Research articles for the 2020-08-20

A Preliminary Assessment of the Impact of the COVID-19 Pandemic on Azerbaijani Economy
Azerbaijan became the country among the post-soviet countries, that allocated the largest share of GDP, in order to eliminate the economic challenges caused due to the outbreak of COVID-19. Providing favorable economic conditions in the post-pandemic period is as crucial as supporting the economy during the period of the pandemic. Thus, it seems like all implemented programs and activities, including the huge amount of government funding, is going to maintain the economic balance and provide the development over the long-term period. It is an undeniable fact that the impact of the pandemic on the economy might be fully assessed only over time. Experience demonstrates that early evaluation may lead to even greater recession and instability. This paper aims to demonstrate the challenges faced by Azerbaijan in the framework of the fight against a pandemic. Since the economy of a country was affected, a detailed analysis may provide a better understanding of the outcome, enlightening the areas which need more support and development.

Analytic Calibration in Andreasen-Huge SABR Model
K.E. Feldman

We derive analytic formulae which link $\alpha$, $\nu$ and $\rho$ parameters in Andreasen-Huge style SABR model to the ATM price and option prices at four equally spaced strikes on the sides of ATM. We give two applications. First, we give a characterisation for the SABR parameters in terms of the swap rate forward probability density function. Second, we show how Andreasen-Huge SABR can be combined with other well know analytic SABR formulae to allow consistent use in the non-arbitrage region.

Bond Misallocation and Liquidity Risk
Liu, Shuo
Which corporate bond's yield is more exposed to search frictions? Is the exposure correlated with dealers' inter-mediation? We propose a measure of bond's mis-allocation among dealers and show its correlation with bond's liquidity risk which is attributed to search frictions. This measure is defined as the cross-sectional covariance of dealers' private valuations for a bond and their corresponding inventory positions. Using a transaction-level dataset on U.S. corporate bonds, we verify: a higher mis-allocation is associated with a higher magnitude of liquidity risk. A search-match model with dealers' endogenous search efforts offers an explanation on this correlation.

CEO Power and Luck: Impact of Stock Markets on Building Powerful CEOs
Al Sabah, Turk
The optimal view of managerial power theory suggests that corporate boards reward CEOs with power for good performance as the boards' assessment of their ability is higher. In evaluating the CEO's quality, economic theory predicts that boards filter out luck from performance. Luck represents exogenous shocks to performance, such as market-wide conditions, that are outside the CEO's control. Contrary to the prediction, we find that CEOs are rewarded power for luck. In the baseline specification, a one standard deviation increase in firm performance due to luck leads to a 3% increase in CEO-power relative to the median. This finding is mainly driven by firms with weaker governance in terms of board structure and institutional ownership. We also find some evidence suggesting that CEOs who are managing those firms are rewarded power when luck is good, but are not punished equally when luck is bad. This may suggest that, given the opportunity, CEOs strategically time their entrenchment following good firm and market performance.

Circuit Breakers and Magnet Effect: Empirical Evidence from Chinese Securities Market
Liu, Jie,Zhu, Yinglun,Zhu, Jianzhi
This paper examines the impact of circuit breakers on the stock price using the empirical evidence from Chinese securities market in 2016. The empirical evidence indicates that circuit breakers trigger the magnet effect and stocks on trading days with circuit breakers show a significant downward tendency when index approaches circuit breaker thresholds, compared to stocks of the control group. In addition, the magnet effect is more significant for stocks with better past returns, lower liquidity and higher trading leverage. Moreover, stocks with better past returns and higher liquidity obtain higher returns on the next trading day, while trading leverage has little impact. The results not only contribute to the previous literature by demonstrating the existence of the magnet effect and investigating its influencing factors, but also illustrate that the magnet effect is one of the most important reasons why the circuit breakers mechanism failed to stabilize the stock price in China.

Detecting and explaining changes in various assets' relationships in financial markets
Makoto Naraoka,Teruaki Hayashi,Takaaki Yoshino,Toshiaki Sugie,Kota Takano,Yukio Ohsawa

We study the method for detecting relationship changes in financial markets and providing human-interpretable network visualization to support the decision-making of fund managers dealing with multi-assets. First, we construct co-occurrence networks with each asset as a node and a pair with a strong relationship in price change as an edge at each time step. Second, we calculate Graph-Based Entropy to represent the variety of price changes based on the network. Third, we apply the Differential Network to finance, which is traditionally used in the field of bioinformatics. By the method described above, we can visualize when and what kind of changes are occurring in the financial market, and which assets play a central role in changes in financial markets. Experiments with multi-asset time-series data showed results that were well fit with actual events while maintaining high interpretability.

