Research articles for the 2020-07-28

A decomposition formula for fractional Heston jump diffusion models
Marc Lagunas-Merino,Salvador Ortiz-Latorre

We present an option pricing formula for European options in a stochastic volatility model. In particular, the volatility process is defined using a fractional integral of a diffusion process and both the stock price and the volatility processes have jumps in order to capture the market effect known as leverage effect. We show how to compute a martingale representation for the volatility process. Finally, using It\^o calculus for processes with discontinuous trajectories, we develop a first order approximation formula for option prices. There are two main advantages in the usage of such approximating formulas to traditional pricing methods. First, to improve computational effciency, and second, to have a deeper understanding of the option price changes in terms of changes in the model parameters.

Across the Pond: The Impact of the GDPR on the Resiliency of U.S. Firms’ Board of Directors
Klein, April,Manini, Raffaele,Shi, Yanting (Crystal)
One of the prime responsibilities of the board of directors is to understand and oversee its firm's risk profile. Unlike more traditional studies, this paper studies the resiliency of U.S. firms' board of directors to a growing threat, cyber risk. We exploit a recent European Union (EU) regulation, the General Data Protection Regulation (GDPR), as a quasi-exogenous shock to the cyber risk landscape assess whether boards of U.S. firms change their focus and governance structure to deal with this new challenge. Although an EU regulation, the GDPR applies to all American public firms with at least one EU user. We find that, compared with the period before the GDPR, U. S. firms disclose more about the board's oversight of cyber risk on their Form DEF 14A. Further, boards add more directors with cyber/IT expertise, and they more frequently assign cyber risk oversight to the board or to board committees. We predict and find these changes to be positively associated with the market's assessments of firms' net costs embedded within the GDPR. Our findings suggest that, on average, American corporate boards promptly engaged to changes in cyber risk.

Advanced Strategies of Portfolio Management in the Heston Market Model
Jarosław Gruszka,Janusz Szwabiński

There is a great number of factors to take into account when building and managing an investment portfolio. It is widely believed that a proper set-up of the portfolio combined with a good, robust management strategy is the key to successful investment. In this paper, we aim at an analysis of two aspects that may have an impact on investment performance: diversity of assets and inclusion of cash in the portfolio. We also propose two new management strategies based on the MACD and RSI factors known from technical analysis. Monte Carlo simulations within the Heston model of a market are used to perform numerical experiments.

Advertising Arbitrage
Kovbasyuk, Sergey,Pagano, Marco
Arbitrageurs with a short investment horizon gain from accelerating price discovery by advertising their private information. However, advertising many assets may overload investors' attention, reducing the number of informed traders per asset and slowing price discovery. So arbitrageurs optimally concentrate advertising on just a few assets, which they overweight in their portfolios. Unlike classic insiders, advertisers prefer assets with the least noise trading. If several arbitrageurs share information about the same assets, inefficient equilibria can arise, where investors' attention is overloaded and substantial mispricing persists. When they do not share, the overloading of investors' attention is maximal.

Alibaba: A Case Study of Synthetic Control
Fried, Jesse M.,Kamar, Ehud
Alibaba, the NYSE-traded Chinese ecommerce giant, is currently valued at over $500 billion. But Alibaba’s governance is opaque, obscuring who controls the firm. We show that Jack Ma, who now owns only about 5%, can effectively control Alibaba by controlling an entirely different firm: Ant Group. We demonstrate how control of Ant Group enables Ma to dominate Alibaba’s board. We also explain how this control gives Ma the indirect ability to disable (and perhaps seize) VIE-held licenses critical to Alibaba, providing him with substantial additional leverage. Alibaba is a case study of how corporate control can be created synthetically with little or no equity ownership via a web of employment and contractual arrangements.

Audit Committee Member Characteristics and Committee Effectiveness: Evidence from Turkish Banking Sector
Erzurumlu, Yaman O.,Avci, Gurcan
Lack of corporate governance was addressed as one of the reasons for financial scandals and crises experienced during the 2000s. Financial crises were followed by audit committee mechanism revision, and focus shifted onto how audit committees’ governance quality could be improved. Using a unique data set, this study investigates the impact of audit committee membership characteristics on the governing quality of the audit committee measured by operational loss in the Turkish Banking Sector. Results imply that gender diversification and multiple directorships of the members improve the governance effectiveness while auditing background alone does not make significant improvement after controlling for industry experience. Differences in cultural background and insufficient funding of the committee could be detrimental to the effectiveness of banks’ audit committees at mitigating operational risk. Trends of the member characteristics for 2006-2012 suggest that the 2008 turbulence has mainly had a disciplinary effect on active audit committees.

Belief Distortions and Macroeconomic Fluctuations
Bianchi, Francesco,Ludvigson, Sydney C.,Ma, Sai
This paper combines a data rich environment with a machine learning algorithm to provide estimates of time-varying systematic expectational errors ("belief distortions") about the macroeconomy embedded in survey responses. We find that such distortions are large on average even for professional forecasters, with all respondent-types over-weighting their own forecast relative to other information. Forecasts of inflation and GDP growth oscillate between optimism and pessimism by quantitatively large amounts. To investigate the dynamic relation of belief distortions with the macroeconomy, we construct indexes of aggregate (across surveys and respondents) expectational biases in survey forecasts. Over-optimism is associated with an increase in aggregate economic activity. Our estimates provide a benchmark to evaluate theories for which information capacity constraints, extrapolation, sentiments, ambiguity aversion, and other departures from full information rational expectations play a role in business cycles.

Board Dynamics Over the Startup Lifecycle
Ewens, Michael,Malenko, Nadya
Venture capital (VC) backed firms face neither the governance requirements nor a major separation of ownership and control of their public peers. These differences suggest that independent directors could play a unique role on private firm boards. This paper explores the dynamics of VC-backed startup boards using new data on board member entry, exit, and individual director characteristics. We document several new facts about board size, the allocation of control, and composition dynamics. At formation, a typical board has four members and is entrepreneur-controlled. Independent directors are found on the median board after the second financing event, when control over the board becomes shared, with independent directors holding the tie-breaking vote. These patterns are consistent with independent directors playing both a mediating and advising role over the startup lifecycle, and thus representing another potential source of value-add to entrepreneurial firm performance.

