Research articles for the 2020-09-20

A bounded operator approach to technical indicators without lag
Frédéric Butin

In the framework of technical analysis for algorithmic trading we use a linear algebra approach in order to define classical technical indicators as bounded operators of the space $l^\infty(\mathbb{N})$. This more abstract view enables us to define in a very simple way the no-lag versions of these tools. Then we apply our results to a basic trading system in order to compare the classical Elder's impulse system with its no-lag version and the so-called Nyquist-Elder's impulse system.

An energy-driven macroeconomic model validated by global historical series since 1820
Herve Bercegol,Henri Benisty

Global historical series spanning the last two centuries became recently available for primary energy consumption (PEC) and Gross Domestic Product (GDP). Here through a thorough analysis of the data, we propose a new, simple macroeconomic model whereby physical power fuels economic power. From 1820 to 1920, the linearity between global PEC and world GDP justifies basic equations where, originally, PEC incorporates unskilled human labor that consumes and converts food energy. In a consistent model, both physical capital and human capital are fed by PEC and store energy. In the following century, 1920-2016, GDP grows quicker than PEC, displaying periods of linearity of the two variables, separated by distinct jumps interpreted as radical technology shifts. The GDP to PEC ratio accumulates game-changing innovation, at an average growth rate proportional to PEC. These results seed alternative strategies for modelling and political management of the climate crisis and energy transition.

Could the ESG Sector Lead the Recovery of the COVID-Economy?
Gamlath, Suresh
The June 2020 outlook for the world economy, forecast a ‘synchronised deep downturn’ much worse than the 2008 crisis and ‘an uncertain recovery’. The impact of ‘lockdown’ on economic activity had a profound effect on the fortunes of firms, households, and entire industries around the world. While some sectors were buoyed by the sharp growth of home-based online working and entertainment; an overwhelming majority experienced significant contraction as demand stalled. The likelihood of large-scale corporate collapse and structural decline of industries have drained investor-confidence and have confined capital to the side-lines. With the fiscal multiplier suppressed by significant firm-exits and job-destruction; conventional fiscal stimulus could prove to be less effective than expected. This raises urgent questions about which sectors would be able to remain sufficiently intact to lead a sustainable recovery. During the tumultuous early months, while broad market indices were experiencing dramatic swings, firms with high ES ratings were observed to have higher returns, lower volatility, and higher profit margins. While the low exposure of ESG portfolios to oil and commodity markets may prove to be a partial explanation for these early observations; the preservation of ES credentials can contribute to the resiliency of supply chains (as a direct result of meeting ESG requirements) and invoke higher confidence among investors. ESG firms can also attract higher consumer loyalty that the pandemic has accelerated, as people place a greater emphasis on the quality of the environment. Based on recent and earlier works we put forward the argument that the ESG sector has the potential to attract substantial private investment (not only impact-first, but also financial-first) in the covid-economic environment and contribute significantly to a sustainable recovery. We also discuss the impediments to ESG investing, including the stability of the policy-environment and the problem of ‘green financing’.

Crude Oil Prices and Crypto-Assets: What Are the Effects of COVID-19 Pandemic?
Mzoughi, Hela,Ghabri, Yosra,Guesmi, Khaled
The current global COVID-19 pandemic is adversely affecting the oil market (West Texas Intermediate) and crypto-assets markets. This paper empirically investigates the extent to which interdependence in markets may be driven by COVID-19 effects. We fit copulas to pairs of before and after returns, analyze the observed changes in the dependence structure, and discuss asymmetries on the propagation of crisis. We also use the findings to construct portfolios possessing desirable expected behavior. We find that the dependence structure changes significantly after the global pandemic providing valuable information on how COVID- 19 crisis affects inter-dependencies. The results also prove the intrinsic characteristic of the gold as a safe haven.

Did Financial Markets Overreact to COVID-19?
Cheong, Calvin,Ariff, Mohamed,Subramaniam, Niviethan Rao
Prior studies have shown that the COVID-19 pandemic has led to negative returns and increased volatilities in various financial markets. Not many however have sought to investigate why. With anecdotal evidence pointing to investors earning abnormal returns despite the pandemic, this paper sought to determine whether markets â€" for whatever reason â€" were overreacting to the pandemic. Using a sample of the largest 3,000 companies across 15 countries, we found evidence that markets were overreacting to various COVID-19 events. Specifically, we found that markets showed strong signs of reversal in response to negative events (e.g. lockdowns, confirmed cases, deaths). Positive events (e.g. vaccine development, recoveries) did not elicit a similar response. Our results suggest that the volatilities and negative returns during the sample period may be driven by non-COVID factors. This will have profound implications for future COVID-financial markets research and government policy as it redirects attention to individual countries rather than adopting a “global” approach to research or policy-setting.

