that investment horizon of institutional owners is an important factor in explaining strategies explored in hedge fund activism as well as their effects on firm value. The findings support the notion of collaborative monitoring role of long-term institutional investors and hedge fund activists.

Institutional Investment Horizons, Corporate Governance, and Credit Ratings: International Evidence
Driss, Hamdi,Drobetz, Wolfgang,El Ghoul, Sadok,Guedhami, Omrane
Using a comprehensive set of firms from 57 countries over the 2000â€"2016 period, we examine the relation between institutional investor horizons and firm-level credit ratings. Controlling for several firm- and country-specific factors, as well as for firm fixed effects, we find that larger long-term (short-term) institutional ownership is associated with higher (lower) credit ratings. This finding is robust to sample composition, alternative estimation methods, and addressing endogeneity. Long-term institutional ownership affects ratings more during times of higher expropriation risk, for firms with weaker internal governance, and for those in countries with lower-quality institutional environments. Additional analysis shows that long-term investors can facilitate access to debt markets for firms facing severe agency problems. These findings suggest that, unlike their short-term counterparts, long-term investors can improve a firm’s credit risk profile through effective monitoring.

Is It Worth Reducing GHG Emissions? Exploring the Effect on the Cost of Debt Financing
Pizzutilo, Fabio,Mariani, Massimo,Caragnano, Alessandra,Zito, Marianna
Notwithstanding the proliferation of papers dealing with the corporate finance implications of the so-called “carbon risk”, very few studies analysed in depth the relationship between the firm’s environmental risk profile and the cost of debt financing. We contribute to this stream of research by inspecting the relationship between EuroStoxx 600 companies’ carbon emissions and cost of debt financing. We argue that lenders mitigate the impact of borrowers’ GHG emissions on their future cash flows primarily requiring firms with higher carbon emissions intensity to pay significantly higher costs for financing their operations through indebtedness. We also found statistically significant evidence to support the conclusion that the positive effect of carbon emissions reduction on the cost of debt financing is relevant both for high and low emitting industries. Finally, we postulated that high emitting firms pay, on average, a higher cost of debt financing than less olluting firms but are less penalized if an increase in their carbon intensity occurs. To the best of our knowledge, this is the very first study to directly document the impact of carbon emissions on the cost of debt financing for non-financial European industries, substantially enriching the existing environmental financial literature.

Latent Group Structures with Heterogeneous Distributions
Leng, Xuan,Chen, Heng,Wang, Wendun
This paper aims to identify the latent grouped heterogeneity of distributional effects. We consider two panel quantile regression models with additive fixed effects, where quantile slope coefficients differ across groups. The first model allows grouped and time fixed effects, and we propose a composite-quantile approach to jointly estimate group memberships, slope coefficients, and fixed effects. We show that using multiple quantiles improves clustering accuracy if memberships are quantile-invariant. Our second model extends the first specification by allowing individual and time fixed effects, and we propose an innovative double-clustering estimation approach. We apply the methods to examine the relationship between managerial incentives and risk-taking behavior.

M&A Activity and the Capital Structure of Target Firms
Flannery , Mark J.,Hanousek, Jan,Shamshur, Anastasiya,Tresl, Jiri
Using a large sample of European acquisitions, we find that acquired firms substantially close the gap between their actual and optimal leverage ratios. The bulk of this adjustment occurs quite rapidly â€" within a year of the acquisition. The typical over-levered firm adjusts its debt-to-assets ratio from 34.4% in the year before acquisition to 20% in the year after. (The adjustment is smaller, but still quite rapid, for targets that had been under-leveraged.) These adjustments occur primarily through debt issuances or retirements. We also investigate whether target firms’ pre-merger leverage contributes to the probability of them being acquired. We find that firms further away from their optimal leverage are more likely to be acquired: for an average firm, an increase in the absolute leverage deviation from 1% to 10% of total assets increases the probability of being acquired by 4.1% to 5.6% (The larger effect applies to over-leveraged firms.) Overall, our results provide support for the trade-off theory of capital structure and suggest that financial synergies have a significant role in the typical European acquisition decision.