Cash-Forward Arbitrage and Dealer Capital in MBS Markets: COVID-19 and Beyond
Song, Zhaogang,Liu, Haoyang,Sarkar, Asani ,Chen, Jiakai
Abstract We examine the economic mechanisms that limited arbitrage between the cash and forward markets of agency MBS, and whether asset purchases of the Federal Reserve (Fed) alleviated price dislocations. We find that the cash-forward basis, or the price difference between the cash and forward markets of agency MBS controlling for differences in fundamentals, widened significantly by $0.9 per $100 face value during the height of the COVID-19 crisis. The widening basis was accompanied by a significant increase in selling by customers in the cash market, indicating a “scramble-for-cash” following the liquidity shock. Dealers provided liquidity by increasing both their long cash and short forward positions significantly but the basis continued to widen, implying that balance sheet costs constrained dealers' inventories. We estimate dealers' average costs of holding inventory for five weeks as about $0.8. We also find that primary dealers affiliated with banks subject to Basel III liquidity regulations increased their positions more than others. The basis narrowed by about \$0.7 following the Fed's MBS purchases in the forward market. We attribute this effect to the faster settlement schedules of the Fed's purchases, compared to the market convention, which allowed a faster deployment of capital. Overall, our results show that the combined liquidity constraints of investors and dealers led to severe price dislocations, and the Fed, in its role as the “dealer of last resort”, absorbed the liquidity demand that dealers lacked the capacity to meet.

Convergence of the Kiefer-Wolfowitz algorithm in the presence of discontinuities
Miklos Rasonyi,Kinga Tikosi

In this paper we estimate the expected error of a stochastic approximation algorithm where the maximum of a function is found using finite differences of a stochastic representation of that function. An error estimate of $O(n^{-1/5})$ for the $n$th iteration is achieved using suitable parameters. The novelty with respect to previous studies is that we allow the stochastic representation to be discontinuous and to consist of possibly dependent random variables (satisfying a mixing condition).

Determinants of International Consumption Risk Sharing in Developing Countries
Gardberg, Malin
Complete financial markets allow countries to share their consumption risks internationally, thereby creating welfare gains through lower volatility of aggregate consumption. This paper empirically looks at international consumption risk sharing and its determinants in a panel of 120 countries from 1970 to 2014. Contrary to some previous studies, I show that financial liberalization and financial integration has a significantly positive impact on international consumption risk sharing in poorer developing countries, whereas in emerging market countries only capital account openness has an impact. Moreover, there is some evidence that high income inequality or a high share of low income individuals reduces consumption smoothing in less developed countries. Lack of financial reforms, a lower degree of financial integration and higher inequality can thus partly explain why the degree of risk sharing is lower in developing countries than in advanced economies.

Discounting and Climate Policy
van der Ploeg, Rick
The social rate of discount is a crucial driver of the social cost of carbon (SCC), i.e. the expected present discounted value of marginal damages resulting from emitting one ton of carbon today. Policy makers should set carbon prices to the SCC using a carbon tax or a competitive permits market. The social discount rate is lower and the SCC higher if policy makers are more patient and if future generations are less affluent and policy makers care about intergenerational inequality. Uncertainty about the future rate of growth of the economy and emissions and the risk of macroeconomic disasters (tail risks) also depress the social discount rate and boost the SCC provided intergenerational inequality aversion is high. Various reasons (e.g. autocorrelation in the economic growth rate or the idea that a decreasing certainty-equivalent discount rate results from a discount rate with a distribution that is constant over time) are discussed for why the social discount rate is likely to decline over time. A declining social discount rate also emerges if account is taken from the relative price effects resulting from different growth rates for ecosystem services and of labour in efficiency units. The market-based asset pricing approach to carbon pricing is contrasted with a more ethical approach to policy making. Some suggestions for further research are offered.

Do Analysts Learn from Each Other? Evidence from Analysts' Location Diversity
Cen, Ling,Chang, Yuk Ying (Candie),Dasgupta, Sudipto
Consistent with the idea that some of the noise in analysts' earnings forecasts originates in their geographic locations, we find that when analysts' locations are geographically more dispersed, the consensus forecast is more accurate, suggesting a diversification effect. Importantly, analysts' individual forecasts are also more accurate, implying that analysts incorporate idiosyncratic (private) information in their peer's forecasts when generating their own forecasts. Moreover, in line with efficient weighted average forecasting behavior, the weights assigned to peer forecasts vary with measures of the precision of the analyst's signal and those of the peers. Overall, we find strong evidence of analyst learning.

Economic Reality, Economic Media and Individuals' Expectations
Kristoffer Persson

This paper investigates the relationship between economic media sentiment and individuals' expetations and perceptions about economic conditions. We test if economic media sentiment Granger-causes individuals' expectations and opinions concerning economic conditions, controlling for macroeconomic variables. We develop a measure of economic media sentiment using a supervised machine learning method on a data set of Swedish economic media during the period 1993-2017. We classify the sentiment of 179,846 media items, stemming from 1,071 unique media outlets, and use the number of news items with positive and negative sentiment to construct a time series index of economic media sentiment. Our results show that this index Granger-causes individuals' perception of macroeconomic conditions. This indicates that the way the economic media selects and frames macroeconomic news matters for individuals' aggregate perception of macroeconomic reality.

Financial Intermediation and Technology: What&Apos;S Old, What&Apos;S New?
Boot, Arnoud W. A.,Hoffmann, Peter,Laeven, Luc
We study the effects of technological change on financial intermediation, distinguishing between innovations in information (data collection and processing) and communication (relationships and distribution). Both follow historic trends towards an increased use of hard information and less in-person interaction, which are accelerating rapidly. We point to more recent innovations, such as the combination of data abundance and artificial intelligence, and the rise of digital platforms. We argue that in particular the rise of new communication channels can lead to the vertical and horizontal disintegration of the traditional bank business model. Specialized providers of financial services can chip away activities that do not rely on access to balance sheets, while platforms can interject themselves between banks and customers. We discuss limitations to these challenges, and the resulting policy implications.