Does Local Competition and Firm Market Power Affect Investment Adviser Misconduct?
Gelman, Michael,Shoham, Amir,Tarba, Shlomo,Khan, Zaheer
This paper examines the impact of local competition and local firm market power on misconduct by analyzing the investment adviser market. The study is based on an extensive sample of more than 3.8 million employee-year observations of investment advisers resulting in 709,416 firm-county-year observations over 12 years. The findings show that a firm’s market power at the county level and county market competition have a negative influence on investment adviser misconduct. The result is robust to a battery of empirical tests. We show that in counties where the same firm has greater local market power, it exhibits less misconduct. We also identify the effect of local competition and market power on misconduct using two exogenous shocks, M&A and ending a local monopoly. We establish the adviser’s employment stability as a novel channel for explaining the impact of local competition and firm market power on misconduct.

Dynamic Mean-Variance Efficient Fractional Kelly Portfolios in a Stochastic Volatility Model
He, Xue Dong,Jiang, Zhao Li
Fractional Kelly portfolios are popular investment strategies in the market. In this paper, we improve the mean-variance efficiency of a fractional Kelly portfolio by minimizing the variance of the return of a portfolio subject to the constraint that the expected return rate of the portfolio is as high as that of the fractional Kelly portfolio. We consider so-called equilibrium portfolio strategies due to time inconsistency caused by the mean-variance criterion. We drive an equilibrium strategy in closed form and show that it reduces the variance of portfolio return compared to the fractional Kelly portfolio, although the reduction is quantitatively small.

Financial Friction and Gains (Losses) from Trade
Ebrahimian, Mehran,Firooz, Hamid
How does financial friction influence gains from trade? To answer this question, this paper develops a general equilibrium model of international trade with cross-country financial friction heterogeneity, as the source of comparative advantage. Although product markets are competitive, production of firms in finance-dependent sectors of a closed economy is supported by a markup over marginal cost, so that a higher profit prevents firms from strategically defaulting on loans. Trade liberalization reduces the price of the finance-dependent good, which benefits the consumers; however, economic rents of producing finance-dependent goods flow out to the financially less-frictional economy, which is welfare-reducing. In sum, gains/losses from trade is determined by the financing friction severity of the partner country. We test the empirical predictions of the model. In particular, while we show that financial development matters for the growth of finance-dependent industries in open economies, we do not find such an evidence for closed economies.

For Whom Corporate Leaders Bargain
Bebchuk, Lucian A.,Kastiel, Kobi,Tallarita, Roberto
At the center of a fundamental and heated debate about the purpose that corporations should serve, an increasingly influential “stakeholder-ism” view advocates giving corporate leaders the discretionary power to serve all stakeholders and not just shareholders. Supporters of stakeholder-ism argue that it would address growing concerns about the impact of corporations on society and the environment. By contrast, critics of stakeholder-ism object that corporate leaders should not be expected to use expanded discretion to benefit stakeholders. This Article presents novel empirical evidence that can contribute to resolving this key debate. During the hostile takeover era of the 1980s, stakeholder-ist arguments contributed to the adoption of constituency statutes by more than thirty states. These statutes authorize corporate leaders to give weight to stakeholder interests when considering a sale of their company. We study how corporate leaders in fact used the power awarded to them by these statutes in the past two decades. In particular, using hand-collected data, we analyze in detail more than a hundred cases governed by constituency statutes in which corporate leaders negotiated a sale of their company to a private equity buyer.We find that corporate leaders have used their bargaining power to obtain gains for shareholders, executives, and directors. However, despite the risks that private equity acquisitions posed for stakeholders, corporate leaders made very little use of their power to negotiate for stakeholder protections. Furthermore, in the cases in which some protections were included, they were practically inconsequential or cosmetic. We conclude that constituency statutes failed to deliver the benefits to stakeholders that they were supposed to produce.Beyond their implications for the long-standing debate on constituency statutes, our findings also provide important lessons for the ongoing major debate on stakeholder-ism. At a minimum, stakeholder-ists should identify the causes for the failure of constituency statutes and examine whether the adoption of their proposals would not suffer a similar fate. After examining several possible explanations for the failure of constituency statutes, we conclude that the most plausible explanation is that corporate leaders have incentives not to protect stakeholders beyond what would serve shareholder value. The evidence we present indicates that stakeholder-ism should be expected to fail to deliver, as constituency statutes did; stakeholder-ism therefore should not be supported, even by those who deeply care about stakeholders.