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

Measuring Global Macroeconomic Uncertainty
Moramarco, Graziano
This paper provides new indices of global macroeconomic uncertainty and investigates the cross-country transmission of uncertainty using a global vector autoregressive (GVAR) model. The indices measure the dispersion of forecasts that results from parameter uncertainty in the GVAR. Relying on the error correction representation of the model, we distinguish between measures of short-run and long-run uncertainty. Over the period 2000Q1-2016Q4, global short-run macroeconomic uncertainty strongly co-moves with financial market volatility, while long-run uncertainty is more highly correlated with economic policy uncertainty. We quantify global spillover effects by decomposing uncertainty into the contributions from individual countries. On average, over 40% of country-specific uncertainty is of foreign origin.

Mechanics of good trade execution in the framework of linear temporary market impact
Claudio Bellani,Damiano Brigo

We define the concept of good trade execution and we construct explicit adapted good trade execution strategies in the framework of linear temporary market impact. Good trade execution strategies are dynamic, in the sense that they react to the actual realisation of the traded asset price path over the trading period; this is paramount in volatile regimes, where price trajectories can considerably deviate from their expected value. Remarkably however, the implementation of our strategies does not require the full specification of an SDE evolution for the traded asset price, making them robust across different models. Moreover, rather than minimising the expected trading cost, good trade execution strategies minimise trading costs in a pathwise sense, a point of view not yet considered in the literature. The mathematical apparatus for such a pathwise minimisation hinges on certain random Young differential equations that correspond to the Euler-Lagrange equations of the classical Calculus of Variations. These Young differential equations characterise our good trade execution strategies in terms of an initial value problem that allows for easy implementations.

Network effects and the appointment of female board members in Japan
Matthias Raddant,Hiroshi Takahashi

We investigate the dynamics in the networks of Japanese corporates and its interplay with the appointment of female board members. We find that firms with female board members show homophily with respect to gender and often have above average profitability. We also find that new appointments of women are more likely at boards which observe female board members at other firms to which they are tied by either ownership relations or corporate board interlocks.

One Model Is Not Enough: Heterogeneity in Cryptocurrencies’ Multi-fractal Profiles
Bariviera, Aurelio F.
This letter studies of the multi-fractal dynamics in 84 cryptocurrencies. It fills an important gap in the literature, by studying this market using two alternative multi-scaling methodologies. We find compelling evidence that cryptocurrencies have different degree of long range dependence, and â€" more importantly â€" follow different stochastic processes. Some of them follow models closer to mono-fractal fractional Gaussian noises, while others exhibit complex multi-fractal dynamics. Regarding the source of multi-fractality, our results are mixed. Time series shuffling produces a reduction in the level of multi-fractality, but not enough to offset it. We find an association of kurtosis with multi-fractality.

Option Market Making with Inventory Risk: The Effect on Information Diffusion
Didisheim, Antoine
This paper develops a model to study how option market makers' inventory and capital influence the relative informativeness of the option and stock markets. The model suggests that the option market maker's capital defines a lower bound for the option market informativeness. In addition, when perfect hedging is impossible, a larger inventory of sold (bought) options diminishes the informativeness of changes in the option's ask (bid) quote and increases the informativeness of changes in the option's bid (ask) quote. Finally, the model implies that noisy information is more likely to enter through the option market than the stock market. My empirical analysis provides stylized facts consistent with the model's key implications.

Option pricing models without probability: a rough paths approach
John Armstrong,Claudio Bellani,Damiano Brigo,Thomas Cass

We describe the pricing and hedging of financial options without the use of probability using rough paths. By encoding the volatility of assets in an enhancement of the price trajectory, we give a pathwise presentation of the replication of European options. The continuity properties of rough-paths allow us to generalise the so-called fundamental theorem of derivative trading, showing that a small misspecification of the model will yield only a small excess profit or loss of the replication strategy. Our hedging strategy is an enhanced version of classical delta hedging where we use volatility swaps to hedge the second order terms arising in rough-path integrals, resulting in improved robustness.

Orders Backlog in Earnings Conference Calls
Feldman, Ronen,Govindaraj , Suresh ,Livnat, Joshua,Suslava, Kate
Firm disclosure of order backlog (OB) is considered important to assess future sales and profits. The extant literature on OB has generally documented positive associations between increases in OB and market returns. These associations were based on annual disclosures of backlog in 10-K filings, and could have been caused by other simultaneous disclosures that were also correlated with order backlog. To focus on the direct effects of backlog on market participants, we use references to OB in earnings conference call transcripts. We find incremental market reactions to OB after controlling for earnings surprise and other information communicated during the conference call. Our findings also reveal that OB disclosures are more relevant when they are supported by numbers and when firms derive a material amount of their demand from OB.