Going Bankrupt in China
Li, Bo,Ponticelli, Jacopo
Using new case-level data we document a set of stylized facts on bankruptcy in China and study how the staggered introduction of specialized courts across Chinese cities affected insolvency resolution and the local economy. For identification, we compare cases handled by specialized versus traditional civil courts within the same city. Specialized courts hire better-trained judges and cut case duration by 35%. State-owned firms experience larger declines in case duration relative to privately-owned firms, consistent with higher judicial independence. Cities introducing specialized courts experience faster firm entry, larger increase in average capital productivity and reallocation of employment out of "zombie" firms-intensive sectors.

Gold and Oil Prices: Abnormal Returns, Momentum and Contrarian Effects
Caporale, Guglielmo Maria,Plastun, Alex
This paper explores price (momentum and contrarian) effects on the days characterised by abnormal returns and the following ones in two commodity markets. Specifically, using daily Gold and Oil price data over the period 01.01.2009-31.03.2020 the following hypotheses are tested: H1) there are price effects on days with abnormal returns, H2) there are price effects on the day after abnormal returns occur; H3) the price effects caused by abnormal returns are exploitable. For these purposes average analysis, t-tests, CAR and trading simulation approaches are used. The main results can be summarised as follows. Hourly returns during the day of abnormal returns are significantly bigger than those during average â€Å"normal� days. Prices tend to move in the direction of abnormal returns till the end of the day when these occur. The presence of abnormal returns can usually be detected before the end of the day by estimating specific timing parameters, and a momentum effect can be detected. On the following day two different price patterns are detected: a momentum effect for Oil prices and a contrarian effect for Gold prices respectively. Trading simulations show that these effects can be exploited to generate abnormal profits.

Growth, Industrial Externality, Prospect Dynamics, and Well-being on Markets
Emmanuel Chauvet

Functions or 'functionings' enable to give a structure to any activity and their combinations constitute the capabilities which characterize economic assets such as work utility. The basic law of supply and demand naturally emerges from that structure while integrating this utility within frames of reference in which conditions of growth and associated inflation are identified in the exchange mechanisms. Growth sustainability is built step by step taking into account functional and organizational requirements which are followed through a project up to a product delivery with different levels of externalities. Entering the market through that structure leads to designing basic equations of its dynamics and to finding canonical solutions, or particular equilibria, after specifying the notion of maturity introduced in order to refine the basic model. This approach allows to tackle behavioral foundations of Prospect Theory through a generalization of its probability weighting function for rationality analyses which apply to Western, Educated, Industrialized, Rich, and Democratic societies as well as to the poorest ones. The nature of reality and well-being appears then as closely related to the relative satisfaction reached on the market, as it can be conceived by an agent, according to business cycles; this reality being the result of the complementary systems that govern human mind as structured by rational psychologists. The final concepts of growth integrate and extend the maturity part of the behavioral model into virtuous or erroneous sustainability.

Heterogeneity and the Dynamic Effects of Aggregate Shocks
Andreas Tryphonides

Using a semi-structural approach, the paper identifies how heterogeneity and financial frictions affect the transmission of aggregate shocks. Approximating a heterogeneous agent model around the representative agent allocation can successfully trace the aggregate and distributional dynamics and can be consistent with alternative mechanisms. Employing Spanish macroeconomic data as well as firm and household survey data, the paper finds that frictions on both consumption and investment have rich interactions with aggregate shocks. The response of heterogeneity amplifies or dampens these effects depending on the type of the shock. Both dispersion in consumption shares and the marginal revenue product of firms, as well as the proportion of investment constrained firms are key determinants of the fiscal multiplier.

Housing Collateral Reform and Economic Reallocation
Fazio, Dimas,Silva, Thiago
This paper examines how banks reallocate credit after the introduction of a more enforceable housing collateral contract in Brazil. This new contract greatly improved the repossession of real estate assets used as collateral for personal and business loans. We find opposing effects of this policy. Because of the stronger enforcement, credit supply increased in municipalities with higher homeownership, leading to the creation of new firms, higher employment, and economic performance. However, banks restricted credit to borrowers in low homeownership municipalities. These areas experienced a decline in entrepreneurship, local labor demand, and economic activity. The credit reallocation was greatest for credit-constrained banks, consistent with higher external financing costs. Finally, the differential effects in credit supply induced a redistribution of labor in the economy: workers migrated from low to high homeownership municipalities after the reform.

How Did COVID-19 Shaped the Tweets Sentiment Impact upon Stock Prices of Sport Companies?
Derouiche, Karim,Frunza, Marius
This article aims to study the link between Twitter announces and stock prices of sports companies during the COVID crisis. In many instances, news, announces, social media content affect the evolution of stock prices. This paper assesses the relationship between the sentiment of social media and the evolution of stock prices. The study focuses on companies from the sports sector due to their popularity and the consistent number of followers on social networks, which provide a sound basis of analysis. Two aspects are explored: the Granger causality analysis of the tweets on stock prices and the event study related to the COVID crisis. The approach is implemented for a sample of 18 listed companies in the sports sector.

Insider Trading with Temporary Price Impact
Weston Barger,Ryan Donnelly

We model an informed agent with information about the future value of an asset trying to maximize profits when subjected to a transaction cost as well as a market maker tasked with setting fair transaction prices. In a single auction model, equilibrium is characterized by the unique root of a particular polynomial. Analysis of this polynomial with small levels of risk-aversion and transaction costs reveal a dimensionless parameter which captures several orders of asymptotic accuracy of the equilibrium behaviour. In a continuous time analogue of the single auction model, incorporation of a transaction costs allows the informed agent's optimal trading strategy to be obtained in feedback form. Linear equilibrium is characterized by the unique solution to a system of two ordinary differential equations, of which one is forward in time and one is backward. When transaction costs are in effect, the price set by the market maker in equilibrium is not fully revealing of the informed agent's private signal, leaving an information gap at the end of the trading interval. When considering vanishing transaction costs, the equilibrium trading strategy and pricing rules converge to their frictionless counterparts.