Modelling multi-period carbon markets using singular forward backward SDEs
Chassagneux Jean-Francois,Chotai Hinesh,Crisan Dan

We introduce a model for the evolution of emissions and the price of emissions allowances in a carbon market such as the European Union Emissions Trading System (EU ETS). The model accounts for multiple trading periods, or phases, with multiple times at which compliance can occur. At the end of each trading period, the participating firms must surrender allowances for their emissions made during that period, and additional allowances can be used for compliance in the following periods. We show that the multi-period allowance pricing problem is well-posed for various mechanisms (such as banking, borrowing and withdrawal of allowances) linking the trading periods. The results are based on the analysis of a forward-backward stochastic differential equation with coupled forward and backward components, a discontinuous terminal condition and a forward component that is degenerate. We also introduce an infinite period model, for a carbon market with a sequence of compliance times and with no end date. We show that, under appropriate conditions, the value function for the multi-period pricing problem converges, as the number of periods increases, to a value function for this infinite period model, and that such functions are unique.

Optimal Network Compression
Hamed Amini,Zachary Feinstein

This paper introduces a formulation of the optimal network compression problem for financial systems. This general formulation is presented for different levels of network compression or rerouting allowed from the initial interbank network. We prove that this problem is, generically, NP-hard. We focus on objective functions generated by systemic risk measures under systematic shocks to the financial network. We conclude by studying the optimal compression problem for specific networks; this permits us to study the so-called robust fragility of certain network topologies more generally as well as the potential benefits and costs of network compression.

Option Implied VIX, Skew and Kurtosis Term Structure Indices
Madan, Dilip B.,Wang, King
Comparisons are made of the CBOE skew index with those derived from parametric skews of bilateral gamma models and from the differentiation of option implied characteristic exponents. Discrepancies may be attributed to strike discretization in evaluating prices of powered returns. The remedy suggested employs a finer and wider set of strikes obtaining additional option prices by interpolation and extrapolation of implied volatilities. Procedures of replicating powered return claims are applied to the fourth power and the derivation kurtosis term structures. Regressions of log skewness and log excess kurtosis on log maturity confirm the positivity of decay in these higher moments. The decay rates are below those required by processes of independent and identically distributed increments.

Payment Banks: Digital Revolution in Indian Banking System
Mehta, Dr. Neha,, Sweety
Digital revolution in India has brought paradigm shift in the banking system and financial transactions due to online payment. Payment gateways, e-commerce applications and other benefits boost smartphone users towards digital transactions. This study focuses on identifying factors important for customers to use payment banks for transaction. The identified dimensions for the usage of payment banks are; user friendly, convenience, cost effectiveness, security and easy cash management. People look for the aforesaid factors while they transact through payment banks. To validate the factors and check the model fit, a confirmatory factor analysis was run using AMOS. The analysis confirms constructs convergent validity and reliability, and model fit.

Portfolio Optimization of 60 Stocks Using Classical and Quantum Algorithms
Jeffrey Cohen,Alex Khan,Clark Alexander

We continue to investigate the use of quantum computers for building an optimal portfolio out of a universe of 60 U.S. listed, liquid equities. Starting from historical market data, we apply our unique problem formulation on the D-Wave Systems Inc. D-Wave 2000Q (TM) quantum annealing system (hereafter called D-Wave) to find the optimal risk vs return portfolio. We approach this first classically, then using the D-Wave, to select efficient buy and hold portfolios. Our results show that practitioners can use either classical or quantum annealing methods to select attractive portfolios. This builds upon our prior work on optimization of 40 stocks.

Portfolio Selection under Median and Quantile Maximization
He, Xue Dong,Jiang, Zhao Li,Kou, Steven
In this paper, we study a portfolio selection problem in which an agent trades a risk-free asset and multiple risky assets with deterministic mean return rates and volatility and wants to maximize the alpha-quantile of her wealth at some terminal time. Because of the time inconsistency caused by quantiles, we consider intra-personal equilibrium strategies. We find that among the class of time-varying, affine portfolio strategies, the intra-personal equilibrium does not exist when alpha>1/2, leads to zero investment in the risky assets when alpha<1/2, and is a portfolio insurance strategy when alpha=1/2. We then compare the intra-personal equilibrium strategy in the case of alpha=1/2, namely under median maximization, to some other strategies and apply it to explain why more wealthy people invest more precentage of wealth in risky assets. Finally, we extend our model to account for multiple terminal time.