Pandemic-Resistant Corporate Law: How to Help Companies Cope with Existential Threats and Extreme Uncertainty During the Covid-19 Crisis
Enriques, Luca
This essay argues that, to address the Covid-19 crisis, in addition to creating a special temporary insolvency regime, relaxing provisions for companies in the vicinity of insolvency, and enabling companies to hold virtual meetings, policymakers should tweak company law to facilitate equity and debt injections and address the consequences of the extreme uncertainty faced by European firms. After some general reflections upon the type of rules that are needed in these exceptional times, examples of temporary corporate law interventions for the emergency are provided. Specifically, rules to facilitate injections of equity capital and shareholder loans are suggested, together with relaxations of directors’ liability rules and measures to protect firms against hostile takeovers. All of these measures should apply merely by default and only for so long as the emergency lasts. The essay concludes with some thoughts about how to make normal-times corporate law ready for similar emergencies in the future. The goal is both to reduce the risk that the temporary extreme measures enacted for this crisis are made permanent under the pretence that another crisis may hit again and to have quick adaptation mechanisms already in place to respond to such a crisis.

Predictability Puzzles
Eraker, Bjorn
Dynamic equilibrium models based on present value computation imply that returns are predictable but also generate particular patterns of predictability in asset returns. I take advantage of this to construct a set of tests of Equilibrium Generated Predictability (EGP). I apply the tests to document two puzzles: First, option implied or realized measures of volatility ought to predict returns but do not. Second, the Variance Risk Premium (VRP) predicts returns but only at long horizons. VRP fails the tests of EGP as the term structure of predictable variation is inconsistent with an equilibrium interpretation.

Propping in the Pyramidal Business Groups in Turkey
Gürünlü, Meltem
This article investigates the existence of propping in Turkish business group firms for the years 2010â€"2016 (150 firms and 1,050 firm-year data in total). It is claimed that pyramidal ownership in Turkey is used to prop up intra-group funds and is a beneficial vehicle providing a less costly way of financing. The empirical results of the research indicate the existence of propping in the Turkish business groups and bring a debt and dividends (debt service hypothesis) related explanation for the propping phenomenon in the pyramidal business groups. Accordingly, the key findings indicate that firms within the business group transfer funds to each other via debt and dividends channels in order to reduce financial distress. Hence, business groups in Turkey use pyramidal ownership as a financing vehicle to increase internal capital market funds and a substitute for incomplete financial markets. Propping provides an implicit insurance against bankruptcy risk.

Quantitative Easing and Financial Risk Taking: Evidence from Agency Mortgage Reits
Frame, W. Scott,Steiner, Eva
An emerging literature documents a link between central bank quantitative easing (QE) and financial institution credit risk-taking. This paper tests the complementary hypothesis that QE may also affect financial risk-taking. We study Agency MREITs â€" levered shadow banks that invest in guaranteed U.S. Agency mortgage-backed securities (MBS) principally funded with repo debt. We show that Agency MREIT growth is inversely related to the Federal Reserve’s Agency MBS purchases, reflecting investor portfolio rebalancing. We also find that these institutions increased leverage during the later stages of QE, consistent with “reaching for yield” behavior. Agency MREITs seem to concurrently adjust their liquidity and interest rate risk profiles.

Risks on Global Financial Stability Induced by Climate Change
Mandel, Antoine
There is increasing concern among financial regulators that changes in the distribution and frequency of extreme weather events induced by climate change could pose a threat to global financial stability. In order to assess this risk, we develop a simple model of the propagation of climate-induced shocks through financial networks. Weshow that the magnitude of global risks is determined by the interplay between the exposure of countries to climate-related natural hazards and their financial leverage. Climate change induces a shift in the distribution of impacts towards high-income countries and a thus larger amplification of impacts as the financial sectors of high-income countries are more leveraged. Conversely, high-income countries are more exposed to financial shocks. In high-end climate scenarios, this could lead to the emergence of systemic risk as total impacts become commensurate with the capital of the banking sectors of countries that are hubs of the global financial network. Adaptation policy, or the lack thereof, appears to be one of the key risk drivers as it determines the future exposure of high-income countries.