Interest Rates, Market Power, and Financial Stability
Martinez-Miera, David,Repullo, Rafael
This paper shows the relevance of market power to assess the effects of safe interest rates on financial intermediaries' risk-taking decisions. We consider an economy where (i) intermediaries have market power in granting loans, (ii) intermediaries monitor borrowers which lowers their probability of default, and (iii) monitoring is costly and unobservable which creates a moral hazard problem with uninsured depositors. We show that lower safe rates lead to lower intermediation margins and higher risk-taking when intermediaries have low market power, but the result reverses for high market power. We examine the robustness of this result to introducing non-monitored market finance, heterogeneity in monitoring costs, and entry and exit of intermediaries. We also consider the effect of replacing uninsured by insured deposits, market power in raising deposits, and funding with both deposits and capital.

Italy in the Eurozone
Keuschnigg, Christian ,Kirschner, Linda,Kogler, Michael,Winterberg, Hannah
Using a DSGE model with nominal wage rigidity, we investigate two scenarios for the Italian economy. The first considers sustained policy commitment to reform. The results indicate the possibility of `growing out of bad initial conditions', if fiscal consolidation is combined with a program for bank recovery and for competitiveness and growth. The second scenario involves a strong asymmetric recession. It is likely to be very severe under the restrictions of the currency union. A benign exit from the Eurozone with stable investor expectations could substantially dampen the short-run impact. Stabilization is achieved by monetary expansion, combined with exchange rate depreciation. However, investor panic may lead to escalation. Capital market reactions would offset the benefits of monetary autonomy and much delay the recovery.

Kicking the Can Down the Road: Government Interventions in the European Banking Sector
Acharya, Viral V.,Jager, Maximilian,Steffen, Sascha,Steinruecke, Lea
We analyze the determinants and the long-run consequences of government interventions in the eurozone banking sector during the 2008/09 financial crisis. Using a novel and comprehensive dataset,we document that fiscally constrained governments “kicked the can down the road” by providing banks with guarantees instead of full-fledged recapitalizations. We adopt an econometric approach that addresses the endogeneity associated with governmental bailout decisions in identifying their consequences. We find that forbearance caused undercapitalized banks to shift their assets from loans to risky sovereign debt and engage in zombie lending, resulting in weaker credit supply, elevated risk in the banking sector, and, eventually, greater reliance on liquidity support from the European Central Bank.

Leveraging the Power of Place: A Data-Driven Decision Helper to Improve the Location Decisions of Economic Immigrants
Jeremy Ferwerda,Nicholas Adams-Cohen,Kirk Bansak,Jennifer Fei,Duncan Lawrence,Jeremy M. Weinstein,Jens Hainmueller

A growing number of countries have established programs to attract immigrants who can contribute to their economy. Research suggests that an immigrant's initial arrival location plays a key role in shaping their economic success. Yet immigrants currently lack access to personalized information that would help them identify optimal destinations. Instead, they often rely on availability heuristics, which can lead to the selection of sub-optimal landing locations, lower earnings, elevated outmigration rates, and concentration in the most well-known locations. To address this issue and counteract the effects of cognitive biases and limited information, we propose a data-driven decision helper that draws on behavioral insights, administrative data, and machine learning methods to inform immigrants' location decisions. The decision helper provides personalized location recommendations that reflect immigrants' preferences as well as data-driven predictions of the locations where they maximize their expected earnings given their profile. We illustrate the potential impact of our approach using backtests conducted with administrative data that links landing data of recent economic immigrants from Canada's Express Entry system with their earnings retrieved from tax records. Simulations across various scenarios suggest that providing location recommendations to incoming economic immigrants can increase their initial earnings and lead to a mild shift away from the most populous landing destinations. Our approach can be implemented within existing institutional structures at minimal cost, and offers governments an opportunity to harness their administrative data to improve outcomes for economic immigrants.

Mutual Fund Performance and Flows During the COVID-19 Crisis
Pastor, Lubos,Vorsatz, Blair
We present a comprehensive analysis of the performance and flows of U.S. actively-managed equity mutual funds during the COVID-19 crisis of 2020. We find that most active funds underperform passive benchmarks during the crisis, contradicting a popular hypothesis. Funds with high sustainability ratings perform well, as do funds with high star ratings. Fund outflows largely extend pre-crisis trends. Investors favor funds that apply exclusion criteria and funds with high sustainability ratings, especially environmental ones. Our finding that investors remain focused on sustainability during this major crisis suggests they view sustainability as a necessity rather than a luxury good.

Negative Monetary Policy Rates and Systemic Banks' Risk-Taking: Evidence from the Euro Area Securities Register
Bubeck, Johannes,Maddaloni, Angela,Peydro , Jose-Luis
We show that negative monetary policy rates induce systemic banks to reach-for-yield. For identification, we exploit the introduction of negative deposit rates by the European Central Bank in June 2014 and a novel securities register for the 26 largest euro area banking groups. Banks with more customer deposits are negatively affected by negative rates, as they do not pass negative rates to retail customers, in turn investing more in securities, especially in those yielding higher returns. Effects are stronger for less capitalized banks, private sector (financial and non-financial) securities and dollar-denominated securities. Affected banks also take higher risk in loans.

Nonbanks, Banks, and Monetary Policy: U.S. Loan-Level Evidence Since the 1990s
Elliott, David,Meisenzahl, Ralf,Peydro , Jose-Luis,Turner, Bryce C.
We show that credit supply effects and associated real effects of monetary policy depend on the size of nonbank presence in the respective lending market. Nonbank presence also alters how monetary policy affects the distribution of risk. For identification, we use exhaustive loan-level data since the 1990s and Gertler-Karadi (2015) monetary policy shocks. First, different from the literature showing that low monetary policy rates increase credit supply and risk-taking by banks, we find that higher monetary policy rates shifts credit supply for corporates, mortgages, and consumers shifts from regulated banks to less regulated, more fragile nonbanks. Moreover, this shift is more pronounced for ex-ante riskier borrowers. Second, nonbanks reduce the effectiveness of the bank lending channel of monetary policy at the loan-level. However, this reduction varies substantially across lending markets. Total credit and real effects are largely neutralized in consumer loans and the associated consumption, but not in corporate loans and investment.