Positionality-Weighted Aggregation Methods on Cumulative Voting
Takeshi Kato,Yasuhiro Asa,Misa Owa

The issue in solving social problems is how to respect minority opinions, which are often ignored in general majority rules. To build consensus on pluralistic values and make social choices in consideration of minority opinions, we propose aggregation methods that give weighting to the minority's positionality on cardinal cumulative voting. Based on quadratic and linear voting, we formulated three weighted aggregation methods that differ in the ratio of votes to cumulative points and the weighting of the minority to all members, and calculated the frequency distributions of the aggregation results, assuming that the distributions of votes follow normal distributions. From these calculation results, we found that minority opinions are likely to be reflected as weighting increases proportionally in two of the above three methods. This means that Sen and Gotoh's idea of considering the social position of unfortunate people on ordinal ranking, that welfare economics considers under an axiomatic approach, was shown by weighting the minority's positionality on cardinal voting. In addition, we can know the contents such as the number and positionality of the minority from the analysis of the aggregation results. It will be useful for promoting mutual understanding between the majority and minority by visualizing the contents of the proposed aggregation methods interactively in the consensus-building process. With the further development of information technology, the consensus building on cardinal choices based on big data will be necessary. We would like to use the proposed aggregation methods for making social choices for pluralistic values such as social, environmental, and economic.

Post-Covid Africa: The Controls of National Planning
Amonya, Fred
Crises force us to stop and think. This paper examines the prospect of deep reform of national planning in Africa in response to COVID-19. The paper is a contrasted case study of Kenya and Uganda. The attempt at generalisation across Africa draws on a shared history of state formation. And a contrast of the two countries teases out a tension, which tension the paper uses to illuminate the two policy spaces. The analytical frame draws on control theory. The paper argues that neither country is likely to see structural reform of their national planning. Yet, the epistemological thrust of the paper is not that deduction but questions arising along the scrutiny of the policy spaces.

Reforming the State-Based Forward Guidance through Wage Growth Rate Threshold: Evidence from FRB/US Simulations
Sudiksha Joshi

I have analyzed the practicality of the Evans Rule in the state based forward guidance and possible ways to reform it. I examined the biases, measurement errors, and other limitations extant in the unemployment and the inflation rate in the Evans Rule. Using time series analysis, I calibrated the thresholds of ECI wage growth and the employment to population ratio and investigated the relationship between other labor utilization variables. Then I imposed various shocks and constructed impulse response functions to contrast the paths of eight macroeconomic variables under three scenarios. The results suggest that under the wage growth rate scenario, the federal funds rate lift off earlier than under the current Evans Rule.

Screening Talent: Absolute or Percentile Thresholds?
Balakrishnan, Ramji ,Lin, Haijin,Sivaramakrishnan, Shiva
Matching talents to tasks is an important part of job design. Organizations routinely use performance thresholds to group agents by talent. We see thresholds defined both in terms of an individual's own performance (absolute value) and in terms of peer performance (percentiles). Intuition suggests a preference for percentile thresholds because the resulting rank-order statistic is sufficient to assess relative talent. Yet, in the context of a task assignment problem in which the objective is to match talent with task type (using two agents and two task types), we show that absolute thresholds can dominate percentile thresholds under either of two conditions. First, flexibility in task assignment tilts the balance toward absolute thresholds. Second, performance manipulation can adversely affect the inherent advantage of percentile thresholds because they motivate agents to invest relatively more in personally costly influence activities that cast their performance in a favorable light. We examine how these results hold up when there are countably large number of agents and discuss empirical implications.

Short-term Forecasting of the COVID-19 Pandemic using Google Trends Data: Evidence from 158 Countries
Fantazzini, Dean
The ability of Google Trends data to forecast the number of new daily cases and deaths of COVID-19 is examined using a dataset of 158 countries. The analysis includes the computations of lag correlations between confirmed cases and Google data, Granger causality tests, and an out-of-sample forecasting exercise with 18 competing models with a forecast horizon of 14 days ahead. This evidence shows that Google-augmented models outperform the competing models for most of the countries. This is significant because Google data can complement epidemiological models during difficult times like the ongoing COVID-19 pandemic, when official statistics maybe not fully reliable and/or published with a delay. Moreover, real-time tracking with online-data is one of the instruments that can be used to keep the situation under control when national lockdowns are lifted and economies gradually reopen.