Effects of COVID-19 Early Release of Pension Funds. The Case of Chile
Lorca, Miguel
Under the COVID-19 pandemic and its unprecedented economic effects, several policymakers worldwide have turned to retirement savings accounts to support individuals in severe financial hardship. Given the haste, the long-term impacts and their distribution across the population have been scarcely analyzed. Using data from the Chilean Social Protection Survey joined with administrative information and Monte Carlo simulations, this paper evidences that an early release of 10% of pension funds with its minimum and maximum amounts results in an average withdrawal of US$ 2.643, equivalent to 22.75% of retirement savings. Thus, each withdrawn dollar causes a 1.76 times loss in future retirement savings, reducing monthly life annuity benefits by 7.35% with a great heterogeneity across current age, gender, and income distribution. Due to this policy, monthly government supplements need to increase by 4.93% for those aged 65 years old and increases with age, to compensate those falls on self-funded benefits. Therefore, measures to mitigate those effects could be considered. Enforcement of labor market regulations to ensure that each worker contributes to the pension system and no evasion of contributions show the biggest impacts. Even when incentives or conditions that delay retirement at least one year are slightly lower, they also have a significant impact.

Generalized distance to a simplex and a new geometrical method for portfolio optimization
Frédéric Butin

Risk aversion plays a significant and central role in investors' decisions in the process of developing a portfolio. In this framework of portfolio optimization we determine the portfolio that possesses the minimal risk by using a new geometrical method. For this purpose, we elaborate an algorithm that enables us to compute any generalized Euclidean distance to a standard simplex. With this new approach, we are able to treat the case of portfolio optimization without short-selling in its entirety, and we also recover in geometrical terms the well-known results on portfolio optimization with allowed short-selling. Then, we apply our results in order to determine which convex combination of the CAC 40 stocks possesses the lowest risk: not only we get a very low risk compared to the index, but we also get a return rate that is almost three times better than the one of the index.

International Trade Finance from the Origins to the Present: Market Structures, Regulation and Governance
Olivier Accominotti,Stefano Ugolini

This chapter presents a history of international trade finance - the oldest domain of international finance - from its emergence in the Middle Ages up to today. We describe how the structure and governance of the global trade finance market changed over time and how trade credit instruments evolved. Trade finance products initially consisted of idiosyncratic assets issued by local merchants and bankers. The financing of international trade then became increasingly centralized and credit instruments were standardized through the diffusion of the local standards of consecutive leading trading centres (Antwerp, Amsterdam, London). This process of market centralization/product standardization culminated in the nineteenth century when London became the global centre for international trade finance and the sterling bill of exchange emerged as the most widely used trade finance instrument. The structure of the trade finance market then evolved considerably following the First World War and disintegrated during the interwar de-globalization and Bretton Woods period. The reconstruction of global trade finance in the post-1970 period gave way to the decentralized market structure that prevails nowadays.

Is segregating anti-vaxxers a good idea?
Matteo Bizzarri,Fabrizio Panebianco,Paolo Pin

We study and SI-type model, with the possibility of vaccination, where the population is partitioned between pro-vaxxers and anti-vaxxers. We show that, during the outbreak of a disease, segregating people that are against vaccination from the rest of the population decreases the speed of recovery and may increase the number of cases. Then, we include endogenous choices based on the tradeoff between the cost of vaccinating and the risk of getting infected. We show that the results remain valid under endogenous choices, unless people are too flexible in determining their identity towards vaccination.

Labor Force Telework Flexibility and Asset Prices: Evidence from the COVID-19 Pandemic
Favilukis, Jack Y,Lin, Xiaoji,Sharifkhani, Ali,Zhao, Xiaofei
We show that labor force telework flexibility (LFTF) is a first-order effect in accounting for the variations of asset prices and firm policies during the COVID-19 pandemic. Specifically, firms in high LFTF industries significantly outperform firms in low LFTF industries in stock returns. The positive LFTF-return relation extends to G7 countries and is stronger in countries with more severe pandemic. A decomposition analysis of the LFTF measure shows that the job characteristics associated with the central component of telework, information and communication technologies, are the main driving force of the result. A dynamic neoclassical model of firms operating multiple job tasks together with pandemic shocks captures the positive relationship between labor force flexibility and stock returns. The model mechanism highlights that i) job task flexibility is a key driving force of the cross-industry heterogeneity in firm value fluctuations, and ii) combining labor productivity (supply) and uncertainty shocks is crucial to generate the large drop and persistent recovery in firm value and output.