One Size Does Not Fit All: External Driver of The Cryptocurrency World
Erzurumlu, Yaman O.,Oygur, Tunc,Kirik, Alper
Purpose â€" Considering the different motivations for the creation of each of these cryptocurrencies, the purpose of this paper is to examine whether there is a dominant external factor in the cryptocurrency world. Using a novel two-step time and frequency independent methodology, the authors examine a large scope of cryptocurrencies and external factors within the same period and analytical framework.Design/methodology/approach â€" The examined cryptocurrencies are Bitcoin, Ethereum, Ripple,Litecoin, Monero, and Dash. In total, 18 external factors from 5-factor families are selected based on the mining motivation of these cryptocurrencies. The study first examines discrete wavelet transform-based (WTB) correlations, reduces the dimension, and focus on relevant pairs. Selected pairs are further examined by wavelet coherence to capture the intermittent nature of the relationships allowing the most needed “Flexibility of frequency and time domains”.Findings â€" Each coin appears to operate as a unique character with the exception of Bitcoin and Litecoin. There is no prominent external driver. The cryptocurrency market is not a clear substitute for a specific factor or market. Two-step WTB filtered wavelet coherence analysis help us to analyze a large number of factor without the loss of focus. The co-movements within the cryptocurrencies spillover from Ethereum to altcoins and later to Bitcoin.Originality/value â€" The study presents one of the first examples of two-step WTB filtered wavelet coherence analysis. The methodology suggests an approach for the simultaneous examination of a large number of variables. The scope of the study provides a rather holistic view of the co-movements of external factors and major cryptocurrencies.

Operational Risk Capital
Conlon, Thomas,Huan, Xing,Ongena, Steven
We study the response of banks to the introduction of a new capital requirement relating to operational risk. To isolate the effect of this new regulation on realized operational risk losses, we take advantage of the partial US implementation relative to full European adoption. Operational risk losses are reduced in treated banks. The extent of loss reduction depends upon the measurement approach used to calibrate operational risk capital requirements. Banks with low institutional ownership and those without binding regulatory capital constraints also present significant loss reduction. We link these findings to incentives for improved risk management and governance post treatment.

Pandemics, Intermediate Goods, and Corporate Valuation
Laeven, Luc
We evaluate the role of input-output linkages and social distancing in transmitting the COVID-19 shock to the valuation of U.S. corporates. Using a new dataset on sectoral dependence on the use and sale of intermediate goods, we find that firms that depend on the sale of intermediate goods to sectors affected by social distancing are more affected by the crisis. We estimate that the indirect effect of social distancing through input-output linkages is at least as important as its direct effect. Several tests are consistent with the view that larger firms and firms with cash buffers are better able to absorb the pandemic shock.

Portfolio Optimization on the Dispersion Risk and the Asymmetric Tail Risk
Young Shin Kim

In this paper, we propose a multivariate market model with returns assumed to follow a multivariate normal tempered stable distribution defined by a mixture of the multivariate normal distribution and the tempered stable subordinator. This distribution is able to capture two stylized facts: fat-tails and asymmetric tails, that have been empirically observed for asset return distributions. On the new market model, a new portfolio optimization method, which is an extension of Markowitz's mean-variance optimization, is discussed. The new optimization method considers not only reward and dispersion but also asymmetry. The efficient frontier is also extended from the mean-variance curve to a surface on three dimensional space of reward, dispersion, and asymmetry. We also propose a new performance measure which is an extension of Sharpe Ratio. Moreover, we derive closed-form solutions for two important measures used by portfolio managers in portfolio construction: the marginal Value-at-Risk (VaR) and the marginal Conditional VaR (CVaR). We illustrate the proposed model using stocks comprising the Dow Jones Industrial Average. First perform the new portfolio optimization and then demonstrating how the marginal VaR and marginal CVaR can be used for portfolio optimization using the model. Based on the empirical evidence presented in this paper, our framework offers realistic portfolio optimization and tractable methods for portfolio risk management.

Pricing and Hedging Options on Assets with Options on Related Assets
Madan, Dilip B.,Wang, King
The problem studied is the pricing of options on the CBOE Skew index. The option pricing theory developed seeks to hedge the risk using positions in the market for options on a related asset and the option is then priced at the cost of this hedge. The theory is applied to pricing VIX options using the market for SPY options and pricing options on JPM using the market for XLF options. The approach is then applied to illustrate the pricing of CBOE Skew Index options using the market for SPY options. The Skew Index smile is then seen to imply the VIX and SKEW of the Skew Index itself.

Product Market Competition and the Relocation of Economic Activity: Evidence from the Supply Chain
Chen, Chen,Dasgupta, Sudipto,Huynh, Thanh,Xia, Ying
We show that increasing competition changes the location of economic activity and, in turn, affects supply chain relationships. Using establishment-level data, we find that when upstream product markets become more competitive, suppliers are more likely to relocate their establishments closer to customers. Following the supplier's relocation, its sales to the customer increase, its relationship with the customer is less likely to be terminated, and its innovation is more aligned with the customer's innovation. However, the improved relationship, by causing the supplier to engage more in innovation dedicated to the customer, adversely affects creative innovation, which is known to drive growth.

Risk Sharing within the Firm: A Primer
Pagano, Marco
Labor income risk is key to the welfare of most people. This risk is mainly insured "within the firm" and by public institutions, rather than by financial markets. This paper starts by asking why such insurance is provided within the firm, and what determines its boundaries. It identifies four main constraining factors: availability of a public safety net, moral hazard on the employees' side, moral hazard on the firms' side, and workers' wage bargaining power. These factors explain three empirical regularities: (i) family firms provide more employment insurance than nonfamily firms; (ii) the former pay lower real wages, and (iii) firms provide less employment insurance where public unemployment benefits are more generous. The paper also explores the connection between risk sharing and firms' capital structure: greater leverage calls for high wages to compensate employees for greater job risk; nevertheless, firms may want to lever up strategically in order to offset the bargaining power of labor unions. Hence, the distributional conflict between shareholders and workers may limit risk sharing within the firm. By contrast, bondholders and workers are not necessarily in conflict, as both are harmed by firms' risk-taking. In principle, firms may also insure employees against uncertainty about their own talent, but their capacity to do so is constrained by workers' inability to commit to their employer: in the presence of labor market competition, high-talent employees will leave unless paid in line with their high productivity, making uncertainty about talent uninsurable. The paper concludes by showing that risk sharing within firms has declined steadily in the last three decades, and by discussing the financial, competitive, technological and institutional developments that may have conjured this outcome.