Robust Market Making via Adversarial Reinforcement Learning
Thomas Spooner,Rahul Savani

We show that adversarial reinforcement learning (ARL) can be used to produce market marking agents that are robust to adversarial and adaptively-chosen market conditions. To apply ARL, we turn the well-studied single-agent model of Avellaneda and Stoikov [2008] into a discrete-time zero-sum game between a market maker and adversary. The adversary acts as a proxy for other market participants that would like to profit at the market maker's expense. We empirically compare two conventional single-agent RL agents with ARL, and show that our ARL approach leads to: 1) the emergence of risk-averse behaviour without constraints or domain-specific penalties; 2) significant improvements in performance across a set of standard metrics, evaluated with or without an adversary in the test environment, and; 3) improved robustness to model uncertainty. We empirically demonstrate that our ARL method consistently converges, and we prove for several special cases that the profiles that we converge to correspond to Nash equilibria in a simplified single-stage game.

Robust pricing and hedging via neural SDEs
Patryk Gierjatowicz,Marc Sabate-Vidales,David Šiška,Lukasz Szpruch,Žan Žurič

Mathematical modelling is ubiquitous in the financial industry and drives key decision processes. Any given model provides only a crude approximation to reality and the risk of using an inadequate model is hard to detect and quantify. By contrast, modern data science techniques are opening the door to more robust and data-driven model selection mechanisms. However, most machine learning models are "black-boxes" as individual parameters do not have meaningful interpretation. The aim of this paper is to combine the above approaches achieving the best of both worlds. Combining neural networks with risk models based on classical stochastic differential equations (SDEs), we find robust bounds for prices of derivatives and the corresponding hedging strategies while incorporating relevant market data. The resulting model called neural SDE is an instantiation of generative models and is closely linked with the theory of causal optimal transport. Neural SDEs allow consistent calibration under both the risk-neutral and the real-world measures. Thus the model can be used to simulate market scenarios needed for assessing risk profiles and hedging strategies. We develop and analyse novel algorithms needed for efficient use of neural SDEs. We validate our approach with numerical experiments using both local and stochastic volatility models.

Securities-Based Crowdfunding by Startups: Does Auditor Attestation Matter?
Gong, Jing,Krishnan, Jayanthi,Liang, Yi
We examine financing outcomes for small businesses seeking to sell public securities in a setting characterized by high information asymmetry, weak requirements for auditor participation, and a complete absence of the Big N auditors. Issuers that raise capital from small unsophisticated investors through crowdfunding under the Securities and Exchange Commission’s Regulation Crowdfunding (RegCF) often need no auditor attestation or only weak auditor attestation in the form of reviews, not audits, of their financial statements. We find that (1) auditor reviews are positively associated with both the probability of crowdfunding success and the total amount raised, and (2) this positive association is stronger for PCAOB-registered auditors. Further, by comparing voluntary and mandatory users of the auditor reviews, we document monitoring and signaling benefits of the reviews. We conjecture that, for issuers that voluntarily procure reviews, the reviews serve to signal their high future prospects.

Share Buybacks, Monetary Policy and the Cost of Debt
Elgouacem, Assia,Zago, Riccardo
Share buybacks have become common practice across U.S corporations. This paper shows that firms finance these operations mostly through newly issued corporate bonds, and that the exogenous variation in the cost of debt -due to innovations in monetary policy- is key in explaining managers' incentives to repurchase their own shares. Under our identification strategy, we find that firms are more likely to repurchase in periods of accommodative monetary policy when the yield on bond adjusts in the same direction. This behavior has macroeconomic implications as it diverts resources from investment and employment, thus reducing the transmission of accommodative monetary policy at firm-level.

Stochastic Impatience and the Separation of Time and Risk Preferences
Dillenberger, David,Gottlieb, Daniel,Ortoleva, Pietro
We study how the separation of time and risk preferences relates to a behavioral property that generalizes impatience to stochastic environments: Stochastic Impatience. We show that, within a broad class of models, Stochastic Impatience holds if and only if risk aversion is not too high relative to the inverse of the elasticity of intertemporal substitution. In particular, in the models of Epstein and Zin (1989) and Hansen and Sargent (1995), Stochastic Impatience is violated for all commonly used parameters.