Mean-variance portfolio selection with tracking error penalization
William Lefebvre,Gregoire Loeper,Huyên Pham

This paper studies a variation of the continuous-time mean-variance portfolio selection where a tracking-error penalization is added to the mean-variance criterion. The tracking error term penalizes the distance between the allocation controls and a reference portfolio with same wealth and fixed weights. Such consideration is motivated as follows: (i) On the one hand, it is a way to robustify the mean-variance allocation in case of misspecified parameters, by "fitting" it to a reference portfolio that can be agnostic to market parameters; (ii) On the other hand, it is a procedure to track a benchmark and improve the Sharpe ratio of the resulting portfolio by considering a mean-variance criterion in the objective function. This problem is formulated as a McKean-Vlasov control problem. We provide explicit solutions for the optimal portfolio strategy and asymptotic expansions of the portfolio strategy and efficient frontier for small values of the tracking error parameter. Finally, we compare the Sharpe ratios obtained by the standard mean-variance allocation and the penalized one for four different reference portfolios: equal-weights, minimum-variance, equal risk contributions and shrinking portfolio. This comparison is done on a simulated misspecified model, and on a backtest performed with historical data. Our results show that in most cases, the penalized portfolio outperforms in terms of Sharpe ratio both the standard mean-variance and the reference portfolio.

Optimal Search and Discovery
Rafael P. Greminger

This paper studies a search problem where a consumer initially is aware of only a few products. To find a good match, the consumer sequentially decides between searching among alternatives he is already aware of and discovering more products. I show that the optimal policy for this search and discovery problem is fully characterized by tractable reservation values. Moreover, I prove that a predetermined index fully specifies the purchase decision of a consumer following the optimal search policy. Finally, a comparison highlights differences to classical random and directed search.

Price and Volatility Spillovers between Global Equity, Gold, and Energy Markets Prior to and during the COVID-19 Pandemic
Elgammal, Mohammed,Ahmed, Walid M.A.,Alshami, Abdullah
This study sets out to provide fresh evidence on the dynamic interrelationships, at both return and volatility levels, between global equity, gold, and energy markets prior to and during the outbreak of the novel coronavirus. We undertake our analysis within a bivariate GARCH(p, q) framework, after orthogonalizing raw returns with respect to a rich set of relevant universal factors. Under the COVID-19 regime, we find bidirectional return spillover effects between equity and gold markets, and unidirectional mean spillovers from energy markets to the equity and gold counterparts. The results also suggest the presence of large reciprocal shock spillovers between equity and both of energy and gold markets, and cross-shock spillovers from energy to gold markets. Most probably driven by the recent oil price collapse, energy markets appear to have a substantial cross-volatility spillover impact on the others. Our results offer implications for policymakers and investors.

Private Equity and COVID-19
Gompers, Paul A.,Kaplan, Steven N.,Mukharlyamov, Vladimir
We survey more than 200 private equity (PE) managers from firms with $1.9 trillion of assets under management (AUM) about their portfolio performance, decision-making and activities during the COVID-19 pandemic. Given that PE managers have significant incentives to maximize value, their actions during the current pandemic should indicate what they perceive as being important for both the preservation and creation of value. PE managers believe that 40% of their portfolio companies are moderately negatively affected and 10% are very negatively affected by the pandemic. The private equity managersâ€"both investment and operating partnersâ€"are actively engaged in the operations, governance, and financing in all of their current portfolio companies. These activities are more intensively pursued in those companies that have been more severely affected by the Covid-19 pandemic. As a result of the pandemic, they expect the performance of their existing funds to decline. They are more pessimistic about that decline than the VCs surveyed in Gompers et al. (2020b). Despite the pandemic, private equity managers are seeking new investments. Relative to the 2012 survey results reported in Gompers, Kaplan, and Mukharlyamov (2016): the PE investors place a greater weight on revenue growth for value creation; they give a larger equity stake to management teams; and, they also appear to target somewhat lower returns.