Speculator Spreading Pressure and Commodity Futures Risk Premium
Gong, Yujing,Gozluklu, Arie Eskenazi,Kim, Gi H.
This paper investigates the impact of speculative trading on the commodity futures risk premium. We focus on speculators’ spread positions, and study the asset pricing implications of spreading pressure on the cross-section of commodity futures returns. Spreading pressure negatively predicts futures excess returns even after controlling for well-known determinants of futures returns such as basis-momentum. A long-short portfolio based on spreading pressure signal carries a significant risk premium of 20.95% per annum in the era of financialization of commodity markets. Our single-factor model provides a better cross-sectional fit than the existing factor models. We show that spreading pressure reflects speculators’ expectations on the change in the shape of futures term structure, is linked to commodity index investment, and the spreading pressure factor is explained by innovations in real economic uncertainty.

Support for Small Businesses Amid Covid-19
Goodhart, Charles,Tsomocos, Dimitrios P.,Wang, Xuan
A sizeable proportion of enterprises, especially SMEs, in receipt of financial assistance

The Cleansing Effect of Banking Crises
Gropp, Reint,Ongena, Steven,Rocholl, Jörg,Saadi, Vahid
We assess the cleansing effects of the recent banking crisis. In U.S. regions with higher levels of supervisory forbearance on distressed banks during the crisis, there is less restructuring in the real sector and the banking sector remains less healthy for several years after the crisis. Regions with less supervisory forbearance experience higher productivity growth after the crisis with more firm entries, job creation, and employment, wages, patents, and output growth. Supervisory forbearance is greater for state-chartered banks and in regions with weaker banking competition and more independent banks, while recapitalization of distressed banks through TARP does not facilitate cleansing.

The Distributional Impact of the Pandemic
Hacioglu Hoke, Sinem,Känzig, Diego R.,Surico, Paolo
The top quartile of the income distribution accounts for almost half of the pandemic-related decline in aggregate consumption, with expenditure for this group falling much more than income. In contrast, the bottom quartile of the income distribution has seen the smallest spending cuts and the largest earnings drop but their total incomes have fallen by much less because of the increase in government benefits. The decline in consumers' spending preceded the introduction of the lockdown, whose partial lifting has triggered a stronger recovery in sectors with a lower contract rate. The largest spending contractions are concentrated in the most affluent regions. These conclusions are based on detailed high-frequency transaction data on spending, earnings and income from a large Fintech company in the United Kingdom.

The Economics of Deferral and Clawback Requirements
Hoffmann, Florian,Inderst, Roman,Opp, Marcus M.
We analyze the effects of regulatory interference in compensation contracts, focusing on recent mandatory deferral and clawback requirements restricting (incentive) compensation of material risk-takers in the financial sector. Moderate deferral requirements have a robustly positive effect on equilibrium risk-management effort only if the bank manager's outside option is sufficiently high, else, their effectiveness depends on the dynamics of information arrival. Stringent deferral requirements unambiguously backfire. We characterize when regulators should not impose any deferral regulation at all, when it can achieve second-best welfare, when additional clawback requirements are of value, and highlight the interaction with capital regulation.

The Financial Position of the Workers Most Affected by the Pandemic: An Analysis Drawing on the Spanish Survey of Household Finances
Pidkuyko, Myroslav,Villanueva, Ernesto
In the European economies, employment in the retail sector, in accommodation and food services and in the arts and recreation activities has been hit especially hard by the pandemic, so it is important to ascertain the financial resources that the individuals working in these sectors have available to withstand a possible fall in their income. This article draws on the Banco de España’s Survey of Household Finances (EFF, by its Spanish abbreviation) to characterise the financial position of the workers most affected by the present crisis. In 2017, these sectors employed approximately half of all women and the under-35s, two population groups with relatively lower labour income levels. In many cases, these workers lived in households that included higher income earners, which may partially mitigate the incidence of possible job losses. Even so, in 2017, 28% of those employed in the sectors affected lived in households whose financial assets amounted to less than one month’s income, and one in 12 lived in households for which debt repayments amounted to more than 40% of their pre-tax income. Among the workers in the sectors most affected by the pandemic, the financial position of those who were less able to work from home and those employed in the accommodation and food services and arts and recreation sectors was relatively more vulnerable.

The Hidden Costs of Strategic Opacity
Babus, Ana,Farboodi, Maryam
We explore a model in which banks strategically hold interconnected and opaque portfolios, despite increasing the likelihood they are subject to financial crises. In our framework, banks choose their degree of exposure to other banks to influence how investors can use their information. In equilibrium banks choose portfolios which are neither fully opaque, nor fully transparent. However, their portfolios are excessively interconnected to obfuscate investor information. Banks can create a degree of opacity that decreases welfare, and makes bank crises more likely. Our model is suggestive about the implications of asset securitization, as well as government bailouts.

The Impact of Bank's Internal Governance Mechanism on Operational Loss: Evidence from Turkey
Erzurumlu, Yaman O.,Avci, Gurcan
We study the impact of internal governance mechanisms on the operational risk management provided with deposit banks of Turkey as a Basel compliant representative banking system. Drawing from internal audit, internal control, and risk management literature, we consider the impact of characteristics of these mechanisms on the degree of operational loss at the subcommittee level. Two factors stand out as improving the internal governance of banks. Internal governance quality improves resulting in less material operational loss with adequate staffing. Organization of the internal governance mechanisms, carefully structured control points, and sufficient reporting to senior level management in banks ensure that banks’ shareholders experience fewer surprises. Excess funding has limited or no effect on mitigating operational loss. Characteristics are more significant for internal audit and internal control subcommittees than they are for risk management subcommittee. Results are robust when tests are repeated with aggregated data in order to capture potential cooperation between and contribution of the individual units.