Streaks in Daily Returns
Klos, Alexander,Koehl, Alexandra,Rottke, Simon
A simple model of return extrapolation suggests that streaks in returns, which we define as n-day consecutive over-/under-performance relative to the market, predict future returns. We test this prediction using daily U.S. data and find strong empirical support. Buying stocks with negative streaks and selling stocks with positive streaks yields annualized Sharpe ratios around 2. We replicate the results in international markets and are able to increase the Sharpe ratio to above 3 by diversifying across regions. We argue that liquidity is unlikely to explain the results as streak portfolio returns based on mid-quote-prices are strongest among stocks with the lowest bid-ask spreads.

The '7% Solution' and IPO (Under)Pricing
Busaba, Walid Y.,Restrepo, Felipe
We investigate the effect of the “7% solution”â€"the fact that underwriters in the U.S. charge a 7% spread to most IPOs between $20 million and $100 million in sizeâ€"on the ensuing pricing of the offerings. Our identification exploits the variation in spreads that is due to distinct kinks in the relation between spread and offer size at these two thresholds. We find that the spread positively influences underpricing but also the offer-price adjustment from the filing range’s midpoint. Our evidence indicates that the spread influences the aftermarket price, suggesting that underwriters can shape, not merely discover, investor valuations.

The Effect of Tightening Credit Standards on Lending Relationships
Bosshardt, Joshua
This paper examines how firms adapt to tightening credit standards by adjusting their lending relationships. I first show using a difference-in-differences strategy that the introduction of stress testing led small businesses to concentrate their debt within a smaller number of banks. I then explain this finding with a calibrated model of bank competition in which firms have an incentive to establish a small number of concentrated lending relationships to facilitate efficient screening by their lenders. Tightening credit standards decreases the surplus from lending by reducing the availability of credit, but the adjustment of lending relationships can substantially mitigate this loss.

The Home Office in Times of COVID-19 Pandemic and its impact in the Labor Supply
José Nilmar Alves de Oliveira,Jaime Orrillo,Franklin Gamboa

We lightly modify Eriksson's (1996) model to accommodate the home office in a simple model of endogenous growth. By home office we mean any working activity carried out away from the workplace which is assumed to be fixed. Due to the strong mobility restrictions imposed on citizens during the COVID-19 pandemic, we allow the home office to be located at home. At the home office, however, in consequence of the fear and anxiety workers feel because of COVID-19, they become distracted and spend less time working. We show that in the long run, the intertemporal elasticity of substitution of the home-office labor is sufficiently small only if the intertemporal elasticity of substitution of the time spent on distracting activities is small enough also.

The Impact of XBRL Adoption on Local Bias: Evidence from Mandated U.S. Filers
Li, Bing,Liu, Zhenbin,Qiang, Wei,Zhang, Bohui
This paper investigates how eXtensible Business Reporting Language (XBRL) adoption affects the information advantage of local investors relative to their non-local counterparts. By employing the recent staggered SEC mandates of XBRL as a natural shock, we show that institutional investors’ local bias decreases after firms adopt XBRL when preparing their financial statements. These results hold in a difference-in-difference research design with firm and year fixed effects or using matched nonadopting firms as controls, as well as a regression discontinuity design. The impact of XBRL adoption on reducing local bias can be explained by three economic channels: decreased information processing costs, increased corporate disclosures, and improved analyst coverage. We further find that institutions’ superior stock returns in geographic proximate equity investments significantly reduces after the XBRL mandate. The observed reduction in institutional investors’ local bias within U.S. companies following the XBRL mandate also applies to the international setting. Overall, our findings support regulators’ claim that XBRL adoption levels the playing field between local and non-local investors.