Robust Asymptotic Growth in Stochastic Portfolio Theory under Long-Only Constraints
David Itkin,Martin Larsson

We consider the problem of maximizing the asymptotic growth rate of an investor under drift uncertainty in the setting of stochastic portfolio theory (SPT). As in the work of Kardaras and Robertson we take as inputs (i) a Markovian volatility matrix $c(x)$ and (ii) an invariant density $p(x)$ for the market weights, but we additionally impose long-only constraints on the investor. Our principal contribution is proving a uniqueness and existence result for the class of concave functionally generated portfolios and developing a finite dimensional approximation, which can be used to numerically find the optimum. In addition to the general results outlined above, we propose the use of a broad class of models for the volatility matrix $c(x)$, which can be calibrated to data and, under which, we obtain explicit formulas of the optimal unconstrained portfolio for any invariant density.

Scenes from a Monopoly: Quickest Detection of Ecological Regimes
Neha Deopa,Daniele Rinaldo

We study the stochastic dynamics of a renewable resource harvested by a monopolist facing a downward sloping demand curve. We introduce a framework where harvesting sequentially affects the resource's potential to regenerate, resulting in an endogenous ecological regime shift. In a multi-period setting, the firm's objective is to find the profit-maximizing harvesting policy while simultaneously detecting in the quickest time possible the change in regime. Encapsulating the idea of environmental surveillance, the use of quickest detection method allows us to easily translate our framework to real-time detection. Solving analytically, we show that a negative regime shift induces an aggressive extraction behaviour due to a combination of faster detection, a sense of urgency, and higher markups. Precautionary behaviour can result due to increasing resource rent. We study the probability of extinction and show the emergence of catastrophe risk which can be both reversible and irreversible.

Semi-closed form prices of barrier options in the Hull-White model
Andrey Itkin,Dmitry Muravey

In this paper we derive semi-closed form prices of barrier (perhaps, time-dependent) options for the Hull-White model, ie., where the underlying follows a time-dependent OU process with a mean-reverting drift. Our approach is similar to that in (Carr and Itkin, 2020) where the method of generalized integral transform is applied to pricing barrier options in the time-dependent OU model, but extends it to an infinite domain (which is an unsolved problem yet). Alternatively, we use the method of heat potentials for solving the same problems. By semi-closed solution we mean that first, we need to solve numerically a linear Volterra equation of the first kind, and then the option price is represented as a one-dimensional integral. Our analysis shows that computationally our method is more efficient than the backward and even forward finite difference methods (if one uses them to solve those problems), while providing better accuracy and stability.

Short dated smile under Rough Volatility: asymptotics and numerics
Peter K. Friz,Paul Gassiat,Paolo Pigato

In [Precise Asymptotics for Robust Stochastic Volatility Models; Ann. Appl. Probab. 2020] we introduce a new methodology to analyze large classes of (classical and rough) stochastic volatility models, with special regard to short-time and small noise formulae for option prices, using the framework [Bayer et al; A regularity structure for rough volatility; Math. Fin. 2020]. We investigate here the fine structure of this expansion in large deviations and moderate deviations regimes, together with consequences for implied volatility. We discuss computational aspects relevant for the practical application of these formulas. We specialize such expansions to prototypical rough volatility examples and discuss numerical evidence.

Simplicial persistence of financial markets: filtering, generative processes and portfolio risk
Jeremy D. Turiel,Paolo Barucca,Tomaso Aste

We introduce simplicial persistence, a measure of time evolution of network motifs in subsequent temporal layers. We observe long memory in the evolution of structures from correlation filtering, with a two regime power law decay in the number of persistent simplicial complexes. Null models of the underlying time series are tested to investigate properties of the generative process and its evolutional constraints. Networks are generated with both TMFG filtering technique and thresholding showing that embedding-based filtering methods (TMFG) are able to identify higher order structures throughout the market sample, where thresholding methods fail. The decay exponents of these long memory processes are used to characterise financial markets based on their stage of development and liquidity. We find that more liquid markets tend to have a slower persistence decay. This is in contrast with the common understanding that developed markets are more random. We find that they are indeed less predictable for what concerns the dynamics of each single variable but they are more predictable for what concerns the collective evolution of the variables. This could imply higher fragility to systemic shocks.

Who Raised from the Abyss? a Comparison between Cryptocurrency and Stock Market Dynamics during the COVID-19 Pandemic
Caferra, Rocco,Vidal-Tomás, David
This research examines the behaviour of cryptocurrencies and stock markets during the COVID-19 pandemic through the wavelet coherence approach and Markov switching autoregressive model. Our results show a financial contagion in March, since both cryptocurrency and stock prices fell steeply. Despite this turn-down, cryptocurrencies promptly rebounded, while stock markets are trapped in the bear phase. In other words, we observe that the price dynamics during the pandemic depends on the type of the market. These findings are relevant for investors since some hedging properties can be found in the cryptocurrency response to such a drastic event.