The Influence of Board of Directors on the Corporate Social Performance in the Indian Manufacturing Sector
This paper aims to contribute, to the empirical evidence for the influence of Board of Directors on the Corporate Social Performance (CSP). A sample of top 10 companies of BSE, over the period from 2015 to 2019, was examined. The results indicated that the Board of Director influenced the Corporate Social Performance, measured by the CSR amount and the final performance of the firm, measured by Return on Assets. The Corporate Social Performance has a mediating role in the relation between the CSP and Board of Directors, in the manufacturing sector of India.

The Matthew Effect and Modern Finance: On the Nexus between Wealth Inequality, Financial Development and Financial Technology
Frost, Jon,Gambacorta, Leonardo,Gambacorta, Romina
This paper analyses the role of financial development and financial technology in driving inequality in (returns to) wealth. Using micro data from the Survey on Household Income and Wealth (SHIW) conducted by the Bank of Italy for the period 1991-2016, we find evidence of the "Matthew effect" - a capacity of wealthy households to achieve higher returns than other households. With an instrumental variable approach, we find that financial development (number of bank branches) and financial technology (use of remote banking) both have a positive association with households' financial wealth and financial returns. While households of all wealth deciles benefit from the effects of financial development and financial technology, these benefits are larger when moving toward the top of the wealth distribution. Still, the economic significance of this gap fell in the last part of the sample period, as remote banking became more widespread.

The Out-of-Sample Performance of Carry Trades
Hsu, Po-Hsuan,Taylor, Mark P.,Wang, Zigan
We carry out a large-scale investigation of the out-of-sample profitability of in-sample profitable carry trade strategies, using foreign exchange data for 48 countries spanning a period from 1983 to 2015 and employing reality check and stepwise tests to correct for data-snooping bias (the factor of luck in model selection). Carry trade strategies chosen as profitable in one period are generally not profitable in an ensuing out-of-sample sample period, especially after correcting for data-snooping, and even after allowing for learning and stop-loss strategies. Any evidence of consistency in carry trade profitability that is found is concentrated in a relatively brief historical period, 2001-2005. We further investigate particular currency pairs that may drive the out-of-sample profitability during this period, and find their performance to be unstable in general. Our findings thus highlight the instability and the factor of luck in generating profits from carry trades.

The Persistence of Miscalibration
Boutros, Michael,Ben-David, Itzhak,Graham, John R.,Harvey, Campbell R.,Payne, John W.
Using 14,800 forecasts of one-year S&P 500 returns made by Chief Financial Officers over a 12-year period, we track the individual executives who provide multiple forecasts to evaluate how they adapt and recalibrate in response to return realizations. We present a simple model of Bayesian learning which suggests that the evolution of beliefs should be impacted by return realizations, but that stronger priors yield a sluggish response. While CFOs' forecasts are unbiased, their confidence intervals are far too narrow, implying a very strong conviction in their beliefs. Consistent with Bayesian learning, we find that when return realizations fall outside of ex-ante confidence intervals, CFOs' subsequent confidence intervals become significantly wider. However, the magnitude of the updating is apparently dampened by the tightness of prior beliefs and, as a result, miscalibration persists.

The Portfolio Composition Effect
Müller-Dethard, Jan,Weber, Martin
Does the evaluation of a portfolio of stocks depend on its composition of winner and loser stocks? To test this, we define a simple, counting-based measure of performance - the number of winner relative to the number of loser stocks in a portfolio - and examine how this composition measure affects individuals' willingness to invest in a portfolio. We derive testable predictions for the proposed composition measure from a framework which combines category-based thinking with mental accounting. Consistent with our predictions, we find across all experiments that individuals allocate larger investments to portfolios with more winner than loser stocks relative to alternative portfolios with more loser than winner stocks, although both portfolios (1) have realized identical overall portfolio returns and (2) show identical expected risk-return characteristics. Building on our experimental findings, we analyze fund flows of exchange-traded funds on leading equity market indices. We identify that the proposed portfolio composition measure is positively related to future net fund flows.

The Real Effects of Exchange Rate Risk on Corporate Investment: International Evidence
Taylor, Mark P.,Wang, Zigan,Xu, Qi
We empirically investigate the real effects of exchange rate risk on investment activities of international firms. We provide cross-country, firm-level evidence that greater unexpected currency volatility leads to significantly lower capital expenditures. The effect is stronger for countries with higher economic openness and for firms that do not use currency derivatives to hedge. We empirically test the implications of two potential mechanisms: Real options and precautionary savings. Our findings are consistent with both explanations. Two historical events in the FX markets strengthen the identification of our results.

The Risk of Being a Fallen Angel and the Corporate Dash for Cash in the Midst of COVID
Acharya, Viral V.,Steffen, Sascha
Data on firm-loan-level daily credit line drawdowns in the United States reveals a corporate “dash for cash” induced by COVID-19. In the first phase of extreme precaution and heightened aggregate risk, all firms drew down bank credit lines and raised cash levels. In the second phase following the adoption of stabilization policies, only the highest-rated firms switched to capital markets to raise cash. Consistent with the risk of becoming a fallen angel, the lowest-quality BBB-rated firms behaved more similarly to non-investment grade firms. The observed corporate behavior reveals the significant impact of credit risk on corporate cash holdings.

The Risk of Being a Fallen Angel and the Corporate Dash for Cash in the Midst of Covid
Acharya, Viral V.,Steffen, Sascha
Data on firm-loan-level daily credit line drawdowns in the United States reveals a corporate

The Second Worldwide Wave of Interest in Coronavirus since the COVID-19 Outbreaks in South Korea, Italy and Iran: A Google Trends Study
Artur Strzelecki

The recent emergence of a new coronavirus, COVID-19, has gained extensive coverage in public media and global news. As of 24 March 2020, the virus has caused viral pneumonia in tens of thousands of people in Wuhan, China, and thousands of cases in 184 other countries and territories. This study explores the potential use of Google Trends (GT) to monitor worldwide interest in this COVID-19 epidemic. GT was chosen as a source of reverse engineering data, given the interest in the topic. Current data on COVID-19 is retrieved from (GT) using one main search topic: Coronavirus. Geographical settings for GT are worldwide, China, South Korea, Italy and Iran. The reported period is 15 January 2020 to 24 March 2020. The results show that the highest worldwide peak in the first wave of demand for information was on 31 January 2020. After the first peak, the number of new cases reported daily rose for 6 days. A second wave started on 21 February 2020 after the outbreaks were reported in Italy, with the highest peak on 16 March 2020. The second wave is six times as big as the first wave. The number of new cases reported daily is rising day by day. This short communication gives a brief introduction to how the demand for information on coronavirus epidemic is reported through GT.