The Influence of Stablecoin Issuances on Cryptocurrency Markets
Ante, Lennart,Fiedler, Ingo,Strehle, Elias
Stablecoins are digital currencies whose value is pegged to fiat currencies like the dollar or other assets. They were created as a more flexible alternative to fiat currencies for cryptocurrency exchanges and constitute an increasingly important aspect of cryptocurrency markets and alternative finance. We analyze the influence of stablecoin issuances on the returns of major cryptocurrencies across 565 issuance events of $1 million or more for seven different stablecoins on four different blockchains between April 2019 and March 2020. Our event study reveals cryptocurrency market downturns in the week before a stablecoin issuance and positive abnormal returns for major cryptocurrencies in the twenty-four hours before and after the issuance. Effect sizes differ across stablecoins. Counterintuitively, we find that issuance size does not significantly affect the abnormal returns. We conclude that stablecoin issuances contribute to price discovery and market efficiency of cryptocurrencies.

The Long-Run Relationship Between Financial Development and House Prices
Awaworyi Churchill, Sefa,Ivanovski, Kris,Mintah, Kwabena,Zhang, Quanda
We examine the relationship between financial development and house prices in the Group of Seven (G7) countries over the period 1870 to 2016. We use parametric panel data models that incorporate interactive fixed effects and non-parametric models that allow us to examine non-linearities and the time-varying nature of the relationship. Our parametric estimates show a positive relationship between financial development and house prices. The results from our non-parametric model reinforce this finding but also show evidence of a negative effect of financial development prior to the mid-twentieth century, suggesting a time-varying non-linear impact. We find that inequality and mortgage loans are mechanisms through which financial development transmits to house prices. Financial crisis moderates the relationship between financial development and house prices, although this works only through sovereign defaults. Our findings are robust to a suite of robustness and sensitivity checks.

The Predictability of Stock Returns in Taiwan
Liang, Samuel Xin
We investigate the cross-sectional predictability of stock returns after controlling for systematic risk factors in Taiwan. We additionally control for GDP growth, industrial production growth and inflation rate because they have a significant and negative pricing premium across stock returns after controlling for market, value and size factors. The negative pricing of GDP growth and Industrial production growth captures the cheap pricing of a stock’s fundamentals because their pricing premiums become insignificant after competing with a stock’s book-to-market ratio, cash-flow yield, earnings yield, dividend yield and leverage yield. The pricing of the inflation factor is negative because a high inflation rate increases the operating costs of corporations and hurts their profitability in Taiwan. We conclude that a stock’s value and cash-flow yield cross-sectionally predict stock returns at 1% level after controlling for market, value and size factors, GDP growth, industrial production growth, and inflation rate.

The Shrouded Business of Style Drift in Active Mutual Funds
Chua, Angeline Kim Pei,Tam, On Kit
This study investigates the motivation and performance consequence of intentional style drift in an exclusively in-house fund management industry in China. With style drift, fund investors are exposed to investment portfolio outside their risk-return preference but are generally unaware that their risk and return expectations are disrupted, and the functioning of the fund market undermined. Our study provides evidence for the first time about the incentive that motivates style drift behavior. We find that style drift increases a fund’s subsequent net inflows, thus affirming the maximization of AUM-linked compensation as the motivation for fund manager’s style drift behavior. We also find that larger funds have greater incentive to drift. We demonstrate that style drift behavior interferes with the picking of quality stocks to deliver fund performance for fund investors. Style drift as an unobserved risk behavior harms fund investor interest and undermines market integrity.

The U.S. Bond Market Before 1926, Part III: Total Return Versus Basic Yield, 1897 - 1926
McQuarrie, Edward F.
Bond prices from 1897 to 1926 have not been compiled. Financial historians have made do with yield series offered by Macaulay (1938) or with yield summaries found in Durand (1942), Hickman (1958), or Homer (1963). Where holding period returns have been of interest (Siegel 2014), these have been constructed using yield estimates rather than price observations. I found these yield estimates to be problematic in multiple respects, notably a focus on the pure interest rate, the basic yield, rather than the average yield that could be obtained by investors holding a broad index of large, liquid investment grade bonds. Accordingly, I collected and here report price observations for over 300 corporate bonds trading on the NYSE between 1897 and 1926. I find that market yields were higher, and holding period returns stronger, than currently understood. The result is to push forward the point where stocks first began to out-perform bonds to the years following World War II. This paper in conjunction with previous efforts shows that stock and bond portfolios performed about the same over the first century and a half after the founding of US financial markets. No sustained out-performance by stocks can be found prior to World War II.