Stress Testing and Bank Business Patterns: A Regression Discontinuity Study
García, Raffi E.,Steele, Suzanne
This paper examines whether forward-looking disclosure requirements impact firm business patterns. We rely on the implementation of the Comprehensive Capital Analysis Review (CCAR) stress test on U.S. bank holding companies as our identification strategy. Using a regression discontinuity design to exploit the quasi-experimental properties of the regulation around the different bank-size policy thresholds, we document four key findings. First, stress testing reduces moral hazard by decreasing the risk-weighted assets percentage. Second, the decrease in moral hazard is not at the expense of bank lending since reducing risk results in higher concentrations in lending as banks shift out of higher-risk assets. Third, stress test banks' lower risk is perceived by investors and results in lower funding costs relative to non-stress test banks. Fourth, the increase in regulatory oversight and stricter capital and transparency requirements do not cause large banks to manipulate their bank size to avoid complying with the stress test requirements. These results are consistent with the optimality condition in the banking sector.

Systemic risk statistics with scenario analysis
Fei Sun,Yichuan Dong

Systemic risk is a critical factor for both mathematical physics and risk management. In this paper, we consider a special class of risk statistics, named systemic risk statistics. Our result provides a new approach for addressing systemic risk, especially in large scale integration. By further developing the properties related to systemic risk statistics, we are able to derive dual representation for such risk.

The Static and Dynamic Connectedness of Environmental, Social, and Governance Investments: International Evidence
Umar, Zaghum,Kenourgios, Dimitris,Papathanasiou, Spyros
We investigate the connectedness of the most significant global equity indices that comprise companies with the highest environmental, social, and governance (ESG) performance. Motivated by the rapid growth of socially responsible investing during the last two decades, we examine whether these investments are prone to similar exogenous economic and financial shocks as their conventional counterparts. Employing a variety of influential macroeconomic and financial variables over the period 10/1/2007- 4/15/2020, we document statistically significant and consistent transmissions between the employed equity indices throughout the sample period. In particular, the connectedness exhibits dynamic patterns during three periods: the European sovereign debt crisis, the systemic Greek problems, and the outbreak of the coronavirus pandemic. We also find that developed equity markets are the shock transmitters to Asian and other emerging markets. Our results highlight the risk of contagion and the diminishing portfolio diversification benefits of these equity indices during turbulent periods.

Trust in Financial Institutions: A Survey
van der Cruijsen, Carin,de Haan, Jakob,Roerink, Ria
Trust in financial institutions is widely considered important. However, a clear overview of studies on the drivers of trust is missing. We intend to fill this gap in the literature. After discussing why trust in financial institutions is important, we turn to its measurement, where we distinguish between trust in one’s own institution and trust in institutions in general (narrow-scope and broad-scope trust), and discuss how these measures differ from generalized trust (i.e. trust in other people with whom there is no direct relationship). Finally, we survey the determinants of trust in financial institutions and discuss a wide range of drivers. First, trust in financial institutions depends on the economic situation: it behaves procyclically and is negatively affected by financial crises. Second, the behavior of the financial institutions matters: prudent conduct, the provision of good services and financial health have a positive effect on trust. Third, although consumer characteristics also relate to trust, many of these relationships are context-dependent. Fourth, there is a positive association between narrow-scope trust on the one hand and broad-scope trust and generalized trust on the other. Last, policy measures and supervisory actions can help prevent loss of trust.

West Australian Pandemic Response: The Black Swan of Black Swans
David Cavanagh,Mark Hoey,Andrew Clark,Michael Small,Paul Bailey,Jon Watson

The COVID-19 Pandemic has been described as the global challenge of our time, an enormous human tragedy with dramatic economic impacts. This paper describes the response and expected recovery process for Western Australia, where a rapid and effective response was implemented. This has enabled an early transition into an expected recovery both in health and economic terms. The positive lessons learned from this experience are documented as they emerge in order to support other states and nations as they address this issue globally in the near-term and consider enduring improvements for the longer term. While the authors have personal experience in the WA context, wider observations across Australia and selected international benchmarks are also included. Key lessons include the importance of good health advice in Australia's interest; timely, synchronized and aligned action at all levels of government; a program of well communicated, aligned health and economic measures which support all in society allowing a very high level of appropriate community behaviour, ensuring the health system was not overloaded; innovation in telehealth, testing, pandemic modelling, and integrated operations which also allowed essential industries to continue; and strong border and travel controls with highly effective isolation preventing community spread, ultimately enabling rapid elimination of the disease from the hospital system. In combination, these demonstrate that in the case of Western Australia the result of first eliminating the disease from the community, and then reopening the economy progressively at a strong pace, has enabled a world leading outcome in both in health and economic terms. The lessons from this experience are widely applicable, shareable both as supporting service to other regions and through knowledge transfer.