The Sensitivity of Cash Savings to the Cost of Capital
Acharya, Viral V.,Byoun, Soku,Xu, Zhaoxia
We show theoretically and empirically that in the presence of a time-varying cost

Tracking Spillovers During the Taper Tantrum: Evidence from Institutional Investor Transactions in Emerging Markets
Farrell, Diana,Eckerd, George,Zhao, Chen,O'Brien, Melissa
In this report, we study the mid-2013 taper tantrumâ€"a market event comprised of a series of policy communications from the Federal Reserve that contributed to sharp volatility across global asset pricesâ€"as a case study to shed light on a widely-referenced monetary policy shock. Our research documents and analyzes the trading activity of institutional investors to provide policymakers and researchers with a picture of the interplay between market price movements and investor behavior. The work is motivated by the growing importance of unconventional monetary policy and the role of the market participants in transmitting such signals across markets. We use proprietary data that includes global financial markets transactions (foreign exchange and government bond trades) executed by all types of institutional investors, made available by the Markets Division of J.P. Morgan’s Corporate & Investment Bank. We find that flows of institutional investors have substantial explanatory power for EM currency performance. In particular, the extent of EM currency depreciation during the taper tantrum is correlated with the trading activity of a relatively small set of hedge funds and banks associated with momentum, as well as asset managers that do not typically exhibit systematic behavior. During the taper tantrum, asset manager net flows became increasingly correlated with changes in EM currencies and the net flows of certain banks and hedge funds, reflecting potential herding behavior that had a significant impact on prices. We also find evidence of a time-varying relationship between net flows and EM currency price action consistent with a larger impact of net flows amid the rise in market volatility over the period. Our findings illustrate how private investor trading activity can be an important, but difficult-to-predict, component in monetary policy transmission mechanism. Central banks should continue to advance their understanding of how policy measures designed to influence market prices also affect the behavior of market participants.

U.S. Populist Rhetoric and Currency Returns
Filippou, Ilias,Gozluklu, Arie Eskenazi,T. Nguyen, My,Taylor, Mark P.
We develop a novel measure of U.S. populist rhetoric. Aggregate Populist Rhetoric (APR) Index spikes around populist events. We decompose the APR Index into sub-indices. We show that APR Index and International Relations sub-index are negatively priced in the cross-section of currency excess returns. Currencies that perform well (badly) when U.S. populist rhetoric is high yield low (high) expected excess returns. Investors require high risk premium for holding currencies which underperform in times of rising U.S. populist rhetoric, especially in the post-crisis period. A long-short strategy that buys (sells) currencies with high (low) exposure to U.S. populism offers strong diversification benefits.

Uncertainty and Dispersion in Professional Interest Rate Forecasts: International Evidence and Theory
Cukierman, Alex,Lustenberger, Thomas
We examine the cross-country relationships between measures of forecast uncertainty, forecast dispersion across individual forecasters and the variabilities of short-term interest rates and long-term yields. The main findings are: (i) Forecast uncertainty and forecast dispersion are positively and significantly related across countries for both short-term interest rates and long-term yields. (ii) A positive, albeit weaker, relation is found between forecast uncertainty and interest rate variability. (iii) Forecast dispersion of short-term interest rates and rates' variability are also positively associated. The evidence is followed by a Bayesian learning model that discusses conditions under which the results above are implied by theory.

Value Creation in Shareholder Activism: A Structural Approach
Albuquerque, Rui A.,Fos, Vyacheslav,Schroth, Enrique J.
We model an investor's choice between filing Schedules 13D and 13G and use the model to estimate expected returns to activist and passive investing. Using the model, we decompose average Schedule 13D filing announcement returns into treatment (75.2%), stock picking (12.2%), and sample selection components (12.6%). The treatment component of Schedule 13D announcement returns predicts improvements in firm performance and a lower probability of a proxy contest, suggesting that our estimate of the treatment component identifies more effective activism campaigns. Counterfactual analysis shows that if all investors shared the private cost of activism, a large fraction of Schedule 13G filings would have been filed as Schedule 13D, resulting in substantial firm value gains.

Wealth Redistribution in Bubbles and Crashes
Lou, Dong
Using comprehensive administrative data from China, we document a substantial increase in inequality of wealth held in risky assets by Chinese households in the 2014-15 bubble-crash episode: the largest 0.5% households in the equity market gain, while the bottom 85% lose, 250B RMB through active trading in this period, or 30% of either group's initial equity wealth. In comparison, the return differential between the top and bottom groups in 2012-14, a period of a relatively calm market, is an order of magnitude smaller. We examine a number of possible explanations for these findings and discuss their implications.

Where Do Institutional Investors Seek Shelter When Disaster Strikes? Evidence from Covid-19
Glossner, Simon,Matos, Pedro,Ramelli, Stefano,Wagner, Alexander F.
Institutional investors played a crucial role in the COVID-19 market crash. U.S. stocks with higher institutional ownership -- in particular, those held more by active, short-term, and domestic institutions -- performed worse. An analysis of changes in holdings through the first quarter of 2020 reveals that mutual funds, investment advisors, and pension funds favored stocks with strong financials (low debt and high cash), whereas hedge funds sold stocks indiscriminately. None of these institutional investor groups appear to have actively tilted their portfolios toward firms with better environmental and social performance. Data from a large discount brokerage indicate that retail investors acted as liquidity providers. Overall, the results suggest that when a tail risk realizes, institutional investors express a preference for "hard" measures of firm resilience.