The Zero Lower Bound and Financial Stability: A New Role for Central Banks?
Schulze, Tatjana,Tsomocos, Dimitrios P.
Financial stability objectives have taken a new place in central bank preferences next to the traditional dual mandate of monetary policy. When (external) pressures to raise interest rates from the zero lower bound (ZLB) increase, central banks must take into account the effects of an increase in nominal interest rates on financial stability not only via bank profitability but also via aggregate default in the economy. We develop a general equilibrium model with a financial sector, an autonomous central bank, and collateral default to analyze:(a) how monetary policy and financial stability objectives affect optimal policies, and (b) how a lift-off from the ZLB affects bank profitability, liquidity, and default:(i) when the central bank cares only about monetary policy objectives, and (ii) when the central bank cares also about financial stability objectives. A lift-off from the ZLB exacerbates default but mitigates default-induced debt-deflation when the central bank has control over one instrument for each policy objective. A dual mandate without considering financial stability concerns increases the variance in targeted policy outcomes across states of nature. Pursuing financial stability objectives on top of the dual mandate makes optimal monetary policy less pro-cyclical in our model. Our findings do not support the argument that a departure of the interest rate from the ZLB restores bank profitability.

To Herd or Not to Herd: Do Intangible Assets Affect the Behavior of Financial Analyst Recommendations?
Segara, Reuben,Wu, Bochen,Yao, Juan
The extent to which financial analysts provide ‘herd’ rather than ‘bold’ (or anti-herd) earnings forecasts has important implications to market efficiency. Troublingly, past studies suggest that financial analysts tend to herd when providing earnings forecasts to avoid risks to their careers and reputations. Identifying any contributing factor(s) for financial analyst herding behavior can lead to policies to help reduce such harmful conduct. In this study, we identify whether the level of intangible assets for a firm being analyzed contributes towards the intensity of financial analyst’ herding behavior. Using three accounting-based proxies for intangibles, a positive association is found between firm-specific intangible asset intensity and analyst herding behavior. Our findings show that analysts are less confident in providing their opinion for firms with a high intensity of intangible assets, which confirms the view that herding behavior is dependent on task difficulty. Furthermore, we find evidence that analysts’ firm-specific experience, the size of their brokerage house and their prior forecasting accuracy reduce herding tendency.

Uncertainty-Aware Lookahead Factor Models for Quantitative Investing
Lakshay Chauhan,John Alberg,Zachary C. Lipton

On a periodic basis, publicly traded companies report fundamentals, financial data including revenue, earnings, debt, among others. Quantitative finance research has identified several factors, functions of the reported data that historically correlate with stock market performance. In this paper, we first show through simulation that if we could select stocks via factors calculated on future fundamentals (via oracle), that our portfolios would far outperform standard factor models. Motivated by this insight, we train deep nets to forecast future fundamentals from a trailing 5-year history. We propose lookahead factor models which plug these predicted future fundamentals into traditional factors. Finally, we incorporate uncertainty estimates from both neural heteroscedastic regression and a dropout-based heuristic, improving performance by adjusting our portfolios to avert risk. In retrospective analysis, we leverage an industry-grade portfolio simulator (backtester) to show simultaneous improvement in annualized return and Sharpe ratio. Specifically, the simulated annualized return for the uncertainty-aware model is 17.7% (vs 14.0% for a standard factor model) and the Sharpe ratio is 0.84 (vs 0.52).

What Is the True Valuation Motive for Increasing Share Repurchases? An Analysis of Firm, Institutional and Short Selling Trading Behavior
Yang, Jin Young,Segara, Reuben
Our study investigates the true valuation motive for increasing share repurchases. To do so, we analyze the contemporaneous trading dynamics between short sellers, institutional investors and the firm itself around the actual share repurchases. We regress quarterly changes in share repurchases on quarterly changes in short interest and quarterly changes in institutional holdings. We find that firms repurchase more intensely against increased short selling and that institutional investors trade in parallel with the repurchasing firm. The inclusion of changes in institutional holdings into our regression models enables our study to support the undervaluation motive for driving firm’s management to increase repurchasing activity. We posit that firms disagree with short seller’s intrinsic valuation of the firm where consistent with previous literature we find that this disagreement subsequently leads to positive abnormal returns after the share repurchases.